Ninth Circuit Says Kaye Scholer Client Can Proceed with Securities Suit

Kaye Scholer achieved a significant litigation victory for one of its clients, investor David Hildes, who lost approximately $25 million when his Harbinger Corporation (Harbinger) stock was exchanged for Peregrine Systems, Inc. (Peregrine) stock pursuant to a materially false registration statement issued by Peregrine. A three-judge panel of the U.S. Court of Appeals for the Ninth Circuit unanimously reversed an earlier district court decision barring Hildes from amending his securities complaint against certain former outside Peregrine directors, allowing Hildes to proceed with his lawsuit.

The matter began in 2000, when Hildes was a director of software company (Harbinger). Peregrine and Harbinger entered into merger discussions, and eventually a merger agreement, under which Harbinger would become a wholly-owned subsidiary of Peregrine and each outstanding share of Harbinger stock would be exchanged for .75 shares of Peregrine common stock. Harbinger’s obligations to effect the merger were subject to certain conditions, including the SEC’s acceptance of a to-be-filed registration statement by Peregrine that accurately reflected its financial results. Six weeks later, Peregrine later filed the registration statement, signed by the former Peregrine outside directors. Harbinger and Peregrine’s shareholders approved the merger.

In 2002, Peregrine shareholders brought a class action against the outside directors and others, alleging various violations of the securities laws. Hildes opted out of the class action and filed his own lawsuit. Hildes alleged that Peregrine’s financial statements contained numerous omissions and misrepresentations, including a more than $120 million overstatement of revenue and a more than $190 million understatement of net losses. Hildes claimed that, as a result of this fraud, Peregrine’s stock price was artificially inflated, causing him to lose more than $25 million.

Hildes initially brought suit against Peregrine’s former auditing firm and others. When he moved for leave to amend his complaint to add claims against Peregrine’s former outside directors, the district court denied Hildes’ motion to amend on the basis that Hildes’ Section 11 claim was futile. The district court reasoned that because Hildes had entered into a voting agreement and irrevocable proxy with Peregrine prior to the registration statement’s effective date, which required that Hildes’ shares be voted in favor of a merger, Hildes’ alleged losses could not have been caused by the false registration statement. Hildes’ sole issue on appeal was whether the district court had erred in denying him leave to amend his complaint to add a Section 11 claim against the outside directors.

The Ninth Circuit reversed, agreeing with Kaye Scholer’s arguments that Hildes never made a binding commitment to exchange his Harbinger shares for Peregrine shares prior to the filing of the registration statement. Citing Hildes’ allegations that, if the registration statement had been accurate,  Harbinger’s board would have declared Peregrine in breach of the merger agreement and terminated the merger agreement, which would have terminated the voting agreement and proxy or alternatively, that had the registration statement been truthful, Harbinger’s shareholders would have voted against the merger, the Ninth Circuit held that Hildes had sufficiently alleged that Peregrine’s material misstatements had caused his losses and, therefore, he had stated a potentially meritorious claim.  

According to Kaye Scholer litigator Michael Lynn, who argued the appeal, “The district court’s decision would have let the defendants off the hook for their role in signing the false and misleading registration statement that ultimately led to our client’s losses. We are pleased that the Court of Appeals rejected the district court’s approach and recognized that our client has a potentially meritorious claim against the defendants. Our client looks forward to vigorously pursuing his claim in the district court, where we hope that he will ultimately be able to recover the millions of dollars he lost as a result of the Peregrine fraud.” 

Partner Robert Barnes, of the firm’s Los Angeles office, and Associate Kyle D. Gooch, of the firm’s New York office, also assisted on the appeal. Kaye Scholer will continue to represent Hildes in the next stages of this litigation.