NEW YORK (Reuters) - Blackstone Group LP BX.N suffered a legal setback on Thursday as a federal appeals court revived a lawsuit accusing the private equity firm of hiding bad investments before raising $4.7 billion in its 2007 initial public offering.
Investors accused Blackstone of failing to properly reveal at the time of the IPO that its investments in a bond insurer, a semiconductor company and real estate were losing value, limiting potential performance fees and raising the chance that fees could be “clawed back” by limited partners.
Blackstone, one of the world’s largest and best-known private equity firms, offered 153 million common units at $31 each when it went public in June 2007.
But the price fell to about $7 by the time the plaintiffs filed an amended complaint in October 2008, during a global credit crisis and recession. It eventually bottomed at $3.55 in February 2009, and has yet to fully recover.
A unanimous three-judge panel of the 2nd U.S. Circuit Court of Appeals in New York said a lower court judge erred in dismissing the case. Investors had sought to hold Blackstone, co-founder and Chief Executive Stephen Schwarzman, co-founder Pete Peterson and others responsible for their losses.
“Plaintiffs plausibly allege that material information was omitted from, or misstated in, defendants’ initial public offering registration statement and prospectus,” in violation of federal securities law, Judge Chester Straub wrote.
“We see no principled basis for holding that an historically ‘private’ equity company that has chosen to go public is somehow subject to a different standard under the securities disclosure laws and regulations than a traditional public company with numerous subsidiaries,” Straub added.
Blackstone spokesman Peter Rose said the firm will defend against the lawsuit, calling the investors’ allegations “totally without merit.”
DISCUSSING KNOWN PROBLEMS
Thursday’s ruling comes amid expectations of rising IPO activity in 2011, including from auto and mortgage lender Ally Financial Inc, pipeline company Kinder Morgan Inc, and others.
“The court is reminding companies of the well-established principle that they have to talk about something known that may result in a bad outcome,” James Fanto, a professor at Brooklyn Law School, said in an interview. “It is also telling private equity firms they are no different from anyone else.”
In afternoon trading, Blackstone units were up 16 cents, or 1 percent, at $16.91 on the New York Stock Exchange. Fanto said “it’s possible investors saw this coming, and factored in a settlement into Blackstone’s stock price.”
David Brower, a lawyer for the Blackstone investors, said his clients could number in the tens of thousands, and plan to pursue the case in the federal district court in Manhattan.
“We’re very pleased,” Brower, a partner at Brower Piven PC, said. “The ruling is particularly important because it confirms that SEC rules create a duty on companies going public to disclose known trends that could materially affect results.”
REASONABLE INVESTORS WANT TO KNOW
Investors contended that New York-based Blackstone should have revealed prior to its IPO a $331 million investment in FGIC, a bond insurer hurt by subprime mortgages; a $3.1 billion investment in Freescale Semiconductor Inc, which would lose a key contract; and some commercial real estate investments.
Blackstone countered that securities law did not require it to disclose expansive details about hundreds of investments.
U.S. District Judge Harold Baer ruled for Blackstone in September 2009. He said FGIC and Freescale were not material relative to Blackstone’s $88.4 billion of assets, and the investors failed to link known problems in residential housing to Blackstone investments in commercial and hotel properties.
But Straub said reasonable investors “would almost certainly want to know” information that Blackstone thought could materially hurt revenue from corporate private equity.
The judge also said it is plausible that a collapse in residential real estate and home loan securitizations might reasonably hurt commercial real estate investments.
“It is only when there is both materiality and a duty to disclose that a company may be held liable for omitting information,” he wrote. “These requirements provide sufficient protection against the opening-of-the-floodgates argument advanced by Blackstone and accepted by the District Court.”
The case is Litwin et al v. Blackstone Group LP et al, 2nd U.S. Circuit Court of Appeals, No. 09-4426.
Reporting by Jonathan Stempel, editing by Gerald E. McCormick, Dave Zimmerman and Tim Dobbyn
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