The US Securities and Exchange Commission (SEC) and the US Department of Justice (DOJ) recently announced parallel actions against an activist short seller and his firm, charging them with multiple counts of securities fraud.1 The charges are the latest reminder of the prevalence of short sellers who seek to drive down the stock price of public companies by engaging in “short-and-distort” campaigns. In these campaigns, short sellers sell a public company’s stock short and then spread disparaging, false rumors about the company, attempting to profit from the stock price decrease caused by their misinformation.
Details of the Enforcement Actions
The DOJ indictment alleged that the activist short seller, Andrew Left, had engaged in a market manipulation scheme designed to impact the stock prices of companies that he targeted, and charged him with engaging in a securities fraud scheme.2 According to the DOJ, the short seller publicized sensationalized headlines encouraging readers to sell or buy the stock of a target company. The short seller then profited on the resulting stock price movement by reversing the trading positions of his firm, Citron Capital LLC. In effect, the short seller closed out positions at prices different from the target prices that he publicly recommended.
In a parallel civil action, the SEC also charged the short seller and his firm with engaging in a $20 million multi-year manipulation scheme to defraud investors.3 The alleged conduct, which mirrors that alleged in the DOJ indictment, includes publishing false and misleading statements regarding stock trading recommendations. The SEC claims that Left planned to trade in direct contradiction to public statements.
What the Enforcement Actions Mean for US Public Companies
The ongoing enforcement actions shine a light on short-and-distort campaigns and the challenges they pose to the US capital markets. These campaigns continue to be prevalent against US public companies, as short sellers may take advantage of market volatility. There are several considerations for US public companies when determining how to address, and whether and how to respond to, short-and-distort campaigns, which raise a variety of concerns for targeted companies.
A company’s response to a short seller should be multi-faceted and involve a cross-functional team bringing together input from executive management, legal, investor relations, and finance, with the board of directors remaining apprised as appropriate. How to manage a short attack most effectively is highly fact-specific, but may involve: taking the time to identify the source (who often has published its reports anonymously) and the misleading or inaccurate information; determining if there is any truth to the content and whether there is misrepresentation of the facts presented; deciding if a public response is merited; monitoring the impact on the company’s stock price;4 and, to the extent relevant, developing a public communications plan.
On an ongoing basis, companies should consider whether risk factor disclosure about the potential impact of short-and-distort campaigns is appropriate in periodic reports filed with the SEC. Depending on the nature, extent and consequences of the inaccurate information, press releases and/or a more coordinated investor relations response may be warranted. In extreme cases (including where repeated lower-profile responses have not succeeded), companies may consider pursuing private litigation5 against short sellers (bearing in mind that the anonymity of many short sellers adds increased complexity to this strategy6) or seeking to persuade the DOJ or SEC to investigate the attacks. In some cases, responding publicly—whether in investor communications or litigation—may serve only to amplify and extend the life of a report that may well be discounted by most investors. Lodging complaints about short selling campaigns can also lead to government scrutiny of the targeted company, with some companies that complained to the government about, or initiated private litigation against, potential short selling schemes themselves becoming the target of SEC investigations.7 Overall, multiple considerations must be taken into account, and companies targeted by short attacks should always take a step back to assess the damage and weigh their strategic options.
Recent Rulemaking
A new rule may help the SEC and issuers in identifying certain entities engaged in short and distort campaigns. The SEC recently passed Rule 13f-2, which requires that investment managers file a Form SHO within 14 calendar days after the end of each month, for each equity security over which the investment manager, or any person under that investment manager’s control, has investment discretion with respect to a gross short position meeting the rule’s applicable thresholds.8 The compliance date for Rule 13f-2 and Form SHO is January 2, 2025, with the SEC publishing aggregated short sale information beginning in April 2025.
1 See https://www.sec.gov/enforcement-litigation/litigation-releases/lr-26056; https://www.justice.gov/criminal/criminal-vns/case/united-states-v-andrew-left.
2 This offense carries a statutory maximum sentence of 25 years in federal prison in addition to 17 counts of securities fraud, each of which carries up to 20 years in federal prison.
3 The SEC is seeking civil monetary penalties, disgorgement, and prejudgment interest.
4 Short-and-distort campaigns, if accompanied by a significant decline in stock price, could increase the risk of shareholder litigation or government enforcement against targeted companies.
5 For instance, public companies may bring claims for defamation, tortious interference in business, violations of state anti-fraud statutes, and other tort-based claims, attempting to recover some of the damages sustained from short and distort campaigns.
6 Many popular financial websites allow short sellers to remain anonymous while promulgating damaging, defamatory reports. Often, such users will claim a First Amendment right to remain anonymous when public companies attempt to identify them.
7 Allied Capital Corporation (Allied) lobbied the SEC to investigate David Einhorn and his hedge fund, Greenlight Capital LLC (Greenlight), after Einhorn publicly explained Greenlight’s short position in Allied and alleged overvaluation of many of Allied’s investments. See https://www.sec.gov/files/oig-496redacted.pdf. Although its investigation of Einhorn and Greenlight was ultimately closed, the SEC followed by scrutinizing Allied, finding that Allied had violated the books and records and internal controls provisions of the US Securities Exchange Act of 1934 (Exchange Act) by failing to maintain accounts that accurately reflected the valuations it recorded of its securities. See https://www.sec.gov/litigation/admin/2007/34-55931.pdf. Additionally, Biovail Corporation (Biovail) brought suit against a number of hedge funds for a short and distort scheme in which Biovail alleged that conspirators spread false information regarding accounting practices and kickback allegations. The suit was ultimately resolved when a New Jersey state court dismissed Biovail’s complaint for failure to state a cause of action. See https://www.nytimes.com/2009/08/21/business/21sac.html. Two years after the original lawsuit was initiated, however, the SEC sued Biovail and a number of its senior executives for engaging in fraudulent accounting schemes. See https://www.sec.gov/enforcement-litigation/litigation-releases/lr-20506.
8 See Rider A.
Rider A
For equity securities of an issuer that are registered under Section 12 of the Exchange Act or for which the issuer is required to file reports pursuant to Section 15(d) of the Exchange Act, the applicable threshold is a monthly average gross short position in the equity security of (i) $10 million or more or (ii) a percentage of shares outstanding in the equity security of 2.5% or more, at the close of regular trading hours. For equity securities of non-reporting company issuers, the applicable threshold is a gross short position in the equity security of $500,000 or more at the close of regular trading hours on any settlement date during the calendar month.
