Extracted from Law360
We anticipate securities litigation to return to pre-pandemic trends in 2021. While there have been relatively few COVID-19-related securities class actions to date, there may be an uptick in 2021 as stock-price drops take time to manifest into litigation.
Further, because of increased recoveries and the presidential election, we may also see increased whistleblower and U.S. Securities and Exchange Commission enforcement activity in 2021.
Increased COVID-19-Related Securities Class Actions
As the COVID-19 pandemic continues globally, we may see an increase in COVID-19-related securities class actions as companies wrestle with disclosing potential effects of a vaccine on business and any predicted recovery or financial guidance.
Though not as many as predicted last spring, in general in 2020 COVID-19 spurred two types of pandemic-related lawsuits: (1) those concerned with receiving and using federal funds or loans in connection with relief programs; and (2) those related to corporate disclosures and representations of COVID-19's impacts on their operational prospects and financial results.
A class action filed in August 2020 in the U.S. District Court for the Northern District of California against Vaxart Inc. exemplifies the first group of COVID-19-related cases. The complaint alleges that Vaxart misled investors by claiming to be a part of Operation Warp Speed, a government program tasked with quickly creating and distributing a coronavirus vaccine.
Once the stock price jumped, but before an article announced that Vaxart would not be part of Operation Warp Speed, a controlling Vaxart shareholder sold a large portion of its shares, grossing nearly $200 million. Due to the unprecedented race to create and distribute a vaccine, there may be other, similar lawsuits filed in 2021.
The second group of cases relates to corporate disclosures and representations of COVID-19's impacts on their operational prospects and financial results.
But for the SEC's April 2020 guidance, which was designed to encourage transparency amid uncertain times, many of these suits may not have occurred. The guidance encourages publicly held companies to disclose "as much information as is practicable regarding their current financial and operating status, as well as their future operational and financial planning."
The guidance put public companies in a position to disclose enough information to avoid SEC enforcement for lack of disclosure, but not information that could mislead investors about the companies' continuing health and operating ability. This can be a hard balance to strike at a time of such uncertainty and instability.
Recent filings against entities such as Forescout Technologies Inc. and Velocity Financial LLC foretell a potential increase in these types of securities claims.
In a class action filed in the U.S. District Court for the Northern District of California, Forescout Technologies shareholders allege that the company presented January 2020 projections in its March preliminary and definitive proxies, ignoring and concealing the internally known "disastrous [first] quarter and the risk COVID-19 posed to Forescout's business and pending Transaction."
Similarly, purchasers of Velocity Financial's initial public offering shares filed a suit in the U.S. District Court for the Central District of California. There, the plaintiffs allege that the IPO offering materials were misleading because the defendants:
failed to provide any information to investors 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.
These cases are still in the very early pleading stages.
Given the volatility in the stock market caused by a global pandemic, we expect COVID-19-related securities class actions will continue to be of keen interest to the plaintiffs bar in 2021, and depending on the results and recoveries of the cases described above, that appetite could increase.
Industries Hit Hardest by COVID-19 Expected to Face More Lawsuits
Consistent with the COVID-19-related lawsuits, we anticipate certain industries to face increased securities class actions, particularly the entertainment and travel industries. The early shareholder claims against two cruise lines have paved the way for similar shareholder suits against some of the industries hit hardest by COVID-19.
In March, shareholders of Norwegian Cruise Line filed a suit in the U.S. District Court for the Southern District of Florida and alleged that the company issued misleading statements about the threats and risks that COVID-19 poses to their industry, operations and financial outlook.
The plaintiffs partly relied on internal emails, which promoted an alleged aggressive sales strategy at the onset of the pandemic. Just a few months later, in May, shareholders of Carnival Corp. filed a similar suit also in the U.S. District Court for the Southern District of Florida, alleging that the cruise line hid its knowledge of the risks COVID-19 posed to its business and industry.
The recent settlement agreement for The Cheesecake Factory Inc. may also indicate the likelihood of SEC involvement in COVID-19 disclosures in hard-hit industries going forward.
There, the SEC Enforcement Division charged The Cheesecake Factory with issuing statements that allegedly misled shareholders because while it publicly reported in April that its restaurants were "operating sustainably," it failed to disclose that it only had cash on hand to support 16 weeks of operations, if current conditions continued. The Cheesecake Factory settled with the SEC and paid a fine of $125,000.
The Cheesecake Factory matter indicates an evolution in SEC COVID-19 enforcement. Before this case, the SEC's COVID-19 enforcement tended to consist of charging companies making outright fraudulent claims, such as false claims about its ability to distribute a large number of masks or distribute incredibly accurate in-home COVID-19 tests.
After the Cheesecake Factory enforcement, we may see the SEC crack down on other entertainment and hospitality companies that they believe misled investors in more subtle ways about their continued operations in a pandemic. There may also be an additional uptick in enforcement cases in 2021 if the new presidential administration prioritizes regulatory scrutiny on public companies.
Further, it is worth noting that the banking industry is susceptible to these types of actions in the current environment. Much like the entertainment and tourism industries, banks' operating activities and financial projections have faced increased uncertainty this year, with bank valuations falling globally.
The impact of COVID-19 has and could continue to prompt borrowers — both commercial and residential — to miss loan payments, which causes an increase in banks' loan loss reserves and reduces cash flow.
For example, as we saw in the 2008 financial crisis, if loan losses increase in a sudden and material way, that can hinder a bank's ability to meet its obligations to its depositors and maintain minimum capital requirements, ultimately leading to closure by the regulators.
This may be less likely to occur than we saw in 2007-2009 if there is a rapid recovery in the financial sector once a safe vaccine is widely available, but there will be uncertainty through 2021, and banks will need to carefully balance taking protective measures and being prepared for the worst with sharing optimistic statements with their shareholders if they want to avoid plaintiff and regulatory scrutiny.
Whistleblowing to Continue Its Upward Trend
The number of whistleblowing cases also saw a significant increase in 2020. Tumultuous financial times may be a factor in such an uptick. Since the onset of the pandemic, and in the concomitant wake of the volatility in the market, whistleblowing tips have increased steadily
Uncertainty in job security can lead to misconduct in the workplace, which becomes an outlet to aggravated employees seeking refuge with SEC enforcement. We expect these numbers to continue to increase as the market faces continued uncertainty.
Specifically, corporate whistleblower tips for wrongdoing within financials and disclosures could spike as the SEC reviews and investigates the financial impact of COVID-19 on each corporation's public statements.
Additionally, these tips may climb in the health care industry as the pandemic continues to rage in hospitals and clinics across the U.S. Tensions are high this year, and many employees have filed lawsuits following their dismissals after expressing concerns about their employer's handling of COVID-19 and other health and pandemic-related workplace concerns.
These tips and complaints could continue to increase as nonessential employees return to a normal workplace environment despite still facing the same COVID-19 concerns and pressures found in hospitals.
In 2020, we saw a few massive awards given out to whistleblowers. On Sept. 24, 2020, the SEC approved new regulations that made it clear that the awards could be lowered through certain positive and negative factors. While ultimately rejected, when the SEC first proposed the regulations, it signaled its desire to impose additional criteria that could reduce the size of large rewards.
The debates around the September regulations suggests that the SEC views some of these awards as too large and a drain on resources. The new regulations also streamlined the whistleblower program's process to easily dispel frivolous claims. Coupled with the increase in complaints through the pandemic, we expect to see more whistleblower awards generally, but we may not see the massive award tags that we saw in 2020.
Tougher SEC Enforcement Going Forward
Perhaps the biggest effect of the presidential election in the securities world will be the installment of new SEC leadership. Analysts expect President-elect Joe Biden to appoint a chairperson — such as former Commodity Futures Trading Commission Chairman Gary Gensler or former U.S. Attorney for the Southern District of New York Preet Bharara — who will send a "tough on Wall Street" message.
Regardless of who takes over the role, we expect a more rigid stance from the SEC and perhaps a greater focus on higher corporate penalties on both the regulatory and enforcement sides.