As I have noted in recent blog posts, there have already been several securities class action lawsuits filed this year related to the current wave of SPAC activity. These recently filed lawsuits have only just been filed and have not yet made their way to the dispositive motion stage. However, there are also other earlier-filed SPAC-related lawsuits pending, involving SPAC-related transactions that preceded the current SPAC wave. One of these earlier filed securities lawsuits involves Alta Mesa Resources, a company that collapsed within the first year after it was formed in a 2018 merger with a SPAC. On April 14, 2021, Southern District of Texas Judge George C. Hanks, Jr. denied the defendants’ motion to dismiss in the Alta Mesa case, in a ruling that may be of interest in relation to the numerous more-recently filed SPAC-related lawsuits. A copy of the order denying the defendants’ motion to dismiss can be found here.
Silver Run Acquisition Corporation II, a Special Purpose Acquisition Company (SPAC), completed an IPO in March 2017. On August 16, 2017, Silver Run announced its plan to merge with two separate but interrelated oil-and-gas companies, Alta Mesa Holdings LP (AMH) and Kingfisher Midstream LLC. The merger proxy stated that AMH and Kingfisher were “poised for accelerating growth” with significant increases in production and earnings expected by 2019. The merger closed on February 9, 2018, with the transaction valued at $3.8 billion. The combined company was known as Alta Mesa Resources, Inc., with AMH and Kingfisher as subsidiaries of Alta Mesa. Following the transaction, Alta Mesa’s securities were publicly traded.
Two months after the merger closed, Alta Mesa filed its first 10-K as a public company, and also issued an earnings release. Among other things, the company released EBITDA and production estimates that were, as the subsequently filed securities complaint alleged, “dramatically reduced” from the equivalent figures in the proxy statement. As 2018 progressed, the company continued to release similarly disappointing news, each news release announcing a further reduction in production estimates accompanied by a decline in Alta Mesa’s share price.
In February 2019, the company announced that it would not be able to file its 2018 annual report on time and that it was going to be taking material asset impairment charges, with the write-downs totaling $3.1 billion (less than twelve months after the merger transaction that had valued the company at $3.8 billion). In May 2019, the company announced that the SEC was investigating circumstances involved possible material weaknesses in the company’s internal controls. When the company ultimately filed its annual report in August 2019, the report identified sixteen material weaknesses in the company’s internal controls.
In September 2019, the company filed for Chapter 11 bankruptcy protection. Alta Mesa’s assets sold for $320 million, less than 10% of Alta Mesa’s claimed post-merger value of $3.8 million
As detailed here, in January 2019, shareholder plaintiffs filed a securities class action lawsuit against Alta Mesa in the Southern District of Texas. The plaintiffs filed their Second Amended Consolidated Complaint (here) on April 6, 2020. The complaint names as defendants 12 individuals who were officers or directors of Alta Mesa (including one individual who had been CEO of Silver Run prior to the merger); two other individuals who were officers of Silver Run; and four related entities, including Riverstone, which had sponsored the Silver Run SPAC, and the three investment firms that owned AMH or Kingfisher prior to the merger. Several of the individual defendants were also officers or directors of Riverstone, the SPAC sponsor.
The complaint was filed on behalf of the investors who voted in favor of the merger and investors who purchased shares of Alta Mesa (or its predecessor in interest, Silver Run) between August 16, 2017 (the date the merger was announced) and May 17, 2019.
The complaint alleges that prior to the merger, the defendants made a series of misrepresentations to induce Silver Run investors to vote in favor of the merger, including, among other things, using misleading reserve and financial projections to overstate the value of AMH and Kingfisther. The complaint alleges further that the misrepresentation of the company’s reserves and projections continued after the merger, and both before and after the defendants failed to disclose the company’s internal control and reporting weaknesses.
The complaint alleges that the defendants violated Sections 10(b), 14(a) and 20(a) of the Securities Exchange Act of 1934. The plaintiffs seek to recover damages on behalf of the plaintiff class.
The defendants moved to dismiss the complaint.
The April 14, 2021 Order
In his April 14, 2021 order, Judge Hanks denied the defendants’ motion to dismiss. As a general matter, Judge Hanks said that “the circumstances surrounding the company’s financial reporting … are alone enough to entitle Plaintiffs to discovery.”
In ruling on the motion with respect to the plaintiffs’ claims under Section 10(b), Judge Hanks focused on the company’s various disclosures shortly after the merger closed, as well as the $3.1 billion write-down. Judge Hanks said, “Under the circumstances, the enormity of the write-down over such a short period of time is enough for the case against these defendants to proceed.”
Judge Hanks also noted “other allegations sufficient to satisfy the pleading requirement.” Specifically, he noted that “the write-down constituted over 80% of Alta Mesa’s value and was disclosed a year after the special purpose acquisition company merger.” The write-down, Judge Hanks noted, “came simultaneously with the news that Alta Mesa’s accounting firm identified sixteen ‘material weaknesses.’” Judge Hanks also noted that “the SEC is investigating the write-down and Alta Mesa’s accounting practices.” In addition, Judge Hanks said, the plaintiffs allege that AMH prior to the merger and Alta Mesa after the merger “clandestinely used unconventional and unsustainable drilling methods to inflate reserve and earning estimates both before and after the merger.”
Accordingly, Judge Hanks concluded that the plaintiffs “have pled facts sufficient to show that the defendants who signed the March 29, 2018 10-K acted with the requisite severe recklessness under Section 10(b).” The same circumstances, Judge Hanks said, “also satisfy the pleading requirements under Section 14(a)” with respect to the individual defendants whom the plaintiff alleged participated in the preparation, review, and dissemination of the proxy. (Interestingly, among the defendants to whom Judge Hanks referred with respect to the proxy misrepresentations is Riverstone, the SPAC sponsor.)
With respect to the plaintiffs’ control person liability claims under Section 20(a), Judge Hanks noted that the plaintiff had alleged a “complex web” of ownership and business relationships and other factors that “satisfies the relaxed and lenient pleading standard for evaluating whether a plaintiff has sufficiently alleged a claim for control person liability.” Judge Hanks even denied the dismissal motion as to two former officers of Silver Run (which individuals were also Riverside-affiliated persons), and as to three pre-merger owners of AMH and Kingfisher, even though these individuals and entities were not named as defendants in the Section 10(b) and Section 14(a) claims.
Judge Hanks concluded his opinion by noting that while the PSRLA was enacted in part to discourage frivolous “strike suits,” the Court, he said, “cannot conclude that this lawsuit is an impermissible ‘strike suit.’” The Court, he added, “cannot opine at this point whether Plaintiffs’ claims will survive a motion for summary judgment, but Plaintiffs have established entitlement to discovery.”
Most of Judge Hanks’s 29-page opinion consists of a detailed review of the plaintiffs’ factual allegations, and of the facts and circumstances surrounding the collapse of Alta Mesa. By comparison to his review of the facts, Judge Hanks’s legal analysis is relatively short. Which is another way of saying that the outcome of this dismissal motion ruling was largely determined by the facts. Alta Mesa’s massive write-down just a year after the merger clearly had an impact on Judge Hanks’s consideration of the defendants’ dismissal motion.
But while this ruling was very fact-specific, there are some things about the ruling that are relevant in thinking about what it might mean for the other pending SPAC-related cases.
The first is that he denied the dismissal motion as to all defendants, including not just the directors and officers of Alta Mesa, but also as to the former officers of the SPAC, Silver Run, as well as to the SPAC sponsor, Riverside. He even denied the motion as to the control person liability claims, even as to the two former officers of the SPAC and the pre-merger owners of Kingfisher and AMH.
The fact that the SPAC sponsor and the pre-merger owners of the merger target companies all got swept into this lawsuit is interesting enough all by itself; the fact that the motions of these defendants to dismiss the claims filed against them were denied is even more interesting. The presence of these defendants in the lawsuit and the fact the claims against them were allowed to stand are very interesting considerations for any of us called upon to think about the potential scope and reach of liability relating to SPACs – particularly with respect to the potential scope and reach of liability arising out of a de-SPAC merger transaction. The liability equation looks a lot more open-ended if the cast of potentially liable characters includes the SPAC sponsor and the pre-merger owners of the private company target.
The liability equation also raises some complex potential insurance coverage issues, as several of the individuals named as defendants were sued in more than one capacity. The pre-merger officers of the SPAC are also named as executives of Riverside, the SPAC sponsor, as well. At least one individual, is named in his capacity as an executive of the SPAC and as an officer and director of Alta Mesa. The cross-liabilities create a complex picture from an insurance coverage standpoint.
Judge Hanks noted that there is no way to tell at this point whether the plaintiffs’ allegations will prove to be sufficient to survive a motion for summary judgment. To pick just one issue, will the plaintiff be able to come forward with sufficient factual matter to support the allegation that the various entities and individuals in fact exercised “control” sufficiently to support the control person liability claims? For now, at least, the plaintiffs have survived the initial pleading hurdle, and the case will go forward.
This lawsuit does share a common feature with several of the more recently filed SPAC-related securities suits, and that is the fact that here as in many of the recent cases, things went bad from the very start. It is hard to tell what went wrong here, as in many of the other cases, but it is clear that whatever happened, things clearly did not go as the participants in the merger would have hoped. When things go wrong right from the beginning, it does raise the concern that there was something wrong with the basic concept involved with the deal. At a minimum, there is a pretty clear suggestion that Alta Mesa was not ready for the burdens and scrutiny that go along with being a public company. There is also the question whether the absence of the process and discipline that is usually involved in a traditional IPO might have made a difference here.
As a result of the massive wave of SPAC IPOs over the last few months, there are now over 430 SPACs currently seeking a merger partner. The plan, of course, for each of the SPACs to complete a successful merger transaction. Over the coming months, there is going to be a steady stream of de-SPAC transactions. The sequence of events here presents a cautionary tale for everyone prospectively involved in a de-SPAC merger. Of course, many de-SPAC mergers will be successful. However, some will not. My fear is that there is going to be more de-SPAC transaction-related securities litigation to come, perhaps a lot more; some of the litigation, like this lawsuit, will survive the initial dismissal motion.