The troubled deal in which Advent International Corporation was to acquire cybersecurity firm Forescout Technologies, Inc. is already the subject of litigation pending in Delaware Chancery Court, and indeed a trial in the Delaware merger dispute case is scheduled for July. Now Forescout shareholders have filed a separate securities lawsuit, alleging that between the time the deal was announced in February 2020 and the time that Forescout announced in May 2020 that Advent had advised Forescout that Advent would not “consummate” the acquisition, Forescout made a series of misrepresentations about the company’s financial condition and performance. Among other things, the investors allege that Forescout misrepresented or omitted to disclose the impact that the COVID-19 outbreak was having on its financial performance. A copy of the plaintiffs’ June 10, 2020 complaint can be found here.
On June 10, 2020, plaintiff shareholders filed a securities class action lawsuit in the Northern District of California against Forescout; its CEO; and its CFO. The complaint is filed on behalf of investors who purchased Forescout securities between February 6, 2020, the date Forescout announced the Advent acquisition, and May 15, 2020, the day Forescout announced that Advent had communicated to Forscout that Advent “would not be proceeding to consummate the acquisition of Forescout.”
The complaint alleges that when Forescout announced the merger, Forescout “knew that its business had begun to suffer a dramatic and undisclosed downturn, including in its fast-growing Asia Pacific and Japan (‘APJ’) region that was impacted by COVID-19 starting in January.” The complaint also alleges that Forescout’s revenues for the fourth quarter 2019 were inflated through what was later alleged by a whistleblower to be a “channel stuffing scheme.” The complaint alleges that because of these factors “Forescout knew that the consummation of the [Merger] was exceptionally risky at the time it announced the Merger Agreement.”
The complaint further alleges that in the March 3, 2020 preliminary proxy and in the March 24, 2020 definitive proxy Forescout continued to present its initial projections developed in January and continued “to omit the ongoing disastrous quarter and the risks COVID-19 posed to Forescout’s business and pending Transaction.” By the time of definitive proxy was filed, “Forescout and its senior officers knew that COVID-19 was severely and disproportionately impacting Forescout’s business,” that Advent had expressed concerns about Forescout’s financial condition, and that there was a risk that the Transaction would not close.
Forescout did not amend the proxy to disclose the “rapidly increasing concerns regarding the impact of COVID-19.” Forescout’s shareholders approved the proposed merger at a Special Meeting on April 23, 2020, but, the complaint alleges “shareholders were deprived of a full and fair opportunity to vote but did not without the truth regarding Advent’s concerns relating to COVID-19 and intent not to proceed with the Transaction.”
In early May 2020, the complaint alleges, Advent advised Forescout that Advent was considering not closing the merger, for reasons that were “100% COVID-related.”
On May 11, 2020, Forescout filed its first quarter 10-Q. The filing contained extensive risk factor disclosure relating to the coronavirus outbreak. However, the complaint alleges, the risk factors “failed to warn investors that COVID-19 was having a disproportionate impact on Forescout and that Advent was considering not closing the merger.”
On May 15, 2020, a representative of Advent sent Forescout a letter in which Advent formally advised Forescout that it was not consummating the merger. Among other things, in attempting to terminate the merger deal, Advent asserted that a “Material Adverse Effect” had occurred, the financial impact of the COVID-19 outbreak, which had a “materially disproportionate effect on [Forescout’s] business relative to other companies of similar size operating in the industries in which [Forescout] conducts business.”
On May 19, 2020, Forescout sued Advent in Delaware Chancery Court seeking specific performance of the merger agreement. The Delaware litigation remains pending and is scheduled for trial in July. Many of the allegations in the recently filed securities lawsuit complaint are based on pleadings filed in the Delaware litigation.
The securities class action lawsuit complaint alleges that the defendants violated Sections 10(b) and 20(a) of Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks damages on behalf of the class.
The underlying Delaware litigation relating to this failed merger is only one of several lawsuits currently pending in which the essential dispute is whether the COVID-19 outbreak represents a Material Adverse Effect that relieves the buyer of completing the deal. (For example, on June 10, 2020, Simon Property Group sued Taubman Centers in Michigan state court seeking a declaratory judgment that the COVID-19 outbreak represents a material adverse effect relieving Simon of its agreement to acquired Taubman.)
This new securities class action lawsuit against Forescout is first one that I am aware of where the shareholders of the disappointed target company have sued the company and its senior officials claiming to have been misled about the impact of the coronavirus on the company and the possible effect of the pandemic on a pending merger transaction.
The one thing the set of circumstances does show is the devastating ripple effect the coronavirus outbreak is having on business operations and financial transactions. The pandemic has disrupted and will continue to disrupt the business world in myriads of ways. As this case shows, the pandemic’s extensive impact can result in litigation of varying kinds based on varying issues and raising varying allegation pertaining to the outbreak.
By my count, this lawsuit represents the eleventh COVID-19 related securities class action lawsuit filed so far. It is the first to be filed involving a failed merger deal, but there undoubtedly will be further lawsuits arising out of business transactions that fell apart or were disrupted by the pandemic and its economic consequences.
While among the 11 securities suits filed so far there are multiple cases against cruise ship companies and biotechnology companies, this lawsuit is the first to be filed against a cybersecurity firm. I have to say that my untutored assumption would have been that cybersecurity firms would be prospering in the outbreak, not suffering a revenue downturn – and perhaps that kind of assumption is somewhere in the issues being disputed in the Delaware litigation.
The first of the COVID-19 related securities suits were filed almost exactly three months ago, on March 12, 2020. In the litigious U.S., eleven securities suits in three months is a relatively modest amount. So far at least, the COVID-19-related securities litigation could hardly be described as a “wave” of litigation – more like a steady flow. I do believe that we will continue to see COVID-19-related D&O lawsuits to be filed, and that perhaps there will be more filed as we move from the public health crisis phase to the economic recovery phase. The economic fallout will continue to accumulate for months to come, and as companies make statements about their ability to recover and about their financial condition, there will be increased occasions on which investors could be disappointed and might attempt to argue that they have been misled.