Securities Regulation Daily Company recklessly failed to disclose loan keeping top tenant a float
Monday, August 3, 2020

Company recklessly failed to disclose loan keeping top tenant a float

By Rodney F. Tonkovic, J.D.

A company made a conscious decision not to disclose that a top tenant was only able to pay its rent because of a working capital loan.

A Second Circuit panel reversed a district court's judgment that a complaint failed to show that a company recklessly disclosed incomplete and misleading information. The complaint alleged that the company discussed the financial well-being of a top tenant, notably, its ability to pay rent, without mentioning that the tenant had received a $15 million working capital loan from the company. The panel concluded that the company made a conscious decision not to disclose the loan so that it could understate the extent of the tenant's problems. Because the appellate panel found that the company was at least reckless, it reversed the judgment of the district court and remanded for further proceedings (In re: Omega Healthcare Investors, Inc. Securities Litigation, August 3, 2020, Wesley, R.).

This putative class action was brought against Omega Healthcare Investors and its chief executives. Omega is a real estate investment trust that invests in healthcare facilities, either owning the properties and leasing them to operators or providing mortgage financing to the operators. Omega's non-GAAP financial measures reported to the market primarily reflect rents paid by its operators.

Rent past due. In early 2017, Omega's second-largest tenant, representing 7 percent of its investment portfolio, was experiencing financial problems and became delinquent on its rent. In response, Omega provided the tenant a $15 million working capital loan. The complaint alleges that Omega failed to disclose this loan.

Shortly after the loan was made, Omega held a conference call during which the "performance pressure" facing the tenant was discussed. The loan was never mentioned, but Omega noted that the tenant was past due on its rent while giving assurances that the tenant would bounce back. During 2017's second quarter, Omega continued to report the tenant's liquidity pressures while remaining optimistic that conditions would improve. According to the complaint, Omega reported that the tenant had been making partial rent payments, but failed to disclose that these payments were funded by the still-undisclosed loan. The tenant still had not recovered by the end of the third quarter of 2017, and Omega reported impairments and lowered its guidance to reflect the loss of revenue. The tenant eventually filed for bankruptcy in March 2018.

The complaint claimed that Omega misled investors by failing to disclose the $15 million loan, which gave an inaccurate picture of the tenant's financial well-being. The district court dismissed the complaint, holding that while the failure to disclose the loan was a material omission, the plaintiffs failed to plead a strong inference that Omega acted with the requisite scienter.

Duty to disclose. At issue on appeal was whether the district court erred in finding that the complaint failed to adequately plead scienter. The court first confirmed that Omega had a duty to disclose the loan because failing to do so made its statements about the performance of one of its largest assets misleading. Without disclosing the existence of the loan, the court explained, the statements about the tenant's rent payments gave a false impression of its financial health and concealed the extent its solvency problems.

Recklessness. Moving on, the court concluded that Omega's decision not to disclose the loan in the context of disclosures about the tenant's financial health was reckless. The allegations gave rise to a strong inference that Omega was at least reckless in choosing to disclose incomplete and misleading information about the inability of one of its top tenants to pay rent without the loan. The tenant's performance impacted Omega's financial health, and it must have known that revealing the full extent of the tenant's problems would trouble its investors. The facts as alleged, the court concluded, created a compelling inference that Omega consciously chose not to disclose the loan so it could understate the extent of the tenant's financial difficulties.

The case is No. 19-1095.

Attorneys: Jacob A. Goldberg (The Rosen Law Firm P.A.) for Royce Setzer, Earl Holtzman and Dror Gronich. Eric Rieder (Bryan Cave Leighton Paisner LLP) for Omega Healthcare Investors, Inc.

Companies: Omega Healthcare Investors, Inc.

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