Last month, Part I of this article examined Oil and Gas Reserves, Safety Policies, and Fracking. This month’s portion examines solar companies, Chinese companies, and recently filed class actions.
Throughout the past ten years securities litigation has made front-page news in the energy sector and federal securities class action filings against energy companies have increased in the past three years.
The profitability of solar equipment manufacturers dropped sharply in 2011 due to stiff competition from Chinese firms. In 2011, the price of conventional solar panels from China fell 30 percent. As a result, several U.S. solar companies filed for bankruptcy.
But solar companies’ problems did not stop there. The Obama administration suffered a political black-eye when Solyndra LLC—the “hallmark of the president’s green jobs program”—filed for bankruptcy in September 2011. Solyndra had received $535 million in loan guarantees from the Department of Energy in the fall of 2009.
And, in February 2012, First Solar, Inc. (NASDAQ FSLR) disclosed that it suffered a large decrease in sales, and had informed the SEC months earlier that it was opening an internal investigation regarding possible reporting violations relating to a solar farm project made to meet a deadline to receive a federal loan guarantee. In turn, the SEC opened a formal investigation on November 17, 2011.
Following First Solar’s disclosures, shareholders filed a class action lawsuit in the District of Arizona in March 2012. Plaintiffs allege that throughout the class period, defendants made false and/or misleading statements, as well as failed to disclose: (1) the full impact of certain manufacturing flaws on the company’s earnings; (2) the company was improperly recognizing revenue concerning certain products in its systems business; and (3) the company lacked adequate internal and financial controls.
Shareholders also filed four derivative suits between April 3, 2012 and April 19, 2012, containing similar factual allegations to the class action, and claiming that certain directors breached their fiduciary duties.
The Chinese economy continues to expand and, as a result, Chinese companies continue to seek additional financing. One of the most popular ways for a Chinese company to raise cash is to list on a U.S. stock exchange. As a consequence, the past two years have seen a dramatic increase in securities litigation against Chinese companies. In 2010, there were 12 securities class actions against Chinese companies, but one year later, that number had more than tripled to 39, representing approximately 18 percent of all securities class actions filed in 2011. Put in perspective, suits against all foreign issuers combined in 2010 represented only 11.4 percent of all securities class actions filed. This surge can likely be attributed to efforts by U.S. regulatory authorities, and shareholders, to pressure certain Chinese companies about their bookkeeping practices. The SEC’s exercise of increased oversight has come in part because many Chinese companies went public in the U.S. through “reverse mergers,” a process that has been characterized as being less credible than a traditional IPO.
A number of energy companies with Chinese origins have been swept up in this recent focus on Chinese companies. Some examples of Chinese energy companies facing a securities class action or a disclosed regulatory investigation during 2011 or 2012 include: Silvercorp Metals, Inc., China Integrated Energy, Inc., Puda Coal, Inc., Sino Clean Energy, Inc., SinoTech Energy Ltd., and Qiao Xing Universal Resources, Inc.
The bottom line is that U.S.-listed Chinese energy companies should exercise heightened vigilance surrounding favorite topics for SEC investigations and shareholder actions due to the marked increase in regulatory and private litigant attention.
Recently Filed Class Actions
Recently, several securities class actions have been lodged against well-known energy companies. By and large, allegations in these lawsuits are typical of the claims brought in most securities class actions—they all involve allegations of false and misleading statements to the investing public. The following is a brief summary of the allegations in some recent cases against energy sector companies:
On March 28, 2012, a purported class of Dynegy shareholders sued the company and certain of its officers and directors in the Southern District of New York. The suit claims that Dynergy’s CEO, CFO, and investor Carl Icahn “knew or recklessly failed to inform investors that Dynergy’s wholly-owned subsidiary fraudulently transferred direct ownership in one of Dynergy’s indirectly-owned subsidiaries directly to Dynergy.” The suit follows on the heels of a report by the Chapter 11 examiner in Dynergy’s bankruptcy case that found the company’s restructuring transaction undertaken last year constituted a fraudulent conveyance.
On April 2, 2012, plaintiffs in a class action complaint filed in the Southern District of Texas alleged that Hyperdynamics issued materially false and misleading statements regarding the company’s business and financial results, mainly regarding the development of its wells offshore of the Republic of Guinea in West Africa.
Delta Petroleum Corp.
Delta is an independent oil and gas company engaged primarily in the exploration for, and acquisition, development, production, and sale of, natural gas and crude oil. Its core area of operations is the U.S. Rocky Mountain region. According to a complaint filed on April 18, 2012 in the District of Colorado, certain of Delta’s officers and directors made materially false and misleading statements concerning the company’s financial results causing the company’s stock price to fall from a high of $11.70 per share on February 28, 2011 to a low of $0.71 per share on November 10, 2011.
Chesapeake Energy Corporation
Chesapeake is a leading natural gas producer that aggressively promotes the use of fracking. Recently, private litigants filed multiple class actions against it and the SEC disclosed the existence of an investigation. According to a complaint filed on April 26, 2012 in the Western District of Oklahoma, the allegations revolve around Chesapeake’s CEO owning roughly 1.35 million shares of Chesapeake stock and holding a share of Chesapeake’s oil and gas wells pursuant to the Company’s Founders Well Participation Program (the FWPP). Under that program, the CEO has the right to purchase a 2.5 percent interest in each well drilled by Chesapeake, must pay a proportionate share of related costs, and is entitled to a proportionate share of revenues generated.
The allegations claim that starting in 2009, the CEO leveraged all of his FWPP interests in order to pay up front development costs. He not only secured loans on his ownership interests in the wells, but also sold off revenue “participation rights” in the wells. The CEO also secured a personal loan in excess of $500 million from a hedge fund that engaged in financing transactions with Chesapeake. As a result, by year-end 2011, the CEO had amassed personal debt on Chesapeake-related wells exceeding $1 billion. The size of the debt and the CEO’s leveraging of all his FWPP-related interests allegedly represented material undisclosed risks to Chesapeake investors. Its CEO was excessively leveraged according to plaintiffs, and his ability to satisfy those debts was dependent upon the Company's successful performance of the mortgaged wells.
Chesapeake shares plummeted $1.06—or 5.5 percent—representing over $500 million in market value losses. On April 26, 2012, Chesapeake abruptly terminated the FWPP program, while Board members disclaimed any knowledge of the size of the CEO’s indebtedness.
Against the backdrop of increasing private litigant and regulatory activity, public companies in the energy sector should maintain awareness of securities litigation, from traditional class actions to SEC investigations. Setting the right tone at the top and establishing good internal controls are the best ways to prevent risk of securities litigation. And, if allegations of wrongdoing surface, knowing when and how to conduct a proper investigation tends to go a long way in effectively dealing with most lawsuits and investigations.