This client alert was republished by the Harvard Law School Forum on Corporate Governance and Law360.
As noted in our earlier alert concerning securities fraud litigation under Section 10(b) of the Securities Exchange Act, the spread of COVID-19 and its effect on the global economy have caused extreme market volatility and, beginning in mid-February, the largest decline in stock prices since the 2008 financial crisis. Market volatility has historically precipitated increased securities litigation and might be expected to have an outsized impact on claims under the Securities Act, given rescissory damages and the absence of a requirement that plaintiffs plead and prove loss causation.1 Although it is still too early to tell whether issuers that went public just before and then amid the COVID-19 crisis will face Securities Act lawsuits in greater than average numbers, plaintiffs are poised to file suit against issuers of substantial offerings whose share prices have been impacted by the recent market decline. The following analysis of offerings during late 2019 and early 2020, immediately prior to and during the COVID-19-induced market volatility, and the Securities Act complaints filed against some of those issuers amid the market unrest provide preliminary insights into whether, when and on what basis recent issuers—and their underwriters and auditors—are facing Securities Act litigation.
I. The Issuers and the Offerings
Initial public offerings (IPOs) in the United States remained active in late 2019 and early 2020, even as global concerns about COVID-19 grew. IPOs also continued despite COVID-19’s outsized impact on market returns beginning in mid-February 2020. Between November 1, 2019, and April 24, 2020 (described here as the “Review Period”), 52 issuers conducted IPOs on United States–based exchanges.2
Issuers that went public spanned the globe. Just over 60 percent of those issuers had their primary place of business in the United States. Of the remaining non-US issuers, the majority are headquartered or primarily operate in China.
IPOs during the Review Period also focused heavily on the healthcare, technology and financial sectors—the same sectors that represented the majority of IPO activity during 2019 as a whole.3 Healthcare accounted for the greatest number of offerings—approximately 45 percent—during the Review Period. Those healthcare issuers are almost exclusively based in the United States. Technology accounted for the second-largest number of offerings, with approximately 15 percent. Only half of those issuers are based in the United States. And the financial sector made up the third-largest number of offerings, representing just over 10 percent. Like technology, only about half of the financial companies that went public are United States–based.
Healthcare issuers that went public during the Review Period mostly experienced positive stock price returns between the close of trading on the day after the offer date and April 24, 2020, generally consistent with the fact that healthcare securities have outperformed most other sectors since November 2019.4 Stock prices for technology companies have been harder hit; as of April 24, 2020, three-fourths of technology issuers that went public during the Review Period had negative returns between the close of trading on the day after the offer date and April 24, 2020. Technology securities as a whole, however, have performed only moderately worse than healthcare securities over the Review Period. Financial issuers have been particularly hard hit during the recent market decline, with approximately 85 percent of financial issuers that went public during the Review Period experiencing negative returns between the close of trading on the day after the offer date and April 24, 2020; the industry as a whole is down almost 24 percent over the Review Period.
Finally, IPOs during the Review Period ranged widely in size, from approximately $5.2 million to nearly $2 billion. The largest three offerings were conducted by Brazil-based financial company XP, Inc., for nearly $2 billion; North Carolina–based pharmaceutical company PPD, Inc., for over $1.6 billion; and Canada-based environmental company GFL Environmental Inc. for over $1.4 billion.
II. The Issuers That Have Faced Suits
To date, plaintiffs have filed complaints alleging violations of Sections 11, 12(a) and 15 of the Securities Act against three issuers that went public during the Review Period. Plaintiffs’ firms have announced investigations of purported securities law violations by at least one other issuer.
Canaan, Inc. On March 4, 2020, plaintiffs filed suit against Canaan, Inc., and its underwriters in the District of Oregon.5 Canaan, a China-based technology company, raised approximately $90 million during its initial public offering on November 21, 2019.
The complaint alleges that Canaan’s offering documents failed to fully disclose a related-party transaction with a China-based company; that Canaan’s “financial health was worse than what was actually reported”; that Canaan had “recently removed numerous distributors from its website just prior to the IPO, many of which were small or suspicious businesses”; and that, contrary to Canaan’s disclosures, several of the company’s largest clients were not likely to be repeat customers. Plaintiffs claim that the truth about Canaan’s alleged misstatements emerged on February 20, 2020, when a third party published a report “explaining Canaan’s numerous false and/or misleading statements” and detailing the supposed inaccuracy of the allegedly false portions of the company’s registration statement. That day, the price of Canaan’s American depositary shares (ADS) fell “over 6.8%,” from $5.71 to $5.32.
Since the close of trading on the first day after its IPO, Canaan’s ADS price has fallen 53 percent. By contrast, the technology sector had a positive return of 3 percent, suggesting Canaan has significantly underperformed its industry sector.
XP, Inc. On March 21, 2020, plaintiffs filed suit against XP, Inc., and its underwriters in the Eastern District of New York.6 XP, a financial services company based in Brazil, conducted a nearly $2 billion offering—the largest during the Review Period—on December 11, 2019.
Plaintiffs allege that XP failed to fully disclose related-party transactions with a Brazil-based bank, technological issues, and risks related to relying on Independent Financial Agents as part of the company’s business strategy, and that XP “had material weaknesses . . . [and] fired its previous accounting firm due [to] that firm finding and disclosing material weaknesses.” Plaintiffs state that on March 6, 2020, a third party published a report allegedly “detailing . . . how XP had misled investors and failed to disclose pertinent information generally and in its Registration Statement.” XP’s shares allegedly “plummeted . . . 25.5%” over the next two trading days.
Since the close of trading on the first day after its IPO, XP’s ADS price has fallen 34 percent. The financial sector has also dropped 29 percent over the same period, suggesting XP has underperformed its industry sector by 5 percent.
Phoenix Tree Holdings. On April 24, 2020, plaintiffs filed the first Securities Act suit directly related to the COVID-19 crisis against Phoenix Tree Holdings and its underwriters in the Southern District of New York. Phoenix, a China-based real estate company, raised approximately $130 million during its January 17, 2020, offering.
Plaintiffs allege that Phoenix failed to disclose the volume of complaints made by residents of its apartment buildings and did not warn of the potential impact of COVID-19 on its business. The complaint asserts that at the time Phoenix went public, COVID-19 “was already ravaging China—particularly Wuhan, which was widely regarded as the epicenter of the virus and a significant hub for Phoenix,” and that although the company warned that “business could . . . be adversely affected by the effects of Ebola virus, H1NI flu, H7N9 flu . . . or other epidemics,” Phoenix did not specifically identify risks related to COVID-19. The truth allegedly began to emerge “as Phoenix’s going-public transaction was publicized, and investors began to understand that the coronavirus was significantly and adversely impacting the Company’s business and operations,” and then finally spilled out on March 25, 2020, when Phoenix issued a press release “caution[ing] investors that it expected the coronavirus to adversely affect its financial performance for the first quarter of 2020.” Plaintiffs do not allege a specific stock drop.
Since the close of trading on the first day after its IPO, Phoenix’s ADS price has fallen 48 percent. The real estate sector fell 17 percent over the same period, suggesting Phoenix has underperformed its industry sector by roughly 31 percent.
Velocity Financial. While a complaint has yet to be filed, at least four plaintiffs’ firms are seeking potential clients in connection with the IPO of Velocity Financial, a California-based financial company that raised approximately $94 million during its January 17, 2020, IPO.
Since the close of trading on the first day after its IPO, Velocity’s share price has fallen 78 percent. That is roughly 49 percent worse than the financial sector’s performance.
III. Comparing Issuers That Have Faced Suit
There are a number of similarities among the three issuers against which Securities Act complaints have been filed.
Offering Size. Unsurprisingly, complaints have been filed against issuers that raised a substantial amount of capital during their IPOs. Canaan, XP and Phoenix each raised around $100 million or more—a threshold that is close to the median deal size of $110 million for issuers that listed on the NYSE or NASDAQ during 2019.7
Quarterly and Annual Disclosures. None of the issuers that have been sued had filed a quarterly or annual report at the time plaintiffs filed suit.
Location of Issuer. So far, United States–based issuers that went public during the Review Period have not been subject to Securities Act litigation. All three issuers against which Securities Act claims have been asserted are based outside of the United States; two of them are based and primarily operating in China.
Auditors and Underwriters. Canaan, XP and Phoenix all retain prominent Big Four auditing firms and had their IPOs underwritten by established banks.8 Although the underwriters of each IPO have been named as defendants in the Securities Act suits filed to date, no suits have named auditors as defendants.
Stock Performance Relative to Industry Benchmark. The securities for all four issuers that have been sued appear to have underperformed their industry sectors by more than 5 percent—three of the four (Canaan, Phoenix and Velocity) by substantially greater than 5 percent.
By contrast, several other recent issuers with significant security price declines that have outperformed their industry benchmarks have thus far avoided suit. For example, Fangdd Network Group Ltd., a China-based financial issuer whose share price has declined 25 percent since the close of trading on the day after its November 1, 2019, offering of approximately $78 million, has not been sued. The financial sector fell 26 percent over the same period, suggesting that Fangdd has outperformed its industry sector by 1 percent. And perhaps most notably, GFL Environmental Inc., a Canada-based industrial company whose share price has declined nearly 14 percent since the close of trading on the first day after its March 3, 2020, offering of over $1.4 billion, has also avoided suit. The industrial sector declined 19 percent over the same period, suggesting that GFL has outperformed its industry sector by 5 percent.
IV. Comparing the Securities Act Complaints
There are also some similarities among the Securities Act claims filed against Canaan, XP and Phoenix.
Plaintiff Firms. The Rosen Law Firm has filed complaints against Canaan and XP, two of the three issuers that have been sued to date. This is consistent with the Rosen Law Firm’s history of filing early complaints and for suing non-US issuers. In 2019, Rosen Law Firm was the most active firm in “first-in-court” filings in securities class actions against non-US issuers.9 Pomerantz LLP, which was the second-most active firm in 2019 in first-in-court securities class actions filings against non-US issuers, also has filed suit against Canaan and XP, and is actively seeking plaintiffs on whose behalf to file suit against Velocity Financial.10 Three other firms—Robins Geller Rudman & Dowd LLP; Bronstein Gewirtz & Grossman, LLC; and Bragar Eagel & Squire, P.C.—are also actively seeking plaintiffs in multiple cases; Robins Geller and Bronstein Gewirtz have filed suit against Phoenix and Canaan, respectively. Johnson Fistel, LLP, is seeking plaintiffs in one case; the firm has also filed a state court complaint against XP. Notably, some of the largest plaintiff firms active in Securities Act litigation, including Bernstein Litowitz Berger & Grossmann LLP, have not filed Securities Act complaints, and do not appear to be publicly seeking plaintiffs on whose behalf to file suit against any issuers that went public during the Review Period.
Date of Suit. Not surprisingly, each of the Securities Act cases was filed after the market decline that began in mid-February 2020, between three or four months after each IPO.
Claims Asserted. Like most Securities Act cases, the suits filed against Canaan, XP and Phoenix each allege claims under Sections 11, 12(a) and 15 of the Securities Act. Notably, none of the cases asserts claims under Section 10(b) of the Exchange Act, which would require that plaintiffs meet the higher burden of pleading and proving scienter and loss causation.
Substantive Allegations. Disclosure of related-party transactions has been a focus of the plaintiffs in two of the three complaints filed to date. This is consistent with a trend in 2019 toward plaintiffs filing numerous securities claims that alleged a failure to disclose significant related-party transactions with non-US parties.11 Only the complaint against Phoenix asserts misrepresentations concerning COVID-19.
V. Preliminary Observations
While the number of Securities Act suits against issuers that went public in late 2019 or early 2020 remains limited, the following observations can be made.
First, and not surprisingly, the issuers that have been sued conducted larger offerings and have experienced sizeable share price declines. Securities Act claims thus far have targeted offerings of around $100 million or more.
Second, issuers whose securities have underperformed the industry average since the close of trading on the day after their IPO have faced suit, while large issuers with sizeable share price declines that have outperformed their industry sectors have not. Thus, although market volatility may drive Securities Act claims, so far only IPOs that have underperformed their industry sectors have been the subject of Securities Act claims.
Third, amid the COVID-19-induced market volatility, issuers continue to be sued for alleged misstatements unrelated to the COVID-19 crisis. It is possible—perhaps even likely—that plaintiffs will file additional claims challenging COVID-19-related disclosures as IPOs nearer to the onset of the COVID-19-induced market volatility become the subject of Securities Act claims.
Finally, the sole subjects of Securities Act complaints to date have been issuers not based in the United States. Whether that trend persists remains to be seen.
While the ultimate trends in Securities Act litigation amid the COVID-19 crisis are not yet clear, WilmerHale is closely monitoring developments in this area. If you have any questions or require assistance with a securities litigation matter, please feel free to reach out to the authors of this alert or any of your contacts at WilmerHale.
