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Financial Reporting and the Law

In United Food and Commercial Workers Union Local 880 Pension Fund v. Chesapeake Energy Corporation, the U.S. Court of Appeals for the Tenth Circuit affirmed a lower court’s dismissal of the complaint on a motion for summary judgment. The Tenth Circuit rejected the plaintiff’s arguments that Chesapeake’s offering documents violated Sections 11, 12(a)(2), and 15 of the Securities Act. It concluded that the offering documents omitted disclosure that Chesapeake “had changed its risky hedging strategy and . . . CEO McClendon had pledged substantially all his company stock as security for margin loans and lacked the resources to meet margin calls.”

Although the plaintiff had argued “that it is inappropriate to consider the May 8-K because it was not part of the offering materials,” the court held that Chesapeake’s disclosure in its earnings release furnished (but not filed) on Form 8-K “supplied essentially all the information whose absence in the Registration Statement is the basis of Plaintiff’s claim.” Quoting Slater v. A.G. Edwards & Sons, Inc., 719 F.3rd 1190 (10th Cir. 2013), the court explained that the analysis of the undisclosed information’s materiality depends on whether the omitted disclosure would have “significantly alter[ed] the total mix of information available” to a reasonable investor.

In considering the total mix of available information, the court explained that “[p]ublic documents are part of that total mix if an investor interested in a particular type of information about a company would know of the existence of the record and could readily access it.” Chesapeake had furnished the earnings release on a Form 8-K, which the court noted is “readily available.” The court concluded that “a reasonable investor interested in Chesapeake’s swap practices would know from prior 8-Ks that these disclosures provide the latest information on the subject.”

With respect to the claim that Chesapeake’s disclosure about the CEO’s pledges were inadequate, the court concluded that the disclosure complied with Item 403(b) of Regulation S-K “and further disclosure was not required.” Although the disclosure did not point out that the CEO “lacked the financial resources to always be able to cover his margin calls,” the court concluded that “the risk was obviously inherent in the quantity of margined stock disclosed.”