Companies navigating the current heath crisis and dealing with its financial effects face a number of risks. Among the many risks is the possibility of business litigation. For publicly traded companies, the litigation risks include the possibility of securities class action litigation. Even in the midst of a pandemic, the steps companies can take to try to mitigate their securities class action litigation remain the same – manage disclosures, control insider trading, and handle bad news appropriately, among other things – but the coronavirus outbreak has added new dimensions to these steps. Well-advised companies will be making the appropriate adjustments, and, as discussed below, D&O insurance underwriters will be (or perhaps, should be) monitoring companies closely to see which companies are making the adjustments.
As I have detailed on this blog, there have already been several securities class action lawsuits arising out of the coronavirus outbreak (as discussed most recently here). There undoubtedly will be more pandemic-related securities suits, as the impact of the pandemic on individual companies unfolds. In coming months, plaintiffs’ lawyers – and for that matter, the SEC — armed with the benefit of hindsight will closely scrutinize prior disclosures of companies whose business fortunes lag.
For that reason, it will be more important than ever for companies to manage their disclosures with an eye on mitigating securities class action litigation risks. As discussed in a May 14, 2020 article on the Harvard Law School Forum on Corporate Governance entitled “Operating in a Pandemic: Securities Litigation Risk and Navigating Disclosure Concerns” (here), there are a number of steps that well-advised companies should be taking in light of the securities litigation exposure.
The article’s authors note that the SEC has provided “extensive disclosure guidance” regarding the COVID-19 outbreak. For example, on March 25, 2020, the SEC’s Division of Corporate Finance issued a document entitled “CF Disclosure Guidance: Topic No. 9” (here), the outlined the disclosure approach companies should be taking in light of the pandemic. Among other things ,the guidance directs companies, when considering what information will be material to investors and subject to disclosure, to assess “the effects COVID-19 has had on the company, what management expects its future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties.”
In light of the SEC’s guidance, the article’s authors suggest that companies take a number of steps, in conjunction with guidance from their outside legal counsel. First, the authors suggest that companies should “revisit risk factors and any forward-looking statements in light of the pandemic.” In order to be position to take advantage of the PSLRA’s Safe Harbor, material forward-looking statements should be accompanied by “disclosure of any specific risks faced by the company that could render any of its forward-looking statements untrue.” The authors also note that the SEC has specifically directed that forward-looking disclosures by companies include “as much information as practicable.”
These considerations take on increased significance as companies enter the recovery and re-opening phase. All companies face a great deal of uncertainty concerning the timing and impact of the recovery process. SEC officials have indicated in a number of pandemic-related releases that companies making good-faith efforts to appropriately frame forward-looking statements will not be second-guessed.
Nevertheless, the article’s authors state, companies should “ensure that they are both documenting the rationale for decisions related to accounting and disclosure judgments and continuing to provide robust internal control over financial reporting as possible given the current circumstances.” Companies that previously identified hypothetical risks associated with pandemic or public health crises should update their filings to reflect current events.
Finally, in light of the disclosure requirements of Item 303 of Regulation S-K, companies should adjust the management discussion of risk, trends, and uncertainties to reflect the business, operating, and financial circumstances that the company faces.
Additional commentary about appropriate disclosures in light of the pandemic appears in the next section, as well.
One of the most dangerous allegations securities class action plaintiffs can make is the occurrence of insider trading at suspicious times and in suspicious amounts. For that reason, one of the most important securities litigation loss prevention steps companies can take is to ensure that insider trading takes place at times less likely to raise suspicion, through the use of trading blackouts and trading windows.
The coronavirus outbreak raises a host of new issues when it comes to trading windows and trading blackouts. In their March 23, 2020 statement about market integrity, the SEC Enforcement Divisions co-directors specifically noted that insiders are likely to have material nonpublic information about the impact of the coronavirus on their business, and that trading while in possession of visibility into the impact of the coronavirus could be deemed insider trading. The co-directors specifically urged that company officials with access to this type of information should be vigilant about keeping the information confidential and complying with insider trading prohibitions.
As discussed in a May 14, 2020 Law360 article entitled “Insider Trading Windows Bring New Risks During Crisis” (here), the considerations that the Enforcement Division directors emphasized suggest that customary rules about the timing of trading windows may need to be revisited. Typically, companies will open trading windows to permit insiders to trade within a day or two of the companies’ quarterly earnings release. However, because the rapidly changing circumstances arising from the pandemic, companies “should delay permitting insiders to trade and not reopen the window at this time.”
The article’s authors note that company officials have access to daily information about “demand, the supply chain, pricing, employee health” and other business trend information, and therefore will be “better able to predict how well the company will be able to withstand and bounce back from the pandemic.” Although this type of daily information might not ordinarily be deemed material nonpublic information for insider trading purposes, “in the current uncertain environment and with the benefit of hindsight, the SEC could take a different position.”
Companies considering whether to re-open trading windows “should be sure that they have provided sufficient disclosure around the impact of the coronavirus on the business and management’s expectations of the impact going forward.” This disclosure should include “discussion of the company’s current and expected liquidity positions and expected financial needs, as well as mitigation efforts instituted by the company to protect workers and customers.” In addition, in light of the controversies surrounding the receipt of funds under the Paycheck Protection Program, companies should disclose “the nature, amount and effect of any federal or state aid.”
Consistent with the SEC’s disclosure guidance, companies are “strongly encouraged to avoid generic or boilerplate disclosures and to tail disclosures to their particular financial considerations and challenges.”
The article’s authors conclude by noting that “while there may be a path for some companies to follow” in order to open trading windows, many companies “may conclude that in this especially challenging and unpredictable time, trading by company insiders should just wait.”
Many companies are in financial distress as result of the economic disruption the pandemic has caused. In the weeks and months ahead some of these distressed companies will become insolvent and head into bankruptcy.
As discussed in a April 21, 2020 article from the Torys law firm entitled “COVID-19: Potential Liability of Directors and Officers of Insolvent Companies” (here), insolvency is of particular concern to directors and offices because there may be heightened risk of personal liability arising under additional duties and obligations that apply in the insolvency context. These concerns are exacerbated by the fact that customary protections, such as company indemnification, may be unavailable. Losses to creditors and shareholders “make it likely that the conduct and activities of directors and officers in the lead-up to and during insolvency will receive much greater scrutiny, often with the benefit of hindsight.”
The possibility of this later scrutiny is all the more excruciating given that company officials are “likely to face difficult decisions regarding the timely disclosure of material information in the context of a potential insolvency and the impact of the COVID-19 pandemic on the company.”
In light of these considerations, the law firm’s memo’s author suggest that directors of companies facing insolvency risks should take a number of specific steps, including: reviewing and enhancing corporate governance systems and protocols, and ensuring that minute books and corporate records are current and well-maintained; ensuring that financial reporting systems are operating appropriately and that directors are receiving reports on an accelerated basis; ensuring that management is properly positioned to address the circumstances, including accessing appropriate expertise; increasing the frequency of board meetings, with enhanced reporting, as the company considers restructuring or refinancing; ensuring that legally required segregated trust accounts (such as for tax) are in place, appropriate segregated, and functioning.
The author makes a number of other key suggestions in his long list of recommendations for directors of companies facing insolvency risks.
Taking appropriate steps to mitigate the risk of securities class action litigation is always well-advised. There is nothing about the pandemic that alters the truth of this observation. However, the circumstances surrounding the pandemic shed significant new light on the well-established securities litigation risk management measures.
There are a host of new disclosure considerations arising from the pandemic to be taken into account in light of the pandemic. The pandemic presents additional considerations when it comes to insider trading issues, particularly with respect to the timing of the opening of trading windows. And the financial disruption resulting from the pandemic, which may force some companies into insolvency present a host of considerations for companies and their executives to consider as they grapple with their companies’ financial challenges.
Directors and officers of companies concerned about the potential liability exposures arising from the pandemic will want to consult with their outside counsel with respect to the issues discussed above and with respect to other considerations that could help mitigate their securities litigation exposures.
The hope is that companies taking these kinds of steps will be less likely to be hit with securities class action litigation, or to be better able to defend themselves if they are sued. The flip side of these companies’ improved securities litigation profile is that, from the D&O insurance underwriting perspective, these companies should represent better insurance risks.
At the present moment, the D&O insurance marketplace is in substantial disarray. The pandemic has disrupted routine insurance placement processes, and insurers are responding with a variety of new underwriting and pricing approaches, and even in some cases seeking to introduce new terms and conditions and to reduce their exposed capacity. While the underwriters alarm in the midst of the current crisis is understandable, among the many problems with the current D&O insurance underwriting environment is that in some instances underwriters’ reactions are sweeping far too broadly, and in some instances insufficiently differentiating between and among different risks.
The optimistic premise of this blog post is that there are steps that well-advised companies can take in order to mitigation their securities litigation risk. In presenting this view, I have not simply expressed my own opinions, but rather taken care to quote leading legal experts, who have detailed the ways that companies can in fact improve their securities litigation exposure. If companies are able to improve their securities exposure profile by taking these steps, then companies taking these steps should be recognized as representing better securities litigation risks – among others, by D&O insurance underwriters.
Those who have known me for a long time know that I have long been an advocate of securities litigation loss prevention. One of the long-standing arguments I have made in support of securities litigation loss prevention is that companies adopting appropriate measures not only will be less likely to be hit with securities litigation, and should therefore enjoy preferred treatment from D&O insurance underwriters. The expectation behind the possibility of preferred treatment is that underwriters will actually differentiate among risks – as they should, even in the midst of a pandemic.