Securities Class Actions Stemming from COVID-19: the Seemingly Never-Ending Pandemic Risk

In order to mitigate exposure moving forward, director and officer and company liability insurance underwriting needs to consider the evolution of claims and litigation tied to COVID-19.

by Cary J. Economou, Senior Counsel, Clyde & Co and Sarah Abrams, Director, Management Liability Claims, Markel Corporation

The number of securities class actions resulting from the pandemic filed since Spring 2020 total 26,[1] less than initially anticipated but with an expectation of an increase in 2021.  In order to mitigate exposure moving forward, director and officer and company liability insurance underwriting needs to consider the evolution of claims and litigation tied to COVID-19.

A particular liability surrounds disclosure litigation stemming from company filings with the U.S. Securities and Exchange Commission (SEC) and other regulatory agencies regarding the impact of COVID-19 to business.  At various times between March 2020 and June 2020, the SEC issued guidance designed to encourage transparency amid the uncertain times.[2] The SEC advised publicly held companies to disclose “as much information as is practicable regarding their current financial and operating status, as well as their future operational and financial planning.”[3]

Initially the broad disclosure language was not heavily scrutinized.  However, given the new Biden administration appointments at the SEC and Consumer Financial Protection Bureau (CFPB), disclosure claims are more likely to be evaluated on the basis of what companies and their officers and directors have come to understand from what has happened to date, and how well prepared they are to address and/or to disclose all of the facts and risks associated with their reactions to past, as well as future events.  This point is illustrated by the differences in allegations between disclosure litigation filed early on in the pandemic as opposed to litigation filed after months of enduring the pandemic. 

For example, Berg v. Velocity Financial, Inc., No. 20-cv-6780 (C.D. Cal.), which was filed in July 2020, involved claims against Velocity Financial, Inc., a real estate finance company. Velocity went public in January 2020, and thereafter, its share value declined. The putative securities class action alleged that Velocity misrepresented or failed to disclose material facts in its offering materials concerning: (i) the company’s underwriting process; (ii) the growth of non-performing and short-term, interest-only loans in its investment portfolio; (iii) a substantial and durable market for real estate investors; and (iv) risks facing its business, including those relating to the pandemic.  In January 2021, Berg was dismissed on the basis that Velocity could not have anticipated the extent of the pandemic in early January 2020 when it went public. The court found that Velocity’s public statements made before or in the early days of the pandemic were protected to the extent they failed to predict the COVID-19 crisis and its business impact. The court did note that the offering materials specifically cautioned investors that Velocity’s business might be affected by “changes in national, regional or local economic conditions or specific industry segments,” including those caused by “acts of God,” and thus, covered the pandemic.[4]

Recent disclosure litigation may not fare so well.  Leung v. bluebird, Inc., et al., No. 21-cv-00777 (D. Mass.) was filed on February 12, 2021. The complaint alleges that defendants made materially false and misleading statements, in the summer and early fall of 2020, regarding the Company's business, operations, and compliance policies, and specifically downplayed the foreseeable impact of disruptions related to the COVID-19 pandemic on bluebird timely obtaining FDA approval of its treatment.  The complaint asserts as a result of all the foregoing (among other things), it was foreseeable that bluebird would not submit the treatment in the second half of 2021 like it had previously represented, thus, bluebird’s public statements were materially false and misleading at all relevant times.

The primary differences in allegations between these two lawsuits have to do with timing – what did the companies know about the pandemic and when did they know it.  If a company made disclosures early on in the pandemic which have since been challenged, the holding in Berg may be beneficial as the knowledge of COVID-19’s negative impact on business was limited and/or could not be anticipated.  However, if a company’s alleged false statements were made months into the pandemic when it had more information and operating experience within the pandemic, any business impact and/or the true extent of any impact was known or should have been known.  A company in that position likely will receive no traction from the Berg decision.  As a result, management risks come into play stemming from false blame on COVID-19 for negative financial performance when the liability likely resulted from poor management and/or misconduct. 

There is an anticipation that disclosures should also include impact of market volatility and bankruptcy risk arising from COVID-19 impact to lines of business.  Many of the issues that are of concern to companies with respect to their disclosure obligations will also be of concern to insurance underwriting. Coming out of the pandemic, underwriting at the individual policy level will be essential in managing insurer risk profiles. 

To that end, areas of interest to consider in a post-pandemic environment include, but are not limited to, operational challenges, expenditures, relationships, and financing considerations:

• Understanding how management will address current pandemic and future pandemics
  • It would be hard to claim that a director or officer had prior knowledge about or anticipation of COVID-19 and/or future plausible pandemics, generally, but going forward there will be increased focus on D&Os preparing for such events in terms of supply chain backups and/or other operational plans in place to deal with future outbreaks.
• Has the company’s board created any new committees/positions to promote rapid-response decision-making as external developments warrant? Is the company obtaining internal or external resources to help keep the board informed in such circumstances?
• What are the company’s plans for remote working from employee to board level? Has the company ensured continuity? Is an overhaul in IT infrastructure required to ensure continued operations in the event of another pandemic/future lock downs?
• How will the company handle potential liquidity issues caused by a future pandemic/lockdown?
  • Is there any material impact in liquidity position and outlook due to a decrease in cash flow from operations?
• Will the company continue to have access to revolving lines of credit or address whether capital can be raised in the public or private markets to address liquidity needs?
  • Will the company need to provide additional collateral, guarantees, or equity to obtain funding? What impact, if any, on the ability to obtain additional funding due to any changes, or potential changes, in credit rating due to pandemic/lockdown?
• What is the projected impact (or reasonable likelihood of future impact) of changes to the financial condition and short- and long-term liquidity in the event of a future pandemic/lockdown?
• Will the company have the ability to timely service the debt and other obligations?
• Will the company modify share dividends, stock buybacks, insider trading rules, etc. in the event of a future pandemic/lockdown?
• Will the company need to reduce and/or terminate any material business operations or dispose of any material assets or line of business?
• Does the company need to consider prior disclosures that may be changed because of a future pandemic/lockdown impacting market conditions?
• Does the company have contracts with third parties where “force majeure” could come into play and excuse performance? Does the company plan to disclose such contracts and any potential impact on the company should that occur?
  • Will the company need to alter terms with customers? If so, what is the impact of such action on financial condition and /or liquidity?
  • Does the company rely on certain supplier or other finance programs which could be impacted and what are the risks in the event those arrangements cease to exist?

While not all-encompassing, the above considerations given the current and developing litigation landscape are meant to assist risk profiling by director and officer and company liability underwriters in a COVID-evolving landscape.