We all are familiar with the phenomenon of event-based securities litigation. Suits are filed when practically any M&A transaction or data breach is announced. COVID-19 (coronavirus) is no different, and we might be on the precipice of a tsunami of securities litigation in the ensuing days, months and years as companies update prior disclosures and make new public disclosures.
Now is the time to mitigate the risk.
We anticipate plaintiffs making a variety of claims. Going back in time, they might challenge whether companies previously disclosed potential weaknesses in their supply chains or threats to demand for their products or services from a global event. For example, companies that encountered disruptions from SARS or other major events emanating from Asia might be alleged to have been on notice of material potential risks from a pandemic such as COVID-19.
Shifting to the present, plaintiffs might claim that companies are not timely disclosing current risks and impacts to their operations. These matters include the effects from supply chain issues and falling demand, government-mandated quarantines, isolation and shut-down orders that stop or drastically curtail operations, and problems created by countries retreating inside their borders and barring outsiders from entering.
Plaintiffs have already started to file coronavirus securities fraud suits. In one suit against a cruise line, plaintiffs allege that an 8-K and 10-K filed in February were false and misleading because they failed to disclose misleading sales tactics allegedly used by employees to entice customers to purchase cruises despite the coronavirus outbreak. In another suit filed against a pharmaceutical company, shareholders claim that the company made false and misleading public statements that it had developed a coronavirus vaccine.
The SEC’s statements
Within this backdrop, the first step to minimizing the risk of securities litigation is to follow the US Securities and Exchange Commission’s (SEC) instructions.
On March 4, 2020 the SEC issued an order granting conditional regulatory relief from certain filings and the furnishing of proxy and information statements to investors, subject to certain conditions.1 In that order, the SEC made a point to “remind public companies and other persons who are the subjects of this Order to continue to evaluate their obligations to make materially accurate and complete disclosures in accordance with the federal securities laws.”2
In the press release accompanying the order, SEC Chairman Jay Clayton made a statement emphasizing the need for companies to collaborate with auditors to disclose all material risks to their business and operations to the fullest extent practicable:
"We also remind all companies to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments. How companies plan and respond to the events as they unfold can be material to an investment decision, and I urge companies to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements. Companies providing forward-looking information in an effort to keep investors informed about material developments, including known trends or uncertainties regarding coronavirus, can take steps to avail themselves of the safe harbor in Section 21E of the Exchange Act for forward-looking statements."3
In the same press release, the SEC recognized that prior disclosures might need to be updated:
Depending on a company’s particular circumstances, it should consider whether it may need to revisit, refresh, or update previous disclosure to the extent that the information becomes materially inaccurate.4
Based upon the SEC’s instructions and our prior experience with securities litigation, companies should take care to make full and complete disclosures in the Risk Factor and Management Discussion and Analysis sections of their filings, as well as to examine their financial reporting. Companies might consider COVID-19’s impact on their supply chain, consumer demand, sales, manufacturing, operations and employees, in addition to the ability to operate in light of the recent government shut-down orders and travel restrictions.
Companies should also take full advantage of the safe harbor for forward-looking statements, and they might consider couching predictions of future impacts of COVID-19 in terms of forward-looking statement language. Companies might also review, and potentially update, their forward-looking statement disclaimer language to incorporate the coronavirus pandemic.
As the SEC noted in its press release, this is a good time to review prior forward-looking statements that are now materially inaccurate, especially in connection with disruptions to supply chains and demand for products and services. Some courts have found duties to update prior forward-looking statements that, for example, contain an implicit factual representation that remains “alive” in the minds of investors as continuing representations.
It could also be beneficial for companies to make liberal use of statements of opinion and to be clear when doing so. It is more difficult for plaintiffs to challenge statements of opinion as opposed to statements of fact, and companies can preface such disclosures with language such as “we believe” or “it is our belief” to be clear it is not a statement of fact.
Guard against insider trading and selective disclosure
The coronavirus situation is evolving by the minute, and the enormous price volatility in the stock market heightens insider trading and selective disclosure risks. In its press release, the SEC warned that “where a company has become aware of a risk related to the coronavirus that would be material to its investors, it should refrain from engaging in securities transactions with the public and to take steps to prevent directors and officers (and other corporate insiders who are aware of these matters) from initiating such transactions until investors have been appropriately informed about the risk.”5 The SEC also cautioned that “[w]hen companies do disclose material information related to the impacts of the coronavirus, they are reminded to take the necessary steps to avoid selective disclosures and to disseminate such information broadly.”6
We are at the starting line of what appears to be a generational event. Taking careful steps now in making disclosures will pay dividends when the securities litigation wave begins in earnest.