Extracted from Law360
More than a year has passed since the beginning of the COVID-19 pandemic and the filing of the first COVID-19-related securities class actions, and courts are beginning to issue the first round of decisions on motions to dismiss in those cases.[1]
Three initial decisions on motions to dismiss reflect that courts are going to closely scrutinize allegations related to COVID-19 and analyze challenged statements in view of the pandemic-related information available at the time, including scrutinizing what the company could have reasonably known at the time of its public statements.
The primary takeaway is that, even in the wake of a global pandemic and unprecedented volatility in the stock market, courts continue to recognize that the heightened pleading standard of the Private Securities Litigation Reform Act acts as a roadblock to ferret out thin and conclusory claims even at the earliest stage of a securities fraud case.
Likewise, in the first half of 2020, the U.S. Securities and Exchange Commission provided market participants with significant guidance around the pandemic, ranging from how to think about COVID-19-related disclosures to how to hold an annual meeting on Zoom.
At the same time, the SEC began bringing enforcement actions for pandemic-related frauds and other illicit schemes, including those allegedly promising nervous investors miracle COVID-19 tests and solutions.[2]
But since that initial flurry, the SEC has issued only a trickle of additional guidance and has brought few notable enforcement actions.
The First Motion to Dismiss Rulings
During the first half of 2021, courts ruled on several motions to dismiss in pandemic-related securities class actions. The motions met varying success but showed that, in light of the global uncertainty surrounding the impact of COVID-19, plaintiffs will still face major hurdles in bringing claims related to the impact of COVID-19 on a company's business operations.
Real Estate Finance Company
On Nov. 11, 2020, a securities class action plaintiff filed a suit against Velocity Financial Inc., a real estate finance company, in the U.S. District Court for the Central District of California, alleging violations of Sections 11 and 15 of the Securities Act.
In Berg v. Velocity Financial, the plaintiff alleged that Velocity made multiple misstatements in its January 2020 prospectus, including that Velocity omitted material facts related to the impact of the COVID-19 pandemic on its business.[3] Specifically, the plaintiff claimed that certain statements misleadingly touted favorable market conditions, even though the coronavirus "was set to disrupt the entire real estate market."[4]
The plaintiff alleged that Velocity failed to describe industry trends and uncertainties it reasonably expected would have a material effect on its net sales, revenues or income from continuing operations.[5]
In late January, the Velocity court granted the company's motion to dismiss. The court stressed the early stage of the pandemic and the uncertainty of its impact on Velocity's business operations.
The court found that the plaintiff failed to allege "that Defendants would or could have known the extent of the coronavirus pandemic, or even the presence of the disease in America, at the time of the [initial public offering]."[6]
Travel Company
In early April, pandemic-related securities fraud class action claims brought against Norwegian Cruise Line and certain executives met a similar fate in the U.S. District Court for the Southern District of Florida.[7] In one of the first COVID-19-related securities fraud class actions, filed March 12, 2020, the plaintiff asserted that Norwegian's Feb. 20, 2020, Form 8-K and accompanying press release failed to disclose adverse facts related to the impact of COVID-19 on the company's business.[8]
The plaintiff also challenged statements made during a conference call that same day, including Norwegian's statement that it intended to continue to employ its current marketing strategy, without disclosing its use of "deceptive" marketing tactics related to using scripted, one-line statements to convince customers to book cruises despite the risks of COVID-19.[9]
The plaintiff further alleged that Norwegian's 10-K, filed one week later, included additional purportedly misleading statements about the company's marketing initiatives, focus on health and safety, and improvements in week-over-week bookings.[10]
The court granted Norwegian's motion to dismiss in full. The court found that the company's statements about its marketing strategy "constitute[d] nothing more than corporate puffery" and that the company was not required to disclose its use of the one-line statements.[11]
The court further noted that, at the time Norwegian used the one-line statements, then-President Donald Trump made similar statements regarding COVID-19 and that the one-line statements were therefore arguably not deceptive.[12]
The court added that Norwegian's vague statements about improving bookings and the company's safety measures also constituted corporate puffery and that many of the challenged statements were accompanied by specific, cautionary language and were protected by the PSLRA's safe harbor provision.[13]
Finally, the court found that the plaintiff failed to plead scienter because the complaint alleged no facts connecting the individual defendants to the alleged marketing scheme.[14]
Pharmaceutical Company
Not all defendants have had success dismissing COVID-19-related securities fraud claims. In at least one case, the court found that the plaintiff plausibly alleged that the defendant knew its statements about a COVID-19 vaccine made early in the pandemic were false and misleading when made.
In a securities fraud class action filed in the U.S. District Court for the Eastern District of Pennsylvania on the same day as Norwegian, the plaintiffs survived a motion to dismiss COVID-19 vaccine-related securities fraud claims.[15]
The plaintiffs challenged three primary categories of alleged misstatements made by Inovio Pharmaceuticals Inc. and its CEO, Joseph Kim:
- Kim's statements about Inovio constructing a vaccine in three hours, which he purportedly made during a nationally televised interview and during a televised meeting with Trump;
- Statements about Inovio's progress toward producing 1 million vaccine doses in 2020; and
- Inovio's claim that it was selected for inclusion in Operation Warp Speed, the U.S. government's vaccine development program.[16]
The court in large part denied Inovio's motion to dismiss. Because of Kim's statements about Inovio's construction of a vaccine, the court found that the plaintiffs sufficiently alleged that the company "misled investors into believing that the company had quickly created [or constructed] a vaccine it had only designed."[17]
The court also rejected Inovio's defense that its statements about manufacturing capacity were forward-looking and thus protected by the PSLRA safe harbor, agreeing with the plaintiffs that the statement concerned Inovio's then-current manufacturing capacity, rendering it a present, rather than a forward-looking, statement.[18]
The court found that the plaintiffs adequately alleged that nearly all of Inovio's statements concerning its vaccine manufacturing capacity were false and misleading when made.[19] The court, however, dismissed the plaintiffs' claims concerning Inovio's statements that it was selected for inclusion in Operation Warp Speed, finding that those statements were immaterial.[20]
SEC Guidance and Enforcement Actions Slowing Down
While private securities class action plaintiffs began filing suits, the SEC started providing market participants with guidance related to COVID-19 and filed a limited number of COVID-19-related enforcement actions. This trend appears to be waning.
SEC Guidance
In January 2020, as COVID-19 began to appear in the headlines and the U.S. faced its first confirmed case of the virus, former SEC Chairman Jay Clayton issued the commission's first statement related to COVID-19, emphasizing the potential importance of the effects of COVID-19 on investment decisions and directing SEC staff to monitor issuer disclosures and provide the market with guidance.[21]
As the pandemic spread in the months that followed, the SEC announced that the "the effects of COVID-19 could impact the ability of certain companies … to meet their reporting obligations"[22] and provided assistance and relief to many types of market participants, from public companies to investment advisers.
While the SEC issued extensive relief and guidance in March, April and May 2020, including at least 35 no-action letters, staff guidance statements and other COVID-19-related announcements, guidance slowed in the second half of the year, with the commission issuing only seven COVID-19-related statements between June and December 2020.[23]
Since Jan. 1, 2021, as vaccinations have become increasingly accessible, virus cases in the U.S. have declined and the stock market has boomed, the SEC has withdrawn at least three pieces of guidance aimed at providing temporary flexibility or relief related to short-term funding and affiliated transactions for certain market participants in the wake of COVID-19.
The commission has also issued only a single additional piece of COVID-19-related guidance since the beginning of the year. The guidance related to conducting shareholder meetings in light of ongoing concerns related to COVID-19 and was intended to assist "issuers, shareholders, and other market participants affected by COVID-19 with meeting their obligations under the federal proxy rules."[24]
This follows on related guidance issued in the early months of the pandemic concerning changing the date, time or location of a shareholder meeting due to COVID-19, including conducting virtual shareholder meetings.
While the commission's new guidance does not require market participants to offer any particular type of accommodations related to COVID-19, the SEC "strongly encourage[s] all parties and intermediaries involved in the proxy voting process — including broker-dealers, transfer agents, and proxy service providers — to be flexible and work collaboratively with one another."[25]
SEC Enforcement Actions
The SEC's public enforcement actions during 2020 focused heavily on microcap issuers, including multiple issuers purporting to offer technology or equipment used to treat COVID-19. That trend appears to have continued through the first months of 2021.
For instance, on Feb. 11, the SEC charged Arrayit Corp., focused heavily on microcap issuers based in California, and its CEO with making allegedly false and misleading statements about the development of a COVID-19 test and with failing to file required financial reports.[26]
The complaint alleges that Arrayit falsely stated that it had developed a COVID-19 blood test, that it had submitted the test for emergency approval and that there was a high demand for the test.[27]
To date, the SEC appears to have announced only one enforcement action against a mid- or large-cap public company. In December 2020, the SEC announced that it settled charges with The Cheesecake Factory Inc., a Nasdaq-traded restaurant company, for "making misleading disclosures about the impact of the COVID-19 pandemic on its business operations and financial condition."[28]
Per the SEC's order, The Cheesecake Factory issued false and misleading statements in its March 23 and April 3, 2020, 8-K Forms when it stated that its restaurants were "operating sustainably" during the COVID-19 pandemic when the company was in fact losing $6 million in cash per week, and projected that it only had 16 weeks of cash remaining.
The order further stated that while The Cheesecake Factory did not disclose this information in its public filings, the company shared some of this information with potential private investors or lenders in connection with an effort to raise at least additional liquidity.[29]
The order also stated that the company failed to disclose letters to its landlords stating that the company would not pay its April 2020 rent due to a "severe decrease in restaurant traffic [due to COVID-19]."[30]
Expectations for the Future
Given these developments, it is important that issuers and other market participants consider ongoing securities litigation and enforcement risks and trends related to COVID-19.
Uncertainty Surrounding COVID-19
While the outcomes of the vast majority of the securities fraud class actions filed to date remain to be seen, these initial decisions show that courts will continue to pay close attention to the facts and circumstances surrounding alleged statements or omissions related to COVID-19, and may take into account the state of scientific and public knowledge at the time a statement is made.
Framing Disclosures
Issuers should continue to pay close attention to their disclosures of risks related to COVID-19 and should bear in mind how courts have framed their initial decisions when making such disclosures.
Expiration of SEC Relief and Guidance
As COVID-19 vaccinations become more prevalent and accessible, the SEC appears likely to continue to withdraw guidance issued specifically to accommodate the changing needs of market participants amid COVID-19. Issuers and other market participants who have utilized or followed such guidance should closely monitor these changes.
[1] https://www.sec.gov/oiea/investor-alerts-and-bulletins/ia_frauds.
[2] See Berg v. Velocity Fin., Inc. ("Velocity"), No. 2:20-cv-06780-RGK-PLA, 2021 U.S. Dist. LEXIS 17933 (C. D. Cal. Jan. 25, 2021).
[3] Velocity, 2021 U.S. Dist. LEXIS 17933, at *2-3. Douglas v. Norwegian Cruise Lines ("Norwegian") , No. 20-21107-Civ-Scola, 2021 U.S. Dist. LEXIS 69755 (S.D. Fla. Apr. 10, 2021); McDermid v. Inovio Pharms., Inc. ("Inovio"), No. 20-01402, 2021 U.S. Dist. LEXIS 28203 (E.D. Pa. Feb. 16, 2021).
[4] Velocity, 2021 U.S. Dist. LEXIS 17933 at *3.
[5] Id. at *22-23.
[6] Id. at *24.
[7] See Norwegian, 2021 U.S. Dist. LEXIS 69755, at *2-3.
[8] Id. at *3-4.
[9] Id. at *4-5.
[10] Id. at *5-6.
[11] Id.
[12] Id. at *7-8.
[13] Id. at *23-24.
[14] Id. at *30.
[15] Inovio, 2021 U.S. Dist. LEXIS 28203, at *36-37.
[16] Id. at *15-16.
[17] Id. at *17.
[18] Id. at *24-27.
[19] The court found that plaintiffs failed to allege falsity as to Inovio's April 30, 2020 statements concerning a deal with a particular vaccine manufacturer, saying that plaintiffs failed to establish why Inovio's statement that the deal would "significantly expand" manufacturing of the vaccine was misleading.
[20] Id. at *33-35.
[21] https://www.sec.gov/news/public-statement/clayton-mda-2020-01-30.
[22] https://www.sec.gov/sec-coronavirus-covid-19-response.
[23] Id.
[24] https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns.
[25] Id.
[26] https://www.sec.gov/litigation/litreleases/2021/lr25029.htm.
[27] Id.
[28] https://www.sec.gov/news/press-release/2020-306.
[29] https://www.sec.gov/litigation/admin/2020/34-90565.pdf.
[30] Id.