COVID-19 has had an unprecedented effect on the securities and derivatives markets. Public companies and market participants face significant operational challenges and unpredictability, including evolving and novel regulatory requirements. In this environment, it may be tempting to dismiss or defer concerns about securities and derivatives enforcement activities and investor litigation, but that would be a mistake. The Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and other market regulators continue to operate, though with new procedures. Private securities litigation filings remain high. And regulators have emphasized—and demonstrated—their commitment to protecting investors and maintaining confidence in the fairness and integrity of both the securities and derivatives markets in these unprecedented times. Public companies and market participants need to remain vigilant and ensure their own practices and procedures reflect this reality.
Securities and Derivatives Regulators Are Open for Business and Are Prioritizing COVID-19-Related Insider Trading and Other Anti-Fraud Concerns
The SEC and the CFTC have transitioned to telework (with limited exceptions) but have communicated unequivocally that they are open for business. The SEC Enforcement Division continues to conduct testimony—albeit telephonically—and to file lawsuits and institute administrative proceedings. A March 18, 2020 SEC order states that parties to administrative proceedings should continue making filings but do so electronically. The CFTC Enforcement Division likewise remains operational. To the extent enforcement proceedings have slowed, anecdotal evidence suggests a planned delay of weeks rather than months. And SEC staff are also signaling that investigations will keep moving forward through both the fact-gathering stage, relying on document and information requests, and resolution, relying on telephonic discussions and virtual meetings.
Meanwhile, the SEC Office of Compliance Inspections and Examinations (OCIE) remains operational, though it has moved to conducting examinations through correspondence unless a physical presence is necessary. OCIE has also encouraged registrants to utilize regulatory relief with assurances that doing so will not be a risk factor for an examination. CFTC and National Futures Association (NFA) examinations have likewise moved to correspondence, and on-site visits have been postponed, though NFA remains open, with staff working off-site.
Similarly, the Financial Industry Regulatory Authority (FINRA) remains fully operational with staff working remotely and some matters on hold. FINRA is temporarily limiting new routine requests for information, including in connection with cycle examinations. In addition, FINRA has postponed all in-person arbitration and mediation proceedings scheduled through May 31, 2020, and all Office of Hearing Officers hearings of disciplinary proceedings through April, except for pending expedited proceedings, as they are not conducted in person.
State securities regulators also continue to function, although many states have limited on-site staff, and many state regulators are providing temporary relief to registrants. For example, the staff members of the New York Investor Protection Bureau (IPB) are working remotely and the IPB has granted limited, temporary relief from certain filing requirements.
Meanwhile, regulatory priorities have shifted to meet the current environment. Evidence is mounting that the near-term focuses will include misuse of material nonpublic information and other violations of the anti-fraud provisions related to COVID-19. For instance:
- The SEC’s update regarding the agency’s COVID-19 response on its website indicates that “[t]he agency is actively monitoring our markets for frauds, illicit schemes and other misconduct affecting U.S. investors relating to COVID-19—and as circumstances warrant, will issue trading suspensions and use enforcement tools as appropriate.”
- On March 23, 2020, the Co-directors of the Division of Enforcement, Stephanie Avakian and Steven Peikin, issued a statement emphasizing the importance of protecting against the improper dissemination and use of material nonpublic information in these dynamic circumstances. They explained that, as a consequence of the unique circumstances presented by COVID-19, “corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances,” particularly if earnings reports or other filings are delayed due to the virus. And they noted that a greater number of people may have access to material nonpublic information than they do in other times. They urged individuals to be mindful of confidentiality obligations and to comply with prohibitions on insider trading, and also urged “public companies to be mindful of their established disclosure controls and procedures, insider trading prohibitions, codes of ethics, and Regulation FD and selective disclosure prohibitions.” Likewise, they reminded broker-dealers, investment advisers and other registrants to comply with policies and procedures that are designed to prevent the misuse of material nonpublic information.
- The SEC has already issued at least four trading suspensions relating to COVID-19. For instance, on March 25, 2020, the SEC announced a temporary trading suspension in Zoom Technologies, Inc., due to concerns about investor confusion between Zoom Technologies, Inc. (a Delaware corporation with principal offices in Beijing, China, that has not provided any public disclosures since 2015) and Zoom Video Communications (the videoconferencing company).
- The CFTC’s COVID-19 website indicates that the agency has pivoted its resources to respond to the changing environment, including increased monitoring of derivatives markets and their participants to detect and pursue potential misconduct.
- On March 18, 2020, the CFTC Director of Enforcement, James McDonald, stated that the CFTC “will aggressively pursue misconduct in our markets tied to the impact of the coronavirus pandemic.”
- The SEC’s Office of Investor Education and Advocacy recently published an Investor Alert warning investors to be wary of “pump-and-dump” schemes where promoters claim that the products or services of publicly traded companies can prevent, detect, or cure coronavirus.
- The CFTC published a Customer Advisory warning investors who look to alternative investments, such as precious metals or virtual currencies, for assurance in volatile markets that they are at heightened risk of being victimized. The alert notes that “[f]raudsters commonly use major news events, such as the spread of COVID-19, to add credibility to their cons or manipulate emotions.”
- Consistent with the priorities articulated by the SEC, FINRA has indicated that it will prioritize matters that present the most risk in the current environment, and will focus on monitoring for fraud, illicit schemes and other manipulative activities seeking to take advantage of the tumultuous conditions created by COVID-19 and ongoing market volatility. On March 27, Jessica Hopper, FINRA’s Executive Vice President of Enforcement, issued a statement that “[n]ow, more than ever, it is important that FINRA Enforcement act quickly and aggressively to stop those who would use these uncertain times to take advantage of vulnerable investors or to manipulate the markets.”
- Finally, the US Department of Justice (DOJ) has indicated a focus on combatting COVID-19-related fraud, including via a memorandum on March 16, 2020, from Attorney General William Barr.1
In short, regulatory inquiries and enforcement have continued unabated. While regulators have communicated a willingness to be flexible and provide prompt relief to issuers, exchanges, and other registrants with regard to transitioning to teleworking, filing deadlines, and the like, they have simultaneously communicated a strong message that they remain vigilant and have a strong appetite to combat fraud in the current environment. As a result, public companies and market participants may find themselves facing increasing questions about their responses to COVID-19. For example, regulators could apply increased scrutiny to the efforts taken by public companies and regulated entities to protect material nonpublic information and prevent improper trading on it. And regulated entities in “gatekeeper” roles are likely to come under regulatory scrutiny if they do not recognize and mitigate the novel and unexpected risks resulting from the pandemic.
Private Securities Litigation Is Not Slowing Down and May Increase
Although each day seems to bring news of yet another court curtailing operations and limiting new filings, the pace of new private securities lawsuits has not abated, and we anticipate that it is likely to increase. This is unsurprising, because such litigation thrives on market volatility and uncertainty. Stock price drops create aggrieved investors, and rapidly changing business conditions quickly render corporate disclosures obsolete. Securities class actions are already on file alleging failure to warn investors about risks posed by COVID-19. While the early targets have been obviously affected companies (such as cruise lines and pharmaceutical companies developing COVID-19-related products), it is predictable that an innovative private plaintiffs’ bar will soon widen the net. At the same time, boards of directors are and will continue to be in the crosshairs of shareholder derivative lawsuits challenging the efforts of corporate fiduciaries to guide public companies through unprecedented business and economic conditions.
This environment calls for increased vigilance in mitigating the risk of securities litigation. Companies should ensure that any disclosures they make going forward are accurate in light of the current environment.
Boards of directors also need to increase their vigilance. Even before the COVID-19 crisis, an opinion by the Delaware Court of Chancery arguably signaled increased scrutiny of board-level monitoring of companies’ enterprise risks. With that in mind, boards should consider whether COVID-19 now implicates an enterprise risk, requiring clear documentation of related governance procedures and active monitoring and oversight.
COVID-19 has upended everyday life and the securities and derivatives markets. In the face of investors’ significant worries about their health and financial well-being, regulators are on high alert for any misconduct even arguably attributable to improper efforts to take advantage of COVID-19 and its associated disruptions. In addition, daily market volatility and quickly changing conditions are likely to result in an increasing number of suits by private plaintiffs, and issuers must therefore consider the unprecedented impacts of COVID-19 on a daily basis. Although regulators, courts, and plaintiffs have been willing to show reasonable flexibility with immediate deadlines and logistical challenges, they are not slowing down—they are speeding up. They are active, vigilant and highly attuned to the unprecedented risks COVID-19 has created. Public companies and market participants that fail to anticipate and respond to these risks are likely to find themselves facing regulatory and litigation risk in the future.