In a thorough and well-reasoned decision, a judge in the SDNY dismissed a 16(b) complaint alleging that investors in a private placement formed a 13(d) group and thereby became ten percent owners subject to Section 16. The decision should give investors in PIPEs and other private placements some comfort that otherwise unaffiliated investors do not become a group just because they appoint a lead investor and separately enter into common post-closing arrangements with the issuer.
The 12 defendants are investment funds and an individual who purchased convertible notes and warrants of Genius Brands pursuant to a single stock purchase agreement. Each investor had its own legal counsel, but one investor, Anson Investments, was appointed lead investor and allegedly negotiated the SPA. The SPA provided that, at closing, the defendants would pay for the securities with $7 million cash and $4 million in promissory notes, with Anson serving as “collateral agent” to hold collateral securing each defendant’s promissory note.
The conversion/exercise prices of the Genius notes and warrants were subject to reduction upon stockholder approval, which the SPA required Genius to seek. As a condition to closing, Genius was required to obtain agreements to vote in favor of the transaction from existing investors holding at least 40% of the stock (“principal investors”) and lock-up agreements barring the principal stockholders from selling stock for 15 months after closing.
After closing and shareholder approval, each of the defendants signed a consent and waiver allowing Genius to sell additional common stock in a separate offering, provided that Genius file a registration statement registering the shares underlying their warrants by a certain date. After the registration statement was filed, each of the defendants entered into a conversion agreement with Genius requiring it to convert all of its notes into common stock and a leak-out agreement limiting its sales of stock if the market price remained below a specified level.
In dismissing the complaint, the judge said that none of the allegations supported an inference that the defendants had formed a group, among themselves or with the principal investors. Among the courts notable legal conclusions were:
- Whether or not the SEC’s recent statement that formation of a group does not require an “agreement” is entitled to deference, the SEC also said that whether a group exists depends on “facts and circumstances” and that circumstantial evidence may establish that investors “combined in furtherance of a common purpose.” A “combination,” in turn, requires more than parallel investment decisions, and generally is evidenced by meetings, communications or solicitations among investors.
- Rule 13d-5(b)(2), which provides a safe harbor for investors in a private placement if four conditions are met, establishes an exemption from Section 13(d) where a group otherwise exists and does not mean that investors who do not satisfy the conditions are necessarily a group.
- Investors in a private placement do not form a group with existing investors of an issuer who enter into a voting agreement or lock-up agreement with the issuer to facilitate the closing, based on a theory that the investors are intended third party beneficiaries of the agreements.
The court held that none of the agreements cited by the plaintiff evidenced a combination to further any common objective other than to invest in Genius. “Cooperative” activity, the court said, such as appointing a lead investor and a collateral agent, does not create a combination absent a showing that the investors were motivated by a desire to affect control or otherwise engage in concerted activity.
Courts sometimes are hesitant to grant a motion to dismiss a complaint alleging formation of a group, given the fact-intensive nature of the inquiry. Fortunately this judge reviewed the allegations and the law carefully and came to a justified conclusion. The case is not over yet, though, because the judge granted the plaintiff leave to amend.
– Alan Dye, Section16.net, April 5, 2023