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In recent years, the Ninth Circuit has limited a plaintiff’s ability to rely on a short seller report as “corrective disclosure” for pleading loss causation in a federal securities law claim. As this Alston & Bird alert reports, the Fourth Circuit has recently chimed in and followed the Ninth Circuit’s lead.

In Defeo v. IonQ Inc., 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 Fourth Circuit explained . . . 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 determined that disclaimers in the report “rendered it inadequate to reveal any alleged truth to the market” — pointing to the fact that the Scorpion Capital report “relies on anonymous sources for its nonpublic information and disclaims its accuracy” and “admits some quotations may be paraphrased, truncated, and/or summarized,” which the Fourth Circuit says “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.”

While both the Fourth Circuit and the Ninth Circuit left open the possibility that a short seller report may be used in litigation in certain circumstances, the alert notes that many short seller reports include the same disclaimers that disqualified the Scorpion Capital report from qualifying as corrective disclosure. Accordingly, it says the decision will 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.”

A recent blog from Kevin LaCroix on The D&O Diary includes this additional observation:

It was particularly of interest to me that the court did not find that the short-seller’s report did not cause the company’s share price to decline; in fact, the appellate court expressly acknowledged that the company’s share price did decline after the report was published. The appellate court was careful to distinguish between the revelation of fraud (of the kind that could establish loss causation) and the allegation of fraud (which alone are insufficient to establish loss causation), a critical distinction in considering whether the plaintiffs had sufficiently alleged that “new information” had been disclosed to the marketplace for purposes of pleading loss causation.

I also think it is important to note that this case is a SPAC-related lawsuit, a fact that I noted and emphasized at the time this case was first filed. This aspect of the case is important to highlight because quite a number of the SPAC-related suits that have been filed over the last several years are, like this one, based on allegations that first surfaced in short-seller reports. The district and appellate courts’ consideration of the short-seller report allegations here could prove relevant in many of the other SPAC-related lawsuits that have been filed.

– Meredith Ervine