As readers know, since the beginning the coronavirus outbreak in the U.S., I have been tracking the coronavirus-related D&O lawsuits as they are filed. As the lawsuits have started to accumulate, one challenge has been keeping a firm grasp on what it is that makes a lawsuit coronavirus-related. In the following post, I discuss two recently filed securities class action lawsuits that after some deliberation I have decided to include on the list of coronavirus-related securities suits. Though I have included them on the list, I will be the first to acknowledge that that the inclusion of these lawsuits, particularly the second of the two discussed below, is not beyond question. My hope is that by going through my logic for including the two lawsuits and my reasoning for including them on the list that readers will weigh in and share their thoughts about whether either or both of these lawsuits properly should be classified as coronavirus-related. I describe the two recently-filed lawsuits below, along with a description of my reasons for including them on the list.
The United States Oil Fund Securities Lawsuit
The first of the two lawsuits is a securities class action lawsuit filed on June 19, 2020 by a plaintiff shareholder in the Southern District of New York against United States Oil Fund LP (USO); a related entity; and two USO executives. The lawsuit purports to be filed on behalf of investors who purchased USO securities between March 19, 2020 and April 28, 2020. A copy of the complaint can be found here.
USO is an exchanged-traded fund (ETF) designed to track daily changes in the spot price of Western Texas Intermediate (WTI) crude oil delivered to Cushing, Oklahoma. USO aimed to achieve its investment objective by investing substantially all of its portfolio assets in near month WTI futures contracts.
Extraordinary market conditions in early 2020 made the Fund’s investment objective unfeasible. As recounted in the complaint, “oil demand fell precipitously as governments imposed lockdowns and businesses halted operations in response to the coronavirus pandemic.” An oil price war between Saudi Arabia and Russia exacerbated the situation, as oil production expanded while export prices fell. An excess oil supply caused the storage facilities in Cushing to approach capacity, causing a rare dynamic known as a “super contango” in which futures prices for oil substantially exceeded the spot price. Buyers trying to “buy on the dip” poured millions of dollars into USO Fund. These “converging factors,” according to the complaint, caused USO “to suffer exceptional losses and undermined the Fund’s ability to meet its investment objective.”
The complaint alleges that the defendants possessed insider knowledge about the consequences of these extraordinary events; however, rather than disclosing the known impacts and risks, the defendants, according to the complaint, “conducted a massive offering of USO shares,” ultimately selling billions of dollars of USO shares into the market. Though the offering increased the fees payable to defendants, “it exacerbated the undisclosed risks … by magnifying trading inefficiencies and causing USO to approach position and accountability limits.”
In the days that followed, “USO quickly deteriorated.” The ETF Fund suffered “billions of dollars of losses and was forced to abandon its investment strategy.” In response, USO quickly transformed from a passive ETF “to an almost unrecognizable actively managed fund struggling to avoid a total implosion.” In April and May, the defendants “belatedly acknowledged the extreme threat and adverse impacts the Fund had been experiencing at the time of the March offering.”
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The complaint alleges that as a result of the defendants’ misrepresentations and omissions, the class suffered billions of dollars and losses. The complaint seeks to recover damages on behalf of the plaintiff class.
Although the circumstances alleged in the complaint are unusual and complicated, the important allegations in the complaint involves the disruption in oil demand resulting from the government ordered COVID-19 shutdown. Of course, the facts alleged involve other circumstances and factors. But there is no doubt that one of the significant factors was the disruption in the global oil market caused by the pandemic. The complaint expressly references the shutdown and the disruption the pandemic caused. For that reason, I have put the lawsuit on my list of securities class action lawsuit filings related to the coronavirus outbreak. (I have further comments about this lawsuit in the Discussion section, below.)
The Colony Capital Complaint
An interesting contrast to the USO lawsuit is a separate securities class action lawsuit filed on May 26, 2020 against Colony Capital, a Real Estate Investment Trust (REIT), and certain of its directors and officers. The lawsuit was filed in the Central District of California behalf of a class of investors who purchased the company’s shares between August 9, 2019 and May 7, 2020. A copy of the Colony Capital complaint can be found here.
The Colony Capital lawsuit incorporates two basic sets of allegations. The first set has to do with the company’s sale of its industrial portfolio to Blackstone. The company’s plan to sell the industrial portfolio was first announced in August 2019. The complaint alleges that that the planned sale of the industrial portfolio and resulting bifurcation of its asset portfolio was “foreseeably likely to have a negative impact on Colony’s financial and operating results.”
The second set of allegations in the Colony complaint relates to the other half of Colony’s assets that were the result of the “bifurcation” – that is, the portfolio of hotels and health-care related properties that remained with the company. This remaining portfolio, according to the complaint, “carried unsustainable levels of debt” secured by the hotels and healthcare properties, and thus were susceptible to default.
During the class period, the company made a number of statements to the effect that it had addressed all of its near-term debt maturities. However, the complaint alleges, on May 8, the company announced that it had defaulted on $3.2 billion of debt secured by hotels and healthcare-related properties and that Colony had received a notice of acceleration covering $780 million of the defaulted debt.
The complaint itself says nothing about why the company defaulted on the $3.2 billion in debt. However, as a loyal reader pointed out to me in an exchange of emails about the Colony Capital lawsuit, in an earnings call the same day as it announced the default, the CEO said “As noted in our earnings release, the company is in default on a significant portion of the hotel portfolio investment level, nonrecourse debt as a result of the COVID-19 crisis and its impacts on the hotel industry at large. The company is in dialogue with all of its lending — with all of its lending counterparties and as well has begun discussions with advisers to evaluate strategic and financial alternatives to maximize the value of its hospitality assets.”
The transcript of Colony’s May 8, 2020 earning call, which can be found here, goes into significant detail about the extraordinary impact that the coronavirus outbreak and resulting government-ordered shutdowns had on the company’s business operations and revenues. For anyone interesting in thinking about the business impacts of the pandemic, the transcript actually makes for interesting (albeit sobering) reading.
Turning to the question of whether or not the Colony Capital lawsuit belongs on the list of coronavirus-related lawsuits, there is a definite on the one hand/on the other hand problem. On the one hand, the complaint itself doesn’t mention anything about the pandemic. The words COVID-19 and coronavirus do not appear in the complaint. On the other hand, the crux of the lawsuit is the company’s default disclosed in its May 8 earnings release; there can be no question whatsoever that the default that is the crux of the lawsuit occurred because of the business disruption arising from the coronavirus-outbreak.
This case poses a challenging question: Can a lawsuit be coronavirus-related if the complaint in the lawsuit doesn’t even mention COVID-19 or the pandemic? Ultimately, upon reading the transcript of the May 8 call, I concluded that it is impossible to say that this lawsuit is not coronavirus-related. However, I can see that some observers might say that the absence of any mention of the pandemic in the complaint ought to be dispositive. I have decided to include the Colony Capital lawsuit on the list, but I am very interested in readers’ views and I welcome comments either through the blog’s comment feature or by email (email@example.com ).
In any event, the addition of the United States Oil Fund case and the Colony Capital case to the list brings the total number of pandemic-related securities class action lawsuits filed so far to 15.
The Unites States Oil Fund case is not only the first ETF to be added to the list, but it is also the first company to be sued as a result of the massive disruption the oil and gas industry suffered earlier this year due to the coronavirus outbreak. The disruption in the oil and gas industry due to the pandemic and the Saudi/Russian feud was massive; obviously many other companies in the industry or, like the ETF, with ties to the industry, were also affected, and there could well be other companies who get hit with D&O claims as a result.
The oil and gas industry obviously is not the only industry that has been massively disrupted by the pandemic. Indeed, as the Colony Capital lawsuit illustrates, there has been massive disruption in the hotel industry. Other parts of the hospitality industry (including restaurants), as well as airlines, adult living facilities, movie theaters, cruise lines, casinos, have also been massively disrupted. Companies in these industries and other companies whose business strategies were disrupted, as USO’s business strategy was disrupted and as Colony Capital’s hotel operations were disrupted, may also find themselves hit with D&O claims. (I noted in that regards that there have already been two securities class action lawsuits filed against companies in the cruise ship industries.)
In prior posts about coronavirus-related securities suits, I have noted that all of these lawsuits represent examples of event-driven litigation. The COVID-19 pandemic clearly is a massive, global event. The circumstances involved in these two lawsuits underscore the magnitude of the event that the pandemic represents, and the extent of the disruption. Given the extraordinary circumstances in which every business is now operating, and the plaintiffs’ bar’s clear enthusiasm for filing event-driven lawsuits, it seems likely that we will see many more lawsuits like the two described above, particularly in the industries that have been hardest hit.
To reiterate a point I made at the outset, as the pandemic-related lawsuits have accumulated, it has become an increasing challenge to try to sort out whether or not a particular lawsuit is or is not coronavirus-related. This particular tracking problem seems likely to continue as well. My takeaway from trying to think about the two cases discussed above is that the question of whether or not a given lawsuit is or is not coronavirus-related can’t depend just on what the plaintiffs include in their complaint. The entire circumstances should be considered – a fact that could pose some significant tracking challenges.
I welcome readers’ views on all of the above.