On September 28, 2020, Judge Dale A. Kimball of the United States District Court for the District of Utah granted a motion to dismiss a putative securities fraud class action asserting violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 against an online home goods retailer (the "Company") and certain of its current and former officers. Mangrove Partners Master Fund, Ltd. v. Overstock.com, No. 2:19-CV-709-DAK-DAO (D. Utah Sept. 28, 2020). Plaintiff, a short seller, alleged that the Company (i) manipulated the market by issuing a digital dividend through the Company's newly developed alternative trading platform and triggering a "short squeeze," and (ii) misrepresented the purpose of the digital dividend by not disclosing it would result in a short squeeze and the Company's financial condition by adjusting its earnings guidance upwards. The Court dismissed the claims because they were based on "speculation and fraud-by-hindsight."
The Company developed blockchain technology to create an alternative trading platform for investors to trade digital securities as part of its plans to transition from an online retailer to a blockchain technology business. In July 2019, the Company announced it would issue dividends for its common and preferred stock in digital tokens to promote its alternative trading platform. The Company also explained that the digital tokens would not be (and were not required to be) registered and that, under federal securities laws, they could not be traded for approximately six months after their issuance. During that same time period, the Company revised its earnings guidance upward based on increased customer retention for its retail business. Shortly after the digital dividends announcement, the Company's CEO resigned when his relationship with a Russian spy became public. Approximately one month later, the Company adjusted its earnings guidance downward and the former CEO sold over 4.7 million Company shares for $90 million.
Plaintiff, who as noted was a short seller, claimed that the Company misrepresented (i) its financial condition by revising its earnings guidance upward, and (ii) its purpose for issuing digital dividends as business driven when the real objective was to increase the stock price around the time of the CEO's anticipated departure. Plaintiff also claimed that the Company manipulated the market by causing an artificial short squeeze and an increase in share price through its digital dividends. Short sellers—who borrow stock from a brokerage—sell the borrowed stock at a time when they believe the market price for the stock is high and purchase them back when they believe the stock price is low, returning the newly purchased stock to the brokerage. If a dividend is issued on a stock that a short seller has borrowed, the short seller is obligated to pay the dividend to the lender. The digital dividend and the six-month lock-up period thus would force short sellers to cover their positions at an inflated price.
The Court rejected these claims. The Court first held that earnings guidance is "the quintessential example of a forward-looking statement protected by the PSLRA's safe harbor" and that plaintiff's reliance on the missed guidance was a "classic attempt to plead fraud by hindsight." The Court also held that the Company's downward revision of its earnings guidance after the CEO left the Company did not demonstrate that prior guidance was false but only that a different management team took a different approach. The Court also held that there was nothing misleading about the Company's statements on the digital dividend. The Company stated a legitimate business purpose—i.e., facilitating the Company's transition from an online retailer to a blockchain company—and plaintiff had failed to allege any facts for their contention that the purpose of the digital dividend was to target short sellers. Additionally, the nature and the terms of the digital dividend were clearly disclosed such that its impact was clearly understood, and "[t]here is no duty to disclose something so obvious that the entire market immediately understands it."
The Court next held that there was no market manipulation because defendants "could not 'manipulate' a market via truthful statements" regarding the nature of the digital dividends. The Court further held that plaintiff's claim that defendants knew that the dividend would cause an increase in share price was "speculation and fraud-by-hindsight." In so holding, the Court rejected plaintiff's argument that deception was not an element of a market manipulation case because Section 10(b) uses the disjunctive "or" and prohibits "any manipulative or deceptive device." Instead, the Court adhered to well-settled law that "conduct cannot run afoul of Section 10(b) unless it involves deception," and here, the Court held there was no deception. The Court also held that there was nothing improper about the dividend being "locked-up," which was a product of the Company's compliance with the SEC regulations. The Court explained that "a company cannot be penalized for taking measures to benefit shareholders who are hoping for the company to succeed," and short sellers who bet that a company will fail do so at their own risk and are "not entitled to special consideration."
The Court also dismissed allegations related to the CEO's departure and subsequent sale of Company stock, holding that plaintiff failed to allege any facts to support the contention that defendants were aware at the time they announced the digital dividend that the CEO would be leaving the Company and because, at the time the CEO sold his Company stock, he had left the Company and had the same information as everyone in the market.
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