Expert Challenge Fails to Topple $400M Shareholder Merger Suit

By Maggie Tamburro

A magistrate judge out of a Delaware federal district court has rejected an expert challenge and granted class certification in a securities suit alleging fraud, recklessness, and materially false and misleading statements in connection with a $400 million shareholder-approved merger that allegedly went awry.

The case, originally filed in 2010, was given the green light on June 6 to proceed as class action after the judge refused to exclude the testimony of lead plaintiff’s expert, who sought to rely on an event study that the defendants challenged as unreliable under Federal Rule of Evidence 702 and Daubert.

The case is perhaps illustrative of a growing trend of high-dollar securities lawsuits brought by disgruntled shareholders and investors involving allegedly soured mergers and acquisitions – at a time that seems favorable to certification of plaintiffs in securities fraud class actions.

The court made no secret about its views on the matter here. In analysis of the “superiority” inquiry under the federal rules that govern class certification, the opinion noted, “This circuit favors allowing class certification in securities fraud cases, recognizing, ‘the interests of justice require that in a doubtful case . . . any error, if there is to be one, should be committed in favor of allowing a class action.’”

According to a July 2013 mid-year securities litigation update published by the law firm Gibson Dunn, securities merger and acquisition related litigation continues to grow and merger-related cases represent a “significant portion of new federal court securities class action filings.” The update cites an astonishingly high figure of investor challenges, noting, “Today over 80% of all M&A transactions are challenged by investors, either in federal court class actions, state court class actions, or shareholder derivative actions.”

A Blank Check Company Comes Under Shareholder Scrutiny

Such was the case here, in a securities fraud action brought by lead plaintiff on behalf of shareholders and investors challenging a merger involving a “blank check company.”

A blank check company is defined by the Securities and Exchange Commission (SEC) as “a development stage company that has no specific business plan or purpose or has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, other entity, or person.” A type of blank check company, according to the SEC, is a special purpose acquisition company (SPAC) – which lead plaintiff alleged was the kind of entity at issue here – created “specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe,” according to the SEC.

The defendant here, a publicly traded “blank check company,” raised funds from public investors through an initial public offering (IPO) and set a time frame of twenty-four months in which to acquire a “qualifying” operating company, or else the company would be dissolved and the IPO proceeds would be returned to shareholders, according to the court’s ruling.

The company’s IPO was apparently completed in November of 2007, raising approximately $430 million and allegedly making it one of the (then) top largest IPOs to be made by a SPAC. But certain events transpired along the way that resulted in the filing this class action suit.

The Chain of Events

According to the opinion, the following transpired:

• In May of 2008, the company publicized and filed with the SEC its merger agreement to acquire another company known as China Water and Drinks, Inc. (China Water) for a purchase price of $625 million in cash and stocks, according to the opinion. The opinion states that the company “praised China Water and the merger,” characterizing it as a “special opportunity.”

• In June of 2008 the company filed a Form S-4 registration statement with the SEC for the proposed merger, disclosing certain risk factors pertaining to China Water, including, inter alia, information about lack of internal controls and due diligence assurance. The statement also disclosed that acquisition of China Water could have negative effects on market perceptions involving the company, and could “potentially cause violations of net worth requirements or other covenants due to post-combination debt financing.” These and other disclosures were repeated at various times.

• Due to allegations of “market instability,” the merger was apparently renegotiated, and the purchase price reduced in September of 2008 to approximately $400 million.

• In October of 2008, the company allegedly issued a joint proxy and recommended its shareholders approve the merger. Although the proxy restated deficiencies in internal controls and other risk factors, and projected a net loss of over $2 million for the first six months of 2008, the company reassured investors it would exceed the qualifying business combination requirement and encouraged voting in favor of the merger and amendment of incorporation documents – effectively removing the requirement to return IPO funds if the company failed to meet the twenty-four month time frame.

• The merger was secured in October of 2008.

Stock Prices Tumble

After the merger, certain events occurred and financial and other disclosures apparently surfaced which caused negative market reaction – and the stock price began to tumble. In short, by February of 2010, China Water’s total value had been written down to $21 million, reflecting a 96% reduction from the initial acquisition price of over $600 million, according to the opinion.

Lead plaintiff in the case brought the action on behalf of stockholders entitled to vote on the merger and other investors during the class period, alleging fraud, recklessness, and false material and misleading statements. In October of 2012, plaintiff filed a motion to certify the class, and defendants later filed a motion to exclude plaintiff’s expert.

Defendants’ Motion to Exclude Plaintiff’s Expert

Defendants in the case argued that plaintiff’s expert’s report, which utilized an event study to test for market efficiency, was scientifically flawed, and should therefore be excluded as unreliable. Although the defendants conceded that an event study is regularly used in such securities class action cases, they asserted that plaintiff’s application of its methodology was flawed, and it failed to demonstrate a cause and effect relationship between stock price and news to establish an efficient market (an element of the fraud-on-the-market theory in securities actions which allows a rebuttable presumption of reliance).

However, the court disagreed, stating that the Third Circuit has noted that the federal rules “display a preference for admissibility,” cautioning district courts from employing a threshold that would require plaintiffs “to prove their case twice.”

The court stated, “While defendants suggest other dates to include in his event study, none are necessary for the study to be admissible. [Plaintiff’s expert’s] study included earnings-related announcements, which, in his opinion, would impact the market, and thus demonstrate market efficiency.”

Noting that the defendants’ arguments go to weight, not admissibility, the court noted, “While [plaintiff’s expert’s] study may not be perfect, it is not unreliable. Defendants may challenge [the expert’s] conclusions in the appropriate forum, that is, at trial.”

More to Say… Experts and Class Certification

The court didn’t stop there. It had more to say about experts and securities class actions, specifically whether such a battle of the experts was appropriate for the class certification stage in this context.

Here the parties’ experts came to different conclusions in their event studies, specifically disagreeing about the cause and effect relationship between the alleged misrepresentations made by defendant and the price of the securities.

While plaintiff’s expert opined that the common shares did respond to “new, material, company-specific news,” the defendants’ expert flatly disagreed, stating that the common shares “did not respond differently on news days versus no-news days and thus did not trade in an efficient market.”

With regard to such conflicting expert opinions at the class certification stage, the court stated, “[T]he court does not need to conduct an analysis of which expert is more credible at the class certification stage; instead, this argument may be proper at trial or on a motion for summary judgment.”

The court went on, “Further, if the court were to determine which expert was more credible, it would engage in an analysis of the merits of plaintiff’s claim. Even though a merits analysis often overlaps with a class certification motion, a court only needs to conduct an analysis of the merits when necessary” (citing the Supreme Court’s decision this term in Amgen).

Case One to Follow

The case is instructive in light of the foregoing trends in securities litigation. Not only does it address a growing area of litigation, it also applies two recent U.S. Supreme Court decisions, issued just this term: Amgen, which specifically addressed class certification and securities class actions, and Comcast, which addressed the role of a plaintiff’s damage expert at the class certification stage.

Although Comcast denied class certification – unlike the decision here – the judge in this ruling distinguishedComcast since it addressed antitrust, not securities, litigation.

The case and ruling is In Re Heckmann Corp. Securities Litigation, 1:10-CV-378 (D. Del., June 6, 2013).

Have courts strayed too far on the side of favoring class certification in securities actions?

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Maggie Tamburro

Maggie Tamburro is an attorney and writer who holds a Juris Doctor from The John Marshall Law School and a Bachelor of Arts from the University of Texas. She was admitted to the Illinois Bar in 1994 and Florida Bar in 1999 and has significant experience in legal research, editing, and writing. Maggie is active her in local community, holding various publicly appointed civic board positions.

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