The COVID-19 pandemic has created a disclosure nightmare for public companies. The Securities and Exchange Commission (SEC) has recognized this challenge and, to its credit, has provided relief to public companies by, among other things, extending the deadline for companies to file certain disclosure reports. Nonetheless, companies are faced with the challenge of crafting disclosures regarding the risks presented by the coronavirus crisis to their business and operations and their plans for addressing those risks. This challenge is made all the more difficult by the looming presence of securities class action firms, which already have sued companies over coronavirus-related disclosures. In addition, the SEC in the recent past has charged companies for allegedly insufficient disclosures made in reaction to crisis situations.
The COVID-19 pandemic is wreaking havoc on the world economically. Businesses are being harmed in a myriad of ways, from losing customers, to supply chain disruptions, to employee layoffs. Many businesses and industries will change their operations in the short term and possibly permanently, while others will cease to exist. Public companies have a unique responsibility under federal securities laws to disclose information to the public, including assessments and plans relating to their business and operations and related risks. Such assessments and disclosures become thorny in the face of volatile markets, unprecedented events, and colossal business uncertainty.
SEC Relief in Response to COVID-19 Pandemic
Recognizing the extreme challenges presented by the COVID-19 pandemic, the SEC has provided guidance regarding, and relaxed, certain regulations governing public companies. On March 25, the SEC issued an order granting public companies a 45-day extension (subject to certain conditions) for filing periodic SEC reports (e.g, Forms 10-K, 20-F and 10-Q) due between March 1, 2020, and July 1, 2020. Also on March 25, the SEC Division of Corporation Finance issued guidance regarding disclosure (and other) obligations that companies should consider with respect to COVID-19. In addition, the SEC previously issued guidance for companies regarding changing annual meeting dates and conducting “virtual” shareholder meetings in response to the COVID-19 pandemic.
Importantly, SEC Chairman Jay Clayton recently emphasized that the SEC is expecting each public company to carefully assess and disclose the impact of, and its plan for addressing, the COVID-19 pandemic. Furthermore, on March 23, the co-directors of the SEC’s Enforcement Division (Stephanie Avakian and Steven Peiken) issued a statement expressing the Enforcement Division’s commitment in the face of the COVID-19 pandemic to protect investors and maintain confidence in the securities markets and emphasizing the importance of “following corporate controls and procedures,” including disclosure and related regulations.
Recent Class Action Lawsuits and SEC Enforcement Actions
In addition to serving the interests of shareholders and satisfying regulatory requirements, careful disclosures can help reduce potential liability should a company face securities class action lawsuits or SEC enforcement scrutiny. Indeed, at least two companies already have been slapped with lawsuits by securities class action law firms alleging misleading coronavirus-related disclosures. It is also worth noting that the SEC has charged companies for allegedly insufficient disclosures made in reaction to crisis situations. These private lawsuits and SEC enforcement actions are summarized below.
Norwegian Cruise Lines (Securities Class Action): On March 12, 2020, Norwegian Cruise Lines was sued for allegedly making false and misleading disclosures and omissions relating to the business impact of the COVID-19 pandemic. A securities class action complaint claimed that Norwegian, despite the negative impact of the COVID-19 outbreak on its business, continued to announce positive outlooks for the company. To support this allegation, the complaint cited various disclosures by Norwegian, including the following statement in a press release: “our Company has an exemplary track record of demonstrating its resilience in challenging environments and we remain confident in our ability to deliver strong performance over the long term.” The plaintiffs further alleged that Norwegian failed to disclose that it directed its sales staff to provide customers with unproven and/or blatantly false statements about COVID-19 to entice customers to purchase cruises. Douglas v. Norwegian Cruise Lines et al., No. 1:20-cv-21107-RNS (S.D. Fl.).
Inovio Pharmaceuticals (Securities Class Action): The same day the Norwegian Cruise Lines lawsuit was filed, a securities class action lawsuit was filed against Inovio Pharmaceuticals (and its CEO (J. Joseph Kim). The complaint alleged that the defendants falsely claimed that Inovio had developed a COVID-19 vaccine within a matter of hours of receiving the DNA sequence and had plans to start human testing in the coming months. Contrary to an Inovio press release and public comments by Kim, according to the complaint, Inovio had not fully developed a COVID-19 vaccine and they had no reason to believe the company would have the necessary regulatory approvals to begin human trials in the near future. McDermid v. Inovio Pharmaceuticals, Inc. et al, No. 2-20-cv-1402-GJP (E.D. Pa).
Lumber Liquidators (SEC Enforcement Action): In March 2019, the SEC charged Lumber Liquidators with fraud and fined it $6 million for making false statements in response to public allegations that its products contained illegal levels of formaldehyde. Lumber Liquidators, a discount retailer of hardwood flooring, was the subject of a CBS 60 Minutes news program segment that showed an undercover video of the company’s suppliers stating that they provided the company with products that did not comply with regulatory requirements. To promptly counter the negative implications of the 60 Minutes segment, the day after the episode aired, Lumber Liquidators issued a press release that the SEC later claimed falsely denied the allegations and included misleading affirmative assertions about its compliance efforts. The SEC alleged that Lumber Liquidators knew that its largest supplier had failed third-party formaldehyde emissions testing and was also unable to produce documentation proving its regulatory compliance. Separately, Lumber Liquidators was charged criminally and paid an additional $27 million criminal fine.
SeaWorld Entertainment (SEC Enforcement Action): Six months before the Lumber Liquidators enforcement action, the SEC charged SeaWorld Entertainment Inc. and its former CEO and VP of Communications with fraud for misleading investors about the impact the documentary film Blackfish had on the company’s reputation and business. Blackfish criticized SeaWorld’s treatment of its orca whales and received significant media attention as the film’s popularity quickly increased. The SEC alleged that untrue and misleading statements and omissions were made in SEC filings, earnings releases and calls, and statements to the press regarding the impact of Blackfish on the company. Ultimately, SeaWorld acknowledged a material decrease in park attendance caused by the negative publicity emanating from Blackfish. The defendants paid over $5 million in fines.
Appropriate disclosures regarding the COV-19 pandemic will be unique to each company and are not conducive to general advice. Instead, identified below are three issues for public companies to consider (and to discuss with counsel as appropriate) regarding the disclosure implications of the COVID-19 pandemic.
- The SEC chairman recently expressed the seriousness with which the SEC is viewing the disclosure obligations of companies with respect to the COVID-19 pandemic. On March 4, Chairman Clayton opined: “We  remind all 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. How companies plan and respond to the events as they unfold can be material to an investment decision . . . .”
- A company’s disclosures should address the primary risks of the COVID-19 pandemic to its specific business and operations, plans for addressing those risks, and the impact on its business and financial results. As to the disclosure of business risks, the SEC’s Division of Corporation Finance reminded public companies that “a number of existing rules or regulations require disclosure about the known or reasonably likely effects of and the types of risks presented by COVID-19. As a result, disclosure of these risks and COVID-19-related effects may be necessary or appropriate in management’s discussion and analysis, the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over reporting, and the financial statements.”
- It is best to avoid generic, boilerplate language as companies will be impacted differently by the pandemic depending on a multitude of factors (e.g., industry, customer base, suppliers, geographic location). Instead, a company should carefully tailor disclosures to reflect the impact of the pandemic on its specific business. In this regard, the SEC’s Division of Corporation Finance advised that “Disclosure about [COVID-19] risks and effects, including how the company and management are responding to them, should be specific to a company’s situation” and encouraged “disclosure that is tailored and provides material information about the impact of COVID-19 to investors and market participants.” We encourage public companies to review a detailed list of questions the SEC’s Division of Corporation Finance recommended companies consider when assessing COV-19-related effects on their present and future operations.
- Additionally, companies should be mindful of the possible need to revisit, refresh or update previous disclosures to the extent information has become materially inaccurate.
- Given the vast uncertainty businesses are facing, and the unprecedented nature of the pandemic, taking a more conservative approach to COVID-19-related disclosures may be appropriate. Indeed, the SEC’s Division of Corporation Finance acknowledged that it may be difficult to assess or predict with precision the broad effects of COVID-19 on industries or individual companies and noted that “the actual impact will depend on many factors beyond a company’s control and knowledge.”
Selective Disclosure (Regulation FD)
- When companies are ready to make COVID-19-related disclosures, they should do so in the proper formats and, in particular, avoid selectively disclosing that information in violation of Regulation FD. It is important to remind relevant employees of the restrictions on information disclosure and to seek approval of communication content and communication channels.
- Both the SEC and Enforcement Co-Directors Avakian and Peiken recently emphasized the importance of companies complying with Regulation FD with respect to COVID-19 disclosures. Specifically, in its March 25 order, the SEC stated: “[w]hen companies do disclose material information related to the impacts of the Coronavirus, they are reminded to take the necessary steps to avoid selective disclosures and to disseminate such information broadly.”
- When COVID-19 has affected a company in a material manner or a company becomes aware of a material risk related to the COVID-19 that would be material to investors, it should ensure that relevant procedures are invoked and followed to prevent the company and insiders from trading the company’s securities until the risk is disclosed.
- SEC Enforcement Co-Directors Avakian and Peiken warned that there is a heightened risk of improper trading arising from (1) the potentially increased value of a company’s COVID-19-related information given the current unprecedented situation; (2) the possibility of more insiders than usual having access to a company’s confidential information should additional experts and consultants be retained; and (3) insiders possessing confidential COVID-19 information for a longer period than usual should a company delay its SEC filings.
- As such, Avakian and Peiken as well as the SEC advised companies to take affirmative steps to prevent the company and corporate insiders from engaging in illegal insider trading based on material nonpublic information relating to the COVID-19 pandemic.