Distortion To Static: Key First Circuit Opinion Clarifies Limits For Short Sellers

• Jurisdiction: United States,Federal
• Law Firm: Holland & Knight
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Securities
• Author: Evan Nelson, Scott Mascianica and Jessica B. Magee
• Published date: 20 January 2023

The U.S. Court of Appeals for the First Circuit on Jan. 3, 2023, ruled against Defendant Gregory "Emmanuel" Lemelson's request for a new trial in SEC v. Lemelson.¹ The opinion and the underlying matter are critical reads for public companies and short-sellers alike, as Lemelson is one of the few litigated SEC matters involving "short and distort" allegations. As detailed below, the First Circuit's opinion provides key insights into, among other things, First Amendment application to short-seller allegations and fact-versus-opinion arguments that are critical to determining whether short-seller statements are actionable.

Below, we outline key facts from the underlying action and First Circuit opinion, along with some key takeaways.

Background

In 2018, the SEC filed a civil action against Lemelson and his investment firm Lemelson Capital Management LLC (Firm), alleging that he violated antifraud provisions of the Securities Exchange Act of 1934 (Exchange Act) and the Investment Advisers Act of 1940 (Advisers Act) in connection with some of his statements against Ligand Pharmaceuticals, Inc. (Ligand).² Lemelson and his Firm advised a hedge fund - for which it made investment decisions - to amass a sizeable short position in Ligand. Thereafter, Lemelson made a series of statements via interviews and written publications about Ligand, its licensing partner Viking Therapeutics (Viking) and Ligand's flagship drug "Promacta." Ligand's stock dropped 16 percent in the days after Lemelson's first report and ultimately fell approximately 34 percent overall. Those losses netted roughly $1.3 million in profit for the hedge fund from the short positions.

The SEC alleged that several of Lemelson's statements were false and misleading and charged him with violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and violating Section 206 of the Advisers and Rule 206(4)-8 thereunder. ³ On Nov. 5, 2021, the jury found that Lemelson did not violate the Advisers Act, nor did his conduct constitute an overall short-and-distort scheme under subsections (a) and (c) of Rule 10b-5. However, the jury did find that Lemelson intentionally or recklessly made three material misstatements in violation of Rule 10b-5(b):

• Promacta Statement: In June of 2014, Lemelson published a report in Seeking Alpha stating that Ligand "face[d] it[s] biggest existential threat" from "what is likely to be a momentous impairment of its largest royalty generating asset, Promacta," due largely to a competitive threat from a new drug called Sovaldi. Two days later Lemelson discussed Promacta with Ligand's investor relations representative. The day after that, Lemelson gave a radio interview on Benzinga where Lemelson said:

Promacta accounted for 72 percent of [Ligand's] royalty revenues ... [and] is literally going to go away ... I mean I had discussions with management just yesterday - excuse me, their [investor relations] firm, and they basically agreed. And they said, look, we understand Promacta is going away.⁴

• Viking Statements: Two weeks later...