As issuers work to prepare their quarterly securities filings during the COVID-19 pandemic, including endeavoring to heed the SEC’s recent encouragement to focus on forward-looking disclosure, they may find themselves asking whether they will face an increased risk of securities litigation in the current economic climate.
The question is a good one. Indeed, the SEC has recently stressed that calendar-year companies should be mindful that their first-quarter results likely do not reflect the full impact of the COVID-19 pandemic, the economic effects of which—including the full impact of travel bans, shelter-in-place orders, and their ilk—did not take hold in many jurisdictions until later in the quarter. Thus, merely reporting on the results for Q1 is likely not to provide the full picture that investors seek.
Many companies are concerned that providing additional disclosure in these uncertain times will expose them to securities litigation risk. Some companies have already faced federal securities lawsuits for material misstatements or omissions based on their disclosures made in the face of growing uncertainty.
While those suits are at an initial phase and there are any number of defenses to them, they indicate generally the types of claims investors are currently bringing and can provide some guidance for how to minimize the chances of having to defend against similar claims.
The lawsuits we have seen so far fall into two main categories:
- alleged understatement of the impact of COVID-19 on a company’s business; and
- alleged overstatement of a company’s ability to supply needed products.
To help minimize litigation risk, companies should keep the following important considerations in mind when drafting disclosures.
Couch predictions appropriately, including with meaningful cautionary language
Through the Private Securities Litigation Reform Act (PSLRA), which governs federal securities class actions in the US, Congress created several safe harbors for forward-looking statements, including one safe harbor that applies if two conditions are met:
- the forward-looking statements are identified as such, and
- the company includes meaningful cautionary language that describes risk factors that could cause the forward-looking statements not to come true.
While cautionary language that is “a vague or blanket (boilerplate) disclaimer” will not provide protection, language that is “substantive and tailored to the specific” projections or estimates will do so.
For this reason, the existing forward-looking-statements legend and risk factors that companies have in their disclosure documents should be reviewed, updated, and made specific to current known risks, particularly if COVID-19 has affected and may continue to affect the company.
Clearly identify opinions
Because the securities laws primarily target mis-statements of material fact, statements of opinion are often inactionable.
While there are no magic words, language such as “we believe” or “it is our opinion that” will help make clear to investors and readers that the statement is one of opinion.
Even when a statement is an opinion, companies should seek to ensure that it cannot be challenged under the securities laws.
Under the Supreme Court’s decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, an opinion is actionable only in limited circumstances:
- if the speaker did not actually believe the opinion;
- the opinion contained embedded misstatements of fact; or
- the speaker omitted facts that undercut her opinion and that a reasonable person "would expect an issuer to have before making the statement".
Thus, when including opinion statements in disclosures, a company should confirm that any embedded factual statements are true and that the company does not know of material facts undermining the opinion.
Carefully review risk-factor language
When describing the risks that a company may face, a company should ensure that it does not describe risks as mere possibilities when they have already come to pass.
The SEC and courts both have made clear that characterizing something as merely a risk when it is a near (or actual) certainty does not insulate a speaker for liability.
For instance, in 2018 the SEC found that Yahoo! violated the securities laws by disclosing that a data breach was a possible risk that could materially affect the company when the company had already been subject to a significant data breach.
Specifically, although the company knew it had suffered a data breach in 2014, it continued to warn for nearly two years: “If our security measures are breached, our products and services may be perceived as not being secure,” and the company “may incur significant legal and financial exposure.” The SEC found that disclosure to be materially false or misleading.
Courts have similarly warned in securities cases that a speaker cannot suggest that “there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away.”
Be sure to describe known trends and uncertainties
SEC Regulation S-K requires issuers to include in their annual and quarterly reports management’s discussion and analysis (MD&A) of the issuer’s financial condition and results of operation. Item 303 of Regulation S-K mandates that a company “describe any known trends or uncertainties” that the issuer reasonably expects to affect sales, revenue, or income.
Courts have split on whether Item 303 creates an independent duty to disclose information, such that omitting that information is actionable as securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
Yet even in those jurisdictions where Item 303 does not create an independently actionable disclosure duty, issuers can still be liable for omitting material information when doing so makes other statements misleading.
Issuers should therefore recognize that misstatements or omissions of material information required by Item 303 could lead to a class action and should carefully review their MD&A disclosures.
Evaluate existing controls procedures
As companies evaluate their usual disclosure channels, they should consider whether—given the pandemic and disruptions to their business, including the effects of any layoffs and furloughs and the remote nature of significant operations—their existing disclosure controls and procedures are effective to capture material information.
A careful review of disclosure processes will ensure that they are not only effective, but that the company’s disclosures are accurate and free of any material omissions or misstatements.
For more information about the legal implications of COVID-19, please visit our coronavirus alert hub.
