By Dean Seal

Law360 (June 11, 2020, 8:33 PM EDT) -- Building on counterclaims filed by Advent International Corp. last week, investors in Forescout Technologies Inc. have filed a stock-drop suit in California federal court against the cybersecurity company over a scrapped $1.9 billion take-private deal.

The putative class action filed Wednesday claims that while the May 18 announcement of the Advent acquisition's dissolution "entirely surprised" investors, Forescout and its senior management had known for months that business was experiencing a significant decline, due in part to COVID-19's impact on operations in Asia, and that the company's fourth-quarter numbers for the year prior were inflated by an alleged "channel stuffing" scheme.

"Because of these factors, Forescout knew that the consummation of the transaction was exceptionally risky at the time it announced the merger agreement," the suit alleged. "Forescout neither disclosed these facts to investors nor Advent at the time it signed the merger agreement."

Forescout likewise failed to inform investors that Advent started raising concerns about the cybersecurity company's financial performance as early as March, a month after the $33-per-share acquisition was inked, and that it hadn't been meeting its obligations under the merger agreement, creating the later-realized risk that the merger would not close, the suit alleges.

The shareholders aim to hold Forescout and its top brass liable for the 23.5% share price drop that occurred on May 18.

California-based Forescout provides software that helps organizations monitor the devices connected to their network. The Advent takeover deal publicized in February would have had the private equity firm buy Forescout at a 30% premium over its share price from October 2019.

But on May 18, the day the transaction was set to be finalized, Forescout announced that Advent had put the deal on hold the Friday prior, with no guarantee an agreement would be reached. Forescout's share price, which had previously closed at $29.52, closed at $22.57 that day, according to the investors behind Wednesday's suit.

Forescout launched a lawsuit against Advent two days later in Delaware state court, alleging the private equity firm had violated the terms of their agreement by backing out and challenging the firm's claim that the deal couldn't close because of a "material adverse effect" that occurred at Forescout.

"We have satisfied all conditions to closing under our merger agreement, and a material adverse effect has not occurred," Theresia Gouw, chair of the Forescout board, said in a press release announcing its May lawsuit in Delaware. "The only change since the merger agreement was jointly executed in February is the deepening of the COVID-19 pandemic, which has significantly impacted global macroeconomic conditions."

Advent quickly pushed back on Forescout's claims, first in a statement saying the deal was put on hold "after an extensive analysis that included information provided by Forescout, the company's first-quarter 2020 financial results, and a detailed forecasting exercise to better understand future performance."

"There has been a disproportionate effect on the company's business relative to its direct peers, most of which have reported strong financial performance in the current environment," Advent said last month, noting it was "disappointed" in Forescout's decision to pursue litigation.

Then on June 5, Advent responded with counterclaims and said Forescout was trying to shift blame for the sputtered deal to the coronavirus rather than the fact that its "financial and operational performance had fallen off a cliff" while competitors prospered.

Advent's letter to Forescout terminating the deal has since been revealed as an exhibit in the Delaware litigation, as the investor suit noted Wednesday, and asserts that Forescout "will be insolvent at the time of closing after giving effect to the proposed transaction." The sides are currently sparring over the alleged insolvency of any post-takeover Forescout in the state court litigation.

In California federal court, Forescout's investors are now firing securities claims at the company for concealing downturns, including in its fast-growing Asia Pacific and Japan region due to the spread of COVID-19 in January, when it announced the merger in February alongside positive fourth-quarter earnings.

The federal suit also points to a subpoena in the Delaware action that shows Advent received an email on May 5 from a whistleblower, who claimed Forescout had engaged in undisclosed "channel stuffing" by sending one of its resellers more products than it could sell, thus inflating revenues for the fourth quarter of the previous year.

The investors claim that while they were being kept in the dark about Forescout's dramatic downturn, 12 of the company's competitors were experiencing a roughly 20% uptick in year-over-year revenue, leading the investors to expect Forescout had as well.

"Unfortunately, Forescout knew but failed to advise investors that its positive statements were no longer true and its first-quarter revenue declined year-over-year by 24%," the suit stated.

Alleging that Forescout's most senior executives had millions of dollars to gain by pushing the transaction to a close without coming clean about the company's issues and that it failed to meet its obligations under the merger agreement with Advent, the shareholders seek damages on behalf of Forescout investors who acquired shares between the day of the acquisition announcement and the day Advent called it off.

"We are aware of this complaint, which is related to a previously filed complaint," a representative for Forescout told Law360 on Thursday. "We believe this suit is without merit and intend to vigorously defend ourselves."

Counsel for the investors did not immediately respond to a request for comment Thursday.

The investors are represented by Marc M. Seltzer and Krysta K. Pachman of Susman Godfrey LLP and Andrew J. Entwistle, Vincent R. Cappucci, Brendan J. Brodeur and Andrew M. Sher of Entwistle & Cappucci LLP.

Counsel information for Forescout was not available.

The case is The Arbitrage Fund et al. v. Forescout Technologies Inc. et al., case number 3:20-cv-03819, in the U.S. District Court for the Northern District of California.

--Editing by Janice Carter Brown.

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