When I recently read KaloBios (Ticker “KBIO”) had filed for bankruptcy as a results of events tied to Martin Shkreli’s recent arrest, the securities litigator in me wondered what strategies would I take if I represented class plaintiffs or defendants in one of the class action lawsuits?
As a primer, here is a brief illustration of the framework of a typical shareholder class action fraud lawsuit.
Many shareholder class action fraud lawsuits based on prohibitions promulgated under Section 10 of the Securities & Exchange Act of 1934 rely on the “fraud on the market” theory, which evolved from a Supreme Court case called Basic v. Levinson
and was recently affirmed in Hallburton v. Erica P. John Fund.
The theory is that in the fraud context, where a plaintiff is required to plead that it relied on the fraud, class action plaintiffs, who transact in publicly-traded securities, are entitled to a rebuttable presumption of reliance on the misstatements provided (1) the misstatements were publicly known, (2) the misstatements were material, (3) the plaintiffs transacted in the securities during the relevant period, and (4) the securities at issue are traded in an efficient market. The foundation of the “fraud on the market” theory is that in an efficient market, where the entire market has access to all material information, material fraudulent information defrauds the entire market because, an efficient market (presumably) prices securities based on all available material information.
In a nutshell, class plaintiffs would need to show that in connection with plaintiffs’ purchase (or sale) defendants knowingly (also known as scienter) made a misstatement (or omission) of a material fact upon which the plaintiffs relied and ultimately caused losses for the plaintiffs. In the Rosen Law Firm class action, allegations include:
“[D]efendants issued materially false and misleading statements to investors and/or failed to disclose that: (1) the CEO of KaloBios was engaged in a scheme involving the illegal use of stock from Retrophin, Inc. to pay off debts associated with other unrelated business ventures; (2) the discovery and revelation of that scheme would likely undermine KaloBios’ operations and prospects; and (3) as a result, defendants’ statements about KaloBios’s business, operations, and prospects were materially false and misleading and/or lacked a reasonable basis at all relevant times. When the true details entered the market, the lawsuit claims that investors suffered damages. “
Then, I thought could short sellers successfully allege that they had been defrauded? The following are some facts that strengthen securities fraud claims for short sellers:
- 11/09/2015 KBIO 8-K stating among other things KBIO’s $6.6 million cash payment to MidCap Financial and a restructuring, which will cost KBIO $400K-$500K and eliminate 61% of the Company’s workforce. On 11/09/2015, Herb C. Cross, KBIOs interim CEO & CFO at that time, acquired stock options that will be exercisable from 11/19/2016 onward, which suggests the CFO at least expected KBIO to have ongoing operations.
- On 11/13/2015 (Friday, the 13th), KBIO releases a press release that reiterates the information found in the 11/09/2015 8-K and adds that KBIO retained the Brenner Group to assist wind down operations.
- On 11/14/2015, Martin Shkreli hosted lived video during which he takes a phone call from “Albert” and stated: “…long time ago, I was forced to cover something…once in my career, I had a buy-in that was problematic…I don’t want to think about borrows.” One could argue that Martin Shkreli, a former victim of a short-squeeze that ultimately led to the demise of his MSMB Capital Management, knew that the fact the KBIO was listed on FINRA’s Regulation SHO list, would be an easy target for manipulation.
- On 11/16/2015 (Monday), Martin Shkreli and his consortium begun their KBIO share acquisition strategy.
Facts that Weaken Shareholder Fraud Claims for short sellers:
- The unusual trading volume for a heavily shorted stock that bids up into the close in the face of no news is a sign to cover. Trading 101 consistently reminds market participants to “buy the rumor; sell the news”, and the trading volume suggested that there was ample opportunity to cover. As Martin Shkreli reminded shorts, there’s no legal obligation for any long shareholder to lend stock so that a short seller can maintain its position.
Bottom line: KBIO plaintiffs reliance on the fraud on the market theory is adversely impacted by the actual information that was in the markets, and short sellers should always be cognizant of buy-in risk.