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In a February 10, 2010 opinion (here), the Second Circuit reversed the lower court's dismissal of the securities class action lawsuit relating to The Blackstone Group's June 2007 IPO. The decision, which represents a noteworthy victory for plaintiffs, contains an extensive analysis of "materiality" requirements and could prove significant in the many other pending cases alleging misrepresentations or omissions regarding the subprime meltdown and the ensuing deterioration of the financial marketplace.
Blackstone, a leading asset manager and financial advisory firm, conducted an IPO in June 2007. As reflected here, in April 2008, investors who had purchased securities in the offering filed the first of several securities class action lawsuits against Blackstone and certain of its directors and officers, alleging that the company had made material misrepresentations and omissions in its IPO offering documents.
The investors alleged that at the time of the offering, Blackstone knew that two of its portfolio companies (FGIC Corporation, a monoline financial guarantor, and Freescale Semiconductor), as well as its real estate fund investments, were experiencing problems. The investors allege that the defendants knew that these problems could subject the company to a claw-back of performance fees or result in reduced performance fees. The defendants moved to dismiss.
In a September 22, 2009 order (here), Southern District of New York Judge Harold Baer, Jr. granted the defendants' motions to dismiss, holding that the alleged misrepresentations or omissions regarding FGIC and Freescale were neither quantitatively nor qualitatively material, and further holding that the alleged misrepresentations regarding Blackstone's real estate investments were insufficient because the plaintiffs' allegations failed to specify how the residential mortgage woes would have a foreseeable material effect on Blackstone's real estate investments. The plaintiffs appealed.
The February 10 Order
In an opinion written by Judge Chester J. Straub for a three judge panel, the Second Circuit reversed the district court, holding that the lower court had erred in dismissing the plaintiffs' complaint.
The Second Circuit's analysis focused on Blackstone's obligation under Item 303 of Reg. S-K to disclose material risks, trends and uncertainties that could affect the firm's financial results.
In holding that the complaint's allegations regarding the offering documents' omission in connection with Blackstone's investments in FGIC and Freescale met both the quantitative and qualitative materiality requirements, the Court rejected Blackstone's argument that a loss in one of its portfolio companies might be offers by a gain in another. "Blackstone," the Court said, "is not permitted, in assessing materiality, to aggregate the negative and positive effects on its performance fees in order to avoid disclosure of a particular negative event."
The Court added that "were we to hold otherwise, we would effectively sanction misstatements in a registration statement or prospectus related to particular portfolio companies so long as the net effect on revenues of a public private equity firm like Blackstone was immaterial." The question is not whether an investment's loss in value will affect revenues but the firm "expects the impact to be material."
In concluding that the district court had erred in holding that the plaintiffs' allegations did not satisfy the qualitative materiality requirements, the Court noted that the firm's Corporate Private Equity division was the firm's "flagship segment," adding that because the segment "plays such an important role in Blackstone's business and provides value to all of its other asset management and financial advisory services," a reasonable investor "would almost certainly want to know information related to that segment that Blackstone reasonable expects will have a material adverse effect on its future revenues."
The Court added that it could not conclude that Freescale's loss of an exclusive contract with it larges customer was immaterial in connection with one of the firm's Corporate Private Equity firm's largest investments. The Court noted that the failure to disclose the negative developments at FGIC and Freescale "masked a reasonably likely change in earnings, as well as a trend, event or uncertainly that was likely to cause such a change."
Read the article in its entirety at the D&O Diary, a blog by Kevin LaCroix.