IN THE UNITED STATES DISTRICT COURT

FOR THE EASTERN DISTRICT OF PENNSYLVANIA

CLIFFORD C. MARSDEN and MING XU, : CIVIL ACTION

Individually and on Behalf of All :

Others Similarly Situated, : 04-4020

:

Plaintiffs, :

:

v. : 

:

SELECT MEDICAL CORP., MARTIN :

JACKSON, ROBERT A. ORTENZIO, :

ROCCO ORTENZIO, and PATRICIA RICE, :

:

Defendants. :

MEMORANDUM AND ORDER

Joyner, J. February , 2007

Presently before the Court is Defendants’ Motion for

Certification of Interlocutory Appeal Pursuant to 28 U.S.C. §

1292(b) (Doc. No. 44), Plaintiffs’ Opposition (Doc. No. 51) and

Defendants’ reply (Doc. No. 54) thereto. After considering the

parties’ submissions, the Court concludes that its earlier

analysis of loss causation under Dura Pharmaceuticals, Inc. v.

Broudo, 544 U.S. 336 (2005), was erroneous with respect to

Plaintiffs’ theory of liability for securities fraud based on

Defendants’ allegedly improper revenue practices. For the

reasons below, the Court now holds that Plaintiffs have failed to

allege the necessary loss causation to advance this theory of

liability. The Court therefore VACATES in PART its previous

decision, GRANTS Defendants’ Motion to Dismiss Plaintiffs’

security fraud claims premised on alleged improper revenue

practices, and DENIES as MOOT Defendants’ Motion.

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 1 of 17
1 The Court assumes the reader’s familiarity with the

underlying facts and allegations. For a detailed summary of the

factual allegations in this case, see this Court’s earlier

opinion, Marsden v. Select Medical Corp., 04-4020, 2006 U.S.

Dist. LEXIS 1675 (E.D. Pa. Apr. 6, 2006).

2 Under the Eastern District of Pennsylvania’s local rules,

a party must file a motion for reconsideration “within ten (10)

days of entry of the judgment, order, or decree concerned.” Loc.

R. Civ. P. 14(g).

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Discussion1

I. The Court may reconsider its April 6, 2006 decision sua

sponte.

Defendants did not file a motion for reconsideration,2 but

“so long as [this Court] has jurisdiction over [a] case, it

possesses inherent power over interlocutory orders, and can

reconsider them when it is consonant with justice to do so.”

United States v. Jerry, 487 F.2d 600, 605 (3d Cir. 1977). This

Court’s April 6, 2006 decision denying in part Defendants’ motion

to dismiss is an interlocutory order. See, e.g., Cabirac v.

Commissioner of Internal Revenue, 02-8057, 2003 U.S. Dist. LEXIS

14588, at *1 (E.D. Pa. June 23, 2003). And it is surely the case

that rectifying a clear error of law is “consonant with justice.”

After all, were this a formal motion for reconsideration, the

Court could grant it (among other reasons) “to correct a clear

error of law or to prevent manifest injustice.” General

Instrument Corp. of Delaware v. Nu-Tek Elecs. & Mfg., Inc., 3 F.

Supp. 2d 602, 606 (E.D. Pa. 1998), aff'd., 197 F.3d 83 (3d Cir.

1999); see also Jilin Pharm. USA, Inc. v. Chertoff, 447 F.3d 196,

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 2 of 17
3 Because the parties have thoroughly briefed the issue of

loss causation both for this motion and the earlier motion to

dismiss, the Court did not request any further briefing on the

issue. It therefore views its decision to reconsider the loss

causation issue sua sponte without further briefing as being

unfair to neither party.

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199 (3d Cir. 2006) (citing Harsco Corp. v. Zlotnicki, 779 F.2d

906, 909 (3d Cir. 1985)). Moreover, as this Court’s April 6,

2006 Memorandum Opinion and Order did not dispose of every claim,

it is "subject to revision at any time before the entry of

judgment adjudicating all the claims and the rights and

liabilities of the parties." Fed. R. Civ. P. 54(d); see also

Mohammad v. Kelchner, 03-1134, 2005 U.S. Dist. LEXIS 40762, at *6

(W.D. Pa. Apr. 27, 2005). It is therefore clearly proper for the

Court to reconsider its earlier decision sua sponte.

3

II. Plaintiffs do not adequately plead loss causation under Dura

Pharmaceuticals with respect to their theory of liability

premised on improper revenue practices.

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

proscribes (1) the “use or employ[ment]” of any “deceptive

device,” (2) “in connection with the purchase or sale of any

security,” and (3) “in contravention of Securities and Exchange

Commission rules and regulations.” 15 U.S.C. § 78j(b). Under this

statute, the SEC promulgated Rule 10b-5, which forbids the making

of any “untrue statement or material fact” or the omission of any

material fact “necessary in order to make the statements made . .

. not misleading.” 17 C.F.R. § 240.10b-5(b). The statute and

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 3 of 17
4 The basic elements of a federal securities fraud claim

involving purchases or sales of securities publically traded

securities are: (1) a material misrepresentation (or omission);

(2) scienter, i.e., a wrongful state of mind; (3) a connection

with the purchase or sale of a security; (4) reliance, often

referred to in cases involving public securities markets

(fraud-on-the-market cases) as "transaction causation;” (5)

economic loss; and (6) “loss causation," i.e., a causal

connection between the material misrepresentation and the loss.

See, e.g., Dura, 544 U.S. at 340.

5 The heightened pleading requirements also require a

plaintiff to “specify each statement alleged to have been

misleading [and] the reason or reasons why statement is

misleading [and allege] facts giving rise to a strong inference

that the defendant acted with the required state of mind.” 15

U.S.C. § 78u-4(b)(1) – (2). Not to be forgotten, of course, is

the basic requirement under Rule 9(b) of the Federal Rules of

Civil Procedure that “all averments of fraud . . . shall be

stated with particularity.”

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rule together permit individuals to bring private damages actions

that resemble common law tort actions for deceit and

misrepresentation. See, e.g., Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. 723, 730 (1975). And so the elements of 10b-5

claim are well-established.4 But unlike its common law

predecessors, federal private securities actions are subject to

the heightened pleading requirements of the Private Securities

Litigation Reform Act of 1995 (“PSLRA”). At issue here is the

requirement that private plaintiffs must prove loss causation

under Section 78u-4(b)(4) of PSLRA.5 In relevant part, it

provides:

Loss Causation. In any private action

arising under this chapter, the plaintiff

shall have the burden of providing that the

acts or omissions of the defendant alleged to

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 4 of 17
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violate this chapter caused the loss for

which the plaintiff seeks to recover damages.

15 U.S.C. § 78u-4(b)(4). A plaintiff therefore shows loss

causation by alleging and ultimately proving that the defendant’s

fraud caused her to suffer actual economic loss. See, e.g.,

Emergent Capital Inv. Mgmt. LLC v. Stonepath Group, Inc., 343

F.3d 189, 198-99 (2d Cir. 2003).

In Dura Pharmaceuticals, the Supreme Court resolved a

circuit split by unanimously holding that a securities plaintiff

does not plead loss causation by merely alleging (and later

establishing) that the price of the security on the date of the

purchase was inflated because of the defendant’s

misrepresentation(s). See 544 U.S. at 342. Justice Breyer’s

opinion began by observing that at the moment the initial

transaction takes place, a plaintiff has suffered no loss because

“as a matter of pure logic . . . the inflated purchase payment is

offset by ownership of a share that at that instant possesses

equivalent value.” Id. And if a purchaser were to sell these

shares “before the relevant truth [about the seller’s

misrepresentation]. . . leaks out,” that misrepresentation will

not have caused any loss. Id (emphasis added). Indeed, it is

only after “the truth makes its way into the market place [that]

an initially inflated purchase price might mean a later loss.” Id

(emphasis in original). In other words, to successfully plead

loss causation requires a plaintiff to allege that the stock

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 5 of 17
6 In the Court’s previous opinion, it opined that loss

causation requires the value of the shares must drop

“significantly” after the truth became known. See Marsden, 2006

U.S. Dist. LEXIS 16795, at *39. The Court acknowledges that this

language tracks that used by the Supreme Court in Dura. See 544

U.S. at 347. (“The complaint’s failure to claim that Dura’s share

price fell significantly after the truth became known suggests

that the plaintiffs considered the allegation of purchase price

inflation alone sufficient.”). But it believes that this

language – that the drop in stock price be “significant” – is

dicta for at least two reasons. First, the Supreme Court did not

hold that a securities plaintiff fails to plead loss causation,

as a matter of law, by failing to allege that a defendant’s share

price fell by some specified percentage. Second, this language

was ultimately unnecessary to the Supreme Court’s holding because

the Dura plaintiffs attempted to establish loss causation by

simply alleging that they had paid inflated amounts for their

shares. The Supreme Court did not address the issue of what drop

in stock price is sufficient to establish loss causation when the

relevant truth became known to the market.

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price fell after the truth about the misrepresentation was made

known to the market.6 See id.; see also Glaser v. Enzo Biochem,

Inc., 464 F.3d 474, 477 (4th Cir. 2006); D.E. & J Limited

Partnership v. Conaway, 133 Fed. Appx. 994, 1000 (6th Cir. 2005)

(unpublished); Semerenko v. Cendant Corp., 223 F.3d 165, 185 (3d

Cir. 2000) (“Where the value of the security does not actually

decline as a result of an alleged misrepresentation, it cannot be

said that there is in fact an economic loss attributable to that

misrepresentation. In the absence of a correction in the market

price, the cost of the alleged misrepresentation is still

incorporated into the value of the security and may be recovered

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 6 of 17
7 Dura cited approvingly Semerenko’s analysis of loss

causation. See 544 U.S. at 345.

8 The District Court had dismissed the drug-profitability

claim because the plaintiffs did not adequately “allege the

appropriate state of mind, i.e., that the defendants had acted

knowingly, or the like.” Dura, 544 U.S. at 340. The Supreme

Court did not review the correctness of this decision.

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at any time simply by reselling the security at the inflated

price.”).7

In Dura, plaintiffs had alleged two theories of liability:

(1) that Dura (or its officials) made false statements concerning

its drug profits and sales; and (2) that Dura falsely claimed (or

overstated) the company’s prospects of gaining approval from the

Food and Drug Administration (“FDA”) for its new asthmatic spray

device. See Dura, 544 U.S. at 339. It was this second theory of

liability that was before the Supreme Court.8 The Court

concluded that the Dura plaintiffs did not adequately plead loss

causation with respect to the spray device claim because Dura’s

share price fell significantly on news that its earnings would be

lower than expected because of slow drug sales, rather than any

news about the spray device. Id. at 346. Plaintiffs therefore

did not plead loss causation for the spray device claim because

there were no allegations “that Dura’s share price fell

significantly after the truth [that the FDA would not approve the

device] became known.” Id. at 347. Because Dura’s earnings

announcement was silent with respect to the spray device, the

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 7 of 17
9 Plaintiffs allege that Select’s improper patient referral

practices allowed it to artificially (and misleadingly) inflate

revenue figures. See, e.g., Amended Complaint (“Am. Compl.”) at ¶

132. These allegedly improper patient referral practices

included: (1) payment of improper kickbacks for patient

referrals; (2) payment of bribes for premature patient transfers;

and (3) improper patient churning, which would create multiple

reimbursable discharges for the same medical condition. See id.

at ¶ 132 (c), (d), (e). Plaintiffs further allege that these

improper revenue practices continued unabated because Select

failed to institute appropriate internal controls. See, e.g.,

id. at ¶¶ 50, 51, 128, 131. The Court treats the allegations of

improper revenue practices and inadequate controls as

interrelated and not separate theories of liability. But even if

these were separate theories of liability, the Court concludes

that Plaintiffs fail to plead loss causation on either because

the May 10, 2004 Press Release did not reveal any “truths” that

Select maintained either inadequate internal controls or

improperly recognized revenue. See Slip Op., post at 11-14.

10 Plaintiffs contend that Defendants knew or should have

known that the Centers for Medicare and Medicaid Services (“CMS”)

was planning to issue a new rule that could negatively impact

Select’s revenue model by limiting certain types of patient

referrals. See, e.g., Am. Compl. at ¶¶ 132(f), 150(g), 169(g),

176.

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drop in share price could not have been caused because of any

action (or inaction) by the FDA.

Like the Dura plaintiffs, Plaintiffs in this action allege

two theories of liability: (1) Select Medical Corporation’s

(“Select”) concealed its poor financial condition by employing

improper revenue practices9 (“improper revenue practices theory”)

and (2) Select knew of likely changes to federal

Medicare/Medicaid regulations that could negatively affect its

business model but did not publicly alert investors of these

changes (“regulatory changes theory”).10 This Court’s earlier

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 8 of 17
11 Plaintiffs argue that they are not pursuing two separate

theories of liability but rather one “inherently intertwined”

claim. Plaintiff’s Memorandum in Opposition to Defendants Motion

for Certification (“P. Memo.”) at 2. The Court disagrees with

the view that Plaintiffs have one grand theory of liability. 

Plaintiffs’ argument is as follows: (1) Defendants engaged in

improper Medicare practices that resulted in improper revenue,

(2) this led to greater government scrutiny, which (3) resulted

in regulatory changes that had substantially adverse effects on

Select’s revenue, earnings and entire business model. See id. 

The first problem with this argument is Plaintiffs make no

allegations that government regulators were specifically

scrutinizing Select’s revenue practices. Rather, Plaintiffs’

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decision concluded that Plaintiffs had adequately pled loss

causation with respect to each of these theories of liability.

See Marsden, 2006 U.S. Dist. LEXIS 1675, at *41. Upon careful

reconsideration, the Court now recognizes that this was not

entirely correct.

This Court did not make the same mistake as the Ninth

Circuit had in Dura - namely, it did not hold that Plaintiffs in

this action successfully pled loss causation by merely alleging

that they had paid inflated amounts for their shares in reliance

of Select’s misrepresentations. And, indeed, Defendants concede

that with respect to the regulatory changes theory, Plaintiffs

have adequately pled loss causation. See Memorandum of Law in

Support of Motion of Defendants for Certification Pursuant to 28

U.S.C. § 1292(b) (“D. Memo.”) at 15-16 n.5. Rather, the Court

did not consider carefully enough whether the “truth” that

Plaintiffs allege was adequate to establish loss causation for

both theories of liability.11

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 9 of 17
allegations are of a general nature - that the growth of longterm care hospitals (“LTCHs”) had raised concerns about abuses in

Medicare billing. See, e.g., Am. Compl. at ¶¶ 65-69. There are

no allegations in Plaintiffs’ Amended Complaint linking the

changes in federal regulations to any specific abuses by

Defendants. Second, Plaintiffs’ allegations of improper revenue

practices are far broader in scope than the resultant regulatory

changes. For example, Plaintiffs allege that Defendants engaged

in garden-variety fraud by obtaining patient referrals through

bribes and kickbacks. And they allege that this was only

possible because Defendants failed to put into place adequate

internal controls. Yet, the proposed regulatory changes

mentioned in the May 11, 2004 Press Release refer only to placing

a cap on the percentage of “hospital within a hospital”

referrals. It makes no mention of other regulatory changes or

any specific investigations into Select’s revenue practices. And

there is nothing to suggest that Defendants’ alleged practices of

bribing, offering kickbacks and patient churning could not

continue even after the new regulations went into place. 

Accordingly, the Court treats Plaintiffs’ allegations as

encompassing two discrete theories of liability of securities

fraud.

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Plaintiffs allege that the truth about Select’s improper

revenue practices and the likelihood of changes in federal

regulations came to light on May 11, 2004. See Am. Compl. ¶¶ 186-

190. That day, Select issued a press release which, in relevant

part, stated: 

This afternoon, the Centers for Medicare and

Medicaid Services (“CMS”) issued a press

release announcing among other things,

proposed regulatory changes applicable to

long-term acute care hospitals that are

operated as a “hospital within a hospital.” 

The proposed rule would change the

requirements necessary for a “hospital within

a hospital” to qualify for reimbursement as a

long-term acute care hospital. Under the

proposed rule, to receive reimbursement as a

long-term acute care hospital, no more than

25 percent of any “hospital within a

hospital’s” admissions may be from its host

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 10 of 17
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hospital. Most of Select’s long-term acute

care hospitals currently would not meet this

proposed requirement, and therefore would be

subject to lower levels of reimbursement. . .

. Select believes that, if adopted, the

proposed rule would have a material adverse

effect on Select’s results of operations for

periods after the rule becomes effective.

D. Memo., Exhibit A (“May 11, 2004 Press Release”). Plaintiffs

argue that this press release indicates that the “proposed

regulatory change . . . would have a substantial adverse effect

on Select’s revenue, earnings and entire business model.” Am.

Compl. at ¶ 187. And more importantly, this announcement

revealed that Select’s earlier statements were “materially false

and misleading.” Id. at ¶ 195.

The Court’s previous decision reasoned that the May 11, 2004

Press Release was sufficient to establish loss causation for both

theories of liability because:

That other factors may contribute to a price

drop should not, however, preclude plaintiffs

from pursuing claims based on those factors. 

Rather, allegations that the other factors

contributing to the loss are themselves

actionable seem to be the missing link in

cases addressing loss causation.

Marsden, 2006 U.S. Dist. LEXIS 16795, at * 41. The Court

acknowledges that this analysis was incomplete, if not a bit

perfunctory. Having re-examined those cases addressing loss

causation since the Supreme Court’s decision in Dura, as well as

those that anticipated it, the Court concludes that the “missing

link” is typically the failure by securities plaintiffs to

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 11 of 17
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adequately allege that the market ever learned about the “truth”

of a defendant’s misrepresentation. And that’s exactly the

deficiency in Plaintiffs’ theory premised on improper revenue

practices.

The May 10, 2004 Press Release mentions only the expected

effect that CMS’ proposed rule capping the number of “hospital

within hospital” referrals to 25% would have on Select’s future

operations (i.e. revenues). There is not a single reference in

the press release to either Select’s past revenue practices or

the adequacy of its internal controls. Moreover, the press

release makes no mention that Select’s then-revenue practices

constituted improper Medicare practices. The scope of

information contained in the May 10, 2004 Press Release is

limited; it indicates only that Select’s business model would be

adversely affected by the new regulation. And this type of

public declaration – that a proposed regulatory change could

negatively impact a company’s future performance – is not an

admission to past improprieties in its business practices. 

Indeed, the Court concludes that this type of admission is no

different than a company filing for bankruptcy. In this latter

case, the filing of a bankruptcy petition does not amount to an

admission that a company had previously misrepresented its

financial condition. See D.E. & J Limited Partnership, 133 Fed.

Appx. at 1000 (that a stock price dropped after a bankruptcy

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 12 of 17
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announcement is not necessarily an acknowledgment of prior

misrepresentations, absent any public disclosure of these

misrepresentations); cf Lentell v. Merrill Lynch & Co., 396 F.3d

161, 175 n.4 (2d Cir. 2005) (Merrill Lynch’s downgrades of its

stock recommendations does not amount to a “corrective disclosure

. . . because they do not reveal to the market the falsity of the

prior recommendation”); see also In re Telluim, Inc. Securities

Litigation, 02-5878, 2005 U.S. Dist. LEXIS 26332, at *12 (D.N.J.

Aug. 26, 2005) (disclosure that quarterly revenues will be lower

than expected is not the type of announcement that alone is

sufficient to “demonstrate a market correction of an earlier

artificial inflation caused by defendants’ misrepresentations”).

In short, Select’s press release merely acknowledges the

impact of a future regulatory change. This was not a corrective

public disclosure about its past revenue practices. In fact,

Plaintiffs’ Amended Complaint makes not a single allegation that

Select ever publicly disclosed that it maintained improper

revenue practices or misrepresented its revenues. Simply put,

while it might be true that Select’s revenue practices were

improper, and while it might be true that it misrepresented its

revenues, none of that information was ever disclosed to the

market. And absent any such disclosures, the price of Select’s

stock could not possibly have reflected this information. The

market cannot react to information of which it is unaware. And

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 13 of 17
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to proceed on a fraud-on-the-market theory, it must be assumed

that the price of a company’s stock reflects all publicly

available information. See, e.g., Basic v. Levinson, 485 U.S.

224, 248-49 (1988). 

Plaintiffs’ Amended Complaint includes no allegations that

Select’s share price fell after the market became aware of its

allegedly improper revenue practices. The May 10, 2004 Press

Release establishes loss causation only with respect to theory of

liability that Select misrepresented (or failed to disclose)

information about the likelihood of certain regulatory changes.

But it includes no disclosures about Select’s past revenue

practices. And Plaintiffs may not rely upon it to proceed on a

theory of liability premised on Select’s allegedly improper

revenue practices.

Conclusion

Justice Frankfurter once remarked that, “Wisdom too often

never comes, and so one ought not to reject it merely because it

comes late.” Henslee v. Union Planters Nat'l Bank & Trust Co.,

335 U.S. 595, 600 (1949) (Frankfurter, J., dissenting). This is

one of those moments. But by correcting its error now, the Court

is hopefully saving the parties (and itself) from potentially

time-consuming, unnecessary and costly discovery into a theory of

liability not properly before this Court. For the foregoing

reasons, the Court concludes that Plaintiffs have failed to plead

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 14 of 17
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loss causation with respect to their security fraud claims

premised on Select’s allegedly improper revenue practices. An

appropriate Order follows.

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 15 of 17
12 The Court offers the parties this opportunity to seek

clarification, if necessary, of this Memorandum and Order with

the hope that it may stave off any future discovery disputes.

IN THE UNITED STATES DISTRICT COURT

FOR THE EASTERN DISTRICT OF PENNSYLVANIA

CLIFFORD C. MARSDEN and MING XU, : CIVIL ACTION

Individually and on Behalf of All :

Others Similarly Situated, : 04-4020

:

Plaintiffs, :

:

v. : 

:

SELECT MEDICAL CORP., MARTIN :

JACKSON, ROBERT A. ORTENZIO, :

ROCCO ORTENZIO, and PATRICIA RICE, :

:

Defendants. :

ORDER

AND NOW, this day of February, 2007, it is hereby

ORDERED that:

1. Defendants’ Motion for Certification of Interlocutory

Appeal Pursuant to 28 U.S.C. § 1292(b) (Doc. No. 44) is DENIED as

MOOT.

2. This Court’s April 6, 2006 Memorandum and Order is

VACATED IN PART, and Defendants’ Motion to Dismiss Plaintiffs’

security fraud claims arising from alleged improper revenue

practices is GRANTED.

3. The parties may each file a motion seeking clarification

or modification (including any suggested modifications to its

language) of this Memorandum and Order by February 14, 2007.

12

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 16 of 17
BY THE COURT:

____________________

J. CURTIS JOYNER, J.

Case 2:04-cv-04020-JCJ Document 63 Filed 02/12/07 Page 17 of 17