In two dismissal motion grants last week in pending SPAC-related securities suits, the respective courts’ rulings could have potential significance for other pending or prospective SPAC-related cases. The January 10, 2023, ruling in the SPAC-related suit involving DraftKings has important implications for the many pending SPAC-related cases based on short seller reports, and the January 11, 2023, ruling in the Lucid case has potential implications for SPAC-related securities suits based on alleged pre-merger misrepresentations. The two rulings and their potential significance are discussed below.
Diamond Eagle Acquisition Corp. (DEAC) was a Special Purpose Acquisition Company (SPAC). DEAC completed an IPO on May 10, 2019. On December 22, 2019, DEAC announced its plan for a three-way merger between DEAC; predecessor DraftKings (old DK); and SBTech Global Limited. The merger was completed on April 23, 2020.
On June 15, 2021, short-seller Hindenburg Research published a report alleging that the merger with SBTech exposed DraftKings to allegations of dealings in black-market gaming. Among other things, the report, which claimed to be based on interviews with former SBTech employees, as well as investigation of illicit international gaming websites, alleged that “SBTech has a long and ongoing record of operating in black markets,” and estimated that 50% of SBTech’s revenue is from markets where gambling is banned.” The subsequently filed securities lawsuit complaint claimed that DraftKings’ share price declined over 4% on the news.
In July 2021, a plaintiff shareholder commenced a securities class action against DraftKings; certain former executives of DEAC; certain executives of DraftKings; and former executive of SBTech. In his complaint, the plaintiff alleged, in reliance on the Hindenburg Research report, that “SBTech had a history of unlawful operation” and “accordingly, DraftKings’ merger with SBTech exposed the Company to dealings in black-market gaming.” The defendants filed motions to dismiss
In a January 10, 2023, opinion (here), Southern District of New York Judge Paul A. Engelmayer granted the defendants’ motions to dismiss. In doing so, Judge Engelmayer noted that “a global deficiency spanning [the plaintiff’s complaint’s] theories of fraud.” The plaintiff’s allegations concerning the SBTech’s business practices “are virtually entirely based on the Hindenberg Report, which in turn was largely based on unsourced or anonymously sourced allegations.” Judge Englemeyer said that the “threadbare sourcing and the conclusory quality” of the lawsuit’s allegations “are ultimately fatal.”
In reviewing the complaint’s allegations based on the short-seller report, Judge Engelmeyer noted two specific ways in which the complaint’s reliance on the Hindenberg Research report was “problematic.” The first is that, given the short seller’s economic incentive, a short seller’s allegations “must be considered with caution.” Second, the Hindenberg report itself is based on unidentified and unspecified confidential sources; allegations based on confidential sources must meet certain standards to corroborate their reliability – standards that Judge Engelmeyer said had not been met here. To the contrary, after reviewing the anonymous sources quoted in the report, Judge Engelmeyer say that the statements “suffer from all the indicia of unreliability that have led courts often not to credit attributions to unnamed sources in short-seller reports.”
Given that the complaint “does not adequately allege the fact of operations in black-market countries during the class period, it necessarily does not plead a failure to disclose the risks therefrom.” Because the plaintiff had already twice previously amended his complaint, Judge Engelmayer’s dismissal of the case was without leave to further amend.
Churchill Capital Acquisition Corporation IV (Churchill IV), is a special purpose acquisition corporation (SPAC) that was formed in April 2020 and that completed an IPO on July 30, 2020. On February 22, 2021, Churchill IV announced that it had entered an agreement to merge with Lucid Motors, an electric automobile manufacturing company. Lucid was founded by Peter Rawlinson in 2007.
On February 4, 2021 (that is, still weeks before the merger was announced), Rawlinson, the Lucid CEO, told Forbes that the company wants to build 6,000 vehicles in 2021, potentially generating revenues of $900 million. That day, Churchill IV’s shares closed at $30.22.
According to the subsequently filed securities lawsuit complaint, Rawlinson appeared in interviews on CNBC on February 5, 2021, and on Fox Business News on February 16, 2021, in which he talked about the company’s 2021 production plans and plans for growth. Churchill IV’s stock price continued to climb, closing on February 18, 2021 at an all-time high of over $58.
On February 22, 2021, the Churchill IV merger was formally announced. That same evening, Rawlinson told Bloomberg News that production of the first Lucid car would be delayed until at least the second half of 2021, and that the company was projecting 2021 production of 557 vehicles, instead of 6,000 as he had previously said. After the merger closed, the company announced further reductions in its production plans and production timetable.
A plaintiff shareholder subsequently filed a securities class action lawsuit against Lucid; directors and officers of the SPAC; Rawlinson; and other executives. The complaint was filed on behalf of pre-merger purchasers of the SPAC’s stock, based on allegations that the various pre-merger statements had driven up the SPAC’s stock price based on assertions about Lucid’s future production capabilities and the expectation that the two companies were about to merge.
In a January 11, 2023, opinion (here), Northern District of California Judge Yvonne Gonzalez Rogers granted the defendants’ motion to dismiss (although denying the defendants’ motion to dismiss the complaint on the grounds that the plaintiff lacked standing). Judge Gonzalez Rogers granted the motion on the grounds of materiality, holding that the plaintiff’s complaint “does not plead facts showing that statements” concerning Lucid “would be material to any reasonable purchaser of [the SPAC’s] stock at a time when no merger between the companies had been announced and, indeed, when it remained unconfirmed that the parties were even engaged in discussions.”
The court said further that the complaint “fails to allege that the merger was likely to take place when Rawlinson made the alleged statements or when plaintiffs purchased [the SPAC’s] stock.” When the plaintiff purchased the SPAC’s stock, “neither company had acknowledged they were in discussion, let along indicated that a merger was likely.” News article about a possible merger and changes in the SPAC’s share price in response to Rawlinson’s media appearances “also are not reasonable indicators that the merger was likely to take place. The alleged articles were not based on confirmed statements from the company. They were speculative.”
To show information regarding a potential merger is material “plaintiffs must be able to allege that the merger was likely to occur at the time they relied on defendants’ misrepresentation.” The Court “cannot conceive of how plaintiffs could reasonably think a merger was likely when Lucid and [the SPAC] had not even publicly acknowledged that a merger was being considered.” The court granted the motion to dismiss, with leave for the plaintiff to submit a proposed amended complaint together with a motion to amend the pleadings.
These two rulings each in their own way have potentially significant implications for pending or prospective SPAC-related securities suits.
Judge Engelmayer’s ruling in the DraftKings case is significant because of his skeptical reading of the plaintiff’s allegations based on nothing more than the short seller’s report. Judge Engelmayer’s skepticism started with the short seller’s obvious financial incentives to try to drive down the value of DraftKings’ stock. The short seller report’s reliance on unnamed confidential sources, whose statements lacked the requisite indicia of reliability, further deepened his skepticism.
The significance of Judge Engelmayer’s consideration of these issues, beyond the DraftKings’ case itself, is that many of the SPAC-related lawsuits filed in the last couple of years have been filed in reliance on nothing more than the allegations in a short-seller report. By my count, 21 of the 54 SPAC-related securities suits (38.8%) filed between January 1, 2021, and December 31, 2022, were filed based in reliance on allegations in short seller reports (with are least four cases other than the DraftKings case based on Hindenburg Research reports).
Judge Engelmayer’s skepticism of the plaintiff’s allegations here based on nothing more than the short seller report suggests that the plaintiffs in these other cases could face an uphill battle in trying to establish that their complaints meet the fundamental pleading requirements To be sure, Judge Engelmayer did not say that complaints based on short seller reports could never meet the requirements – but the standards are high, and Judge Engelmayer’s analysis suggests that many of the short-seller based complaints may not make it past the pleading stage.
The court’s ruling in the Lucid case is interesting because the underlying allegations related to statements made by the CEO of the merger target company, before the merger was completed . Many of the SPAC-related securities suits have involved allegations based on alleged pre-merger statements. However, what arguably makes the Lucid case distinct is that the supposedly misleading statements were made not only pre-merger, but before the later merger had even been announced. Moreover, the widespread public conjecture about a possible merger was “speculative” (and for that matter could not even be attributed to the defendants). While the court’s ruling underscores the challenge of basing securities claims on statements made before a merger is announced, the ruling arguably has less relevance to claims based on alleged statements after the merger announcement.
One final observation is that with the dismissals granted in these and other SPAC-related securities suits, the alternative vehicle of Delaware state court direct action breach of fiduciary duty cases (like, for example, the Gig3 case in which the Delaware Court of Chancery recently denied the motion to dismiss, as discussed here), may look to the plaintiffs’ lawyers like a more attractive option that the pursuit of securities class action lawsuits.
Special thanks to a loyal reader for providing me with a copy of the DraftKings opinion.