October 21, 2014

Tenth Circuit: Total Mix of Disclosures Adequately Advised Investors of Risks

The Tenth Circuit Court of Appeals issued its opinion in United Food & Commercial Workers Union Local 880 Pension Fund v. Chesapeake Energy Corp. on Friday, August 8, 2014.

Chesapeake Energy Corporation was one of the country’s largest producers of natural gas, and in July 2008, it sold 25 million shares of common stock in a public offering. Later in 2008, the financial crisis hit, and Chesapeake suffered badly. A group of investors led by United Food and Commercial Workers Union Local 880 Pension Fund filed suit against Chesapeake in the Southern District of New York, citing violations of §§ 11, 12(a)(2), and 15 of the Securities Act and alleging that the Registration Statement for the offering was materially false and misleading because Chesapeake should have disclosed that it had a risky gas price hedging strategy and that Chesapeake’s CEO, Aubrey McClendon, had pledged substantially all his stock as security for margin loans. On Chesapeake’s motion, the case was transferred to the Western District of Oklahoma. Chesapeake moved for summary judgment, which the district court granted, finding that (1) the Registration Statement disclosed the risks associated with Chesapeake’s hedging strategy; (2) Chesapeake had adequately disclosed that McClendon had pledged most of his shares for collateral; and (3) additional disclosures about McClendon’s financial resources would be unreasonable because they would require speculation. The plaintiffs appealed.

The Tenth Circuit examined Chesapeake’s disclosures prior to the stock offering and found they adequately conveyed that Chesapeake was engaging in risky hedging strategies. The Registration Statement included general information about Chesapeake’s hedging strategy and conveyed Chesapeake’s anticipated future losses due to the strategy. Additionally, SEC filings incorporated in the Registration Statement disclosed information about Chesapeake’s “knockout swaps,” which were their most risky hedge investment. Plaintiffs allege that because Chesapeake disclosed some information about its knockout swaps, it had a duty to update that information, but the Tenth Circuit disagreed. The Tenth Circuit found that the information was provided in several SEC filings, and the total mix of information available to a reasonable investor revealed sufficient information about Chesapeake’s knockout swaps.

Next, the Tenth Circuit looked at Chesapeake’s disclosures regarding McClendon’s pledging of stock for margin loans. Plaintiffs alleged that the Registration Statement did not adequately disclose McClendon’s investments. The Tenth Circuit disagreed, noting that the Registration Statement contained disclosures required by Item 403(b) and further disclosure was not required or reasonable.

The Tenth Circuit affirmed the district court’s grant of summary judgment.

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