During the period 2010 to 2012, plaintiffs’ lawyers rushed to file a wave of securities suits against U.S.-listed Chinese companies. In general, the cases filed as part of this wave that have reached the settlement stage have settled for relatively modest amounts. However, at least one of these cases has now resulted in an absolutely eye-popping damages award.
On November 14, 2013, Southern District of New York Judge Shira Scheindlin entered a default judgment order including a damages award of $882.3 million against Longtop Financial Technologies Ltd. and its former CEO, Wai Chau Lin. A copy of the order can be found here. However, as impressive as the size of this award is, the plaintiffs now have to try to enforce the judgment against the company and former CEO, both of whom are located in China and both of whom already proved elusive for purposes of service of process.
Unlike many of U.S.-listed Chinese companies, Longtop Financial did not obtain its U.S. listing through a reverse merger, but instead it became a public company through a conventional IPO in 2007. Its shares traded on the NYSE. At one point, its market capitalization exceeded $1 billion. Questions bgan to dog the company when Citron Research published an April 26, 2011 online report critical of the company. Among other things, the report questioned the company’s “unconventional staffing model,” alleged prior undisclosed “misdeeds” involving management, and referenced “non-transparent” stock transactions involving the company’s chairman, among other things. Other critical research coverage followed.
Longtop’s problems took another turn for the worse in May 2011 when, in advance of the high profile IPO of Chinese social networking company, Renren Network, Longtop’s CFO, who sat on Renren’s board as chair of the audit committee, resigned to prevent the questions at Longtop from affecting Renren’s IPO.
Then on May 23, 2011, in a filing with the SEC on Form 8-K, the company announced that both its CFO and its outside auditor, Deloitte Touche Tomatsu (DTT) had resigned. In its accompanying press release (here), the company said that DTT stated that it in its May 22, 2011 letter of resignation that it was resigning as a result of, among other things,
(1) the recently identified falsity of the Company’s financial records in relation to cash at bank and loan balances (and possibly in sales revenue); (2) the deliberate interference by certain members of Longtop management in DTT’s audit process; and (3) the unlawful detention of DTT’s audit files.
DTT further stated that it was “no longer able to rely on management’s representation’s in relation to prior period financial reports, and that continued reliance should no longer be place on DTT’s audit reports on the previous financial statements.”
Securities class action lawsuits followed. The actions were consolidated before Judge Scheindlin in the Southern District of New York. The defendants in the lawsuits included the company, certain of its directors and officers (including the company’s former CFO, Derek Palaschuk) and Deloitte Touche Tohmatsu.
In her November 14 order, Judge Scheindlin reviewed the plaintiffs’ efforts to effect service of process on the company and on Wai Chau Lin, the company’s former CEO. In December 2011, the plaintiffs served the company with a copy of the complaint in English and simplified Chinese through its registered agent for service of process in the United States.
The plaintiffs first attempted to serve Lin with the summons and complaint pursuant to the Hague Convention on Service Abroad. However, this attempt proved unsuccessful as the service papers were returned in March 2013.after a Chinese government bureau reported that it had “failed to find the charge person and nobody came to the court to take documents.” Judge Scheindlin separately authorized the plaintiffs to serve Lin via email. The plaintiffs subsequently filed proof of service on Lin via email.
Both the company and Lin failed to appear or otherwise respond to the complaint. After the time to respond had elapsed, the clerk of court entered defaults against the company and the two defendants. The plaintiffs then moved for entry of default judgment, including in their motion an expert report on damages supporting a damages claim of $882.3 million. On November 14, 2013, Judge Scheindin entered a default judgment against the Company and Lin, in the form and amount the plaintiffs had requested.
The default judgment order finds the company and Lin jointly and severally liable for the damages amount of $882.3 million plus prejudgment interest of 9% from February 21, 2008 to the date of payment.
While the amount of the damages award is impressive, the question remains of how valuable the order will prove to be. The likelihood that a Chinese court would recognize and enforce the judgment, and that the plaintiffs could find assets of the company or Lin to satisfy the award, is remote.
The plaintiffs’ hopes that they might be able to extract some recovery from the Deloitte affiliate that acted as Longtop’s auditor were dashed in April 2013, when Judge Scheindlin dismissed the last of the remaining claims against the audit firm.
The one remaining defendant that plaintiffs have in their sights is the former CFO, Derek Palaschuk, whom the plaintiffs were able to serve in Canada in 2012 and who filed a motion to dismiss the plaintiffs’ claims against him. In a June 29, 2012 opinion (here), Judge Scheindlin, though acknowledging that the online research reports may well have been biased owing to the online analysts’ financial interests as short sellers of Longtop’s stock, nonetheless rejected Palaschuk’s motion. Among other things, she found that the plaintiffs had sufficiently alleged that in various company press release and financial filings, Palaschuk had made misleading statements about the company’s financial condition and the basis for its growth.
In her November 14 order, Judge Scheindlin retained jurisdiction over the action for purposes of the plaintiffs’ ongoing case against Palaschuk.
As impressive as the size of the damages award against the company and Lin may be, it also illustrates the problem that the plaintiffs in these cases face. The plaintiffs face enormous procedural challenges just trying to prosecute these actions in the ordinary course; routine procedures as basic as service of process may present insurmountable obstacles. The prospects for effecting a recovery may be remote.
Though a number of plaintiffs’ firms rushed to file the various cases against U.S.-listed Chinese companies between 2012 and 2012, many of these cases seem unlikely to moneymakers for the plaintiffs. Even large awards like the one Judge Scheindin entered here may prove to represent empty victories.