ATTORNEY: MURIELLE STEVEN WALSH
POMERANTZ MONITOR, SEPTEMBER/OCTOBER 2014
Pomerantz recently prevailed in an appeal before the Fifth Circuit In re Houston American Sec. Lit. The court reversed and remanded district Judge Harmon’s order dismissing the complaint.
The case involves misrepresentations by Houston American, a Texan oil drilling company, about the amount of its recoverable oil reserves, as well as the success of the company’s oil drilling efforts in a particular region, the so-called “CPO4 Block.” In November 2009, the company made the extraordinary claim that the CPO4 Block contained 1-4 billion barrels of recoverable oil reserves. Later, after it began drilling in the block, Houston American represented to investors that the drilling was producing significant “hydrocarbon shows,” which generally indicate the presence of oil.
The case alleges that, in fact, the company had never conducted any of the necessary tests to substantiate its estimate of recoverable oil, and that company executives were aware of significant problems concerning the drilling operations which conflicted with positive statements they made about the drilling. Houston American eventually admitted that it had abandoned drilling efforts in CPO4, and that the SEC was investigating what had happened.
The district court dismissed the complaint, holding that it failed to substantiate either of the required elements of scienter or loss causation. With respect to scienter, it accepted allegations by our confidential witnesses that the individual defendants were aware of serious problems with their drilling operations when they made positive statements about them to investors; and it also accepted the allegation that the defendants had no reasonable basis for their assertion that the CPO4 block had billions of barrels in recoverable oil reserves.
The court nonetheless found that defendants’ decision to invest additional money into the drilling ($5 million of corporate funds, not their own), somehow negated any inference of scienter as a matter of law. The district court reasoned that it would make no sense for the defendants to invest additional money in a venture if they didn’t believe it would ultimately be successful. In reversing, the Fifth Circuit emphasized that defendants’ personal beliefs about the ultimate success of their operations are irrelevant because they were aware of, but concealed, negative information that was inconsistent with those professed beliefs.
The district court had also held that plaintiffs had not sufficiently pleaded that their losses were directly caused by the misrepresentations, as opposed to “other economic factors.” The Fifth Circuit found that this too, was an error, because it imposed a heightened pleading requirement for loss causation that is not required under the Supreme Court’s decision in Dura.
A few weeks after the Fifth Circuit decision came down, the SEC filed a formal complaint against Houston American and its executives, alleging securities fraud.