As I have noted on this site as the cases have accumulated (most recently here), since March 2020 plaintiffs’ lawyers’ have filed over two dozen coronavirus-related securities class action lawsuits. But even as the plaintiffs’ lawyers appeared eager to pursue these types of claims, the question has remained about how these lawsuits will fare. Now, in first dismissal motion ruling in a coronavirus-related securities suit, the court has granted the defendants’ motion to dismiss, in the coronavirus-related securities suit filed last July against Velocity Financial. A copy of Central District of California Judge Gary Klausner’s January 25, 2021 order can be found here.
Velocity Financial is real estate finance company that originates and manages loans issued to borrowers to finance the purchase of residential rental and commercial real estate investment properties. The company completed an IPO in January 2020. The SEC declared the company’s Registration Statement effective on January 16, 2020 and the company’s shares began trading on the NYSE on January 17, 2020. Following the IPO, the company experienced setbacks, and after the company’s May 18, 2020 disclosure to investors of adverse developments, the company’s shares were trading more than 80% below the IPO offering price.
As discussed here, on July 20, 2020, a plaintiff shareholder filed a securities class action lawsuit against Velocity; its private equity sponsor; certain of its directors and officers; and its offering underwriters, alleging that there were material misrepresentations and omissions in the company’s offering documents. The complaint purported to be filed on behalf of all purchasers of the company’s common stock in connection with the company’s January 2020 IPO. The complaint alleged that the defendants had violated sections Sections 11 and 15 of the Securities Act of 1933.
The plaintiff’s amended complaint (here), alleged that the company’s offering documents had mischaracterized the risks of its loan underwriting practices; failed to inform investors about the company’s rising portfolio of nonperforming loans; and distorted the real estate market conditions and Velocity’s ability to capitalize on it. The plaintiff also alleged that the defendants had failed to disclose information required by Items 303 and 105 of Reg. S-K, specifically that there was uncertainty in the real estate market due to the coronavirus outbreak.
The Pandemic-Related Allegations
Although the focus on the amended complaint is largely on the company’s disclosures pertaining to its underwriting practices and the condition of its loan portfolio, the amended complaint does specifically allege that the defendants
failed to disclose the potential impact of a brewing pandemic on Velocity’s business and operations, despite the fact that the international spread of the novel coronavirus had already been confirmed at the time of the IPO. Instead, the Offering Materials contained generic warnings that market turmoil could eventually erupt and affect Velocity’s business and told investors that Velocity “operates in a large and fragmented market with substantial demand for financing and limited supply of institutional financing alternatives.”
The complaint further alleges that the
failure to disclose information concerning the onset of the coronavirus pandemic, or its actual and potential implications for the Company’s operational and financial conditions and prospects, rendered the Offering Material’s positive descriptions of the market, demand for investor loans for commercial real estate, and the Company’s business material incomplete and misleading. These developments, risks, and uncertainties, which existed at the time of the IPO but were not disclosed to investors in connection with the IPO, had a material adverse effect on Velocity’s business, operations, and financial results.
The defendants’ filed a motion to dismiss the plaintiff’s amended complaint.
The January 25, 2021 Order
In his January 25, 2021 Order, Judge Klausner granted the defendants’ motion to dismiss. In granting the motion, Judge Klausner held that the allegedly misleading statements with respect to Velocity’s underwriting practices were not actionable because there are mere “puffery.” Judge Klausner further held that the plaintiffs did not plausibly allege that the defendants hid expected increases in nonperforming loans. In that respect, Judge Klausner noted that while the materials presented showed that some growth in nonperforming loans was expected, “there was also an unexpected increase due to the coronavirus pandemic.”
With respect to the plaintiffs’ allegations that the defendants violated Section 303 by failing to report on uncertainties in the real estate market due to the coronavirus, Judge Klausner said that “Plaintiff does not allege that Defendants would or could have known the extent of the coronavirus pandemic, or even the presence of the disease in America, at the time of the IPO. Thus, there would have been no need for Defendants to include any disclosure about the pandemic in its offering materials.”
Finally, with respect to the plaintiff’s allegations that defendants’ failure to include risk factors relating to the coronavirus outbreak violated Item 105 of Reg. S-K, Judge Klausner said that the “Plaintiff has not adequately alleged how Defendants would have known about the coronavirus risk at the time of the IPO to include a more specific warning. Thus, Defendants did not need to include more specific disclosures about the coronavirus pandemic.”
While Judge Klausner’s order does represent the first occasion on which a court had ruled on a claimant’s coronavirus-related securities law claims, the reality is that the centerpiece of this lawsuit was the plaintiff’s allegations concerning Velocity’s underwriting practices and the condition of its loan portfolio, rather than the add-on coronavirus allegations. The coronavirus allegations seem to have been included because it really looks like the reason the company’s performance deteriorated after its IPO was the onset of the pandemic. As I noted at the time that the plaintiff first filed his complaint, the pandemic allegations are “thin.” Given that we all lived through these events and we all have a pretty good idea of what was known and what was not known in mid-January 2020, the amended complaint’s coronavirus-related allegations do not fare well under a simple straight face test.
Despite the difficulty of trying to project later knowledge about the coronavirus outbreak backwards to the January 2020 time frame, this lawsuit against Velocity is only one of several coronavirus-related securities suits involving companies that completed IPOs in January 2020 and that supposedly failed to alert investors about how the outbreak would affect the company’s future performance.
As discussed here, late last week, a plaintiff shareholder filed a coronavirus-related securities class action lawsuit against Chinese social media company Lezhi, which completed its U.S. IPO at almost the exact same time as Velocity.
By the same token, as noted here, in April 2020, a plaintiff shareholder filed a securities class action lawsuit against Chinese residential real estate company Phoenix Tree Holdings, which also completed a U.S. IPO at about the same time as Velocity and Lezhi.
While the coronavirus-related circumstances in China in January 2020 were different than in the U.S. at the same time, as I noted in my blog posts about the Lezhi and Phoenix Tree lawsuits, even with respect to China there are serious questions about what could have been known about the coronavirus outbreak in mid-January 2020. In all three of these cases, the plaintiffs’ coronavirus-related claims raise serious concerns that the allegations are based on fraud by hindsight.
In any event, Judge Klausner’s ruling in the Velocity Financial case does underscore the fact that while the plaintiffs’ lawyers have been willing to pile into coronavirus-related securities litigation, it remains to be seen how these various lawsuits will fare. At a minimum, Judge Klausner’s ruling shows that allegations tending toward a supposed failure to anticipate the outbreak or its consequences will face scrutiny.
Special thanks to a loyal reader for providing me with a copy of Judge Klausner’s order.