On March 21, 2023, Judge Paul A. Engelmayer of the United States District Court for the Southern District of New York granted in part and denied in part a motion to dismiss a putative class against a Chinese internet company (the “Company”), its co-founder and chief executive officer (the “CEO”), and two other executives, alleging violations of Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 and Rule 10b-5.  Altimeo Asset Management v. Qihoo 360 Technology Co. Ltd. et al., 19 Civ. 10067, 2023 WL 2585942 (S.D.N.Y. Mar. 21, 2023).  Plaintiffs alleged that the Company engaged in a scheme to depress the price of the Company’s American Depositary Shares (“ADSs”) to enable them to pay shareholders an unfairly low price when they took the Company private as part of a merger in 2016 (the “Go-Private Merger”).  The Court held that two of the categories of alleged misstatements were actionable, while one category was not.  The Court further dismissed the claims of plaintiffs who tendered shares in connection with the Go-Private Merger (“Tenderer Shareholders”), but sustained the claims of plaintiffs who sold shares after the Go-Private Merger was announced but before the effective date (“Seller Shareholders”).  This decision follows the Court’s previous dismissal of plaintiffs’ claims, which we covered here, and the Second Circuit’s revival of those claims, which we covered here.

As of 2015, the Company provided various internet and cloud-based products to hundreds of millions of customers.  In June 2015, the CEO and a group of private investment companies (the “Buyer Group”) approached the Company’s board of directors with a going-private proposal, which included acquiring all of the Company’s outstanding shares for $77.00 in cash per ADS.  In December 2015, the Company’s financial advisor provided an opinion that the offer, which represented “a premium of 16.6% to the closing price of the Company’s ADSs on June 16, 2015, the last trading day prior to the Company’s announcement of its receipt of a ‘going-private’ proposal,” and “a premium of 32.7% to the average closing price of the Company’s ADSs during the 30 trading days prior to its receipt of a ‘going-private’ proposal,” was fair to Company shareholders.  Shortly thereafter, the Company entered into a merger agreement.  Between January 11, 2016, and March 3, 2016, the Company published four successive versions of proxy materials, seeking to persuade shareholders to vote for the Go-Private Merger.  In March 2016, the shareholders voted in favor of the Go-Private Merger at an extraordinary meeting.

Plaintiffs alleged that the Company’s proxy materials contained materially false and misleading statements about (i) the fairness of the proposed terms; (ii) the reasons for the Go-Private Merger; and (iii) the strategic alternatives that the Company had considered.  According to plaintiffs, these statements were misleading because the proxy materials did not mention that the Buyer Group had a concrete plan to relist the Company on a Chinese stock exchange at a higher valuation.  Plaintiffs alleged that had the Company disclosed the Buyer Group’s intention to relist the Company, more shareholders would have attended the extraordinary meeting and voted against the Go-Private Merger or would have dissented from the Go-Private Merger and exercised appraisal rights in the Cayman Islands.  On November 2, 2017, more than 15 months after the Go-Private Merger, the Company merged with a publicly traded company that was already listed on the Shanghai Stock Exchange.  Through this reverse merger or “backdoor listing,” the Company was able to list its main internet business on the Chinese stock market without the regulatory hurdles associated with an initial public offering.  In February 2018, the Company began trading on the Shanghai Stock Exchange.

The Court first addressed the three categories of alleged misstatements, finding two of them to be actionable.  In addressing plaintiffs’ allegations about the “fairness” of the proposed terms, the Court found that while the Company’s statements were statements of opinion rather than fact, and therefore generally non-actionable, they fell under the exception articulated in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund that a statement may be actionable if it fails to disclose a fact that would “conflict with what a reasonable investor would take from the statement itself.”  The Court found that the existence of a plan to relist the Company on the Chinese stock market was a fact that necessarily needed to be disclosed for the Company’s “fairness” statements not to mislead shareholders.  As to the Company’s statements about why the Go-Private Merger occurred in the first place, the Court found these statements to be misleading given the context.  Specifically, the Court noted that the Go-Private Merger, “as alleged, was the first step in a two-step plan to later go public again, and leaving out the second part omitted a—if not the—main reason to go private.”  With respect to the third category of misstatements, however, the Court held that plaintiffs had not sufficiently alleged that the Company’s statements about a lack of “viable alternatives” were false.  Plaintiffs argued that these statements were false “because, in fact, a backdoor listing was such an alternative.”  The Court rejected this argument, noting that the Company’s statements about alternatives “expressly presupposed [the Company’s] “continuing to operate” or “remaining as a public company.”  The Court therefore held that these misstatements were not actionable because “[t]here [were] no facts pled suggesting that an alternative plan existed—let alone was viable—whereby all shareholders could have retained their interests in [the Company] once private so as to be able to capitalize on a future relisting.”

The Court next addressed economic loss and loss causation for Tenderer Shareholders, who received $77 per ADS, and the Seller Shareholders, who sold their ADSs after the Go-Private Merger was announced and prior to the effective date of the Go-Private Merger.  The Court first granted the motion to dismiss the Tenderer Shareholders’ claims for failing to allege a plausible theory of economic loss and loss causation.  The Court emphasized that the Tenderer Shareholders “received the $77/ADS share offered in connection with the Merger,” which “reflect[ed] a significant appreciation over the price at which [the Company] was trading before the announcement of the Merger.”  The Court held that plaintiffs’ “theory that events following the rejection of [the Go-Private Merger] would have transpired so as to reward plaintiffs for their shares at a price exceeding $77/ADS” “was far too contingent and anchored in guesswork to support a viable § 10(b) claim.”  In contrast, the Court denied the motion to dismiss Seller Shareholders’ claims, finding that “[t]he chain of causation for the [Seller Shareholders] is, in sum, short and plausible.”  Seller Shareholders argued that “but for the proxy materials’ misstatements, the stock’s price would have more closely hugged the $77/ADS share price during the months between the announcement and the completion of the Merger, whereas in fact, the price dipped to a close of $67.83 during that period, and often closed little above $70/ADS share during significant portions of that period.”  The Court held that Seller Shareholders had adequately alleged that, but for the fraud, their “sales would have been at higher prices, or the sellers would have held onto their shares through to the exchange date and secured $77/ADS share.”

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