The Fifth Circuit handed a significant victory yesterday to defendants that face federal securities lawsuits over merger-related proxy disclosures, ruling that the Private Securities Litigation Reform Act (“PSLRA”) safe harbor for forward-looking statements applies to claims based on purportedly misleading projections in a merger proxy. The published decision in Heinze v. Tesco Corporation (Case No. 19-20298) could make it easier for defendants to obtain dismissal of these cases on the pleadings, thus conserving defense costs and potentially driving down the settlement value of these cases. Companies should make sure that the projections used in merger-related proxy disclosures contain robust cautionary language to maximize the probability of dismissal.
It has long been a truism that mergers and acquisitions involving companies publicly traded on US stock exchanges are highly likely to result in shareholder litigation. These lawsuits have increasingly been filed as federal class actions asserting claims under Section 14(a) of the Securities Exchange Act based on purported deficiencies in the proxy disclosures filed in advance of the shareholder vote on the transaction. A substantial portion of these suits allege that the unlevered cash flow or EBITDA projections contained in the proxy omit material information and understate the actual future earnings potential of the target company. The prevalence of these lawsuits has played a major role in fueling the overall surge in federal securities class action filings over the past several years.
The Heinze suit—which challenged a business combination between Tesco Corporation and Nabors Industries Ltd.—was a classic example of this type of case. The proposed combination was approved by Tesco’s shareholders and, because Tesco was incorporated in Alberta, received preliminary and final approval from an Alberta court. Nonetheless, multiple shareholders filed suit in the Southern District of Texas, contending that Tesco omitted or misstated material information in the Schedule 14A proxy statement filed with the Securities and Exchange Commission prior to the shareholder vote on the transaction. One of the plaintiffs, Norman Heinze, elected to pursue the case to judgment.
The proxy contained “base case” and “growth case” projections for Tesco’s estimated revenue and EBITDA for 2017 and 2018. Heinze alleged that these projections were misleading because they did not include projections for 2019-22, which Heinze asserted would be higher than the 2017-18 projections. Heinze also argued that the proxy only contained EBITDA projections and misleadingly omitted unlevered cash flow projections, which Heinze likewise asserted would provide a more complete valuation picture for Tesco. In addition, Heinze alleged that the implied equity value ranges calculated from the projections were misleading because they did not include an implied per share equity value range for the growth case projections. Heinze also asserted that the proxy misleadingly omitted a comparable transactions analysis performed by Tesco’s financial advisor and misleadingly described the premium for the transaction as “significant,” which Heinze claimed would have been undercut if premiums for comparable transactions had been disclosed. US District Judge Alfred H. Bennett dismissed the case with prejudice, holding that the complaint failed to allege well-pled facts showing that the proxy disclosures were actionably misleading and failed to overcome the PSLRA safe harbor with respect to the projections.
The Fifth Circuit affirmed Judge Bennett’s dismissal. Writing for a unanimous three-judge panel that included Chief Judge Priscilla R. Owen and Judge Leslie H. Southwick, US Circuit Judge Andrew S. Oldham concluded that the complaint failed to allege facts showing that any of the “omitted” information rendered any of the projections or other affirmative disclosures materially misleading. Heinze alleged no basis for why the projections were actually misleading other than his bare assertion that oil prices were likely to rise in later years, a proposition that the Fifth Circuit characterized as “rank speculation” that companies have no duty to disclose. (Heinze, slip op. at 10.) The Fifth Circuit emphasized that “[w]ithout a viable claim alleging that the projections are misleading, Heinze is left with only a pure-omission theory that is untethered to any specific false or misleading representation in the proxy statement.” According to the opinion, “[s]uch pure-omission claims are not cognizable,” as plaintiffs must identify how an omitted fact renders an affirmative disclosure materially misleading. (Id. at 11.) “Without an affirmatively false or misleading statement ‘therein,’ there can be no claim.” (Id.) The Fifth Circuit also rejected plaintiff’s claims over the use of the word “significant” to describe the premium and regarding the omitted comparable transactions analysis, holding that these claims were likewise unsupported by any well-pled fact other than the conclusory assertion about future oil prices. (See id. at 6-7, 10, 14-15.) The court further concluded that the adjective “significant” was immaterial, as “[a] reasonable shareholder would have relied on the actual quantity of the premium to assess its significance, rather than the adjective ‘significant.’” (See id. at 6-7.)
Of particular importance, the Fifth Circuit also rejected Heinze’s argument that the PSLRA safe harbor for forward-looking statements does not apply to projections underlying a fairness opinion in a merger proxy disclosure. The safe harbor protects forward-looking statements that are “accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement” and that are made without actual knowledge that the statement is materially misleading. See 15 U.S.C. § 78u-4(5(c)(1)(A). The Fifth Circuit rejected Heinze’s assertion that the PSLRA’s legislative history reflected an intent to preclude application of the safe harbor in the merger proxy context, holding that the challenged revenue and EBITDA projections fell “comfortably within” the safe harbor’s “unambiguous text.” (See Heinze, slip op. at 13-14.) Because the projections were identified as forward-looking and were accompanied by “several” pages of cautionary statements, including specific warnings about the volatility of oil prices, the safe harbor applied. (See id. at 13.)
By clarifying that “pure omission claims are not cognizable” under Section 14(a) and that the PSLRA safe harbor applies to projections contained in merger proxy disclosures, the Heinze decision should provide defendants a clearer path towards dismissal of Section 14(a) claims in the Fifth Circuit and should be persuasive authority in other jurisdictions. Consistent with the PSLRA’s plain language, companies should ensure that all forward-looking statements in proxy disclosures are accompanied by specific cautionary language providing industry-specific and company-specific risks that could cause actual results to differ from the projections.
Gerard G. Pecht and Peter A. Stokes represented Tesco and its former directors in the district court and on appeal in this matter.