DealLawyers.com Blog

In In re: Shanda Games Limited Securities Litigation, (2d. Cir.; 2/25), the 2d Cir. reversed a district court’s ruling & allowed plaintiffs to proceed with securities law claims premised on allegedly false and misleading projections included in a merger proxy and on the target board’s statement that the merger was “fair” to the minority stockholders.

The litigation arose of out of a 2015 going private transaction involving Shanda Games, a China-based maker of online games incorporated in the Cayman Islands. The plaintiffs were former minority stockholders led by David Monk, and they alleged that certain directors and executive officers of the company made false and misleading statements and omissions in Shanda’s merger proxy in an effort to conceal that the deal price did not reflect the fair value of the company’s shares and thereby discourage the exercise of appraisal rights.

Among their other claims, the plaintiffs alleged that the projections included in the company’s merger proxy were materially misleading as was the board’s characterization of the merger as “fair” to the minority stockholders.  The plaintiffs also claimed that the company’s failure to update the proxy statement to include disclosure concerning the performance of a key new product represented a material omission.

With respect to the projections included in the merger proxy, the plaintiffs focused on the manner in which projected amortization and depreciation expense were calculated in preparing the projections and contended that the proxy. They pointed out that manner in which those expense categories were determined differed from historical practice and violated accounting principles.  The Court agreed:

At the start, Monk has adequately alleged that basic accounting principles were violated in the preparation of the March 2015 Projections. Prior to the Freeze-Out Merger, Shanda had estimated depreciation and amortization based on the estimated useful life of the assets. But as the Complaint alleges, for the March 2015 Projections, Shanda used a new method, one which “assumed that depreciation and amortization would grow at a rate that was a function of revenue growth” in violation “of basic accounting principles.” App’x 761, ¶ 169. This method resulted in the impossible outcome of the book value of Shanda’s capital assets becoming negative in 2018. App’x 761-62, ¶ 170.

To be sure, Shanda was permitted to choose any accepted accounting method while characterizing its process for preparing the Projections as reasonable. But it was limited to accepted methods. Cf. New Eng. Carp., 80 F.4th at 170 (“[A] plaintiff will be unable to establish that [a statement] is false merely by showing that other reasonable alternative views exist. Where those alternatives exist, the speaker making the statement (expressing an opinion) can choose among them ․” (emphasis added)). This is because a reasonable investor assured by Shanda that the Projections were reasonably prepared would infer that basic accounting principles were followed.

The plaintiffs also contended that statements to the effect that the disclosure contained in the proxy statement was a “summary of the financial projections provided by management” to the company’s financial advisor and the buyer group was misleading, because the projections presented in the proxy statement excluded a year of data that was part of the projections. The Court agreed, concluding that with one out of five years of data excluded, the projections in the proxy statement did do not constitute an accurate summary of the material provided to the financial advisor and the buyer group.

The plaintiffs further challenged the statements in the proxy that the transaction was fair to the minority stockholders.  In that regard, they noted that the defendants were aware that the company’s key new product was performing significantly better than projected and that this resulted in the company being significantly more valuable than the valuation reflected in the deal price.  As a result, they alleged that the defendants knew that this statement of opinion was false. The Court agreed:

We also conclude that Monk has adequately alleged that by the time of the Final Proxy the Defendants did not believe that the Merger was fair and that describing the Merger as fair did not align with the information in Shanda’s possession. At that point, MIIM had launched and the game’s initial success was such that the Defendants “could not possibly have believed the Buyout was fair.” . . . Shanda was able to track in-game purchases, the source of revenue for MIIM, in real time and management reviewed the data at least weekly. It is reasonable to infer that Defendants therefore would have known about MIIM’s success because MIIM generated over $90 million each month between its launch in August and the issuance of the Final Proxy in October. Monk thus plausibly alleges that Shanda knew that the fairness opinion was based on assumptions that had proven incorrect, yet Shanda continued to state that the Merger was fair. Accordingly, Monk has adequately pleaded that these statements are actionable.

However, the Court rejected the plaintiffs’ claims that the failure to update the proxy materials to include information on the new product’s performance did not represent a material omission, because under Cayman law, there was no duty to disclose that information.

– John Jenkins