In a development that some may find more than a little bit ironic, U.K.-based litigation finance firm Burford Capital has been hit with a securities class action lawsuit following a drop in its share price after a short seller published a report questioning the company’s financial reporting. Burford has denied the short seller’s allegations and has also raised interesting questions about trading in its securities at the time of the research report’s release. A copy of the August 21, 2019 complaint filed against the company and certain of its executives can be found here.
The Muddy Waters Research Report
Burford is the world’s largest litigation funding firm. It is based in the United Kingdom, with offices in the U.S. Burford’s shares are publicly traded on the London Stock Exchange. Its shares and American Depositary Receipts (ADRs) trade over-the-counter (OTC) in the U.S.
On August 7, 2019, short-seller and research firm Muddy Waters published a research report questioning Burford Capital’s financial reporting. The day before it released the report, Muddy Waters issued a brief statement on Twitter previewing the then-forthcoming report.
Among other things, the Muddy Waters report asserted that Burford “heavily manipulates” two of its financial reporting metrics, the return on invested capital (ROIC) and the internal rate of return (IRR). The report claims that Burford has “egregiously misrepresented” its financial performance by use of these metrics. The report also asserted that Burford “actively misleads investors” about its accounting for realized gains, in what the report characterizes as “deception.” The report also questioned Burford’s corporate governance and financial reporting structure. The report states that Burford “is already arguably insolvent.” The price of Burford’s shares dropped in response to the Twitter pre-release and then dropped more steeply the next day when the report was issued.
On August 8, 2019, Burford issued a press release in response to what it called a “short attack.” The press release describes the Muddy Waters report as “false and misleading.” The report, the press release states, contains “many factual inaccuracies,” “simple analytical errors and selective use of information,” and “fallacious insinuations.” The press release provided a detailed rebuttal to the specific assertions in the Muddy Waters report.
On August 12, 2019 , Burford issued another press release (here), stating that based on an analysis of trading it its shares, it had found evidence “consistent with illegal market manipulation” at the time of the Muddy Waters pre-release Tweet and subsequent report release. (The description in the Burford press release of the alleged trading activity in Burfore shares makes for some very interesting reading.) Burford stated in its press release that it had provided the evidence to regulators and criminal authorities. The U.K.’s Financial Conduct Authority stated on August 12, 2019 that it was conducting a “wide-ranging” inquiry into trading of Burford’s stock following the Twitter pre-release statement and the release of the report. Later press reports suggested that the U.S. Securities and Exchange Commission and Department of Justice were also investigating the trading in Burford shares.
On August 21, 2019, an individual Burford securitiy holder filed a securities class action lawsuit against Burford and certain of its directors and officers in the United States District Court for the Eastern District of New York. The complaint purports to be filed on behalf of a class of persons who purchased Burford securities between March 18, 2019 and August 7, 2019.
The complaint quotes extensively from the Muddy Waters research report. In heavy reliance on the Muddy Waters report, the complaint alleges that the defendants made false and misleading statements or failed to disclose that: “(1) Burford has been manipulating its metrics including ROIC and IRR, to create a misleading picture of investment returns to investors; (2) these manipulations hid the fact that the Company is at high risk for a liquidity crunch and is already arguably insolvent; and (3) as a result of the aforementioned misconduct, Defendants’ statements about Burford’s business, operations, and prospects were materially false and/or misleading and/or lacked a reasonable basis at all relevant times.”
The complaint alleges that the share price of Burford’s ordinary shares and ADRs fell 17% in response to the Twitter pre-release and then fell again more than 40% after the report release. The complaint alleges that the defendants’ alleged misrepresentation or omissions violated Sections 10(b) and 20 of the ’34 Act, and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the purported class.
The complaint has only just been filed so it would be highly premature to speculate about the possible success of the action. I do think it is worth point out that specific allegations of scienter in the complaint are scarce, to say the least. We can certainly anticipate that in its defense that Burford will attempt to portray itself as the victim, as the target of a short-seller hit job that was designed to reward traders who profited by decline in the price of the company’s securities.
For those for with a taste for the ironic, the spectacle of the world’s largest litigation funding firm getting hit with a securities class action lawsuit may be of particular interest. The only thing that might come close is the October 2016 securities class action lawsuit filed in Australia against the publicly traded plaintiffs’ firm Slater & Gordon. The Slater & Gordon lawsuit ultimately settled for the payment of AUS$36.5 million.
Some readers may wonder about the applicability of the U.S. securities laws to transactions in Burford’s securities, in light of the Morrison standards. Burford’s shares are listed on the London Stock Exchange. Under Morrison, the U.S. securities laws would not apply to the LSE transactions in Burford’s securities and the investors who traded in Burford securities on the LSE will not be a part of the U.S. securities lawsuit.
However, according to the complaint, Burford’s ordinary shares and ADRs trade OTC in the United States. The complaint does not contain any allegations whether or not the ADRs are sponsored or what percentage of Burford’s overall publicly available securities the OTC securities represent. The plaintiff class in this case would be restricted exclusively to the investors who purchased their Burford securities OTC in the U.S.
While this story has a long way to run, I think anyone who is interested in this situation will want to take a few moments and read the description in Burford’s August 12 press release about the alleged trading in Burford’s shares. The description of the trading makes for some very interesting reading, to say the least, and also goes a long way to explain why regulators in both the U.K. and the U.S. are investigating the trading activity. While this new securities class action lawsuit will be interesting to follow, what may prove to be even more interesting is the outcome of the regulatory investigations.