Friday, April 16, 2021

Rapid financial collapse was enough to show SPAC misled about value

By Rodney F. Tonkovic, J.D.

A company's loss of most of its value after less than a year of existence helped persuade a district court that there was severe recklessness. The complaint said that a SPAC overstated the value of two target companies to secure approval of a merger and continued to inflate estimates afterwards. After barely a year in existence, the combined company disclosed a write-down of over 80 percent of its value. The court found that the size and seriousness of the write-down combined with other factors was sufficient to show that signers of the company's initial Form 10-K, which denied any overvaluing, acted with severe recklessness (Camelot Event Driven Fund, A Series Of Frank Funds Trust v. Alta Mesa Resources, Inc., April 14, 2021, Hanks, G.).

This action arose out of the collapse of Alta Mesa Resources, Inc. In March 2017, a special purpose acquisition company ("SPAC") called Silver Run Acquisition Corporation II completed its IPO. Under the terms of its prospectus, Silver Run had two years to acquire a target business with a value of at least 80% of the IPO proceeds ($1.035 billion). The SPAC's management targeted two oil-and-gas companies: Alta Mesa Holdings, LP ("AMH") and Kingfisher Midstream LLC in a transaction valued at $3.8 billion. 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 was approved in early 2018 and the new combined company became known as Alta Mesa Resources.

Earnings and value plummet. Less than two months after the merger closed, Alta Mesa filed a Form 10-K and earnings release disclosing that the EBITDA and production estimates in the proxy had been nearly halved. Alta Mesa's executives nevertheless denied that this meant that AMH and Kingfisher had been overvalued in the proxy. Alta Mesa continued to post similar disappointing news as 2018 marched on, with each disclosure followed by a drop in share price. In February 2019, Alta Mesa announced that it would record impairment charges totaling $3.1 billion. After a number of delinquent filings and reports of material weaknesses in internal controls, the company filed for bankruptcy in September 2019, and the AMH and Kingfisher assets ultimately sold for $320 million.

Intentional inflation. The plaintiffs sued a total of 18 defendants including Alta Mesa and Silver Run executives and four business entities. The complaint essentially argued that the defendants intentionally overstated the value of AMH and Kingfisher's assets, using misleading reserve and financial projections to secure the approval of Silver Run's shareholders. Among other allegations, the plaintiffs said that Alta Mesa used non-standard, unsustainable drilling techniques to inflate short term profits, such as drilling too many wells too close together. These practices, and their distorting effects, continued after the merger as the company scrambled to increase production. According to the plaintiffs, Alta Mesa hoped to inflate Kingfisher's value in order to quickly spin it off in an IPO.

Enormous write-down. The fraud claims were based mainly on Alta Mesa's first Form 10-K and the later write down equivalent to over 80 percent of the company's value. The court said that the "enormity" of the write down over such a short period was sufficient for the case to proceed. Plus, the write down arrived simultaneously with news that Alta Mesa's accountants had identified sixteen material weaknesses in its internal control over financial reporting (which the SEC is investigating). The facts pleaded sufficiently showed that the defendants who signed the initial Form 10-K acted with severe recklessness, the court said. The same circumstances also satisfactorily pleaded proxy claims against five defendants who participated in the preparation and dissemination of the proxy.

The case is No. 4:19-cv-957.