With the news about the coronavirus outbreak dominating the headlines, other important stories have faded into the background — though they definitely have not gone away. Among these important continuing stories is the U.S. trade war with China. The frontlines of this trade war are on the battlefield of economic competition, which these days includes, among other things, export and import controls and other coercive measures. As one commentator has put it, the “highest-profile example of the United States’ use of targeted coercive measures against China is its yearlong campaign against Huawei, China’s national-champion telecommunications company.” And as a recently filed lawsuit demonstrates, among the implications of the two countries’ competition – and specifically, the U.S. measures targeting Huawei – is a risk that affected companies can be exposed to government investigations and also to D&O claims.
Alpha and Omega Semiconductor Ltd. designs, develops and supplies power semiconductors. On February 5, 2020, in connection with the company’s release of its fourth quarter and year-end financial results, the company announced that the U.S. Department of Justice “recently commenced an investigation into the Company’s compliance with export control regulations relating to certain business transaction with Huawei and its affiliates (‘Huawei’).”
The company’s statement went on to say that “in connection with this investigation, [the Department of Commerce] has requested the Company to suspend shipments of its product to Huawei.” The statement also said that the company’s “financial performance in the March quarter will be negatively impacted by the Huawei shipment interruption and by additional professional fees incurred in connection with the investigation.”
The company also said that “The Company is cooperating fully with federal authorities in the investigation. The Company has maintained an export control compliance program and has been committed to comply fully with all applicable laws and regulations.”
On March 19, 2020, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against the Company, its CEO, and its CFO. The complaint is filed on behalf of a class of Alpha and Omega shareholders who purchased the company’s securities between August 7, 2019 and February 5, 2020. A copy of the plaintiff’s complaint can be found here.
The complaint quotes at length from the company’s February 5 earnings release and then alleges that the defendants “failed to disclose to investors: (1) that the Company’s export control practices were in violation of applicable laws and regulations; (2) that, as a result, the Company was vulnerable to regulatory scrutiny and liability; and (3) that, as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
The complaint also quotes at length from the company’s various SEC filings during the class period, including, for example, the company’s August 23, 2019 filing on Form 10-K, in which the company said, among other things, that “We have adopted a global business model under which we maintain significant operations and facilities through our subsidiaries located in the U.S., China, Taiwan and Hong Kong. … Our international operations may subject us to the following risks: … economic and political stability, including trade tension between the U.S. and China.”
The complaint alleges that the defendants’ misrepresentations or omissions violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The complaint seeks damages on behalf of the putative class.
The filing of a securities suit based on underlying alleged trade regulation violations is not unprecedented. There have in fact been securities suits in the past filed in the wake of trade law violation allegations (as discussed, for example here). In particular, there have been prior lawsuits filed in connection with alleged violations of Russian trade sanctions, as discussed here. Prior D&O lawsuits arising out of alleged trade law violations include prior lawsuits involving semiconductor sales (for example, here).
While there have been lawsuits in the past arising out of alleged trade regulation violations, this lawsuit is the first I am aware of arising out the current U.S. trade war with China, and specifically the first relating to the U.S.’s targeting of Huawei.
In many respects, this lawsuit and the prior suits relating to alleged trade regulation violations are one example of a larger phenomenon, which the filing of follow-on securities lawsuits in the wake of regulatory action or investigation (discussed in greater length here).
The securities suits following regulatory action, in turn, are themselves part of an even larger phenomenon – that is, event-driven litigation, in which a securities suit is filed based not on alleged accounting or financial misrepresentations but rather on an event that has disrupted the company’s business operations. Here, the event is the DOJ investigation against the company based on trade issues pertaining to Huawei.
Among the features of this case that are similar to other event-driven suits are the complaint’s scienter allegations. Like many event-driven lawsuits, the scienter allegations in this complaint are scarce. The court is going to have to look hard to find allegations sufficient to carry this case over the initial pleading hurdles.
There is another curious thing about this complaint. Although the complaint contains many lengthy quotations from the company’s SEC filings, the various portions of text quoted in almost every example have absolutely nothing to do with the company trade law compliance. The one notable exception to this generalization is the brief statement in the company’s most recent 10-K in which the company warned that the risks that may arise from the company’s operations includes the risk arising from “economic and political instability, including trade tension between the U.S. and China.” The seeming absence of alleged misrepresentations does not preclude the plaintiff from attempting to sustain his case based on alleged omissions; however, his case then in effect boils down to a contention that the company should have told investors it was violating the law, a challenging theory on which to proceed.
In any event, for purposes of the readers of this blog, this case is of greatest interest because it represents an example of a D&O claim arising out of the current U.S. trade war with China. Despite the seeming all-consuming predominance of the coronavirus outbreak, the trade war is going to continue to go on, even if only in the background for now. Companies are dealing with a lot right now, but even with the predominance of the COVID-19 pandemic, companies are going to have to continue to deal with the fallout from the trade war. As this case shows, among the risks these companies face will be the possibility of D&O claims based on alleged trade law violations. This risk is a concern both for the companies themselves and for their D&O insurers.
Along those lines, the risk for companies and their D&O insurers includes not only the possibility of follow-on civil lawsuits like this one. The risk includes the possibility of the underlying regulatory investigation, which entails its own significant costs. These cost in turn raise the question of whether or not the company can get D&O insurance coverage for the cost incurred in responding to a trade regulation investigation. In a prior post (here), I discussed at length this issues involved with the question of the possibility of D&O insurance coverage for trade sanction violation investigations.