Hastings Law Journal Volume 72 Issue 2 Article 6 2-2021 “You Have to Understand”: The Saga of Longfin Corp. Reveals the Danger of Trading Halts Imposed by Self-Regulating Exchanges Thomas Davis Follow this and additional works at: https://repository.uchastings.edu/hastings_law_journal Part of the Law Commons Recommended Citation Thomas Davis, “You Have to Understand”: The Saga of Longfin Corp. Reveals the Danger of Trading Halts Imposed by Self-Regulating Exchanges, 72 HASTINGS L.J. 687 (2021). Available at: https://repository.uchastings.edu/hastings_law_journal/vol72/iss2/6 This Note is brought to you for free and open access by the Law Journals at UC Hastings Scholarship Repository. It has been accepted for inclusion in Hastings Law Journal by an authorized editor of UC Hastings Scholarship Repository. For more information, please contact [email protected]. “You Have to Understand”: The Saga of Longfin Corp. Reveals the Danger of Trading Halts Imposed by Self-Regulating Exchanges THOMAS DAVIS†† Late 2017 marked, perhaps, the peak of Bitcoin frenzy. A number of specious, if not outright fraudulent issuers took advantage of this craze by publicly listing their stock while touting some connection to blockchain technology. One of these issuers, Longfin Corp., exploded to a $6 billion market cap despite being little more than an empty shell promoted by alleged fraudsters. Short sellers who investigated Longfin were seemingly correct about the company being worthless, but a lengthy trading halt instituted by Nasdaq caused many of these short sellers to suffer considerable losses instead of cashing out on what would otherwise be hugely profitable short positions. This Note proposes changes to the regulatory scheme that currently allows self- regulating exchanges like Nasdaq to issue such trading halts with almost no restrictions. The recommended changes would further the principles of free and open markets and transparency that are fundamental to the securities laws by preventing exchanges from arbitrarily halting trade for extended periods of time. † Recent graduate of the University of California, Hastings College of the Law, Class of 2020; Articles Editor, Hastings Law Journal. Thank you to Professors Jared Ellias and John Crawford for their feedback and edits throughout the writing process. Further thanks to the many amateur traders, named and unnamed, whose experiences form the basis of this Note. † The Securities and Exchange Commission (SEC) disclaims responsibility for any private publication or statement of any SEC employee or commissioner. This Note expresses the Author’s views and does not necessarily reflect those of the commission, the commissioners, or other members of the staff. Lastly, this Note was originally scheduled for publication in the fall of 2020 but was unavoidably delayed due to world events. In the interim, Longfin was the subject of a flurry of legal developments; in particular, government enforcement actions. These developments do not impact the argument presented in this Note and have been omitted to avoid the inconvenience of resubmitting the Note to the SEC for review and approval. [687] 688 HASTINGS LAW JOURNAL [Vol. 72:687 TABLE OF CONTENTS INTRODUCTION ............................................................................................... 689 I. SROS WIELD CONSIDERABLE REGULATORY POWER ................................. 691 A. THE SRO SYSTEM .......................................................................... 691 B. QUASI-GOVERNMENTAL ABSOLUTE IMMUNITY OF SROS ............. 693 C. THE T12 HALT ............................................................................... 694 II. THE SAGA OF LONGFIN CORP. ................................................................... 696 A. SETTING THE STAGE: THE CRYPTO CRAZE OF 2017 ...................... 696 B. THE LONGFIN IPO .......................................................................... 697 C. THE ZIDDU “ACQUISITION” ............................................................ 698 D. THE FIRST CNBC INTERVIEW ........................................................ 699 E. VENKAT BREAKS THE INTERNET .................................................... 701 F. SHORTING LONGFIN ........................................................................ 702 G. THE CALM BEFORE THE STORM ..................................................... 705 H. AS LONGFIN RALLIES, THE SHORTS PILE IN ................................... 706 I. LONGFIN EXITS THE RUSSELL, AND THE CRACKS WIDEN ............... 708 J. THE HALT ........................................................................................ 709 K. APRIL 20 AND MAY 18 PUTS EXPIRE ............................................. 711 L. THE END: LONGFIN DELISTS AND RESUMES TRADING OTC .......... 712 III. PROBLEMS AND LIABILITIES .................................................................... 712 A. THE PROBLEM ................................................................................ 712 B. LITIGATION PROVIDES LITTLE RECOURSE ..................................... 715 IV. RETHINKING REGULATORY HALTS .......................................................... 715 A. TRANSPARENCY ............................................................................. 715 B. RETHINKING SRO POWER TO HALT ............................................... 716 CONCLUSION ................................................................................................... 718 February 2021] THE SAGA OF LONGFIN CORP. 689 INTRODUCTION Whether diligent or not, regulators can and do fail in preventing frauds and scams from listing on public exchanges. This creates a ripe hunting ground for short sellers (colloquially, investors or traders who bet against an asset),1 who have a substantial monetary incentive to root out and expose these frauds— picking up the investigatory slack where regulators come up short. Shorting a company can take various forms, all of them fraught with risks. Some of these risks are baked-in, unavoidable consequences of the financial instruments used to short. Others stem from sensible protective measures put in place by regulators to maintain market stability. These risks are generally well- established and accepted by those who choose to enter the world of short selling. This Note explores another type of risk; one that exists only because of the heavy-handed use of trading halts by self-regulating stock exchanges. The story of Longfin Corp. clearly demonstrates the nature of this risk and why the regulatory justifications for its existence do not hold up to scrutiny. After debuting at $5 per share on the Nasdaq in December 2017, the stock price of Longfin Corp. (NASDAQ: LFIN) fluctuated wildly during the handful of months it was listed on the exchange, enjoying a multibillion-dollar market cap for most of that time.2 The purported FinTech and cryptocurrency company attracted considerable scrutiny from short sellers for several reasons, not least of which being two interviews given live on CNBC by the company’s embattled CEO Venkat Meenavalli.3 In those few months, the suspicions of the short sellers were seemingly validated, and regulators alleged that Longfin’s IPO was replete with fraud from the very start.4 Throughout this saga, Longfin was heavily shorted, much to the chagrin of Meenavalli, who pointed much of his ire in their direction.5 Notably, many of these short sellers were retail traders who congregated in online discussion forums to investigate Longfin and trade on their shared information.6 The alleged improprieties of Meenavalli and his co-conspirators are not, however, the focus of this Note. Stripping behind the more absurd aspects of Longfin’s story leaves little more than an alleged run-of-the-mill stock promotion scheme, albeit one that was quite successful for a short period of time. Rather, this Note concerns actions undertaken by Nasdaq and other large 1. For an extensive explanation of the mechanics of short selling, see discussion infra Part II.F. For an explanation of the role short sellers play in the market, see discussion infra Part III.A. 2. See Lily Katz & Brad Oleson, Longfin’s Wild Crypto Ride Goes Beyond Any Short Seller Attack, BLOOMBERG (Apr. 6, 2018, 9:50 AM), https://www.bloomberg.com/news/articles/2018-04-06/don-t-blame- longfin-s-short-sellers-for-crypto-stock-s-wild-ride; Complaint at 7, Sec. & Exch. Comm’n v. Longfin Corp., 316 F. Supp. 3d 743 (S.D.N.Y. 2018) (No. 18-CV-2977). 3. See Katz & Oleson, supra note 2. 4. Kate Rooney, SEC Takes Aim at Controversial Crypto Company Longfin, Freezes $27 Million in Proceeds from Insider Stock Sales, CNBC, https://www.cnbc.com/2018/04/06/sec-freezes-27-million-from- stock-sales-involving-ceo-of-crypto-company-longfin-and-three-others.html (June 11, 2018). 5. Evelyn Cheng, CEO of Controversial Crypto Company Longfin Blames Short Sellers for Stock Plunge, CNBC, https://www.cnbc.com/2018/04/04/controversial-crypto-stock-longfin-surges-then-halted-after-its- announced-ceo-to-appear-on-cnbcs-fast-money.html (Apr. 5, 2018). 6. See discussion infra Part II.E. 690 HASTINGS LAW JOURNAL [Vol. 72:687 institutions that manifested considerable, unjustified losses by short sellers who were “too right” about Longfin’s fraudulent nature. Following repeated failures to recognize and address the various frauds and deficiencies related to the company, Nasdaq issued a regulatory trading halt on the stock on April 6, 2018, which stayed in place until Longfin voluntarily delisted to the over-the-counter (OTC) market