Are investors misled if they only read the headline?

A federal judge on Thursday expressed major concerns whether Vaxart, a biotechnology company based in San Francisco, and Armistice Capital, a hedge fund that was once its largest shareholder, have to face a securities lawsuit that says they exaggerated the prospects of a COVID-19 vaccine.

While company insiders and Armistice walked away with hundreds of millions of dollars, U.S. District Judge Vince Chhabria in San Francisco questioned whether they violated securities laws by taking advantage of naive investors who say they misunderstood statements about the potential of successfully developing a vaccine. Chhabria said the companies' conduct may have been "manipulative and deceptive in the colloquial sense of the words but not in the legal sense."

The class action detailed an alleged pump and dump scheme that the plaintiffs said was orchestrated by Armistice and Vaxart executives to exploit the global rush to develop and manufacture a COVID-19 vaccine. The complaint targeted statements the plaintiffs said were made by Vaxart, at the direction of Armistice, that it was chosen to participate in Operation Warp Speed, a federal program granting billions of dollars to pharmaceutical companies to accelerate development of a vaccine.

Armistice proceeded to almost entirely cash out its stake in the company following the announcement. The value of stock options given to Vaxart executives just a few weeks earlier skyrocketed.

Vaxart is under investigation by the Department of Justice and Securities and Exchange Commission.

But whether there's liability for investors to pursue a lawsuit is murky, according to Chhabria.

Securities laws prohibit directors of a company from making false statements to investors. A lawsuit must identify such statements that would be interpreted as misleading to a reasonable investor to survive dismissal.

Vaxart attorney Riccardo Mauro DeBari, a partner at Thompson Hine LLP, argued the complaint can't proceed because "you have unreasonable investors unreasonably relying on immaterial statements."

"Even if we all know that the series of misleading statements would cause the stock price to artificially inflate, and even if corporate executives capitalized on having made those misleading statements?" Chhabria asked.

DeBari responded that the statements were only misleading for people "who read the first 11 words of a news release and didn't go past that."

The disputed news release starts with the headline "Vaxart's COVID-19 Vaccine Selected for the U.S. Government's Operation Warp Speed," but goes on to clarify that it was only chosen to participate in preliminary U.S. government studies to determine potential areas for possible program partnership.

Chhabria agreed that investors who flocked to buying Vaxart stock may have done so based on "irrational speculation." He questioned whether precedent on whether an investor can be considered to have acted reasonably "makes sense anymore in this day and age of day trading and people reacting so quickly to news."

Reed R. Kathrein, a partner at Hagens Berman Sobol Shapiro LLP representing the investors, countered that the U.S. Supreme Court has barred a practice called "scalping," in which a company neglects to inform investors of an intent to sell immediately after the stock price is inflated. He said, "Even if the statements aren't false, you're liable."

"That can't be right, because that happens all the time in securities cases," Chhabria replied. "I've dismissed dozens of securities lawsuits where corporate executives blew smoke and subsequently sold shares."

DeBari pushed back against claims that there was any backroom dealing, explaining that every part of Armistice's plan was disclosed to the market.

Shortly before Vaxart made the allegedly misleading statements, the company abruptly agreed to change the terms of its contract with Armistice that allowed the hedge fund to buy 21 million shares for as little as 30 cents each and immediately cash out on all of them instead of selling in smaller batches. Armistice proceeded to sell all of the shares in June following the news release announcing Vaxart's selection for Operation Warp Speed for as much as $12.98 a share.

The hedge fund made over $320 million, according to the lawsuit. In re: Vaxart, Inc. Securities Litigation, CV20-05949 (N.D. Cal., filed Aug. 23, 2020).