Last Tuesday, EROS International Plc (NYSE: EROS) said it filed a lawsuit in New York County Supreme Court suing Mangrove Partners, Manuel P. Asensio, GeoInvesting, LLC, and numerous other individuals and entities, some of which remain anonymous at this time, but will be identified as the case unfolds.
EROS, a producer and distributor of Indian films, alleges that the defendants and co-conspirators embarked on a “short and distort” campaign, taking a short position (betting the stock price will go down) and then disseminating material false, misleading and defamatory information about EROS, a move to try and deliberately manipulate the stock lower for their profit.
In August 2015, shares of EROS traded as high as $39.01. In February 2016, shares tanked to a low of $5.59 following the filing of the class action lawsuit against EROS.
Short and distort strategies aren’t new by any stretch; they’ve been going on for decades, but very hard to prove. The internet exacerbated the problem, making everyone a potential author with a global reach. Websites such as Seeking Alpha, which widely distributes user-submitted material with little-to-no fact checking, have become popular distribution points for market participants with an array of publication motives.
Because it drives traffic to read controversial material, the publishing websites almost never remove the oft-iniquitous and anonymous articles, even when the target companies publicly and litigiously dismantle the piece. The rest of the equation involves the publisher assuming no responsibility for the user-generated article.
Anonymous articles and no one taking responsibility. That’s two key ingredients to printing whatever you want about a company.
In the case of EROS, several dubious, pen-name-authored articles appeared on Seeking Alpha prior to and subsequent to a class action lawsuit being filed against EROS in November 2015. Again, this is a well-known strategy as so-called shareholder’s rights law firms constantly troll the web looking for articles for which to use as the basis for a class action lawsuit, ultimately seeking a payday through a settlement with the target company.
In many instances, such as with a case targeting Innovation Pharma (OTCQB: IPIX) when it was named Cellceutix, the law firm literally “copied and pasted” entire sections from a Seeking Alpha article as the bulk of an initial complaint.
Throughout the litigation, which Cellceutix won when the courts dismissed with the case with prejudice, the plaintiff’s law firm kept amending the article, moving further away from the original complaint and article in a desperate attempt to create a moving target to try and send the case to trial.
Interestingly, the lead plaintiff in that case happened to be a previous lead plaintiff for the law firm. Even more interesting is the fact that no other plaintiffs were reported. That certainly begs the question of conspiracy or just bad luck?
Essentially, these types of law firms will do whatever it takes to conjure up a lead plaintiff, take their lawsuit template and throw everything against the wall to see what sticks, hoping if the judge orders a trial that the target company’s insurance company will step in an effectively say, "It will be cheaper to settle that go through a jury trial."
If, by some chance that happens, the law firm then takes is exorbitant fees and splits what’s left, if anything, amongst the plaintiffs.
The cycle is allowed to perpetuate itself due to lack of regulatory oversight and a legal system that is constructed to allow frivolous and damaging lawsuits.
The dynamic of bad actors using websites like Seeking Alpha, trolling law firms instantly issuing press trumpeting an investigation, subsequent class action lawsuits where someone is looking for an easy payday and courts failing to impose sanctions on law firms disregarding PSLRA mandates for proper due diligence before filing a claim has been intact for years.
Why? Because it’s hard to prove stupid. Authors, which sometimes actually disclose that they are motivated by a short positions, can write whatever they want under the protection of free speech laws, as the article is merely their opinion. When exactly commentary and opinion becomes libel or market manipulation is something that the courts have been slow to define by laying down precedent.
Sanctions against law firms filing frivolous cases would go a long way to slow or break the cycle, but, the reality is that lawyers aren’t generally swift to punish their career brethren.
Maybe the tide is beginning to change. About a decade ago, the SEC went after former Schottenfeld Group trader Paul S. Berliner for spreading false rumors about Alliance Data Systems Corp. while holding a short position, one of the first cases of its type. However, Berliner skated away, settling with a fine and ban from associating with a broker or dealer without admitted to any wrongdoing.
EROS is apparently sick of the system allowing short sellers to mercilessly slam companies. Last month, the U.S. District Court for the Southern District of New York dismissed, with prejudice, the class action suit brought against the company and certain officers.
Just like so many others before it, plaintiffs alleged violations of the Securities Exchange Act of 1934, filing several complaints and amendments in the process. The judge didn’t agree, ruling in favor of EROS without leaving room to amend again.
EROS is not walking away with the first victory, firing back with a lawsuit of its own that the beat down tactics were part of a "multi-year disinformation campaign" orchestrated by parties that profited by illegally manipulating the market.
While it sounds astonishing, some people actually make the argument that companies defending themselves by suing the attackers is either an admission of guilt or failure to capitalize on an opportunity to buy back stock at depressed prices.
We can’t help but see these views as ridiculous, blaming the victim and a complete lack vision with regards to the big picture. Damages can be substantial and cascading, with reputation, growth initiatives, existing shareholders, funding opportunities and more all feeling the pain while those behind the short and distort efforts profit.
That’s without even touching on the damage done to innovation. To add some color, consider that biotechs (especially small ones) are often easily-manipulated targets.
If these companies that are the lifeblood of new drug development can’t get funding as a direct consequence of the diabolical short campaign, then new drugs, biologics, diagnostics and treatments aren’t advanced. It’s not a reach; it’s a fact and a direct consequence of the short and distort methods allowed to be employed and prosper today.
The SEC recognizes the dissemination of fake news and false information as a problem and priority for policing. About two weeks ago, a Cyber Unit was created for targeting cyber-related misconduct. In a PR on the formation of the unit, the first misconduct listed was “Market manipulation schemes involving false information spread through electronic and social media.”
In conjunction with the efforts of the SEC, it would be a sea change if the courts start cracking down on the parties responsible for the “hit pieces” and law firms piling on without proper due diligence that realistically are little more than components of racketeering ploys.
That’s not saying that the new defendants in the EROS case are guilty of anything, but if they are and if a law firm filed the initial suit against EROS frivolously, it is high time that repercussions for such actions are laid down with an iron fist to set precedent and deter future illegal activity by any parties engaged in the malicious practices and vexatious litigation.
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