Disappointment, litigation follow top IPOs in 2019

Wall Street welcomed companies this year that had long postponed their entries into the public market in favor of growth. For most top offerings, only disappointment -- and litigation -- followed.

Investors poured heaps of money into the initial public offerings of technology unicorns Uber Technologies Inc. and Lyft Inc., prompting multibillion-dollar valuations.

Lyft raised $2.3 billion in its IPO to a $24.3 billion valuation in March. Two months later, Uber raised $8.1 billion in its IPO to an $82.4 billion valuation.

Both companies have since been hit with a flurry of lawsuits alleging they misled investors after massive losses.

Being a publicly-traded company means accountability to shareholders, and that's proven especially problematic for technology companies trying to toe the line between growth and profitability.

The number of IPO-related lawsuits have doubled since 2013, estimated litigation research firm ISS Securities, which noted they are mostly directed toward high-valuation technology companies.

Kevin LaCroix, an attorney and executive vice president at insurance brokerage firm RT ProExec, said, "They're at their highest level ever if you look at the ratio of lawsuits to public companies."

Cooley LLP partner Patrick Gibbs, who focuses largely on securities litigation, agreed, saying the area is extremely active. Compared to previous years, the "likelihood of companies getting sued post IPO has gone up," he said.

Legal and financial experts are forecasting the uptick in IPO litigation has forced some companies to entirely reconsider exposing themselves to shareholder liability, or at least to postpone it until there's less legal exposure.

Despite a record year for the U.S. stock market, only 111 companies offered IPOs this year compared to 134 last year, according to the University of Florida professor and IPO expert Jay Ritter.

"Companies that might've rushed to go public have put the brakes on," he said.

Companies that are going public now are especially vulnerable, according to LaCroix. He said unprofitability and "very optimistic valuations" make for compelling shareholder lawsuits.

"There's an unfortunate pattern," he said. "It didn't work out well in the dot com era and that's happening now."

In September, WeWork became the highest profile example to postpone its IPO, after revealing massive losses and a confusing corporate governance structure, forcing then-CEO Adam Neumann to resign. Just months later, minority shareholders filed a class action in San Francisco Superior Court alleging the board of directors breached its fiduciary duty.

A record-breaking 83% of IPOs in 2018 involved companies that lost money in the 12 months leading up to their debuts, according to data compiled by Ritter.

But just because there are more lawsuits doesn't mean there's more fraud, LaCroix continued, partially attributing the increase to changes in the law.

Last year's Supreme Court decision in Cyan v. Beaver County Employees Retirement Fund drastically changed the landscape of IPO-related lawsuits, agreed LaCroix, Gibbs and Nassiri & Jung LLP partner Kassra Nassiri, who specializes in shareholder lawsuit litigation. The ruling allowed shareholder lawsuits brought under the Securities Act of 1933 to be filed in more plaintiff-friendly state courts in addition to federal court.

"Cases that might not otherwise be filed are now filed in state court," Nassiri said.

In addition to high settlement rates, shareholder lawsuits also have high rates of being dismissed at the pleading stage before the merits of the claims are scrutinized at trial, according to data compiled by the Stanford Securities Litigation Analytics project. Of 652 securities class actions filed from 2006 to 2010, 280 cases were dismissed or voluntarily dropped and 257 settled.

Gibbs estimated fewer cases have been dismissed and more cases have settled since the Supreme Court decision last year.

The lawsuits in state court also have a much lower burden of proof than lawsuits in federal court, which are brought under the Securities Exchange Act of 1934, Gibbs added.

"There are procedural and tactical advantages," LaCroix confirmed.

Bolstered by changes in the law, the uptick in IPO securities ligation may additionally be a product of investor overoptimism, especially those investing in the technology unicorns, suggested the legal experts.

In a lawsuit he was trying to get dismissed, LaCroix recalled the judge telling him, "You'd have to be an idiot to invest in this," after he read the company's corporate disclosure.

Ritter described the subsequent stock drop after a reputable company makes its Wall Street debut to overly optimistic expectations as the market applying a "sanity check."

Uber warned it may never make a profit in an IPO disclosure in April. The filing underscored Uber's massive growth but laid out a worrisome path to profitability because of potential regulation, delays in autonomous vehicle innovation and increased competition.

The company cautioned it expected operating expenses to "increase significantly in the foreseeable future," and it "may not achieve profitability."

"The reality is that a lot of the times, the marketplace is tougher than executives had hoped it would be," Ritter said.

Uber has since been hit with at least two class actions alleging it misled investors. The Gibbs Law Group is similarly "investigating allegations that investors may have overpaid if they bought stock at Uber's IPO price," according to the firm's website.

Because shareholder lawsuits often settle quickly, Nassiri said "opportunistic" lawyers "throw a bunch of things at the wall and see what sticks."

"When you see a stock price fall after an IPO, you figure where there's smoke there's fire," he said.

Also troublesome is the incentive for company directors and officers planning IPOs to embellish the prospects of their business, agreed LaCroix. He called the problem "pervasive" and Ritter agreed.

"They're under no obligation to tell investors their expectations are too optimistic because the reality is that none of them know," Ritter said.