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(Article from Securities Law Alert, February 2021) 

For more information, please visit the Securities Law Alert Resource Center

On January 25, 2021, the Central District of California dismissed a putative class action lawsuit alleging that a real estate finance company, certain of its officers and directors, and its private equity sponsor made misrepresentations and/or omissions of material fact in the company’s offering documents. Berg v. Velocity Fin., 2021 WL 268250 (C.D. Cal. 2021) (Klausner, J.).[1] Notably, this is the first decision on a motion to dismiss in a securities class action involving allegations related to COVID-19, according to Stanford University’s Securities Class Action Clearinghouse.

No Plausible Inference That Defendants Anticipated the Growth of Nonperforming Loans

Plaintiff alleged that defendants “failed to disclose that at the time of the IPO the [c]ompany’s non-performing loans had dramatically increased in size from the figures provided in the [o]ffering [m]aterials, as measured by both the amount of unpaid principal balance and as a percentage of the [c]ompany’s overall loan portfolio.” The court held that “[t]aken together, there is no plausible inference that [d]efendants anticipated the rate of nonperforming loans to have increased to the extent that it did prior to the IPO.” The court concluded that “[i]nstead, the [investor call] transcript supports the inference while some growth of nonperforming loans was expected, there was also an unexpected increase due to the coronavirus pandemic.”  

Plaintiff further alleged that “[d]efendants failed to disclose the potential impact of a brewing pandemic on [the company’s] business and operations.” Specifically, the company stated in its offering materials that “[w]e believe that there is a substantial and durable market opportunity for investor real estate loans . . . .” The court held that the company’s “statement about the real estate market [is] no different from the nonactionable statements in Police Retirement System.”[2] The court explained that the company’s statement in this case “is like the company in Police Retirement System stating, ‘that there is potential growth in the dVP market.’” The court continued that “[i]n both cases, the companies propound the favorable state of their respective markets, and the companies’ ability to capitalize on them.” The court concluded that “these statements cannot form the basis of a Section 11 securities claim.”

Item 303 Disclosure Not Required if Plaintiff Failed to Allege That Defendants Would or Could Have Known the Pandemic’s Extent

Plaintiff alleged that defendants also violated Item 303 of Regulation S-K because the offering materials failed to disclose that “a brewing pandemic presented uncertainty that was likely to adversely affect the economy and real estate market.” The court explained that “Item 303 requires disclosure when there is knowledge of an adverse trend, material impact, and that the future material impacts are reasonably likely to occur from the present-day perspective.” With respect to these allegations, the court found that “[p]laintiff does not allege that [d]efendants would or could have known the extent of the coronavirus pandemic, or even the presence of the disease in America, at the time of the [January 2020] IPO.” The court then held that “[t]hus, there would have been no need for [d]efendants to include any disclosure about the pandemic in its offering materials.”

No Need for Specific Item 105 Disclosure if Plaintiff Failed to Adequately Allege How Defendants Would Have Known About Coronavirus Risks

Plaintiff alleged that defendants also violated Item 105 of Regulation S-K by failing to “adequately warn purchasers of common stock in connection with the IPO of the issues [the company] was then facing as a result of the coronavirus.” The court explained that “Item 105 requires a discussion of the material factors that makes an investment in the registrant or offering speculative or risky.” The court pointed out that “[a]t minimum, [d]efendants disclosed that its business may be affected by changes in national, regional or local economic conditions or specific industry segments, which may be caused by ‘acts of God.’” The court found that “[p]laintiff has not adequately alleged how [d]efendants would have known about the coronavirus risks at the time of the IPO to be able to include a more specific warning.” The court then concluded that “[d]efendants did not need to include more specific disclosures about the coronavirus pandemic.”