Pomerantz Achieves $18 Million Settlement in Quorum Health Litigation

POMERANTZ MONITOR | SEPTEMBER OCTOBER 2020

By Michael J. Wernke

In a significant victory for investors, Pomerantz, as counsel for the class, achieved an $18 million settlement in a securities fraud class action against Quorum Health Corporation (“Quorum”) and Community Health Systems, Inc. (“CHS”), as well as certain current and former officers of the two companies. Chief Judge Waverly D. Crenshaw, Jr. in the U.S. District Court of the Middle District of Tennessee granted preliminary approval of the settlement on July 27, 2020 and set the final approval hearing for November 30, 2020.

CHS is one of the nation’s largest operators of hospitals. Quorum, an operator and manager of hospitals, was created when CHS spun off 38 of its hospitals on April 29, 2016 into a new stand-alone company. Pomerantz brought the action on behalf of investors in Quorum that acquired Quorum shares following the spin-off. The complaint alleged that Quorum, CHS and the officers violated Section 10(b) of the Securities Exchange Act as well as Section 20(a), the “control person” provision, by issuing financial statements for Quorum that misrepresented its financial condition.

Specifically, our complaint alleged that the defendants misled investors as to the financial condition and prospects of Quorum as a stand-alone company by overstating Quorum’s goodwill. Goodwill is an intangible asset that arises when one company purchases another for a premium value. The value of a company’s brand name, customer base and good customer relations are examples of goodwill. When a company like CHS purchases hospitals like those that came to make up Quorum, it must record the amount it paid for those hospitals in excess of the fair value of the hospitals’ assets as goodwill, and then must periodically test the goodwill, recording an “impairment” to the goodwill when it is more likely than not that the carrying amount of goodwill exceeds its fair value.

In addition to being required to test the goodwill for impairment annually, a company must also test it whenever “triggering events” suggest that the expected future cash flows of the asset have significantly declined. The complaint alleged that the defendants knowingly inflated Quorum’s goodwill and failed to take a necessary impairment to enable CHS to get rid of its worst performing hospitals at an inflated price. As part of the spin-off, the defendants caused Quorum to take on $1.2 billion in debt, which was immediately paid to CHS as a “special dividend” for the assets of Quorum. As a result of the defendants’ false statements about Quorum’s goodwill, investors that acquired Quorum stock following the spin-off paid an inflated price.

The truth concerning Quorum’s financial condition and prospects was revealed shortly after the spin-off (and after CHS received its $1.2 billion) when, on August 10, 2016, Quorum reported its financial results for the second quarter of 2016, announcing that after only two months of operations as a stand-alone company, it was recording a massive $200 million impairment to goodwill. As a result, Quorum’s stock price plummeted $4.99, or almost 50%, damaging investors.

The settlement was achieved after approximately three years of hard-fought litigation. The defendants moved to dismiss the complaint, which the court denied in April 2018. The court’s opinion was particularly significant because it held that the CHS defendants, in addition to the Quorum defendants, were “makers” of the false statements of goodwill in Quorum’s initial financial statements even though the SEC filings were filed on behalf of only Quorum. Normally, only the company and its officers whose stock the class purchased are liable for false statements under the federal securities laws. Here, that would be Quorum and its officers. However, the court accepted Pomerantz’s argument that CHS and its officers should also be liable for the false statements because Quorum was part of CHS prior to the spin-off and all of Quorum’s financials in the spin-off documents were calculated by CHS employees prior to the spinoff.

In April 2019, Pomerantz secured class certification on behalf of investors and also successfully opposed the defendants’ petition to the Court of Appeals for the Sixth Circuit to reverse the class certification.

Discovery was wide-ranging. It involved analyzing over five hundred thousand pages of documents concerning highly complex issues of finance and accounting. Approximately thirty depositions were conducted (several of which spanned two days) and the parties exchanged reports by seven experts on issues concerning accounting standards, asset valuation and stock price movement.

In early 2020, defendants filed a motion for summary judgment, which Pomerantz opposed. In support of our briefing, we submitted to the court hundreds of documents that were uncovered during discovery, which we argued revealed that, despite their knowledge of Quorum’s poor financial prospects as a stand-alone company, defendants drastically inflated the cash flow model used to secure the financing for the spin-off, utilizing what one employee referred to as “borderline absurd” assumptions for revenue and earnings growth. Documents and testimony revealed that defendants used the same inflated cash flow model to test Quorum’s goodwill for impairment, thereby concealing the existence of the impairment. We also submitted documents uncovered in discovery that we argued demonstrated that days before the spin-off, as defendants were preparing to report the Quorum hospitals’ first quarter 2016 results, defendants manipulated certain expenses in order to inflate Quorum’s financial results and further conceal the company’s dire prospects.

On April 7, 2020, Quorum finally succumbed to debts and filed for Chapter 11 bankruptcy. While the action was automatically stayed as to Quorum pursuant to the Bankruptcy Code, Chief Judge Crenshaw ruled that the class action would continue as to CHS and the officer defendants.

The parties were in the final preparations for the July 10, 2020 trial when Chief Judge Crenshaw held a conference on May 29, 2020, during which he informed the parties that he would be denying defendants’ motion for summary judgment. Defendants agreed to settle the action a few days later.

Pomerantz’s perseverance resulted in a recovery that provides the class of investors with as much as 43% of recoverable damages—an excellent result when compared to historical statistics in class action settlements.