Court Dismisses Securities Fraud Claims, Citing Unreliability of Short-Seller Report
In Ng v. Berkeley Lights, Inc., the district court for the Northern District of California addressed motions to dismiss filed by the defendant Berkeley Lights, Inc. (BLI), and related individuals and entities. 2024 WL 695699, at *1. (Note: The authors’ law firm represented BLI and certain individual defendants in this litigation.) The lawsuit alleged that the defendants made false and misleading statements and omissions regarding the functionality of the company’s flagship product, a laboratory instrument called the “Beacon.” The Beacon is a platform designed to analyze and process cell data for use in developing and commercializing biotherapeutics and other cell-based products. During the class period, BLI allegedly promoted the Beacon as faster and more precise than other instruments on the market.
Around a year after BLI went public, activist short-seller Scorpion Capital published a report in which it alleged failures of BLI’s business model and the Beacon. The allegations in the report were based on interviews with former employees, industry scientists, and several of BLI’s largest customers. The report concluded that only a few biotech companies could afford the BLI instruments and that customer complaints would limit the company’s potential to grow. After the release of the report, BLI’s stock price dropped substantially. The plaintiffs sued, in relevant part, under Section 10(b), and the defendants moved to dismiss the case.
The district court granted the motions to dismiss. In its analysis, the court twice discussed the short-seller report. First, the court held that the plaintiffs had not sufficiently alleged that the report supported their allegations of falsity. The court noted its “serious reservations as to the reliability of the Scorpion Report.” Id. at *9. The court explained that the Scorpion report was produced by a short seller, which had an obvious financial interest in BLI’s decline. The court explained further that the report was based on confidential sources that were unidentified and unspecified: “Though [the plaintiffs] need not necessarily name these confidential sources, they must describe them ‘with sufficient particularity to establish their reliability and personal knowledge.’” Id. The plaintiffs argued that the Scorpion report described interviews with 7 former BLI employees and 14 major BLI customers and that the information provided by these sources “shows that the interviewed employees held relevant roles at BLI through which they could observe details about the Beacon and BLI’s finances.” Id. But the court disagreed, noting that the complaint relied entirely on the self-interested short seller’s own assertions that the characterizations passed on by the witnesses were credible and that the allegations in the complaint (like those in the Scorpion report itself) contained “no particularized details about these former employees’ job titles or period of employment,” nor did the complaint “provide details establishing that any of the witnesses had routine interactions with the Beacon or firsthand knowledge of facts contradicting BLI’s executives’ public statements.” Id.
Second, the court held that the plaintiffs had not sufficiently pleaded loss causation because the short-seller report was not a corrective disclosure. The court found important that the report contained a number of disclaimers that disavowed its completeness and accuracy, and the court again noted that Scorpion Capital was an “admitted short-seller with an admitted financial incentive to convince others to sell.” Id. at *16–17. These facts would “invariably cause investors” to take the report’s contents “with a healthy grain of salt,” making it inadequate as a corrective disclosure. Id. at *17. The court held that this was true even if the report presented new information to the market by providing analysis that “pulled together disparate sources and connected data in ways that were not plainly obvious.” Id. The plaintiffs argued that the report was distinguishable from other short-seller reports because the report’s author, Scorpion Capital, was not anonymous but a well-known activist short-seller entity. The court did not find the distinction persuasive because the identity of the entity that sponsored the report (as opposed to the identity of the actual person who wrote the representations in it) did not change the character of the report. That is, the Scorpion report was still “anonymous” for purposes of the analysis. Accordingly, the court granted the defendants’ motions.
Court Rejects Short-Seller Report as Corrective Disclosure in Health Insurance Broker Securities Case
In another case coming out of the Northern District of California, the district court dismissed the claims against defendant eHealth and related individuals. In re eHealth, Inc. Sec. Litig., 2023 WL 6390593, at *1. eHealth is a health insurance broker that receives commissions from insurance companies for policies it sells on their behalf. The earnings that eHealth reported to investors were based on the commissions that the company anticipated it would receive for each policy. During the class period, eHealth allegedly overstated its earnings. In particular, the plaintiff alleged that eHealth’s officers made materially misleading statements regarding eHealth’s expected earnings by concealing information about associated costs. On April 8, 2020, research firm Muddy Waters Capital issued a report alleging that eHealth’s “highly aggressive accounting” masked a “significantly unprofitable business,” overstating revenue and operating profit while understating a significant operating loss. Id. at *2. The company’s stock price fell significantly. Then, on July 23, 2023, eHealth announced its earnings results for the most recent quarter, which “confirmed” various aspects of the Muddy Waters report. The company’s stock price fell further, and the plaintiff’s Section 10(b) lawsuit followed.
Although the court found that the plaintiff had adequately pleaded both falsity and scienter, the court dismissed the claims for failure to plead loss causation. Id. at *7 (citing the “high bar that plaintiffs must meet in relying on self-interested and anonymous short-sellers”). In relevant part, the court held that the Muddy Waters report could not constitute a corrective disclosure for substantially the same reasons as above: (1) “Muddy Waters is a short-seller with a financial incentive to convince others to sell”; (2) the short-seller report disclaimed any warranty and made no representations as to the accuracy, timeliness, or completeness of the information contained therein; and (3) the report had no identified author and appeared to contain only public information. Id. at *8. Finding that no other statement constituted a corrective disclosure, the district court dismissed the plaintiff’s claims.
Court Finds Short-Seller Report Can Support Loss Causation in Electric Vehicle Securities Case
In a third case, In re Mullen Automotive Inc. Securities Litigation, the district court for the Central District of California granted in part and denied in part the defendants’ motion to dismiss, allowing the Section 10(b) claim to go forward. There, the plaintiff brought a securities class action lawsuit against an electric vehicle start-up company, its founder, and its successor entity (Mullen Auto), after the company went public via a reverse merger. In re Mullen Automotive, 2023 WL 8125447, at *1 (C.D. Cal. Sept. 28, 2023). The complaint alleged that the defendants issued a number of misleading press releases leading up to and following the company’s reverse merger with Net Element, a publicly traded payment processing company. The alleged misstatements contained false information about electric vehicle orders, overstated battery testing results, touted manufacturing facilities that were not usable, presented unrealistic timelines, and promoted nonexistent commercial partnerships.
Five months after the reverse merger completed, Hindenburg Research released a 32-page report claiming to be an exposé of Mullen Auto’s purported corporate fraud. The company’s stock price fell by 2.6 percent and then by 10.2 percent over the next two days. Mullen Auto then issued a press release stating that it would manufacture its own batteries at its facility in Monrovia, California—abandoning, according to the plaintiff, its previous plans to start manufacturing electric sport-utility vehicles at that site. Mullen Auto’s share price dropped further the next two days, and the plaintiff brought suit. The lawsuit relied substantially on the allegations in the Hindenburg report, as well as alleged statements by confidential witnesses described in the complaint as former employees.
The court granted in part and denied in part the defendants’ motion to dismiss. On the issue of loss causation, the defendants argued that the Hindenburg report could not serve as a corrective disclosure because the report “revealed only publicly available information.” Id. at *11. The court disagreed. It observed that the report contained “more than readily available public information,” including information received by contacting another company’s chief executive officer, the Environmental Protection Agency’s press office, various former employees and executives, and others. Id. “The [complaint] adequately allege[d] that this information would not have been readily available to investors and was not already known by the market.” Id. The defendants argued in the alternative that the report was not prepared by a qualified author, citing Hunt v. Bloom Energy Corp., 2021 WL 4461171, at *19–20 (N.D. Cal. Sept. 29, 2021). But the court explained that in Hunt, the report at issue relied on public utility data that appeared to simply be repackaged and “failed to explain how the authors had the expertise to aggregate the data in such a manner as to add new information.” In re Mullen Automotive, 2023 WL 8125447, at *11. The court here did not have similar concerns.
Conclusion
On January 15, 2025, Hindenburg Research, a “repeat-player” short seller whose work spawned multiple securities cases, closed its doors. Ben Foldy, “Wall Street’s Pre-Eminent Short Seller Is Calling It Quits,” Wall St. J., Jan. 15, 2025. But, elsewhere, activist short sellers have shown no signs of slowing down. Indeed, the founder of Hindenburg Research has stated he plans to “open-source every aspect of our model and how we conduct our investigations” over the next six months so that others may “learn[] the craft.” Hindenburg Research, A Personal Note From Our Founder (Jan. 15, 2025).
In federal securities cases, courts in the Ninth Circuit are typically unwilling to accept allegations based on short-seller reports at face value and will closely scrutinize both the nature of the report and the underlying allegations at the pleadings stage. Inside and outside counsel advising a company targeted by a short-seller report should anticipate a securities class action lawsuit may follow and should be prepared to confront the short-seller report and its allegations on a motion to dismiss. It is important, as suggested by the decisions above, to distinguish a report allegedly “revealing” fraud from a report that merely offers a new investment thesis based on existing public information.
