On September 12, 2018, the Securities and Exchange Commission charged hedge fund, Lemelson Capital and its adviser, Gregory Lemelson (together with Lemelson Capital, “Lemelson”), with perpetrating an unlawful short attack on Ligand Pharmaceuticals. The SEC’s complaint alleges that Lemelson built a short position in Ligand and then made a series of demonstrably false and misleading statements to destabilize the company’s shareholder base and cause a drastic drop in stock price. The SEC alleges that as a result of this scheme, Lemelson reaped more than $1.3 million as investors sold their positions in Ligand after losing confidence in the stock.
Short Attack Activism in a Nutshell
A short attack is a coordinated campaign where an activist investor, oftentimes a hedge fund, takes a large short position in a company, and simultaneously releases negative information about that company in attempt to drive down the share price. In general, short sellers borrow shares from their brokers, sell them, and bet they can repay the brokerage with shares bought later at a lower price. Activist investors make money from their short attacks when they drive the price of a stock down, thereby reaping a profit by paying back the brokerage with lower-priced shares.
The 2018 Activist Investing Annual Review reports that, in 2017, there were 137 short activism campaigns in the United States, with 185 reported for 2016 and 186 reported for 2015. The most frequently cited allegation made by activist short sellers in 2017 was “major business fraud,” followed by “medical effectiveness” and “stock promotion.” Id. The complaint against Lemelson is apparently the first time the SEC has prosecuted a hedge fund for a short attack in the most recent wave of short activism – previously the agency had generally demonstrated “skepticism” toward short attack allegations. See, e.g., Charles F. Walker and Colin D. Forbes, SEC Enforcement Actions and Issuer Litigation In The Context Of A “Short Attack,” 68 BUS. LAW. 687, 689 (2013).
Lemelson’s Short Attack on Ligand
Lemelson took a short position in San Diego-based Ligand Pharmaceuticals Inc. in May 2014. Following this investment, the SEC’s complaint alleges that Lemelson used written reports, interviews, and social media to disseminate untrue claims about Ligand Pharmaceuticals, in a scheme to drive down the stock price in order to profit from its short position. Among other allegedly false statements, Lemelson asserted that Ligand was “teetering on the brink of bankruptcy” and that Ligand’s marquee Hepatitis C drug, Promacta, was going to become obsolete, despite neither claim having any basis in fact – according to the SEC’s complaint. The SEC also alleges that Lemelson misled investors by citing a doctor’s negative views on the same drug – without also disclosing the fact that the doctor was Lemelson’s largest investor (and who therefore had a significant financial interest in Ligand’s stock price declining, due to Lemelson’s short position). The SEC’s complaint alleges that following Lemelson’s short reports, Ligand’s stock price dropped approximately 16%, and Lemelson reaped $1.6 million in gains.
The SEC’s Action and Lemelson’s Response
What sets Lemelson’s short attack apart from the many others that have occurred without regulatory scrutiny appears to be the demonstrably false statements and glaring material omissions throughout Lemelson’s statements on Ligand. For example, Lemelson stated that Ligand’s primary source of licensing revenue, the drug Promacta, was on the brink of obsolescence – a statement made without any basis in fact. Three days later, he doubled down on this statement, falsely claiming in an interview that a Ligand representative stated the company knew Promacta was “going away.” He further asserted that “Ligand’s fair value is roughly $0 per share, or 100 percent below the current stock price,” all the while increasing his own short position. As such, the SEC has charged Lemelson and Lemelson Capital Management with fraud, and seeks the return of their allegedly illegal gains, with interest. The SEC is also seeking a monetary penalty.
In response, Lemelson has denied the allegations, accusing the SEC of bringing the complaint in “an effort to destroy the reputation of a whistleblower, who provided factually accurate and critical information concerning an alleged massive multi-year accounting fraud at Ligand Pharmaceuticals.” Lemelson also cited the private securities litigation against Ligand, which was commenced on July 27, 2018 by investors in eight bond funds, seeking $3.8 billion and accusing Ligand of unfairly changing the terms of a bond agreement. This lawsuit follows multiple class-action securities fraud lawsuits brought against Ligand starting in 2016.
What This Means for Companies Under a Short Attack
This might be a promising sign for issuers that the SEC might be starting to focus more closely on short attack activism. However, we would expect short attackers, mindful of this SEC action, to more carefully vet the underlying bases for their short theses before commencing their short attacks, perhaps stopping some short attacks dead in their tracks before they even see the light of day.
Short activism, however, does not appear to be going away anytime soon, and companies under a short attack are not defenseless. There are a host of tools available to blunt the force of a short attack, both legally and through a proactive communications strategy to restore and maintain investor confidence.