Fourth Circuit Holds That Short-Seller Report Does Not Establish Loss Causation for Securities Claims

The U.S. Court of Appeals for the Fourth Circuit recently affirmed the dismissal of a securities class action for failure to plead loss causation based on a “short-seller” report.  The decision in DeFeo v. IonQ, Inc. (4th Cir. Apr. 8, 2025) held that allegations based on the report did not establish loss causation with “sufficient specificity” because the report had been published by a “self-interested” short-seller, had relied on “anonymous sources for its nonpublic information,” had “disclaim[ed] its accuracy,” and had admitted that quotations from former employees and/or paid experts might have been “‘paraphrased, truncated, and/or summarized solely at our discretion, and do not always represent a precise transcript of those conversations.’”

In so ruling, the Fourth Circuit followed two decisions from the Ninth Circuit. Like the Ninth Circuit, the Fourth Circuit did not hold that “a short-seller’s report can never support the loss causation element” of a securities-fraud claim, and it declined to “impose a categorical ban on using short-seller reports to plead loss causation.”  But the Fourth Circuit’s decision, like the Ninth Circuit’s prior rulings, probably will increase the skepticism with which courts view short-seller reports as the bases for securities-fraud claims arising from stock-price declines following the issuance of such reports.

Background

IonQ is a public company that develops quantum computers. In May 2022, Scorpion Capital LLC published a lengthy report calling IonQ a “‘scam built on phony statements about nearly all key aspects of the technology and business.’”

The report contained numerous caveats, including the following:

• Scorpion was short on IonQ stock and stood “‘to realize significant gains in the event that the price of [IonQ’s] . . . securities decline[s] or change[s].’”

• The report reflected Scorpion’s “‘opinions . . . held in good faith’” and was based on “‘the public information, sources, the interviewed individuals, and any social media posts cited in this report.’”

• Scorpion “‘cannot and does not provide any representations or warranties with respect to the accuracy of those materials.’”

• Quotations of experts whom Scorpion had consulted “‘do not reflect all information [the experts] have shared with us, including, without limitation, certain positive comments and experiences with respect to IonQ,’” and “‘may be paraphrased, truncated, and/or summarized solely at our discretion, and do not always represent a precise transcript of those conversations.’”

• The experts “‘typically received compensation for their conversations with us and may have conflicts of interest or other biases with respect to IonQ . . . .’”

• The information provided by unnamed former employees “‘may be outdated . . . .’”

IonQ criticized the report two days later and published a fuller statement the following week.  Nevertheless, IonQ’s stock price declined in the wake of Scorpion’s report.

Shareholders filed a securities class action, which the district court dismissed for failure to plead falsity, scienter, and loss causation.  Plaintiffs sought leave to amend, but the court denied the motion, holding that the proposed amended complaint still failed to plead loss causation.  The Fourth Circuit affirmed the dismissal, addressing only loss causation.

Fourth Circuit’s Decision

The Fourth Circuit began by emphasizing that loss causation is an essential element of securities-fraud claims under §§ 10(b) and 14(a) of the Securities Exchange Act.  A plaintiff must plead with “sufficient specificity” – “a standard largely consonant with Fed. R. Civ. P. 9(b)’s particularity requirement” – “(1) the exposure of the defendant’s misrepresentation or omission, i.e., the revelation of new facts suggesting the defendant perpetrated a fraud on the market, and (2) . . . such exposure resulted in the decline of the defendant’s share price.”  Accordingly, an examination of loss causation “requires asking whether the market could have perceived [a putative disclosure] as true.”  “[I]t is not enough to plead that some allegation of fraud hit the market if it is implausible to believe that said allegation revealed any new truth to the market.”

The court held that Scorpion’s report did not meet this standard because of the numerous warnings suggesting its unreliability:  Scorpion had had a financial motive to tank IonQ’s stock price; it had relied on anonymous sources; it had disclaimed the accuracy of its opinions and its factual assertions; it had paid its experts, who might have had conflicts of interest; it had relied on former employees whose information might not have been current; it had admitted to altering quotations; etc.  The report thus was not sufficiently credible to be deemed to have revealed any “new truth to the market.”

The court did not rule that short-seller reports can never establish loss causation; indeed, it noted that, “[i]n appropriate circumstances, a short-seller report’s financial motivation may not disqualify it from use in litigation as alleging that it exposed a company’s fraud to the market.”  “But when a short seller makes the kinds of disclaimers the [Scorpion] Report does here, its potential evidentiary value evaporates.  While all short seller reports will likely share the same ulterior profit motivation, not all will rely entirely on anonymous sources for their incendiary claims, disclaim the accuracy of their opinions as well as that of the non-public source material from which it claims those opinions derived, and admit to tailoring quotations to fit the publisher’s narrative.”

The Fourth Circuit relied on two Ninth Circuit decisions that had reached similar conclusions:  In re Nektar Therapeutics Securities Litigation, 34 F.4^th 828 (9th Cir. 2022), and In re BofI Holding, Inc. Securities Litigation, 977 F.3d 781 (9th Cir. 2020).

Implications

Short-seller reports have frustrated public companies for many years.  The reports purport to express the short-seller’s “opinions,” and the short-seller generally discloses its financial interest in causing the target company’s stock price to fall.  But despite those disclosures, short-seller reports can have significant market ramifications.

The Fourth and Ninth Circuit opinions evidence significant skepticism about whether short-seller reports can reveal new “truths” to the market, as a plaintiff must plead (and eventually prove) to establish loss causation.  As the Fourth Circuit noted, most such reports will share at least some characteristics, especially the publisher’s profit motive.

Nevertheless, the Fourth and Ninth Circuit rulings show the need to look not only at the publisher’s motive but also at the specifics of the report.  While the Fourth Circuit held that Scorpion’s report contained too many indicia of unreliability, not all reports will do so.

Short-seller reports frequently rely on anonymous sources – a factor that influenced the Fourth Circuit’s ruling.  But some reports might also do detailed analyses of publicly available information and data that are not necessarily of questionable reliability.  And while the underlying information might have been publicly available, it might have been so arcane or so scattered that a reasonable investor could not be expected to have done the analysis and drawn the conclusions that the short-seller did after a detailed (and financially motivated) investigation.  In those circumstances, a court might hold that the short-seller’s report is sufficiently specific and reliable to establish loss causation, at least at the pleading stage.

One other point of interest in the Fourth Circuit’s decision is the court’s application of a “sufficient specificity” standard, “largely consonant with Fed. R. Civ. P. 9(b)’s particularity requirement,” for pleading loss causation.  Since the enactment of the Private Securities Litigation Reform Act of 1995, some courts have debated whether the statute’s heightened standard for pleading Exchange Act claims applies to the loss-causation element of securities-fraud claims or whether the laxer, general pleading standard under Fed. R. Civ. P. 8(a) applies.  The Fourth Circuit appears to have adopted a heightened pleading standard for loss causation.