Earlier this month, the U.S. Center for Disease Control announced the end in the U.S. of the COVID-19-related public health emergency that began in March 2020. Yet even though the public health emergency has now officially ended, the pandemic’s effects still continue to affect company’s financial results, and still continue to result in COVID-19-related securities class action lawsuits. In the latest litigation example, late last week a plaintiff shareholder filed a securities class action lawsuit against The Walt Disney Company related to the fallout from the company’s early pandemic-related success with and commitment to its Disney+ streaming services, a bet that soured as the pandemic progressed. The new filing shows that though the public health emergency may have ended, the pandemic-related securities litigation risk continues.
Background
Disney launched its Disney+ streaming service in late 2019. In February 2020, Robert Chapek was named Disney’s CEO, a position in which he served until he was fired in November 2022. Just a month after Chapek assumed his new position, COVID-19 hit. The pandemic and related lockdowns negatively impacted many of Disney’s businesses. In November 2020, the company reported its first annual loss in more than 40 years. But while most of Disney’s businesses suffered, the company’s new Disney+ streaming service rapidly took off. The number of subscribers to the service far exceeded initial goals.
Because of the success of the Disney+ service, Chapek, according to the subsequently filed securities lawsuit complaint, decided to “go all in” on Disney’s direct-to-consumer streaming strategy, “essentially staking his legacy on the success or failure of Disney+.” In pursuit of this strategy, Chapek launched a major reorganization of the company, among other things creating a new reporting segment called the Disney Media and Entertainment Distribution (DMED) division.
The complaint alleges with respect to this distribution strategy, Disney “repeatedly mislead investors about the success of the Disney+ platform by concealing the true costs of the platform, concealing the expense and difficulty of maintaining robust Disney+ subscriber growth, and claiming that the platform was on track to achieve profitability and 230-260 paid global subscribers by the end of fiscal year 2024.”
Disney made these representations, the complaint alleges, even though the Disney+ subscriber numbers had been boosted by low level promotional pricing and by “a near-captive audience of consumers who were homebound due to COVID-19 restrictions.”
To conceal these “adverse facts,” the defendants, the complaint alleges, “engaged in a fraudulent scheme designed to hide the extend of Disney+ losses and to make the grow trajectory of Disney+ subscribers appear sustainable.” Among other things, the company shifted costs out of the new DMED division to make it appear the Disney+ platform was performing better financially than was the case. The defendants also, according to the complaint, repeatedly reiterated the fiscal year 2024 profitability and global subscriber estimates for Disney+.
However, on November 2, 2022, when Disney reported its financial results for its fiscal fourth quarter and full fiscal year, it missed analyst estimates and reported a $1.47 billion operating loss for its direct to consumer division, including a decline in average revenue per Disney+ subscriber. The complaint alleges that the company’s share price decline 13% on this news. The complaint also alleges that two weeks later, the company announced that its board of directors had terminated Chapek.
After Chapek’s firing, a Wall Street Journal article (here), reported on behind the scenes problems at the company, including internal concerns about cost-shifting that was used to hide expenses that should have been attributed to Disney+, in order to try to make the streaming service appear to be closer to profitability than it actually was.
The Lawsuit
On May 12, 2023, a plaintiff shareholder filed a securities class action lawsuit in the Central District of California against Disney, Chapek, and two other executives. A copy of the complaint can be found here. The complaint purports to be filed on behalf of a class of investors who purchased the company’s shares between December 10, 2020 (when the company’s new direct to consumer strategy was announced) and November 8, 2022 (when the company announced its disappointing financial results).
The complaint alleges that during the class period, the defendants failed to disclose: “(a) that Disney+ was suffering decelerating subscriber growth, losses, and cost overruns; (b) that the true costs incurred in connection with Disney+ had been concealed by Disney executives by debuting certain content intended for Disney+ initially on Disney’s legacy distribution channels and then making the shows available on Disney+ thereafter in order to improperly shift costs out of the Disney+ segment; (c) that DMED had made platform distribution decisions based not on consumer preference, consumer behavior, or the desire to maximize the size of the audience for the content as represented, but based on the desire to hide the full costs of building Disney+’s content library; (d) that the Company was not on track to achieve its 2024 Disney+ paid global subscriber and profitability targets, that such targets were not achievable, and that such estimates lacked a reasonable basis in fact; and (e) that, as a result of (a)-(d) above, defendants had materially misrepresented the actual performance of Disney+, the sustainability of Disney+’s historical growth trends, the profitability of Disney+, and the likelihood that Disney could achieve its Disney+ subscriber and profitability targets.”
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the plaintiff class.
Discussion
There are a lot of different ways that this new complaint might be considered; I have chosen to discuss it here as an example of the continuing phenomenon of COVID-19-related securities litigation. However, I acknowledge that reasonable minds may differ about whether this lawsuit in fact qualifies as COVID-related. There was obviously a lot going on at this company, not all of it pertaining to COVID.
However, there are at least a couple of interrelated reasons why I think this case should be counted as COVID-related. The first is that all of the decisions the company’s management made to go all in on the Disney+ streaming platform was because of the distorted impact that the COVID outbreak and related lockdowns had on the platform’s early subscriber numbers. At a time when the company’s other businesses were suffering, Disney+ soared, because of the pandemic. Going all in on the platform looked smart at the time. But then as pandemic evolved, and lockdowns eased, the platform’s subsequent performance disappointed. From my perspective, the story the plaintiff is trying to tell here depends on the dynamics caused by the pandemic.
The other reason why I think this case should be counted as COVID-related is that the sequence of events the complaint describes fits a factual pattern that has emerged as the pandemic has evolved, and that has given rise to cases involving companies whose prospects surged at the outset of the pandemic but whose fortunes subsequently lagged as the circumstances changed. Here, think, for example,of Peloton. The allegations in this new complaint fit this pattern; just as those other cases have been counted as COVID-related, I think this case, too, should count as COVID-related.
I will say that this case does show how, as time has gone by it has gotten harder and harder to say with certainty what it is that does or doesn’t make a new complaint COVID-related.
In any event, according to my tally (and assuming that this new case should indeed be counted as COVID-related), this case represents the 68th COVID-related securities suit to be filed since the initial COVID outbreak in the U.S. in March 2020, and the 6th COVID-related securities suit to be filed so far this year. COVID-related securities suits were among the important contributing factors contributing to the total number of securities suits filed over all during 2022. It appears that the COVID-related cases continues to be a factor in the number of securities suits filed this year as well.
