Key Takeaways
In this edition of Dechert's Securities & Derivative Litigation Quarterly Update, we:
- Review Fourth Circuit's High Bar for Short-Seller Reports: The Fourth Circuit joined the Ninth Circuit in holding that anonymous and self-interested short-seller reports are generally unreliable for establishing loss causation for securities fraud claims. Plaintiffs must demonstrate that such reports reveal new, credible truths to the market.
- Assess Disgorgement of Attorneys' Fees in Frivolous Claims: The Northern District of Illinois ordered disgorgement of attorneys' fees in Berg v. Akorn, Inc., following the Seventh Circuit's holding that lawsuits seeking proxy statement disclosures that were not "plainly material" under the PSLRA violated FRCP Rule 11(b)'s bar against filing frivolous lawsuits.
- Highlight Caution for Securities Fraud Litigants and Counsel: Both cases underscore Federal Courts' continued scrutiny of securities fraud lawsuits by ensuring that loss causation is adequately established and disclosures sought are "plainly material."
Fourth Circuit Joins Ninth Circuit in Dismissing Securities Fraud Claims Based on Unreliable Short-Seller Reports
On April 8, 2025, the Fourth Circuit issued a ruling in Defeo v. IonQ, Inc.1 addressing, for the first time, whether a short-seller report may be used to establish loss causation as required to bring securities fraud claims under Sections 10(b), 14(a), and 20(a)2 of the Securities Exchange Act of 1934. In Defeo, the Fourth Circuit analyzed a short-seller report issued by Scorpion Capital LLC (the "Scorpion Report" or "Report") on May 3, 2024, which highlighted four alleged misrepresentations regarding IonQ, Inc's ("IonQ") business. On May 4, 2024, IonQ issued a press release generally rebuking the accuracy of the Scorpion Report and highlighting the author's short position. Between May 2 and May 12, IonQ's stock value dropped from US$7.86 per share to US$4.34 per share.3
Following the drop in stock price, Plaintiff-Shareholders sued IonQ and individuals associated with it (collectively, "Defendants") for an alleged failure to disclose the four material facts regarding IonQ's business referenced in the Scorpion Report.4 Plaintiff-Shareholders also alleged that IonQ's May 4 press release qualified as a corrective disclosure sufficient to establish loss causation. The United States District Court for the District of Maryland dismissed Plaintiffs' claims and denied leave to amend on futility grounds. The Fourth Circuit affirmed the lower court's decision, holding that Plaintiff-Shareholders had (i) "fail[ed] to clear the high bar" of establishing that the short-seller report revealed any new "truth" to the market, thus, the Report could not be considered a corrective disclosure for purposes of establishing loss causation; and (ii) the press-release was not a corrective disclosure. Each finding is addressed in turn.
First, the court found that Plaintiffs failed to adequately allege that the Scorpion Report revealed any new truth of Defendants' alleged fraud to the market, as is required to establish loss causation. In particular, the court pointed to the Scorpion Report's reliance "on anonymous sources," its disclaimers regarding "the accuracy of [the sources'] opinions as well as that of the non-public source material from which [the Report] claims those opinions derive" and admissions of "tailoring" quotations in the Scorpion Report to "fit the publisher's narrative."5 In its decision, the Fourth Circuit referenced Ninth Circuit precedent in similar cases,6 adopting the rationale that "when authors of a report are 'anonymous and self-interested short-sellers who disavowed any accuracy,' their reports are 'rendered . . . inadequate' for purposes of pleading loss causation."7 However, the Fourth Circuit, like the Ninth Circuit, noted that its ruling "do[es] not impose a categorical ban on using short-seller reports to plead loss causation" because "in appropriate circumstances, a short-seller report's financial motivation may not disqualify it from use in litigation as alleging that it exposed a company's fraud to the market."8 Nonetheless, the court found that it was "implausible" for the Scorpion Report, published by an activist short seller, to "reveal some new truth to the market."9 The court also rejected the argument that news articles published after the draft Report contained "additional factual allegations [that] might turn the otherwise implausible claim that this sort of short-seller report exposed the truth to investors into a claim plausible enough to survive a motion to dismiss," finding that "the articles do not credit the Report's revelation of IonQ's fraud as contributing to the decline in share price so much as they credit the allegation of fraud as a contributing factor."10 Indeed, far from a "revelation" of IonQ's fraud, the court explained that the articles suggest no more than a possible correlation between the Report's publication and IonQ's stock price decline — in other words, "correlation does not equal causation."11
Second, the Fourth Circuit rejected the Plaintiff-Shareholders' argument that IonQ's press release qualified as a corrective disclosure because it "did not dispute — or even address — any of the claims in the Scorpion Report."12 Instead, the court found that the press release, when read in its totality, derided the Scorpion Report and "could not reasonably be read . . . to relate back to the Report's claims such as to 'reveal to the market in some sense the fraudulent nature of IonQ's business, as allegedly uncovered by the Report."13
The Fourth Circuit's ruling underscores the high bar plaintiffs must meet when relying on self-interested and anonymous short-seller reports to plead loss causation. While the court left the door open to the potential use of reliable short-seller reports, many short-seller reports include the same types of disclaimers the court found problematic here. This opinion adds to the growing line of precedent noting the inherent unreliability of using short-seller reports for purposes of establishing loss causation in a securities fraud class action.
Federal District Court Orders Disgorgement of Attorneys' Fees After Voluntary Dismissal of Securities Fraud Action Where Disclosures Sought Were Not "Plainly Material"
On March 10, 2025, the Northern District of Illinois issued a decision in Berg v. Akorn, Inc.,14 mandating the return of mootness fees paid to attorneys ("Plaintiffs' counsel") representing shareholders ("Plaintiff-Shareholders") of Akorn, Inc. ("Akorn") in six lawsuits alleging violations of Section 14(a) of the Securities Exchange Act of 1934. The Plaintiff-Shareholders initially alleged that the defendants failed to disclose material information in a proxy statement related to a proposed merger between Akorn and Fresenius Kabi AG.15 The lawsuits were voluntarily dismissed once Akorn amended its proxy statement to add disclosures and agreed to pay US$332,500 in attorneys' fees to Plaintiffs' counsel.16 The District Court's ruling comes after a decision by the Seventh Circuit Court of Appeals clarifying the District Court's right to enforce Rule 11(b)'s prohibition against frivolous lawsuits which, as the District Court found, encompasses lawsuits seeking the disclosure of information that is not "plainly material."
After the suits were voluntarily dismissed as moot, another Akorn shareholder (the "Intervenor") filed an intervention motion seeking to disgorge the attorneys' fees paid to Plaintiffs' counsel, arguing that the original claims were frivolous.17 The Intervenor also sought an order enjoining Plaintiffs' counsel from filing lawsuits in which the "only goal is to extract money for counsel."18 On September 25, 2018, the District Court denied the motion to intervene finding that the right to intervene originated from Plaintiffs' counsel's duty to him as a putative class member, and that this duty was limited to the duty not to prejudice the intervenor's interests in the class action litigation.19 The District Court reasoned that the payment of attorneys' fees was not harmful to the class claims, but rather to Akorn, thus the proper mechanism to demand recovery was through a derivative suit.20 The District Court added that the intervenor's allegation that the class claims were worthless meant that the value of the claims could not be prejudiced, thus no duty could be violated as to warrant intervention.21 In a separate opinion issued on June 24, 2019, the District Court recognized that the disclosures sought were not "plainly material" and "worthless to the shareholders" yet Plaintiffs' counsel enjoyed a windfall in the form of attorneys' fees for suggesting "immaterial changes to the proxy statement."22 As a result, the District Court relied on its "inherent authority to rectify the justice that occurred" and ordered disgorgement.23
On appeal, two Plaintiff-Shareholders argued that the District Court lacked jurisdiction to reopen the underlying cases to order disgorgement because the cases had been dismissed, and that the intervenor could not file a motion to reopen as a non-party. On April 15, 2024, the Seventh Circuit Court of Appeals issued a decision rejecting this argument, finding that the intervenor had standing and could seek to reopen the case because he has a "claim in common with the main action" and "class counsel and Akorn are looking out for their own interests rather than those of the class," making intervention "appropriate."24 In its ruling, the Seventh Circuit explained that the intervenor had standing because he "suffer[ed] some loss from the diversion of corporate money, which affects the value of his shares," despite how minimal the loss might be.25 The Seventh Circuit however dismissed the Plaintiff-Shareholders' appeals for lack of standing because the Plaintiff-Shareholders "w[ould] not recover a penny or obtain any other relief whether or not the attorneys collect fees."26
The Seventh Circuit also found that while the District Court had authority to order disgorgement, the District Court's reference to "inherent authority" should have been to Section 78u–4(c)(1) of the Private Securities Litigation Reform Act ("PSLRA") and Rule 11 instead.27 Section 78u–4(c)(1) mandates that in any private action arising under the Securities Exchange Act of 1934, "the court shall include in the record specific findings of compliance by each party and each attorney representing any party with each requirement of Rule 11(b) of the Federal Rules of Civil Procedure as to any complaint, responsive pleading, or dispositive motion."28 Rule 11(b) effectively prohibits the filing of pleadings used for an improper purpose, such as to "needlessly increase the cost of litigation" as well as arguments that are frivolous or unsupported by fact or law.29 Accordingly, the Seventh Circuit interpreted the District Court's ruling as a finding that the pursuit of "plainly immaterial" changes to the proxy statement violated Rule 11(b), noted that the District Court has "discretion over the choice of sanction," and remanded to the District Court for it to "select[] an appropriate remedy (if any)" after providing Plaintiffs' counsel with notice and an opportunity to be heard on the alleged Rule 11(b) violations.30
On March 10, 2025, the District Court issued a ruling on remand ordering the disgorgement of funds and rejecting Plaintiffs' counsel's argument that a voluntary dismissal is not a final adjudication for purposes of implicating the relevant section of the PSLRA.31 The court analyzed several newly presented disclosures, but maintained that none of the disclosures sought were "plainly material" and "[a]ccording to the Seventh Circuit, PSLRA claims for disclosure of information that are not plainly material are frivolous and violate Rule 11, and thus are sanctionable."32 The District Court acknowledged intervenor's request for additional sanctions that would (1) require all signing plaintiffs' counsel and their firms to disclose and cite the District Court's finding, along with a related opinion in future lawsuits and demand letters concerning corporate merger transactions, including tender offers; (2) require counsel to disclose retention agreements with the plaintiffs; (3) require counsel to disclose all purported mootness fees extracted in similar suits and demand letters; and (4) impose monetary penalties.33 The court indicated that it was inclined to order all of the requested sanctions except for monetary penalties but requested additional briefing on the issue before deciding.34
On April 7, 2025, three motions for reconsideration of the District Court's March 10 Order were filed by attorneys and law firms potentially subject to sanctions, asserting a variety of arguments.35 The District Court stayed briefing on the propriety of additional sanctions pending resolution of the pending motions for reconsideration. A law firm party nonetheless filed a memorandum of law propounding several arguments opposing the imposition of additional sanctions.36 Briefing on the motions for reconsideration is complete and the District Court has not yet issued a ruling or scheduled a hearing.
The District Court and Seventh Circuit's decisions to date serve as a reminder to litigants and counsel in securities fraud cases to exercise caution when alleging inadequate disclosures under Section 14(a) of the Securities Exchange Act by reinforcing the relevance and import of the requirement that the disclosures sought are "plainly material."
Footnotes
1. Defeo v. lonQ, Inc., 134 F.4th 153 (4th Cir. 2025).
2. Loss causation is a necessary element of Section 10(b) and 14(a) claims, and "because § 20(a) liability is derivative, a complaint predicating such a claim on a § 10(b) or § 14(a) violation also depends on loss causation." Id. at 161.
3. Id. at 159.
4. Plaintiff-Shareholders alleged that lonQ "did not have a 32-qubit computer, that its existing systems were nowhere near miniaturization, that [it] had misled investors about its system's error rates and error correction, and [it] had misrepresented the source of its purported contract bookings increase." Id. at 162.
5. Id. at 164.
6. In re Nektar Therapeutics Sec. Litig., 34 F.4th 828, 839 (9th Cir. 2022); In re Bofl Holding, Inc. Sec. Litig., 977 F.3d 781, 794-95 (9th Cir. 2020).
7. Defeo v. lonQ, Inc., 134 F.4th at 163 (citing In re Nektar Therapeutics Sec. Litig., 34 F.4th at 840).
8. Id. at 164.
9. Id.
10. Id. at 164 (cleaned up) (emphasis in original).
11. Id.
12. Id. at 165.
13. Id. (citation and quotations omitted).
14. Berg v. Akorn, Inc., No. 1:17-cv-05016, 2025 WL 755704 (N.D. III. Mar. 10, 2025).
15. Id. at *1.
16. Id.
17. See Alcarez v. Akorn, Inc., 99 F.4th 368 (7th Cir. 2024).
18. See id. at 372.
19. House v. Akorn, Inc., No. 1:17-cv-05018, 2018 WL 4579781, at *2-3 (N.D. III. Sept. 25, 2018). 20. Id.
20. Id.
21. Id.
22. House v. Akorn, Inc., 385 F. Supp. 3d 616, 623 (N.D. III. 2019).
23. Id. at 622-23.
24. Alcarez v. Akorn, Inc., 99 F.4th 368, 375 (7th Cir. 2024).
25. Id.
26. Id. at 374.
27. Id. at 377.
28. Id. at 376 (citing 15 U.S.C. § 78u-4(c)(1)).
29. Id. (citing FRCP Rule 11(b)).
30. Id.
31. Berg v. Akorn, Inc., 2025 WL 755704, at *2, 5.
32. Id. at *4.
33. Id.
34. Id.
35. Mot. Recons. 1, Dkt. No. 145, Berg v. Akorn, Inc., No. 1:17-cv-05016 (Apr. 7, 2025); Mot. Interv. & Recons. 1-2, Dkt. No. 149, Berg v. Akorn, Inc., No. 1:17-cv-05016 (Apr. 7, 2025); Mot. Interv. 3, Dkt. No. 152, Berg v. Akorn, Inc., No. 1:17-cv-05016 (Apr. 7, 2025).
36. Monteverde & Assocs. Brief Opp. Sanctions 2-3, Dkt. No. 158, Berg v. Akorn, Inc., No. 1:17-cv-05016 (Apr. 21, 2025).
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