Law360 (May 28, 2020, 4:21 PM EDT) --
Market volatility has historically precipitated increased securities litigation and might be expected to have an outsized impact on claims under the Securities Act, given rescissory damages and the absence of a requirement that plaintiffs plead and prove loss causation.
Although it is still too early to tell whether issuers that went public just before and then amid the COVID-19 crisis will face Securities Act lawsuits in greater than average numbers, plaintiffs are poised to file suits against issuers of substantial offerings whose share prices have been impacted by the recent market decline.
The following analysis of offerings during late 2019 and early 2020, immediately prior to and during the COVID-19-induced market volatility, and the Securities Act complaints filed against some of those issuers amid the market unrest provide preliminary insights into whether, when and on what basis recent issuers — and their underwriters and auditors — are facing Securities Act litigation.
The Issuers and the Offerings
Initial public offerings in the U.S. remained active in late 2019 and early 2020, even as global concerns about COVID-19 grew. IPOs also continued despite COVID-19's outsized impact on market returns beginning in mid-February. Between Nov. 1, 2019, and April 24, 2020, 52 issuers conducted IPOs on U.S.-based exchanges.
Issuers that went public spanned the globe. Just over 60% of those issuers had their primary place of business in the U.S. Of the remaining non-U.S. issuers, the majority are headquartered or primarily operate in China.
IPOs during the review period also focused heavily on the health care, technology and financial sectors — the same sectors that represented the majority of IPO activity during 2019 as a whole. Health care accounted for the greatest number of offerings — approximately 45% — during the review period.
Those health care issuers are almost exclusively based in the United States. Technology accounted for the second-largest number of offerings, with approximately 15%. Only half of those issuers are based in the U.S. And the financial sector made up the third-largest number of offerings, representing just over 10%. Like technology, only about half of the financial companies that went public are U.S.-based.
Health care issuers that went public during the review period mostly experienced positive stock price returns between the close of trading on the day after the offer date and April 24, generally consistent with the fact that health care securities have outperformed most other sectors since November 2019.
Stock prices for technology companies have been harder hit; as of April 24, three-fourths of technology issuers that went public during the review period had negative returns between the close of trading on the day after the offer date and April 24.
Technology securities as a whole, however, have performed only moderately worse than health care securities over the review period. Financial issuers have been particularly hard hit during the recent market decline, with approximately 85% of financial issuers that went public during the review period experiencing negative returns between the close of trading on the day after the offer date and April 24; the industry as a whole is down almost 24% over the review period.
Finally, IPOs during the review period ranged widely in size, from approximately $5.2 million to nearly $2 billion. The largest three offerings were conducted by Brazil-based financial company XP Inc., for nearly $2 billion; North Carolina-based pharmaceutical company PPD Inc., for over $1.6 billion; and Canada-based environmental company GFL Environmental Inc. for over $1.4 billion.
The Issuers That Have Faced Litigation
To date, plaintiffs have filed complaints alleging violations of Sections 11, 12(a) and 15 of the Securities Act against three issuers that went public during the review period. Plaintiffs firms have announced investigations of purported securities law violations by at least one other issuer.
On March 4, the plaintiffs filed a suit against Canaan Inc., and its underwriters in the U.S. District Court for the District of Oregon. Canaan, a China-based technology company, raised approximately $90 million during its initial public offering on Nov. 21, 2019.
The complaint alleges that Canaan's offering documents failed to fully disclose a related-party transaction with a China-based company; that Canaan's "financial health was worse than what was actually reported"; that Canaan had "recently removed numerous distributors from its website just prior to the IPO, many of which were small or suspicious businesses"; and that, contrary to Canaan's disclosures, several of the company's largest clients were not likely to be repeat customers.
The plaintiffs claim that the truth about Canaan's alleged misstatements emerged on Feb. 20, when a third party published a report "explaining Canaan's numerous false and/or misleading statements" and detailing the supposed inaccuracy of the allegedly false portions of the company's registration statement. That day, the price of Canaan's American depositary shares, or ADS, fell "over 6.8%," from $5.71 to $5.32.
Since the close of trading on the first day after its IPO, Canaan's ADS price has fallen 53%. By contrast, the technology sector had a positive return of 3%, suggesting Canaan has significantly underperformed its industry sector.
On March 21, the plaintiffs filed a suit against XP Inc., and its underwriters in the U.S. District Court for the Eastern District of New York. XP, a financial services company based in Brazil, conducted a nearly $2 billion offering — the largest during the review period — on Dec. 11, 2019.
The plaintiffs allege that XP failed to fully disclose related-party transactions with a Brazil-based bank, technological issues, and risks related to relying on independent financial agents as part of the company's business strategy, and that XP "had material weaknesses ... [and] fired its previous accounting firm due [to] that firm finding and disclosing material weaknesses."
The plaintiffs state that on March 6, a third party published a report allegedly "detailing ... how XP had misled investors and failed to disclose pertinent information generally and in its Registration Statement." XP's shares allegedly "plummeted ... 25.5%" over the next two trading days.
Since the close of trading on the first day after its IPO, XP's ADS price has fallen 34%. The financial sector has also dropped 29% over the same period, suggesting XP has underperformed its industry sector by 5%.
Phoenix Tree Holdings
On April 24, the plaintiffs filed the first Securities Act suit directly related to the COVID-19 crisis against Phoenix Tree Holdings Ltd. and its underwriters in the U.S. District Court for the Southern District of New York. Phoenix, a China-based real estate company, raised approximately $130 million during its Jan. 17 offering.
The plaintiffs allege that Phoenix failed to disclose the volume of complaints made by residents of its apartment buildings and did not warn of the potential impact of COVID-19 on its business.
The complaint asserts that at the time Phoenix went public, COVID-19 "was already ravaging China — particularly Wuhan, which was widely regarded as the epicenter of the virus and a significant hub for Phoenix," and that although the company warned that "business could ... be adversely affected by the effects of Ebola virus, H1NI flu, H7N9 flu ... or other epidemics," Phoenix did not specifically identify risks related to COVID-19.
The truth allegedly began to emerge "as Phoenix's going-public transaction was publicized, and investors began to understand that the coronavirus was significantly and adversely impacting the Company's business and operations," and then finally spilled out on March 25, when Phoenix issued a press release "caution[ing] investors that it expected the coronavirus to adversely affect its financial performance for the first quarter of 2020."
The plaintiffs do not allege a specific stock drop.
Since the close of trading on the first day after its IPO, Phoenix's ADS price has fallen 48%. The real estate sector fell 17% over the same period, suggesting Phoenix has underperformed its industry sector by roughly 31%.
While a complaint has yet to be filed, at least four plaintiffs firms are seeking potential clients in connection with the IPO of Velocity Financial LLC, a California-based financial company that raised approximately $94 million during its Jan. 17 IPO.
Since the close of trading on the first day after its IPO, Velocity's share price has fallen 78%. That is roughly 49% worse than the financial sector's performance.
Comparing Issuers That Have Faced Suits
There are a number of similarities among the three issuers against which Securities Act complaints have been filed.
Unsurprisingly, complaints have been filed against issuers that raised a substantial amount of capital during their IPOs. Canaan, XP and Phoenix each raised around $100 million or more — a threshold that is close to the median deal size of $110 million for issuers that listed on the New York Stock Exchange or Nasdaq stock market during 2019.
Quarterly and Annual Disclosures
None of the issuers that have been sued had filed a quarterly or annual report at the time the plaintiffs filed a suit.
Location of Issuer
So far, U.S.-based issuers that went public during the review period have not been subject to Securities Act litigation. All three issuers against which Securities Act claims have been asserted are based outside of the United States; two of them are based and primarily operating in China.
Auditors and Underwriters
Canaan, XP and Phoenix all retain prominent Big Four auditing firms and had their IPOs underwritten by established banks. Although the underwriters of each IPO have been named as defendants in the Securities Act suits filed to date, no suits have named auditors as defendants.
Stock Performance Relative to Industry Benchmark
The securities for all four issuers that have been sued appear to have underperformed their industry sectors by more than 5% — three of the four (Canaan, Phoenix and Velocity) by substantially greater than 5%.
By contrast, several other recent issuers with significant security price declines that have outperformed their industry benchmarks have thus far avoided a suit.
For example, Fangdd Network Group Ltd., a China-based financial issuer whose share price has declined 25% since the close of trading on the day after its Nov. 1, 2019, offering of approximately $78 million, has not been sued. The financial sector fell 26% over the same period, suggesting that Fangdd has outperformed its industry sector by 1%.
And perhaps most notably, GFL Environmental Inc., a Canada-based industrial company whose share price has declined nearly 14% since the close of trading on the first day after its March 3 offering of over $1.4 billion, has also avoided litigation. The industrial sector declined 19% over the same period, suggesting that GFL has outperformed its industry sector by 5%.
Comparing the Securities Act Complaints
There are also some similarities among the Securities Act claims filed against Canaan, XP and Phoenix.
The Rosen Law Firm PA has filed complaints against Canaan and XP, two of the three issuers that have been sued to date. This is consistent with the Rosen Law Firm's history of filing early complaints and for suing non-U.S. issuers. In 2019, Rosen Law Firm was the most active firm in first-in-court filings in securities class actions against non-U.S. issuers.
Pomerantz LLP, which was the second-most active firm in 2019 in first-in-court securities class actions filings against non-U.S. issuers, also has filed a suit against Canaan and XP, and is actively seeking plaintiffs on whose behalf to file a suit against Velocity Financial.
Three other firms — Robins Geller Rudman & Dowd LLP; Bronstein Gewirtz & Grossman LLC; and Bragar Eagel & Squire PC — are also actively seeking plaintiffs in multiple cases.
Robins Geller and Bronstein Gewirtz have filed a suit against Phoenix and Canaan, respectively. Johnson Fistel LLP is seeking plaintiffs in one case; the firm has also filed a state court complaint against XP.
Notably, some of the largest plaintiffs firms active in Securities Act litigation, including Bernstein Litowitz Berger & Grossmann LLP, have not filed Securities Act complaints, and do not appear to be publicly seeking plaintiffs on whose behalf to file a suit against any issuers that went public during the review period.
Date of Suit
Not surprisingly, each of the Securities Act cases was filed after the market decline that began in mid-February, between three or four months after each IPO.
Like most Securities Act cases, the suits filed against Canaan, XP and Phoenix each allege claims under Sections 11, 12(a) and 15 of the Securities Act. Notably, none of the cases asserts claims under Section 10(b) of the Exchange Act, which would require that the plaintiffs meet the higher burden of pleading and proving scienter and loss causation.
Disclosure of related-party transactions has been a focus of the plaintiffs in two of the three complaints filed to date. This is consistent with a trend in 2019 toward plaintiffs filing numerous securities claims that alleged a failure to disclose significant related-party transactions with non-U.S. parties. Only the complaint against Phoenix asserts misrepresentations concerning COVID-19.
While the number of Securities Act suits against issuers that went public in late 2019 or early 2020 remains limited, the following observations can be made.
First, and not surprisingly, the issuers that have been sued conducted larger offerings and have experienced sizeable share price declines. Securities Act claims thus far have targeted offerings of around $100 million or more.
Second, issuers whose securities have underperformed the industry average since the close of trading on the day after their IPO have faced a suit, while large issuers with sizeable share price declines that have outperformed their industry sectors have not. Thus, although market volatility may drive Securities Act claims, so far only IPOs that have underperformed their industry sectors have been the subject of Securities Act claims.
Third, amid the COVID-19-induced market volatility, issuers continue to be sued for alleged misstatements unrelated to the COVID-19 crisis. It is possible — perhaps even likely — that plaintiffs will file additional claims challenging COVID-19-related disclosures as IPOs nearer to the onset of the COVID-19-induced market volatility become the subject of Securities Act claims.
Finally, the sole subjects of Securities Act complaints to date have been issuers not based in the U.S. Whether that trend persists remains to be seen.
Christopher Davies is a partner, Robert Kingsley Smith is counsel and Sierra Shear is a senior associate at WilmerHale.
Partners Michael Bongiorno and Timothy Perla contributed to this article.
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.
 Dean Seal, As Investor Suits Tick Up, Loss Causation May Be A Hard Sell, Law360 (May 4, 2020), https://www.law360.com/securities/articles/1269242/as-investor-suits-tick-up-loss-causation-may-be-a-hard-sell?nl_pk=4abaa913-5925-4c88-aca6- de18429e3f60&utm_source=newsletter&utmmedium=email&utm_.campaign=securities; Dustin Prial, Market Volatility Pushes Surge Of First-Half Class Actions, Law360 (July 25, 2018), https://www.law360.com/articles/1067017/market-volatility-pushes-surge-of-first-half-class-actions.
 The IPOs analyzed for this article were identified by Cornerstone Research and did not include special-purpose acquisition companies and blank-check companies.
 Ernst & Young, Global IPO trends: Q4 2019, at 9 (2019), https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/growth/ey-global-ipo-trends-q4-2019.pdf.
 The securities returns cited in this article are based on an analysis by Cornerstone Research. All securities returns are calculated as of April 24, 2020.
 On March 6, 2020, a different set of plaintiffs filed a substantially similar complaint in New York state court. See Salmaan et al. v. Canaan et al., Case No. 651515/2020 (N.Y. Sup. Ct. Mar. 6, 2020).
 On March 19, a different set of plaintiffs filed a similar complaint in New York state court. See Kazi et al. v. XP Inc. et al. Case No. 65177/2020 (N.Y. Sup. Ct. Mar. 19, 2020). A third complaint alleging substantially similar claims was filed on April 16 in the Eastern District of New York.
 Global IPO trends: Q4 2019, supra note 3, at 9.
 Canaan and XP retain PricewaterhouseCoopers, and Phoenix retains KPMG. Underwriters for these offerings include Citigroup, Credit Suisse, JPMorgan, Morgan Stanley, BofA Securities, UBS Investment Bank and Goldman Sachs & Co. LLC, among others.
 David H. Kistenbroker, Joni S. Jacobsen and Angela M. Liu, Non-U.S. Issuers Targeted in Securities Class Action Lawsuits Filed in the United States, Harvard Law School Forum on Corporate Governance (Mar. 29, 2020), https://corpgov.law.harvard.edu/2020/03/29/non-u-s-issuers-targeted-in-securities-class-action-lawsuits-filed-in-the-united-states/.
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