The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

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For reasons I am sure they find good and sufficient, Chinese companies have been seeking listings on the U.S. securities exchanges. The Chinese companies (or at least some of them) have also been discovering an added side-effect of a U.S. listing – that is, exposure to a class action lawsuit under the U.S. securities laws.

The latest Chinese company to be sued is RINO International Corporation, which has its headquarters in Dalian, in China’s Liaoning province. As reflected in their November 15, 2010 press release (here), plaintiffs’ lawyers have filed a complaint against the company and certain of its directors and officers in the Central District of California.

The complaint (which can be found here) alleges that in RINO's SEC filed annual report for fiscal 2009, RINO reported $193 million of revenue, but in the annual report RINO filed for 2009 with the China State Administration for Industry and Commerce, it reported only $11 million of revenue. This discrepancy, "along with other accounting inconsistencies and questionable transactions between RINO and its management, has raised red flags and prompted an internal review."

RINO joins a growing list of Chinese companies that have been named as defendants in securities class action lawsuits in the U.S. in 2010. There have been as many as 14 new securities class action lawsuits filed against foreign domiciled in 2010 (out of a total of about 154 new lawsuits filed this year), but seven of the 14 (including the new lawsuit against RINO) involve Chinese companies.

The other six Chinese companies to be sued are Fuqi International (about which refer here), China Natural Gas (here), China-Biotics (here), Duoyuan Printing (here), Duoyuan Global Water (here), and China Green Agriculture (here). Interestingly six of the seven have been filed just since the last week of August 2010, all of which of course were filed after the U.S. Supreme Court’s decision in the Morrison case (about which refer here), which seemingly narrowed the range of foreign-domiciled companies U.S. private securities litigation exposure.

Taken collectively, these lawsuits could be interpreted to suggest that at least some Chinese companies have experienced some difficulties adapting to the burdens and responsibilities involved with a U.S. listing.

But there seems to be more going on here that just that. A review of the basic allegations in these cases suggests a common thread among at least some of the cases. In three of the cases – the ones involving China-Biotics, China Green Agriculture, and RINO – the allegation is that the companies reported different revenue and other financial information to the Chinese authorities than they reported in the SEC filings.

One might conjecture on the possible reasons why these companies might have reported different figures to their domestic authorities than they did in their SEC filings. For example, the companies might have been seeking to avoid domestic tax liabilities. (Of course, there is always the possibility that the differences in the reports are attributable to differing reporting conventions, but you would think that it that were the explanation, that would be disclosed in their SEC filings.) These companies’ reporting discrepancies are more than a little bit puzzling, as it seems probable that the differences would be detected, given the public availability of the SEC filings.

It probably should be added that while the recent upsurge in new lawsuit filings against Chinese companies is unquestionably noteworthy, this observation should also be put in context. According to news reports, 226 Chinese companies are currently listed on the NYSE, AMEX and NASDAQ. In the context of these 226 Chinese companies whose securities trade in the U.S., the seven securities lawsuits this year involving Chinese companies may appear less significant.

Nevertheless, when you have multiple companies domiciled in a single country outside the U.S. being sued in securities class action lawsuits over the course of just a few weeks, the phenomenon seems worthy of note.

Indeed, though the number of Chinese listings has continued to surge, questions about the listed companies have also followed, as for example in the August 26, 2010 Barron’s article "Beware This Chinese Export" (here). The Barron’s article particularly warns about Chinese companies that achieve their U.S. listing through a reverse merger with a domestic shell company. Among other things the article notes that:

The group has been a minefield of revenue disappointments and earnings restatements. Financial filings the companies make with the Securities and Exchange Commission often diverge from those filed with the Chinese government—by drastic amounts. Investor and analyst visits to corporate facilities in China reveal operations smaller and less impressive than shown in U.S. presentations. The companies too often select auditors who have previously signed off on the financials of companies that turned out to be busts. Some companies' securities filings don't disclose the involvement of promoters in China or the U.S., who …have disquieting track records in the stock market.

Similar concerns prompted the PCAOB to issue a July 12, 2010 warning about accounting practices associated with these Chinese companies, particularly those whose U.S. listing originated with a reverse merger. Securities analysts have expressed a certain wariness of these U.S. listed Chinese companies as well.

Given these concerns, it probably comes as no surprise that litigation has arisen. The likelihood seems to be that more securities suits involving Chinese companies will follow.