Crises Are Becoming Fodder for Investor Lawsuits (Part One)
This is the first installation of a two-part series. Part Two will appear in a future post.
As if crisis communicators didn’t have enough to worry about, a new report highlights a trend that could keep a company’s misfortune in the public eye for years after the occurrence: so-called event-driven securities litigation.
The report, released Oct. 24 by the U.S. Chamber of Commerce’s Institute for Legal Reform, notes a growth in class actions in which investors contend companies knew or should have known about an adverse event, such as a data breach, regulatory probe, explosion, or mass-tort lawsuit. The company is accused of concealing the possibility of such an event or failing to warn about it. Obviously, after the crisis occurs, the stock price tanks.
This departs from the typical securities-fraud suit, which involves financial misrepresentations — cooking the books — requiring that the company to restate its earnings.
It’s not that event-driven cases were unheard of in the past, but that they are on the rise. According to the report, 88 event-driven suits were filed last year, a 225 percent increase over 2012. They are especially growing in the pharmaceutical, biotech, and medical areas. One reason for the even-driven rise is a lack of opportunity for financial-reporting cases because financial restatements have plummeted, according to the report.
(In 2017, securities-lawsuit filings overall hit a record for a second straight year — jumping more than 50 percent, from 271 to 412 — a trend that has continued in the first half of this year, according to Cornerstone Research.)
So, companies have to contend not only with consumer lawsuits that result from, say, a food-borne illness, but also with litigation brought by their shareholders, who argue the company knew or should have known about the threat. They may argue the company was obligated to disclose the risk or lied about it.
For example, after the BP Deepwater Horizon oil spill in 2010, there were criminal and civil cases including over Clean Water Act violations and a claims process for area residents. In addition, BP shareholders sued, leading to the biggest investor class-action settlement in 2017, at $175 million, according to Columbia University securities-law professor John C. Coffee, Jr.
U.S. securities regulation is a “disclosure” regime; investors suing over a company crisis have to point to a false statement or omission the company made about the potential for such a crisis — one that falsely buoyed the stock price, which returned to Earth once the crisis was revealed.
One example the report points to is that of New York-based Arconic (formerly part of Alcoa), which made the building material with which London’s Grenfell Tower was clad. Last year the residential building caught fire, killing 72 people. Shareholders argue Arconic “knew of the material’s flammability but failed to disclose that fact to investors,” according to the Chamber of Commerce.
Other litigation mentioned include the accusation that Johnson & Johnson knew its talcum powder causes cancer.
The U.S. Chamber of Commerce has long been a strong foe of securities-fraud litigation — the report is entitled “A Rising Threat: The New Class Action Racket That Harms Investors and the Economy” — and it argues that most of these event-driven lawsuits are without merit. For one thing, it says, the plaintiffs can’t sufficiently allege the negative event caused the stock drop. Another issue is the need to prove “scienter” — that the company acted intentionally or recklessly in making false statements or omissions.
Still, these cases will bring reputational challenges for companies. We will discuss that issue further in our next post.
Photo Credit: Shutterstock
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