Earlier this month, a civil judgment was entered in the federal courthouse for the Southern District of New York, granting DraftKings motion to dismiss a class action stemming from a 2021 short-seller report. The order signed by Judge Paul Engelmayer ended the plaintiffs’ case at the trial court level.
The case involved statements made in the lead-up to DraftKings becoming a publicly traded company via a Special Purpose Acquisition Company (SPAC.) The plaintiffs argued that DraftKings misled investors about the company’s business with regards to SBTech, which was combined with DraftKings via the merger.
However, the plaintiffs’ case, according to the judge, was significantly based on a report from a short-seller firm Hindenburg Research, which according to the decision relied extensively on anonymous information and reports from ex-employees, with the plaintiffs failing to plead sufficient evidence that the events which were alleged to have taken place actually did.
Background on the case
In April 2020, DraftKings transitioned from a venture-capital darling to a publicly-traded company via a SPAC merger arranged by a company called Diamond Eagle Acquisition Company. The merger and listing of DraftKings on public markets was one of the more highly anticipated SPAC launches, and the value of the share price rose quickly after listing.
As part of the SPAC, DraftKings merged with SBTech. The deal, approved on April 23, 2020, brought to market one of the most valuable gambling companies in a long time.
In June 2021, Hindenburg Research, a famous firm associated with short-seller reports, issued a report on DraftKings, which largely focused on SBTech’s business operations before the merger. Notably, the report claimed that SBTech had operated in jurisdictions where some forms of gambling are illegal, as well as alleged the company had done business in Iran for a few years but ended in 2019.
More from DraftKings complaint
In the plaintiffs’ second amended complaint, according to the opinion, the plaintiffs argued that:
DraftKings made public statements to the effect that SBTech, its subsidiaries, and its clients complied with applicable gaming laws and did not violate certain anti-corruption and anti-bribery laws, or relevant United States sanctions.
The opinion notes that the plaintiffs’ second amended complaint argued that DraftKings also made public statements that omitted material facts related to SBTech’s business dealings.
The Hindenburg report
The Hindenburg report was a bombshell when it dropped. According to the report, SBTech had a “long and ongoing record of operating in black markets where online gambling is illegal.”
The day the report was released, DraftKings’ stock price dropped $2.11, more than 4%. The opinion notes that while the Hindenburg Report contained serious allegations:
counsel for plaintiffs in this case represented that they attempted to confirm employee statements quoted in the Report by contacting Hindenburg’s founder, but were unable to speak with him or to confirm the statements in the Report attributed to unidentified former employees.
The inability to verify the events in the Hindenburg Report would ultimately be the focus of the Court’s dismissal, in addition to doubts about the Defendants’ “scienter”, or state of mind, regarding any intent to deceive investors.
Decision in DraftKings case
According to the Judge’s opinion, the entirety of the plaintiffs’ claims rests on a single proposition regarding SBTech allegedly operating in black markets and that DraftKings’ representations about SBTech’s business were “false and misleading.”
The Court observes that the plaintiffs’ complaint has
a global deficiency spanning the SAC’s [Second Amended Complaint] theories of fraud. The SAC’s claims as to SBTech’s business practices are virtually entirely based on the Hindenburg Report, which in turn was largely based on unsourced or anonymously sourced allegations.
Two main issues
The Court observes two problems with basing the allegations on the Hindenburg Report. First, the Hindenburg Report is a short-seller report. The Judge says that given a short seller’s interest in seeing a stock price go down, the “allegations must be considered with caution.”
Second is the confidential sources that the Report is based upon. The Court highlights that the inability of the plaintiffs’ attorneys to verify and interview the sources of the report results in the Court discounting the report.
In analyzing key arguments that the plaintiffs’ made with regard to SBTech’s alleged black market operations, the Court said the allegations:
suffer from all the indicia of unreliability that have led courts often not to credit attributions to unnamed sources in short-seller reports.
Not enough specifics
The Judge goes on to note that the statements by former employees lack details about the employees’ tenure at their former jobs and many of the statements are general without specific details corroborating the claims.
In dismissing the plaintiffs’ second amended complaint, the Court concluded that there was not sufficient detail in the pleading to draw a conclusion that the case should continue to trial.
What to make of DraftKings decision?
The case is a significant victory for DraftKings.
The plaintiffs could still appeal the decision, though a notice of appeal has not yet been docketed, according to PACER.
In the meantime, the decision almost certainly lifts a cloud that had hung over DraftKings.