On October 15, 2024, a three-judge panel of the United States Court of Appeals for the Tenth Circuit affirmed a decision by the United States District Court for the District of Utah granting a motion to dismiss a putative securities class action against an online retailer (the "Company"), its former CEO, and other senior management at the Company. The Mangrove Partners Master Fund, Ltd. v. Overstock.com, Inc., et al., No. 21-4126 (10th Cir. Oct. 15, 2024). Plaintiff asserted claims under Sections 10(b), 20(a), and 20A of the Securities Exchange Act, and Rule 10b-5 thereunder.
According to the complaint, between May and September 2019, the Company and the individual defendants allegedly developed a scheme to manipulate the Company's stock price and force short sellers to close their positions by distributing dividends in the form of an unregistered blockchain-based digital security token. In May 2019, the Company allegedly announced improvements in its earnings and raised its projected earnings guidance. Two days after the announcement, the Company's CEO allegedly sold 15% of his stock in the Company for roughly $10 million. In July 2019, the Company allegedly raised its projected earnings guidance again. As alleged by plaintiff, the CEO then allegedly learned that his romance with a Russian spy was about to go public, which would force his resignation from the Company. So, according to plaintiff, the CEO and the Company announced the blockchain dividend which, as an unregistered security, would allegedly be untradeable during a six-month lock-up period, thereby preventing short sellers from fulfilling contractual obligations to transmit dividends to the lenders from whom they borrowed the shares. This allegedly forced short sellers to close their positions by buying the Company's stock and returning the shares to their lenders. As a result of the purported scheme, the Company's trading volume and stock price allegedly increased, and multiple market analysts allegedly published articles describing the dividend as an artificial short squeeze.
In August 2019, the Company allegedly reported its Q2 financial results and announced that its retail division was profitable for the first time in two years. Two weeks later, the Company's CEO allegedly announced his resignation and left the United States for Indonesia. The Company's share price hit a 52-week high on September 13, 2019, nearly double the price at which it was trading just ten days earlier. The now-former CEO then allegedly published a blog post in which he confirmed that he had designed the dividend with knowledge that "it put legitimate short sellers in a bind." Further, on September 18, 2019, the Company allegedly announced that it was postponing the dividend because the SEC objected to the plan to distribute unregistered blockchain security tokens. That same day, the price of the Company's stock fell to $14.97, but between September 16, 2019 and September 18, 2019, the former CEO allegedly sold an additional 4.7 million shares for roughly $90 million. From there, the Company's stock price allegedly continued to fall. And on September 23, 2019, after the Company allegedly announced that its earnings were lower than projected, the share price fell to $11.19. On September 24, 2019, the Company filed a registration statement for the dividend.
Plaintiff, an alleged short-seller hedge fund that covered its short position in response to the dividend plan, filed suit in the United States District Court for the District of Utah. Plaintiff alleged several Exchange Act violations, including (1) making false or misleading statements about the Company's financial performance in violation of Section 10(b); (2) manipulating the market through an artificial short squeeze in violation of 10(b); (3) control person liability under Section 20(a); and (4) illegal insider trading by the CEO in violation of Section 20A. After plaintiff filed an amended complaint, defendants moved to dismiss for failure to state a claim, and the district court granted that motion. Plaintiff then appealed.
On appeal, the three-judge panel of the 10th Circuit affirmed the dismissal.
First, the Court agreed that plaintiff failed to state a Section 10(b) claim based on allegedly false or misleading statements because the complaint did not adequately plead reliance. The Court found that plaintiff's fraud-on-the-market theory of reliance was not plausible because plaintiff alleged that it purchased the Company's stock because of the upcoming unregistered blockchain dividend, not because of any allegedly false or misleading statements about the Company's financial performance. The Court observed that "if Plaintiff bought its shares to avoid breaching its lending contracts, it cannot also have bought its shares because of Defendant's alleged misstatements."
Next, the Court held that plaintiff failed to allege any deceptive or manipulative act that would give rise to a manipulation claim under Section 10(b). The Court found that defendants' act of issuing an unregistered dividend, on its own, could not constitute a manipulative act. The Court analyzed the precedent of courts in the Second, Third, Fifth, and Eight Circuits and adopted the principle that "for market activity to 'artificially' affect the price of securities, the manipulative conduct must be 'aimed at deceiving investors as to how other market participants have valued a security.'" But defendants' disclosures provided market participants with "notice that short sellers might buy [the Company's] stock to cover their positions before the dividend's record date." The Court concluded that "[b]ecause buyers and sellers possessed sufficient information to form judgments about how [the Company]'s dividend would impact [the Company]'s share price, Plaintiff fails to allege that [the Company] 'deceived investors as to how other market participants have valued a security.'"
The Court also rejected plaintiff's argument that the dividend was manipulative because defendants possessed a manipulative intent. The Court distinguished cases finding that open-market conduct constituted manipulation when accompanied by manipulative intent, concluding that such cases lacked truthful disclosure. Because defendants fully disclosed the dividend plan, the Court found that their intent could not transform their conduct into a manipulative act.
And the Court further rejected plaintiff's argument that the dividend was manipulative because the Company omitted material information, including that it did not truly intend to issue an unregistered dividend, that the dividend was illegal, and that the true reason for the dividend was to create an artificial price for the CEO's benefit. Even though the Company ultimately registered the dividend, the Court found that plaintiff had not alleged facts to support a reasonable inference that the Company never intended to issue the dividend as an unregistered security. Instead, the Court credited the "obvious alternative explanation" that the SEC persuaded the Company to change course after the Company announced the dividend plan. Moreover, plaintiff failed to establish how the Company's dividend plan would have violated any law. And as for the true intent behind the dividend, the Court found that plaintiff's allegations of post-hoc statements by the CEO were insufficient to establish that the Company announced the dividend to benefit the CEO personally.
Because the Court held that the Company had not violated Section 10(b), it also held that plaintiffs failed to allege control person liability as to the individual defendants and affirmed the dismissal of the Section 20(a) claim.
Finally, the Court held that plaintiff failed to fully brief all grounds for which the district court had ruled on plaintiff's claim of insider trading, observing that "[w]hen an appellant does not challenge a district court's alternate ground for its ruling, we may affirm the ruling."
Accordingly, the Court affirmed the lower court's decision granting the motion to dismiss.
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