Publicly traded companies should take steps now to prepare for stock-drop litigation in the wake of COVID-19.

We saw plaintiffs attorneys file these lawsuits in the wake of the 2008 financial crisis and the outbreaks of Ebola and SARS. While the precipitating events may change, the resulting cases from the securities class action bar follow a predictable pattern.

First, a significant issue leads to a substantial drop in the stock price of a publicly traded company. Then plaintiffs attorneys file class action lawsuits alleging that certain representations or disclosures made by the company were materially misleading because they either mischaracterized or understated the potential risk from such events, or misstated the company's reaction to them. These statements are typically found in U.S. Securities and Exchange Commission filings, such as an 8-K or 10-Q, but other public statements, such as investor calls, press releases or media interviews, can provide fodder for such claims as well.

Based on these allegedly "misleading" statements, plaintiffs may bring claims for securities fraud under Section 10b-5 of the Securities Exchange Act of 1934, which requires proof of fraudulent intent. If the statements in question are included in a registration statement or prospectus, plaintiffs can allege an even more problematic violation of the Securities Act of 1933, which does not require proof of fraudulent intent as would be necessary for a successful 10b-5 claim. Additionally, at least in some judicial circuits, plaintiffs may pursue a private right of action asserting the company failed to disclose "any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations" in violation of SEC Regulation S-K.

These risks do not fall solely on the corporate entity. Under Section 20(a) of the Exchange Act, individual officers or directors of targeted companies can be included as individual defendants on the theory that they are "controlling persons" of the corporate defendant and therefore are individually liable for its alleged violations.

There is no question stock-drop litigation will occur in the wake of the COVID-19 pandemic. In fact, it is already happening. Norwegian Cruise Lines faces a lawsuit in a Florida federal court filed by investors who said they were defrauded and suffered a precipitous drop in the stock price after the company stated in its 8-K and 10-K that sales projections after the disclosure of the virus remained ahead of the prior year, but failed to disclose that those projections were allegedly based on inappropriate sales tactics and carried a high risk of cancellations. Another class action, filed against drug manufacturer Inovio Pharmaceuticals and its CEO in federal court in Pennsylvania, claims investors were misled when CEO exaggerated both the timing and effectiveness of a COVID-19 vaccine. After reports indicated Inovio was not, in fact, close to bringing such a vaccine to market, the company's stock price plummeted and litigation followed soon after.

While most litigation remains in a "holding pattern" as federal courts are operating on a significantly limited basis, we expect to see a spike in such cases when the courts return to something closer to business as usual.

During this current period of "calm before the storm," potentially affected companies would be well-advised to do what they can to best position themselves moving forward. At the outset, it is important to heed the advice of the SEC, which issued a release on March 4 reminding "all companies to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their businesses and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments."

A few weeks later, on March 25, the SEC again emphasized that "a number of existing rules or regulations require disclosure about the known or reasonably likely effects of, and the types of risks presented by, COVID-19." The SEC counseled firms to consider and report on a number of material issues, including how COVID-19 has impacted their financial condition and operations, expected impact on future operating results, liquidity or borrowing issues caused by the pandemic, the impact of operational changes (such as work-at-home directives or travel restrictions), and multiple other factors.

Companies should reflect on, and appropriately report, their assessment for the pandemic's impact on their business and plan for dealing with it. But they must be careful to avoid selectively disclosing such information in a way that could be perceived as giving some investors an unfair advantage over others. They must also be cautious about overstating the impact or the prospects for near-term recoveries in a way that potential plaintiffs could point to as "unfulfilled promises." At the same time, they must consider appropriate disclosures of known risks or liabilities or they risk claims based on material omission of facts that would have been material to investors.

It's critical to have counsel review public filings and significant public statements, particularly in light of the current environment. Any forward-looking statements must be carefully considered and discussed with legal counsel to ensure that, to the extent possible, they take advantage of all safe-harbor protections, contain meaningful cautionary language and do not provide fodder for the plaintiffs class action bar.

The question isn't whether stock-drop litigation claims are coming—they are. There is only one question at this point: What can companies do to prepare for this issue and address it head-on?

Brian Masternak is a partner and litigator at the law firm Warner Norcross + Judd. He can be reached at [email protected].