Scienter Pleading Flaws Fatal To Investor Suit Against Energy Execs

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July 8 — Chesapeake Energy Corp. shareholders failed to allege that certain corporate officials acted with culpable intent when they made allegedly false statements about the company's financial obligations, the U.S. Court of Appeals for the Tenth Circuit affirmed July 8 .  

According to Judge Monroe McKay, the plaintiffs “have not shown anything more than alleged knowledge of arguably material facts.”

“[W]e are simply not persuaded these allegations give rise to a cogent and compelling inference of scienter,” he continued.

Land-Grab Strategy

According to the court, the plaintiffs alleged that between April 2009 and May 2012, the defendants materially misled the public about two types of financial obligations—a program in which Chesapeake received immediate cash in exchange for the promise to produce and deliver gas over time, and a plan under which the chief executive officer, defendant Aubrey McClendon, was permitted to purchase up to a 2.5 percent interest in new gas wells drilled in a given year.

The plaintiffs alleged that with respect to the payment program, the defendants “touted the more than $6.3 billion raised” through the transactions, but did not disclose that the program would require Chesapeake to incur future production costs of approximately $1.4 billion.

Meanwhile, the wells program allegedly set McClendon's interests in conflict with the company's interests. Because the plan did not require McClendon to bear the cost of buying and exploring land on which no wells ultimately were drilled, the plaintiffs contended, it created an incentive for McClendon “to cause the company to engage in an aggressive land-grab strategy that maximized his odds of participating in productive wells but contributed to Chesapeake's debt problems.”

Allegedly, the defendants' misstatements and omissions caused the public to believe that the Chesapeake financial situation was improving, leading to a significant rise in stock price. However, the Chesapeake stock price plummeted by almost 60 percent when the true facts were revealed, the appeals court recapped.

The district court dismissed the complaint for failure to allege scienter; it did not reach the question of whether the defendants made material misstatements.

Affirming, the appeals court found “little in the complaint to support the conclusory allegation” that the allegedly misleading statements and omissions were motivated by an intent to defraud or that the defendants recklessly disregarded material facts that would have been important to a reasonable investor.

The plaintiffs were represented by Labaton Sucharow LLP, New York. Orrick Herrington & Sutcliffe LLP, San Francisco, represented the defendants.

The decision is available at