General Publications April 9, 2020

“Early Securities Class Actions Highlight COVID Litigation Risk,” Law360, April 9, 2020.

Extracted from Law360

The spread of the coronavirus across the world has rocked the global economy and led to a sudden U.S. stock market decline reminiscent of the 2008 recession.

Because of this, companies and boards across industries face unexpected and unprecedented complex legal, business and operational issues. Such market-impacting events often lead to stock-drop litigation, governmental agency investigations, books and records requests, and shareholder derivative actions regarding board oversight.

It is important for boards and senior management to consider how to manage the risks associated with those potential actions.

No company could have predicted the coronavirus specifically. Nevertheless, an opportunistic plaintiffs’ bar may argue that a company’s disclosures more generally failed to warn of a company’s risks related to a pandemic like the coronavirus.

Companies that now face unforeseen major event cancellations, travel interruption, business continuity issues, customer losses or product liability claims from this global health crisis are perhaps even more likely to face lawsuits or demands for information from shareholders. In fact, coronavirus-related securities class actions are already being filed across the country.

In what appears to be the first securities class action brought in connection with the coronavirus pandemic, Norwegian Cruise Lines and two of its officers were sued this month in the U.S. District Court for the Southern District of Florida. In that case, the plaintiff alleges that Norwegian made misleading statements in late February indicating positive outlooks for the company, despite the coronavirus outbreak.

The complaint highlights reporting on leaked emails from Norwegian’s sales managers who allegedly encouraged employees to mislead customers about COVID-19. Among the information allegedly conveyed to customers in scripted statements by Norwegian’s sales team are claims that the coronavirus only survives in cold temperatures and assurances that the potential dangers of COVID-19 were overhyped.

After these leaked emails were published in outlets like the Washington Post and Miami New Times, Norwegian’s shares fell nearly 36%. Notably, the allegations do not seem to tie the supposed misleading emails addressed to customers to any specific misleading statements in the company’s SEC filings or made to investors.

On the same day the litigation against Norwegian was filed, an investor of Inovio Pharmaceuticals Inc. initiated a coronavirus-related securities fraud class action against the company and its CEO in the U.S. District Court for the Eastern District of Pennsylvania.

Inovio’s stock price more than quadrupled after its CEO publicly met with President Donald Trump and garnered global attention by claiming Inovio had developed a COVID-19 vaccine with trials scheduled to start in April.

The complaint alleges that the company had not actually developed a coronavirus vaccine, as exposed by a research report calling for a U.S. Securities and Exchange Commission investigation into the company’s “ludicrous and dangerous claim that they designed a [COVID-19] vaccine in 3 hours,” leading the company to publicly state that what it had designed is a vaccine construct, in other words, a “viable approach to address the COVID-19 outbreak.”

Whether the lawsuits against Norwegian and Inovio will survive motions to dismiss and whether they are a prelude to a wave of similar opportunistic coronavirus-related class actions remains to be seen.

The Private Securities Litigation Reform Act establishes a high burden to plead a securities claim, particularly as to scienter. Specifically, the PSLRA requires plaintiffs to plausibly allege a strong inference that defendants acted recklessly or with an intent to defraud shareholders.

In the coronavirus context, a strong defense against plaintiffs will be to point out that the plaintiffs cannot satisfy this heightened pleading standard without plausibly alleging specific facts that companies and their executives knowingly made false statements about the impact of the coronavirus on their business.

After all, no one could have predicted even just a few weeks ago how widely it would spread and the devastating impact it would have on the global economy.

In addition, statements about the coronavirus and its impact could be considered statements of opinion, rather than statements of fact, under the federal securities laws. That distinction is significant because for a statement of opinion to be false and misleading, a plaintiff must show not only that it was objectively false but also that the speaker subjectively knew it was false at the time the statement was made.

Likewise, if the required cautionary language is used, forward-looking statements about the coronavirus could fall under the safe harbor provision of the federal securities laws, which bars suits based on protected forward-looking statements.

The impact of the coronavirus has already started to present unique challenges for public companies in preparing disclosures to shareholders and the SEC. Indeed, SEC Chairman Jay Clayton recently asked 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.”

The SEC emphasized that the coronavirus is likely to impact companies beyond those with significant operations in China and reminded companies disclosing material information related to the coronavirus to “take the necessary steps to avoid selective disclosures and to disseminate such information broadly.”

Among other key SEC disclosure rules, companies should pay special attention to Item 303 of SEC Regulation S-K, which requires disclosure in the management discussion and analysis section of known trends or uncertainties expected to have a material impact on net sales or revenues or income.

In recent years, the plaintiffs’ bar has attempted to shoehorn an alleged Item 303 violation into a claim under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule10b-5. But whether an alleged Item 303 violation can successfully give rise to a private claim under Section 10(b) is jurisdiction-specific because of a split among the federal circuit courts of appeals.

While the U.S. Courts of Appeals for the Third, Sixth, Ninth and Eleventh Circuits have rejected claims that an Item 303 violation creates disclosure obligations under Section 10(b) or Rule 10b-5, the U.S. Court of Appeals for the Second Circuit has left open the possibility that a failure to disclose information required by Item 303 can also constitute a violation of Section 10(b) and Rule 10b-5.

In any event, the SEC is fully empowered to bring claims for violations of Item 303.

In response to these evolving risks, companies should consider whether their public filings appropriately disclose coronavirus-related risks. Thoughtfully drafted disclosures relating to performance, product safety and projections will be critical to mitigate potential securities litigation risk.

Boards should give deliberate thought to documenting their consideration of, and response to, the coronavirus. Shareholder plaintiffs can use investigative tools such as books and record requests to gain access to documents that reflect the board’s consideration of these issues, and such documents — or lack thereof — may provide the basis for future shareholder derivative actions regarding the board’s duties.

Companies should also exercise particular caution with public statements concerning areas of their business that may be affected and will want to review their forward-looking guidance and risk factors for potential updates.

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