5th Circuit Revives Investor Lawsuit Against Six Flags over Failed China Deal

Executives for Six Flags Entertainment Corp. told investors that licensing fees from 11 new theme parks in China could add $60 million annually to the company’s earnings.

Instead, cancellation of the projects forced the company to deduct $15 million from previously reported revenues in February 2020. The price of Six Flags stock plunged 16%, erasing $2.4 billion in shareholder value, plaintiffs in an investor lawsuit allege.

Pension funds for two labor unions filed a class-action lawsuit against Six Flags and its former executives seeking compensation for shareholders’ losses. A federal judge in Fort Worth dismissed the lawsuit, in part, because most of the evidence came from a confidential informant.

The 5th Circuit Court of Appeals, however, revived the class-action attempt in a ruling Wednesday. The panel said US District Court Judge Mark Timothy Pittman erred by discounting the credibility of the confidential informant’s statements, and also by finding that misleading statements made by the company were mere “puffery” and not a valid basis for a lawsuit.

“We hold that the complaint adequately alleges that Six Flags improperly recognized revenue on the China parks in its class period financial statements due to defendants’ misleading statements regarding the parks’ construction progress and the admission of $15 million in overstated revenue in 2018,” the appellate panel’s opinion says.

Six Flags is the largest regional theme park operator in the world, with 27 parks in the United States, Mexico and Canada. The company expanded rapidly after it was founded with a single park in Texas in 1961, but by the 2000s its revenues were declining. Six Flags was forced it to sell off properties in Europe and file for bankruptcy.

After emerging from bankruptcy in 2010, the company implemented an incentive pay plan for its top executives that encouraged growth of its earnings before interest, taxes, depreciation and amortization, or EBITDA. Chief Executive Officer James Reid-Anderson was eligible for a $29 million bonus and Chief Financial Officer Marshall Barber $3.6 million if the company reached its $600 million EBITDA goal in 2017.

In 2014, Six Flags formed a partnership with a real estate developer in China, Riverside Investment Group, and initially planned to open two parks. But in 2017, the company announced that it was moving forward with plans to open 11 new parks in 2019, 2020 and 2021. Lucrative licensing deals would contribute a minimum of $60 million to Six Flags’ EBITDA, the company said.

Riverside, however, was not living up to its commitments. Six Flags told investors in February 2019 that the China parks would be delayed one year. In January 2020, the company disclosed that Riverside had defaulted on its payment obligations. The Six Flags stock price dropped from $73.38 to $31.89, the lowest price in seven years. (The company’s stock price has continued to decline since then, closing at $25.50 on Thursday.)

The Oklahoma Firefighters Pension and Retirement System, the Electrical Workers Pension Fund and other investors filed a lawsuit alleging that Six Flags had violated the Securities Exchange Act of 1934. A confidential informant, described by the plaintiffs as a former international construction and project management director for Six Flags, reported that the company had known in 2018 that the parks would not open on schedule. Riverside had not funded the purchase of rides for the theme parks, had not commissioned blueprints and had done minimal construction work, the informant said.

Nonetheless, Reid-Anderson and Barber continued to tell financial analysts that the projects were proceeding on schedule. Six Flags announced a delay in 2019, but still insisted that the projects were “substantially on track,” according to the complaint. Six Flags did not acknowledge until 2020 that Riverside was in default.

Judge Pittman approved a motion by Six Flags to dismiss the investor lawsuit because most of the factual allegations were based on statements by a confidential informant. The judge said prior 5th Circuit decisions have instructed judges to “discount allegations from confidential sources.”

Also, Pittman found that many of the statements that the investors labeled as “misrepresentations” were actually just “puffery,” meaning vague positive statements that offer no specific information.

The 5th Circuit panel, however, said in its opinion that some confidential informants are more credible than others. The plaintiffs’ confidential source, identified as FE1, had given detailed information about Six Flags’ dealings with Riverside. What’s more, the informant’s statement that no significant construction work had been done was corroborated with a photograph of the construction site.

The District Court had also held that “generalized positive statements about a company’s progress are not a basis for liability,” citing a 2001 5th Circuit ruling. The appellate panel said it is true that abstract statements would not support any finding of liability, but Six Flags made specific statements about project timelines.

“We do not undertake the task of grouping all the contested statements as either puffery or not, but we do hold that the district court was applying too broad a definition to that concept,” the panel said.

The panel reversed the District Court’s ruling and remanded the case.

Top photo courtesy of Six Flags Entertainment Corp.