Column: Muddy Waters Research report saves shareholder case against China’s biggest real estate brokerage

KE Holdings

27/02/2024 21:55

(The opinions expressed here are those of the author, a
columnist for Reuters.)
    By Alison Frankel
       Feb 27 (Reuters) - How much credence should judges
overseeing shareholder class actions give to reports by short
sellers?
    U.S. District Judge Gregory Woods of Manhattan confronted
that question in a ruling on Monday in a case accusing the
gigantic Chinese real estate brokerage KE Holdings  2423.HK  of
drastically overstating key financial metrics, including how
many agents and stores actively use its online platform.
    Shareholder lawyers from Robbins Geller Rudman & Dowd based
their allegations almost entirely on a 2021 report by the
short-seller Muddy Waters Research, which tagged KE as a
“massive fraud” after  an extensive investigation. 
    In their motion to dismiss the shareholder case, KE’s
counsel urged Woods to disregard claims based on the Muddy
Waters report because, among other things, Robbins Geller failed
to conduct an independent investigation to corroborate the short
seller’s accusations. 
    New York federal courts have generally been leery of
short-seller reports because outfits like Muddy Waters and
Hindenburg Research have an obvious financial motive to drive
down the share price of companies they have targeted.
    I told you last year, for instance, about a series of recent
decisions by U.S. District Judge Paul Engelmayer of Manhattan in
shareholder class actions premised on short-seller reports.
Engelmayer tossed all three cases — and though he didn’t
categorically slam the door on cases that rely on short-seller
reports, he said plaintiffs' lawyers have to give judges a good
reason to trust short-sellers' assertions.
    In Monday’ KE decision, Woods cited Engelmayer’s decisions,
agreeing that judges overseeing securities cases should be wary
of short-seller reports, especially when the reports include
allegations from confidential or anonymous sources.
    But Woods pointed out that Engelmayer’s cautionary rulings,
including the 2023 dismissal of an investor class action based
on a Hindenburg report criticizing DraftKings  DKNG.O , “should
not be misread as stating a rule that short seller reports are
to be disregarded.”
    In effect, Woods said that courts have to look at the
substance of the underlying short-seller accusations.
    In this case, he said, the Muddy Waters report on KE wasn’t
based just on anonymous sources. The short-seller developed
computer programs to crunch publicly available data from KE’s
platform, then sent out investigators to verify its data-based
suspicions about how many stores and brokers were actually using
the platform. Muddy Waters also used Chinese government data to
raise doubts about the number of KE employees in key real estate
markets.
    This report, in other words, did not merely recite
unsubstantiated allegations from anonymous whistleblowers, Woods
said. Muddy Waters included data analysis, photographs,
screenshots and transcripts to back its assertions. The
short-seller’s evidence, the judge said, amounted to
“sufficiently reliable support” for shareholder’s claims.
    To be sure, Woods did end up dismissing most of the
shareholder case. He tossed shareholders’ Exchange Act
allegations in their entirety because he concluded that their
complaint failed to show KE’s fraudulent intent. He also
dismissed claims that KE was required to disclose how many of
its purported platform users were inactive.
    But Woods ruled that investors can proceed with Securities
Act claims that KE’s filings for its $2.3 billion, post-IPO
stock offering in 2020 contained false statements about the
metrics at the heart of the Muddy Waters report.
    A KE spokesperson did not respond to my email. The company,
which is represented by Skadden, Arps, Slate, Meagher & Flom and
O’Melveny & Myers, has said repeatedly that the Muddy Waters
report was fatally flawed because (among other things) it was
based only on publicly available data, not on KE’s internal
information. (Full disclosure: My daughter works at Skadden but
is not in the securities group and was not involved in this
case.)
    KE told Woods that its audit committee conducted an
independent investigation of the Muddy Waters allegations after
the short-seller’s report and found them to be unsubstantiated.
The company also said that the market quickly shrugged off Muddy
Waters’ report, rebounding in a day of trading from an initial
5.75% drop.
    Robbins Geller did not offer comment on Woods’ decision. The
judge gave shareholders three weeks to file an amended complaint
to try to revive their Exchange Act claims.
    I don’t want to overstate the implications of Woods’
analysis of the Muddy Waters report. Securities class action
defendants, for the most part, have done an impressive job of
persuading courts not to rely on allegations from traders whose
goal is to drive down a company’s share price.
    Indeed, just last week, in a shareholder class action
against Chinese entertainment streaming company iQIYI  IQ.O ,
iQIYI’s lawyers from Skadden told U.S. District Judge Diane
Gujarati of Brooklyn about six decisions in the last year that
rejected shareholder claims based on short-seller reports.
    The judges in all six of those rulings, according to
Skadden’s letter brief, concluded that short-sellers were either
unreliable — because of their own self-interest or because of
flimsy investigations — or were merely repackaging
already-public information.
    But Woods’ KE decision is a reminder that short-seller
reports are not created equal. Shareholder lawyers might want to
keep that in mind when they contemplate class actions that
depend on short-seller allegations.
    
    Read more:
    DraftKings investors can't rely on short-seller report to
prove fraud - N.Y. judge    
    Short-seller Muddy Waters takes aim at Chinese firm KE
Holdings
    
    

 (Reporting By Alison Frankel)