General Publications December 4, 2015

“SDNY Raises the Bar for Claims Based on Short Reports,” Law 360, December 4, 2015.

Extracted from Law360

An emerging trend in securities litigation is for a stockholder to file suit on the heels of a drop in a company’s stock price after a short seller publishes a negative report.[1] The short reports typically identify some alleged misstatement, often related to the profits the company reported. The complaints in the stockholder cases simply parrot those accusations and allege that the officers named as defendants had knowledge of the true state of affairs but failed to disclose it to the company’s stockholders. Thus, for the plaintiffs bar, a short seller’s report can provide grist for the mill for a securities fraud claim.

At their worst, these short reports can be blatantly and demonstrably false. And, in every instance, they are published with the self-evident intent to profit by depressing the company’s stock price. The private rights of action under the securities laws are, of course, designed to remedy losses caused by an issuer’s false and fraudulent statements. In these cases, however, the plaintiffs seek to manufacture a lawsuit out of losses caused solely by a short seller’s erroneous attack on the company.

As discussed below, Judge Valerie Caproni in the Southern District of New York recently rejected a plaintiff’s attempt to abuse the securities laws in this manner, holding the complaint’s repackaged allegations failed to satisfy the demanding pleading requirements of the Private Securities Litigation Reform Act.[2] Harris v. AmTrust Financial Services Inc. et al., Case No. 14-0736, Slip Op. at 2 (S.D.N.Y 2012).

In AmTrust, the plaintiff, a purported AmTrust stockholder, alleged that he suffered losses from a downturn in the market price of AmTrust’s stock following a short seller’s publication of a report on the company that falsely accused AmTrust of engaging in transactions with overseas affiliates solely to remove losses from its consolidated financial statements. Following the publication of the short seller’s report, the share price of AmTrust dropped by $6.63 per share, or 20.2 percent. The complaint was filed shortly thereafter and asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933.

To use the label applied by the court, the short seller’s report was clearly the “impetus” for the action against AmTrust. As summarized in the court’s decision, the short seller’s report alleged that AmTrust had transferred approximately $290 million in losses to its affiliates and had failed to account properly for the transfer of those losses on its consolidated statements with the result that those losses effectively disappeared. To support this conclusion, the short seller cited financial disclosures that AmTrust’s subsidiaries filed with insurance regulators in the United States and Bermuda. The court emphasized that the disclosures filed by the subsidiaries were prepared using statutory accounting principles, in contrast to AmTrust’s consolidated financial statements, which were prepared using generally accepted accounting principles (GAAP). According to the short seller’s erroneous report, when one compared the aggregate of the losses disclosed in the various disclosures filed by AmTrust’s subsidiaries with the losses disclosed in AmTrust’s consolidated financial statements, it revealed a discrepancy of approximately $290 million.

As the court noted, the complaint relied “almost entirely” on the content of the short report for its allegations and applied the same flawed methodology as the short report by comparing the consolidated financial statements of AmTrust, prepared according to GAAP, with the financial disclosures of its various subsidiaries, prepared according to statutory accounting principles. The complaint, however, reached a slightly different conclusion than the short report with regard to what that comparison revealed.

According to the plaintiff, the discrepancy between the consolidated losses reported by AmTrust and the aggregate of the losses reported by its subsidiaries revealed not the disappearance of $290 million in losses, but the mischaracterization of those losses as nonunderwriting expense items rather than losses generated from insurance operations. The plaintiff asserted that this misclassification violated unspecified GAAP provisions and materially overstated the profitability of AmTrust’s insurance operations. The complaint alleged that the defendants misclassified the losses to mask a failure to set reasonable loss reserves and to secure continued access to sources of capital, which were allegedly needed to plug the holes created when reserves inevitably proved inadequate.

The defendants moved to dismiss the complaint for failure to state a claim, and the court dismissed all claims with prejudice. The court held the plaintiff had not “plausibly” alleged a misstatement by simply protesting that it could not “tick and tie” the losses reported in AmTrust’s “consolidated financial statement to the losses its individual subsidiaries reported to insurance regulators.” Slip Op. at 18. The court concluded that, in “the absence of a restatement or allegations pointing to objective facts that Defendants’ accounting methods violated GAAP,” the court could not infer that AmTrust violated the securities laws. Slip Op. at 20. The court also discarded the plaintiff’s allegations regarding the reasonableness of the company’s loss reserves, finding those allegations nothing more than “a difference of opinion.” Slip Op. at 22.

The court concluded that the allegations with regard to scienter were likewise inadequate. The scienter allegations focused primarily on the magnitude of the alleged misclassification and suggested that the individual defendants, as officers of AmTrust, must have been aware of the accounting treatment applied to intercompany transactions. The court held that the complaint’s broad allegation that the individual defendants “knew” of the alleged misclassification “lack[ed] the specificity required to plead a securities fraud claim.” Slip Op. at 26.

The court gave examples of the specificity absent from the complaint, including the failure to allege that the individual defendants reviewed reports that contained the same analysis performed by the plaintiff or, even if such a review took place, that the differences between GAAP and statutory accounting practices would not have explained any discrepancies highlighted by that analysis. Slip Op. at 26-27.

Finally, the court held that the complaint failed “to plead facts that establish a causal connection between the alleged misstatements and the alleged loss.” Slip Op. at 22 n.30. The court described the short seller’s report as a “17-page dissertation” that addressed a single topic — why short sellers had wagered correctly on AmTrust. Slip Op. at 22 n.30. The court concluded that the complaint failed “to allege any facts to show that the price decline was caused, in whole or in part, by the cherry picked pieces of the report that it contend[ed were] true and not the allegations” that the plaintiff had “cast aside.”[3] Slip Op. at 22 n.30.Accordingly, the court also held that the plaintiff had failed to plead loss causation.


The motive of a short seller issuing a report is clear — to depress a company’s stock price to make a profit. One can debate whether it is lawful for short sellers to seek to manipulate stock prices in this manner. But plaintiffs cannot properly convert the self-serving criticism of a short into an alternate reality in which speculation substitutes for the detailed facts needed to satisfy the elevated pleading standards controlling securities claims. In AmTrust, to create the appearance of substance, the complaint parroted the short report, quoted at great length the company’s public filings and liberally sprinkled around the catchphrases of fraud. The court made clear, however, that the law requires more than a simple cut and paste job to plead a cognizable claim as a matter of law.

[1] A short seller “speculates that a particular stock will go down in price and seeks to profit from that drop.” Levitin v. PaineWebber Inc., 159 F.3d 698, 700 (2d Cir. 1998). A short sale begins with the speculator selling stock that is not owned and is instead borrowed, usually from the short seller’s broker. After some period of time has passed, the short seller will purchase the stock in the market and deliver it to the broker, as a repayment of the loan. If, over that period, the price of the stock has declined, as the short seller speculated, the short seller can purchase the stock at a lower price than the price at which the borrowed stock was sold and, thereby, profit from the difference between the sale price and the purchase price. See id.

[2] 15 U.S.C. §§ 78u-4, et seq.

[3] Another court reached a similar conclusion recently in Jordan Cianci v. Blue Earth Inc. et al., Case No. 14-08263 (C.D. Cal.). Like in AmTrust, the plaintiff in Blue Earth filed suit shortly after the stock of the company dropped in response to doomsday predictions contained in the voluminous report of an anonymous short seller. The court held that the plaintiff had “not plausibly pled that the stock price was impacted by the specific disclosures alleged in the [complaint], as opposed to by the massive amount of negative information contained in the [short] report that was unrelated to the alleged misrepresentations.”

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