Recent trends in US securities and derivative litigation

June 2021  |  SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION

Financier Worldwide Magazine

June 2021 Issue

For the first time in several years, securities fraud cases declined in 2020, largely due to the coronavirus (COVID-19) pandemic. However, we do not expect this decrease to continue. Just three months into 2021, the following are a few of the issues trending in this practice area: (i) securities litigation against non-US-based issuers; (ii) securities and derivative litigation arising from special purpose acquisition companies (SPACs) and de-SPAC transactions; (iii) securities and derivative litigation arising from COVID-19; and (iv) derivative litigation raising issues relating to diversity.

Increase in securities fraud class actions against non-US issuers

As reported in our Annual Survey, securities class actions filed against non-US issuers actually increased in 2020 – going from 64 filed in 2019 to 88 filed in 2020, an increase of 37.5 percent, thus disrupting 2020’s general trend of a decrease in securities litigation. Non-US issuers based in China accounted for the largest percentage with 28 complaints, followed by those based in Canada, with 12.

Many non-US issuers mistakenly believe they are immune from securities fraud class actions filed in the US, so long as the company does not sponsor its American depository receipts (ADRs), but as Stoyas v. Toshiba Corporation, et al. has taught us, that is not necessarily the case. Although Toshiba’s common shares trade on the Tokyo Stock Exchange, and Toshiba’s unsponsored Level I ADRs that trade in the US were set up by a depositary bank without Toshiba’s involvement, on remand from the Ninth Circuit, the judge denied the defendants’ motion to dismiss, finding that the plaintiffs plausibly alleged that the parties incurred irrevocable liability within the US.

More recently, courts have sidestepped the question and dismissed the cases against non-US issuers on the basis of forum non-conveniens. However, given that these cases are based on courts’ discretionary rulings, non-US issuers should recognise the potential risk and prepare accordingly.

Securities litigation relating to SPACs

Undoubtedly, SPAC transactions have become a popular vehicle for transitioning a private company into a publicly traded one, and with the increase in these types of transactions, securities litigation relating to SPACs and de-SPAC transactions are on the rise. SPACs are newly formed corporations that raise capital through an initial public offering (IPO) and seek to use the proceeds to acquire an operating business within a specific time (usually 18 to 24 months). In 2020, 244 SPACs raised $78bn across the year. In the first quarter of 2021, SPAC IPOs surpassed the amount raised in 2020.

The Securities and Exchange Commission (SEC) has signalled an increased focus on SPACs which undoubtedly will lead to more securities and derivative litigation. On 8 April 2021, the acting director of the SEC’s division of corporate finance cautioned that statements made in a de-SPAC transaction are not subject to less risk of liability than those made in a traditional IPO, and questioned whether the Private Securities Litigation Reform Act’s (PSLRA’s) exclusion from its safe harbour of ‘initial public offerings’, may include de-SPAC transactions.

Allegedly unique risks inherent to these types of transactions, which give rise to securities litigation, should be considered. Plaintiffs may allege that a specific time period to identify a target places pressure on the SPAC board, which may result in a poor choice of target or inadequate disclosures about future financial prospects. As the SEC offers guidance, the pool of potential attractive targets begins to dry up or operating companies fail to meet expectations, we anticipate an increased risk of securities and derivative litigation.

Securities fraud cases arising from COVID-19

More than one year into the pandemic, securities fraud class actions arising from COVID-19 are still being filed – perhaps signalling that this wave of suits is far from over. Many litigators initially speculated that there would be a surge of securities cases arising from the pandemic, but during the first few months, most of the cases targeted the travel and healthcare industry.

The paucity of cases early on can be attributed to the stock market’s remarkable rebound, as well as the difficulty for plaintiffs’ firms to plead loss causation – a demonstration that the investors’ loss was actually caused by the alleged misrepresentations rather than general market conditions.

However, enterprising plaintiffs have begun to file claims arising out of disclosures made relating to operations, financial conditions and the impact of the pandemic, and we expect that trend to continue. Similarly, there has been a number of derivative cases filed alleging that directors breached their fiduciary duties during the pandemic, including, for example, Inovio Pharmaceuticals, SCWorx and Chembio Diagnostics, among others. As the first quarter of 2021 has demonstrated, COVID-19 related securities and derivative cases are far from over.

Derivative cases and issues of board diversity

As protests regarding racial injustice sweep the US and more companies are taking steps to increase diversity, equity and inclusion, plaintiffs’ firms have attempted to expand theories of liability in shareholder litigation by filing derivative actions challenging the lack of diversity on corporate boards.

Similar to when shareholder litigation arose in the wake of the #MeToo movement relating to sexual harassment policies and board-level oversight, multiple shareholder lawsuits have been filed in courts across the country alleging directors breached their fiduciary duties by falsely representing that a company is committed to racial diversity when, in fact, the company lacks Black directors. Claims have likewise targeted allegedly false statements in proxy statements or codes of conduct about a ‘commitment to diversity’ in violation of Section 14(a) of the Exchange Act.

Nonetheless, where defendants are subject to a shareholder derivative suit relating to these issues, they have a number of strong dismissal arguments at their disposal. Thus, it is unclear whether such suits will ultimately gain traction. While there is not a one-size-fits-all solution in preventing these shareholder lawsuits, companies and their boards should consider carefully examining the diversity of their directors and officers, as well as individuals in management positions overseeing diversity efforts.

 

Joni Jacobsen and Angela Liu are partners at Dechert LLP. Ms Jacobsen can be contacted on +1 (312) 646 5813 or by email: joni.jacobsen@dechert.com. Ms Liu can be contacted on +1 (312) 646 5816 or by email: angela.liu@dechert.com.

© Financier Worldwide

BY

Joni Jacobsen and Angela Liu

Dechert LLP

©2001-2024 Financier Worldwide Ltd. All rights reserved. Any statements expressed on this website are understood to be general opinions and should not be relied upon as legal, financial or any other form of professional advice. Opinions expressed do not necessarily represent the views of the authors’ current or previous employers, or clients. The publisher, authors and authors' firms are not responsible for any loss third parties may suffer in connection with information or materials presented on this website, or use of any such information or materials by any third parties.