The Rise and Fall of VeraSun, Continued

A shareholder suit against the board and management of the former VeraSun illustrates important considerations for all ethanol producers.
By Todd Taylor and James Dorsey | May 21, 2010
By now, the story of VeraSun's rise and fall is familiar to everyone in the ethanol industry. At its peak, VeraSun Energy Corp. was the largest ethanol producer in the U.S., and it was often talked about as the acquirer of choice for any single-plant ethanol company looking to cash in, even as the market started to turn down. As a result, the swift fall for VeraSun was a shock to the industry. What is happening now with VeraSun and some of its very unhappy shareholders may also cause shockwaves throughout the industry.

In VeraSun's public announcement Sept. 16, 2008, that it found itself on the wrong side of both the corn and ethanol markets, VeraSun concluded that it expected "to incur a net loss for the third quarter of 2008 in the range of between $63 million (40 cents per share) and $103 million (65 cents per share)." Conditions rapidly went downhill and Oct. 31, 2008, VeraSun declared bankruptcy. Eventually, its plants were sold off and its assets liquidated in the bankruptcy. VeraSun creditors recouped what they could from the sale of those assets and walked away licking their wounds. Unfortunately for the VeraSun shareholders, they received nothing.

Shareholders File
Until recently, this seemed to be the end of the story. Some VeraSun shareholders, however, are now fighting back by going after VeraSun's former executives. This development could have implications for other ethanol companies facing hard times, whether or not they are publicly held companies. In a complaint filed in United States District Court for the Southern District of New York on Nov. 10, a number of shareholders of VeraSun brought a class action lawsuit for securities law violations. VeraSun escaped being named only because it is protected by the bankruptcy laws. Donald L. Endres, VeraSun's chairman and CEO, Danny C. Herron, the chief financial officer, and Bryan D. Meier, the chief accounting officer, were not so lucky and are all named defendants.

These shareholders claim that from March 12, 2008, to Sept. 16, 2008, VeraSun and the defendants made statements that failed to disclose information about the company that would have put the market on notice about the risks facing the company.

As referenced above, in 2008, sharply rising corn prices caused VeraSun to take certain actions it believed necessary to protect its margins. On Sept. 16, 2008 VeraSun stated:

"In July 2008, after corn prices had risen from approximately $6 per bushel at the end of May 2008 to almost $8 per bushel due to extraordinary weather conditions in the Midwest and broader market commodity trends, we effectively priced our corresponding physical purchases of corn at the then-current market price, which proved to be significantly higher than today's market prices for corn. In addition, based on market forecasts that prices would continue to rise, we entered into a number of "accumulator" contracts relative to corn requirements for the third and fourth quarters that, in each case, allowed us to purchase a specified volume of corn at prices below then-prevailing market rates, but also required us to purchase that same volume of corn (in addition to the initial purchase) at one or more lower prices per bushel should market prices decline to or below those lower levels over the duration of the contract. Shortly thereafter, corn prices commenced a sharp decline from almost $8 per bushel to a low of under $5 per bushel in mid-August 2008. As a result, we were required under the accumulator contracts to purchase additional amounts of corn at prices that proved to be higher than prevailing market prices."
According to the complaint, VeraSun's statements before the Sept. 16, 2008, announcement failed to disclose the true nature of the risks facing the company. Specifically, they allege that VeraSun failed to disclose the following adverse facts: (I) VeraSun was a speculative commodities trader; (II) VeraSun engaged in speculative and risky derivative transactions that exposed it to substantial financial and liquidity risk; (III) VeraSun experienced substantial loses on speculative derivative transactions causing margin pressures on the company; (IV) as a result of those margin pressures, the company sold out of a large short position in corn and incurred substantial losses; (V) the company entered into highly risky "accumulator" contracts that obligated VeraSun to purchase increasing amounts of corn after the price of corn fell; and (VI) VeraSun's financial condition and especially its liquidity were negatively impacted as a result of speculative commodity transactions, ultimately causing the company to file for bankruptcy. According to the complaint, these alleged misrepresentations and/or omissions occurred both in the reports that the company filed with the Securities and Exchange Commission and in various press releases and public comments made by the company.

Further, according to the plaintiff's lawyer: "On September 16, 2008, VeraSun announced that it commenced a public offering of 20 million shares of its common stock to raise money for ‘general corporate purposes.' The true purpose of this public offering was to raise capital in an effort to prevent a disastrous impact from the huge losses experienced by the Company as a result of its speculative trading and risky bets on the price of corn. In response to the Company's announcement on September 16, 2008, shares of the Company's stock fell $3.81 per share, or 70 percent, from a close of $5.22 per share before the announcement, to close at $1.41 per share on September 17, 2008, on extremely heavy trading volume."

The plaintiffs are alleging that VeraSun knew or should have known of these risks and failed to inform its investors about these risks and the consequences should the risks materialize. As a result of these risks and the failures to disclose them, the plaintiffs allege that they suffered the loss of all the value of their shares. According to the most recent SEC filing by VeraSun, as of Oct. 31, its total shareholders' equity was a negative $26,479,000. The plaintiffs are seeking damages equal to the difference between the price they paid for their shares and the price today—essentially they want all of their money back.

Implications for All
While the VeraSun saga is interesting in its own right, it is also valuable as a learning tool for other ethanol plant board members and executives. VeraSun's executives are being sued because they allegedly lied to their shareholders about the nature of VeraSun's business and the risks associated with that business. Every board member and executive officer of a company, registered with the SEC or not, has a duty to speak truthfully to their shareholders when they speak at all. If they are unwilling or unable to disclose all of the material facts, they should not speak. This includes shareholder meetings, shareholder newsletters, letters to the editor of the local paper, and coffee shop chats with friends about the company.

VeraSun, as an SEC-reporting company, had a duty to speak and provide information through its SEC reports, which is not the case for non-SEC-reporting companies. But its duty to disclose all material information when it spoke is the same duty that applies to any company, even privately held ones. Also, because VeraSun was trying to sell shares, it had to describe its business and risks in full detail, so the investors could make informed investment decisions. Every ethanol plant that has raised equity capital had that same duty, and that is why the disclosures in a prospectus are important if the business starts to suffer. These disclosures, if done properly, can help protect the company, the board and executives from securities fraud claims.

Because shareholders' main source of information about a company comes from the board and executives, shareholders rely on them to provide accurate and honest information that allows them to determine how to vote in board elections and whether to buy or sell shares. Being careful about shareholder communications, even casual discussions, can help avoid these issues. Therefore, many companies prohibit board members and executives from publicly discussing any material information about the company and appoint a designated spokesperson. Directors and executive officers who are either required to disclose certain information under SEC rules, or who chose to do so voluntarily, must be careful to give the full picture, not just the good news. This becomes even more important when times are tough, as shareholders may call their director and officer friends looking for information and advice on what to do. Painting an overly optimistic picture can definitely land a director or officer in trouble.

It is also important to consider how your decisions may be viewed in retrospect. VeraSun's executives likely believe they made good and reasonable business decisions and disclosed the material facts. While they are not being sued for breaches of fiduciary duty, those claims regularly accompany securities fraud claims and it is important to realize that having a well-reasoned process for making decisions is often just as important as the decision itself, as it can help establish that you fulfilled your fiduciary duty of care should an unexpected event suddenly lay waste to your best laid plans.

A few years ago during a board meeting for an ethanol client that was doing an equity drive, a board member rather hotly questioned just how much disclosure about risks was really needed. He asked if any ethanol company had ever been sued for fraud. He was told that it was just a matter of time. Well, that time is up. EP

(Note: Neither the authors nor the law firm of Fredrikson & Byron, represent the plaintiffs, defendants or VeraSun, and the authors expressly disclaim any opinion regarding the merits of the allegations against the defendants, nor should any such opinion be inferred by the reader.)

James E. Dorsey practices in the area of commercial litigation at Frederickson & Byron and is the chair of the valuation dispute and litigation group, which encompasses shareholder disputes, condemnation, and real estate tax matters. Reach him at (612) 492-7079 or [email protected]. Todd A. Taylor is the co-chair of Fredrikson & Byron's clean technology group and focuses on biofuels and biomass projects. Reach him at (612) 492-7355 or [email protected]