In my recent year-end wrap up of directors’ and officers’ liability and insurance issues that arose during 2021, I conjectured that several current economic circumstances – including in particular supply chain disruptions – could lead to D&O claims in 2022. The way that D&O claims might arise out of these economic conditions is illustrated in a new securities class action lawsuit filed against the software company Cerence, which experienced a reduction in automobile industry demand for its products and services due to the global semiconductor shortage. A copy of the complaint filed against Cerence on February 25, 2022 can be found here.

 

Background

Cerence builds and licenses artificial intelligence-powered virtual assistants primarily for companies in the automotive industry, including automobile original equipment manufacturers (OEMs.) The company generates revenues from selling software licenses and cloud-connected services to its OEM and OEM supplier customers.

 

During the period relevant to the subsequently filed lawsuit, the automobile industry experienced what the complaint calls “headwinds” due to supply chain issues and semiconductor shortages. Despite these conditions, on February 8, 2021, the company raised its fiscal year 2021 revenue and profit metrics and provided revenue guidance through fiscal year 2024. The complaint alleges that throughout the class period, the company “repeatedly assured investors that the Company’s guidance ‘took into consideration the current risks and uncertainties of the semiconductor device shortages that are impacting auto production.’”

 

Nevertheless, on November 22, 2021, the company announced revenue guidance for the first quarter and full fiscal year 2022 that was, according to the complaint, “well below analysts’ expectations.” According to the complaint, the price of the company’s shares fell 20% on this news. Then in December 2021, the company announced the resignation of the company’s CEO, Sanjay Dhawan, and Dhawan’s replacement as CEO by Stefan Ortmanns. According to the complaint, the company’s share price fell a further 11% on this news.

 

The complaint alleges that “investors only learned the full extent of Defendants’ misrepresentation” on February 7, 2022, when the company made several additional disclosures. First, the company announced that its CFO, Mark Gallenberger, would be retiring effective March 11, 2022. Second, in a related conference call, the new CEO Ortmanns announced that he had reviewed the company’s plans and forecasts, as a result of which he had determined that the company’s “conversion from bookings to revenue will take longer than expected,” as a result of which the company even further lowered its 2022 guidance, and withdrew its guidance for 2024. The complaint alleges that the company’s share price fell a further 30% on this news.

 

The Lawsuit

On February 25, 2022, a plaintiff shareholder filed a securities class action lawsuit in the District of Massachusetts against Cerence, Dhawan (the former CEO), and Gallenberger (the CFO whose retirement was announced on February 7, 2022). The complaint purports to be filed on behalf of investors who purchased the company’s securities between February 8, 2021 (the date the company raised its fiscal year 2021 revenue and profit metrics) and February 4, 2022 (the latest trading day prior to the company’s February 7, 2022 announcements).

 

The complaint alleges that during the class period, the defendants failed to disclose: “(1) that the global semiconductor shortage had a materially negative impact on demand for Cerence’s software licenses; (2) that Defendants masked the impact of the semiconductor shortage on demand for the Company’s software licenses by pulling forward sales; and (3) that, as a result of the above, Defendants’ statements about Cerence’s business, operations, and prospects were false and misleading and/or lacked a reasonable basis.”

 

The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the plaintiff class.

 

Discussion

Anyone who reads the business pages knows that there currently are several economic challenges facing businesses, including economic inflation, labor shortages, and supply chain disruption. The recent Russian invasion of Ukraine could exacerbate at least some of these conditions. These factors could impact companies’ operations or financial results, which could in turn affect companies’ share prices. Whether or not these circumstances will lead to securities litigation or other D&O claims arguably depends not only on how the company deals with the adverse business conditions but, as this case shows, what the company says about how the adverse conditions are affecting the company and its business.

 

This lawsuit has only just been filed and it remains to be seen whether the plaintiff’s claims will prevail. The defendants undoubtedly will contest the plaintiff’s claims and deny the plaintiff’s allegations. But taking the plaintiff’s allegations on their face, the case, even though as yet unproven, does show how a company’s alleged willingness to try to soft-pedal or downplay the impact of the current adverse business circumstances can lead to D&O claims. To be sure, the company’s various statements about the impact of the semiconductor shortage on demand for its products and services may in fact have been accurate statements of the company’s beliefs at the time the statements were made, and it was only later changes that caused the company to revise its earlier views. But this case does show that efforts to downplay the impact of the current adverse circumstances could lead to D&O claims.

 

This case is not the first in which the impact of supply chain disruptions has led to D&O claims. As I noted in prior blog posts, supply chain disruption-related securities lawsuits previously were filed against Romeo Power (discussed here) and Sleep Number (discussed here). Romeo Power, a manufacturer of batteries for electric vehicles, had experienced disruption in the supply of component parts for its batteries. Sleep Number had experienced a disruption, caused by the Texas winter storms, of the foam used in manufacturing the company’s mattresses.

 

The disruptions to the global supply chain seem likely to continue, and, as I noted above, may even be exacerbated by the recent Russian invasion of Ukraine. (The Russian invasion could also exacerbate economic inflation, as well.) These circumstances present a host of challenges to businesses. This case highlights the fact that what companies say about the impact of the circumstances on their operations and finances could affect the companies’ litigation risk.

 

One final note. The complaint in this lawsuit doesn’t say anything about the COVID-19 pandemic. However, there is no doubt that the current global supply chain disruption is a second-level effect of the disruption caused by the coronavirus pandemic. The connection between this case and the pandemic is sufficiently attenuated that I would not be comfortable trying to classify this claim as pandemic-related. However, the case does show that in thinking about the scope of the litigation risk arising from the pandemic, consideration needs to be given not only the direct, first-level impacts of the pandemic, but also to the indirect, second-level impacts (such as inflation, labor supply shortages, and economic inflation) as well. Given the magnitude of the current economic challenges, it seems likely that the second-level impacts will continue for some time to come, and to create litigation risk as well.