Securities and Other Shareholder Litigation in the Wake of COVID-19

Securities Litigation Alert | April.15.2020

The current bear market began only a month ago and the securities plaintiffs’ bar wasted no time bringing its first set of actions. The stock market decline caused by COVID-19 has led to economic conditions this country has not seen in roughly a decade. This environment is ripe for plaintiffs to bring securities class actions and shareholder derivative litigation. The lawsuits filed so far indicate that public companies need to proceed cautiously, and not just regarding their statements related to the coronavirus.

How This is Different Than the 2008 Downturn

The type of securities and shareholder litigation being filed now is fundamentally different than the rash of securities class actions and other shareholder litigation filed following the 2008 financial crisis. In 2008, the stock market crash was the result of systemic issues within the financial system. Most securities class actions had the same theory of fraud: financial institutions with the help of the real estate industry had created dubious securities and then misrepresented the risks to the public. For that reason, most lawsuits were limited to the financial and real estate sectors. The current bear market is the result of a black swan event that is affecting companies in every area of the economy for a diverse set of reasons. Because there is no industry-specific scapegoat, the fraud claims will be more wide-ranging than they were after 2008. For the same reason, the fraud allegations will also need to be more individualized.

Securities Lawsuits Filed Since the Bear Market Began

So far, the securities class actions and other shareholder litigation filed as a result of the COVID-19 market decline reflect this expectation. The first set of lawsuits filed focused on statements companies made directly related to coronavirus.

First, Norwegian Cruise Lines has had two lawsuits filed against it that allege that the company made specific materially false and misleading misstatements in 8-K and 10-K filings in late February 2020 and in internal emails around the same time.[1] The complaint summarizes emails leaked to the media in which salespeople directed their staff to lie to potential customers about the effects of COVID-19, including that it was only a cold weather disease and that the epidemic-related cancellation of cruises in Asia had led to high demand for itineraries in other locations. When these emails were published in the Washington Post and the Miami New Times, the company’s share price fell significantly.

While cruise lines have faced securities class actions in other market downturns (see, e.g., In re Royal Caribbean Cruises Ltd., 1:11-22855-CIV, 2013 WL 3295951 (S.D. Fla. April 19, 2013)), the allegations in the complaints and emails already available to plaintiffs in the current cases make it unlikely that Norwegian Cruise Lines will be successful in getting the complaints dismissed at the motion to dismiss stage.[2]

Similarly, in March 2020, a classic stock-drop case was filed against Inovio Pharmaceuticals. In that action, plaintiff alleges that the company repeatedly bragged that it had constructed a coronavirus vaccine in “three hours” and would be ready to test it on humans in the near future.[3] This highly publicized assertion caused the price of Inovio stock to skyrocket. When Inovio’s claim was disputed by a research firm who called for an SEC investigation into the company’s statements, the company admitted that it had only developed a precursor to a vaccine and not an actual vaccine. The news caused the stock price to drop by 71% in two days.

Plaintiffs’ firms, however, are not limiting their cases to those involving specific misstatements about COVID-19. A case brought against the now-household-name Zoom Video Communications alleges that Zoom made misstatements about its encryption and data privacy practices in SEC filings and on earnings calls as early as 2019 when the company went public.[4] The company, which offers technology to conduct meetings remotely and has skyrocketed in popularity since states began issuing stay-at-home orders, had previously stated that communications made using its service were protected by end-to-end encryption and that any related data was kept private. When stories came to light in March and April 2020 that the company was in fact not encrypting meetings and that private meetings like Alcoholics Anonymous were being “Zoom bombed” by internet trolls, Zoom’s stock price dropped almost 20%. While public skepticism about Zoom’s commitment to privacy had been in the news since the fall of 2019, it only became a front-page story because of the attention coronavirus had brought to the company.

Another recent case against CenterState Bank and its Board of Directors for alleged misstatements in their registration statements was also driven by, if not directly related to, the COVID-19 outbreak.[5] Plaintiffs in that case argue that the bank failed to disclose relevant facts about the merger discussion between CenterState and South State Corporation, another regional bank with whom CenterState was planning to merge. The merger agreement, including the exchange ratio that provided a premium to CenterState’s stock, was adopted and approved by CenterState’s board in January 2020, but since then, the stock for both banks has dropped significantly more than the Nasdaq index, while the exchange ratio for the merger has remained the same. Plaintiffs are seeking information about how the board agreed to the exchange ratio and to block the merger.

We cannot predict whether these cases will survive motions to dismiss, especially under the Private Securities Litigation Reform Act’s strict standard for pleading fraud, but they demonstrate the range of ways plaintiffs will leverage the market crisis caused by coronavirus.

What to Expect Going Forward

While we are unlikely to see a large volume of securities class actions and other shareholder litigation essentially alleging claims based on the same generic facts as we did after 2008, companies should proceed with caution in the current market. As the few cases already filed indicate, plaintiffs will use the bear market to bring shareholder claims that otherwise may not have been worthwhile pre-COVID-19. Plaintiffs will try to ferret out attempts to bury specific negative news in the stock drops caused by the general economic downturn. Plaintiffs will be on the lookout for stock prices that have dropped by a larger percentage than others in their industry, and may build their case from there.

Directors should also be wary of derivative litigation that alleges they failed to protect the company from losses arising from COVID-19. This is especially true as we move forward and increasingly start to feel the effects of COVID-19 on the overall economy, including the stay-at-home orders now in place in the majority of states and the record-high and still increasing rate of unemployment. Boards should carefully document their business decisions around COVID-19 with the expectation that their thought-processes will likely come to light if the company is later involved in litigation. Thoughtful documentation will give context to the company’s reasoning and knowledge when the decision was made, and demonstrate that the Board was acting in the company’s best interest at the time.

In addition to documentation, now is the time for Boards of Directors to work closely with management to ensure that the company remains in compliance with the rapidly evolving regulatory environment, and Directors should stay up-to-date on new, applicable federal and state laws. They should understand how any future operational stress will affect the company’s current liquidity and debt. Directors should also review current D&O insurance plans to confirm that the Board and management are adequately covered for events that proceed from the COVID-19 crisis. To accomplish this, directors should be meeting even more frequently while the pandemic is ongoing.

Public companies also need to exercise caution around statements made in response to the coronavirus. There may be a long tail for COVID-19 suits if companies are tempted to misrepresent the pandemic’s effects on their business or their response to the pandemic. The Private Securities Litigation Reform Act contains a safe harbor provision that insulates forward-looking statements from liability when they are accompanied by meaningful cautionary language “identifying important factors that could cause actual results to differ materially from those” in the statement.[6] Companies should make sure to qualify any statements about how they are weathering this storm, because the future remains uncertain.

The SEC has issued guidance for COVID-19-related disclosures during this time. It suggests that companies should assess how COVID-19 has affected their business by thinking about the pandemic’s effects on the following issues: (1) the company’s financial condition and operations; (2) the company’s financial resources and capital, including access to funding sources; (3) the assets on a company’s balance sheet; (4) any material impairments, such as goodwill, intangible assets, long-lived assets, right of use assets, and investment securities; (5) the effects of remote work arrangements on its operations; (6) challenges in implementing business continuity plans; (7) the demand for its products or services; (8) the supply chain used to distribute products or services; (9) constraints on human capital resources and productivity; and (10) whether travel restrictions will impede business goals.[6]

These are the same types of disclosures on which plaintiffs will focus when bringing securities litigation. Initially, it was thought that COVID-19 would only affect supply chains in China, but as wide swaths of the United States and countries across Europe are now sheltering in place and practicing social distancing, many more supply chains will be affected. The service sector of the economy has already strongly felt the pandemic’s effects on consumer demand. Companies whose employees are able to work from home may have already observed a drop-off in productivity as parents care for young children who are now without daytime caregivers. In addition, companies who were not touched by the initial wave of mandatory closures must consider the follow-on effects of some industries being almost entirely shut down.

Companies should consider whether tailored disclosures on any of the above issues are necessary. The SEC advises that in addition to the mandatory material disclosures, companies should “provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management.”[7] Management would also do well to revisit earlier disclosures about COVID-19 and assess if any updates are necessary as the situation evolves.

The SEC also cautions that companies and corporate insiders, as always, must refrain from trading prior to the dissemination of material nonpublic information related to the effects of COVID-19.[8] Even if a stock sale does not rise to the level that would trigger the SEC or DOJ to open an insider trading investigation, suspicious stock sales, typically identified as those out of line with an individual’s prior practices, can also be used by plaintiffs to indicate scienter in a securities class action at the motion to dismiss phase.

[1] Douglas v. Norwegian Cruise Lines Holdings Ltd., et al., Case No. 1:20-cv-21107 (S.D. Fla. March 12, 2020); Atachbarian v. Norwegian Cruise Lines, et al., Case No. 1:20-cv-21386 (S.D. Fla. March 31, 2020).
[2] In In re Royal Caribbean Cruises Ltd., 1:11-22855-CIV, 2013 WL 3295951 (S.D. Fla. April 19, 2013), plaintiffs alleged that statements made in quarterly earnings calls and SEC filings allegedly concealed lagging demand, bookings, and pricing softness in the Mediterranean due to the recession and the geopolitical instability caused by the Arab Spring. Royal Caribbean was successful in getting the case dismissed on a motion to dismiss.
[3] McDermid v. Inovio Pharmaceuticals, Inc., et al., Case No. 2:20-01402 (E.D. Pa. March 12, 2020).
[4] Drieu v. Zoom Video Communications, et al., Case No. 5:20-cv-02353 (N.D. Cal. April 7, 2020).
[5] Cooksey v. CenterState Bank Corp, et al., Case No. 1:20-cv-01709 (E.D.N.Y. April 6, 2020).
[6] 15 U.S.C. § 78u-5(c) 
[7] Securities and Exchange Commission Division of Corporation Finance, “CF Disclosure Guidance: Topic No. 9” available at (March 25, 2020).
[8] Id.
[9] Id.