Shareholder Class Action Against Toymaker Looks Broken

SAN FRANCISCO (CN) — A federal judge said Wednesday he “just doesn’t see” that toy maker Leapfrog’s board of directors misled investors to push through a $72 million merger with VTech last year.

“The board could have decided to make the judgment you wanted them to make, but that’s a business decision, not a falsity issue,” U.S. District Judge William Orrick III told an attorney for a class of Leapfrog investors.

Lead plaintiff Pete Manger sued Leapfrog and its directors in March 2016, claiming they used deceptively gloomy financial projections to push through the $72 million acquisition, for which shareholders got a “paltry” $1 per share. The merger was completed on April 4, 2016.

Class attorney James Wilson Jr. said the board misled investors about how soon it would face a liquidity crisis and lose its ability to borrow money, so it could reject a better offer by L&M Acquisitions, of $1.10 per share.

“The liquidity issue is an illusion,” Wilson said, adding that Leapfrog paid off $20 million of its credit debt in January 2016. “Where did that come from if they were struggling?”

But Leapfrog’s attorney Mark Foster said market demand for the company’s educational toys was dwindling year after year, and the company “faced a serious risk of being put out of business” before the end of 2016.

The company’s revenue, cash on hand and assets had fallen by at least 40 percent each year while its liabilities kept increasing, Foster told the judge.

Foster said there was nothing misleading about the company’s recommendation statement for the merger, which said that Leapfrog faced a “significant possibility” that it would lack the liquidity and credit needed to continue operating by the first or second quarter of 2016.

In an opposition to Leapfrog’s motion to dismiss, the shareholders said the board “misleadingly focused” on the failure of the LeapTV product, but failed to mention that demand for its Epic tablet product had exceeded sales projections.

Still, Orrick did not appear persuaded that the board intentionally misled investors.

“Epic’s success, it seems, was not hidden,” Orrick said. “It didn’t mean the company’s statements were false or misleading. Liquidity statements about running out of cash by the first quarter don’t seem inconsistent.”

After indicating that he would dismiss the shareholders’ second amended complaint, Orrick ended the 20-minute hearing and said he would issue a ruling soon.

Wilson is with Faruqi & Faruqi in New York City; Foster with Morrison & Foerster in San Francisco.

Leapfrog faces a separate class action, filed in January 2015, accusing it of misleading investors about dwindling prospects for its children’s educational toys, including its Leap TV.

In February, U.S. District Judge Edward Chen dismissed some claims against Leapfrog in that case, but refused to dismiss allegations based on the company’s failure to take a write-off for long-lived asset impairment in the third quarter of 2014.

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