In 2008 Chеsapeake Energy Corporation was one of the largest producers of natural gas in the United States, with thousands of wells in several states. By early July of that year the price of natural gas had risen to its highest level since the end of 2005 and Chesapeake’s stock price had risen about 50% in the prior six months. Against that background, on July 9, 2008, Chesapeake sold 25 million shares of common stock in a public offering.
Soon thereafter, a financial crisis rocked the global economy. The New York Stock Exchange Composite Index — tracking the exchange where Chesapeake was listed— fell more than 30% in the three months after the Chesapeake offering. Chesapeake was hit even harder, with sharp drops in the prices of natural gas and' Chesapeake’s stock.
United Food and Commercial Wоrkers Union Local 880 Pension Fund (Plaintiff), representing the class of all persons who purchased securities in the offering, contends that Chesapeake and named individual defendants (collectively Chesapeake), violated §§ 11, 12(a)(2), and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k, 77Z(a)(2), and 77o, because the Registration Statement for the offering was materially false and misleading. (Plaintiff also raised claims against other defendants associated with the underwriting of the offering.) According to Plaintiff, Chesapeake should have disclosed (1) that it had expanded a risky gas-price hedging strategy that made it vulnerable to a fall in natural-gas prices, and (2) that CEO Aubrey McClendon had pledged substantially all his company stock as security for margin loans’ and lacked the resources to meet margin calls. The district court granted summary judgment for Chesaрeake. On June 21, 2013, the court dismissed the claims against the underwriter defendants without prejudice and granted a joint motion for entry of judgment under Fed. R.Civ.P. 54(b) as to Chesapeake. Plaintiff appeals. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm because Chesapeake’s alleged omissions were not material or misleading.
I. BACKGROUND
Chesapeake was the country’s third-largest producer of natural gas at the time of the offering. It produced billions of cubic feet of natural gas each day and had trillions of cubic feet of reserves. Its strategy was to focus on the discovery, acquisition, and development of natural gas in the United States. Before the offering the company had increased production every year for 18 years, and in the first quarter of 2008 it had drilled hundreds of new wells.
The stock offering was on July 9, 2008. Information about Chesapeаke and the details of the offering were set forth in the Registration Statement, which included a prospectus and incorporated by reference some of Chesapeake’s recent filings with the Securities and Exchange Commission (SEC). Chesapeake sold 25 million shares of common stock in the offering.
Natural-gas prices had been rising steeply. From December 31, 2007, to July 3, 2008, less than a week before the offering, the price had moved from $7,483 per million Btu (British thermal units) to $13,577. Unsurprisingly, Chesapeake’s stock price had also risen. In the six months preceding the offering its stock price had increased by almost half. But the upward trends sharply reversed after
This suit originated in 2009 when various parties filed complaints against Chesapeake and its investment bankers in the Southern District of New York. The district court consolidated the lawsuits and appointed Plaintiff to represent the class. Plaintiff filed its amended complaint on September 11, 2009. On Chesapeake’s motion, the case was transferred a month later to the Western District of Oklahoma. Chesapeake moved for summary judgment on December 28, 2011.
The district court granted Chesapeake’s motion. It ruled (1) that the Registration Statement “disclosed in detail the risks associated with Chesapeake’s hedging strategy,” Order at 22, United Food & Commercial Workers Union v. Chesapeake Energy Corp., No. CIV-09-1114-D,
II. DISCUSSION
“We review the district court’s grant of summary judgment de novo, applying the same standards that the district court should have applied.” Merrifield v. Bd. of Cnty. Comm’rs,
A. The Applicable Statutes
Plaintiff alleges violations of sections 11, 12(a)(2), and 15 of the Securities Act of 1933. Section 11 imposes liability on certain persons
Section 12(a)(2) similarly imposes liability on any person who “offers or sells a security ... by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading.” 15 U.S.C. § 77i(a)(2). The definition of materiality is the same as under section 11 (and under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b)), see Morgan Stanley,
[T]he language of sections 11 and 12(a)(2) creates three potential bases for liability based on registration statements and prospectuses filed with the SEC: (1) a misrepresentation; (2) an omission in contravention of an affirmative legal disclosure obligation; and (3) an omission of information that is necessary to prevent existing disclosures from being misleading.
Id. at 360.
Section 15 states that “[e]very person who, by or through stock ownership, agency, or otherwise, ... controls any person liable under sections [11 and 12], shall also be liable jointly and severally with and to the same extent as such controlled person.” 15 U.S.C. § 77o(a). In other words, section 15 allows “a person who controls a party that commits a violation of the securities laws” to “be held jointly and severally liable with the primary violator.” Maher v. Durango Metals, Inc.,
Plaintiff argues that Chesapeake violated these securities laws because the materials it provided in connection with its public stock offering should have disclosed (1) that it had changed its risky hedging strategy and (2) that CEO McClendon had pledged substantially all his company stock as security for margin loans and lacked the resources to meet margin calls. We turn first to the allegations involving hedging and then those involving McClendon’s margin loans. For each claim we set out additional relevant background before discussing the merits of the claim.
Chesapeake used a hedging strategy to manage price volatility in the market for natural gas. Hedging enables a seller to lock down how much it will earn when it sells its natural gas in the future so that it does not have to worry about dramatic fluctuations in price. Perhaps to oversimplify a bit, say Chesapeake wanted to be assured that when it sold a million Mcf (thousand cubic feet) of gas on a date 20 months in the future (the sale date), it would be paid $9 per Mcf (the fixed price). It could enter into a contract (wholly separate from Chesapeake’s sales of gas to customers) under which Chesapeake would receive from (or pay to) a third party (often a financial institution like Morgan Stanley or Lehman Brothers) the difference between the market price of that quantity of gas on the sale date and the cоst of that quantity at the fixed price. If the market price dropped below the fixed price, Chesapeake would be protected by a payment from the third party that equaled the difference between what it was paid on the market' and what it would have been paid if the market price had been $9 per Mcf. On the other hand, if the market price on the sale date exceeded $9, Chesapeake would have to pay the third party the excess of what it was paid on the market over what it would have been paid at $9 per Mcf. These contracts — called swaps — matured up to 30 months in the future. Although the swaps stabilized Chesapeake’s financial position and decreased its vulnerability to fluctuations in the price of natural gas,
Chesapeake also entered into more complicated hedging contracts. For example, it used knockout swaps, which were like ordinary swaps except that the other party was excused from paying if the market price of natural gas fell below a certain threshold (the knockout price) on the date of maturity. The knockout price was generally set about three dollars below the negotiated fixed price. Knockout swaps provided less protection from falling prices than ordinary swaps because they did not limit Chesapeake’s risk if the price of natural gas fell too far. In that event Chesapeake would be left with the market price for its natural gas. On the other hand, the other party to .a swap contract would pay Chesapeake more to enter into a contract with a. knockout feature because of that added risk assumed by Chesapeake. If ordinary swaps represented a bet that natural gas prices would not exceed the fixed price, the knockout feature represented a bet that prices would not drop below thе knockout price.
Chesapeake had increased its income by hundreds of millions of dollars through the use of knockout swaps. Its swaps had been “knocked out” by low natural-gas prices only four times before the offering. But when natural gas prices fell dramatically in 2008, the knockout provision was expensive for Chesapeake. Plaintiff esti
The Registration Statement included general information about Chesapeake’s hedging strategy. It explained that when natural-gas prices rose, its hedging strategy would be costly: “[0]ur hedging strategy allows us to predict with greater certainty the effective natural gas and oil prices to be received for our hedged production,” but “can also limit the prices we actually realize for our natural gas and oil production and therefore reduce our natural gas and oil revenues in the future.” ApltApp., Vol. II at 949. The Registration Statement also disclosed that because natural gas and oil prices had risen “dramatically” in 2008, its hedging strategy had “negatively impacted our earnings in the first quarter of 2008 during which we incurred $1.1 billion of unrealized losses.” Id. Not predicting the imminent fall in natural-gas prices, it assumed that prices would continue to rise and said that “we anticipate incurring additional substantial unrealized losses in the quarter ended June 30, 2008, and we expect such losses could result in our reporting negative revenues from natural gas and oil sales and will result in an overall net loss for such quarter.” Id.
Although absent from the Registration Statement itself, information about knockout swaps could be found in the SEC filings incorporated in the statement. Of those filings, the May 10-Q — a quarterly report with data through March 2008— provided the most reсent disclosures about Chesapeake’s knockout swaps. It listed the volume of knockout swaps Chesapeake had entered into that would mature in 2008, 2009, and 2010, and stated the average fixed price and the average knockout price for the contracts.
Plaintiff argues that Chesapeake violated securities laws when its Registration Statement did not disclose that it had entered into more knockout swaps and raised the knockout prices after it filed the May 10-Q. For specific data on the increase in knockout-swap volume and the increase in knockout prices after the May 10-Q and before the July offering, Plaintiff points to Chesapeake’s August 8-K, which came out after the offering. (8-Ks are forms to notify investors of certain events important to the company.) Plaintiff contends that Chesaрeake’s failure to disclose these changes concealed two kinds of risk: (1) more swaps with knockout provisions meant increased vulnerability to a fall in natural-gas prices; and (2) the knockout swaps were riskier than they had been in the past because they had higher knockout prices (natural-gas prices would not need to fall to as low a price before the knockout provision was triggered). According to Plaintiff, investors would have wanted to know about Chesapeake’s increased emphasis on knockout swaps because “[w]hen natural gas prices hit a knockout price, the consequences are severe: the counterparty need not perform, and Chesapeake loses its hedged price.” Aplt. Br. at 39. It says that once Chesapeake chose to prоvide information about its knockout hedging strategy by incorporating the May 10-Q, “it had a duty to be both accurate and complete.” Id. at 38 (internal quotation marks omitted). We hold, however, that there was no violation of Chesapeake’s disclosure duties. We doubt that the Registration Statement was misleading. Certainly, Plaintiff has failed to support its claim that Chesapeake changed its knockout hedging strategy in the second quarter of 2008.
In any event, Chesapeake had publicly disclosed before the offering the gist of what was later disclosed in the August 8-K. We look first at the Registration Statement and the documents it incorporates.
The authorities relied on by Plaintiff do not support its contention that Chesapeake’s disclosures were misleading. Plaintiff cites In re Lehman Brothers Securities & ERISA Litigation,
Plaintiff similarly cites Caiola v. Citibank, N.A.,
Moreover, almost all the change in Chesapeake’s knockout-swap hedging was disclosed before the offering date in the May 8-K filed by Chesapeake with the SEC. To support its claims that the changes in the hedging were “dramatic,” Aplt. Br. at 37, and “substantial[ ],” id. at 38, Plaintiffs brief compares the data in the May 10-Q with the data in the August 8-K, which showed that after the first quarter of 2008 Chesapeake increased the volume of knockout swaps and the knockout prices. In the interval between the two reports Chesapeake increased the volume of swaps maturing in the last two quarters of 2008 by 12%, the volume of swaps in 2009 by 25%, and the 2010 swaps by 61 %. (The knockout prices are harder to compare because the 10-Q reports an average price while the 8-K reports a rаnge.) Almost all these increases, however, are reported in the May 8-K. Between the May 8-K and the August 8-K the increase in volume was only 3% for 2009 swaps and there was no increase for 2010 swaps;
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Plaintiff argues that it is inappropriate to consider the May 8-K because it was not part of the offering materials. But the report is still relevant. The claim here is that Chesapeake failed to disclose material information, and “[mjateriality ... depends on the information that already exists in the market.” Slater,
We recognize that in United Paperwork-ers the court refused to consider disclosures in a 10-K not submitted to the shareholders with the proxy materials. But there were several circumstances different from what are present here. United Paperworkers concerned a proxy request to vote on a shareholder proposal to require the company to undertake certain environmental initiatives. Garber,
Also distinguishable are the two cases cited by Plaintiff to support its view that the May 8-K should not be considered. In New Jersey Carpenters Health Fund v. Royal Bank of Scotland Group, PLC,
Finally, Plaintiff argues that summary judgment was inappropriаte on materiality because it offered expert testimony that the omissions were material, the stock price dropped after the August 8-K was released, and Chesapeake restructured its hedges in the fall of 2008 to avoid the consequences of falling gas prices. But none of that evidence can overcome the fact that the May 8-K supplied essentially all the information whose absence in the Registration Statement is the basis of Plaintiffs claim. Additional disclosure would not have “altered the total mix of information available” to investors. Slater,
C. McClendon’s Margined Stock
Chesapeake’s CEO at the time of the offering, Aubrey McClendon, owned more than 5% of the company. Most of his shares were held in margin accounts and pledged as collateral for hundreds of millions of dollars of loans. McClendon had purchased the shаres on margin using borrowed money. So long as the price of Chesapeake stock rose, the shares provided sufficient collateral for the loans. In fact, the quantity of shares held in the accounts would be in excess of collateral requirements and federal regulations would allow him to take excess cash or securities out of the margin accounts. See 12 C.F.R. § 220.4(e)(1), (2).
Unfortunately for McClendon, Chesapeake stock plummeted during the financial crisis. Rather than enjoying excess collateral, he had to sell nearly all his Chesapeake stock between October 8 and 10, 2008, to meet margin calls. These sales were disclosed after the market closed on October 10. McClendon released a public statement saying: “These involuntary and unexpected sales were precipitated by the extrаordinary circumstances of the worldwide financial crisis.... In no way do these sales reflect my view of the company’s financial position or my view of Chesapeake’s future performance potential.” ApltApp., Vol. II at 535 (internal quotation marks omitted). The closing price of Chesapeake’s stock declined from 27.567 on October 3 to 15.7471 on Friday, October 10, although it bounced back up to close at 20.5704 on October 14.
Plaintiff argues that the Registration Statement was inadequate because it did not disclose that McClendon “had risked nearly all his Chesapeake shares on margin loans.” Aplt. Br. at 51. This failure to disclose, it argues, violated section 11 both because it was required by 17 C.F.R. § 229.403(b) (Item 403(b)) and because it made the Registration Statement misleading. See Slater,
To be sure, the disclosures about McClendon’s holdings were limited. The Registration Statement included an SEC form DEF 14A filed on April 29, 2008, stating only that McClendon owned 29,-529,975 shares of Chesapeake (5.5% of the total shares outstanding) and that 29,332,-493 of those shares were “held in bank or brokerage margin accounts or escrow ac
Security ownership of management. Furnish the following information, as of the most recent practicable date, in substantially the tabular form indicated.... Show [in the first two columns the class of stock and the name of the owner,] in column (3) the total number of shares beneficially owned and in column (4) the percent of the class so owned. Of the number of shares shown in column (3), indicate, by footnote or otherwise, the amount of shares that are pledged as security....
17 C.F.R. § 229.403(b).
Plaintiff contends that Chesapeake’s disclosure did not comply with Item 403(b) because the disclosure of how many shares McClendon held in margin accounts did not disclose how many shares were pledged as collateral. It correctly points out that just because a security is held in a margin account does not mean that it serves as collateral. See Capital Mgmt. Select Fund Ltd. v. Bennett,
But while Plaintiff is correct that not all shares held in margin accounts necessarily serve as collateral, there is no merit to its claim that Chesapeake’s Item 403(b) disclosures were misleading. Item 403(b) requires disclosure of shares pledged as security and permits doing so “by footnote оr otherwise.” Given that context, a reasonable .investor would- have understood that Chesapeake included its Schedule 14A footnote to satisfy the Item 403(b) obligation to report shares pledged as security. As Chesapeake explains, there is “no requirement that officers and directors list or describe the accounts in which they hold corporate stock.” Aplee. Br. at 33. The obvious purpose of the footnote was to fulfill Chesapeake’s Item 403(b) obligation, not to needlessly inform investors about what types of accounts McClendon owned. Indeed, Plaintiff adopted this commonsense reading of Chesapeake’s disclosure in the allegations of its amended complaint. Paragraph 34 of the amended complaint describes the disclosure as “the statement that Defendant McClendon hаd margined his stock.”
Far from being misleading, Chesapeake’s disclosure method was a conservative way to fulfill Item 403(b)’s requirement. Securities that are excess margin one day can become required collateral the next day if thеy decline in value. See Securities Credit Regulation § 3:53 (2d ed. 2013) (“If, as a result of changes in market values, the customer’s debit balance increases ..., the customer’s margin excess is eliminated, and the amount is no longer available to the customer for new securities transactions or withdrawals.”). All shares held in margin accounts are vulnerable to margin calls, depending on movements in the market. The disclosure that Plaintiff insists on — listing exactly the number of shares serving as collateral at the moment of reporting — can understate risk by obscuring the fact that other shares held in margin accounts might be needed as collateral in the future.
Chesapeake’s failure to specify how many of McClendon’s shares actively served as collateral was not a material omission because, if anything, it provided an excessive warning of risk by overstating the numbеr of collateralized shares. The purpose of the Item 403(b) disclosure was to alert investors to the possibility that McClendon’s interests were not aligned with their own. See 71 Fed.Reg. 53158, 53197 (Sept. 8, 2006) (because shares used as collateral “may be subject to material risk or contingencies that do not apply to other shares,” they “have the potential to influence management’s performance and decisions”). The amended complaint emphasized the importance of this purpose:
[A]n investor knowing of McClendon’s personal financial risk might fear that McClendon would be motivated to cause Chesapeake to take short-term risks in the hope of keeping stock prices high in the short-term at the expense of long-term growth ... or to make large bonus payments to him if his personal investments sour.
Aplt. Br. at 59. Item 403(b) disclosures also alert investors to the possibility that a company’s stock price will fall because a large shareholder like McClendon may be forced to sell many shares at once. But a prudent investor worried about these risks would assume that all of McClendon’s shares held in margin accounts were pledged as collateral. A reasonable inves
Plaintiff argues, however, that even if Chesapeake complied with Item 403(b), it had an independent duty “to disclose that McClendon lacked the resources to meet any potential margin call.” Id. at 67. Because McClendon lacked the necessary financial resources, he had to sell large numbers of shares over a short period of time, presumably depressing the stock’s value.
We reject Plaintiffs argument that further disclosure was required. The risk of margin calls and the consequent need of the owner of the stock to sell shares is obvious. Even the wealthiest investor could lack readily available liquid assets to cover a large margin call, particularly when, as here, the call comes when financial markets are frozen (meaning very few assets are truly liquid). No purpose would have been served by “disclosing” • that McClendon might have to sell a large portion of the margined stock if the bottom dropped out of the market. In a similar context, Judge Sweet noted that “ ‘[i]t is not a violation of any securities law to fail to disclose a result that is obvious even to a person with only an elementary understanding of the stock market.’ ” Newman v. L.F. Rothschild, Unterberg, Towbin,
In addition, the omission of information regarding McClendon’s financial resources is actionable only if the omission was necessary to make something in the Registration Statement not misleading. See Slater,
[T]he Plaintiffs cannot show how the omission of the cross-default provisions made the statement misleading. The statement merely mentions Thornburg’s dependence on repurchase agreements to borrow money and that a decline in the value of their ARM assets could trigger a margin call. There is no mention about the possibility of failing to meet a margin call or its consequences. Default, let alone cascading default, is an entirely different subject that is not even broached in the statement. Because the statement gives no impression, one way or the other, about the effect on the company of failing to meet a margin call, there is no basis for believing the statement was misleading.
Slater,
In re Franchard Corp., 42 S.E.C. 163,
In short, we reject Plaintiffs contention that the Registration Statement was mis
III. CONCLUSION
We AFFIRM the district court’s grant of summary judgment to Chesapeake. We GRANT Chesapeake’s request for judicial notice.
Notes
. Persons subject to liability include:
(1) every person who signed the registration statеment; (2) every person who was a director of (or person performing similar functions) or partner in the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted; (3) every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner; (4) every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with' respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him; (5) every underwriter with respect to such security.
15 U.S.C. § 77k(a).
. Swaps did not always work out as neatly as this idealized description. The Registration Statement explained that they exposed the company to additional risk in certain circumstances, such as if the other party to the swap failed to perform.
. The comparison for 2008 swaps must take into account that some swaps matured in the interim. Although the August 8-K shows a decrease of 26% from the May 8-K, the August 8-K reports on one fewer quarter. Neither report discloses swap volume by quarter; but the May 8-K shows swap volumes of about 24,000 bbtu maturing per month for the rest of, 2008, and the monthly average in the August 8-K is about 28,000, about a 17% increase. The monthly increase between the May 10-Q and the May 8-K was about 15%.
. These disclosure requirements apply “to each class of equity securities of the registrant or any of its parents or subsidiaries, including directors’ qualifying shares, beneficially owned by all directors and nominees, naming them, each of the named executive officers as defined in Item 402(a)(3) (§ 229.402(a)(3)), and directors and executive officers of the registrant as a group, without naming them.” 17 C.F.R. § 229.403(b).
. In full, the relevant paragraph of the complaint reads as follows:
The Registration Statement failed to disclose the true risk and uncertainties concerning Defendant McClendon's holdings of Chesapeake stock. Chesapeake’s Form 14A, dated April 29, 2008, which was incorporated by reference in the Registration Statement, represented that Defendant McClendon beneficially controlled 29,529,975 shares of Chesa*1241 peake stock and footnoted that 29,332[,]493 of those shares were "held in bank or brokerage margin accounts or escrow accounts securing brokerage accounts.” This statement was an inaccurate statement of material fact because the Registration Statement failed to disclose that Defendant McClendon lacked the cash necessary to satisfy his margin loans such that if there was a significant decline in the value of his investments, the stock would be seized and sold into the market, thereby causing a significant decline in the price of Chesapeake stock. Furthermore, the statement that Defendant McClendon had margined his stock did not fully and adequately advise investors of the true risks and uncertainties regarding this action. Indeed, investors did not know that Defendant McClendon lacked the financial resources necessary to satisfy his margins loans such that, if the value of his investments declined, his stock would be seized and sold into the market.
Aplt.App., Vol. I at 53-54 (emphasis added).