Summary
finding statutory standing because plaintiffs "alleged that the Underwriters negotiated the IPO price, controlled the contents and dissemination of the Registration Statement and Prospectus, and offered to engage in transactions to stabilize, maintain or otherwise affect the price of the common shares during and after the offering" and because the underwriters received financial benefit from the offering
Summary of this case from City of Omaha Police v. Evoqua Water Techs. Corp.Opinion
10 Civ. 7235 (GBD)
08-22-2013
JEFF PERRY and SCOTT P. COLE, on behalf of themselves and all others similarly situated, Plaintiffs, v. DUOYUAN PRINTING, INC., WENHUA GUO, XIQUING DIAO, BAIYUN SUN, WILLIAM D. SUH, CHRISTOPHER P. HOLBERT, LIANJUN CAI, PUNAN XIE, JAMES ZHANG, PIPER JAFFRAY & CO., ROTH CAPITAL PARTNERS, LLC, and FRAZER, LLP, Defendants.
MEMORANDUM DECISION AND ORDER
:
Lead Plaintiffs Joseph E. Sciarro, Scott P. Cole, Richard Pearson, and Plaintiff Jeff Perry (collectively, "Plaintiffs") brought this putative class action on behalf of all persons or entities who purchased or otherwise acquired securities issued by Duoyuan Printing, Inc. ("DYP") between November 6, 2009 and March 28, 2011 (the "Class Period") against DYP, several of its individual officers and directors, its underwriters, Piper Jaffray & Co. and Roth Capital Partners LLC (collectively, the "Underwriters"), and its auditor, Frazer LLP, for various securities law violations.
Plaintiffs charged DYP and several of its individual officers and directors with violations of Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated thereunder, as well as Sections 11 and 12(a)(2) of the Securities Act. Plaintiffs and DYP, including the individual DYP defendants, subsequently entered into a stipulation and agreement of settlement pursuant to Rule 23 of the Federal Rules of Civil Procedure. On August 1, 2013, the Court issued an order preliminarily approving the settlement (ECF No. 128).
The Underwriters and Frazer respectively move to dismiss the Consolidated Complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure for failure to state a claim.
DYP and its individual officers and directors also filed a separate motion to dismiss (ECF No. 86). In light of this Court's order, which preliminarily approved a class settlement between Plaintiffs and DYP, and the individuals of the company named as defendants, that motion is now moot.
Plaintiffs allege that the Underwriters violated Sections 11 and 12(a)(2) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§77k and §§77l, respectively, by preparing and disseminating a prospectus and registration statement in connection with an initial public offering that contained grossly inflated financial information. Plaintiffs allege that Frazer violated Section 10(b) (and Rule 10b-5 promulgated thereunder) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78j(b), and Section 11 of the Securities Act because the statements in Frazer's auditor report (submitted with DYP's prospectus and registration statement) attesting to compliance with the Public Company Accounting Oversight Board ("PCAOB") and the Generally Accepted Accounting Principles ("GAAP") were false and misleading.
The Underwriters' motion to dismiss is DENIED. Defendant Frazer's motion to dismiss is GRANTED.
BACKGROUND
The following factual allegations are taken from the Consolidated Complaint (ECF No. 64), or documents attached to it or incorporated by reference, and are deemed to be true for the purposes of a motion to dismiss. See Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002).
I. DYP's Initial Public Offering
DYP is a China-based corporation that designs, manufactures, and sells offset printing equipment through one of its three subsidiaries, Duoyuan Digital Press Technology Industries (China) Co., Ltd., Langfang Duoyuan Digital Techonology Co., Ltd., and Hunan Duoyuan Printing Machinery Co., Ltd.. Cons. Compl. (ECF No. 64), ¶¶ 18, 32. On November 4, 2009, DYP filed an amended registration statement on Form S-1/A with the United States Securities and Exchange Commission ("SEC"). On November 6, 2009, DYP made an initial offering ("IPO") pursuant to which it offered 6,455,918 shares of stock at a price of $8.50 per share. Id. ¶ 35. Defendants Piper Jaffray and Roth Capital served as the underwriters for the IPO, assisted in the preparation and dissemination of DYP's IPO materials, negotiated the initial public offering price of the shares, and solicited and sold the shares to investors. Id. ¶¶ 28-29, 79. The Underwriters received $3.8 million and $4.4 million, respectively, in underwriting fees. Id. ¶ 80. Defendant Frazer served as DYP's independent registered public accounting firm and audited the Company's financial statements for fiscal years 2007, 2008, and 2009, served as an expert for the purposes of the IPO and various financial statements, and consented to the inclusion of their audited financial statements for DYP in the IPO. Id. ¶ 31.
Until October 15, 2009, DYP was known as Asian Financial, Inc.
The gravamen of Plaintiffs' Consolidated Complaint stems from the financial information reported in DYP's IPO. Specifically, the registration statement and the prospectus filed in connection with the IPO reported that DYP had: revenues of $67.3 million for the nine-month period ended December 31, 2007 and cash of $7.8 million as of June 30, 2007; revenues of $104.6 million for the calendar year ended December 31, 2008 and cash of $14.2 million as of June 30, 2008; and revenues of $76.9 million for the nine-month period ended December 31, 2009 and cash of $31 million as of June 30, 2009. Id. ¶ 37. Plaintiffs assert that these figures were false and misleading because they grossly overstated the Company's revenue and cash. Id.
The IPO materials also included Frazer's auditor report, which stated, in pertinent part:
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).... We believe that our audits provide a reasonable basis for our opinion.... In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Asian Financial, Inc. and subsidiaries as of June 30, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2009 in conformity with accounting principles generally accepted in the United States of America.Id. ¶ 39. Plaintiffs allege that the statements in the auditor report attesting to compliance with the PCAOB and GAAP were false and misleading because Frazer's audit was not conducted in accordance with the Generally Accepted Auditing Standards ("GAAS"). Id. ¶ 40.
II. Investigation of SAIC Filings by DYP Subsidiaries
As a China-based corporation, DYP is required to file audited financial statements and amendments to its business registration records with the State Administration for Industry & Commerce ("SAIC"), a Chinese government entity that regulates industry and commerce in China. Id. ¶ 35, 48-49. From 2007 until the filing of the Consolidated Complaint, DYP prepared its financial statements to the SAIC using an accounting methodology similar to GAAP in the United States. Id. ¶ 50. Plaintiffs allege that there are no significant differences in GAAP between the United States and China. Id. ¶¶ 52-60. Pursuant to Chinese law, DYP's three subsidiaries filed financial statements for the fiscal years ended December 31, 2007, 2008, and 2009. Id. ¶ 64. These financial statements were audited by Chinese accounting firms in conformance with Chinese GAAP. Id. ¶ 51. Plaintiffs allege that since DYP's operations are run exclusively through the three subsidiaries, DYP's yearly revenue and cash totals could not possibly have been higher than the combined totals of its three subsidiaries. Id.
In November 2011, Plaintiffs successfully obtained translated copies of DYP's SAIC filings during the relevant period. Id. The SAIC filings allegedly revealed financial figures that were in stark contrast to the ones reported to the SEC. Id. ¶ 66. The information Plaintiffs obtained showed that DYP's aggregate revenue as reported to the SAIC for the entire calendar year ended December 31, 2007 was $575,000, as opposed to the $67.3 million in revenues reported to the SEC for the nine-month period ended December 31, 2007. Id. ¶ 67. While DYP reported having $7.8 million in cash as of June 30, 2007, the aggregate cash reported by DYP's subsidiaries in the SAIC filings as of December 31, 2007 was $8,000. Id. ¶ 68. The revenue that DYP reported to the SEC for the calendar year ended December 31, 2008 was $104.6 million. The aggregate of the revenue reported in each of the three subsidiaries' SAIC filings for calendar year ended December 31, 2008, however, was only $817,000. Id. ¶ 69. DYP stated to the SEC that it had $14.2 million in cash as of June 30, 2008. Id. ¶ 70. The cash reported by the three subsidiaries as of December 31, 2008 was $31,000. Id. DYP reported to the SEC total revenue for the first three quarters of calendar year ended December 31, 2009 of $76.9 million. Id. ¶ 71. The corresponding number in the three subsidiaries' SAIC filing for the entire calendar year ended December 31, 2009 was $398,000. Id. Finally, while DYP indicated that it had $31 million in cash as of June 30, 2009, the aggregate cash reported by the three subsidiaries to the SAIC as of December 31, 2009 was $146,000. Id. ¶ 74. The revenues and cash balances that DYP reported to the SEC were more than one hundred times greater than the revenues and cash balances reported to the SAIC. Id. ¶ 2.
III. Subsequent Events
On March 3, 2010, DYP dismissed Frazer and hired Deloitte as its new independent auditor. Id. ¶ 111. Six months later, on September 13, 2010, DYP announced through a press release that it had dismissed Deloitte after Deloitte expressed concern regarding the lack of access to DYP's financial records. Id. ¶ 112. After Deloitte was dismissed, DYP's CEO, Christopher Holbert, DYP's CFO, William Suh, and four directors of DYP's Board of Directors resigned over disagreements regarding Deloitte's dismissal. Id. ¶ 113. On September 20, 2010, Plaintiffs filed an initial complaint alleging that DYP, individual DYP defendants, and the Underwriters violated Section 10 of the Securities Exchange Act and Section 11 of the Securities Act, among other claims, for alleged misrepresentations made in connection with the IPO and other financial documents. Class Action Complaint (ECF No. 1), ¶ 3.
On September 13, 2010, DYP's stock declined more than 54%, by $3.60 per share. Id. ¶ 5. In November 2010, DYP disclosed that the SEC had initiated an investigation into whether DYP had committed fraud in the sale of it securities and lied to Deloitte, its external auditor. Id. ¶ 6. On March 28, 2011 the New York Stock Exchange delisted DYP's stock because DYP was at least six months delinquent in filing its Form 10-K. Id. ¶ 8. DYP's stock closed at $0.25 per share on February 15, 2012. Id. ¶ 9. On February 16, 2012, Plaintiffs filed an amended Consolidated Complaint, dropping its Section 10(b) claim against the Underwriters and adding Frazer as a defendant.
LEGAL STANDARD
To survive a motion to dismiss pursuant to Rule 12(b)(6), "a complaint must contain sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009) (quoting Bell Atl. Corp. v. Twombley, 550 U.S. 544, 570 (2007)). This standard is met "when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id. A court should not dismiss a complaint for failure to state a claim if the factual allegations sufficiently "raise a right to relief above the speculative level." Twombley, 550 U.S. at 555.
The task of the court in ruling on a motion to dismiss is to "assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof." In re Initial Pub. Offering Sec. Litig., 383 F. Supp. 2d 566, 574 (S.D.N.Y. 2005) (internal quotation marks and citation omitted). The court must accept all well-pleaded factual allegations in the complaint as true, and draw all reasonable inferences in the plaintiffs' favor. Chambers, 282 F.3d at 152. In deciding a motion to dismiss, the Court is not limited to the face of the complaint. The court "may [also] consider any written instrument attached to the complaint, statements or documents incorporated into the complaint by reference, legally required public disclosure documents filed with the SEC, and documents possessed by or known to the plaintiff and upon which it relied in bringing the suit." ATSI Commc'ns v. Shaar Fund. Ltd., 493 F.3d 87, 98 (2d Cir. 2007).
"Securities fraud claims are subject to heightened pleading requirements that the plaintiff must meet to survive a motion to dismiss." ATSI Commc'ns, 493 F.3d at 99. These requirements are set forth in Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act (the "PSLRA"). 15 U.S.C. §78u-4(b). Ordinarily, the rules of federal pleading usually require only "a short and plaint statement" of the plaintiffs' claim for relief. Fed. R. Civ. P. 8. However, averments of fraud must be "stated with particularity." Fed. R. Civ. P. 9(b). Rule 9(b) requires that a plaintiff: "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Rombach v. Chang, 355 F.3d 164, 170 (2d Cir. 2004) (internal citation omitted).
"The PSLRA expanded on Rule 9(b)'s requirements by mandating a uniform national pleading standard for securities fraud actions." In re Wachovia Equity Sec. Litig., 753 F. Supp. 2d 326, 347 (S.D.N.Y. 2011). Under this heightened pleading requirement, "any private securities complaint alleging that the defendant made a false or misleading statement must: (1) 'specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading,'"; and (2) "'state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind,'" Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 321 (2007) (internal citations omitted). "Therefore, while we normally draw reasonable inferences in the non-movant's favor on a motion to dismiss, the PSLRA establishes a more stringent rule for inferences involving scienter because the PSLRA requires particular allegations giving rise to a strong inference of scienter." ECA, Local 134 IBEW Joint Pension Trust of Chi. v. JP Morgan Chase Co., 553 F.3d 187, 196 (2d Cir. 2009) (internal quotations and citations omitted).
SECURITIES FRAUD CLAIMS
I. Section 10(b) Claim against Frazer
Section 10(b) makes it unlawful to "use or employ, in connection with the purchase or sale of any security... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b). SEC Rule 10b-5, 17 C.F.R. § 240.10b-5(b), states that it "shall be unlawful for any person...[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." To state a claim in a private action under Section 10(b) and Rule 10b-5, a plaintiff must allege: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission [or transaction causation]; and (5) economic loss; and (6) loss causation." Stoneridge Inv. Partners, L.L.C. v. Scientific-Atlanta, Inc., 552 U.S. 148, 157 (2008) (citing Dura Pharms., Inc. V. Broudo, 544 U.S. 336, 341-42 (2005)); Ganino v. Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000).
In the Consolidated Complaint, Plaintiffs allege Section 10(b) and Rule 10b-5 claims against the auditor defendant, Frazer, but not the Underwriters. While Frazer does not challenge reliance, economic loss, or loss causation, it contends that the Consolidated Complaint fails to identify a false or misleading statement or omission of material fact and fails to establish scienter.
A. False or Misleading Statements of Material Fact
"To state a § 10(b) claim against an issuer's accountant, a plaintiff must allege a misstatement that is attributed to the accountant 'at the time of its dissemination,' and cannot rely on the accountant's alleged assistance in the drafting or compilation of a filing." Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 153 (2d Cir. 2007) (quoting Wright v. Ernst & Young LLP, 152 F.3d 169, 174 (2d Cir. 1998)). A misstatement is actionable only if material, meaning "there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [act]." ECA, 553 F.3d at 197 (quoting Basic Inc. v. Levinson, 485 U.S. 224, 240 (1988)). If the statement is an opinion, it is actionable only if "the complaint alleges that the speaker did not truly have the opinion at the time it was issued." In re Lehman Bros. Sec. & ERISA Litig., 684 F.Supp.2d 485, 494 (S.D.N.Y. 2010) (citing Shields v. Citytrust Bancorp., 25 F.3d 1124, 1131 (2d Cir. 1994) ("A statement of reasons, opinion or belief by such a person when recommending a course of action to stockholders can be actionable under the securities laws if the speaker knows the statement to be false.") (internal citations omitted).
Plaintiffs only allege that Frazer's attestations in the auditor report to having performed its audit in accordance with PCAOB and GAAP are actionable misrepresentations because their audit was not conducted in accordance with GAAS. Auditor reports of GAAS compliance, however, are "inherently ... one[s] of opinion." In re Lehman Bros. Securities and ERISA Litigation, 799 F.Supp.2d 258, 302 (S.D.N.Y. 2011). Consequently, a "[plaintiff must] allege facts that, if true, would permit a conclusion that [the auditor] either did not in fact hold that opinion or knew that it had no reasonable basis for it." Id.
This approach was also adopted by the court in In re Longtop Fin. Technologies Ltd. Sec. Litig., 910 F. Supp. 2d 561 (S.D.N.Y. 2012).
Plaintiffs have not offered any facts to allege that Frazer had a subjective belief that its opinions were false. Similarly, they allege no facts to show that Frazer was aware, or should have been aware, of any wrongdoing by DYP at the time Frazer issued the audit report. Rather, Plaintiffs argue in a conclusory manner that Frazer must have known about the falsity of its remarks because it "could not possibly have believed it had conducted a GAAS compliant audit or that DYP's reported financial results complied with U.S. GAAP." Lead Plaintiffs' Memorandum of Law in Opposition to Frazer LLP's Motion to Dismiss, p. 2. This circular argument is built on the supposition that Frazer should have looked at the SAIC filings in China. However, nowhere do Plaintiffs cite to any authority imposing such a duty on Frazer. Plaintiffs do not allege that Defendant Frazer was aware of any discrepancies between the SAIC filings in China and the SEC filings so as to have actual or constructive knowledge that the audited numbers contained in the registration statement and prospectus were false. Thus, Plaintiffs have failed to demonstrate that Frazer either did not in fact hold the opinions stated in the auditor report, or that there was no reasonable basis for those opinions.
B. Scienter
To state a claim under Section 10(b) and Rule 10b-5, a plaintiff must plead, inter alia, that each defendant "acted with scienter, a mental state embracing intent to deceive, manipulate, or defraud." Tellabs, 551 U.S. at 319 (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-94 (1976)). A complaint will survive a motion to dismiss "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id. at 324. "[A] court must consider plausible, nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff." Id. at 323. At the motion to dismiss stage, the court must "consider the complaint in its entirety," inquiring "whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard." Id. at 323. A plaintiff can establish the requisite strong inference of scienter by alleging facts (1) showing that the defendants had both motive and opportunity to commit the fraud or (2) constituting strong circumstantial evidence of conscious misbehavior or recklessness. ATSI Commc'ns, 493 F.3d at 99; see also 15 U .S.C. § 78u-4(b)(2).
To raise a strong inference of scienter through motive and opportunity, Plaintiffs must allege that the defendants "benefitted in some concrete and personal way from the purported fraud". ECA, 553 F.3d at 198. None of Plaintiffs' allegations in the Consolidated Complaint satisfy the motive and opportunity prong. See, e.g., City of Austin Police Ret. Sys. .v. Kinross Gold Corp., No. 12 Civ. 1203, 2013 U.S. Dist. LEXIS 40523, at *40 (S.D.N.Y. Mar. 22, 2013); Rombach, 355 F.3d at 164 (scienter not sufficiently pled when "complaint identifies no personal interest sufficient to establish motive.").
1. Circumstantial evidence of conscious misbehavior or recklessness
"Recklessness in the scienter context cannot be merely enhanced negligence." ECA, 363 F.3d at 624. It is insufficient for a plaintiff to plead that a defendant simply "ought to have known" about the alleged fraud contained in the statements at issue. In re UBS, 2012 U.S. Dist. LEXIS 141449 at *43 (quoting Hart v. Internet Wire, Inc., 145 F. Supp. 2d 360, 368 (S.D.N.Y. 2001)) (internal quotation marks omitted). To successfully plead recklessness on the part of a non-fiduciary accountant, a plaintiff must allege that the auditor "approximate[d] an actual intent to aid in the fraud being perpetrated by the audited company." Rothman v. Gregor, 220 F.3d 81, 98 (2d. Cir 2000). Under this demanding standard, scienter is not sufficiently alleged simply because an audit failed to detect fraud. In re Advanced Battery Technologies, Inc. Sec. Litig., 2012 WL 3758085 at *16 (S.D.N.Y. 2012). Plaintiffs attempt to satisfy the scienter requirement against Frazer by alleging that Frazer was reckless as a result of: 1) failing to conduct the basic diligence GAAS requires; 2) the sheer magnitude of the fraud; and 3) ignoring various "red flags" which should have alerted it to fraud.
i. Plaintiffs' fail to demonstrate that Frazer failed to conduct the basic diligence GAAS requires in a manner that amounts to recklessness.
The crux of Plaintiffs' scienter allegations is premised on the assumption that Frazer had a duty to know about and/or review DYP's SAIC filings in China. Specifically, Plaintiffs argue that Frazer violated the Generally Accepted Auditing Standards (GAAS) because it failed to "obtain an understanding of relevant industry, regulatory, and other external factors [...] including the legal and political environment" and to read "public information about the company relevant to the likelihood of material financial statement misstatements." Lead Plaintiffs' Memorandum of Law in Opposition to Frazer LLP's Motion to Dismiss, p. 20 (citing Cons. Compl. ¶ 104, which in turn references GAAS Accounting Standard No. 12, ¶¶ 9, 11). Plaintiffs, however, do not articulate why Frazer should have had any reason to consider DYP's SAIC filings in China to be "relevant to the likelihood of material financial statement misstatements" in the United States.
While Plaintiffs argue that In re WorldCom, Inc. Sec. Litig., 2003 WL 21488087, at *7 (S.D.N.Y. June 25, 2003), is instructive in establishing scienter on Frazer's part, that case is readily distinguishable. Unlike in WorldCom, where the court found that auditor Arthur Andersen performed its audit recklessly because it failed in its duty to detect WorldCom's fraud despite improper internal accounting systems and lack of documentation, Plaintiffs here offer no argument to establish any duty Frazer may have had to review DYP's SAIC filings in China.
ii. The magnitude of DYP's alleged fraud does not demonstrate Frazer's recklessness.
Plaintiffs additionally argue that Frazer's failure to detect fraud of such a large magnitude provides circumstantial evidence of its recklessness. While the magnitude of the fraud can support an inference of scienter, a fraud's large size, standing alone, is insufficient to show recklessness. In re Longtop Fin. Technologies Ltd. Sec. Litig., 910 F. Supp. 2d 561 (S.D.N.Y. 2012)(citing Pennsylvania Public School Employees' Retirement System v. Bank of America Corp., 874 F.Supp.2d 341, 362-63 (S.D.N.Y.2012) (dismissing 10(b) claim on the basis that magnitude of fraud is insufficient to state a claim unless coupled with other "convincing allegations"). Here, Plaintiffs' argument that Frazer's scienter is established by the sheer size of DYP's alleged fraud, which was only fully revealed once Plaintiffs had analyzed the SAIC filings in China, is conclusory and unavailing.
iii. Plaintiffs' fail to demonstrate that Frazer ignored any actual red flags.
Plaintiffs' argument that Frazer ignored numerous auditor "red flags" is similarly unavailing. A "red flag" is a sign consciously disregarded by the auditor that "would place a reasonable auditor on notice that the audited company was engaging in wrongdoing to the detriment of its investors." In re IMAX Securities Litigation, 587 F. Supp. 2d 471, 483-84 (S.D.N.Y. 2008). For a red flag to support a strong inference of scienter, the auditor must have actually been aware of its existence. In re Advanced Battery Technologies, Inc. Sec. Litig., 2012 WL 3758085, at *16 (S.D.N.Y. 2012). "Merely alleging that the auditor had access to the information by which it could have discovered the fraud is not sufficient." IMAX, 587 F.Supp.2d at 484. In this case, Plaintiffs contend that Frazer ignored three red flags: (1) that there were vast discrepancies between DYP's SAIC and SEC filings with respect to its revenues and cash; (2) that DYP was involved in a "reverse merger" transaction prior to selling shares to investors; (3) that DYP possessed a complex ownership structure with operations spanning both China and the United States.
The Consolidated Complaint fails to allege that Frazer actually reviewed DYP's SAIC filings, was aware of the discrepancies between DYP's SAIC and SEC filings, or helped prepare the SAIC filings. "Merely alleging that an auditor had access to documents that reveal fraudulent financial reporting, and that the auditor 'should have' reviewed them, or 'would have' reviewed them if the auditor did its job properly, is not sufficient to plead the recklessness necessary to give rise to a strong inference of auditor scienter." In re Advanced Battery, 2012 WL 3758085, at *17 (internal citations omitted); see In re Philip Servs. Corp. Secs. Litig., 383 F. Supp. 2d at 475.
Plaintiffs' argument that Frazer's reverse merger transaction qualifies as a red flag because reverse mergers are "tactic[s] known to be utilized by companies seeking to avoid the regulatory scrutiny that accompanies the IPOs of brand new public companies" also fails. Lead Plaintiffs' Memorandum of Law in Opposition to Frazer LLP's Motion to Dismiss, p. 22. As Frazer correctly notes, this Court has previously determined that reverse mergers were not red flags at the time of audits between 2007 and 2009. See Advanced Battery at *21. Plaintiffs offer no contrary propositions from case law.
Likewise, Plaintiffs' contention that Frazer ignored a red flag apparent from DYP's "highly-complex ownership structure" is unconvincing. While it is unclear as to whether it is actually DYP's ownership, or the fact that DYP's operations are primarily based in China, or both, that Plaintiffs find suspicious, Plaintiffs again fail to offer any case law to support any of these arguments. As Frazer notes in its reply brief, if in fact it were true that having a complex ownership structure and/or primary offices in a foreign country amounted to red flags, the conduct of countless numbers of companies conducting business abroad through subsidiaries would be held in question. Taking into consideration the totality of the facts alleged to give rise to scienter, Plaintiffs failed to establish that Frazer was reckless in issuing its opinion regarding GAAP and PCAOB compliance in the auditor report.
II. Section 11 Claim against Frazer
A. Statute of Limitations
Claims brought pursuant to Section 11 of the Securities Act are governed by the one-year statute of limitations set out under Section 13. 15 U.S.C. § 77m; In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp. 2d 272, 285 (S.D.N.Y. 2009). A "duty of inquiry" is imposed on plaintiffs bringing a Section 11 claim. Jackson Nat'l Life Ins. Co. v. Merrill Lynch & Co., Inc., 32 F.3d 697, 701 (2d Cir. 1994). Thus, the limitations period begins to accrue once the plaintiff "obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge." Kahn v. Kohlberg, Kravis, Roberts & Co., 970 F.2d 1030, 1042 (2d Cir. 1992).
Whether or not a plaintiff is on inquiry notice can be objectively determined and resolved by a court as a matter of law. Dodds v. Cigna Securities, Inc., 12 F.3d 346, 350 (2d Cir. 1993). In making this determination, courts will examine "when the circumstances would suggest to an investor of ordinary intelligence the probability" that a cause of action exists. Staehr v. Hartford Fin. Sevs. Grp., 547 F.3d 406, 427 (citation omitted). Such circumstances, also known as "storm warnings", must "relate[] directly to the misrepresentations and omissions the [plaintiffs] later allege in their action against the defendants." Newman v. Warnaco Grp., Inc., 335 F.3d 187, 193 (2d. Cir 2003).
While Plaintiffs filed their original complaint alleging securities fraud and Section 11 liability against DYP and the Underwriters in September of 2010, Frazer was served only after it was added as a defendant in the case in the amended Consolidated Complaint on February 23, 2012. Plaintiffs allege that their Section 11 claim against Frazer was timely because it was brought within one year of discovering Frazer's specific misconduct, which was discovered after all three of the DYP subsidiaries' SAIC filings were obtained and translated. However, Plaintiffs were aware that Frazer was acting as DYP's accountant during the years preceding 2010, and had in fact attested to the accuracy of DYP's financial statements in a report submitted with DYP's registration statement and prospectus. Given the nature of the allegations against DYP and the Underwriters in the original complaint, Plaintiffs were at least placed on inquiry notice with respect to Frazer's potential misconduct as well. Moreover, Plaintiffs fail to state why the information they uncovered in the SAIC filings was not information that they could have, with reasonable diligence uncovered earlier, before the statute of limitations had run. Plaintiffs' Section 11 claim against Frazer is thus time-barred.
III. Section 11 Claim against the Underwriters
An underwriter may be held liable under Section 11 of the Securities Act if "any part of the registration statement, when such became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a). To withstand a motion to dismiss under Section 11, the plaintiff must allege that:
(1) [it] purchased a registered security either directly from the issuer or in the aftermarket following the offering; (2) the defendant participated in the offering in a manner sufficient to give rise to liability under section 11; and (3) the registration statement "contained an untrue statement of a material fact or omitted to state a material fact required to make the statements therein not misleading."In re Morgan Stanley Info. Fund. Sec. Litig., 592 F.3d 347, 358-59 (2d Cir. 2010) (citing 15 U.S.C. § 77k(a)).
A. Standing - Traceability
"[A]n action under § 11 may be maintained 'only by one who comes within a narrow class of persons, i.e. those who purchased securities that are the direct subject of the prospectus and registration statement.'" Barnes v. Osofsky, 373 F.2d 269, 273 (2d Cir. 1967) (citing Fischman v. Raytheon Mfg. Co., 9 F.R.D. 707 (S.D.N.Y. 1949). However, "modern market conditions may have made the tracing requirement obsolete." In re Global Crossing, Ltd. Sec. Litig., 313 F. Supp. 2d 189, 208 (S.D.N.Y. 2003); see Barnes, 373 F.2d at 273. "In a world in which the 'shares' purchased by a stockholder might be merely electronic entries in a brokerage firms' books, tracing may be impracticable". In re Global Crossing, 313 F. Supp. 2d at 208.
For these reasons, the pleading requirement is not elaborate. Plaintiffs have not been required to explain how their shares can be traced; general allegations that plaintiff purchased "pursuant to" or traceable to [a] false registration statement have been held sufficient to state a claim.Id. (internal citations omitted).
The Second Circuit has explicitly held that "aftermarket purchasers who can trace their shares to an allegedly misleading registration statement have standing to sue under §11 of the 1933 Act." Demaria v. Andersen, 318 F.3d 170, 178 (2d Cir. 2003). Thus, Plaintiffs who assert standing on the basis of having purchased shares "issued pursuant to, or "traceable to" the public offerings when such securities were purchased in an aftermarket rather than in the initial IPO are not foreclosed from bringing a claim under the Securities Act. In re: WRT Energy Sec. Litig., 75 F. Appx. 839 (2d Cir. 2003).
Here, only one effective registration statement was issued on behalf of DYP: the one issued in connection with the November 6, 2009 IPO. The primary source of contention between Plaintiffs and the Underwriters with respect to traceability is the existence and nature of any outstanding unregistered shares at the time Plaintiffs bought their shares in the aftermarket. Citing DYP's prospectus, the Underwriters note that "approximately 7,677,080 common shares, including the 6,455,918 common shares sold in the offering [will] be freely tradeable, without restriction, in the public market." Mitnick Dec. Ex. A, at 35. Therefore, the Underwriters argue, DYP had outstanding shares of freely tradable DYP common stock at the time of the IPO. Plaintiffs, however, contend that all 31,375,500 outstanding common shares were registered pursuant to DYP's IPO. Lead Plaintiffs' Memorandum of Law in Opposition to Piper Jaffray & Co. and Roth Capital Partners' Motion to Dismiss, p. 8.
[P]rior to the offering, there was no market for DYP's shares and certain private placement investors had been eagerly awaiting the registration of their shares, via an effective Registration Statement filed with the SEC, so that their shares could be publicly traded. The Underwriters' argument misreads the cited paragraph; it does not indicate that there were any "already outstanding, freely tradable shares of DYP common stock in the open market." To the contrary, it states that "after this offering," 23,697,970 shares cannot be traded for 180 days but that 7,677,080 shares "will be freely tradable, without restriction, in the public market." [...] Therefore, all investors in the open market - whether their shares are traced to the 6,455,918 offered on November 6, 2009, to the 1,221,162 previously-issued shares freely tradable after to the IPO, or to the 23,697,970 shares tradable after the 180-day lock-up agreements - can trace their purchases to shares registered by the one and only Registration Statement.Id. at 9-10.
Unlike the related case, Li v. Duoyuan Global Water, Inc., No. 10-CV-7233, 2012 WL 3647043 (S.D.N.Y. 2012), DYP issued only one registration statement here, under which, as Plaintiffs allege, all previously outstanding shares were registered. While establishing traceability may impose a greater burden upon Plaintiffs at a later stage in the proceedings, Plaintiffs have adequately alleged that they purchased securities that are the direct subject of the only registration statement at issue in this case.
B. Material Misrepresentation or Omission
"'To prevail on a § 11 [] claim, a plaintiff must show that the relevant communication either misstated or omitted a material fact.'" Fait v. Regions Financial Corp., 655 F.3d 105, 109 (2d Cir. 2011) (quoting Iowa Pub. Emps'. Ret. Sys. V. MF Global, Ltd., 620 F.3d 137, 141 (2d Cir. 2010)). Under Section 11, a misrepresentation of fact is material if "an investor would attach importance to it in making an investment decision." In re APAC Teleservice, Inc. Sec. Litig., 1999 WL 1052004 *9 (S.D.N.Y. 1999).
Plaintiffs allege that the Underwriters are liable under § 11 of the Securities Act as a result of their role in underwriting DYP's registration statement and prospectus, which grossly overstated its revenue and cash. Specifically, the IPO documents:
reported Company revenues of $67.3 million for the nine-month period ended December 31, 2007 and cash of $7.8 million as of June 30, 2007; revenues of $104.6 million for the calendar year ended December 31, 2008 and cash of $14.2 million as of June 30, 2008; and revenues of $76.9 million for the first three quarters of calendar year ended December 31, 2009 and cash of $31 million as of June 30, 2009.Cons. Compl., ¶ 37. DYP's subsidiaries, however, reported to the SAIC revenues of $575,000 and cash of $8,000 in 2007; revenues of $817,000 and cash of $31,000 for 2008; and in 2009, DYP reported $398,000 in revenues and $146,000 in cash. Plaintiffs point to the discrepancies between filings made with the SAIC and the SEC as evidence to demonstrate that the IPO documents contained material misstatements. Plaintiffs claim that in preparing and disseminating the Company's prospectus that included grossly inflated financial results, the Underwriter Defendants are liable as such a misstatement is material. Cons. Compl., ¶ 3.
While the arguments in the Underwriters' motion to dismiss with respect to the Section 11 claim focuses on traceability, the Underwriters also adopt the arguments in Defendant DYP's mooted motion to dismiss. Therefore, the Court additionally considers the claim that the differences in the SAIC filing and SEC filings are a result of differences in U.S. GAAP and Chinese GAAP. Although Plaintiffs here have not proven that the SEC filings were in fact false, as this Court found in Ho v. Duoyuan Global Water, "the extreme discrepancies alleged in the financial report coupled with the logical inference that can be made regarding these figures, at this stage of the proceedings, sufficiently alleges that the statements made in the SEC filings are false." 887 F.Supp.2d at 568. Thus, Plaintiffs have sufficiently pleaded a valid Section 11 claim against the Underwriters, and successfully withstand a motion to dismiss this claim.
IV. Section 12(a)(2) Claim against the Underwriters
Section 12(a)(2) provides a cause of action where securities were sold using prospectuses or oral communications containing material misstatements or omissions. See 15 U .S.C. §§ 771(a)(2); see also In re Morgan Stanley, 592 F.3d at 359. To plead a claim under Section 12(a)(2), the plaintiff must allege that (1) the defendant is a "statutory seller"; (2) the sale was effected by means of a prospectus or oral communication; and (3) the prospectus or oral communication contained a material misstatement or omission. Id.
A. Standing - Statutory Seller
A plaintiff has standing to bring a Section 12 claim only against a "statutory seller". In re IndyMac Mortgage-Backed Sec. Litig., 718 F. Supp. 2d 495, 501-02 (S.D.N.Y. 2010) (citing Akerman v. Oryx Commc'ns, Inc., 810 F.2d 336, 355 (2d Cir. 1987). An individual qualifies as a "statutory seller" if he: (1) "passed title, or other interest in the security, to the buyer for value," or (2) "successfully solicit[ed] the purchase [of a security], motivated at least in part by a desire to serve his own financial interests or those of the securities ['] owner." Pinter v. Dahl, 486 U.S. 622, 642; 647 (1988); see also Capri v. Murphy, 856 F.2d 473, 478 (2d Cir. 1988). Thus, "privity between the buyer and seller is no longer required," and those who solicit sales in question for financial gain will be liable as statutory sellers under Section 12. Commercial Union Assur. Co. v. Milken, 17 F.3d 608, 616 (2d Cir. 1994).
Plaintiffs allege that the Underwriters assisted in the preparation and dissemination of the IPO materials. While none of the Plaintiffs have alleged that they purchased shares of DYP directly from either Piper Jaffray or Roth Capital, courts within the Second Circuit do not require that the putative class representative identify the specific underwriter from which it purchased shares as long as the allegations are sufficient. See In re Worldcom, Inc. Securities Litigation, 294 F. Supp. 2d 392, 423 (S.D.N.Y. 2003). See also In re IndyMac Mortgage-Backed Sec. Litig., 718 F.Supp. 2d 495, 502 (S.D.N.Y. 2010) (finding that Plaintiffs had sufficiently pleaded standing under 12(a)(2) due to allegations that Underwriters solicited, sold and distributed a specific number of certificates on specific dates, and that they had done so for their own personal gain). Plaintiffs here allege that Piper Jaffray sold 3,873,551 of the total number of shares in the Offering and that Roth Capital sold the remaining 2,582,367 shares. Cons. Comp., ¶¶28-29. They have also alleged that the Underwriters negotiated the IPO price, controlled the contents and dissemination of the Registration Statement and Prospectus, and offered to engage in transactions to stabilize, maintain or otherwise affect the price of the common shares during and after the offering. Memo. of Law in Opp'n. of Mot. to Dismiss, Jan. 11, 2013, ECF No. 101, 2. As a result of selling the DYP shares in conjunction with the IPO, each Underwriter received approximately four million dollars. Plaintiffs have thus met their burden at this stage in alleging that both Defendants Piper Jaffray and Roth Capital qualify as statutory sellers.
CONCLUSION
The Underwriters' motion to dismiss (ECF No. 89) is DENIED. The auditor Defendant Frazer's motion to dismiss (ECF No. 92) is GRANTED. Dated: August 22, 2013
The Clerk of Court is directed to close DYP's motion to dismiss (ECF No. 86).
New York, New York
SO ORDERED:
/s/_________
GEORGE B. DANIELS
United States District Judge