IN THE UNITED STATES DISTRICT COURT 

FOR THE EASTERN DISTRICT OF PENNSYLVANIA

LLOYD FREED, Individually :

and On Behalf of All Others :

Similarly Situated : CIVIL ACTION

 :

v. : NO. 04-1233

 : (Consolidated)

UNIVERSAL HEALTH SERVICES, :

INC., et al. :

MEMORANDUM

Padova, J. May 3, 2005

Presently before the Court in this putative class action is

Defendants’ Motion to Dismiss the Amended Consolidated Class Action

Complaint. For the reasons that follow, said Motion is granted.

I. BACKGROUND 

This action is brought on behalf of a class of public

investors who purchased the securities of Universal Health

Services, Inc. (“UHS”) during the period from July 21, 2003 through

February 27, 2004 (the “relevant period”). In Count One of the

Amended Consolidated Class Action Complaint (the “Amended

Complaint”), Lloyd Freed (hereafter “Lead Plaintiff”) alleges

violations of Section 10(b) of the Securities Exchange Act of 1934

(“Exchange Act”), as amended by the Private Securities Litigation

Reform Act of 1995 (“PSLRA”), 15 U.S.C. §§ 78j(b), 78t(a), and Rule

10b-5 promulgated thereunder, see 17 C.F.R. § 240.10b-5, against

UHS; Alan B. Miller, Chief Executive Officer of UHS and Chairman of

UHS’s Board of Directors; and Steve G. Filton, Chief Financial

Officer of UHS. In Count Two of the Amended Complaint, Lead

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 1 of 29
2

Plaintiff alleges violations of Section 20(a) of the Exchange Act

against Defendants Miller and Filton (the “individual Defendants”).

The essence of Lead Plaintiff’s federal securities claims is that

Defendants artificially inflated the price of UHS stock by issuing

public statements and filing earnings reports that omitted or

misstated material facts concerning UHS’s rising level of bad

debts, and by using accounting manipulations to materially

overstate UHS’s financial results. (Am. Cons. Comp. ¶¶ 3, 5, 7.)

UHS is a Delaware corporation which owns and operates acute

care hospitals, behavioral health centers, ambulatory surgery

centers and radiation oncology centers throughout North America and

France, and maintains its principal corporate offices in

Pennsylvania. (Id. ¶¶ 13, 31, 37.) UHS hospitals and staff

provide services which include general surgery, internal medicine,

obstetrics, emergency room care, operating room care, radiology,

oncology, diagnostic care, coronary care, pediatric services,

pharmacy services, and physiotherapy and laboratory procedures.

(Id. ¶ 23.) UHS receives payments for the services it renders from

private-sector insurers, the federal government under the Medicare

program, state governments under their Medicaid programs, and

directly from uninsured patients. (Id.) 

In 2001 and 2002, the overall hospital market sector began to

experience a change in the mix of patients, which led to an

increasing level of uninsured patients. (Id. ¶ 24.) At the same

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 2 of 29
3

time, insured individuals became responsible for an increasing

percentage of healthcare expenditures because the burden of health

care expenses was shifting from employers, private-sector insurers,

and state and federal governments to individuals, while health

insurance premiums, co-pay charges and deductibles were steadily

rising. (Id.) Many hospitals responded to these industry-wide

trends by increasing their levels of bad debt reserves in 2003.

(Id. ¶ 26.) UHS, however, reported that it was not affected by the

changes other hospitals were experiencing, and decreased its level

of bad debt reserves from 11.9% of revenue to 8.5% of revenue.

(Id.) The Amended Complaint alleges that Defendants acted

recklessly in reducing UHS’s levels of bad debt reserves, and that

Defendants kept UHS’s bad debt reserves artificially low by

materially understating the amount of bad debt UHS was

experiencing, thereby overstating UHS’s financial results. (Id. ¶¶

27, 30.) 

A. False and Misleading Statements During the Class Period

According to the Amended Complaint, Defendants’ fraudulent

scheme began with a July 21, 2003 press release over the PR

Newswire, in which UHS announced that its net earnings per share

increased by 19% for the three-month and six-month periods ended

June 30, 2003, over the comparable periods in 2002. (Id. ¶ 31.)

The press release further stated that UHS’s operating margin

“increased to 16.7% in the three-month period ended June 30, 2003

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 3 of 29
4

as compared to 16.0% in the same period of the prior year.” (Id.)

The next day, in response to a question regarding UHS’s bad debt

expenses during a conference call with investors, Defendant Filton

stated that “[w]e actually think that our self-pay utilization as

a percentage of overall utilization is pretty much pancake flat

between 2003 and 2002 and have not seen significant changes.” (Id.

¶ 32.) One month later, on August 13, 2003, UHS filed its

quarterly Form 10-Q report for the three month period ended June

30, 2003. (Id. ¶ 33.) In this report, UHS represented that

operating income and operating margins were important measures of

UHS’s performance. (Id.) The report further stated that

“[o]verall operating margins . . . were 16.7% and 16.0% during the

three month periods ended June 30, 2003 and 2002, respectively.

Operating income increased 15% to $300 million for the six month

period ended June 30, 2003 from $261 million in the comparable

prior year period.” (Id.) 

On October 20, 2003, UHS issued another press release over the

PR Newswire, which stated that “earnings per share . . . for the

three-month period ended September 30, 2003 were $.72, an 11%

increase from the earnings recorded in the third quarter of 2002.”

(Id. ¶ 37.) The next day, during a conference call with investors,

Defendant Filton represented that “[w]e’re not seeing as some of

the other companies have mentioned, a real increase in uninsured or

at least uninsured after insurance patients or a difficulty in

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 4 of 29
5

collecting from those patients.” (Id. ¶ 38.) On November 10,

2003, UHS filed its quarterly Form 10-Q report, which stated that

Operating income increased 11% to $138 million

for the three month period ended September 30,

2003 from $125 million in the comparable prior

year quarter. Overall operating margins were

15.4% and 15.3% during the three month periods

ended September 30, 2003 and 2002,

respectively. The slight increase in the

overall operating margin during the three

month period ended September 30, 2003, as

compared to the comparable prior year period,

resulted from a decrease in the provision for

doubtful accounts to 6.9% of net revenues

during the third quarter of 2003 as compared

to 7.7% in the comparable prior year quarter,

partially offset by an increase in salaries,

wages and benefits to 40.4% of net revenues

during the 2003 third quarter as compared to

39.8% in the comparable prior year quarter.

Contributing to the increase in salaries,

wages and benefits during the third quarter of

2003 as compared to the comparable prior year

quarter was an increase of .4% of net revenues

in employee benefit expenses.

(Id. ¶ 40.) Thereafter, during the 22nd Annual J.P. Morgan

Healthcare Conference held in mid-January 2004, Defendant Miller

stated that UHS’s bad debt ratio had not been increasing at the

same rate as its peers because UHS had not experienced a material

adverse change in self-pay revenues in its markets or in the

collection rates. (Id. ¶ 45.) Defendant Miller further stated

that he expected UHS’s bad debt ratios to remain stable in the near

term. (Id.) 

The Amended Complaint alleges that these statements proved to

have been false because, on February 18, 2004, UHS issued a press

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 5 of 29
6

release over the PR Newswire which stated that 

[t]he Company’s provision for doubtful

accounts was 7.8% of net revenues during the

fourth quarter of 2003 as compared to 6.9%

during the prior year’s fourth quarter. The

increase resulted primarily from an increase

in uninsured and self-pay patients which

unfavorably impacts the collectibility of our

patient accounts. We expect this trend to

continue until there is a notable

strengthening of the labor market.

(Id. ¶ 47.) On March 1, 2004, UHS issued another press release

over the PR Newswire in which it announced that

earnings per diluted share for the three-month

period ending March 31, 2004, could be as much

as 25% lower than the $.84 per diluted share

recorded in the same period in the prior year.

On a same facility basis, the Company’s acute

care hospitals have continued, in the first

two months of 2004, to experience a decline in

inpatient admissions. Moreover, during this

period, certain of the Company’s acute care

facilities have been impacted by a negative

shift in payor mix, a decline in intensity and

an increase in length of stay. In addition,

the rising level of uninsured and self-pay

patients continue to unfavorably impact our

bad debt expense. The Company is vigorously

addressing each of these areas.

(Id. ¶ 49.) In response to this announcement, UHS’s stock dropped

21% to $44.88 per share on volume of 6.7 million shares. (Id. ¶

54). 

B. “True Facts” and Fraudulent Accounting Practices 

The Amended Complaint alleges that, as early as July 23, 2003,

Defendants were aware that UHS’s bad debt exposure was increasing

due to higher levels of uninsured patients and Medicare patients

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 6 of 29
7

who remained hospitalized at UHS facilities beyond the period

reimbursable by Medicaid and Medicare. (Id. ¶ 42(e)-(f).) In

addition, the Amended Complaint avers that UHS’s operating income

was inflated as a result of Defendants failure to (1) make

sufficient allowance for the bad debt it was incurring; (2)

properly write off uncollectible receivables; (3) properly deduct

the appropriate allowance for doubtful accounts from operating

income; and (4) comply with generally accepted accounting

principles (“GAAP”). (Id. ¶ 42(a)-(d).) 

In support of these allegations, the Amended Complaint pleads

the following “true facts.” First, Defendants were aware that

UHS’s levels of bad debt were steadily increasing from July 21,

2003 through February 27, 2004. (Id. ¶¶ 18, 60.) Second,

Defendants admitted that the increase in UHS’s bad debt reserves

for the fourth quarter of 2003 was a “catch up” or “true-up” for

insufficient bad debt reserves during the fiscal year 2003. (Id.

¶¶ 47-56.) Third, the low levels of bad debt UHS had reported were

attributable to fraudulent accounting practices, which concealed

the true amounts of bad debt UHS was encountering. (Id. ¶¶ 5, 34,

42, 51, 61, 66.) 

The Amended Complaint further charges Defendants with

deliberately falsifying UHS’s true levels of bad debt and income by

violating GAAP and Security and Exchange Commission (“SEC”) rules

governing the calculation of uncollectible receivables in its

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 7 of 29
8

financial statements for purposes of inflating UHS’s earnings and

boosting UHS’s stock. (Id. ¶ 66.) Specifically, the Amended

Complaint avers that Defendants improperly delayed the write-off of

uncollectible accounts, intentionally understated UHS’s provision

for doubtful accounts, decreased UHS’s level of bad debt reserves,

and failed to disclose UHS’s policy of accounting for doubtful

accounts. (Id. ¶¶ 68, 73, 76.) These practices allegedly allowed

UHS to materially inflate reported earnings and mislead investors

during the relevant period. (Id. ¶ 73, 80.)

Defendants have moved to dismiss both counts of the Amended

Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) and

9(b), as well as under § 78u-4(b) of the PSLRA.

II. LEGAL STANDARD

When determining a Motion to Dismiss pursuant to Rule

12(b)(6), the court may look only to the facts alleged in the

complaint and its attachments. Jordan v. Fox, Rothschild, O'Brien

& Frankel, 20 F.3d 1250, 1261 (3d Cir. 1994). The court must

accept as true all well pleaded allegations in the complaint and

view them in the light most favorable to the Plaintiff. Angelastro

v. Prudential-Bache Sec., Inc., 764 F.2d 939, 944 (3d Cir. 1985).

A Rule 12(b)(6) motion will be granted when a Plaintiff cannot

prove any set of facts, consistent with the complaint, which would

entitle him or her to relief. Ransom v. Marrazzo, 848 F.2d 398,

401 (3d Cir. 1988). Documents “integral to or explicitly relied

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 8 of 29
9

upon in the complaint” and related matters of public record may be

considered on a motion to dismiss. In re Burlington Coat Factory

Sec. Litig., 114 F.3d 1410, 1426 (3d Cir. 1997).

III. DISCUSSION

A. Count One: Rule 10b-5

Defendants seek the dismissal of Count One of the Amended

Complaint, which asserts a securities fraud claim against UHS and

the individual Defendants pursuant to Section 10(b) and Rule 10b-5.

Section 10(b) prohibits the “use or employ[ment], in connection

with the purchase or sale of any security, . . . of any

manipulative or deceptive device or contrivance in contravention of

such rules and regulations as the Commission may prescribe.” 15

U.S.C. § 78j(b). Rule 10b-5 makes it illegal “[t]o make any untrue

statement of a material fact or to omit to state a material fact

necessary in order to make the statements made, in the light of the

circumstances under which they were made, not misleading . . . in

connection with the purchase or sale of any security.” 17 C.F.R.

§ 240.10b-5(b). To state a Rule 10b-5 claim, a plaintiff must

allege that the defendant (1) made a misstatement or an omission of

a material fact; (2) with scienter; (3) in connection with the

purchase or the sale of a security; (4) upon which the plaintiff

reasonably relied; and (5) that plaintiff’s reliance was the

proximate cause of his or her injury. In re IKON Office Solutions,

Inc., 277 F.3d 658, 666 (3d Cir. 2002). 

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 9 of 29
10

1. Pleading fraud with particularity

Because a claim under Section 10(b) and Rule 10b-5 is a claim

for fraud, a plaintiff must also satisfy the heightened pleading

standard of Federal Rule of Civil Procedure 9(b) and the PSLRA.

Cal. Pub. Employees’ Retirement Sys. v. CHUBB Corp., 394 F.3d 126,

143 (3d Cir. 2004). Rule 9(b) provides that “[i]n all averments of

fraud or mistake, the circumstances constituting fraud or mistake

shall be stated with particularity.” Fed. R. Civ. P. 9(b). “Rule

9(b) requires, at a minimum, that plaintiffs support their

allegations of securities fraud with all of the essential factual

background that would accompany ‘the first paragraph of any

newspaper story’ - that is, the ‘who, what, when, where and how’ of

the events at issue.” In re Rockefeller Center Properties, Inc.

Sec. Litig., 311 F.3d 198, 217 (3d Cir. 2002) (quoting In re

Burlington Coat Factory, 114 F.3d at 1422)). “Although Rule 9(b)

falls short of requiring every material detail of the fraud such as

date, location, and time, plaintiffs must use ‘alternative means of

injecting precision and some measure of substantiation into their

allegations of fraud.’” CHUBB, 394 F.3d at 144 (quoting In re

Rockefeller, 311 F.3d at 216)). The court must analyze each

statement at issue in order to assess whether each alleged

misrepresentation is pleaded with the requisite specificity. In re

Westinghouse Sec. Litig., 90 F.3d 696, 712 (3d Cir. 1996).

In addition, under the PSLRA, a Rule 10b-5 complaint must

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 10 of 29
1 Lead Plaintiff agrees that the Amended Complaint’s “true

facts,” which are based on the investigation of counsel, are pled

on information and belief. (03/09/2004 Tr. at 30.) 

11

“specify each statement alleged to have been misleading, the reason

or reasons why the statement is misleading, and, if an allegation

regarding the statement or omission is made on information and

belief,1 the complaint shall state with particularity all facts on

which that belief is formed.” 15 U.S.C. § 78u-4(b)(1). “[U]nless

plaintiffs in securities fraud actions allege facts supporting

their contentions of fraud with the requisite particularity

mandated by Rule 9(b) and the [PSLRA], they may not benefit from

inferences flowing from vague or unspecific allegations -

inferences that may arguably have been justified under a

traditional Rule 12(b)(6) analysis.” In re Rockefeller, 311 F.3d

at 224. “In other words, pursuant to this ‘modified’ Rule 12(b)(6)

analysis, ‘catch-all’ or ‘blanket’ assertions that do not comply

with the particularity requirements are disregarded.” CHUBB, 394

F.3d at 145.

As mentioned above, Plaintiffs’ 10b-5 claims are based on

allegedly false or misleading statements contained in press

releases issued by UHS, conference calls between financial analysts

and the individual Defendants, and UHS’s quarterly and annual

earnings reports that were filed with the SEC. The subject matter

of the alleged misstatements and misleading information falls into

two general categories: (1) statements that UHS was not

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 11 of 29
12

experiencing an increase in the levels of bad debt during the

relevant period; and (2) Defendants’ use of improper accounting

methods to conceal the rising levels of bad debt and artificially

inflate UHS’s earnings. 

Defendants do not dispute that Lead Plaintiff has identified

Defendants’ allegedly false and misleading statements with

particularity. Defendants instead maintain that Lead Plaintiff has

failed to plead sufficient “true facts” specifying why those

statements were false. Under the heightened pleading standard

imposed by Rule 9(b) and the PSLRA, “it is the ‘true facts’ recited

in the [Amended Complaint] that are of paramount importance . . .

because they provide the exclusive basis for [Lead Plaintiff’s]

claims that the various statements made throughout the [relevant

period] were materially false and misleading . . . and that

Defendants knew of the falsity of the statements and financial

results.” CHUBB, 394 F.3d at 145. 

A complaint can meet these heightened pleading requirements by

providing sufficient documentary evidence and/or a sufficient

description of the personal sources which lead the plaintiff to

believe that certain statements were false or misleading. Id. at

147. Here, Lead Plaintiff has not provided any documentary

evidence to support the Amended Complaint’s allegations of

securities fraud, and instead is proceeding solely on the basis of

information received from confidential sources. (See 03/09/2005

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 12 of 29
13

Tr. at 35.) Lead Plaintiff’s reliance on confidential sources to

supply the requisite particularity for their fraud claims,

therefore, “assumes a heightened importance.” CHUBB, 394 F.3d at

149. 

In assessing the particularity of allegations made on

information and belief which are based on statements by

confidential sources, courts examine “the detail provided by the

confidential sources, the sources’ basis of knowledge, the

reliability of the sources, the corroborative nature of other facts

alleged, including from other sources, the coherence and

plausibility of the allegations, and similar indicia.” Id. at 147.

Under this standard, “so long as plaintiffs supply sufficient facts

to support their allegations, there is no reason to inflict the

obligation of naming confidential sources.” Id. However, a

complaint must contain sufficient information about each source “to

support the probability that the source possesses the information

alleged.” Id. at 155. Accordingly, complaints that rely heavily

on confidential sources to establish the “true facts” must contain

information describing the time period during which the

confidential sources were employed by the defendant corporation,

the dates on which they acquired the information they purportedly

possess, and the manner in which they had access to such

information. Id. at 148. 

Lead Plaintiff contends that Defendants were reckless in

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 13 of 29
14

reducing UHS’s bad debt reserves during the relevant period, and

that Defendants’ statements regarding UHS’s consistently low levels

of bad debt were false and misleading, because Defendants at the

time were aware that UHS’s was in fact experiencing an increase in

its levels of bad debt. In support of this contention, the Amended

Complaint cites to “a former UHS employee from the business office

of LCH [Lancaster County Hospital]” who stated that when the area’s

county hospital closed in the fall of 2002, LCH “immediately began

experiencing an influx of indigent patients seeking treatment

through the emergency room.” (Am. Cons. Compl. ¶ 30.) The Amended

Consolidate Complaint further alleges that the Edinburg Regional

Medical Center (“ERMC”) served as the county hospital before being

purchased by UHS, and that “[a] former ERMC director explained that

ERMC inherited the large indigent patient population from the date

of purchase.” (Id.) 

In addition, the Amended Complaint avers that UHS hospitals

had begun to experience increased numbers of self-pay patients as

early as April 2003, because ERMC at that time “internally recorded

that bad debt was a concern.” (Id. at 39.) The Amended Complaint

does not mention the source from which Lead Plaintiff’s counsel

received this information. The Amended Complaint does allege,

however, that “a former ERMC director confirmed that UHS management

had been focusing on the length of stay issued [sic] at the ERMC

facility from the beginning of 2003, if not earlier.” (Id. ¶ 52.)

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 14 of 29
15

That former director further explained that “the length of stay

issue . . . was related to the indigent patient population who had

no coverage, and likely no ability to pay, from the point of

initial service.” (Id.) 

Both the EMRC and LCH sources were employed in two local UHS

hospitals, and none of them claim to have information regarding a

nationwide increase in the treatment of indigent patients or rising

levels of bad debt at UHS facilities in general. Moreover, the

Amended Complaint does not allege when the confidential sources

were employed by UHS, the dates on which they acquired the

information they purportedly possess, or how these former employees

had access to such information. See CHUBB, 394 F.3d 148. The

Amended Complaint, therefore, pleads insufficient facts to support

the probability that a person in the position occupied by the

confidential sources would possess the information that UHS was

experiencing an increase in levels of bad debt during the relevant

period.

Lead Plaintiff also contends that Defendants acted recklessly

when, in face of UHS’s alleged rising exposure to bad debt,

Defendants failed to increase UHS’s bad debt reserves. In support

of the contention that Defendants were aware of UHS’s rising

exposure to bad debt, the Amended Complaint cites to “former UHS

personnel employed in the business office of [LCH],” who state that

UHS “corporate procedure, unbeknownst to investors, dictated that

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 15 of 29
16

no accounts less than 180 days old were to be considered bad debt

even if an account was known or anticipated to be uncollectible

from the date service was provided.” (Am. Cons. Compl. ¶ 28.)

Similarly, a “former business office employee at LCH” stated that

“UHS’s practice was to bill Medicare and Medicaid for all services

rendered and recognize all revenue at the time of service even if

it was known or anticipated that a large portion of those claims

would be denied.” (Id. ¶ 29) (emphasis deleted). 

The Amended Complaint further cites “[f]ormer employees from

numerous hospitals” for the proposition that all LCH revenue “was

sent to UHS’s corporate office in electronic format approximately

three to four times per day” and that “bi-weekly and monthly

reports tracking accounts receivable and bad debt were provided to

the appropriate executives at UHS’s corporate headquarters.” (Am.

Cons. Compl. ¶ 50.) The Amended Complaint goes on to state that 

former UHS personnel from the office of the

controller at Summerlin Hospital Medical

Center [] confirmed that each UHS Las Vegas

area hospital submitted its financial

information, including uncollectible

receivable account amounts, to Valley Health

Systems, a centralized business office

responsible for billing patients, collecting

receivables and writing off receivables that

were not collected. Valley Health Systems

consolidated the financial information from

the hospitals and forwarded it to UHS’s

corporate accounting department at least on a

monthly basis.

(Id.) In addition, the Amended Complaint avers that 

[a] former director of the Midwest Center for

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 16 of 29
17

Youths and Family Services (“SMCH”) stated

there are ‘no surprises or sudden changes’

when it comes to bad debt levels as it is

known at the point of service whether a

patient is uninsured, and because any

indicators for potential bad debt problems

would appear in reports submitted to UHS

corporate offices for monthly management

meetings.

(Id.) 

Notably, though all of these sources were employed in local

UHS hospitals, the Amended Complaint fails to allege how they would

have had access to information regarding UHS’s operations

nationwide. Where a complaint relies heavily on former employees

who worked in the defendant corporation’s local branches for

information concerning the defendant corporation’s business on a

national scale, a “lack of allegations regarding how or why such

employees would have access to the information they purport to

possess is problematic.” CHUBB, 394 F.3d at 148. The Amended

Complaint also fails to allege at what time the confidential

sources were employed by UHS, or the dates on which they acquired

the information they purportedly possess. See id. The Amended

Complaint, therefore, pleads insufficient facts to support the

probability that a person in the position occupied by the

confidential sources would possess information regarding UHS’s

nationwide operating procedures. Accordingly, the Court finds that

the Amended Complaint fails to plead the falsity of Defendants’

statements during the relevant period with the particularity

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 17 of 29
2 Financial results reported in violation of GAAP are

presumptively misleading. See 17 C.F.R. § 210.4-01(a)(1); CHUBB,

394 F.3d at 152 n.16.

3 Specifically, the Amended Complaint alleges that Defendants

violated the following GAAP principles: (1) financial reporting

should provide information that is useful to present and potential

investors in making rational investment decisions; (2) omissions or

misstatements are material if the judgment of a reasonable person

relying on it would have been changed or influenced by the

inclusion or correction of the item; (3) financial reporting should

provide information about management’s discharge of its stewardship

responsibility to stockholders; (4) financial reporting should

provide information about an enterprise’s financial performance

during a period; (5) financial reporting should be reliable in that

it represents what it purports to represent; (6) no information

that may be necessary to ensure that the report validly represents

underlying events and conditions should be omitted; (7)

conservatism should be used as a prudent reaction to uncertainty;

and (8) contingencies that might result in gains should not be

reflected in accounts.

18

demanded by the PSLRA. 

Lead Plaintiff further contends that Defendants committed

accounting fraud when, in violation of the GAAP and SEC reporting

requirements, Defendants falsely inflated UHS’s earnings and assets

as well as stockholders’ equity earnings by failing to establish

and maintain adequate bad debt reserves during the relevant

period.2 The Amended Complaint alleges that Defendants, in

violation of the GAAP, delayed the recognition and write-off of

uncollectible accounts, understated its provision for bad debt, and

failed to restate UHS’s previously misstated financial statements.3

In support of these contentions, the only “true fact” the Amended

Complaint alleges is that “former UHS employees stated that during

the [relevant period], the Company mandated that no accounts less

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 18 of 29
19

than 180 day [sic] delinquent be written off.” (Am. Cons. Compl.

¶ 70.) 

As above, the Amended Complaint does not allege sufficient

facts to support the probability that the confidential sources

would possess the information they purport to possess. Indeed, the

relevant confidential sources are identified only as “former UHS

employees.” In addition, the Amended Complaint does not rely on

any sources, confidential or otherwise, to substantiate its

allegations that UHS understated its provision for bad debt and

would have been required to restate its earlier financial

statements. The Court further notes that, where a complaint

alleges that defendants distorted certain data disclosed to the

public by using unreasonable accounting practices, the complaint

must state what the unreasonable accounting practices were and how

those practices distorted the disclosed data. In re Burlington,

114 F.3d at 1417-18. Statements of reserve amounts are “fraudulent

only if . . . the responsible parties knew or should have known

that [the amounts of reserve] were derived in a manner inconsistent

with reasonable accounting practices.” Christidis v. Pa. Mortgage

Trust, 717 F.2d 96, 100 (3d Cir. 1983). Accordingly, a complaint

must plead with particularity “the manner in which, in establishing

reserves for bad debts in the financial statements relied upon, the

defendants knowingly departed from reasonable accounting

practices.” Id. To do so, the complaint must “include details

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 19 of 29
20

about when and to what level the accounts receivable should have

been written down, when and to what level the allowance should have

been changed, why the allowance made by the corporation was

unreasonable in light of the [bad debt] experienced, and how many

accounts ultimately were uncollectible.” In re Loewen Group, Inc.

Sec. Litig., Civ. A. No. 98-640, 2004 WL 1853137, at *11 (E.D. Pa.

Aug. 18, 2004). In the absence of such allegations, “neither the

increase of allowance toward the end of the class period nor the

eventual financial ruin of [the defendant corporation] are proof

that defendants committed any acts worse than mismanagement.” Id.

at *12. 

Here, the Amended Complaint does identify with sufficient

particularity which GAAP procedures were allegedly violated.

However, the Amended Complaint does not state when and to what

level bad debt should have been recognized, when and to what level

bad debt reserves should have been changed, or how many accounts

ultimately were uncollectible. See id. Similarly, the Amended

Complaint does not identify the data, or source of data, that was

used to arrive at its conclusions, the amount by which reserves

were distorted, or how much revenue was improperly recognized. See

CHUBB, 394 F.3d at 153. Accordingly, the Court finds that the

Amended Complaint fails to plead facts which would support the

inference that Defendants were engaging in accounting fraud with

the particularity demanded by the PSLRA. 

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 20 of 29
21

2. Failure to State a Claim: Falsity of Statements

The Amended Complaint’s failure to plead the “true facts” with

the particularity required by Rule 9(b) and the PSLRA supports

dismissal apart from Rule 12(b)(6). CHUBB, 394 F.3d at 156.

Dismissal, however is also warranted pursuant to Rule 12(b)(6) for

failure to adequately plead the falsity of Defendants statements.

As the Amended Complaint does not comply with the PSLRA’s threshold

pleading requirements, Lead Plaintiff may not benefit from

inferences stemming from the unparticularized allegations mentioned

above to establish the falsity of Defendants’ statements during the

Class Period. However, even if those allegations were accepted,

they would not give rise to an inference that UHS was experiencing

an increase in bad debt during the relevant period. Thus, the

information provided by the LCH source does not establish that LCH

was experiencing a rising exposure to bad debt beginning in July

2003, but merely that the closing of the county hospital one year

earlier, in the fall of 2002, “immediately” caused LCH to see an

influx of indigent patients. Similarly, the information provided

by the EMRC source does not establish that EMRC experienced an

increase in levels of indigent patients during the relevant period,

or that UHS acquired EMRC, and therefore inherited its unusually

high existing levels of bad debt, during that time. Moreover, the

mere fact that EMRC “internally” recorded that bad debt was “a

concern” at its facility, and that UHS “focused” on the length of

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 21 of 29
4 The Court notes that the Amended Complaint also alleges that

general industry trends showed an increase in levels of bad debt

throughout the hospital sector during the relevant period.

However, Lead Plaintiff has stated that those industry trends are

not relied on to establish the falsity of Defendants’ statements,

but rather were included merely as “a background for . . . the

entire situation.” (03/09/05 Tr. at 29.) The Court agrees that

the fact that UHS’s competitors were experiencing an increase in

bad debt is not relevant to a determination whether Defendants’

statements that UHS’s levels of bad debt during the relevant period

remained comparatively stable were false.

22

patient stays at EMRC in early 2003, does not establish that either

EMRC, or UHS as a whole, were in fact experiencing an increase in

exposure to bad debt during the relevant period. Indeed, the

Amended Complaint itself broadly asserts that “former employees of

various UHS hospitals . . . . report that issues such as length of

stay and increase in the numbers of self-pay patients were either

non-existent, or had been recognized and discussed well before the

[relevant period].” (Am. Cons. Compl. ¶ 52.) The confidential

sources, therefore, fail to establish that UHS was in fact

experiencing an increase in levels of bad debt during the relevant

period, much less that Defendants were aware of any such increase.

The only other source the Amended Complaint relies on for the

falsity of Defendant’s representations are statements made by

Defendants’ themselves and which, according to Lead Plaintiff,

amount to admissions that Defendant’s earlier statements were

false.4 In support of this argument, the Amended Complaint points

to the following statements. First, in a press release issued by

UHS over the PR Newswire on February 18, 2004, UHS reported that

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 22 of 29
23

its provision for doubtful accounts for the fourth quarter of 2003

was 7.8% of net revenues, as compared to 6.9% during the prior

year’s fourth quarter. (Am. Cons. Compl. ¶ 47.) The press release

went on to state that UHS “expect[s] this trend to continue until

there is a notable strengthening of the labor market.” (Id.)

Second, in a press release issued by UHS over the PR Newswire on

March 1, 2004, UHS reported that its earnings per diluted share for

the three-month period ending March 31, 2004, could be as much as

25% lower than the earnings per diluted share recorded in the same

period in the prior year. (Id. ¶ 49.) UHS explained this

development as follows: 

On a same facility basis, the Company’s acute

care hospitals have continued, in the first

two months of 2004, to experience a decline in

inpatient admissions. Moreover, during this

period, certain of the Company’s acute care

facilities have been impacted by a negative

shift in payor mix, a decline in intensity and

an increase in length of stay. In addition,

the rising level of uninsured and self-pay

patients continues to unfavorably impact our

bad debt expense.

(Id.) 

Third, the Amended Complaint cites to the transcript of a

conference call between the individual Defendants and analysts held

on March 1, 2004. During that conference call, Filton stated that

“[b]ad debt expense remains a pressure point in our hospital” and

that “for the most part the general admission softness and pressure

on bad debt are dynamics that have been present now for several

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 23 of 29
24

quarters and for the most part, again, we see across all of our

facilities.” (Id. ¶ 51.) In response to one analyst’s question

concerning whether there was any catch-up charge in UHS’s bad debt

numbers, Filton further stated that “the fourth quarter probably

contained some intra or catch-up in 2004 . . . . Look, I am sure

if we went through the detail we would find some element of catchup in the first quarter of ‘04. I do not think it is material.”

(Id. ¶ 53; 03/01/04 Conf. Tr., Defs.’ Ex. 20.) 

While Lead Plaintiff contends that these statements are

admissions which demonstrate the falsity of Defendants’ earlier

representations, the statements in fact are entirely consistent

with Defendants’ prior disclosures. Indeed, the fact that pressure

on bad debt had been present for several quarters in March 2004 is

mirrored by UHS’s steady increase in bad debt reserves during the

relevant period from 6.83% of net revenues on June 30, 2003, to

8.42% of net revenues on March 31, 2004. (See Am. Cons. Compl. ¶

66.) Moreover, Filton’s statements that the level of bad debt

reserves in the fourth quarter of 2004 probably contained an

immaterial element of catch-up does not amount to an admission that

the statements made by Defendants during the relevant period were

false. Courts have long recognized that “fraud cannot be inferred

merely because at one time the firm bathes itself in a favorable

light but later the firm discloses that things are less than rosy.”

CHUBB, 394 F.3d at 158 (internal quotations omitted). The Court,

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 24 of 29
5 Because the Court concludes that the Amended Complaint does

not plead the “true facts” with sufficient particularity under the

PSLRA and does not establish that Defendants’ representations

during the relevant period were false, the Court does not reach the

question whether the Amended Complaint properly attributes the

allegedly misleading statements to the Defendants, or adequately

pleads the elements of scienter, materiality, and loss causation.

6 While Lead Plaintiff will also have to prove at trial that

the individual Defendants were each “culpable participants” in the

underlying fraud, Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 889-

90 (3d Cir. 1975), “the ‘overwhelming trend in this circuit’ is

that culpable participation does not have to be plead to survive a

25

therefore, concludes that even if the information provided by the

confidential sources is taken into account, the Amended Complaint

fails to establish the falsity of Defendants’ statements during the

relevant period. Accordingly, Defendants’ Motion to Dismiss Count

One of the Amended Complaint is granted.5

C. Section 20(a) of the Exchange Act

Defendants also move to dismiss Count Two of the Amended

Complaint, which alleges that the individual Defendants violated

Section 20(a) of the Exchange Act. Section 20(a) imposes joint and

several liability on any person who “directly or indirectly

controls any person liable” under any provision of the Exchange

Act, “unless the controlling person acted in good faith and did not

directly or indirectly induce the act or acts constituting the

violation or cause of action.” 15 U.S.C. §78t(a). Plaintiffs

alleging a Section 20(a) violation must plead facts showing (1) an

underlying violation by the company; and (2) circumstances

establishing the defendant’s control over the company’s actions.6

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 25 of 29
motion to dismiss.” Jones v. Intelli-Check, Inc., 274 F. Supp. 2d

615, 645 (D.N.J. 2003) (quoting Derensis v. Coopers & Lybrand

Chartered Accountants, 930 F. Supp. 1003, 1013 (D.N.J. 1996)). 

26

La Fata v. Raytheon Co., 207 F.R.D. 35, 45 n.5 (E.D. Pa. 2002).

The heightened pleading requirements of Rule 9(b) do not apply to

Section 20(a) claims. In re U.S. Interactive, Inc. Sec. Litig.,

Civ. A. No. 01-522, 2002 WL 1971252, at *20 (E.D. Pa. Aug. 23,

2002) (citing In re Tel-Save Sec. Litig., Civ. A. No. 98-3145, 1999

WL 999427, at *6 (E.D. Pa. Oct. 19, 1999)); see also In re Enron

Corp. Sec., Derivative & ERISA Litig., Nos. MDL-1446, Civ. A. No.

H-01-3624, 2003 WL 230688, at *11 (S.D. Tex. Jan. 28, 2003)

(concluding that Rule 8 notice pleading standard applies to Section

20(a) claims because “the legislative history behind the

controlling person provision of both the 1933 and 1934 Acts

indicates that Congress sought to reach persons who tried to evade

responsibility under the common law of agency by standing behind

the scenes and having ‘dummies’ under their control commit the

primary violations” and “without discovery, it would be extremely

difficult to know facts where the controlling person was hiding

behind the controlled person”). Here, the Amended Complaint fails

to establish an underlying violation by UHS. La Fata, 207 F.R.D.

at 45 n.5. Accordingly, Defendants’ Motion to Dismiss Count Two of

the Amended Complaint is granted.

D. Leave to Amend

Lead Plaintiff has requested that, should the Court grant any

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 26 of 29
7 Pursuant to Rule 11(b) an attorney who presents a pleading

to the court certifies that to the best of his or her knowledge,

information, and belief, formed after an inquiry reasonable under

the circumstances, “the allegations and other factual contentions

have evidentiary support or, if specifically so identified, are

likely to have evidentiary support after a reasonable opportunity

for further investigation or discovery.” Fed. R. Civ. P. 11(b)(3).

27

part of Defendants’ Motion, the Court also grant Lead Plaintiff

leave to amend the Amended Complaint. By adopting the PSLRA,

Congress has evinced its intent to “provid[e] a filter at the

earliest stage (the pleading stage) to screen out lawsuits that

have no factual basis.” GSC Partners CDO Fund v. Washington, 368

F.3d 228, 246 (3d Cir. 2004) (quotations omitted). However,

“ordinarily, leave to amend is granted when a complaint is

dismissed on Rule 9(b) particularity grounds alone.” CHUBB, 394

F.3d at 165. Here, the Amended Complaint is dismissed not only for

failure to comply the particularity requirements imposed by Rule

9(b) and the PSLRA, but also for failure to state a claim pursuant

to Rule 12(b)(6). Nonetheless, the Court notes that the Amended

Complaint could have been dismissed on particularity grounds alone,

the Court was not previously called upon to rule on a motion to

dismiss in this action, and Lead Plaintiff’s investigation is

ongoing. Accordingly, the Court will permit Lead Plaintiff to move

for leave to file a Second Amended Consolidated Complaint which, in

compliance with Rule 11(b)7, corrects the Amended Complaint’s Rule

9(b), PSLRA and Rule 12(b)(6) pleading deficiencies. 

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 27 of 29
28

III. CONCLUSION

For the foregoing reasons, the Court grants Defendants’ Motion

to Dismiss the Amended Complaint and permits Lead Plaintiff to move

for leave to file a Second Amended Consolidated Complaint. 

An appropriate Order follows. 

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 28 of 29
 IN THE UNITED STATES DISTRICT COURT 

FOR THE EASTERN DISTRICT OF PENNSYLVANIA

LLOYD FREED, Individually :

and On Behalf of All Others :

Similarly Situated : CIVIL ACTION

 :

v. : NO. 04-1233

 : (Consolidated)

UNIVERSAL HEALTH SERVICES, :

INC., et al. :

O R D E R

AND NOW, this 3rd day of May, 2005, upon consideration of

Defendants’ Motion to Dismiss the Amended Consolidated Class Action

Complaint (Doc. No. 29), all submissions received in response

thereto, and the argument held on March 9, 2005, IT IS HEREBY

ORDERED that said Motion is GRANTED and the Amended Consolidated

Complaint is DISMISSED in its entirety. IT IS FURTHER ORDERED that

Lead Plaintiff may move for leave to file a Second Amended

Consolidated Complaint within thirty (30) days of the date of this

Order. 

BY THE COURT:

/s/ John R. Padova

 

 John R. Padova, J.

Case 2:04-cv-01233-JP Document 40 Filed 05/03/05 Page 29 of 29