United States District Court, S.D. New York
IRONWORKERS LOCAL 580 -- JOINT FUNDS; IRONWORKERS LOCALS 40, 361 & 417 -- UNION SECURITY FUNDS; IRONWORKERS LOCAL 40 BUILDING AND GENERAL FUNDS; and BONNIE STEWART, individually and on behalf of all others similarly situated, Plaintiffs,
LINN ENERGY, LLC, LINNCO, LLC; MARK E. ELLIS; KOLJA ROCKOV; DAVID B. ROTTINO; MICHAEL C. LINN; JOSEPH P. MCCOY; GEORGE A. ALCORN; DAVID D. DUNLAP; JEFFREY C. SWOVELAND; TERRENCE S. JACOBS; BARCLAYS CAPITAL INC.; CITIGROUP GLOBAL MARKETS INC.; RBC CAPITAL MARKETS, LLC; WELLS FARGO SECURITIES, LLC; MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED; CREDIT SUISSE SECURITIES (USA) LLC; RAYMOND JAMES & ASSOCIATES, INC.; UBS SECURITIES LLC; GOLDMAN, SACHS & CO.; J.P. MORGAN SECURITIES LLC; ROBERT W. BAIRD & CO. INCORPORATED; BMO CAPITAL MARKETS CORP.; CREDIT AGRICOLE SECURITIES (USA) INC.; CIBC WORLD MARKETS CORP.; HOWARD WEIL INCORPORATED; and MITSUBISHI UFJ SECURITIES (USA), INC., Defendants
Decided: July 7,
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[Copyrighted Material Omitted]
For Ironworkers Locals 40, 361 & 417 - Union Security Funds, Ironworkers Local 40 Building And General Funds, Ironworkers Local 580 - Joint Funds, Lead Plaintiffs: Cheryl D Hamer, PRO HAC VICE, Pomerantz LLP, San Diego, CA USA; Daniel Patrick Chiplock, Lieff Cabraser Heimann & Bernstein, LLP, New York, N.Y. USA; Emma Gilmore, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, New York, N.Y. USA; Jeremy Alan Lieberman, Pomerantz LLP, New York, N.Y. USA.
For Bonnie Stewart, individually and on behalf of all others similarly situated, Lead Plaintiff: Daniel Patrick Chiplock, Lieff Cabraser Heimann & Bernstein, LLP, New York, N.Y. USA; Emma Gilmore, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, New York, N.Y. USA; Jeremy Alan Lieberman, Pomerantz LLP, New York, N.Y. USA.
For Frank Donio, individually and on behalf of all others similarly situated, Larry Forsgren, individually and on behalf of all others similarly situated, Jerome M. Matez, individually and on behalf of all others similarly situated, Jan Patters, individually and on behalf of all others similarly situated, Plaintiffs: Alfred Glenn Yates, PRO HAC VICE, Law Office of Alfred G. Yates, Jr., P.C., Pittsburgh, PA USA; David Avi Rosenfeld, Robbins Geller Rudman & Dowd LLP(LI), Melville, N.Y. USA.
James H. Harrison, Jr., Plaintiff, Pro se.
For Michael Menser, Movant: Nicholas Ian Porritt, LEAD ATTORNEY, Levi & Korsinsky LLP (DC), Washington, DC USA.
For Sidney Riskin, Shelby C. Kurzius, The John J. Curtis Trust, Gerald A. Reed, Glenn Sullivan, Movants: Brian C. Kerr, Brower Piven, A Professional Corporation, New York, Ny Xxxxx.
For Kenneth W. Cox, Movant: Sean M. Handler, LEAD ATTORNEY, Stuart Berman, PRO HAC VICE, Kessler Topaz Meltzer & Check, LLP (PA), Radnor, PA USA.
For The Beaufort Group LP, Movant, Pro se.
For Beeman Holdings, Llc, Movant, Pro se.
For Robert E. Selby, M.D., Movant, Pro se.
For Heavy & General Laborers' Locals 472 & 172 Pension, Annuity And Welfare Funds, Movant, Pro se.
For Boilermaker-Blacksmith National Pension Trust, Movant, Pro se.
For Linn Energy, Llc, Mark E. Ellis, Kolja Rockov, David B. Rottino, Michael C. Linn, Joseph P. Mccoy, George A. Alcorn, David D. Dunlap, Jeffrey C. Swoveland, Terrence S. Jacobs, Linnco, Llc, Defendants: Gerard G. Pecht, LEAD ATTORNEY, Fulbright & Jaworski L.L.P., Houston, TX USA; Jami Elizabeth Mills Vibbert, Fulbright & Jaworski L.L.P. (NYC), New York, N.Y. USA; Peter Andrew Stokes, Fulbright & Jaworski LLP, Austin, TX USA.
For Barclays Capital Inc., Citigroup Global Markets, Inc., Rbc Capital Markets, Llc, Wells Fargo Securities, Llc, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse Securities (Usa) Llc, Raymond James & Associates, Inc., Ubs Securities Llc, Goldman, Sachs & Co., J.P. Morgan Securities Llc, Robert W. Baird & Co. Incorporated, Bmo Capital Markets Corp., Credit Agricole Securities (Usa) Inc., Cibc World Markets Corp., Howard Weil Incorporated, Mitsubishi Ufj Securities (Usa), Inc., Defendants: Jay B. Kasner, LEAD ATTORNEY, Susan Leslie Saltzstein, Skadden, Arps, Slate, Meagher & Flom LLP (NYC), New York, N.Y. USA; Gary John Hacker, Skadden, Arps, Slate, Meagher & Flom, LLP (IL), Chicago, IL USA.
MEMORANDUM DECISION AND ORDER GRANTING DEFENDANTS' MOTIONS TO DISMISS
Colleen McMahon, United States District Judge.
A putative class of shareholders of LINN Energy, LLC (" LINN" ) and LinnCo, LLC (" LinnCo" ) brings this action against LINN, LinnCo, the underwriters of LinnCo's initial public offering, and several LINN/LinnCo officers and directors (collectively, " Defendants" ), for claims arising under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (" Securities Act" ), 15 U.S.C. § § 77k, 77l, and 77o; Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (" Exchange Act" ), 15 U.S.C. § § 78j(b) and 78t(a); and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission (" SEC" ), 17 C.F.R. § 240.10b-5.
Defendants move to dismiss all claims pursuant to Rules 8(a), 9(b), and 12(b)(6) of the Federal Rules of Civil Procedure, and the Private Securities Litigation Reform Act of 1995 (" PSLRA" ). For the reasons set forth below, the Defendants' motions to dismiss are GRANTED.
I. The Parties
Defendant LINN Energy, LLC (" LINN" ) is a publicly-traded energy company that acquires and develops oil and natural gas properties in the onshore United States. It is structured as a limited liability company and is treated as a partnership for federal tax purposes. LINN " units" are listed and traded on the National Association of Securities Dealers
Automated Quotation (" NASDAQ" ) stock exchange.
LINN stated in its SEC filings that the company's " primary goal is to provide stability and growth of distributions for the long-term benefit of its unitholders." Compl. at ¶ 6 (quoting 2012 10-K at 2). " Distributions" are periodic cash payments, similar to dividends, that LINN makes to unitholders. According to Plaintiffs, LINN's distributions are a key focus of its investors. The Complaint alleges that " LINN's units attract investors seeking yield-based investments, as the Company's LLC agreement requires that it make quarterly distributions of all 'available cash' to unitholders, as that term is defined by the agreement." Id.
Defendant LinnCo, LLC (" LinnCo" ) is a separate publicly-traded entity that owns LINN units as its sole asset; LinnCo has no significant assets or operations other than its ownership of LINN units. LinnCo completed its initial public offering (" IPO" ) on October 12, 2012. It is treated as a corporation for federal tax purposes. Buying shares in LinnCo allows investors who prefer a corporate tax structure to own an indirect interest in LINN and to benefit from LINN's quarterly distributions, which they receive as dividends from LinnCo. Like LINN units, LinnCo shares are listed and traded on NASDAQ. See id. at ¶ 4.
Plaintiffs assert that, " [b]ecause [LinnCo]'s sole asset is LINN units, [LinnCo]'s success depends entirely on the operation and management of LINN, and [LinnCo]'s ability to pay dividends to its shareholders depends entirely on LINN's ability to make distributions to its unitholders." Id. at ¶ 5. Indeed, LinnCo's offering documents and its quarterly and annual SEC filings have incorporated LINN's SEC filings by reference and included them as exhibits. See id.
Defendants Mark E. Ellis, Kolja Rockov, David B. Rottino, Michael C. Linn, Joseph P. McCoy, George A. Alcorn, David D. Dunlap, Jeffrey C. Swoveland, and Terrence S. Jacobs (collectively, the " Individual Defendants" ) are officers and directors of LINN and/or LinnCo. See id. at ¶ ¶ 28-37.
Defendants Barclays Capital Inc., Citigroup Global Markets Inc., RBC Capital Markets, LLC, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse Securities (USA) LLC, Raymond James & Associates, Inc., UBS Securities LLC, Goldman, Sachs & Co., J.P. Morgan Securities LLC, Robert W. Baird & Co. Incorporated, BMO Capital Markets Corp., Cré dit Agricole Securities (USA) Inc., CIBC World Markets Corp., Howard Weil Incorporated (n/k/a Scotia Capital (USA) Inc.) and Mitsubishi UFJ Securities (USA), Inc. (collectively, the " Underwriter Defendants" ) are financial services firms that acted as underwriters in connection with LinnCo's IPO on October 12, 2012. See id. at ¶ ¶ 41-61.
Plaintiffs Ironworkers Local 580 -- Joint Funds, Ironworkers Locals 40, 361 & 417 -- Union Security Funds, and Ironworkers Local 40 Building and General Funds are shareholders of LinnCo. Bonnie Stewart is a unit holder of LINN. In accordance with the PSLRA, the Court appointed them as lead plaintiffs at a hearing on October 4, 2013. See id. at ¶ ¶ 24-25.
Plaintiffs seek to represent a class consisting of all persons who (1) " purchased or otherwise acquired LINN units during
the LINN Class Period" (defined as February 25, 2010 through September 17, 2013), (2) " purchased or otherwise acquired LNCO common shares pursuant or traceable to [LinnCo's] IPO Registration Statement and Prospectus issued in connection with [LinnCo's] IPO on or around October 12, 2012, and/or purchased [LinnCo] common shares in the IPO directly from one of the Underwriter Defendants or were successfully solicited by Defendants for their own financial gain," and (3) " purchased or otherwise acquired [LinnCo] common shares during the LNCO Class Period" (defined as October 12, 2012 through September 17, 2013). Id. at ¶ 266.
Plaintiffs refer to the " LINN Class Period" and the " LNCO Class Period" (which is a subset of the LINN Class Period) collectively-- i.e., February 25, 2010 through September 17, 2013--as the " Class Period." Id. at ¶ 1. Plaintiffs purchased LINN units and LinnCo shares during the Class Period. Plaintiffs' claims under the Exchange Act relate to the entire Class Period; their claims under the Securities Act only relate to the period beginning after LinnCo's IPO (the " LNCO Class Period" ). See id.
II. The Alleged Misstatements and Omissions
Like all publicly-traded companies, LINN prepares its financial statements in accordance with Generally Accepted Accounting Principles (" GAAP" ). See 2009 10-K at 59. LINN's quarterly and annual financial statements include the traditional balance sheet, income, and cash flow statements. As permitted by SEC regulations, LINN also discloses " non-GAAP" metrics-- i.e., metrics for which there is no uniform definition under GAAP rules--because LINN believes that these metrics are useful for investors. See SEC Release No. 33-8176, " Conditions for Use of Non-GAAP Financial Measures," 2003 WL 161117, at *1 (January 22, 2003).
Plaintiffs assert that certain non-GAAP metrics disclosed by LINN were materially misleading because they failed to account for the costs associated with purchasing derivative instruments called " put options." See Compl. at ¶ ¶ 8, 15, 93.
To mitigate (or " hedge" ) its exposure to fluctuating oil and gas prices, LINN enters into various derivative contracts that allow it to lock in a fixed or guaranteed minimum price for its production. As LINN disclosed in its 2009 10-K (which it filed at the beginning of the Class Period on February 25, 2010), these transactions are primarily in the form of " swap" contracts, " collars," and " put options." A " swap" contract specifies a fixed price that LINN will receive from the counterparty (as compared to floating market prices); on the settlement date LINN either receives or pays the difference between the swap price and the market price. A " collar" specifies the range of prices that LINN will receive (as compared to floating market prices); on the settlement date LINN has the opportunity to receive up to the price ceiling while being protected against downside risk below the price floor. There are no upfront costs associated with entering into contracts for swaps or collars. See 2009 10-K at 61-62.
In contrast, a " put option" requires LINN to pay the counterparty an upfront fee called a " premium" at the time of purchase. In exchange, LINN obtains the right (but not the obligation) to sell its commodities at a guaranteed minimum price (the " strike price" ) during the life of a multi-year contract. Put options protect LINN from the risk that the prices of the commodities it sells will plummet, while allowing LINN to maintain upside opportunity in case the market price rises above
the strike price. The premium that LINN pays for a put option is equal to the fair market value of the option on the purchase date. After purchase, LINN owes no further amounts under the put option contracts. As LINN explained in its 2009 10-K, LINN " receive[s] from the counterparty the excess, if any, of the fixed price floor over the market price [of the underlying commodity] at the settlement date." 2009 10-K at 62. Where the market price of the commodity has fallen far below LINN's strike price, the company realizes a significant gain upon settlement of the put option. Accordingly, the value of a put option is generally inversely proportionate to the value of the underlying commodity. See Compl. at ¶ 7.
Because put options offer both downside protection and upside opportunity, the upfront costs associated with purchasing put options can be substantial. In the Complaint, Plaintiffs allege that LINN's non-GAAP disclosures throughout the Class Period were materially misleading because LINN failed to disclose that it did not deduct the cost of the premiums paid for settled put options in calculating three non-GAAP metrics: (1) adjusted EBITDA, (2) distributable cash flow (" DCF" ), and (3) the distribution coverage ratio. See id. at ¶ 9. Adjusted EBITDA is the " starting point" for calculating both DCF and the distribution coverage ratio. Id. at ¶ 11. The exact formulas for these non-GAAP figures are discussed in detail below.
Plaintiffs further allege that LINN understated its maintenance capital expenditures (" maintenance capex" ), a figure subtracted from adjusted EBITDA in calculating DCF. Plaintiffs contend that, because maintenance capex was understated, LINN's DCF was overstated.
Plaintiffs assert that these misstatements and omissions were material because LINN " measured its success based on cash distribution coverage ratios and distributable cash flows." Id. at ¶ 13. Further, investors and financial analysts used the DCF and distribution coverage ratio metrics as proxies for determining how much LINN would pay in cash distributions to unitholders. Plaintiffs contend that, by overstating DCF, LINN " presented investors with a materially inflated view of the Company's cash flows available for distribution and, as a result, its ability to continue to sustain or grow its cash distributions." Id. at ¶ 9.
III. LINN's Disclosures
A. GAAP Disclosures
LINN's non-GAAP metrics are derived from its GAAP metrics. So in order to evaluate the completeness of LINN's non-GAAP disclosures, one must start by examining LINN's GAAP disclosures.
LINN's use of derivative instruments is reflected on its GAAP-compliant balance sheet, income statement, and cash flow statement. It is also discussed in the notes accompanying LINN's financial statements.
Since the beginning of the Class Period, LINN has expressly disclosed that it treats derivative instruments (including put options) as assets or liabilities. LINN's 2009 10-K described LINN's three primary types of derivatives (swaps, collars, and put options) and then stated: " Derivative instruments . . . are recorded at fair value and included on the consolidated balance sheets as assets or liabilities." 2009 10-K at 62. LINN's balance sheet lists " derivative instruments" as a line item under " Assets." Id. at 69.
Because LINN treats derivatives as assets--which by definition have lasting value--it capitalizes and amortizes the costs associated with purchasing put options ( i.e., the premiums) and incrementally expenses
them on its income statement over time. " Capitalization" is the process of charging an expenditure to an asset account (as opposed to an expense account) because the expenditure yields benefits for a period in excess of one year. See Joel G. Siegel, Dictionary of Accounting Terms 65 (3rd ed. 2000) (hereafter " Siegel" ).
Once LINN charges the put option premiums to an asset account, it amortizes those costs. " Amortization" is a concept similar to depreciation; it means that, for accounting purposes, a company spreads the costs associated with an intangible asset over its expected useful life, instead of expensing the full cost on its income statement immediately upon purchase. In other words, the company deducts a portion of the costs associated with an asset each year until the asset no longer has value--in this case, when the derivative contract expires. See id. at 23. Amortizing the cost of an asset better matches the expense (amortization) with the extended time period in which the asset may contribute to revenue--a central goal of income statements. In contrast, where a company purchases an item that does not have value beyond the current period, it expenses the full cost of that item in the period incurred, because that is the only period in which the item contributes to revenue generation.
LINN's income statement reflects its amortization of derivative costs (including premiums paid to purchase put options) in the expense line item called " depreciation, depletion and amortization." 2009 10-K at 70.
Income statements include both " cash" items and " noncash" items. Amortization is a " noncash" expense, which means that it does not reflect an actual cash outlay during the period in which it is reported. See Siegel at 296. After LINN makes an initial cash payment to purchase a put option, it expenses a portion of that premium each year for several years through amortization. Accordingly, while LINN's amortization for derivatives is reported as an expense on its income statement in a particular year, LINN does not pay out that amount in cash for derivatives during the reporting period; LINN paid for the derivatives in some previous period. This is the nature of " noncash" expenses like amortization--they do not reflect a cash payment during the period in which they are reported.
Plaintiffs do not allege that LINN's treatment of derivatives as assets or its capitalization and amortization of derivative costs were inappropriate under GAAP. In fact, a financial news article quoted in the Complaint states: " Linn expenses the
cost of puts and other derivatives over a multiyear period when calculating net income, as mandated by accounting rules.'" Compl. at ¶ 197 (quoting Andrew Bary, Drilling Into the Numbers, Barron's, February 16, 2013, http://online.barrons.com/article/SB50001424052748704852604578298253512225108) (emphasis added).
In addition to contributing to LINN's amortization expense, derivatives affect LINN's income statement through the revenue line item called " gain (loss) on oil and natural gas derivatives." 2009 10-K at 70. The notes to LINN's 2009 income statement explain that this line item has two components--" unrealized" gains and " realized" gains. Id. at 93.
As LINN disclosed, " Unrealized gains (losses) represent the change in fair value of the derivative instruments and are noncash items." Id. Once a derivative is recorded on LINN's. balance sheet at its initial " fair value," the company adjusts the value of that asset on its balance sheet each period to reflect its fair market value--a process called " mark-to-market" accounting, which is proper under GAAP. LINN explained that it " determines the fair value of its derivative financial instruments utilizing pricing models for significantly similar instruments." Id. at 62. Mark-to-market accounting better represents the current market value of the assets on a company's balance sheet than does their historical date-of-purchase cost.
Once LINN adjusts the value of its derivatives on its balance sheet, it must record that adjustment ( i.e., the unrealized gain/loss on derivatives) on its income statement. If the estimated market value of LINN's derivatives goes up from one period to the next, the company records the " gain" as revenue on its income statement; if the market value goes down, the company records the " loss" as a reduction to revenue (effectively, an expense). These gains/losses are " unrealized" because LINN has not actually sold or disposed of the asset to which they relate; LINN continues to hold the derivative contract. See Siegel at 461. These unrealized gains/losses are also " noncash" because no money actually changes hands when LINN marks the assets to market and records the change in value on its income statement.
In its 2009 10-K, LINN explained its unrealized loss on derivatives for that year as follows:
Unrealized gains and losses result from changes in market valuations of derivatives as future commodity price expectations change compared to the contract prices on the derivatives. During 2009, expected future oil and natural gas prices increased, which resulted in unrealized losses on derivatives of approximately $591.4 million for the year ended December 31, 2009.
2009 10-K at 41. Though LINN recorded a $591.4 million unrealized loss on its derivatives, it did not actually pay out that amount in cash during 2009; this was a noncash item included on the income statement as a component of the revenue line item " gain (loss) on oil and natural gas derivatives."
The other component of LINN's " gain (loss) on oil and natural gas derivatives" is " realized" gains. In its 2009 10-K, LINN explained that " [r]ealized gains (losses) . . . represent amounts related to the settlement of derivative instruments." Id. at 93 (emphasis added). So realized gains represent the money that actually changes hands at the time that derivative contracts are settled. The only " amounts related to the settlement of" put options are cash inflows ( i.e., revenues) since, as LINN explained, the company never has to pay the counterparty at the time of settlement; rather, the counterparty pays LINN the
" excess, if any, of the fixed price floor over the market price [of the underlying commodity] at the settlement date." Id. at 62. In contrast, LINN has to make cash outlays upon settlement of swap contracts if the swap price is lower than the commodity's market price.
In its 2009 10-K, LINN described its realized gain on derivatives for that year as follows: " During the year ended December 31, 2009, the Company had commodity derivative contracts for approximately 113% of its natural gas production and 80% of its oil and NGL [natural gas liquid] production, which resulted in realized gains of approximately $450.0 million . . ." Id. at 41.
Because in 2009 LINN had a realized gain on derivatives of $450 million and an unrealized loss on derivatives of $591.4 million, LINN reported a combined " gain (loss) on oil and natural gas derivatives" of negative $141.4 million on its income statement--it lost money " on paper," but only because unrealized (or mark-to-market) losses exceeded realized gains (cash dollars received).
Thus, LINN's GAAP-compliant income statement includes three items related to derivatives: (1) amortization of derivative costs as an expense (a noncash item), (2) unrealized gains/losses on derivatives as a revenue item (a noncash item), and (3) realized gains/losses on derivatives as a revenue item (a cash item). All these items enter into the calculation of LINN's " income (loss) from continuing operations" (a profitability measure) and the income statement's bottom line--" net income." Id. at 70. On its 2009 income statement, LINN reported a net loss of approximately $298 million. See id.
Finally, LINN's use of derivative instruments is reflected on its cash flow statement. While an income statement summarizes a company's performance in a particular period by measuring the profitability of its operations (by matching revenues with their associated expenses), the cash flow statement summarizes the cash that actually flowed in and out of the company during the period. There is no " accrual" and no effort to " match" cash inflows with related cash outflows from other periods. The cash flow statement has three different sections: operating activities, investing activities, and financing activities.
The " cash flow from operating activities" section of LINN's cash flow statement starts with LINN's net income (as calculated on the income statement) and then makes several adjustments to net income in its calculation of a figure called " net cash provided by (used in) operating activities." Id. at 72. These adjustments include two noncash items related to derivatives: " depreciation, amortization and depletion" and " mark-to-market on derivatives" ( i.e., unrealized gain/loss on derivatives). The adjustments reverse the effects that those noncash items had on net income, since the items do not reflect actual cash inflows or outflows during the
period. In the case of " depreciation, amortization and depletion," that item was a noncash deduction on the income statement; so LINN adds that item back to net income in calculating net cash provided by operating activities. In the case of " mark-to-market on derivatives," LINN adds back any unrealized loss on derivatives that was deducted on the income statement, or subtracts any unrealized gain on derivatives that was added on the income statement. These adjustments eliminate the effects of noncash items and enable LINN to calculate how much cash it truly generated from operations ( i.e., net cash provided by operating activities) during the period.
In addition, the operating activities section of LINN's cash flow statement includes a deduction called " premiums paid for derivatives." Id. In other words, LINN deducts the cash actually paid to purchase put options during the period (not the money previously paid for options that happened to settle during the period) in calculating net cash provided by operating activities. Plaintiffs acknowledge that, under GAAP rules, it was appropriate to record on the cash flow statement only the upfront costs associated with put options that were purchased during the period. See Pl. Opp. to LINN at 2-3. This is so because a cash flow statement reflects the money that actually changes hands during a period. Accordingly, in calculating net cash provided by operating activities, LINN does not deduct premiums paid in previous periods for put options--even if those put options settled during the period and generated cash inflows--because premiums paid in the past have no cash impact during the period at issue.
On its 2009 cash flow statement, LINN deducted " premiums paid for derivatives" in the amount of $93.6 million. 2009 10-K at 72. A footnote to net cash provided by operating activities stated: " The years ended December 31, 2009, December 31, 2008, and December 31, 2007, include premiums paid for derivatives of approximately $93.6 million, $129.5 million and $279.3 million, respectively." Id. at 51. LINN further explained:
Premiums paid during 2009, 2008 and 2007 . . . were for commodity derivative contracts that hedge future production. These derivative contracts provide the Company long-term cash flow predictability to manage its business, service debt and pay distributions and are primarily funded through the Company's Credit Facility. The amount of derivative contracts the Company enters into in the future will be directly related to expected future production.
Id. (emphasis added). Thus, LINN's cash flow statement makes clear that the " premiums paid for derivatives" are for derivative contracts that it entered into during the reporting period; these contracts will be settled in future periods.
On its 2009 cash flow statement, LINN reported " net cash provided by operating activities" in the amount of approximately $427 million. See id. at 72. This figure is markedly different from LINN's 2009 net loss of $298 million, as reported on the income statement, but that is because LINN's net loss included the effects of noncash items.
To summarize, the costs associated with put options are treated quite differently on LINN's cash flow statement and its income statement. Because " net cash provided by operating activities" only reflects
actual cash inflows and outflows during the period, LINN's cash flow statement includes a deduction for the premiums paid to purchase put options during the period; it does not deduct any premiums that were paid to purchase put options in previous periods, even if those options settled during the period. In contrast, because " net income" reflects the profitability of LINN's operations, the company's income statement approximately matches expenses paid in previous periods with the revenues or losses they subsequently generate. Accordingly, LINN amortizes the cost of a put option; it deducts that cost incrementally over the useful life of the option. So the amortization deduction on the income statement does include a portion of the premiums paid to purchase put options in previous periods, some of which correspond to the options that actually settle (and produce revenue) during the period.
LINN's cash flow statement makes the differences between " net income" and " net cash provided by operating activities" clear by providing a reconciliation between the two measures. See id.
The other financial statements that LINN filed during the Class Period ( i.e., its Form 10-Ks and 10-Qs) contain similar disclosures regarding LINN's GAAP treatment of derivatives. See 2010 10-K at 45, 47, 52, 62, 69-72; 2011 10-K at 71-74, 78, 95; 2012 10-K at 62, 69-72; 1Q 2013 10-Q at 1-4, 11, 23; 2Q 2013 10-Q at 1-4, 11.
Again, Plaintiffs do not challenge the appropriateness of LINN's accounting treatment of derivatives under GAAP or the completeness of its disclosures relating to GAAP metrics. They challenge only LINN's non-GAAP disclosures.
B. Non-GAAP Disclosures
In its financial disclosures, LINN used several non-GAAP metrics, which are metrics that are " calculated and presented on the basis of methodologies other than in accordance with" GAAP. SEC Release No. 33-8176, 2003 WL 161117, at *1. In other words, there is no uniform GAAP rule governing how these metrics are calculated. These metrics included: (1) adjusted EBITDA, (2) DCF, (3) the distribution coverage ratio, and (4) maintenance capex.
1. Adjusted EBITDA
In the Complaint, Plaintiffs allege that LINN failed to properly account for the cost of the premiums paid for settled put options in calculating adjusted EBITDA, DCF, and the distribution coverage ratio. As LINN's disclosures make clear (and as Plaintiffs acknowledge), both DCF and the distribution coverage ratio are derived from adjusted EBITDA.
" EBITDA" is an acronym for a common financial metric--" earnings before interest, taxes, depreciation, and amortization." Compl. at ¶ 65. In other words, EBITDA is net income with the deductions for interest, taxes, depreciation, and amortization added back in. As one might expect, ...