The securities class action lawsuits filed last week against failing or troubled banks felt as if the plaintiffs’ attorneys filing the suits were typing their complaints directly from the text of the day’s newspapers. Another suit filed last week referred to a slightly earlier but even more dramatic news story, the tragic train derailment in East Palestine, Ohio, of a Norfolk Southern freight train. The events surrounding the train disaster undoubtedly will be the subject of personal and environmental lawsuits for years to come. Now, the high-profile event is also the subject of a securities class action lawsuit, in the most recent example of the ways that operational events, rather than financial disclosures, increasingly can lead to securities litigation. A copy of the March 16, 2023, complaint can be found here.
Norfolk Southern Corporation owns Norfolk Southern Railway Corporation. In 2018, Norfolk Southern adopted a strategy known as “Precision Scheduled Railroading” (PSR), an approach to railway operations designed to increase revenues and decrease costs. Among other things, the PSR strategy involved reduction of staff and the use of longer, heavier trains. The goal of the strategy is to reduce the railroad’s “operating ratio” (that is the operating expenses divided by operating revenues).
The company aimed to reduce its operating ratio to 60% by 2021 (the ratio was 65.4% at the time the PSR strategy was adopted), and, by extension to improve profitability. Bonus compensation for key executives at the company was tied to improvements in the PSR ratio and profitability. As the company executed the PSR strategy, its trains grew longer, and the company’s headcount shrank.
The complaint alleges that as the PSR strategy was implemented, the company’s accident rate increased. Nevertheless, the complaint alleges, the company deployed lobbyists in Washington and in state capitals to try to suppress legislation that would have required the adoption of various safety measures.
On February 3, 2023, a Norfolk Southern train derailed near East Palestine, Ohio, not far from the Ohio-Pennsylvania border. Several of the derailed train cars, many of which contained hazardous substances, caught fire. Because of concerns about a possible chemical explosion, the authorities executed a controlled burn of the contents of several cars. State authorities and politicians, as well of representatives of the Environmental Protection Agency and federal railroad supervisory agencies, investigated the derailment and its aftermath. In the days and weeks following the derailment, several governmental officials put the fault for the incident and its aftermath on Norfolk Southern.
On March 16, 2023, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of Ohio against Norfolk Southern; Alan Shaw, the company’s CEO; James Squires, a director and the company’s Chairman until May 2022; and Mark George, the company’s CFO. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between October 28, 2020, and March 3, 2023.
The complaint quotes extensively from various SEC filings and other public statements of the company during the class period to the effect that the company’s spending plans “have been designed to assure the ability to provide safe, efficient, and reliable rail transportation services” and that the company’s Board is “committed to safety as a core value of Norfolk Southern.” The complaint quotes various company statements that “we are dedicated to providing employees with a safe workplace and the knowledge and tools they need to work safely and return home safely every day.” The complaint also has a detailed description of the derailment, its aftermath, its investigation, and the results of the investigation.
The complaint alleges that the during the class period, the defendants failed to disclose the following adverse facts about the Company:
(a) that Norfolk Southern’s PSR, including its use of longer, heavier trains staffed by fewer personnel, had led to the Company suffering increased train derailments and a materially increased risk of future derailments;
(b) that Norfolk Southern’s PSR, including its use of longer, heavier trains staffed by fewer personnel, was part of a culture of increased risk-taking at the expense of reasonable safety precautions due to the Company’s near-term focus solely on profits;
(c) that Norfolk Southern’s PSR, including it use of longer, heavier trains staffed by fewer personnel, rendered the Company more vulnerable to train derailments and train derailments with potentially more severe human, financial, legal, and environmental consequences;
(d) that Norfolk Southern’s capital spending and replacement programs were designed to prioritize profits over the Company’s ability to provide safe, efficient, and reliable rail transportation services;
(e) that Norfolk Southern’s lobbying efforts had undermined the Company’s ability to provide safe, efficient, and reliable train transportation services;
(f) that Norfolk Southern’s commitment to reducing operating expenses as part of its PSR goals undermined worker safety and the Company’s purported “commitment to an injury-free workplace” because the Company’s PSR plan prioritized reducing expenses through fewer personnel, longer trains and less spending on safety, training, technology, and equipment such as hot bearing wayside detectors (a/k/a “hotboxes”) and acoustic sensors;
(g) that Norfolk Southern’s rail services were, as a result of its adoption of PSR principles, more susceptible to accidents that could cause serious economic and bodily harm to the Company, the Company’s workers, the Company’s customers, third parties, and the environment;
(h) that Norfolk Southern had failed to put in place responsive practices and procedures to minimize the threat to communities in the event that these communities suffered the derailment of a Norfolk Southern train carrying hazardous and toxic materials; and
(i) that as a result of (a)-(h) above, defendants’ Class Period statements detailed above regarding the safety of Norfolk Southern’s operations were materially false and/or misleading.
The complaint notes that at various intervals in the wake of the accident and its aftermath, and in the course of the investigation of the incident, the price of the company’s common stock decreased in a stairstep fashion. The complaint alleges that by March 15, 2023 (that is, several days after the end of the purported class period), the price of the company’s shares had declined 19% from its price just prior to the derailment, “as a result of the numerous disclosures and revelations regarding the East Palestine … derailment and other revelations regarding Norfolk Southern’s true operations, which stood in contrast to defendants’ Class Period representations.”
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 class.
The complaint’s description of the derailment, its aftermath, and its investigation makes for interesting reading. The complaint makes a very compelling accusatory case for corporate negligence. However, this is a securities class action complaint, not a corporate negligence complaint, and viewed in that light, the complaint may have some challenges.
There was a time when most securities litigation was about financial fraud. There are of course fewer restatements now than there used to be. As a result, securities suits these days increasingly are about operational mishaps – plane crashes, wildfires, building fires, and so on. Of course, there have always been these kinds of lawsuits; recall, for example, the securities litigation that arose in the wake of the BP Deepwater Horizon oil spill disaster. However, it increasingly seems that securities suits are more about the latest high-profile incident, giving the lawsuits a “ripped from the headlines” feel, as I noted at the top of this post.
This complaint has only just been filed, and it remains to be seen how it will fare. This could prove to be a very successful lawsuit. The underlying circumstances certainly are quite disturbing, which could count for a lot, in the end. However, the sufficiency of the complaint is going to depend on the court’s assessment of the alleged misrepresentations.
The alleged misrepresentations on which the complaint depends – statements that the company’s spending is designed to ensure safe and efficient services; that the company’s board is committed to safety as a core value; and that the company is committed to providing a safe workplace – are pretty generic. However, the plaintiff will argue that it is not the active misrepresentations that deceived investors, but rather it was the failure to disclose that the cost-cutting pressures of the PSR strategy put the company at increased risk of the very type of disaster that occurred.
I am always wary of securities suit allegations that depend on an alleged failure to tell investors in advance that the thing that has happened might happen. How much of what later happened was the company expected to foretell? Even if the company had declared in advance that its business strategy created in increased safety risk (a disclosure of a type that would be distinctive to say the least), would that have been sufficient to alert investors in advance of the actual disaster that occurred?
That said, the disturbing nature of the underlying allegations in this case will add a particular context to the court’s assessment of the plaintiff’s allegations. The court could well conclude that the alleged omissions are sufficient to state a claim for securities fraud.
Some readers may have noted that up to this point I have avoided using the phrase “event driven litigation.” I know that some securities litigation practitioners dislike the expression. I do think it is a useful phrase because it provides a characterization of the many and increasing number of lawsuits that do not involve allegations of financial fraud, but instead involve operational mishaps that investors allegedly had misleadingly been led not to expect would happen.
Given the scale and high-profile nature of the East Palestine derailment, it is hardly surprising that it has spawned litigation. Indeed, many lawsuits have already been filed on behalf of the nearby residents or in relation to the environmental and other damage the derailment caused. This lawsuit, filed in the federal judicial district where the derailment happened and where the damage and harm occurred, stands for the proposition that the incident’s victims include the company’s shareholders.
It may or may not be true, as Bloomberg journalist Matt Levine has written, that “everything everywhere is securities fraud.” And, to be sure, this lawsuit does not contend the train crash itself is securities fraud. However, it does depend on the argument that the train crash revealed securities fraud. Even if it might be argued that this case doesn’t support the theory that “everything is securities fraud,” it does start to seem like every high-profile development is a potential context for yet another “ripped from the headlines” securities lawsuit.