Readers of this blog well know that in recent years there has been unprecedented levels of securities class action litigation activity, and that even in the midst of the current global health crisis plaintiffs’ lawyers have filed what one law firm has characterized as a “wave” of COVID-19-related securities litigation. The heightened pace of securities filings over the last several years has already triggered calls for another round of securities litigation reform. Now, organizations representing business interests have filed a petition with the SEC seeking to have the agency implement a number of reforms to protect businesses from “unjustified COVID-19 lawsuits.”
On October 30, 2020, the U.S. Chamber Institute for Legal Reform and the Chamber’s Center for Capital Markets Competitiveness filed a petition with the Securities Exchange Commission, pursuant to Rule 192(a) of the Commission’s Rules of Practice. (Rule 192(a), which can be found here, provides that “Any person desiring the issuance, amendment or repeal of a rule of general application may file a petition therefor with the Secretary” of the SEC.) The petition urges that the SEC should exercise the authority given to the agency in the PSLRA an “act without delay to place reasonable limits on securities litigation arising out of the COVID-19 pandemic.” A copy of the October 30 petition can be found here.
The petition opens by noting the significant growth in the number of securities class action lawsuit filings in recent years, observing further that one of the factors in this growth has been the rise of event-driven litigation. The petition notes that Congress enacted the PSLRA based on concerns that securities class action lawsuits were “plagued by abusive practices and were driven by lawyers rather than investors.” With the rise of event-driven litigation, the petition suggests, “the same problems have returned.” The event-driven suits represent a “new barrage of lawyer-driven lawsuits” that are “designed to force defendants into settlements regardless of the merits.”
The recent history of event-driven securities suit filings suggests that COVID-19, an event of global dimensions, will “continue to cause significant securities litigation activity, including frivolous claims.” The petition cites this blog and other sources to show that there have already been a significant number of COVID-19 related securities suits (my current tally is 22), and also quotes sources as saying that “we can expect to see more such cases in the future as plaintiffs lawyers seek to capitalize on a volatile stock market and unprecedented market changes.”
The petition cites the authority Congress gave the Commission the PSLRA’s safe harbor provisions (see subsection (g)) to enact rules and regulations that “provide exemptions from or under any provisions of this title, including with respect to liability that is based on a statement or that is based on projections or other forward-looking information, if and to the extent that any such exemption is consistent with the public interest and the protection of investors, as determined by the Commission.” The petition argues further that Congress intended the statutory safe harbor provisions to be a “starting point,” contending further that there are “a number of steps the Commission could take under the rulemaking authority … to curtail unjustified securities class action lawsuits arising out of the pandemic.”
The petition contends that there are at least three steps the Commission could take to “serve the public interest and protect investors by avoiding squandering company time resources on defense and settlement of illegitimate lawsuits – especially given the incredible burdens placed on company management and company resources by the pandemic.”
First, the petition suggests that the Commission’s rulemaking authority should be used to “bar liability for statements about a company’s plans or prospects for getting back to business, resuming sales or profitability, or other statements about the impacts of COVID-19, whether forward looking or not – as long as suitable warnings were attached. Provisions of this type, including the warnings will help to protect companies “already facing economic hardship and uncertainty from Monday-morning quarterbacking by plaintiffs’ lawyers seeking to bring securities class action lawsuits just because the company’s stock price dropped post-pandemic.”
Second, the petition urges, the Commission should “consider limiting liability” for all statements of the kind described in the preceding paragraph to “circumstances in which the plaintiff can prove that the speaker had actual (subjective) knowledge of its falsity.” In other words, the petition argues citing the U.S. Supreme Court’s Omnicare decision, “the Commission would be treating such statements as the equivalent of statements of opinion for purposes of securities fraud claims.” Requiring actual knowledge of falsity “will help ensure that the focus properly remains on the issuer’s knowledge at the time the statement is made, not how well the statement holds up after-the-fact.”
Third, the petition proposes some revisions to protect financial statements themselves, which do not receive any protection from the PSLRA’s statutory safe harbors. The petition proposes that the Commission should “require the inclusion in financial statements a statement reminding financial statement users that a number of elements of financial statements are determined on the basis of projections of future business or market conditions or by applying ‘mark to market’ standards” and that given pandemic-related uncertainties “there is a greater variation than in the past.” The Commission could then “bar liability for claims based on statements that satisfy these warnings, or alternatively, treat them as the equivalent of opinions that require proof of subjective knowledge of falsity in order to be actionable.”
Finally, the petition contends that “given the importance and time sensitivity of the issues raised in this petition, the Chamber requests that the Commission consider this issue expeditiously and initiate the rulemaking process as soon as possible.”
Discussion
The Chamber’s initiative in filing the petition is, at a minimum, a very interesting move, and it will be very interesting to see how the process unfolds.
I have no prior experience with how the Commission treats third-party petitions for rulemaking actions, so on that basis alone I must declare that I literally have no idea what the prospects for this type of petition might be. Even further clouding the picture for me is any the lack of any knowledge of how the Commission will consider a petition for rulemaking that would address not Commission enforcement activity but rather private securities litigation. I also can’t anticipate the extent to which the extraordinary circumstances of the pandemic might affect the Commission’s willingness to consider rulemaking initiatives of the type proposed.
I can at least imagine that one concern that might act as a constraint on the agency’s willingness to entertain the petition’s proposed rulemaking would be a prudential concern that the agency not take any action that might created a safe space within with potential fraudsters might operate, or, worse (from the Commission’s perspective) create the possibility that actors might deceive investors with impunity.
The one thing I do know is that even if the Commission were to start a rulemaking initiative based on the proposal, the proposed rules would be subject to a period for review and comment. We can all expect that if the Commission were to initiate a rulemaking proposal as the petition urges, naysayers and fault-finders would come out of the woodwork, criticizing the initiative on both procedural and substantive grounds (including the petition’s suggestion that Omnicare’s standards for statements of opinion should be applied to statements about, say, a company’s ability to resume business activities, or about matters in a company’s financial statements).
I can also anticipate that even if the Commission were to promulgate rules as the petition urges, any rules promulgated would be of limited duration (although perhaps subject to renewal in the event the Commission believes the continuation of the rules would serve the public interest).
One final thing about the rules proposed in the petition – that is, there is no reason why well-advised companies cannot on their own take the actions that the petition suggests should be required of companies. Thus, as the petition urges in the first of the three proposed actions, companies could (and arguably should now, without awaiting rulemaking) include with their statements about a company’s plans for getting back to business or otherwise about the pandemic’s impact on continuing and future business operations “suitable warnings” underscoring for investors about the uncertainty inherent in the ongoing pandemic. By the same token, companies could (and arguably should now, without awaiting rulemaking) include statements with respect to financial statements that items in the statements are “heavily reliant on current market conditions and projections, all of which are tremendously uncertain due to the pandemic and therefore are highly susceptible to second-guessing in litigation.”
All of that said, the petition represents an interesting initiative, especially given the explosion of securities litigation that has flooded into the courts in recent years. These recent trends undoubtedly suggest that we are likely to continue to see more COVID-19 related securities litigation. It is a legitimate question whether or not this type of litigation is appropriate given all the circumstances surrounding the current global health crisis, and so it will be interesting to see whether the Commission will entertain some type of time-limited pandemic-related relief.