In recent years, public companies have been contending with an increase in securities litigation and private companies have been contending with an increase in Securities and Exchange Commission investigations. COVID-19 threatens to accelerate this trend. Company executives must be careful to disclose any material impact the pandemic is having on their business to minimize the risk of so-called “event-driven” securities litigation.
In “event-driven” litigation, the litigation does not arise from an accounting restatement; instead, there is usually an “event” and a subsequent stock drop that plaintiffs allege has arisen from that event.
Some recent examples include litigation brought against Chipotle and Johnson & Johnson. In Chipotle’s case, investors claimed that the company should have disclosed the circumstances surrounding food-borne illness outbreaks. In Johnson & Johnson’s case, investors claimed that the company intentionally concealed that its talc and talcum powder products were contaminated with asbestos.
As the plaintiff’s bar is ever more creative in finding ways to bring securities litigation, what might securities litigation with regard to COVID-19 look like? Two cases that have already been filed provide some indication.
Cruise line. A securities class action was brought on behalf of a class consisting of all persons who purchased or otherwise acquired the publicly traded securities of a cruise line from February 20, 2020, through March 12, 2020. It is alleged that the defendants made false and/or misleading statements and/or failed to disclose that: (1) the company was employing sales tactics of providing customers with unproven and/or blatantly false statements about COVID-19 to entice customers to purchase cruises, thus endangering the lives of both customers and crew members; and (2) as a result, defendants’ statements regarding the company’s business and operations were materially false and misleading and/or lacked a reasonable basis at all relevant times.
Pharmaceutical company. A securities class action was brought on behalf of all persons who purchased or otherwise acquired the common stock of a pharmaceutical company between February 14, 2020, and March 9, 2020 (the “class period”). It is alleged that during the class period, defendants capitalized on widespread COVID-19 fears by falsely claiming that the company had developed a vaccine for COVID-19.
In the first matter, plaintiffs are seeking to hold the defendants liable for allegedly providing customers with unproven statements or lies about COVID-19 to increase business. In the second matter, plaintiffs are seeking to hold the defendants liable for allegedly lying about their ability and timeframe to develop a vaccine for COVID-19.
Both involve alleged conduct by the defendants that has a very specific link to COVID-19. Future securities litigation may include matters that arise from failure to follow guidance issued by the SEC.
In guidance issued on March 25, 2020, the SEC’s division of corporation finance stated that it is monitoring how companies are disclosing the effects and risks of COVID-19 on their businesses, financial condition, and results of operations. Questions that the SEC asked companies to consider included, but were not limited to:
(1) How has COVID-19 impacted your financial condition and the results of operations? In light of changing trends and the overall economic outlook, how do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition? Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
Based on the guidance provided by the SEC, it is not hard to imagine securities litigation being filed against companies that know COVID-19 will negatively impact sales but do not share that information with the public in an expedient manner.
(2) How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook?
(3) How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets?
(4) Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
(5) Have COVID-19-related circumstances such as remote work arrangements adversely affected your ability to maintain operations, including financial reporting systems, internal control over financial reporting, and disclosure controls and procedures?
(6) Have you experienced challenges in implementing business continuity plans or do you foresee requiring material expenditures to do so?
(7) Do you expect COVID-19 to materially affect the demand for your products or services?
(8) Do you anticipate a material adverse impact of COVID-19 on the supply chain or the methods used to distribute your products or services?
(9) Are travel restrictions and border closures expected to have a material impact on your ability to operate and achieve business goals?
The SEC encouraged companies to disclose information that allows investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change.
The SEC also reminded companies that they can use the safe harbors in Section 27A of the Securities Act and Section 21E of the Exchange Act by providing forward-looking information in an effort to keep investors informed about material developments, including known trends or uncertainties regarding COVID-19.
Therefore, based on the guidance provided by the SEC, it is not hard to imagine securities litigation being filed against companies that know COVID-19 will negatively impact sales but do not share that information with the public in an expedient manner.
Securities litigation could also be filed against companies that know that business operations are going to be materially negatively affected by the financial impact of social distancing and/or the ability to acquire the materials necessary to make or distribute their products or services, but do not make that information public knowledge in a timely fashion.
The SEC may also investigate companies and individuals who act in such a manner as described above, especially if there is evidence of individuals trading in the company’s securities prior to the public dissemination of material information. These potential investigations may not be limited to public companies.
The dealings of private companies and their executives have become an increased area of focus for the SEC, particularly with respect to actual and potential investors. As the SEC has the authority to investigate all companies that seek to raise capital from U.S. investors, private companies would be wise to follow the SEC’s guidance as well.
As the challenges in these unprecedented times continue to evolve, public and private companies should provide material information to their investors and potential investors as it unfolds and make sure to update those disclosures as the facts and circumstances about their companies change. Failure to do so may result in securities litigation and investigations by the SEC.
To help minimize this risk on a pre-claim basis and with any claims that may arise from COVID-19, it is important for insurance brokers and their public and private company clients to work with a carrier that can provide directors’ and officers’ insurance coverage and has an expert claims team that is closely watching COVID-19’s impact on securities litigation and SEC investigations.
Timothy Vazquez is assistant vice president, claims practice leader-directors & officers, of QBE North America.