The COVID-19 pandemic has emerged as a historically disruptive event. In addition to the health crisis, COVID-19 is ravaging the global economy. During the past week, the Dow Jones Industrial Average has closed more than 25% down from its peak last month, wiping away the gains of the last two years and the TSX has closed almost 30% off of its peak last month, recovering somewhat after hitting an eight-year low. In this environment, class action lawyers have likely already begun investigating companies that suffered significant share price movements to determine whether any of them are attractive targets for a lawsuit. Their investigations will focus on two things: (1) the company’s risk disclosure prior to the outbreak; and (2) the company’s current disclosure about the impact of COVID-19 on its business.
1. Quality of risk disclosure
Class counsel examine public filings with a view to assessing whether the “Risk Factors” disclosed by a company are adequate. In the context of the current crisis, did the company disclose what the impact of a pandemic or a Force Majeure on the scale of COVID-19 would be to their business? If the answer is no, this omission could be the anchor to a statutory misrepresentation claim under provincial securities legislation. Any shareholder who purchased shares prior to adequate disclosure being made may have a claim that the price at which the shares traded was inflated because the company did not adequately disclose the risk it faced from a disruptive event like a pandemic.
If a company’s Risk Factors did disclose the risks posed by a pandemic or a Force Majeure, class counsel will analyze whether the disclosure was sufficiently comprehensive. If the company employed boilerplate language that broadly described unspecified harm to the business in the event of a global emergency, they may take the position that the disclosure was inadequate and seek to hold the company responsible notwithstanding the fact that some disclosure was made.
If, on the other hand, a company’s disclosure carefully described the kind of disruptions that the company is vulnerable to in the event of a pandemic or Force Majeure, then class counsel will likely conclude that either they have no case against that company or that there are easier targets to focus on. Simply put, the more comprehensive and specific a company’s risk disclosure has been with respect to the challenges it might face in the event of a global economic disruption, the less attractive the company will be to class action lawyers seeking to commence claims arising out of the COVID-19 crisis.
2. Current disclosure of the impact of COVID-19
The second stage of class counsel’s investigation will be on what a company is saying now about the impact of the COVID-19 crisis on the company. In the event that past filings have inadequately described the risks to the company of a pandemic, the next round of disclosure may constitute corrective disclosure of prior deficiencies (which would typically end the potential class period) or, if the new disclosure itself contains a misrepresentation, may give rise to a new basis for a claim.
Companies have been granted relief from certain filing and delivery requirements by Canadian securities regulators, who have issued blanket relief orders applicable to companies that have filings or deliveries due between March 23rd and June 1st. Companies do not have to apply for the relief, but must meet certain conditions set out in the blanket orders to qualify for the relief. One of those conditions is that they must disclose, by news release, any material business developments that have arisen since the date of their last annual or interim financial statements, and must confirm that no material business developments have occurred since then. For more details on this relief, see our MarketCaps newsletter.
Given how far into the COVID-19 crisis we are, a great deal of care must go into drilling down on all of the ways a company is being impacted by the crisis, and then meeting its disclosure obligations to the public. Given the uncertainty around the duration and severity of the pandemic, companies may be wrestling with whether to even provide guidance about their anticipated financial performance. Those that do should be very careful to adhere to the requirements for protection under the statutory safe harbours lest they be exposed to claims if their guidance is not borne out in the coming months or years.
Companies that are especially vulnerable to specific challenges posed by COVID-19 will need to make it clear to investors precisely how the pandemic has affected their business, and how they expect it will continue to do so in the future. For example, a video game streaming business will not be impacted by a “shelter at home” order the way a brick and mortar video games store would be. A manufacturer of athletic clothing may be compelled by the government to produce hospital gowns and masks during the crisis. How this impacts profitability and existing contracts will likely need to be explained in its disclosure.
Put simply, care should be taken to provide a comprehensive picture of how a company is faring under this health and economic crisis. But that guidance should be sober and proportional. Overly optimistic views are as vulnerable as overly pessimistic views absent proper disclosure of (among other things) the assumptions upon which the forward-looking statements were made. For more on disclosure considerations, see our MarketCaps newsletter.
3. Historical experience
To get a sense of what the litigation landscape might look like in the aftermath of COVID-19, it is worth looking back at what unfolded after the last major health crisis in this century – the Ebola epidemic in 2014.
In 2015, a number of shareholders commenced a class action in the United States District Court of Delaware against the pharmaceutical company iBIO Inc., its president, and its CEO. The pleadings alleged that the president and CEO, in an attempt to raise iBIO’s stock price, made a number of material misrepresentations as to the company’s involvement in a possible cure for the Ebola Virus Disease (EVD) throughout late 2014. EVD infected 11 people in the United States during the 2014-2016 epidemic but was never transmitted to Canada.
iBIO’s president gave a promotional interview to SmallCap Network on October 6, 2014 that, by October 10, 2014, had caused its share price to increase by 83%. On October 11, 2014, iBIO’s CEO was quoted in the Washington Post concerning iBIO’s role in manufacturing an EVD treatment. The next trading day, iBIO’s share price rose again. A number of investors subscribed throughout this period.
On October 20, 2014, it came to light in an article on SeekingAlpha.com that iBIO had never had anything to do with developing or marketing a therapeutic drug in response to EVD. By that point, however, iBIO’s share price had increased by nearly 400% and a number of investors had been misled. According to the pleadings, the misleading statements helped iBIO earn an additional $2.6 million from a sale it effected before its fraud was brought to light. In late 2015, the defendants agreed to settle with the class for nearly $1.9 million.
4. D&O claims arising from COVID-19
The COVID-19 pandemic has already led to the commencement of at least two shareholder actions.
First, a securities class action has been filed against Inovio Pharmaceuticals. A plaintiff shareholder of Inovio alleges that, similar to the iBIO matter, Inovio’s CEO made inaccurate and misleading statements with respect to the company’s efforts to develop a COVID-19 vaccine. The plaintiff here alleges that these statements led to a jump in share prices. When the statements were subsequently exposed as untrue, Inovio’s share price fell from $18.72 per share to $5.70 per share, representing a 71% decline and a $643 million loss of market capitalization.
A second COVID-19 related securities class action has been filed against Norwegian Cruise Lines (NCL). A shareholder of NCL has commenced a class proceeding against NCL, its CEO and its CFO. The crux of the claim is that statements in NCL’s securities filings regarding COVID-19 and its impact on the company’s business were false and misleading.
The allegations have not been proven in either matter. However, the existence of the actions demonstrate how directors and officers are already being held accountable for their responses to COVID-19.
5. Minimizing your exposure
One of the key metrics to determining how attractive a target a company is for class action lawyers is the length of the anticipated “class period” – i.e. the period between the date of the first misrepresentation and the date of the corrective disclosure. The significance of the class period is that only those investors who purchased (or in some cases, sold) shares within the class period will qualify as class members. The wider the spread between the earliest deficient disclosure item and the corrective disclosure, the more shares are likely to have traded, which generally increases the number of eligible class members and the number of affected shares.
The other key metric is the magnitude and speed of the share price drop. The greater the spread between the share price before the inciting incident – in this case the COVID-19 crisis – and the share price after the inciting incident, the greater the potential recovery for eligible class members. The greater the speed of the decline, the easier it is for class counsel to identify a single cause for the drop – namely, the impact of COVID-19 on the company. In contrast, a slow gradual decline over months or years will likely have a host of causes to explain the reduced share value, making the company less attractive to class action lawyers.
If you have concerns that your company has a profile that would attract the attention of class action lawyers – namely, a sharp and significant share price decline combined with a lengthy class period, then steps should be taken to minimize your risk. Experienced securities counsel can help assess any pre-existing disclosure issues and work with you to remediate them in future filings. Likewise, they can work with you to avoid creating any new exposures in future filings, especially those that contain forward-looking statements.
By Alex Zavaglia, Cathleen Brennan, Tyler McRobbie, Rachel B. Runge and Scott Kugler, Gowling WLG
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