Law360 (April 15, 2020, 4:55 PM EDT) --
We expect to see more such cases in the future as plaintiffs lawyers seek to capitalize on a volatile stock market and unprecedented market changes to argue that companies deceived investors by failing to make adequate disclosures.
Cases Already Brought and COVID-19 Disclosures
In recent weeks, we have seen cases brought in the U.S. District Court for the Southern District of Florida against Norwegian Cruise Line Holdings Ltd. and in the U.S. District Court for the Eastern District of Pennsylvania against Inovio Pharmaceuticals Inc.
In the case against Norwegian Cruise Line, plaintiffs alleged that the company's statements about its bookings, resilience in challenging environments, preventative measures to reduce exposure and transmission of COVID-19, and concern about the safety of guests and crew were misleading in light of scripts prepared for sales personnel that reassured customers about the risks of the novel coronavirus.
In the case against Inovivo, the complaint alleges that the company misled its stockholders about the speed of its development of a COVID-19 vaccine.
We expect the issues raised in these cases to be harbinger of future claims.
On March 25, the U.S. Securities and Exchange Commission issued Disclosure Guidance: Topic No. 9, which instructs companies to disclose the risks and effects of COVID-19, "including how the company and management are responding" to those risks.
Acknowledging that these increased disclosures will entail additional risk to issuers, the SEC further advised that "much" of these disclosures will be forward-looking and reminded issuers to undertake these disclosures "in a way to avail companies of the safe harbors" for forward looking statements.
Even before the SEC's updated guidance, however, many public companies had begun including COVID-19 related disclosures in their periodic filings. These disclosures typically ranged from updated risk factors tailored to COVID-19, discussion of COVID-19 as a trend or factor affecting results in management discussion and analysis, and subsequent event disclosures.
In addition, many companies have issued Form 8-Ks updating or withdrawing previous guidance, announcing that guidance will be delayed or unavailable for 2020, updating risk factors and/or trends affecting MD&A disclosures from prior periodic reports, reporting new contracts — particularly in the pharmaceutical contexts — providing updates on business operations — announcing supply chain interruptions or closures — and providing updates on employment matters, including the temporary departure of an executive as a result of COVID-19 or salary reductions.
In the coming weeks and months, we also expect to see a proliferation of lawsuits based on these disclosures.
Culpability for Opinion Statements Issued Before a Consensus Emerged About COVID-19
We expect disclosures issued from late January to early March to be a particularly fertile area for litigation. This time period is significant because it is both when many public companies issued projections for 2020 and filed annual reports on Form 10-K — which typically include a company's most fulsome risk disclosure for any year — and when assessments about the seriousness of the threat posed by COVID-19 were at their most disparate.
Many of these cases will be focused on a company's culpability for opinion statements. In 2015, the U.S. Supreme Court held that a statement of opinion made in a registrations statement filed in connection with a public offering will be deemed misleading for purposes of Section 11 of the Securities Act if it "omits material facts about the ... inquiry into or knowledge concerning [such] statement, … and if those facts conflict with what a reasonable investor would take from the statement itself."
The court stated that an opinion can be misleading by omission where it does not "fairly align ... with the information in the [company's] possession at the time."
The court further noted that "[a]n opinion statement, however, is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way." The court also explained "to avoid exposure for omissions under Section 11, an issuer need only divulge an opinion's basis, or else make clear the real tentativeness of its belief."
Although this decision is, on its face, limited to claims based on statements made in a registration statement, some circuits have held that it also extends to traditional securities fraud class actions brought under Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder by some courts.
In the context of COVID-19, we expect to see increasing scrutiny by courts about whether a company's statements about the effect of COVID-19 had a reasonable basis. This will be a particularly thorny issue in light of the disparate guidance provided by scientists, on the one hand, and the president of the United States, on the other, in the crucial late-January to early March time period.
Certainly, a strong argument can be made that optimistic statements and projections based on statements by the president have a reasonable basis, as a matter of law, because the president had access to more information about the virus than any individual corporate executive.
Further, if a court were to hold that such reliance was not reasonable, it might raise concerns about separation of powers — can an Article III court hold that reliance on the executive branch is unreasonable? Can public companies be held to a higher standard of knowledge than that espoused by the chief executive?
On the other hand, however, we would expect the plaintiffs bar to point to guidance by scientists, and perhaps even the SEC's initial guidance on Jan. 30, as a basis for arguing that the issuers were "aware of undisclosed facts tending to seriously undermine the statement's accuracy," or that the statements of opinion did not "fairly [align] with the information in the issuer's possession at the time."
Did Companies Have Adequate Risk Disclosures?
We also expect to see heightened litigation around a company's risk disclosures. In Topic 9, the SEC expressly stated that many COVID-19 related statements will be subject to the safe harbor for forward looking statements, which provides an absolute bar for liability if, among other requirements, the statements are "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement."
In Omnicare, the Supreme Court also clarified that courts cannot consider opinions in a registration statement to be misleading without taking into account the "surrounding text, including hedges, disclaimers, and apparently conflicting information."
Nonetheless, it has become increasingly common for plaintiff in securities class actions to argue that a risk disclosure framed as a conditional statement can be misleading when the company knows that the risk has already come to pass. Regardless of what one might think of the merit of such an argument — we tend to think courts should not endorse it — some courts have seemingly accepted the idea that a risk disclosure can constitute a misleading statement.
Risk disclosures therefore will raise many of the same issues, and often involve the same analysis, as opinion statements. Courts will need to decide whether conditional risk disclosures should be considered meaningful given that companies might have relied upon the president's assessment of risk levels from COVID-19 in determining how to phrase their risk disclosures.
Courts might also need to decide whether such conditional risk disclosures were misleading given that many in the scientific community believed that there was likely to be a much greater impact than did the president. And, if a company's results are negatively affected by COVID-19 issues, courts might need to decide whether risk disclosures that companies did include can be considered meaningful even if they did not mention COVID-19.
The conference report accompanying the legislation that added the safe harbor for forward looking statements explicitly stated that "[f]ailure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor," but, with the benefit of hindsight (and, with respect to statements issued after March 25, in light of the SEC's guidance), courts might have a difficult time reconciling that language with what is now the likely effect of COVID-19 on public companies.
Will There Be More Section 11 Cases Given Significant Stock Market Decline?
Section 11 of the Securities Act of 1933 provides for liability when a registration statement in connection with a public offering contains a false or misleading statement. Damages in such cases are usually measured by the difference between the price of the offering and the price on the date that the lawsuit was brought, subject to an affirmative defense that the stock price decline did not result from any misleading statement or omission in the registration statement.
The statute of limitations on such claims is one year after discovery of the alleged misstatement or omission with a three year statute of repose from the time of the offering. This statutory scheme essentially means that stockholders do not bring suit if the current price is above the offering price — or the converse is that stockholders can bring suit if the current price is below the offering price.
Given the large decline in the stock market over the last month or so (with possible further declines in the future), companies that conducted an offering in the last three years whose stock price is now below the offering price are now at risk of being sued under Section 11.
Of course, there still needs to have been a false or misleading statement in the company's registration statement for there to be liability, but the incentives to try find such a misleading statement have increased and will increase more depending on how far below the offering price a stock is trading.
There are likely many more issues that will be litigated in the months and years to come as the novel coronavirus and COVID-19 might be the ultimate in event-driven securities litigation, but we expect that the issues discussed above will at least be part of what will decide the outcome of these likely cases.
Richard Zelichov and Christina Costley are partners at Katten Muchin Rosenman LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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