New US decision affecting Chinese companies going private and relisting
The United States Court of Appeals for the Second Circuit recently revived a securities class action lawsuit against Beijing-based Qihoo 360 Technology by investors who claim the company misled them regarding its plans to relist when seeking approval of a take-private transaction. As the decision will likely encourage further lawsuits against relisted Chinese companies, careful attention to public disclosures at all phases of a take-private transaction is critical to effective management of litigation risk.
Qihoo’s Take-Private Transaction
In July 2016, Qihoo completed a US$9 billion take-private transaction that was overwhelmingly approved by its shareholders. In proxy materials prepared for the shareholder vote, Qihoo stated it had no “current plans, proposals or negotiations” for an “extraordinary corporate transaction,” but that in the future, the company “may propose or develop plans and proposals” to relist its shares. Sixteen months after closing, the company announced that it would relist on the Shanghai Stock Exchange through a reverse merger – a so-called “backdoor listing.”
In March 2019, former investors in Qihoo American Depository Shares (ADS) led by Altimeo Asset Management filed a securities class action complaint in the Southern District of New York against Qihoo and certain of its executives on behalf of investors who traded Qihoo securities in the months leading up to the take-private transaction. The plaintiffs alleged that Qihoo and its controlling officers violated Section 10(b) of the Securities Exchange Act of 1934, which authorizes monetary damages to investors who suffered losses by purchasing shares in reliance on material misrepresentations or omissions by an issuer. According to the complaint, Qihoo misled investors by falsely claiming the buyer group had no plans to relist the company when seeking approval for the take-private transaction. In support of their claims, plaintiffs cited a confidential witness and Chinese news reports indicating that the privatization plan contemplated relisting, along with an expert in Chinese M&A transactions who opined that a backdoor listing like Qihoo’s typically takes a year or more to execute.
The District Court Decision
In August 2020, the district court granted defendants’ motion to dismiss the complaint, finding that plaintiffs failed to adequately plead that at the time it went private the company “had in place a concrete plan to relist Qihoo” “as opposed to envisioning a possible future relisting.” Altimeo Asset Mgmt. v. Qihoo 360 Tech. Co., 2020 WL 4734989, at *17 (S.D.N.Y. Aug. 14, 2020). In other words, plaintiffs failed to identify any misrepresentation or omission under the Exchange Act.
Other judges in the Southern District of New York followed suit, dismissing similar cases brought by Altimeo Asset Management against WuXi PharmaTech, JA Solar, and E-House — other US-listed companies who went private only to relist in China.
The Second Circuit’s Decision
Altimeo appealed the Qihoo decision to the Second Circuit Court of Appeals. In a decision issued last week, the appellate court vacated the dismissal, finding that the plaintiffs had adequately alleged a misstatement or omission of material fact. See Altimeo Asset Mgmt. v. Qihoo 360 Tech. Co., 2021 WL 5499455 (2d Cir. Nov. 24, 2021). The panel ruled that plaintiffs’ reliance on confidential witness statements and news reports indicating that a relisting plan was in the works at the time of the take-private transaction, together with the expert opinion regarding the typical timeline for a backdoor relisting, supported plaintiffs’ allegation that the proxy’s assurances that “the Buyer Group does not have any current plans” to relist Qihoo were materially misleading. “[I]n order for the company to have been relisted when it was,” the court reasoned, “the [defendants] must have been planning to relist at the time of the shareholder vote” approving privatization.
The Second Circuit remanded the Qihoo case back to the district court to consider whether plaintiffs adequately pleaded additional elements of their securities fraud claim, including scienter. Regardless of the outcome below, its decision is likely to have wider ramifications. The Second Circuit did not create new law – it simply applied existing securities law principles differently than the district court – but its decision may encourage Altimeo Asset Management or other litigious investors to further target Chinese-headquartered companies who have recently relisted in China.
In the wake of the Qihoo decision, companies contemplating a take-private transaction should anticipate continued scrutiny by the plaintiffs’ bar of their public disclosures. Careful attention to complete and accurate disclosures at the time of privatization may forestall shareholder suits entirely or increase the likelihood of achieving dismissal at the pleading stage. Freshfields’ Mergers & Acquisitions and Securities Litigation groups are available to review proposed disclosures and otherwise advise on strategies to minimize securities litigation risk.