When Do Investors Know? Security Class Action Lawsuits, Short Selling, and Pre-filing News Releases

Abstract

Prior literature on security class-action lawsuits generally treats the lawsuit filing day as the day when the event become public, in terms of evaluating event-study returns and informed shorting activity. However, in the days prior to the lawsuit filing, our investigation reveals that there are public announcements of law-firm investigations into more than half of the sued firms. Over our 2009-2019 sample, accounting for these pre-filing investigation announcements weakens prior evidence that suggested short-selling investors tend to anticipate the lawsuit filing from private information or inference from related industry litigation. Strikingly, the average cumulative abnormal return over the 5-day pre-event filing window is about -6.5% for our full sample (similar to prior studies) but it is only about -2.2% when excluding the lawsuits with a recent pre-filing investigation announcement. Regarding responses to the public news releases, we find that: (1) the coincident abnormal short selling and negative abnormal returns are much larger for the higher quality lawsuits, and (2) the abnormal shorting coincident with the initial public news about the lawsuit is reliably negatively related to the post-news abnormal return. Thus, in addition to weakening an anticipatory shorting view, our evidence provides considerable support to conclusions in Engelberg, Reed, and Ringenberg (2012) - - that short sellers are skilled at analyzing publicly available information.