All too often, a short seller issues a public “report” claiming that a public company has engaged in some type of wrongdoing, with the deliberate purpose of causing the public company’s stock price to decline. The short seller issuing the report profits from the decline in the public company’s stock because it has taken a “short” position on the stock, and their so-called reports trade mostly in gossip and innuendo, rather than fact.
That said, these reports frequently have their intended effect, causing a public company’s stock price to decline. In turn, plaintiffs in securities class actions attempt to rely on stock drops after these short seller reports are issued as the basis for claims under the federal securities laws.
In recent years, federal courts have finally begun curtailing plaintiffs’ ability to rely on these short seller reports as “corrective disclosures” for pleading the loss causation element of a federal securities law claim. In particular, yesterday, the Fourth Circuit joined the Ninth Circuit in restricting this pleading tactic by securities class action plaintiffs.
In Defeo v. IonQ Inc.,1 the Fourth Circuit affirmed the district court’s decision granting the defendant’s motion to dismiss because the short seller report the plaintiffs relied on to plead their claim was not a “corrective disclosure” for purposes of loss causation. The short seller report in Defeo was issued by Scorpion Capital LLC. The report purported to rely on public information and interviews with unnamed former IonQ employees, customers, and quantum computing experts. Typical of the salacious headlines in short seller reports, Scorpion Capital claimed IonQ was “running a ‘quantum Ponzi scheme.’” Critically, however, the report also included “a long set of prefatory disclosures” that revealed: (1) Scorpion Capital “is short on IonQ stock” (i.e., it stood to profit if IonQ’s stock price declined in response to the report); (2) “the nonpublic information in the Report may be inaccurate”; (3) the report did not “reflect all information” Scorpion Capital learned from the alleged former employees and experts; and (4) Scorpion Capital may have excluded “certain positive comments and experiences with respect to IonQ.” Although IonQ’s stock was largely stable immediately after the report was issued, it declined by almost 50% within two weeks.
Shareholders then tried to rely on the short seller report as a “corrective disclosure” to plead the loss causation element of a federal securities law claim. The district court, however, rejected their theory and dismissed the case, and the Fourth Circuit has now affirmed the district court’s decision.
The Fourth Circuit had not previously “had occasion to consider whether a short-seller publication … can plausibly expose the truth of a company’s fraud as needed to plead loss causation.” The Fourth Circuit, however, noted that the Ninth Circuit has “considered this precise circumstance, and concluded that similar publications cannot meet the pleading standard,” citing the Ninth Circuit’s decisions in In re Nektar Therapeutics Securities Litigation, 34 F.4th 828, 839 (9th Cir. 2022) and In re BofI Holding Inc. Securities Litigation, 977 F.3d 781, 794 (9th Cir. 2020).2 The Fourth Circuit found “the Ninth Circuit’s jurisprudence” on this issue “persuasive.”
The Fourth Circuit explained, “[b]orrowing the Ninth Circuit’s language,” the plaintiffs “fail to clear the high bar of showing that the” Scorpion Capital “[r]eport revealed the truth of IonQ’s alleged fraud to the market.” The Fourth Circuit noted, in particular, that the Scorpion Capital report “relies on anonymous sources for its nonpublic information and disclaims its accuracy.” The Fourth Circuit also found it “particularly troubling” that Scorpion Capital “admits some quotations” in the report “may be paraphrased, truncated, and/or summarized solely at our discretion, and do not always represent a precise transcript of those conversations.” As the Fourth Circuit explained, this disclaimer “gives Scorpion Capital the kind of editorial license that could allow it to say just about anything and cloak it in the imprimatur of truth in order to make a buck.” In all, the Fourth Circuit held that these “disclosures lead to the conclusion that the character of the” Scorpion Capital report “rendered it inadequate to reveal any alleged truth to the market.”
Although the Fourth Circuit, like the Ninth Circuit, left open the possibility that “[i]n appropriate circumstances, a short-seller report’s financial motivation may not disqualify it from use in litigation as alleging that it exposed a company’s fraud to the market,” many – perhaps even most – reports by short sellers feature the disclaimers that disqualified the Scorpion Capital report from serving as a corrective disclosure in a securities class action.
The Fourth Circuit’s decision will, therefore, be a powerful and persuasive new precedent for defendants as courts hopefully continue curtailing securities class action plaintiffs’ use of short seller reports to plead federal securities law claims.
Footnotes
- No. 24-1709 (4th Cir. Apr. 8, 2025).
- The Fourth Circuit also could have looked to similarly persuasive precedent from the Eleventh Circuit, which the Ninth Circuit relied upon in reaching its conclusions. See Carpenters Pension Fund of Illinois v. MiMedx Group Inc., 73 F.4th 1220, 1246 (11th Cir. 2023); Meyer v. Greene, 710 F.3d 1189, 1198 (11th Cir. 2013).
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