For the first time in several years, securities fraud cases declined in 2020, largely due to the pandemic.1 However, we don’t expect this decrease to continue. Just three months into 2021, there are a number of issues trending in this practice area, including:
- Securities litigation against non-U.S.-based issuers;
- Securities and derivative litigation arising from SPACs and de-SPAC transactions;
- Securities and derivative litigation arising from COVID-19; and
- Derivative litigation raising issues relating to diversity.
Increase in Securities Fraud Class Actions Against Non-U.S. Issuers
As reported in Dechert’s Annual Survey, securities class actions filed against non-U.S. issuers actually increased in 2020—going from 64 filed in 2019 to 88 filed in 2020, an increase of 37.5%,2 and thus disrupting 2020’s general trend of a decrease in securities litigation. Non-U.S. issuers based in China accounted for the largest percentage with twenty-eight complaints, followed by those based in Canada, with twelve.3
Many non-U.S. issuers mistakenly believe that they are immune from securities fraud class actions filed in the U.S. so long as the company does not sponsor its ADRs, but as Stoyas v. Toshiba Corporation, et al. has taught us, that it not necessarily the case.4 Although Toshiba’s common shares trade on the Tokyo Stock Exchange, and Toshiba’s unsponsored Level I ADRs that trade in the U.S. were set up by a depositary bank without Toshiba’s involvement, on remand from the Ninth Circuit, the Judge denied defendants’ motion to dismiss finding that plaintiffs plausibly alleged that the parties incurred irrevocable liability within the U.S.5 More recently, courts have side-stepped the question and dismissed the cases against non-U.S. issuers on the basis of forum non-conveniens.6 However, given that these cases are based on courts’ discretionary rulings, non-U.S. issuers should recognize the potential risk and prepare accordingly.
Securities Litigation Relating to SPACs Likely to Continue
Undoubtedly, Special Purpose Acquisition Companies (“SPAC”) transactions have become a popular vehicle for transitioning a private company into a publicly traded one, and with the increase in these types of transactions, securities litigation relating to SPACs and de-SPAC transactions are on the rise. SPACs are newly formed corporations that raise capital through IPOs and seek to use the proceeds to acquire an operating business.7 Once an IPO is complete, there is a specified deadline (usually 18 to 24 months) to complete the initial business combination. The creation of SPACs has exploded during 2020 as the U.S. securities markets have seen an unprecedented surge in their popularity. In 2020, 244 SPACs raised US$78 billion across the year.8 In the first quarter of 2021, SPAC IPOs surpassed the amount raised in 2020. 9
On March 25, 2021, Reuters reported that the SEC has “opened an inquiry into Wall Street’s black check acquisition frenzy” and is seeking information from Wall Street banks about the involvement with SPAC transactions, including deal fees, volumes, and internal controls and compliance measures in place to deal with transactions.10 On March 31, 2021, the SEC’s Division of Corporate Finance issued a statement to address certain accounting, financial reporting and governance issues that should be carefully considered before a private operating company undertakes a business combination with a SPAC. 11 On April 8, 2021, the Acting Director of the SEC’s Division of Corporate Finance specifically addressed “SPACs, IPOs and Liability Risk under the Securities Laws.”12 Among other things, Acting Director Coates cautioned that statements made in a de-SPAC transaction are not subject to less risk of liability than those made in a traditional IPO, and questioned whether the PSLRA’s exclusion from its safe harbor of “‘initial public offerings,’ may include de-SPAC transactions.”13 These developments may signal an increased risk of SEC inquiries, as well as securities and derivative litigation, arising out of de-SPAC transactions.
The risk of securities litigation arises at several stages of the SPAC life cycle. While at the IPO stage, the risk of litigation is relatively low, during the de-SPAC transaction phase, the risk of securities or derivative litigation is increasingly present. Allegedly unique risks inherent to these types of transactions, which give rise to securities litigation, should be considered.14 For example, in Amo v. Multiplan Corp. f/k/a Churchill Capital Corp., et al.,15 the plaintiff described the SPAC structure, as “conflict-laden and [a structure which] practically invites fiduciary misconduct.” As a result of the alleged inherent conflicts of interests and allegedly “overriding” incentives “to get a deal done—any deal—without regard to whether it is truly in the best interest of the SPAC’s outside investors,” plaintiff alleged that the entire fairness standard (rather than the business judgment rule) should apply.
Plaintiffs may also allege that a specific time period to identify a target (e.g., 24-months) places pressure on the SPAC board, which may result in shortcuts, a poor choice of target or inadequate disclosures about the true risks and future financial prospects. Interestingly, many of the actions relating to the de-SPAC transactions arise following negative reports issued by short sellers.16 As recently reported, the “SPAC bubble” may be showing signs of weakening; in the last week of March, 93% of IPO prices of SPACs fell below their offering prices.17 Indeed, unlike non-SPAC IPOs, SPACs often provide projections to investors because the companies are going public through a merger, not an IPO. If such projections fail to materialize, however, lawsuits are sure to follow. As the pool of potential attractive targets begins to dry up or operating companies fail to meet expectations, we anticipate an increased risk of securities and derivative litigation.
Securities Fraud Cases Arising from COVID-19 Continue to Be Filed
More than one year into the pandemic, securities fraud class actions arising from COVID-19 are still being filed—perhaps signaling that this wave of suits is far from over. As we previously reported, many litigators initially speculated that there would be a surge of securities cases arising from the pandemic, but during the first few months, most of the cases were fact specific and targeted the travel and healthcare industry.18 The paucity of cases early on in the pandemic can be attributed to the stock market’s remarkable rebound, as well as the difficulty for plaintiffs’ firms to plead loss causation—a demonstration that the investors’ loss was actually caused by the alleged misrepresentations rather than general market conditions.
As we predicted, however, enterprising plaintiffs have begun to file claims arising out of disclosures made relating to operations, financial condition and/or the impact of the pandemic, and we expect that trend to continue. Plaintiffs have targeted companies such as Forescout Technologies, Portland Electric and K12, Inc. alleging that they made false or misleading statements or omissions regarding the pandemic’s potential impact on their businesses and industries.19 Similarly, there has been a number of derivative cases filed alleging that directors breached their fiduciary duties during the pandemic, including, for example, Inovio Pharmaceuticals, SCWorx, Chembio Diagnostics, among others. As the first quarter of 2021 has demonstrated, COVID-19 related securities and derivative cases are far from over. 20
While we are starting to see an increased availability of vaccines in the U.S. and possibly some relief from the pandemic, the potential economic impact is yet to be fully realized. As such, companies should continue to be vigilant in making accurate disclosures regarding not only their economic prospects, but the risks they continue to face as a result of the pandemic.
Derivative Cases Raising Issues of Board Diversity
As protests regarding racial injustice sweep the U.S. and more companies are taking steps to increase diversity, equity, and inclusion, plaintiffs’ firms have attempted to expand theories of liability in shareholder litigation by filing derivative actions challenging the lack of diversity on corporate boards. Similar to when shareholder litigation arose in the wake of the #MeToo movement relating to sexual harassment policies and board-level oversight, multiple shareholder lawsuits have been filed in courts across the country alleging boards of directors breached their fiduciary duties by purportedly falsely representing that a company is committed to racial diversity when, in fact, the company lacks Black directors.21 Claims have likewise targeted allegedly false statements in proxy statements or codes of conduct about a “commitment to diversity” in violation of Section 14(a) of the Exchange Act.22
Nonetheless, where defendants are subject to a shareholder derivative suit relating to these issues, they have a number of strong dismissal arguments at their disposal. Thus, it is unclear whether such suits will ultimately gain traction. In Ocegueda v. Zukerberg, et al., one of the few board diversity cases where a court has ruled on a motion to dismiss, the court granted the Facebook defendants’ motion, holding that (i) plaintiff failed to plead demand futility, (ii) the company’s forum selection clause required the derivative claims to be filed in Delaware, and (iii) plaintiff failed to plead a materially misleading statement under Section 14(a).23 Interestingly, the court took note of the fact that plaintiff’s allegations regarding the board composition and nominating process were factually wrong, but nevertheless, allowed plaintiff leave to amend her Section 14(a) claim as it related to broader allegations regarding diversity in the workforce. Given that many of the allegations in the complaint were demonstrably false, this case may be of limited value in determining how other courts will view defendants’ arguments and it remains to be seen whether plaintiff will refile in Delaware Chancery Court. Regardless, arguments relating to demand futility and forum selection clauses will be important arguments for future cases. While there is not a one-size-fits-all solution in preventing these shareholder lawsuits, companies and their boards should consider carefully examining the diversity of their directors and officers, as well as individuals in management positions overseeing diversity efforts.