Saturday, January 23, 2021
Courts really don’t like it when you intentionally issue false projections in order to make a merger look better
So much so, it seems, that they will go out of their way to make sure a securities fraud claim survives a motion to dismiss.
I speak of In re Mindbody Securities Litigation, 2020 WL 5751173 (SDNY Sept. 25, 2020) and Karri v. Oclaro, 2020 WL 5982097 (N.D. Cal. Oct. 8, 2020).
The problem for courts in this context is that projections of future performance are protected by the PSLRA safe harbor. Which means, faced with plausible allegations that corporate insiders were talking down the stock’s potential in order to persuade shareholders to accept a bad deal, courts feel they need to find some other basis on which to sustain the claim.
In Mindbody – the facts of which are also colorfully described in a related Chancery action for breach of fiduciary duty – that basis turned out to be the defendants’ statements about the value of the merger consideration relative to the (artificially low) stock price. The defendants were alleged to have intentionally lowballed their earnings guidance in order to sink the stock, so that the merger offer would seem generous by comparison. But by the end of the quarter, defendants had in their possession the true earnings figures, and confirmation that their earlier projections had been too pessimistic. The court wouldn’t allow a straight-up projections claim to proceed, but it did hold that the proxy materials contained an “actionable omission because Defendants’ statements about Vista’s 68% ‘premium’ implied that Mindbody had no non-public information that would materially affect its share price…. Here, the 68% measuring stick would only have been informative to shareholders if the Defendants believed that the December share price was an accurate reference point. By invoking the ratio of Mindbody’s share price to Vista's offer, Defendants impliedly warranted that, to their knowledge, the share price as of December 21, 2018, was not undervalued.”
Get it? The court wouldn’t allow a lawsuit based on the false projections themselves – and didn’t want to just come right out and say there was a duty to update the false guidance (indeed, it denied so holding) – so, it threaded the needle by treating references to a premium as their own, present-tense half-truths about the true value of the stock.
But that’s nothing compared to the contortions in Oclaro. There, again, plaintiffs alleged that defendants lowballed projections in order to drive the stock down, thus justifying the merger. There, again, the court held that false projections were protected by the PSLRA safe harbor. But what wasn’t protected were valuation estimates derived from the projections, or representations about how the projections were prepared, including representations that they were prepared in good faith, and those claims were allowed to proceed.
Now, defining “forward-looking” has always been something of a challenge in securities cases, but saying the projection is protected by the safe harbor but the valuation based on that projection is not protected is some next-level hairsplitting.
It’s like the fact/opinion distinction, which I’ve complained about before; the line is something that philosophers struggle with, let alone judges, and it’s absurd that courts allow so much to turn on which way the die falls. Everything in financial reporting is based on estimates, often future estimates, and in that context, attempting to distinguish fact from opinion from projection is meaningless; they’re all part of one process. That’s why, for example, the PSLRA safe harbor excludes from its protections any statements that are “included in a financial statement prepared in accordance with generally accepted accounting principles,” and why courts get it wrong when they characterize GAAP financial statements as matters of opinion.