- Pandemic-related events have formed the basis for numerous securities litigation filings since March of this year.
- The U.S. Chamber Institute for Legal Reform recently petitioned the SEC urging it to exercise its authority to protect businesses from unjustified but costly COVID related lawsuits.
- The initial COVID-19 securities litigation cases focused on allegedly misleading statements about drugs or treatments relating to the pandemic, whereas more recent cases have challenged allegedly misleading statements relating to COVID-19 testing, as well as a company’s financial prospects in light of the pandemic.
- Pandemic related suits are not only hitting those in the health care and travel industries, but they also cut across other industries, such as the financial and technology sectors.
- Among other recommendations set forth below, public companies should continue to carefully draft their disclosures and statements relating to financial or other prospects, analyzing all known risks relating to the pandemic and disclosing, as necessary, specific issues relating to the company.
Event-driven litigation continues to fuel the rise of securities class actions against public companies, and that has certainly been the case with COVID-19 related litigation. Pandemic-related events have formed the basis for numerous securities litigation filings since March of this year. In the second half of the year, the allegations have become more nuanced as more events have transpired. Indeed, Plaintiffs appear to be cherry-picking optimistic statements, risk disclosures, as well as COVID-related “truths” in an attempt to manufacture securities litigation claims.
Such suits are not only hitting those in the health care and travel industries as we saw in the initial wave of filings outlined in Dechert’s June analysis1, but they cut across other industries, such as the education, financial and technology sectors, and relate more broadly to financial prospects as well. In addition, other suits have also included Securities Act claims and M&A litigation, and the SEC resulted in many noteworthy COVID-related enforcement actions in 2020. Because so many securities cases are still in the early stages, it is hard to tell how courts will react to these expansive pandemic-related claims filed across the country. What is noticeable is that COVID-driven litigation has highlighted a significant problem with the current securities litigation system, currently being “plagued” with frivolous event-driven litigation—an issue which the U.S. Chamber of Commerce attempted to address with its recent petition.
U.S. Chamber of Commerce Petition. On October 30, 2020, the U.S. Chamber Institute for Legal Reform petitioned the U.S. Securities and Exchange Commission (“SEC”) for rulemaking (the “Petition”) pursuant to Rule 192(a) of the Commission’s Rules of Practice.2 Citing the COVID-19 pandemic, a “disaster unparalleled in recent times”, the Petition urged the SEC to exercise its authority to protect businesses from unjustified but costly COVID related lawsuits.3 Recognizing that it was laudable that the SEC provided guidance to companies in making disclosures about COVID-19 and its impacts earlier in the year,4 the Petition urged that the SEC should go further to limit unjustified COVID-19 lawsuits.5
In urging the SEC to limit pandemic-driven litigation, the Petition specifically discussed actions to serve the public interest and “protect investors by avoiding the squandering of company time resources on the defense and settlement of illegitimate lawsuits—especially given the incredible burdens placed on company management and company resources by the pandemic.”6 In particular, the actions, which are designed to prevent Monday-morning quarterbacking, included:
- The SEC’s authority should be used to bar liability for statements about a company’s plans or prospects for getting back to business, resuming sales or profitability, or other statements about the impact of COVID-19, whether forward-looking or not, as long as suitable warnings are attached.
- In an effort to limit the ability of plaintiffs’ lawyers to seize upon pre-pandemic statements of emergency preparedness to argue that the company misrepresented its readiness, the SEC should consider limiting liability for all such statements to circumstances in which the plaintiff can prove that the speaker had actual knowledge of its falsity. In other words, the SEC should treat such statements as the equivalent of statements of opinion for purposes of securities fraud claims under the Supreme Court’s seminal decision in Omnicare v. Laborers Dist. Council Constr. Indus. Pension Fund, 575 U.S. 175, 182-86 (2015).
- Regarding the risk of COVID related litigation based on alleged misstatements of the financial statements themselves, the SEC should require the inclusion in financial statements of a statement reminding readers that many elements of financial statements are determined on the basis of projections of future business or market conditions or by applying “mark to market” standards, and stating that due to the tremendous uncertainties flowing from the pandemic and its effect on the economy, there is a greater possibility of variation than in the past. The SEC should then bar liability of statements that satisfy such warnings.7
The Petition is clearly a reaction to the COVID-related securities litigation cases filed in the last seven months, with the first wave focusing on healthcare and travel related industries, and the second wave taking a much more expansive approach to purported securities violations.
COVID-Related Drugs and Government Funding. Unsurprisingly, the initial wave of COVID-19 securities litigation cases focused on companies that are alleged to have made misleading statements about drugs or treatments relating to the pandemic. The securities litigation cases filed in the second half of the year have included more allegations which were allegedly misleading in light of FDA statements relating to COVID-19 tests, as well as allegedly false statements relating to government funding.
During the second half of the year, many of the securities suits plaintiffs filed challenged statements relating to companies’ COVID-19 diagnostics tests as being 100% effective, later upended by the FDA announcements relating to the efficacy of COVID-19 tests. For example, in one suit against Co-Diagnostics, Inc. and certain of its directors and officers, plaintiff filed an amended complaint in the District of Utah, alleging violations of Sections 10(b) and 20(a) of the Exchange Act. Specifically, the amended complaint alleges that the company and certain officers and directors made “unequivocal” statements that “its Covid-19 tests were 100% accurate.” The amended complaint alleges that the stock soared to an all-time high and a market capitalization of over $800 million, while earlier in the year, it was at risk of being delisted, having previously traded at $.91 and worth less than $25 million. The amended complaint also alleges that the truth was purportedly revealed when the U.S. Food and Drug Administration announced publicly that no Covid-10 testing was 100% accurate, which purportedly caused the company’s stock to drop.8
Plaintiffs alleged similar allegations against Chembio Diagnostics, Inc. and certain of its officers and directors in a complaint filed in the Eastern District of New York, alleging violations of Section 11, 12(a) and 15 of the Securities Act along with violations of Section 10(b) and 20(a) of the Exchange Act. The company also purportedly represented that its point-of-care diagnostics test for COVID-19 antibodies was 100% accurate, allegedly inflating the stock price and then offering additional shares. The FDA later revoked the Company’s Emergency Use Authorization due to performance concerns with the accuracy of the test, which purportedly caused the stock to drop by over 60%.9
In addition to optimistic statements relating to COVID-19 tests, Operation Warp Speed, a program which commits the federal government to massive funding for the development of COVID-19 vaccines, became an area of attention during the second half of the year. One such suit was filed against Inovio Pharmaceuticals, Inc. and its CEO, CFO, VP of Biological Manufacturing and Clinical Supply Management in the Eastern District of Pennsylvania, asserting violations of Section 10(b) and 20(a) of the Exchange Act and alleging that the company falsely described its development of a COVID-19 vaccination. Interestingly, the complaint alleges that the company and CEO informed investors that its treatment had been “selected” and included by the federal government for “Operation Warp Speed”, and disclosed optimistic statements relating to it. However, on August 9, 2020, the New York Times reported that the company’s claim of “inclusion” by the government in Operation Warp Speed was misleading.10 The motion to dismiss is currently pending.11
Government funding was likewise at the crux of the allegations in the Eastman Kodak litigation filed the District of New Jersey. There, plaintiffs allege that during an eleven-day class period, the company and certain officers violated Sections 10(b) and 20(a) of the Exchange Act by failing to disclose that the company had granted insiders millions of dollars’ worth of options before publicly disclosing that it had received a $765 million loan from the U.S. International Development Finance Corporation under the Defense Production Act to produce pharmaceutical materials, including ingredients for COVID-19 drugs, despite its lack of pharmaceutical experience. In response to increasing public awareness and regulatory scrutiny, the DFC paused the deal and the stock declined.12 As complaints are amended or newly filed, it will be interesting to see if statements relating to Operation Warp Speed or other issues associated with federal funding will be a basis for scrutiny in shareholder suits.
Travel. In the second half of 2020, plaintiff attorneys continue to file a limited number of securities litigation cases against public companies within the travel industry. Royal Caribbean Cruises is the latest cruise line to be the target of another securities class action, though this time the focus is on the company’s COVID-19 safety protocols. The suit was filed in October 2020 in the Southern District of Florida with shareholders seeking remedies under Sections 10(b) and 20(a) of the Exchange Act for a putative class period that is a little over one month long. The complaint alleges that with COVID-cases on Royal Caribbean ships, the company assured the investing public that its safety protocols were “aggressive” and would “ultimately contain the virus”. The complaint alleges that the company made false and misleading statements and failed to disclose material adverse facts about the company’s decrease in bookings outside of China, its inadequate policies and procedures to prevent the spread of COVID-19 on its ships, which artificially inflated the stock.13
Given the lawsuits against cruise lines, it is unsurprising that plaintiffs’ firms have also started targeting airlines, though the viability of such cases are yet to be determined. One such suit was filed in the Eastern District of New York against GOL Linhas Aéreas Inteligentes, a Brazilian company that trades on the NYSE, and certain of its officers and directors, alleging violations of Section 10(b) and 20(a) of the Exchange Act. Defendants purportedly made statements relating to the strength of its financials, stating for example that its financial results were “a reflection of the severe impact that COVID-19 is having on Brazil’s economy, the air transportation industry and our Company” and that the company has maintained a “strong liquidity position.” The crux of the complaint is that such statements were materially misleading because Defendants failed to disclose that GOL had material weaknesses in its internal controls and there was substantial doubt as to the Company’s ability to continue to exist as a going concern.14 The truth purportedly began to emerge when the Company was unable to timely file its 2019 20-F and when it dismissed its auditor.
Insufficient Disclosures Regarding Covid-19's Impact on Operations & Prospects. Exemplifying the far reach of the pandemic’s role in securities litigation, even when companies discussed Covid-19 and its impact on financial prospects, they were still targets of securities litigation.
For example, shareholders brought Section 10(b) and 20(a) Exchange Act claims against Canadian cannabis company Harborside Inc. and certain of its directors and officers in the District of Oregon. The complaint alleges that Harborside issued false and misleading statements and/or failed to disclose that Harborside had undisclosed material weaknesses and insufficient financial controls, its previously issued financial statements were unreliable, its financial statements would need to be restated, and that Harborside’s stock trading would be suspended, among other issues. Throughout the class period, the company made COVID-19 updates and “toute[d] its positioning and business” during the pandemic. For example, the company stated that “[t]he pressures brought on by the COVID-19 pandemic further reinforce Harborside’s ongoing mandate to monitor all financial decision-making with the strictest vigor.” The purported “truth emerged” in a press release announcing the intent to restate financials, whereby the company stated, “no assurance can be given that the anticipated timing of filing will be met due to the impact of the COVID-19 pandemic. . . .”15
Shareholders brought suit against Portland General Electric Company and its CEO and CFO. The complaint alleges that, among other reasons, the defendants failed to disclose that the company lacked effective internal controls over its energy practices, and that the company’s personnel had entered energy trades during 2020 that created significant negative financial exposure for the company. Indeed, the class period begins when the company announced in its first quarter 2020 financial results that “our financial performance this quarter largely reflects conditions experienced prior to the COVID-19 pandemic. . . .” But the company’s statements were allegedly unrealistically positive assessments of the company and its financial well-being and prospects.16
Complaints have also started to focus on business prospects and even cybersecurity issues during the pandemic. On November 19, 2020, shareholders of K12 Inc., a technology-based education company operates virtual learning systems worldwide, brought a securities class action against the company and its CEO and CFO in the Eastern District of Virginia, alleging violations of Sections 10(b) and 20(a) of the Exchange Act. Specifically, the complaint alleges, among other things, that the defendants made materially false and misleading statements and failed to disclose to investors that K12 lacked the technological capabilities, infrastructures, and expertise to support the increased demand for virtual and blended education necessitated by the global pandemic; lacked adequate cyberattack protocols and protections to prevent the disabling of its computer system; was unable to provide the necessary levels of administrative support and training; and lacked a reasonable basis for their positive statements and “self-promotion campaign” about the business, operations, and prospects. After cyberattacks and complaints that the curriculum was not age-appropriate and the teachers were insufficiently trained, among other things, Miami/Dade County and Beaufort County voted to terminate using K12’s online learning platform.17
M&A Litigation & Securities Act Claims. Plaintiffs continued to pursue securities fraud claims relating to M&A deals and offerings in the second half of the year. For example, last July, shareholders brought Section 11 and 15 Securities Act claims against Velocity Financial, Inc., certain of its directors and officers, along with the private equity firm that sponsored the IPO and the underwriters. The complaint, filed in the Central District of California, alleges that at the time of its IPO, the real estate company failed to disclose that the company’s non-performing loans had dramatically increased in size from the figures provided in the Offering Materials, and that defendants failed to provide any information regarding the “potential impact of the novel coronavirus on Velocity’s business and operations, despite the fact that the international spread of the virus had already been confirmed at the time of the IPO.” Instead, the Offering Materials included generic warnings. By May 15, 2020, the company stock closed at more than 80% below the price investors paid for the stock in the IPO just four months earlier.18
Section 14 Exchange Act claims also surfaced during the second half of the year. For example, in Proteostatis Therapeutics, Inc., brought in the Southern District of New York, purported shareholders brought allegations against Proteostatis, a clinical stage biopharmaceutical company, and its board, as well as Yumanity relating to a stock-for-stock reverse merger, whereby Yumanity Therapeutics, Inc. would become an indirect wholly-owned subsidiary of Proteostasis. Bringing claims of violations of Sections 14(a), 20(a), and allegations of breaches of fiduciary duty and aiding and abetting, the complaint alleges that the Registration Statement omits and/or misrepresents information concerning issues like conflicts of interest, financial projections, and data and outputs underlying the financial analyses.19 The complaint alleges defendants made the misstatements and omissions against the backdrop that it had announced it was evaluating its PTI-129 cystic fibrosis drug as a treatment for COVID-19, explaining that the “ongoing COVID-19 pandemic demands the investigation of all possible avenues of resolution.” The complaint alleges that this was in violation of Sections 14(a), 20(a), and included allegations for breach of fiduciary duties and aiding and abetting.
As Dechert previously explained, in the first half of the year the SEC issued guidance for public issuers relating to COVID-19.20 On November 2, 2020, the SEC issued its 2020 Annual Report, which outlined its efforts with regard to COVID-19. In it, the SEC mentions that it has “dedicated substantial resources to address the emerging threats presented by COVID-19 and the ensuing dynamic market conditions,” instituting, among other things, a Coronavirus Steering Committee to centralize and coordinate its efforts and to identify and monitor areas of potential misconduct associated with COVID-19.21 The Enforcement Division opened more than 150 COVID-related inquiries or investigations, many of which are ongoing.22
Some of the SEC’s noteworthy enforcement actions relating to COVID-19 include the following charges:
- Emergency action and asset freeze in an alleged fraudulent scheme that generated more than $25 million from sales of multiple microcap companies’ stock, including four companies that were the subject of recent SEC trading suspension orders.23
- California-based penny stock trader for allegedly conducting a fraudulent pump-and-dump scheme by making hundreds of misleading statements in an online investment forum, including that a company had developed an approved blood test for COVID-19.24
- Applied Biosciences Corp. for allegedly making false or misleading claims regarding its distribution of supposed rapid result finger-prick COVID-19 tests to the general public.25
- Turbo Global Partners, Inc. and its CEO for allegedly issuing false and misleading press releases regarding the company’s purported partnership to sell thermal scanning equipment that would detect individuals with fevers.26
- Praxsyn Corp. and its CEO for allegedly issuing false and misleading press releases claiming that Praxsyn was able to acquire and supply large quantities of N95 or similar masks to protect wearers from the COVID-19 virus.27
- The President and Chief Science Officer of Arrayit Corporation for allegedly making false and misleading statements concerning Arrayit’s development of a COVID-19 blood test.28
Recommendations. To limit potential risks of securities litigation actions, companies should thoughtfully assess their consideration of and responses to this rapidly changing situation, ensure robust internal controls are in place at the management and board level, and document the board’s careful consideration of these issues. For example, the following considerations that the U.S. Chamber of Commerce recommended to the SEC should be implemented:
- Include warnings with statements about a company’s plans for getting back to business or about the pandemic’s impact on continuing and future business operations reminding investors of the “tremendous uncertainty inherent in the ongoing pandemic, which has led to fast-moving changes to the health and business environment.”29
- Include in financial statements a statement reminding readers that many elements of financial statements are determined on the basis of projections of future business or market conditions or by applying “mark to market” standards and stating that due to the tremendous uncertainties flowing from the pandemic and its effect on the economy, there is a greater possibility of variation than in the past.30
Other recommendations are as follows:
- Carefully study the SEC’s guidance on COVID-19 related disclosures;31
- Ensure that the company’s Disclosure Committee is not only issuing a COVID-19 specific disclosure (which hundreds of companies have done), but closely analyzing all known risks relating to the pandemic and disclosing, as necessary, specific issues relating to the company, including but not limited to, vulnerable supply chains, markets, customers, work force issues, cyber risks, liquidity issues, geographic areas, senior management’s illness or incapacitation, among others;
- Companies should consider whether to hold their usual shareholder and board meetings as planned, or whether rescheduling meeting dates, changing meeting locations or switching to “virtual-only” or partially virtual meetings may be appropriate in these circumstances;32
- Use caution when making statements suggesting that the company is well-positioned to weather the pandemic, or other positive statements about drugs, devices or the viability or marketability of their products; utilize the Private Securities Litigation Reform Act’s safe harbor and emphasize the forward-looking nature of such statements;
- Carefully analyze all policies and procedures relating to work force re-entry, product development, corporate disclosures, cyber security, and other related issues to ensure that the policies are updated as necessary to keep pace with this rapidly changing and unprecedented environment;
- Ensure that internal controls exist not only at the management level, but also at the Board level to ensure compliance with all applicable laws and regulations;
- Consider creation of COVID-19 board subcommittee to facilitate rapid information flow and decision making at the board level;
- Closely examine liquidity position and develop strategies to increase liquidity and stress test COVID-19 impact scenarios;
- Consider reduction or suspension of stock repurchased and/or dividend payments going forward;
- Ensure that the Board’s Audit Committee is continuing to work closely with auditors and stress testing all financial reporting;
- Create contingency plans for illness of senior management due to COVID-19, including potential disclosure issues; and
- Thoroughly document Board’s consideration of, and plans to monitor and address, all issues relating to the pandemic and the potential impact on the company.
As COVID-19 continues to cause market uncertainty, companies must remain diligent to ensure that they have robust disclosure strategies in place that are being followed, as well as a process to document the board’s careful deliberation. Companies should do their best to adhere to SEC guidance specifically outlining suggested disclosures related to COVID-19.33
1) D. Kistenbroker and J. Jacobsen, COVID-19 and Securities and Derivative Litigation, DECHERT LLP (June 19, 2020)
2) Letter from Harold Kim, President, U.S. Chamber Inst. for Legal Reform, & Tom Quaadman, Exec. Vice President, Ctr. For Capital Mkts. Competitiveness, to Vanessa Countryman, Sec'y, SEC (Oct. 30, 2020); SEC Rule 192(a) (“Any person desiring the issuance, amendment or repeal of a rule of general application may file a petition therefor with the Secretary.”).
3) Petition, supra note 2 at 1-2, 8.
4) Petition, supra note 2 at 8, n. 37, (citing SEC, Division of Corporate Finance, CF Disclosure Guidance: Topic No. 9 (Mar. 25, 2020); SEC, Division of Corporate Finance, CF Disclosure Guidance: Topic No. 9A (June 23, 2020).
5) Petition, supra note 2 at 9.
7) Id. at 9-10.
8) Am. Compl., Gelt Trading Ltd. v. Co-Diagnostics, Inc. et al., No. 2:20-cv-00368 (D. Utah July 15, 2020).
9) Compl., Special Situations Fund III QP, L.P. v. Chembio Diagnostics, Inc., No. 2:20-cv-03753 (E.D.N.Y. Aug. 17, 2020).
10) Am. Compl., McDermid v. Inovio Pharm., Inc., et al., No. 2:20-cv-01402 (E.D. Penn. Sept. 21, 2020).
11) See also Compl, Himmelberg v. Vaxart, Inc. et .al., No. 3:20-cv-05949-VC (N.D. Cal. Aug. 24, 2020) (allegations arising out of the defendants’ misleading statements concerning Vaxart’s oral COVID-19 vaccine candidate, including its purported selection in “Operation Warp Speed,” which caused the price of the company’s stock to skyrocket).
12) Compl., Tang v. Eastman Kodak Co. et al., No. 3:20-cv-10462 (D.N.J. Aug. 13, 2020).
13) Compl., City of Riviera Beach Gen. Emps. Ret. Sys. v. Royal Caribbean Cruises Ltd., No. 1:20-cv-24111 (S.D. Fl. Oct. 7, 2020). Safety protocols may move to the forefront of more cases outside of the travel context. See Compl., Hartel v. The Geo Grp., Inc., No. 9:20-cv-81063 (S.D. Fla. July 7, 2020) (alleging defendants made material misstatements and/or failed to disclose that GEO Group maintained woefully ineffective COVID-19 response procedures, which subjected residents of the company’s halfway houses to significant health risks).
14) Compl., Hornea v. GOL Linhas Aéreas Inteligentes S.A. et al, No. 1:20-cv-04243 (E.D.N.Y. Sept. 11, 2020).
15) Compl., Shahrohkimanesh v. Harborside Inc. et al., No. 3:20-cv-01551 (D. Or. Sept. 8, 2020).
16) Compl., Hessel v. Portland Gen. Elec. Co., et al., No. 3:20-cv-01523 (D. Or. Sept. 3, 2020).
17) Compl., Lee v. K12 Inc., et al., No. 1:20-cv-01419 (E.D. Va. Nov. 19, 2020).
18) Compl., Berg v. Velocity Fin., Inc., No. 2:20-cv-06780 (C.D. Cal. July 29, 2020).
19) Compl., Aniello v. Proteostasis Therapeutics, Inc., No. 1:20-cv-08578 (S.D.N.Y. Oct. 14, 2020).
20) Dechert LLP, COVID-19 Coronavirus – Considerations for Board and Shareholder Meetings (March 16, 2020).
21) SEC, Division of Enforcement, 2020 Annual Report (Nov. 2, 2020) (“SEC Annual Report”), at 1.
22) SEC Annual Report, supra note 21 at 11-12.
23) SEC Annual Report, supra note 21 at 25 (citing Press Release 2020-131, SEC Charges Microcap Fraud Scheme Participants Attempting to Capitalize on the COVID-19 Pandemic (June 11, 2020)).
24) SEC Annual Report, supra note 21 at 25 (citing Press Release 2020-128, SEC Charges California Trader Engaged in Manipulative Trading Scheme Involving COVID-19 Claims (June 9, 2020)).
25) SEC Annual Report, supra note 21 at 25 (citing Press Release 2020-111, SEC Charges Companies and CEO for Misleading COVID-19 Claims (May 14, 2020)).
27) SEC Annual Report, supra note 21 at 26 (citing Press Release 2020-97, SEC Charges Company and CEO for COVID-19 Scam (Apr. 28, 2020)).
28) SEC Annual Report, supra note 21 at 26 (citing Press Release, 2020-224. SEC Charges Top Executive of California Microcap Company for Misleading Claims Concerning COVID-19 Test and Financial Statements (Sept. 25, 2020)).
29) See Petition, supra note 2 at 9; see also Kevin LaCroix, Petition to SEC Seeks Protection for Companies from Pandemic-Related Securities Suits, D&O DIARY (Nov. 4, 2020).
30) See Petition, supra note 2 at 10; see also Kevin LaCroix, Petition to SEC Seeks Protection for Companies from Pandemic-Related Securities Suits, D&O DIARY (Nov. 4, 2020).
31) See, e.g., SEC, CF Disclosure Guidance: Topic No. 9 (Mar. 25, 2020); SEC, CF Disclosure Guidance: Topic No. 9A (June 23, 2020).
32) Supra note 20, Dechert LLP, COVID-19 Coronavirus – Considerations for Board and Shareholder Meetings (March 16, 2020).
33) Dechert LLP, Covid-19 Coronavirus – Considerations for Board of Directors (Apr. 7, 2020); Dechert LLP, COVID-19 Coronavirus: SEC Disclosure Obligations for Public Companies (Apr. 15, 2020).