Spiraling fears over the coronavirus and the multiplication of virus outbreaks across the globe have impacted the worldwide economy, threatened supply chains, and caused severe stock market declines and disruptions in the U.S. Instability in the stock market tends to lead to litigation, and the plaintiffs’ bar has increasingly filed securities actions in the wake of stock drops that follow significant adverse events. Examples have included event-driven securities litigation stemming from data breaches, product failures, or even sexual harassment litigation. Given the adverse impact of the coronavirus thus far, it is likely that its continuing negative implications for businesses and the financial markets will lead to an increase in securities litigation filings.
The financial and other uncertainties posed by the outbreak of coronavirus are already creating complex disclosure issues for companies across all industries, and we expect these issues to continue. SEC Chairman Jay Clayton has urged 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” because how companies “plan and respond to the events as they unfold can be material to an investment decision.” (See the SEC’s March 4, 2020 Press Release, available here).
While it is unlikely that a plaintiff could prevail on a claim that a company or its management should have predicted the implications of the coronavirus specifically, they may argue that previous disclosures failed to adequately apprise investors of the risks from a global pandemic, supply chain disruptions, or other collateral effects of a virus outbreak or a government’s response to it. Firms that have experienced supply chain or other issues because of past global health crises may be more likely to face a securities fraud lawsuit based on a failure to adequately disclose these potential risks. Furthermore, as the situation develops, and the risks and impact of the current outbreak become clearer, a failure to provide adequate disclosures or to satisfactorily address the risks posed by coronavirus could also lead to potential allegations of securities fraud. Additionally, companies issuing securities in the near future could also face claims under Sections 11 and 12(a)(2) of the Securities Act, which do not require the defendant to have acted with intent or severe recklessness.
In particular, companies should bear in mind Item 303 of SEC Regulation S-K, which requires the disclosure, in a company’s management discussion and analysis (MD&A), of “any known trends or uncertainties . . . that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.”[i] While an alleged failure to disclose such “known trends or uncertainties” may serve as the predicate for claims under Sections 11 and 12,[ii] there is a split among the federal Circuit Courts of Appeals concerning whether such an alleged violation of Item 303 may give rise to a private claim under Section 10(b) of the Securities Exchange Act of 1934.[iii] Therefore, depending on the jurisdiction and the nature of the claim, shareholder plaintiffs may seek to invoke Regulation S-K to support their alleged misstatements and omissions with respect to the coronavirus.
Careful drafting of disclosures, especially those relating to performance, projections and the potential impact of the virus, should help to minimize the potential for liability and maximize defenses against future lawsuits. As the market effects of the virus continue to develop, companies should consider whether they have been sufficiently transparent in their public disclosures about the anticipated impact of the coronavirus on their operations. Companies may also want to consider whether their forward-looking guidance and/or risk factors need to be updated in light of recent developments. In particular, companies should consider updating their cautionary language, especially with respect to forward-looking statements, to maximize the protections of the Private Securities Litigation Reform Act’s (PSLRA) safe harbor. In addition to disclosures in periodic reports, companies should consider whether to provide additional or updated disclosures or guidance in an 8-K filing or a 6-K submission. Just like the battle with the virus, taking proactive measures now may mitigate the impacts later. Proactively providing such disclosures may give a company a better chance of fending off future allegations of fraudulent intent necessary to state a securities fraud claim based on misleading statements or omissions. A more in-depth discussion of the impact of the coronavirus on public and private securities offerings is available here.
The human, business, and financial impact of the coronavirus is growing. Though at this point we cannot know the toll this pandemic will take, it is likely to impose enormous costs in the U.S. and globally. Reporting companies should reduce the risk of private securities litigation by assessing and disclosing the likely impact of the coronavirus on their business operations and financial results. They should also update (or rescind) past guidance where appropriate and consider whether additional coronavirus-specific disclosures are necessary.
We will continue to closely monitor the implications of this pandemic and report on legal developments.
[i] 17 C.F.R. § 229.303(a)(3)(ii). Notably, on January 30, 2020, the SEC proposed updates to Regulation S-K that, if adopted, would require companies to disclose known events “reasonably likely to cause” a material change in the relationship between costs and revenues, lowering the current standard of disclosing known events that “will cause” such a change.
[ii] See, e.g., Panther Partners Inc. v. Ikanos Comm’s, Inc., 681 F.3d 114 (2d Cir. 2012).
[iii] Compare Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 100 (2d Cir. 2015) (failure to disclose under Item 303 can serve as basis for a private Section 10(b) claim); with Carvelli v. Ocwen Fin. Corp., 934 F.3d 1307, 1331 (11th Cir. 2019) (alleged violation of Item 303 cannot serve as basis for a private Section 10(b) claim); In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1054-56 (9th Cir. 2014) (same) ; Oran v. Stafford, 226 F.3d 275, 288 (3d Cir. 2000) (same).