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`UNITED STATES PATENT AND TRADEMARK OFFICE
`_____________________
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`BEFORE THE PATENT TRIAL AND APPEAL Board
`_____________________
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`COALITION FOR AFFORDABLE DRUGS IV LLC
`Petitioner
`v.
`PHARMACYCLICS, INC.
`Patent Owner
`_____________________
`
`Case No. IPR2015-01076
`Patent No. 8,754,090
`_____________________
`
`DECLARATION OF
`JUAN (JULIE) WU, PH.D, M.S.
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`I, Juan (Julie) Wu, Ph.D., M.S., hereby declare as follows:
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`I. Introduction
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`1.
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`I am over the age of eighteen and otherwise competent to make this
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`declaration.
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`2.
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`I have been retained as an expert witness on behalf of the
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`COALITION FOR AFFORDABLE DRUGS IV LLC (“CFAD”) for the above-
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`captioned inter partes review (IPR). I am being compensated for my time in
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`connection with this IPR at my standard consulting rate, which is $400 per hour.
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`My compensation is not contingent on my reaching any particular findings or
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`conclusions, or on any particular outcome in this matter.
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`3.
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`I understand that this declaration is being submitted in support of
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`CFAD’s RESPONSE TO PATENT OWNER’S MOTION FOR SANCTIONS
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`PURSUANT TO 37 C.F.R. § 42.12.
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`4.
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`In preparing this declaration and formulating my opinions, I have
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`reviewed and considered each of the documents cited herein. I have also relied
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`upon my knowledge, research, and experience, described in further detail below.
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`II. Background and Qualifications
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`5.
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`From 2008 to the present, I have held the title of Assistant Professor
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`of Finance, at the Terry College of Business at the University of Georgia. As a
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`finance professor, I teach Ph.D. level research topics in finance, as well as
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`corporate finance theory at the undergraduate level.
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`6.
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`I earned my Ph.D. in Finance from Texas A&M University in 2007.
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`In connection with my Ph.D. studies, I taught managerial finance to
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`undergraduates and instructed incoming Finance Ph.D. students.
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`7.
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`I earned my M.S. in Sociology in 2002 and M.S. in Finance from
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`Texas A&M University in 2003.
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`8.
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`I earned my B.A. in International Finance and English In 1997 from
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`Xi’an International Studies University in China.
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`9.
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`I have authored or co-authored the following publications:
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`• “Short selling and the price discovery process,” with Ekkehart
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`Boehmer, Rev. Fin. Stud. 26: 287-322. (2013) Lead article.
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`o Runner Up prize for the RFS Michael J. Brennan Best
`Paper Award, 2014.
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`• “Equity short selling and bond downgrades,” with Tyler Henry and
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`Darren Kisgen, J. Fin. Intermediation 24:89-111 (2014).
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`• “High short interest effect and aggregate volatility risk”, with
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`Alexander Barinov, J. Fin. Markets 21: 98-122 (2014).
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`• “Merger arbitrage short selling and price pressure”, with Tingting
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`Liu, J. Corp. Fin. 27: 36-54 (2014).
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`10.
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`I am an Ad Hoc Referee for the following finance publications:
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`Journal of Finance; Review of Financial Studies; Journal of Corporate Finance;
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`Journal of Financial Intermediation; Management Science; Journal of Empirical
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`Finance; Journal of Banking and Finance; Financial Management; Journal of
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`Financial Research; Financial Review; International Journal of Managerial
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`Finance; Pacific-Basin Finance Journal; and Review of Financial Economics.
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`11. My work has been presented at the following professional meetings or
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`conferences:
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`• Workshop on The Mathematics of High Frequency Financial
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`Markets, IPAM at UCLA (2015)
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`• American Finance Association (2013)
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`• 7th Singapore International Conference on Finance (2013)
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`• Bachelier conference (2012)
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`• Financial Management Association (2012)
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`• American Accounting Association (2012)
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`• World Finance Conference (2012)
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`• Midwest Finance Association (2012)
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`• 3rd RMA/UNC Academic Forum for Securities Lending Research
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`(2011)
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`• Financial Management Association (2011)
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`• Southern Finance Association (2011)
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`• Singapore Management University Accounting Symposium
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`(2010)
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`• 1st RMA/UNC Academic Forum for Securities Lending Research
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`(2009)
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`• All Georgia Finance Conference (2009)
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`• American Finance Association (2007)
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`• Financial Management Association (2007)
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`• Q-Group Fall meeting (2007)
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`• Workshop on the Microstructure of Foreign Exchange and Equity
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`Markets (2006)
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`12. My professional background is further detailed in my curriculum
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`vitae, which is included with this declaration as Exhibit 1031.
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`III. Short Selling is Legal and Regulated
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`13. Short selling is a sale of a security that the seller does not own. It is a
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`common trading strategy in U.S. equity markets. As indicated in the diagram
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`below, in one of its simpler forms, a short seller first borrows the security from a
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`broker-dealer or an institutional stock lender to immediately sell on the financial
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`market. The short seller later closes out the short position, typically by buying back
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`the security in the open market and returning it to the lender.
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`Borrower
`(i.e. Short
`14.
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`Seller)
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`Loan Fee
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`Broker
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`Lender’s Fee
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`Lender
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`Shares
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`Shares
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`15. Short selling is conducted for a variety of reasons including an
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`investor’s belief that a security is overpriced, and for arbitrage, hedging or market
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`making duties. In recent years, about 1 out of 4 trades involves a short sale. See,
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`e.g., Diether et al, “It’s SHO Time! Short-Sale Price Tests and Market Quality,” J.
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`Fin., 64: 37-73, 38 (2009) (“Diether et al”) (Ex. 1032).
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`16.
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`In current financial markets, it is more costly and risky to short than to
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`long (i.e. buy). A number of regulations and procedures constrain selling a security
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`short. First, short sellers typically must leave the proceeds of their sale (plus a
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`small percent more) to the lender as collateral for the borrowed security. In
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`addition, the borrower often must pay the lender a fee and this fee depends on the
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`demand and supply of the stock in the security lending market. Second, certain
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`trading regulations and procedures govern and constrain short selling. For
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`example, the Securities and Exchange Commission (SEC) “uptick rule” requires
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`that a short transaction be above the price prior to the short trade. Exhibit 1033 is a
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`timeline summarizing the SEC’s short selling regulations. Third, short sellers face
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`additional implicit costs such as “recall risk” and “short squeeze risk.” Recall risk
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`refers to the risk that a short seller will be required to return the stock to its lender
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`before the short seller intended to return to the stock. Short squeezes happen when
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`a firm, in its attempt to resist short selling, asks shareholders to recall their shares.
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`The amount of such a share recall could be sufficiently large that buying pressure
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`causes a spike in the stock price, resulting in a loss to the short seller. When a price
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`spike is very large, the short position can be forced to close due to collateral
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`requirements.
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`IV. Benefits of Short Selling
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`17. Short selling is permitted in the U.S. because it provides the market
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`with several important benefits, including correcting overpricing, providing greater
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`price efficiency, uncovering fraud, providing liquidity, and disciplining
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`management. In order to achieve such benefits while avoiding stock manipulation,
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`the SEC and other authorities have issued regulations that prohibit manipulative
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`short selling that intentionally drives down stock price during periods of market
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`volatility. See, e.g., SEC Final Rule on Amendments to Regulation SHO, 2010, Ex.
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`1034. While some speculate that short sellers could drive down a firm’s stock price
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`with false rumors and then cash out at a low price, such practices based on false
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`rumors are illegal, and there is little academic evidence substantiating this
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`speculation.
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`18. Further, there is little reason to believe that short sellers are more
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`likely to engage in price manipulation than any other party related to a firm—
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`given the potential for unlimited loss to a short position, short selling is less likely
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`to be manipulative.1 In fact, there is evidence showing that short selling actually
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`helps to correct upward stock price manipulation by managers that manipulate
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`earnings and can help to detect other fraud. See, e.g., Karpoff and Lou, “Short
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`Sellers and Financial Misconduct,” J. Fin. 65: 1879-1913, 1880 (2010); Fang et al,
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`“Short Selling and Earnings Management: A Controlled Experiment,” J. Fin., at 4-
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`5 (forthcoming, 2015) (Exs. 1035 and1036). Enron is one well-known example
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`showing how short selling can lead to the discovery of a firm’s earnings
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`manipulation that was inflating the stock price.
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`19.
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`It is important for investors to get accurate price information for a
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`stock because prices affect the allocation of scarce resources. To get prices right,
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`both favorable and unfavorable opinions and research should be expressed and
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`1 For example, if an investor believes that security XYZ is overvalued at its current
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`price of $20 and expects a price drop in the future, the investor can borrow the
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`stock from a lender and sell it for $20 per share. If the price falls to $18 and the
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`short seller buys the security back and returns it to the lender, the short seller earns
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`a $2 per share gross profit. The maximum gross profits for the short sale is capped
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`at $20 per share. The loss can be unlimited because the stock’s price can always go
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`up.
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`disclosed. This helps ensure that stock prices have an opportunity to reflect both
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`positive and negative information. Short selling plays a crucial role to get the
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`bearish information to the market and make the market healthier. Short sellers can
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`discover negative information that would otherwise be overlooked. By trading on
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`such information, short sellers help to better align stock prices with the
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`fundamentals of a firm. See, e.g., Ekkehart Boehmer and Juan (Julie) Wu, “Short
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`Selling and the Price Discovery Process,” Rev. Fin. Stud. 26: 287-322, 318 (2013)
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`(“Boehmer and Wu”) (Ex. 1037).
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`20. Short selling often not only helps to correct overpricing, it can also
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`uncover fraud. Short sellers often face unfounded allegations of price manipulation
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`from targeted firms. One well known example is Allied Capital, Inc., a mid-cap
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`financial company. Short sellers believed the company had committed financial
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`reporting violations. Share prices dropped when this information was revealed.
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`Allied claimed that a well-known short seller was manipulating the market and
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`requested an investigation from the SEC. The SEC found that the short seller’s
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`information was correct and Allied did commit financial reporting violations.
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`Another example occurred when short sellers found and revealed accounting fraud
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`in Spain-based telecommunications company Let’s Gowex SA. Let’s Gowex
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`accused the short seller’s report of defamation. However, within a week, the
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`company’s management confessed that fraudulent accounting had been occurring
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`for at least four years.
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`21. Short selling also provides liquidity to the market. Research shows
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`significant improvements in firms’ liquidity when the SEC suspended the tick test
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`on a sample collection of firms in 2005. Diether et al. (Ex. 1032 at 71). And a
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`recent paper shows that small firms subject to the short selling ban in September
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`2008 experienced severe degradation in liquidity from transaction costs. Boehmer
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`et al., “Shackling Short Sellers: The 2008 Shorting Ban,” Rev. Fin. Stud. 26: 1363-
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`1400, 1381 (2013) (Ex. 1038). The evidence illustrates that short selling enhances
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`firm liquidity. Better liquidity is desirable to firms because it makes it less
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`expensive to raise capital in the equity market.
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`22. Short selling also can affect the behavior of firm managers. Short
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`selling functions as an external governance mechanism to discipline managers.
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`Because short sellers have incentives to find unfavorable information about a firm
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`and trade on it, managers can be disciplined to avoid business activity that would
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`result in potential market punishment of their firm’s stock price. In this way, short
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`selling can reduce temptations managers may have to manipulate accounting
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`information. In fact, recent research shows that managers of firms with a higher
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`threat of short selling are less likely to engage in financial misreporting or earnings
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`manipulation. Massa et al., “The Invisible Hand of Short Selling: Does Short
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`Selling Discipline Earnings Management?” Rev. Fin. Stud. at 29-30 (forthcoming,
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`2015) (Ex. 1039).
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`23. The presence of short selling also improves the quality of internal
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`governance by stimulating shareholders’ investment in internal governance. Massa
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`et al., “Governance through Threat: Does Short Selling Improve Internal
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`Governance?” (INSEAD Working Paper 2013/83/FIN) at 1-2 (Ex. 1040).
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`24. The disciplinary role of short selling can also increase a firm’s
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`innovations. He and Tian., “Short Sellers and Innovation: Evidence from a Quasi-
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`natural Experiment,” (Kelley School of Business Research Paper No. 2014-14)
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`(Ex. 1041). Since informative short selling, by its very nature, brings high quality
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`information to the market for investors to analyze, firms with a solid business
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`model in fact should welcome rather than discourage the practice of short selling.
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`This is because short selling can help separate good firms from the bad ones. When
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`short sellers target a firm due to its weak fundamentals, they express their negative
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`opinion about the firm’s current business model. Dechow et al., “Short-Sellers,
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`Fundamental Analysis and Stock Returns,” J. Fin. Econ. 61:77–106 (2001)
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`(“Dechow et al.”) (Ex. 1042). This assessment can be valuable and help
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`management learn why the firm is lagging behind its competitors. This can be a
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`good thing to the firm’s operations if the management is truly committed to
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`enhancing shareholder value.
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`25. To go one step further, short selling a firm is not only a wake-up call
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`to the firm, but also sends signals to its rivals. Recent research shows that short
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`selling a firm is good news for other firms that compete in the same product
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`markets. Akbas et al., “Peer stock short interest and future returns,” at 1-2
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`(Working Paper, 2015) (Ex. 1043). Accordingly, short selling a firm can also
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`convey useful information to a firm’s competitors.
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`26. Some contend that short selling harms the shareholders of a targeted
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`firm. There are several reasons this is not necessarily accurate. First, shareholders
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`can be better informed in the presence of informed short selling. They not only get
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`favorable information from firm managers, they receive unfavorable information
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`revealed by short sellers. This can help shareholders make decisions to help the
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`firm improve if they decide to stay or vote with their feet by selling their shares.
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`Second, because informative short selling helps to correct overpricing, it can
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`actually protect shareholders from big losses. In the case of Enron, for example,
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`had short selling been more aggressive, the firm’s fraud could have been
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`uncovered earlier, and shareholders’ losses could have been much lower than the
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`reported $60 billion lost.
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`27. Some targeted firms contend that short sellers may make their shares
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`more volatile. The research, however, suggests the opposite. Informative short
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`sellers tend to be contrarians who sell more after periods of positive returns.
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`Dechow et al (Ex. 1042). Dechow et al shows that changes in short selling are
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`positively related to changes in prices. In addition, Diether et al., “Short-Sale
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`Strategies and Return Predictability,” Rev. Fin. Stud. 22: 575-607 at 580, 604-605
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`(2009) (Ex. 1044), shows that short sellers short more when recent prices were
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`high and short less when past prices were low. The nature of short sellers’ use of
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`contrarian strategies tends to contradict the claim that short sellers make share
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`prices more volatile.
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`28.
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`In a world with limited resources, firms compete for resources and
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`investors investigate in which firms to invest. The presence of short selling poses
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`little, if any, harm to the investing public at large. In fact, it can help firms to
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`compete more fairly and help the investing public make more informed allocations
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`of their scarce resources. Investors hope to invest in high quality firms, but find
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`this task extremely difficult because there are such a vast number choices—there
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`are over 5000 publicly listed firms in the U.S. Short selling helps investors become
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`better informed in their investment choices.
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`29. Rather than being somehow “nefarious,” it is actually when short
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`selling is not sufficiently prevalent that the investing public is harmed. Had short
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`selling been more prevalent during the tech bubble period from the late 1990s to
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`the early 2000s, investors who allocated money to the tech industry would have
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`avoided some of the billions of dollars lost. See, e.g., Prof. Lamont congressional
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`testimony (Due to insufficient short selling during the Internet stock mania,
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`“billions of dollars [were] wasted on uneconomic enterprises, millions of investors
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`suffered losses, and hundreds of thousands of workers switched jobs only to see
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`their new companies fail.”) (Ex. 1045).
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`30. Short sellers invest in their ability to collect and assess superior
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`information. For these reasons, while short sellers seek to profit from their
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`investments, their short activist strategies can at the same time generate a positive
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`social impact. In one recent example, a hedge fund shorted the stock of Lumber
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`Liquidators because the hedge fund’s research raised questions about the
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`sustainability of Lumber Liquidators’ high profit margin. Upon investigation, the
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`hedge fund found that the company had been selling Chinese-made laminate
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`flooring containing levels of potentially carcinogenic formaldehyde exceeding the
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`legal limit in California. To raise public awareness, the hedge fund contributed to a
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`segment run on the television program “60 Minutes.” While the hedge fund
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`profited from the declining stock price of Lumber Liquidators, it also helped stop
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`unethical business practices that were dangerous to the public health.
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`31.
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`In addition, research shows that most short sellers gain any
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`information advantage they have by their superior ability to understand public
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`information. Engelberg et al., “How are Shorts Informed? Short-Selling, News and
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`Information Processing,” J. Fin. Econ. 105: 260-278 (2012) (Ex. 1046). The
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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`examples discussed above all show that short sellers get important information
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`from their analysis of a firm’s public information. Short sellers do original research
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`of public information, combined with their insight about the industry, macro news,
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`and knowledge of institutional details to inform the market of data points that
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`should be reflected in accurate stock pricing. So while some argue that short
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`selling is “nefarious” because short sellers can cause and profit from no-
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`information price declines, empirical research reveals that short selling does not
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`cause sudden and excessive price declines unrelated to information. Boehmer and
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`Wu (Ex. 1037 at 309-314). Rather, short selling helps stabilize prices, because
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`research finds that short trading activity is consistent with a short seller’s role of
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`keeping prices in line and close to their efficient values.
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`32.
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`I declare that all statements made herein of my own knowledge are
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`true and that all statements made on information and belief are believed to be true.
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`I understand that willful false statements may subject me to fines, imprisonment or
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`both, pursuant to Section 1001 of Title 18 of the United States Code.
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`Signed:
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`Juan (Julie) Wu, Ph.D., M.S.
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`Date: 08/13/2015
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`Coalition for Affordable Drugs IV LLC - Exhibit 1026
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