The COVID-19 crisis has forced businesses in all sectors to explore new approaches and solutions to deal with the unprecedented challenges presented by the novel coronavirus. Unfortunately, the plaintiffs’ securities class action bar is already proving that, for them, the more things change, the more they stay the same. Plaintiffs’ lawyers are resorting to a familiar playbook (one they pulled out after the 2008 financial crisis, the Ebola and SARS outbreaks, for example) to opportunistically generate lawsuits against publicly-traded companies, generally known as “Stock Drop Litigation.”
The precipitating events may change, but the resulting Stock Drop Litigation cases follow a predictable pattern: A significant issue leads to a substantial drop in the stock price of a publicly-traded company, and the plaintiffs’ bar proceeds to file class action lawsuits alleging that certain public statements made by the company (typically in SEC forms such as 8‑K or 10‑Q) were materially misleading because they either mischaracterized or understated the potential risk to the company from such events, or affirmatively misstated issues related to the company’s response to those events. Based on such statements, plaintiffs may bring claims for securities fraud under Section 10b‑5 of the Securities Exchange Act of 1934 (the “Exchange Act”).
Even more problematic, where the statements are included in a registration statement or prospectus, plaintiffs will allege violation of the Securities Act of 1933 (the “Securities Act”), which does not require proof of fraudulent intent, as would be necessary for a successful 10b‑5 claim. Additionally, at least in some judicial circuits, plaintiffs may pursue a private right of action asserting that the company failed to disclose “any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations” in violation of SEC Regulation S‑K.
There is no question Stock Drop Litigation will occur in the wake of the COVID‑19 pandemic; in fact, it is already happening. Plaintiffs’ securities lawyers have already filed suit in a Florida federal court against Norwegian Cruise Lines alleging investors were defrauded and suffered a precipitous decline in that company’s stock price after the company stated in its 8‑K and 10‑K that sales projections after the disclosure of the virus remained ahead of the prior year, but failed to disclose that those projections were allegedly based on inappropriate sales tactics and carried a high risk of cancellations. Although most litigation remains in something of a “holding pattern” as federal courts are operating on a significantly limited basis while widespread shelter-in-place orders remain in effect, a spike in such cases is widely expected when the courts return to something closer to business as usual.
During this current period of “calm before the storm,” potentially affected companies would be well-advised to do what they can to best position themselves moving forward. At the outset, it is important to heed the advice of the SEC, which issued a release on March 4, 2020, reminding “all companies to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their businesses and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments.”
Although companies should reflect on, and appropriately report, their assessment for the pandemic’s impact on their business and plan for dealing with it, they must be careful to avoid (1) selectively disclosing such information in a way that could be perceived as giving some investors an unfair advantage over others, and (2) overstating the impact or overstating prospects for near-term recoveries in a way that potential plaintiffs could point to as “unfulfilled promises.”
It is always important to have counsel review public filings and significant public statements, but the importance of such review is intensely magnified in the current environment. Any forward-looking statements must be carefully considered and discussed with legal counsel to ensure that, to the extent possible, they take advantage of all safe-harbor protections, contain meaningful cautionary language and do not provide fodder for the plaintiffs’ class action bar.
The question isn’t whether Stock Drop Litigation claims are coming. They are. The only question at this point is, “What can companies do to prepare for this issue and address it head-on?”