Pomerantz Achieves Victory for Qihoo Investors
POMERANTZ MONITOR | JANUARY FEBRUARY 2022
Pomerantz achieved a significant victory for investors when the Second Circuit Court of Appeals vacated the district court’s dismissal of a securities fraud class action against Qihoo 360 Technology Co. Ltd. (“Qihoo”) on November 24, 2021.
Qihoo is a leading technology company in China that provides internet security services and other technology offerings. This case arises out of Qihoo’s management buyout in 2016, followed by the announcement in 2017 that the company would relist on the stock market in China for multiple times what the buyers paid to shareholders in the buyout. A group of buyers that included Qihoo’s top executives took Qihoo private for $9.4 billion in a deal that closed on July 15, 2016. After the buyout, Qihoo split up its businesses and then, on November 2, 2017, SJEC—an elevator-manufacturing company listed on the Shanghai Stock Exchange—announced that it would be conducting a backdoor listing (also known as a reverse merger) with Qihoo’s main businesses. On February 28, 2018, Qihoo’s shares effectively began trading on the Shanghai Stock Exchange; the company had a market capitalization of $62 billion at the end of its first day of trading.
The complaint alleges that that the defendants violated Section 10(b) and other provisions of the Securities Exchange Act of 1934 because they misrepresented that the buyers (including Qihoo’s CEO and President) planned, at the time of the privatization, to relist the company in China. The district court applied an overly demanding standard to conclude that the complaint did not plead a false and misleading statement because it did not adequately allege a “concrete and definite” relisting plan at the time of the buyout, despite the multiple sources of evidence supporting the allegation that the buyers had precisely that plan.
In vacating the district court’s ruling, the Second Circuit explained that the lower court improperly discounted the evidence showing that a relisting plan existed at the time of the buyout. This evidence includes news articles referencing materials provided to investors in the privatization that discussed the relisting plan, an expert’s analysis of the amount of time it takes to plan for a backdoor listing in China, and information from a confidential witness who was at a meeting with one of the defendants. The Second Circuit concluded that these allegations created a “plausible inference that a concrete plan was in place at the time Qihoo issued the Proxy Materials.” This meant that the plaintiffs adequately alleged that “the statement in the Proxy Materials that ‘the Buyer Group does not have any current plans’ to relist Qihoo—as well as its omission of any such plan—was misleading.”
The Second Circuit’s decision contains several notable rulings. First, the decision provides a helpful reminder that “[a]lthough pleading standards are heightened for securities fraud claims, we must be careful not to mistake heightened pleading standards for impossible ones.” This is an important acknowledgment that courts must apply common sense when assessing the plausible inferences that should be drawn from the facts alleged in a complaint at the pleading stage.
In addition, the Second Circuit’s decision is significant in its recognition of what the plaintiffs alleged to be false. The complaint alleged that the defendants’ statement, in the proxy materials for the privatization, that the buyer group did not have any “current plans, proposals or negotiations” for an “extraordinary corporate transaction” was false because the group already had its relisting plan when it made that statement. The district court held that because the proxy materials also noted that after the buyout, the company “may propose or develop plans and proposals” to relist, the plaintiffs faced a higher hurdle in what they were required to show in order to allege the falsity of the defendants’ statements. On appeal, the plaintiffs argued that the defendants’ warning that the company might at some point in the future “propose or develop plans and proposals” to relist has no bearing on whether the buyer group had any “current plans” at the time of buyout. The Second Circuit agreed. Because the complaint plausibly alleged that the buyer group had a plan to relist at the time of the buyout, the defendants’ denial of “any current plans to relist Qihoo” was adequately alleged to be false and misleading.
The Second Circuit’s decision also explains clearly how the materiality element applies here. The plaintiffs argued on appeal that it does not matter how advanced the buyer group’s relisting plan was because the stage of development of the plan relates to the separate issue of materiality, which—particularly in the context of significant corporate transactions—is a fact-intensive issue that cannot be decided on a motion to dismiss. The Second Circuit again agreed. It stated the well-known standard that “a complaint may not properly be dismissed on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance.” The Court also cited cases holding that this standard is particularly important in the merger context, where “the materiality of merger negotiations depends on the specific facts of each case.” For example, information concerning merger negotiations has been held to be “material even when negotiations had not jelled to the point where a merger was probable.” Applying these principles to the facts alleged here, the Court held that because the plaintiffs adequately alleged that negotiations for the relisting “were ongoing—or had already happened— at the time of the shareholder vote,” these facts were not “‘so obviously unimportant to a reasonable investor’ as to allow the dismissal of the appellants’ claims.”
This decision in Qihoo has considerable implications for other cases that raise similar issues. Qihoo is one of several Chinese companies that have gone private from U.S. exchanges in recent years and relisted shortly thereafter on a foreign stock exchange for multiple times the price they paid to investors to take the company private. Other Chinese companies might soon follow, based on recent political and regulatory developments involving Chinese companies that are listed on U.S. exchanges. Multiple other courts have relied on the district court’s now-vacated decision in Qihoo when deciding that a relisting plan was not adequately alleged. Those other courts, as well as courts that address claims about future relistings, will need to apply the Second Circuit’s important Qihoo decision to the facts before them.