Short Sales, Class-Action Lawsuits, and Potential Information Leakages

Abstract

Recent allegations of abusive practices by class-action lawsuit filing firms and short sellers have been brought to the attention of the SEC. These allegations claim that lawyers purposely leak information about filing dates to short sellers and other investors. We investigate these claims by examining shorting activity around securities-related class-action lawsuit filings. We find a significant increase in shorting activity during the five days prior to the lawsuit filing. Further, the return predictability of short selling is markedly higher during the pre-filing period than during non-event periods. In other tests, we also find abnormal shorting activity and abnormally high return predictability during the five days after the filing. Interestingly, both the abnormal post-filing shorting activity and return predictability are driven by filings that result in either cash settlements or judgments for the plaintiffs.

Keywords: Class-Action Lawsuits, Short Selling, Abnormal Returns, Information Leakage

JEL Classification: G14, K00