Securities Regulation Daily Finding no duty to disclose Wells Notice, complaint dismissed
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Monday, January 25, 2016

Finding no duty to disclose Wells Notice, complaint dismissed

By Kevin Kulling, J.D.

A federal court in New York has dismissed a proposed shareholder class action against Lions Gate Entertainment Corp. for alleged fraud in connection with the company’s failure to disclose an SEC investigation and Wells Notice. The company settled with the SEC before any formal charges were brought for alleged violations involving transactions designed to block investor Carl Icahn from gaining control of the company in 2014 (In re Lions Gate Entertainment Corp. Securities Litigation, January 22, 2016, Koeltl, J.).

The complaint. Shareholders of Lions Gate alleged that the company was aware in 2012 that the SEC had begun to investigate the company and its management for making allegedly false statements and representations when Lions Gate announced a series of transactions that constituted a defensive capitalization. According to shareholders, Lions Gate failed to disclose the details of the SEC Enforcement Division investigation, the possibility of an SEC enforcement proceeding, and an imminent settlement with the SEC.

The company settled with the SEC and agreed to pay a civil penalty of $7.5 million in March 2014. Shareholders alleged that the failure to disclose the SEC investigation and possible settlement was a violation of Exchange Act Section 10(b) and Rule 10b-5.

Lions Gate and Icahn. Lions Gate is a multimedia conglomerate that produces and distributes motion pictures, television programs and other forms of entertainment. The complaint also named the company’s former CEO, CFO, and vice chairman of the board as defendants.

In 2010, the Lions Gate board of directors became embroiled in a power struggle with investor Carl Icahn, at the time a minority shareholder in Lions Gate. In 2008 and 2009, after increasing his stake in the company, Icahn approached the board about appointing his own representatives as members of the board while threatening a proxy contest.

After Icahn made a tender offer, the Lions Gate board adopted a shareholder rights plan, also known as a poison pill, as a defensive measure to prevent Icahn’s acquisition of more than 20 percent of Lions Gate outstanding shares.

As part of several transactions, a board member purchased notes that were converted to Lions Gate stock. The company filed a Form 8-K announcing that the company had retired debt. A press release said that the notes were converted into more than 16 million shares, a move that served to decrease the percentage holdings of Icahn. The company said in its press release that the debt conversion was part of Lions Gate’s efforts to reduce its total debt. Lions Gate went on to elect a new board of directors and successfully stopped Icahn’s attempt to gain control from management, according to the court’s opinion and order.

SEC scrutiny. In September 2010, the SEC informed Lions Gate that it was conducting an informal investigation into the disclosures and transactions that were designed to fend off Icahn’s control. In January 2011, the SEC issued a formal order of investigation into whether there was a violation and in July 2012, the SEC sent “Wells Notices” indicating that the SEC Enforcement Division was considering recommending that the SEC file a civil action against the company and its executives for violations of securities laws. In March 2014, the SEC and Lions Gate resolved the matter, with the SEC instituting administrative proceedings and the company agreeing to pay the civil penalty.

The shareholders alleged that the company misrepresented the status of the SEC staff investigation on Forms 10-Q and 10-K by stating that the company did not believe that the outcome of any currently pending claims or legal proceedings would have a material adverse effect on the company’s financial statements.

Complaint dismissed. Addressing allegations that the company’s failure to disclose the investigation was a material omission, the court said that the company did not have a duty to disclose the SEC investigation and Wells Notices because the securities laws do not impose an obligation on a company to predict the outcome of investigations.

In this case, the court said, the SEC never proceeded with a charge against Lions Gate, or any litigation against individual defendants, despite the issuance of Wells Notices discussing their potential liability. The court also said that a government investigation, without more, does not trigger a generalized duty to disclose. The shareholders also failed to allege that the investigation itself was material in that it significantly altered the total mix of information available to an investor.

Ultimately, the court said, the complaint failed to allege that there was a general duty to disclose the SEC investigation, the Wells Notices, or the SEC settlement amount prior to when the settlement was announced. In addition, the court found that there was no duty to disclose under Regulation S-K, Item 102, Item 303, or Item 503.

Scienter. The shareholders had argued the existence of scienter based on the individual defendants being primarily motivated to prevent Icahn’s hostile takeover bid and retain control over their company. The court rejected the argument, saying that the shareholders did not explain how the nondisclosure of the SEC investigation in 2013 and 2014 would enable the defendants to retain control of Lions Gate. The shareholders failed to connect the motive to the allegedly materially false statements and omissions, the court said. The alleged omissions about the SEC investigation were irrelevant to the hostile takeover bid that Lions Gate had rebuffed four years earlier, according to the court.

The case is No. 14-cv-5197.

Attorneys: Rebecca M. Katz (Motley Rice) for KBC Asset Management NV. David Avi Rosenfeld (Robbins Geller Rudman & Dowd LLP) for Laborers Pension Trust Fund-Detroit & Vicinity. George T. Conway, III (Wachtell, Lipton, Rosen & Katz) for Lions Gate Entertainment Corp.

Companies: KBC Asset Management NV; Laborers Pension Trust Fund-Detroit & Vicinity; Lions Gate Entertainment Corp.

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