Tenth Circuit affirms dismissal of short seller’s claims against Overstock

This appeal arises from a securities class action brought by a short seller against Overstock and certain of its former executives alleging that defendants provided knowingly false earnings guidance to the market in order to artificially inflate the price of Overstock securities and then entered into a corporate transaction that was designed to manipulate the market and create a short squeeze.

In 2019, Overstock announced that it would issue a blockchain-based digital security as a dividend to stockholders, and that this security would not be registered with the SEC. Rule 144 of the Securities Act of 1933 provides that unregistered securities cannot be bought or sold within six months of their issuance. Thus, Overstock short sellers would breach their contractual obligations when they received the new digital security as a dividend and were unable to transfer the new security to their lending broker. This announcement forced the short sellers to buy new Overstock shares and close their short positions before the dividend’s record date. The jump in purchasing increased the share price and thereby created a short squeeze.

Separately, plaintiff alleged that Overstock provided the market with earnings guidance that the Company knew could not be achieved, while understating problems in its retail division. According to the plaintiff, Overstock’s former CEO sold millions of shares of Overstock at a significant profit while the market price was artificially inflated by these allege misrepresentations. 

The District Court for the District of Utah granted the defendants’ motion to dismiss both the market manipulation claim and the false statement claim. On appeal, the Tenth Circuit affirmed. With regard to market manipulation, the Court found that such a claim requires a showing that a defendant committed a deceptive or manipulative act. Here, plaintiff did not adequately allege that the defendants were deceptive; the Court held that defendants had made complete and thorough disclosures concerning the digital security at issue, including most importantly the date of the dividend and that the digital security would not be registered with the SEC. The Court emphasized that, while open market transactions accompanied by a manipulative intent can in theory form the basis for market manipulation claims, there must be some element of secrecy for the transaction to become deceptive. 

With regard to the false statement claim, the Court concluded that the appropriate time period to examine is the date that the short seller made the decision to purchase securities to close out the short position, and not the date the plaintiff first took the short position. With that framework, the Court concluded that plaintiff admitted in the complaint that it purchased Overstock securities in order to close out its short position and avoid the short squeeze created by the digital security dividend, and not in reliance on any allegedly false statements made by Overstock. Thus, the Court found that defendants adequately rebutted – at the pleading stage – the “fraud-on-the-market” presumption of reliance. 

This decision emphasizes that, for market manipulation claims, there must be something about the transaction that is deceptive, misleading, or secret in some manner; the fact that a fully disclosed corporate transaction impacts the stock price or had the effect of harming short sellers is not sufficient. For the false statement claim, the decision is significant in that it makes clear that the “fraud-on-the-market” presumption of reliance is not available in every securities case, and that the presumption can rebutted at the pleading stage where a plaintiff concedes that it did not rely on defendants’ allegedly false statements when making the decision to purchase or sell the securities at issue.

Authored by Allison M. Wuertz, William (Bill) Regan, Sean MacDonald, Jacey Gottlieb, and Noah Ramirez.