The Inevitable Wave of COVID-19-Related Securities Litigation: What Public Companies Can Expect and Do to Prepare
The novel coronavirus (COVID-19) continues to rattle global markets, as the ultimate consequences of the pandemic remain unknown. The Dow Jones Industrial Average has plummeted. Eight of its 10 largest one-day declines in history occurred in March 2020.
Against this uncertain backdrop, numerous public companies have begun evaluating the potential impacts of the disease on business operations and earnings. Many have already downgraded prior forecasts or scrapped future guidance entirely, and many have suspended future dividend programs. All public companies are facing tough questions about when and how to disclose the impact of COVID-19.
This is the perfect recipe for “event-driven” securities class action lawsuits, which are securities fraud cases filed after a public company’s stock drops following an adverse event. The “event” preceding the drop may be company-specific (i.e., the announcement of a product recall), or related to a larger societal event (i.e., the #MeToo movement). We expect to see a wave of securities class action filings following the “event” of the COVID-19 pandemic and related market losses.
An uptick in COVID-19-related filings would be consistent with how the securities plaintiffs’ bar responded to the 2008 financial crisis. 2008 saw a nearly 20% increase in federal securities fraud class action filings. [I] So, even though the COVID-19 pandemic and its impacts are unprecedented, follow-on “event-driven” stock-drop lawsuits are certainly not.
I. The First-Filed COVID-19-Related Securities Fraud Class Actions
Consistent with the anticipated trend, three securities fraud class action lawsuits relating to COVID-19 have already been filed. Two of the suits are against Norwegian Cruise Lines and its CEO and CFO for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the Exchange Act). Plaintiffs allege that the company misled investors when, in February 2020, it painted a rosy outlook for its cruise ship operations even though the COVID-19 outbreak had begun in China. [ii] While Norwegian Cruise Lines disclosed some risks of COVID-19 and its “current known impact” in the challenged disclosures, the plaintiffs contend that they were insufficient to warn investors of COVID-19’s impact on the company’s sales and operations. [iii]
The third lawsuit alleges violations of Sections 10(b) and 20(a) of the Exchange Act by Inovio Pharmaceuticals and its CEO. There, the plaintiff alleges that the company’s CEO falsely “claim[ed] unequivocally that the company had successfully developed a vaccine against the spread of COVID-19 and that it anticipated rapidly bringing that vaccine to market.” [iv] According to the complaint, the company’s stock price skyrocketed following the announcement and consistent follow-on disclosures, but plunged after a short-seller questioned the legitimacy of the claims. [v]
The securities fraud class actions filed to date are consistent with expectations that industries with direct connections to the COVID-19 outbreak will be the most susceptible to securities fraud class actions. [vi] While plaintiffs will be sure to monitor an issuer’s claims concerning the ability to ride out the COVID-19 pandemic, the Inovio case tells us that plaintiffs will also scrutinize optimistic claims about a company’s ability to confront the pandemic, such as through the development of COVID-19-related products or the production of personal protective equipment.
Companies in industries more tangentially connected to the COVID-19 pandemic may still be vulnerable to securities class action lawsuits if they suffer material declines in stock prices. In these cases, plaintiffs likely will focus their allegations on inadequate risk disclosures. Plaintiffs may allege that a decline in a company’s stock price was caused by known but undisclosed risks that the company had a duty to disclose to investors. These risks could include those resulting from a pandemic like COVID-19 or from the company’s reliance on particularly vulnerable supply chains, customers, or geographic regions. We expect many plaintiffs to allege that, even if a company could not predict the specific impacts of COVID-19, they should have known of – and warned against – the general risks they would face from such a pandemic. And companies that suffered during previous global health crises, like SARS or H1N1, may find themselves even more vulnerable to these kinds of allegations.
II. Mitigating the Risks of COVID-19 Securities Class Actions
Given the likely inevitable onslaught of COVID-19-related securities litigation, public companies should consider taking proactive steps to minimize risk. The SEC recently “reminded all companies to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from [COVID-19] to the fullest extent practicable to keep investors and markets informed of material developments.” [vii] Thus, issuers can and should examine their disclosures and consider whether they have provided timely and adequate transparency into the expected risks and impacts of the COVID-19 pandemic based on what they know now. Issuers should also consider whether prior forward-looking guidance should be updated or withdrawn and whether cautionary language should be updated to maximize the protections afforded by the safe harbor for forward-looking statements.
Securities plaintiffs’ lawyers are sure to closely monitor public statements by issuers about the COVID-19 pandemic. Issuers should exercise extreme care when making public statements about the COVID-19 outbreak, its impact on the company’s operations or financial position, or the company’s projections and prospects in light of the pandemic.
If an issuer ultimately is confronted with a securities fraud lawsuit, it may find solace in the possibility of challenging the suit for failure to establish the required element of loss causation. Loss causation requires investors to prove that their losses were caused by the company’s alleged fraudulent conduct, rather than unforeseeable economic factors, like the COVID-19-related market crash. To satisfy this element, many circuits—including the Second and Eleventh Circuits—require plaintiffs to present evidence separating the fraud and non-fraud-related causes of the declines in stock price. [viii]It may be particularly difficult for plaintiffs to do so here. But defendants relying on the absence of loss causation as a defense may have to defend an action through summary judgment, or even trial, so that they can rely on expert witnesses to opine on the causes of the stock drops.
III. New Securities Offerings
In addition to securities fraud claims under Sections 10(b) and 20(a) of the Exchange Act, we expect plaintiffs to be aggressive in filing stock-drop cases under Sections 11 and 12(a)(2) of the Securities Act of 1933 for alleged inadequate disclosures. These sections of the securities laws apply to statements made in connection with the offering of securities and, importantly, do not require allegations of fraudulent intent or loss causation to state a claim. Plaintiffs need only identify a material misstatement or omission in the offering documents to survive a motion to dismiss. For this reason, companies considering new securities offerings in the near future should be particularly mindful of COVID-19-related disclosures.
IV. Derivative Litigation
Along with a spike in securities fraud class action lawsuits, we also expect a corresponding rise in derivative lawsuits. Specifically, we anticipate that investors will allege that a company has been damaged as a result of an inadequate response to the COVID-19 pandemic by the board of directors and management. These claims could be predicated on the alleged failure of oversight over business operations, COVID-19-related disclosures, or failure to appropriately respond to red flags. A thorough record showing consideration of COVID-19-related issues and the exercise of sound business judgment are the best defenses to these kinds of derivative claims.
V. Conclusion
As we saw in the wake of the 2008 financial crisis, investors often seek to recoup losses from market crashes by filing stock-drop lawsuits. History has a way of repeating itself, and we have no reason to expect investors’ responses to the COVID-19-related market crash to be any different. Plaintiffs’ firms will closely monitor public company disclosures for any purported failures to identify risks related to the COVID-19 pandemic and its anticipated impacts, failures to update disclosures to reflect the current effects of the pandemic on business operations once known, or failures to update or withdraw prior guidance. Issuers should pay careful attention to all COVID-19-related disclosures and public statements.
[i] See Cornerstone Research, Securities Class Action Filings (2008: A Year in Review) (the “2008 Cornerstone Report”) at 2.
[ii] Douglas v. Norwegian Cruise Lines Holdings Ltd., et al. , Case No. 1:20-cv-21107 (S.D. Fla. March 12, 2020) (the “Douglas Compl.”), ¶¶ 16, 18; Atachbarian v. Norwegian Cruise Lines, et al., Case No. 1:20-cv-21386 (S.D. Fla. March 31, 2020), ¶ 23.
[iii] See, e.g., Douglas Compl. at ¶¶ 18, 21.
[iv] McDermid v. Inovio Pharmaceuticals, Inc., et al. , Case No. 2:20-01402 (E.D. Pa. March 12, 2020), ¶ 15.
[v] Id. , ¶ 6.
[vi] This, too, is consistent with securities litigation following the 2008 financial crisis. In 2008, financial companies were named defendants in nearly 50% of all federal securities class actions. Businesses with connections to subprime lending were most susceptible. See 2008 Cornerstone Report at 2.
[vii] Troutman Sanders, SEC Releases COVID-19 Disclosure Guidance for Public Companies; https://www.sec.gov/news/press-release/2020-53.
[viii] Hubbard v. BankAtlantic BancCorp, Inc., et al. , 688 F.3d 713, 726 (11th Cir. 2012) (“[I]f there are confounding factors that could account for much of the decline in the price of the security, the plaintiff must offer some evidence separating the various causes of the decline in the security’s price even to establish loss causation.”); In re Flag Telecom Holdings, Ltd. Sec Litig., 574 F.3d 29, 36 (2d Cir. 2009) (holding that plaintiffs must “disaggregate those losses caused by ‘changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events from disclosures of the truth behind the alleged misstatements’”).