Beware of stock drop litigation during times of crisis

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Publicly traded companies should take steps now to prepare for stock drop litigation in the wake of COVID-19.

We saw plaintiffs’ attorneys file these lawsuits in the wake of the 2008 financial crisis and the outbreaks of Ebola and SARS. While the precipitating events may change, the resulting cases from the securities class action bar follow a predictable pattern.

First, a significant issue leads to a substantial drop in the stock price of a publicly traded company. Then plaintiffs’ attorneys file class-action lawsuits alleging that certain public statements made by the company were materially misleading because they either mischaracterized or understated the potential risk from such events.

These statements also may have affirmatively misstated issues related to the company’s response to those events. Based on these statements, plaintiffs may bring claims for securities fraud under Section 10b‑5 of the Securities Exchange Act of 1934, which requires proof of fraudulent intent.

If the statements in question are included in a registration statement or prospectus, plaintiffs can allege an even more problematic violation of the Securities Act of 1933, which does not require proof of fraudulent intent.

Additionally, at least in some judicial circuits, plaintiffs may pursue a private right of action asserting the company failed to disclose “any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations” in violation of SEC Regulation S‑K.

There is no question stock drop litigation will occur in the wake of the COVID‑19 pandemic. In fact, it is already happening. Norwegian Cruise Lines faces a lawsuit in a Florida federal court filed by investors who said they were defrauded and suffered a precipitous drop in the stock price after the company allegedly inflated sales projections.

While most litigation remains in something of a “holding pattern” as federal courts are operating on a significantly limited basis, we expect to see a spike in such cases when the courts return to something closer to business as usual.

During this current period of “calm before the storm,” potentially affected companies would be well-advised to do what they can to best position themselves moving forward. At the outset, it is important to heed the advice of the SEC, which issued a release on March 4 reminding “all companies to provide investors with insight regarding their assessment of and plans for addressing material risks to their businesses and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments.”

Companies should reflect on, and appropriately report, their assessment for the pandemic’s impact on their business and plan for dealing with it. But they must be careful to avoid selectively disclosing such information in a way that could be perceived as giving some investors an unfair advantage over others. They must also be cautious about overstating the impact or overstating prospects for near-term recoveries in a way that potential plaintiffs could point to as “unfulfilled promises.”

It’s critical to have counsel review public filings and significant public statements, particularly in light of the current environment. Any forward-looking statements must be carefully considered and discussed with legal counsel to ensure that, to the extent possible, they take advantage of all safe-harbor protections, contain meaningful cautionary language and do not provide fodder for the plaintiffs’ class action bar.

The question isn’t whether stock drop litigation claims are coming. They are. The only question at this point is, “What can companies do to prepare for this issue and address it head-on?”

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