© 2014 The Texas Lawbook.
By Natalie Posgate – (July 24) – The past month has been a good one for Norton Rose Fulbright partners Gerry Pecht and Peter Stokes.
The duo successfully secured two dismissals in the Southern District of New York for securities class action lawsuits against two Houston-based oil and gas companies. One was LINN Energy, LLC/LinnCo, LLC, which was dismissed July 8. The other was a June 23 dismissal for Magnum Hunter Resources Corporation.
But the fact that both lawsuits involved oil and gas companies is far from a coincidence, the lawyers say. In fact, they predict that the energy industry will continue to see many more of these kinds of lawsuits in the energy sector in the years to come.
“We have seen an attack on the energy industry by shareholder plaintiffs,” said Stokes, who is in Norton Rose Fulbright’s Austin office. “Because the energy industry has flourished in recent years, the dark side of that success has been the attraction of more shareholder litigation.”
LINN and LinnCo General Counsel Candice Wells said she and others in her corporate legal department were “frustrated, but not surprised” when LINN shareholders filed their lawsuit.
“We were all familiar with the idea that when a stock price drops, these kinds of cases flowed in,” said Wells, also vice president and corporate secretary at LINN. “The pattern I’ve observed is on any announcement of bad news, it seems there’s a lawsuit filed.”
Stokes agreed.
“At the end of the day, It’s about the money for the plaintiffs’ firm in terms of suing companies who have significant market capitalization and damage potential in stock drop,” he said.
This recent flurry of success is not Pecht’s and Stokes’ first rodeo for securing significant wins regarding similar issues for clients in the energy sector.
The team recently secured yet another case dismissal for Magnum Hunter regarding a class action derivative case tied to the class action securities case. Plaintiffs had filed lawsuits both in the Southern District of Texas and the District of Delaware and judges granted Magnum Hunter’s motion to dismiss in each court. Pecht and Stokes also secured dismissals for Houston-based Helix Energy Solutions and Bermuda-based Nabors Industries Ltd. this March and July 2012, respectively, for lawsuits brought on by investors involving breach of fiduciary duty claims.
And last June, Pecht helped K-Sea Transportation Partners, LP’s federal securities class action get dismissed by the U.S. District Court for the District of New Jersey.
Wells said she decided to hire Pecht and Stokes for LINN’s securities class action lawsuit because of their “excellent history” with these kinds of cases, “extremely reasonable” fees and practical approach to the issue.
“We’re obviously very pleased with the work they did,” Wells said.
The Allegations
LINN and Magnum Hunter’s lawsuits were both brought to fruition last year. The head plaintiffs in LINN’s case, Ironworkers Local 580 – Joint Funds and Bonnie Stewart, claimed LINN and LinnCo provided false and misleading non-GAAP financial metrics.
They stated that LINN misled investors into believing that its calculation of adjusted EBITDA – or net income with interest, taxes, depreciation and amortization added back into it – and distributable cash flow reflected the cash premiums paid in previous years for derivative contracts called “put options” – measures used to hedge LINN’s exposure to fluctuating oil and gas prices.
“That practice, which violated SEC regulations, allowed LINN to maintain its superficially impressive record of making distributions to investors from its ‘available cash,’ and to promise, and ostensibly meet (until April 2013), even higher distribution targets, when in fact LINN could only maintain its distributions by relying on funds from debt and equity offerings,” said a November 2013 memorandum of law of the plaintiffs opposing LINN’s motion to dismiss.
The complaint alleges “only in the midst of an SEC inquiry… did LINN disclose the premiums paid for put options settled during any period.”
In LINN’s reply brief, Pecht argued that the plaintiffs’ claims lacked merit and that LINN never misled its investors.
“No amount of factual particularity can salvage a complaint that does not plausibly allege a misleading statement,” wrote Pecht, who is based in Norton Rose Fulbright’s Houston office and is the firm’s global head of dispute resolution and litigation. “By definition, a calculation is not misleading if the company states what is included in the calculation and what is not.”
The July 8 opinion by U.S. District Judge Colleen McMahon sided with Pecht and Stokes.
“While factual allegations should be construed in light most favorable to the plaintiffs, ‘the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions,’” McMahon wrote in a 50-page opinion.
“The detailed factual recital set forth above makes it perfectly clear that, at all times, LINN and LinnCo told the whole truth and nothing about how they were calculating adjusted EBITDA, DCF, the distribution coverage ratio, and maintenance capex… Plaintiffs take issue with the way LINN chose to calculate these metrics, but that is of no moment. It is not fraudulent for a reporting entity to calculate metrics that are not defined under GAAP… as long as the public is told exactly what the company is doing,” she continued.
In Magnum Hunter’s lawsuit, the plaintiffs claimed Magnum Hunter and its executives violated federal securities laws after reading an April 2013 announcement from the company about dismissing its auditor, PricewaterhouseCoopers. The announcement also revealed news that it would not be able to file its annual 10-K report on time due to “material weaknesses in the company’s internal auditing controls” that PwC advised Magnum Hunter of, the amended complaint said.
As a result of these disclosures, the plaintiffs concluded in their petition that
Magnum Hunter used a “fraudulent course of business” because the company and its directors “made materially false and misleading omissions about the adequacy of Magnum Hunter’s internal and financial controls and the reliability of Magnum Hunter’s publicly-reported financial reports issued throughout the class period.”
In Magnum Hunter’s motion to dismiss, Pecht alluded to supporting allegations from nine confidential witnesses that the plaintiffs claimed they had in their amended complaint.
“Those allegations merely reinforce the non-fraudulent nature of the accounting errors at issue in this case,” Pecht wrote. “None of those allegations shows that any individual defendant knew that Magnum Hunter’s financial statements were inaccurate or that any fraud occurred.”
He also emphasized that the stock price did not suffer in the long term due to Magnum Hunter’s disclosures in April 2013.
“This putative securities class action is premised on a garden variety accounting restatement that resulted in a cumulative non-cash increase of only 5 percent to Magnum Hunter’s total annual loss for 2012,” Pecht wrote. “The stock price completely recovered after Magnum Hunter successfully filed its 2012 Form 10-K in June 2013, reaching a 52-week high just four months later.”
U.S. District Judge Katherine Forrest agreed.
“While it is certainly true that the allegations support an inference of the defendant having had serious control deficiencies and accounting issues over an extended period, there is no factual basis in the complaint to infer that, when the company made its statements – which failed to either reveal the full extent of such issues, or simply failed to foretell the future – it was acting with a knowledge of falsity or an intent to defraud,” Judge Forrest wrote in her 44-page opinion.
Plaintiffs in both lawsuits will have the opportunity to appeal in the U.S. Court of Appeals for the Second Circuit.
Significance of Dismissal
Plaintiffs’ lawyers also filed class actions against LINN and Magnum Hunter in the U.S. District Court for the Southern District of Texas. Both cases were consolidated with those filed in New York.
Prior to the New York lawsuits being filed, the shareholders with smaller derivative claims sued Magnum Hunter’s directors in the U.S. District Court for the Southern District of Texas, the U.S. District Court for the District of Delaware and Harris County. All lawsuits were dismissed either voluntarily or by a judge.
Yet another shareholder derivative lawsuit with slightly different claims was filed this spring in Harris County. Pecht and Stokes have asked the judge to dismiss the lawsuit, but no decision has been made.
Stokes said this multi-jurisdiction phenomenon has become more common in recent years, and he partially attributes the reasoning to the success in being able to defend oil and gas companies in Texas courts – often their home turf.
“Because we’ve been able to defeat these cases in Texas on a regular basis, we’ve seen a migration of litigation against Texas-based companies to the Southern District of New York for hope of garnering a new forum,” he said.
“The significance is no one is able to [justify] these types of cases against energy companies wherever they’re filed,” he added. “When you go through the education process with the court about energy-specific accounting issues… you have judges in New York extremely astute about accounting and financial issues and are able to quickly see through whatever superficial claims are included.”
Stokes’ main piece of advice to other outside counsel hired to handle shareholder class-action securities lawsuits for energy clients is to meet with the company’s financial personnel early in the process “to really understand the nuts and bolts of disclosure issues.” He said by doing so, it helped him and Pecht craft stronger motions to dismiss than they could have done otherwise.
“Our client’s our best resource,” he said. “I can’t overstate how much you can learn from your clients.”
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