Reddit's Legal Battle: A Threat to Shareholder Value and Trust?

The recent securities fraud class action lawsuit against Reddit, Inc. (NYSE: RDDT) has thrown the company's growth narrative into sharp relief. At the heart of the allegations is a claim that Reddit misled investors about the existential threat posed by Google's AI-driven search tools, which have eroded user traffic and, consequently, revenue. For shareholders, the stakes are high: the lawsuit could reshape Reddit's valuation, force strategic pivots, and determine whether investors can recover losses—or face further declines.

The Legal Crossroads: Misstatements or Market Realities?

The lawsuit, Tamraz, Jr. v. Reddit, Inc., filed in June 2025, accuses Reddit's executives of downplaying the impact of Google's AI algorithms, which summarize content directly in search results—reducing the need for users to visit Reddit itself. Key allegations include:
1. False Growth Claims: Reddit allegedly assured investors that user growth remained robust despite a 55% drop in organic search traffic between 2022 and 2025.
2. Revenue Misstatements: Executives failed to disclose that logged-out users (50% of traffic) contributed only 15% of ad revenue, masking vulnerabilities in the company's monetization model.

The timeline underscores the disconnect between disclosures and reality:
- May 1, 2025: Reddit reported slowing user growth, triggering a 4% stock drop to $113.83.
- May 21, 2025: Analyst downgrades after Google's AI impact became clear sent shares plummeting another 9% to $95.85.

Investors now face a critical deadline: until August 18, 2025, they can join the lawsuit or seek lead plaintiff status. Law firms like Bleichmar Fonti & Auld LLP (with a $900M Tesla recovery) and Kessler Topaz (known for $2.7B settlements) are actively recruiting plaintiffs, offering contingency representation.

Financial Fallout: Valuation at Risk

Reddit's financials paint a mixed picture. While revenue grew 62% to $1.3B in 2024, net losses widened to $484M, and margins remain deeply negative. The company's valuation—$21.6B with a P/E of 182x and EV/EBITDA of 727x—relies heavily on future growth. The lawsuit threatens this narrative:

Key Risks:
1. Litigation Costs: A settlement could exceed $100M, though Reddit's $2.2B in cash provides a buffer.
2. Traffic Declines: Analysts project further user loss, with 30% declines possible by 2026 if Google's AI dominance persists.
3. Valuation Collapse: The stock trades at a 25% discount to its $147.71 Wall Street target, reflecting skepticism about Reddit's ability to adapt.

Investor Playbook: Navigating the Uncertainty

Shareholders must act decisively to mitigate risk:

1. Engage with Law Firms: Submit claims by August 18 to participate in potential recoveries. Contact Bleichmar Fonti or Kessler Topaz for contingency representation.
2. Monitor Strategic Shifts: Reddit's new tools, like Reddit Answers, aim to retain users by competing with Google's AI. Track adoption rates and partnerships (e.g., its $60M deal with Google) for clues on traffic stability.
3. Hedge with Options: Consider put options or inverse ETFs (e.g., PROX) to limit downside exposure if the lawsuit drags down the stock.
4. Reassess Valuation: With a P/E of 182x, Reddit's shares are priced for perfection. A settlement or further traffic declines could reset expectations—and valuations—sharply downward.

Conclusion: A High-Stakes Gamble on Innovation

Reddit's future hinges on two variables: resolving the lawsuit and proving its adaptability to AI-driven competition. For investors, the path forward is fraught with uncertainty. While the company's liquidity and pivot to logged-in communities offer hope, the legal overhang and reliance on an eroding traffic model suggest caution.

Final Advice:
- Hold: Only for long-term believers in Reddit's platform strength and ability to innovate.
- Sell: If risk tolerance is low or if the stock fails to rebound above $120.
- Wait: Until the legal outcome clarifies—valuation could swing wildly depending on the ruling.

In the end, Reddit's story is a microcosm of the broader tech sector: innovation must outpace the risks of disruption, and transparency must outweigh the allure of growth at all costs. For now, shareholders are holding their breath.

Data as of June 2025. Past performance does not guarantee future results.