In the latest securities suit related to the coronavirus outbreak, a plaintiff shareholder has filed a U.S. securities class action lawsuit against a Chinese real estate firm whose American Depositary Shares (ADSs) are listed on the NYSE, based on allegations that the company’s January 2020 IPO offering documents failed to disclose the impact of the outbreak on the company’s residential real estate operations in China. This latest filing is the first coronavirus-related securities lawsuit in the U.S. against a non-U.S. company. A copy of the plaintiff’s April 24, 2020 complaint can be found here.
Background
Phoenix Tree Holdings Limited is a Cayman Islands holding company that leases and manages apartments in thirteen cities in China, including Wuhan. The company rents units to tenants under the Danke Apartment and Dream Apartment Brands. The company completed an IPO of its NYSE-listed ADSs in January 2020. The registration statement for the offering was declared effective on January 16, 2020, and the company’s ADSs began trading the next day, January 17, 2020. The company completed its IPO on January 22, 2020. The offering resulted in net proceeds to the company of $128.4 million.
The Lawsuit
On April 24, 2020, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against the company; certain of its directors and officers; and its offering underwriters. The complaint purports to be filed on behalf of purchasers of the company’s ADSs pursuant to or traceable to the January 2020 IPO. The named plaintiff alleges that she bought her ADSs on January 17, 2020. The complaint asserts claims against the defendants for damages under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933.
The gist of the complaint is that the plaintiff’s allegations that the company’s offering documents “misrepresented the nature and level of renter complaints the company received before and as of its IPO, as well as demand in the Chinese residential rental market, and the Company’s exposure to significant adverse developments, resulting from the onset of the coronavirus in China – particularly in Wuhan – at the time of the IPO.”
The complaint alleges that in connection with the IPO, the company made various representations about its residential real estate business operations in China. The complaint alleges that, contrary to various representations in the offering documents, by the time of the IPO, the company was already “the subject of numerous complaints from tenants in China for engaging in questionable conduct.” For example, the complaint alleges, the tenants “complained about Phoenix’s practice of signing them up for bank loans without their knowledge or authorization and using the loan proceeds to fund its operations, while tenants unwittingly repaid the loans in monthly installments akin to rent.”
With respect to the coronavirus outbreak in China, the complaint alleges that the offering documents merely “obliquely warned” that its “business could be adversely affected” by viral outbreaks or epidemics, noting that “operations could be disrupted” if employees were suspected of having any such disease and that financial results “could be adversely affected” if the Chinese economy were to harmed by any such epidemic.
The complaint alleges that “as of the effective date” of the offering materials “the coronavirus was already ravaging China – particularly Wuhan, which was widely regarded as the epicenter of the virus and a significant hub for Phoenix.” The coronavirus outbreak was “adversely affecting Phoenix’s business, as tenants contracted the virus, lost employment, or otherwise experienced difficulty in honoring their leases and paying the rent.”
The complaint goes on to allege that “as the coronavirus continued to spread in China” shortly after the IPO, “tenants complained of Phoenix’s handling of the situation, which harmed the Company’s reputation and financial condition and prospects.” Because the offering materials “did not disclose anything about the coronavirus, much less the impact it was then having on or could have on the Company,” ADS investors “had no opportunity to consider how the worsening situation might impact the Company, including the Company’s relationship with renters.”
The complaint alleges that “competition in the residential rental market in China had suffered at the time of the IPO as the coronavirus ravaged the very locations where Phoenix primarily operated, including Wuhan, the very epicenter of the pandemic,” and further that the company “was contending with extraordinarily adverse development in China at the time of the IPO due to the coronavirus” that could “materially affect the company’s business operations,” including “a material increase in renter complaints and negative press and the prospect that renters could not continue to pay rent and service fees under conditions then existing as of the IPO.”
Information about renter complaints and adverse impact of the coronavirus outbreak “reached the market after the IPO,” according to the complaint. On March 25, 2020, in a press release in which the company announced its financial results for the fourth quarter of 2019, the company said that it expected the coronavirus to adversely affect its financial performance for the first quarter of 2020. This information, the complaint alleges, adversely affected the trading price of the ADSs.
The offering price for the ADSs at the time of the IPO was $13.50 per share. The ADS share price at market close on March 25, 2020 was $7.65. The ADSs share price closed at $6.97 on April 24, 2020.
Further Company Disclosures About the Coronavirus Outbreak
Though not referenced in the complaint, the March 25 press release quotes the company’s founder and CEO as saying “With the coronavirus outbreak, we have experienced a challenging start to 2020. Our thoughts are with those affected by the virus, and we are doing what we can to protect the health and safety of our residents and employees. While continuing to monitor the rapidly evolving situation, we remain focused on our growth strategies of enhancing our technological capabilities, further expanding our scale, expanding and enhancing our product and service offerings, promoting our brand awareness and industry influence, and strengthening and expanding our ecosystem. We are optimistic about our ability to execute on these strategies and are confident in our ability to deliver long-term, sustainable value for our shareholders.”
Also not referenced in the Complaint, the March 25 press release says the following about the coronavirus outbreak:
Since the outbreak of the coronavirus, the Company has proactively initiated measures to protect its residents and support the government’s efforts to combat the epidemic. For example, the Company provided safety notifications and preventative guidelines to residents through multiple channels, immediately launched online travel detail registration, and assisted residents with applying for neighborhood entry permits. In addition, leveraging its online platform, the Company publicized various online facilitation services including launching an online, zero-contact apartment viewing and selection function. Furthermore, the Company offered partial rental waivers to certain affected residents and held discussions with property owners to offer rental waivers during this difficult time. The Company has encouraged employees to work from home as necessary, and implemented temperature checks and frequent disinfection of workplaces. To support the relief effort in Wuhan, the Company provided 800 apartment units in the Wuhan area for medical workers, free of charge, to provide them with places to rest.
The Company expects adverse impacts on its business and financial performance from the novel coronavirus outbreak for the first quarter of 2020. The Company expects a decrease in the occupancy rate as residents delay their return to work, which will result in an adverse impact on the Company’s revenues. Since the outbreak of the novel coronavirus, the Company also adjusted the number of apartment units it operated to counteract some of the adverse impacts on its occupancy rate. As a result, the number of apartment units the Company will operate as of March 31, 2020, is expected to decrease as compared to that as of the end of 2019. In addition, the Company has been taking proactive actions to control its costs and expenses, including significantly slowing down the rate of sourcing and renovating additional apartment units. Furthermore, the Company’s management team has volunteered for a pay cut during this difficult time. The Company currently expects the impacts of the outbreak to be short-term given some early signs of recovery in China, and remains confident in the long-term outlook of its industry and growth prospects.
The extent to which the novel coronavirus outbreak impacts the Company’s operating results for the remainder of the fiscal year is highly uncertain and difficult to predict and will depend on future developments, including the duration, severity, and reach of the outbreak, and actions taken to contain the situation. The Company continues to monitor the rapidly evolving situation in order to evaluate the impact on its business and financial performance and to protect the health and safety of its residents and employees.
Based on current market and operating conditions, the Company expects revenues for the first quarter of 2020 to be between RMB1,900 million and RMB2,000 million. This forecast reflects the Company’s current and preliminary views, which is subject to change and substantial uncertainties, particularly in view of the potential impact of the novel coronavirus outbreak, the effects of which are difficult to analyze and predict.
Discussion
This new complaint represents the fourth U.S. coronavirus-related securities class action lawsuit so far, following the prior filings against Norwegian Cruise Lines (here), Inovio (here), and Zoom (here).
While there have been prior coronavirus-related securities class action lawsuit filings, this is the first so far to be filed against a non-U.S. company. This foreign connection is particularly relevant given the company’s China-based operations and its connection to Wuhan — at least certain of the company’s operations were located at the pandemic’s ground zero.
This complaint is also the first coronavirus-related securities suit so far to be filed alleging violations of Sections 11 and 12 of the ’33 Act, in connection with the company’s January 2020 IPO. The fact that this is a Section 11 case is important. On the one hand, because it is a Section 11 case, the plaintiff does not have to plead and prove that the company acted with scienter. On other hand, because it is a Section 11 case, what the facts were after the time of the company’s IPO is irrelevant to this lawsuit. This lawsuit’s success is entirely dependent on what the facts were at the time that the company’s offering documents were declared effective on January 16, 2020.
We all now know that China was badly hit by the coronavirus outbreak, particularly in Wuhan. It is hard to go back mentally to mid-January. To put myself in the right frame of mind, I went to the New York Times website and took a look at the online version of the newspaper’s January 16, 2020 issue. There was not a single story in the issue about the coronavirus. there were a lot of stories about the jockeying at the time between the many Democratic presidential candidates and about the trade war between the U.S. and China, but not a word about COVID-19.
What was the situation on the ground in China on January 16? To try and get a sense, I went to the online John Hopkins Coronavirus Resource Center, which has a page breaking down the progression of the coronavirus outbreak in Hubei. According to the website, the Wuhan City government did not begin tracking cases of a suspected pneumonia until December 30, 2019. A Shanghai lab first detected a coronavirus similar to SARS on January 5, 2020. Human to human spread of the coronavirus was first announced on January 20, 2020. Wuhan was first placed on quarantine on January 24, 2020. The website’s timeline is a little bit hard to decode on a daily basis, but my interpretation of the graphical data is that on January 23, 2020 (the first specific individual date identified on the graphic chart), there were a total of 444 confirmed cases of the coronavirus and 17 deaths.
While thinking about what the situation was in China at the time this company’s registration was declared effective, it is important to remember that in the early stages of the coronavirus outbreak in China, the Chinese government was actively suppressing the dissemination of information about the outbreak, as detailed in a detailed timeline posted on Axios (here). Among other things, the timeline shows that during a pre-scheduled Chinese Communist Party meeting in Wuhan during the period January 11 to January 17, 2020, the Wuhan Health Commission “insisted” that there were no new cases reported. In February 2020, the Washington Post reported that as of January 16, 2020, people in Wuhan were still being told by the government that the virus outbreak was not a problem and that there were no new cases. As people began to travel for the Lunar New Year celebration (which began on January 24, 2020) that a perception quickly began to grow that the virus was spreading rapidly; only then were Wuhan and then a larger region were locked down.
In other words, it looks like things were just emerging at the time of the company’s IPO and that things got very bad immediately after, but the extent of the looming disaster arguably was not apparent at the time the company’s Registration Statement was declared effective on January 16, 2020, in part because the Chinese government was actively suppressing information about the viral disease.
Because this complaint asserts only ’33 Act claims, what the company did and didn’t say after the IPO is irrelevant, but it is worth noting that the company’s first scheduled periodic reporting filing was the company’s quarterly earnings release on March 25, 2020. Under the U.S. securities laws, based as they are on periodic reporting (by contrast to the system in place in other countries, such as Canada and Australia, which have continuous disclosure requirements), silence cannot be the basis of securities liability. Absent a duty to speak, a company has not duty to make disclosures (of course, subject to the further complicating issue about the duty to update).
Whether this company made a material misrepresentation in its offering materials about the coronavirus outbreak in China is going to come down to a very narrow factual issue, and elusive questions about how a rapidly emerging situation was evolving — as well as what was being hidden at the time by the Chinese government. The one thing that is certain is that the company’s offering document statements cannot be judged based on what later happened.
In addition to being the first coronavirus-related securities suit to be filed against a non-U.S. company, this is also the first to be filed against a residential real estate company. The fact that the company has been sued has a lot to do with the fact that the company just happened to complete its IPO right as the coronavirus outbreak was emerging.
Just the same, the allegations in the complaint and the company’s disclosures in its March 25 press release do show how the coronavirus outbreak has affected the company’s operations. Other real estate companies operating in other jurisdictions around the world undoubtedly experienced their own version of the same thing. As the global health situation evolves and as countries and companies emerge from lockdown, what the residential real estate companies say about the impact of the pandemic on their operations and results, and what the companies say about the extent of their ability to operate and the impact on their financial results going forward potentially could also attract the unwanted attention of plaintiffs’ lawyers.
As I have said before and as I continue to believe, there are going to be significant numbers of coronavirus-related securities class action lawsuits (and shareholder derivative lawsuits, as well), and these lawsuits are going to accumulate for some time to come. The plaintiffs’ lawyers have shown in recent years that they are keen to file event-driven securities suits; the coronavirus outbreak is the biggest event to come along for a very long while.