Although it was not misleading for a company to omit acquisitional growth from financial projections, it was deceptive to claim that the projections reflected more downside risk than upside potential, when this was not actually believed to be the case.
A securities fraud action alleging that a technology company improperly down played its value to make its acquisition by Samsung seem fair to shareholders has survived a motion to dismiss. The District of Connecticut found that a shareholder adequately pleaded that the proxy statement was misleading as to the reason the company revised its financial projections, and also as to a potential conflict of interest on the part of a financial advisor (Baum v. Harman International Industries, Inc., October 3, 2019, Chantigny, R.).
Acquisition by Samsung. Harman International Industries designs and engineers products and solutions for connected car systems and services supporting the Internet of Things. In November 2016, Harman’s board met to consider a proposed acquisition of Harman by Samsung Electronics Co.
At the meeting, Harman’s financial advisors, J.P. Morgan and Lazard, presented a discounted cash flow (DCF) analysis of financial projections that management had developed through fiscal year 2021 ("Management Projections"). Although not labeled as such, the Management Projections reflected only organic growth and did not account for future acquisitions—even though Harman had primarily grown through acquisitions in the past, and Harman’s CEO had stated internally that "strategic bolt-on acquisitions that accelerate growth" were a key aspect of Harman’s corporate strategy. The advisors also presented a DCF analysis of a separate set of projections based on the Management Projections, but downwardly moderated predicted growth by 25 percent (the "Sensitized Projections").
The board approved the acquisition at $112 per share, and subsequently issued a proxy statement to solicit votes on the merger. The plaintiff, a Harman shareholder, alleged that Harman made several misleading statements and omissions in the proxy statement that understated the company’s value, and that as a result, Harman shareholders did not receive adequate compensation in the acquisition.
Misleading statements and omissions. The court found that the complaint adequately alleged that two misstatements and omissions by Harman were materially misleading.
First, the complaint alleged that the proxy falsely stated that Harman management determined that the Management Projections included more downside risk than likely upside potential, thereby justifying the development of the less optimistic Sensitized Projections. This was material because it misled shareholders into discounting the Management Projections forecasts and helped to justify a lower sale price to Samsung.
The plaintiff successfully argued that this statement was both subjectively and objectively false. Harman achieved record revenue growth in 2016, and used the Management Projections, rather than the Sensitized Projections, as a benchmark prior to filing the proxy. Harman’s CEO had described highly similar financial projections from several months prior as "by far very conservative." Moreover, the defendants had an economic incentive to make the acquisition look more attractive, particularly the CEO, who stood to gain millions of dollars if the acquisition went through.
Second, the plaintiff successfully argued that the proxy was false and misleading because it omitted a material fact relevant to a potential conflict of interest of J.P. Morgan. The proxy disclosed that in the two previous years, J.P. Morgan and its affiliates had been compensated for providing certain services to both Samsung and Harman. However, J.P. Morgan neglected to disclose that J.P. Morgan Asset Management served as an investment manager for a Samsung affiliate during the same period that J.P. Morgan acted as a financial advisor on the Samsung-Harman deal. The court observed that by only listing engagements that ended before J.P. Morgan issued its fairness opinion in November 2016, the proxy could have led shareholders to incorrectly believe that J.P. Morgan had no ongoing business relationship with Samsung apart from the acquisition.
Other challenged statements. In contrast, the court found that two challenged statements were not misleading.
It was not misleading for the proxy to omit that Harman’s financial projections did not account for future acquisitions. The proxy specified that the projections, including the Management Projections, "do not take into account any circumstances or events occurring after the date they were prepared." Although the plaintiff did allege that Harman historically built its business through acquisitions and that the company affirmed that acquisitions were central to its strategy, she did not allege that Harman had plans for any specific acquisitions, and a reasonable investor would not have assumed that the Management Projections accounted for purely hypothetical future deals. Therefore, this omission was not material. In addition, the Management Projections fall within the PSLRA safe harbor, as they were identified as forward-looking statements and accompanied by meaningful cautionary language.
The court also did not find it misleading that the proxy stated that Harman did not "as a matter of course" release financial projections and that the projections contained in the proxy were not prepared for public disclosure. That Harman released one set of forecasts in August 2016 did not contradict the statement that the company "does not, as a matter of course, make public long-term projections as to future performance."
Loss causation. The court found that the complaint adequately pleaded loss causation. Transaction causation was plainly met because shareholder approval was required for the acquisition, and the plaintiff plausibly alleged that the shareholders’ approval of the acquisition damaged her. The Management Projections produced a price of approximately $116.25 per share, which was greater than the $112 per share that shareholders ultimately received, and material omissions or false statements justified the production of a weaker set of projections, which, in turn, were relied upon by a potentially conflicted adviser in producing a fairness statement that endorsed the $112 price.
Claims proceed. Accordingly, the plaintiff’s claims based on defendants’ opinion statement regarding the Management Projections and J.P. Morgan’s potential conflict of interest were allowed to proceed.
The case is No. 3:17-cv-00246 (RNC).
MainStory: TopStory FraudManipulation MergersAcquisitions Proxies PublicCompanyReportingDisclosure ConnecticutNews
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