On March 8, 2021, Judge Lewis J. Liman of the United States District Court for the Southern District of New York dismissed a putative securities class action against a midstream oil company (the “Company”), its general partner, and an infrastructure firm that was an affiliate of the general partner and acquired the Company (the “Firm”), as well as certain of the Company's officers and directors, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. Kraft v. Third Coast Midstream, No. 19-cv-9398 (S.D.N.Y. Mar. 8, 2021). Plaintiffs alleged that the Company and the Firm orchestrated a scheme to manipulate the price of the Company's common units (“CUs”) through a series of misstatements and omissions so that the Firm could acquire the Company at a deflated price. The Court dismissed the claims for failure to plead any actionable misstatement or omission or a manipulative act, as well as loss causation or scienter.
In November 2017, the Company announced that it had entered into a merger agreement with another midstream company. That merger agreement terminated in July 30, 2018. In August 2018, the Firm, which was a large Company shareholder, purchased approximately 600,000 CUs, which gave it majority control over the Company's CUs. In September 2018, the Firm made an unsolicited offer to acquire the Company's outstanding CUs, and after some history of acceptance, withdrawal, and a revised buyout offer, the Company and the Firm ultimately consummated a going-private transaction in July 2019.
Against this backdrop, plaintiffs alleged that the Company and the Firm made several misrepresentations and omissions in the following public statements: (1) a July 2018 press release announcing a 75% distribution cut to the CU holders; (2) the Firm's August 2018 Schedule 13D, in which the Firm disclaimed “any specific plan or proposal to acquire, transfer or dispose of [CUs]”; (3) a September 2018 press release disclosing an “unsolicited, non-binding” merger proposal from the Firm; and (4) the Company's December 2018 8-K announcing an amendment to its credit facility, which prevented the Company from declaring or paying any distributions on the CUs unless it reduced its leverage ratio to a certain threshold. Plaintiffs alleged that these statements were false and misleading because they did not disclose the Firm's plan to acquire the Company and were instead made as part of a manipulative scheme to deflate the price of the CUs so that the Firm could acquire the Company at a lower price.
The Court first rejected plaintiffs' claim that any of these statements were false, stating that the claims were “premised on a scheme the existence of which is not supported by allegations of fact but only surmise—and illogical surmise at that.” For example, plaintiffs claimed that the Company cut its distributions in July 2018 to reduce the CU price in furtherance of its undisclosed plan to go private and that the Company intended to use the savings from the cut to pay a termination fee to the other midstream oil company with which it had a merger agreement at the time. The Court held that plaintiffs failed to allege any facts to support this theory, and that they alleged no facts to support the claim that the Company's statement that the distribution cut was part of a revised capital allocation plan was false. The Court also held that there were no allegations that the Company's management involved in the distribution reduction decision knew about any plan for the Firm to take the Company private. The Court similarly rejected as baseless plaintiffs' claim that the Company's suspension of distribution payments in December 2018 was to further the scheme for the Firm to acquire the Company on the cheap, rather than required under the credit facility amendment as was disclosed. The Court explained that plaintiffs' claims amounted to “pure ‘fraud by hindsight,' imputing knowledge and motive to [the Company] . . . based solely on events that subsequently transpired that allegedly harmed Plaintiffs.”
Next, the Court held that plaintiffs' misrepresentation claims were based on a misreading of the disclosure requirements. First, with respect to the Firm's Schedule 13D, which plaintiffs alleged was false because it disclaimed any specific plan or proposal to acquire the Company, the Court held that Schedule 13D “requires disclosure only of plans or proposals that are ‘fixed,' or that are ‘decided upon or intended.'” Thus, the Firm was not required to disclose “the possibility that it would offer to acquire [the Company],” even if the possibility existed. Second, with respect to the Company's September 2018 announcement that it received an unsolicited offer from the Firm, the Court rejected plaintiffs' claim that the announcement was misleading because it did not disclose the timing of the Firm's initial considerations of a potential acquisition. The Court held that “Section 10(b) and Rule 10-b5 ‘do not create an affirmative duty to disclose any and all material information.'”
The Court then considered whether plaintiffs had properly pled loss causation. Plaintiffs alleged that the Company manipulated the CU price by reducing and then suspending the distributions, which depressed the CU price and prompted the Company to accept the Firm's low acquisition offer. The Court held that plaintiffs failed to allege that the price rebounded after the “truth” became known—i.e., that the Firm was making an offer to acquire the Company—or that that disclosure caused plaintiffs any loss. Rather, plaintiffs' claimed losses were a result of decisions with which they disagreed (e.g., reduction and suspension of distributions) and not from misrepresentations or omissions. The Court thus held that plaintiffs' claim was “indistinguishable from a claim of corporate mismanagement or breach of fiduciary duty,” and the fact that “the value of a security held by a plaintiff declines after either management or the market do not perform according to the plaintiff's expectations” was insufficient to plead loss causation. With respect to scienter, the Court held that plaintiffs offered no well-pled allegations that the Company had knowledge of facts or access to information contradicting their public statements, nor any allegation of facts contradicting the reasons given publicly by the Company for reduction of its CU distributions.
Finally, the Court separately addressed plaintiffs' market manipulation claim. The Court emphasized that market manipulation “is distinct from corporate mismanagement that affects the price of a security,” and held that plaintiffs failed to allege a “false price signal to the market.” To the contrary, the share price of the CU accurately reflected the market's reaction to each of the Company's decisions, and plaintiffs' claim, which amounted to no more than that the price was “not what it should have been had [the Company] made other decisions,” was insufficient to support a market manipulation claim.
Originally Published by Shearman & Sterling, March 2021
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