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Litwin v. Blackstone Group, L.P.

Court of Appeals for the Second Circuit
634 F.3d 706 (2011)
ELI5:

Rule of Law:

Under Sections 11 and 12(a)(2) of the Securities Act, an issuer must disclose known trends or uncertainties that are reasonably expected to have a material unfavorable impact on revenues. The materiality of an omission is assessed through a fact-specific inquiry considering both quantitative and qualitative factors, including the significance of the affected business segment, even if the underlying investment is a small percentage of the company's total assets.


Facts:

  • The Blackstone Group, L.P. (Blackstone), a global alternative asset manager with significant Corporate Private Equity and Real Estate business segments, prepared for an Initial Public Offering (IPO) in 2007.
  • A Blackstone-led consortium had purchased FGIC Corp. in 2003, a financial guarantor that subsequently increased its exposure to risky sub-prime mortgage-backed securities; by early 2007, the sub-prime market was showing signs of significant distress.
  • In 2006, Blackstone invested $3.1 billion in Freescale Semiconductor, Inc., which accounted for 9.4% of its Corporate Private Equity assets and was its largest investment in that segment since 2004.
  • In March 2007, just before the IPO, Freescale lost its exclusive manufacturing agreement with Motorola, its largest customer, following years of production issues.
  • Blackstone's real estate funds held investments in residential properties at a time when the broader housing market, particularly the sub-prime mortgage sector, was experiencing a significant downturn.
  • On June 21, 2007, Blackstone's IPO Registration Statement became effective. It described the real estate industry as experiencing 'historically high levels of growth and liquidity' but did not disclose the specific issues concerning FGIC or Freescale.
  • The IPO raised over $4.5 billion, with the net proceeds primarily going to individual defendants and other Blackstone insiders.

Procedural Posture:

  • Landmen Partners, Inc. filed a putative class action complaint against The Blackstone Group, L.P. and several executives (Blackstone) in the United States District Court for the Southern District of New York.
  • The District Court appointed Martin Litwin, Max Poulter, and Francis Brady as lead plaintiffs.
  • The lead plaintiffs (Plaintiffs-Appellants) filed a Consolidated Amended Class Action Complaint.
  • Blackstone (Defendants-Appellees) filed a motion to dismiss the complaint for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).
  • The District Court granted Blackstone's motion and dismissed the complaint with prejudice.
  • The plaintiffs appealed the dismissal to the United States Court of Appeals for the Second Circuit.

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Issue:

Does a registration statement contain material misstatements or omissions in violation of Sections 11 and 12(a)(2) of the Securities Act when it fails to disclose known, adverse trends affecting specific portfolio investments and the broader real estate market, even if those investments represent a small percentage of the issuer's total assets under management?


Opinions:

Majority - Straub, Circuit Judge

Yes. The registration statement plausibly contained material misstatements and omissions because it failed to disclose known adverse trends that were reasonably likely to have a material impact on the company's revenues. A company's duty to disclose under Item 303 of Regulation S-K requires revealing known trends or uncertainties, and the materiality of this information is not determined by quantitative measures alone. The court rejected a formulaic, 5% threshold for materiality, emphasizing that qualitative factors are critical. Here, the alleged omissions concerning FGIC and Freescale were qualitatively material because they related to Blackstone's flagship Corporate Private Equity segment, a significant aspect of its operations and brand identity. Furthermore, the court rejected Blackstone's 'portfolio' defense—the argument that a loss in one company could be offset by gains in others—stating that a company cannot aggregate positive and negative information to avoid disclosing a particular material negative event. Similarly, alleged misstatements and omissions regarding the real estate market were material because the real estate segment constituted nearly a quarter of Blackstone's assets and the company's optimistic statements were directly contradicted by known adverse market trends.



Analysis:

This decision significantly clarifies the disclosure obligations for large, diversified investment firms like private equity groups conducting an IPO. It establishes that a company's complex structure does not shield it from the duty to disclose material, negative information about specific portfolio investments. The court's emphasis on qualitative materiality—particularly the importance of a business segment—means that firms cannot hide problems in key investments simply because they are quantitatively small compared to the firm's total assets. This precedent strengthens investor protection by preventing firms from 'netting out' good and bad news and requires them to be transparent about negative trends affecting qualitatively significant parts of their business.

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