Stock Valuation Testimony by Brattle Expert Upheld in Tech Industry Damages Matter
6D Global Technologies retained a Brattle team in a Rule 10b-5 securities litigation regarding the value of stock in a private placement offering and share exchange in connection with a reverse merger transaction.
Principal Paul Hinton testified in US district court on damages connected to the valuation of micro-cap restricted stock subject to dilution and delisting risks in an illiquid market. Given the complexity involved in valuing shares, the court agreed with Mr. Hinton’s assessment that the plaintiff’s simple calculation alone could not establish a stable foundation for calculating damages, and awarded the plaintiff nominal damages in the amount of $1.
In 2022, the verdict and Mr. Hinton’s analysis were upheld by the US Court of Appeals for the Second Circuit.
Background
In 2014, John Cottam agreed to purchase 2,900,000 shares in 6D Acquisitions, a special purpose vehicle formed for investing in digital marketing/technology company 6D Global Technologies. Shares in 6D Acquisitions were originally to be exchanged for shares in 6D Global Technologies at an exchange ratio of one for one.
However, after entering the agreement but before Mr. Cottam received his shares, CleanTech – 6D Global Technologies’ predecessor company – underwent two reverse stock splits to preserve its stock price and remain listed on NASDAQ. After adjusting the exchange ratio for the effects of the reverse split, investors – including Mr. Cottam – received 6.9 times fewer shares in 6D Global Technologies than they had held in 6D Acquisitions, even though their ownership percentage of the company was unchanged. A dispute arose because the subscription agreement did not contain an explicit provision for a stock-split adjustment to the conversion ratio.
As a result, in 2016, Mr. Cottam brought suit against 6D Global Technologies, 6D Acquisitions, and 6D CEO Tejune Kang, alleging securities fraud and breach of contract claims. Mr. Cottam sought to recover damages for the 2,479,710 shares he purchased but did not receive, and requested $19.6 million in damages based on simple arithmetic calculations.
The district court granted summary judgment in favor of the defendants as to the securities fraud claim, but granted summary judgment to Cottam as to liability on the breach of contract claim. The question remaining was how much in damages Cottam was owed, given the illiquidity of the stock, the effect of the dilution that would result from the issuance of the additional shares to Cottam and other subscribers, and sales restrictions under the contract. In order to succeed, the plaintiff needed to establish a stable foundation for a reasonable estimate of the damages incurred as a result of the actions.
6D Global Technologies retained Brattle to analyze the value of Mr. Cottam’s investment. Brattle Principal Paul Hinton testified as an expert witness at the virtual trial, which was held on March 8, 2021. At trial, Mr. Hinton testified that, due to the fragile nature of 6D Global Technologies, no simple rule of thumb could be applied to establish valuation in this instance. Mr. Hinton also criticized the damages analysis offered by Mr. Cottam as failing to account for factors that would have affected the value of the additional shares he demanded.
Outcome
Following the one-day trial, District Judge Lorna G. Schofield determined that, though Mr. Cottam was indeed entitled to 2,900,000 shares, the value of the omitted shares was in question due to the impact of restrictions on the stock and its lack of liquidity.
The court agreed with Mr. Hinton’s determination that the damages could not be calculated simply, and found that Mr. Cottam’s basic math calculations yielding a damages demand of $19 million did not take into account the impact of illiquidity, stock restrictions, or the financial condition of 6D Global Technologies on the market price of the shares he did not receive.
In her opinion, Judge Schofield – referring to the fact that Mr. Cottam’s valuation of the stock spoke only to dilution and not to other factors – wrote, “Defendant’s expert Mr. Hinton credibly testified that no simple rule of thumb could be applied in this case involving a fragile company that is not well established.” Since Mr. Cottam was unable to meet his burden of showing a stable foundation for a reasonable estimate of the damages incurred, the court denied his request for $19,621,000 in damages and instead awarded nominal damages of $1.
In a subsequent appeal, the plaintiff sought to overturn the decision and have Mr. Hinton’s testimony disqualified, which the US Court of Appeals for the Second Circuit rejected. The initial verdict was affirmed.
The case is Cottam v. Global Emerging Capital Group, LLC et al., case number 1:16-cv-04584, in the US District Court for the Southern District of New York.
The appeal was Cottam v. 6D Global Technologies, Inc. et al., case number 21-1031-CV, in the US Court of Appeals for the Second Circuit.
Case Excerpts
“Defendant’s expert Mr. Hinton credibly testified that no simple rule of thumb could be applied in this case involving a fragile company that is not well established.”
“During trial, Mr. Hinton credibly testified that these factors include dilution caused by the issuance of additional shares; liquidity of the company’s stock in the market; restrictions on the sale of Plaintiff’s shares; and the financial condition of the issuer, including whether the company is mature.”
“ During trial, Mr. Hinton credibly testified that the analysis of the impact of high trading volume on prices depends on the direction of trades.”
