Opinion
Case No. CV 11-05511 DDP (PJWx)
07-10-2013
JEFF FEYKO, individually and on behalf of all others similarly situated, Plaintiff, v. YUHE INTERNATIONAL, INC., GAO ZHENTAO and HU GANG., Defendants.
ORDER DENYING IN PART AND
GRANTING IN PART DEFENDANTS'
MOTION TO DISMISS
[Docket No. 134]
I. Background
Lead Plaintiff aAd Partners LP ("Lead Plaintiff") alleges that it purchased shares of common stock of Yuhe International, Inc. ("Yuhe") during the class period, including in the October 20, 2010 secondary offering of Yuhe shares. (See generally Second Consolidated Amended Complaint ("SCAC").) Lead Plaintiff alleges that it suffered losses because of false statements that Yuhe and its executives made, including false statements made in the second offering. (Id.) Lead Plaintiff has sued various individuals and organizations. (Id.) This Court previously dismissed Lead Plaintiff's allegations against Roth Capital Partners, LLC ("Roth"); Brean Murray, Carret & Co., LLC; and Global Hunter Securities, LLC (the "Underwriter Defendants"). (See generally Order Granting in Part and Denying in Part Motions to Dismiss and Strike ("Order"), Docket No. 128.) Lead Plaintiff has since filed the SCAC. Presently before the Court is the Underwriter Defendants' Motion to Dismiss Lead Plaintiff's Section 11 claim. ("Motion"). (Docket No. 134.)
Yuhe buys chickens, raises them to produce eggs, hatches the eggs and then sells the live day-old chicken (sometimes referred to as broilers). (SCAC ¶ 18.) At issue in this case are various allegedly false statements concerning Yuhe's acquisition of thirteen chicken breeder farms in China from the Weifang Dajiang Corporation ("Dajiang"), an acquisition that would have approximately doubled the number of Yuhe's breeder farms. (Id. ¶¶ 2, 45-46.) Lead Plaintiff alleges that the purchase of these farms never occurred. (Id. ¶ 2.) The Underwriter Defendants managed Yuhe's October 20, 2010 offering, with Roth serving as the lead underwriter. (Id. ¶¶ 23-27.) Lead Plaintiff alleges that the Prospectus Supplement for the October 20, 2010 offering, which was issued as part of the Registration Statement for that offering, falsely stated that Yuhe had acquired chicken breeder farms from Dajiang. (Id. ¶¶ 140-61.)
II. Legal Standard
A complaint will survive a motion to dismiss when it contains "sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). When considering a Rule 12(b)(6) motion, a court must "accept as true all allegations of material fact and must construe those facts in the light most favorable to the plaintiff." Resnick v. Hayes, 213 F.3d 443, 447 (9th Cir. 2000). Although a complaint need not include "detailed factual allegations," it must offer "more than an unadorned, the-defendant-unlawfully-harmed-me accusation." Iqbal, 556 U.S. at 678. Conclusory allegations or allegations that are no more than a statement of a legal conclusion "are not entitled to the assumption of truth." Id. at 679. In other words, a pleading that merely offers "labels and conclusions," a "formulaic recitation of the elements," or "naked assertions" will not be sufficient to state a claim upon which relief can be granted. Id. at 678 (citations and internal quotation marks omitted).
"When there are well-pleaded factual allegations, a court should assume their veracity and then determine whether they plausibly give rise to an entitlement of relief." Id. at 679. Plaintiffs must allege "plausible grounds to infer" that their claims rise "above the speculative level." Twombly, 550 U.S. at 555-56. "Determining whether a complaint states a plausible claim for relief" is a "context-specific task that requires the reviewing court to draw on its judicial experience and common sense." Iqbal, 556 U.S. at 679.
III. Analysis
The Underwriter Defendants seek to dismiss the Section 11 claims of subclass members who bought shares traceable to the October 20, 2011 offering. "Section 11 of the Securities Act of 1933, 15 U.S.C. § 77(k), provides a cause of action to any person who buys a security issued under a materially false or misleading registration statement." In re Century Aluminum Co. Sec. Litig., No. 11-15599, 2013 WL 1633094, at *1 (9th Cir. Apr. 17, 2013). To have standing to sue under Section 11, plaintiffs must show that they "have purchased shares in the offering made under the misleading registration statement," or if they purchased their shares in the aftermarket, standing will be found "provided they can trace their shares back to the relevant offering." Id. The latter approach is "often impossible," and conclusory allegations in the complaint that the shares are traceable will not suffice. Id. at *2-3. Plaintiffs "must do more than allege facts that are merely consistent with both their explanation and defendants' competing explanation." Id. at *4. They must "allege[] facts which, accepted as true, tend[] to exclude the possibility that the defendant['s]" competing explanation is correct. Id.
The Court previously dismissed Subclass members whose shares were only traceable to the October 20, 2010 offering: "[S]ince Plaintiff seeks to represent members of the Subclass who purchased Yuhe stock that is traceable to the secondary offering, and since Lead Plaintiff does not provide any detailed analysis as to how these Subclass members' shares can be traced to the relevant offering, the Court dismisses the Section 11 claims of these subclass members." Order at 14:4-9.
Lead Plaintiff amended the definition of the Subclass to "all persons and entities who purchased or otherwise acquired newly issued Yuhe shares at the Offering price of $7.00 per share pursuant to and traceable (for purposes of the Section 11 claim) to a secondary offering Yuhe made on or about October 20, 2010 and who were damaged thereby." (SCAC ¶ 36.) Lead Plaintiff also alleges that Yuhe sold all of the shares issued pursuant to the October 20, 2010 offering on November 2, 2010. (Id. ¶¶ 61-62.) The Court takes judicial notice that from October 19, 2010, the day before the relevant offering, through March 22, 2011, Yuhe's shares were not traded in the open market at an amount equal to or less than $7.00. (Plaintiff's Request for Judicial Notice ("PRJN" EX. E)); Lee v. City of Los Angeles, 250 F.3d 668, 689 (9th Cir. 2001) (holding that "[a] court may take judicial notice of matters of public record without converting a motion to dismiss into a motion for summary judgment. But a court may not take judicial notice of a fact that is subject to reasonable dispute") (internal quotation marks and citations omitted). That shares in the second offering were sold at $7.00, and that in the open market Yuhe shares were traded at over that amount through March 22, 2011, "tend[s] to exclude the possibility" that the Subclass members who bought Yuhe stock at a price of $7.00 per share prior to March 23, 2011 bought stock that was not traceable to the October 20, 2010 offering. See In re Century Aluminum Co. Sec. Litig., No. 11-15599, 2013 WL 1633094, at *4. Therefore Subclass members who bought Yuhe stock at $7.00 per share from October 20, 2010 to March 22, 2011 have standing.
While this definition suffices at the motion to dismiss stage, more than the price of purchased shares will have to be shown to ultimately prove tracing at trial. In order to show that shares purchased at $7 are directly traceable to a sale from Yuhe or its agent, Lead Plaintiff will have to follow the shares' chain of possession and eventually show that they match a sale or sales from Yuhe or its agent in the secondary offering.
Yuhe used to be listed on Nasdaq. (SCAC ¶ 18.)
The Underwriter Defendants have not disputed the accuracy of Yuhe's stock price, nor have they objected to the Court taking judicial notice of them.
However, Subclass members who purchased Yuhe stock on or after March 23, 2011 do not have standing, because Lead Plaintiff has not alleged sufficient facts that these members' shares are traceable. Indeed, Lead Plaintiff seemed to acknowledge as much in its opposition brief: "Therefore, it is plausible that a subclass member, such as Lead Plaintiff, who purchased shares at a price of $7.00 on or after October 20, 2010 until the date thereafter when the stock price traded at or below $7.00, purchased shares traceable to the Offering." Docket No. 135 at 22:13-17.
The Underwriter Defendants also state that a due diligence affirmative defense is established on the face of the SCAC, because it alleges that they reasonably relied on CVB, Yuhe's auditor, in preparing the Registration Statement for the secondary offering and documents that were part of that statement. See McCalden v. California Library Ass'n, 955 F.2d 1214, 1219 (9th Cir. 1990) (holding that an affirmative defense "must appear on the face of the pleading" for a complaint to be dismissed). Section 11 requires a plaintiff to prove "(1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment." Rubke, 551 F.3d at 1161 (internal quotation marks and citation omitted). Section 11 generally holds "the issuer of the securities . . . absolutely liable." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208 (1976). However, experts "who have prepared portions of the registration statement are accorded a 'due diligence' defense. In effect, this is a negligence standard." Id. The expert must prove it acted with due diligence. Id.
"An underwriter need not conduct due diligence into the 'expertised' parts of a prospectus, such as certified financial statements." In re Software Toolworks Inc., 50 F.3d 615, 623 (9th Cir. 1994). An underwriter "need only show that it 'had no reasonable ground to believe, and did not believe ... that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.'" Id. Courts look to plaintiffs to point to red flags that should have indicated to the underwriter that the financial statements were untrustworthy. See id. at 623-24. In In re Countrywide, a district court allowed an underwriter to establish the due diligence defense at the motion to dismiss stage, because "underwriters may reasonably rely on auditors' statements, absent red flags that the underwriters were in a position to see." 588 F.Supp. 2d at 1175. This Court previously dismissed Lead Plaintiff's Section 11 claim because it pointed to no red flags that should have cautioned the Underwriter Defendants against relying on CVB, Yuhe's auditor. (Order at 19:7-20:2.)
Lead Plaintiff has stated a sufficient Section 11 claim against the Underwriter Defendants. The SCAC alleges: "The Offering also states that 20 breeder farms are in operation, including five of the Dajiang farms." (SCAC ¶ 98.) The SCAC alleges that Yuhe never acquired the Dajiang farms. (Id. ¶¶ 2, 98.) At the time of the October 20, 2010 offering, CVB had not represented that the five Dajiang farms were operational. The first representation that these five farms were operational occurred in Yuhe's July 19, 2010 Form 8-K, which was incorporated by reference into the October 20, 2010 Prospectus Supplement and which was filed more than three months after CVB's audit report was made public. (Id. ¶ 97.) The Prospectus Supplement was "issued to and as part of the Registration Statement." (Id. ¶ 141.)
The July 19, 2010 Form 8-K was incorporated by reference into the October 20, 2010 Prospectus Supplement. (Id. ¶ 97; PRJN Ex. B at 66.)
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The Underwriter Defendants dispute the significance of the representation about the five Dajiang farms being operational by referencing several filings that CVB audited, which indicate that the Dajiang farms would become operational in 2010. (Docket No. 137 at 9:16-10:7.) But the Underwriter Defendants were only entitled to "reasonably rely on auditors' statements, absent red flags," not assume that Yuhe's predictive statements had, in fact, come to fruition. See In re Countrywide 588 F.Supp.2d at 1175. As this Court has previously ruled, the Underwriter Defendants were allowed to rely on the expertised portions of CVB's audit report. But the Underwriter Defendants were not permitted to, as the SCAC alleges, elevate the audited expectancies into an accomplished fact. In other words, an expectation that the farms to would become operational is one thing, stating they are operational indicates something more-it indicates that the Dajiang transaction is being successfully.
Thus, on the face of the SCAC, the Underwriter Defendants relied on Yuhe's statements that five of the Dajiang farms, a quarter of Yuhe's operational farms, were operational. Accordingly, and because due diligence should generally be reserved for a jury to determine, Lead Plaintiff has alleged sufficient facts for a Section 11 claim. See In re Software Toolworks Inc., 50 F.3d 615, 621, 626 (9th Cir. 1994) ("For its due diligence investigation of these sales, however, the Underwriters did little more than rely on Toolworks' assurances that the transactions were legitimate. A reasonable inference from this evidence is that Toolworks fabricated the June sales to ensure that the offering would proceed and that the Underwriters knew, or should have known, of this fraud."); Leasco Data Processing Equip. Corp., 332 F.Supp. 544, 582 (E.D.N.Y.1971) ("Tacit reliance on management is unacceptable; the underwriters must play devil's advocate."); see also Chris-Craft Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370 (2d Cir. 1973) ("Prospective investors look to the underwriter-a fact well known to all concerned and especially to the underwriter-to pass on the soundness of the security and the correctness of the registration statement and prospectus.").
IV. Conclusion
For the reasons stated herein, the Underwriter Defendants' Motion is DENIED, except that the Court dismisses with prejudice Lead Plaintiff's Section 11 claim on behalf of Subclass members who bought Yuhe stock on or after March 23, 2011. However, the only Section 11 allegations against the Underwriter Defendants that survive are those related to the Prospectus Supplement's statement that five of the Dajiang farms were operational. The remaining Section 11 allegations against the Underwriter Defendants are dismissed with prejudice. IT IS SO ORDERED.
DEAN D. PREGERSON
United States District Judge