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| John Schreiber |
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| John Tschirgi |
Days later, however, as the gravity of the coronavirus outbreak began to come into focus, stock markets worldwide plummeted, marking the worst week for stocks since the 2008 financial crisis and ushering in a period of extreme and continuing volatility. By March 23, the Dow Jones Industrial Average had fallen to 18,591.93.
Not surprisingly, this swift market downturn led to a notable uptick in securities class action filings. According to Lex Machina, through April, there had been a 50% year-over-year increase in such complaints.
But in a significant and potentially dispositive development for recently filed stock-drop cases, the second quarter of 2020 ended with stocks having experienced their largest quarterly gain since 1998. In what The New York Times described as "an epic reversal of fortune in the second quarter," the S&P 500 nearly completely recovered from the first quarter plunge, in the most dramatic quarter-to-quarter swing since 1932. Indeed, by July 15, the Dow Jones Industrial Average had rebounded to 26,870.10.
Dow Jones – 2020 Year To Date
A rarely invoked — and, heretofore, rarely applicable — provision of the Private Securities Litigation Reform Act, or PSLRA, may play a crucial role in the spate of recently filed securities fraud lawsuits. The PSLRA's so-called bounce-back rule places a bright-line cap on plaintiffs' damages in such cases. It provides that:
[I]n any private action ... in which the plaintiff seeks to establish damages by reference to the market price of a security, the award of damages to the plaintiff shall not exceed the difference between the purchase or sale price paid ... by the plaintiff for the subject security and the mean trading price of that security during the 90-day period beginning on the date on which the information correcting the misstatement or omission that is the basis for the action is disseminated to the market.
The PSLRA goes on to clarify that the mean trading price is the "average of the daily trading price of that security, determined as of the close of the market each day during the 90-day period." For plaintiffs who sell their stock during the 90-day window, the mean trading price is calculated based on that shorter period between the corrective disclosure and the sale date.
Enacted in 1995, the PSLRA contained various provisions designed to curb frivolous securities litigation. With respect to the damages cap, the legislative history indicates that Congress sought to avoid "substantially overestimat[ing] plaintiff's actual damages" by calculating damages "based on the date corrective information is disclosed," and instead to limit damages "to those losses caused by the fraud and not by other market conditions."
Where a company's stock price recovers during the 90-day look-back period, the bounce-back provision's bright-line cap can sharply limit — and, in some cases, altogether eliminate — available damages.
As the U.S. Court of Appeals for the Ninth Circuit explained in In re: Mego Financial Corporation Securities Litigation, "if the mean trading price of a security during the 90-day period following the correction is greater than the price at which the plaintiff purchased his stock then that plaintiff would recover nothing under the PSLRA's limitation on damages."
Given how few securities class actions proceed to trial, the PSLRA's bounce-back provision has had only limited application since it was enacted. But the current COVID-19-churned markets may provide an opportunity for securities defendants to rely on the absolute damages cap reflected in the bounce-back provision to ward off class actions, potentially even as early as the motion to dismiss stage, when a court can take judicial notice of the movement of the defendant company's stock price.
This defense, which should be considered by all defendants caught in the crosshairs of a securities fraud complaint, will be particularly effective in cases in which it is evident from the company's post-corrective disclosure stock price movement that no putative class member could conceivably recover any damages.
A quick look at the post-corrective disclosure stock price performance of certain companies recently named as defendants in stock-drop cases is instructive in showing how the PSLRA's bounce-back provision could play a significant, and potentially dispositive, role.
In Re: Zoom Litigation
On April 7, a putative shareholder class action complaint was filed in the U.S. District Court for the Northern District of California against Zoom Video Communications Inc., alleging that it had significantly overstated its security infrastructure and capabilities, and that the discovery of these misstatements and subsequent corrective disclosures led to a drop in its stock price.
Zoom had gone public less than a year earlier, on April 18, 2019, at an initial public offering price of $36 per share, before closing on the first day of trading at $62 per share. On March 27, the date of the first alleged corrective disclosure, Zoom's stock was trading at $151.70 per share.
By April 7, 2020, the date the first securities complaint against Zoom was filed, the stock price had dropped to $113.75 per share. But it then immediately began to rise again. By June 24, which was 90 days after the first corrective disclosure, the stock had dramatically rebounded to $255.90 per share — its all-time high at the time.
Zoom's Historical Stock Prices
The Zoom plaintiffs allege a class period commencing as of the IPO on April 18, 2019, and running through April 6, 2020. The stock price remained in double digits until mid-February, and then slowly climbed, reaching its highest point during the class period on March 23 at $159.56 per share.
Assuming for illustrative purposes that the 90-day bounce-back period started to run after the first alleged corrective disclosure on March 27, the mean trading price during that 90-day period was $173.65 per share.
Because this bounce-back period mean trading price is greater than the purchase price — even for those plaintiffs who purchased the stock at its highest level of $159.56 per share during the class period — plaintiffs who held the stock through the 90 days "would recover nothing under the PSLRA's limitation on damages," as per In re: Mego.
To the extent the 90-day period is found to start running after one of the later alleged corrective disclosures, given the trajectory of Zoom's stock price, the average trading price would be even higher, making for a higher hurdle for the plaintiffs to have to clear.
As such, while plaintiffs who bought and sold their stock within a relatively narrow period may be entitled to some damages — assuming they could establish the other elements of their claims — the vast majority of plaintiffs who did not sell their stock in the immediate aftermath of the corrective disclosure likely will not, and Zoom should have a complete defense for any plaintiff who held the stock through the 90-day bounce-back period.
McDermid v. Inovio
In one of the first COVID-19-related stock drop cases that was filed, shareholder plaintiffs allege in the U.S. District Court for the Eastern District of Pennsylvania that during a class period of Feb. 14 through March 9, Inovio Pharmaceuticals Inc. "capitalized on widespread COVID-19 fears by falsely claiming that Inovio had developed a vaccine for COVID-19."
The plaintiffs allege that, in the wake of these repeated public claims, Inovio's stock price rose significantly, only to plummet after a research firm's March 9 report cast serious doubt on the vaccine claims, referring to them as "ludicrous and dangerous."
During the class period, Inovio's stock averaged $5.62 per share, with a high of $14.09 per share on the penultimate day. After the research firm report was publicized on March 9, the stock fell and stayed around $6-$8 per share until later in April when it returned to double digits, briefly surpassed $15 per share, and then hovered between $11-$14 per share toward the end of the 90-day bounce-back period.
The mean trading price during that period was $10.41 per share. As such, for plaintiffs who bought below that average price during the class period, there are no available damages.
And, even for those who bought at the high point during the class period of $14.09 per share, the PSLRA will serve to limit their damages to the difference between their purchase price and the $10.41 per share average trading price during the bounce-back period. This fact pattern should serve to reduce any realistic settlement demand and/or any ultimate judgment.
Wandel v. Gao
In the U.S. District Court for the Southern District of New York, shareholders alleged that, in pushing forward with its IPO earlier this year, China-based co-living platform Phoenix Tree Holdings Ltd. misled investors about the risks posed by the pandemic, specifically with respect to the rental market in China.
The proposed class in Wandel v. Gao includes those shareholders of Phoenix Tree who bought their shares in the Jan. 17 IPO at $13.50 per share. The only corrective disclosure the plaintiffs identify is Phoenix Tree's March 25 unaudited financial results in which "it told investors that it expected the coronavirus to adversely affect its financial performance for the nearly completed first quarter of 2020."
Over the subsequent 90 days, Phoenix Tree's stock price fluctuated between $5.85 to $10.25 per share, trading at an average of $7.80 per share during that time. As such, while the plaintiffs may still have recoverable damages, assuming they could establish the other elements of their claims, the PSLRA's bounce-back rule will serve to lessen them.
Conclusion
The PSLRA's bounce-back rule — which has had limited application in the 25 years since its enactment — is likely to become a key factor in recently filed securities litigation. For some defendants, it may serve to significantly limit available damages, thereby minimizing settlement amounts, while for others it may provide a complete defense. Plaintiffs and defendants alike should take heed.
John Schreiber is a partner and John Tschirgi is an associate at Winston & Strawn LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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