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

Citing the “obvious magnitude” of the Libor-related antitrust litigation, Southern District of New York Judge Naomi Reice Buchwald has given the plaintiffs leave to attempt to amend their complaints to address the shortcomings that previously led her to grant the defendants’ motion to dismiss. Judge Buchwald granted the plaintiffs’ request for leave to file a motion to amend in a short May 3, 2013 order, a copy of which can be found here.

As detailed here, on March 29 2013, Judge Buchwald, in a ruling that she acknowledged at the time might be “unexpected,” granted the Libor benchmark- setting banks’ motions to dismiss the plaintiffs’ consolidated antitrust and RICO claims. In her massive 161-page opinion, Judge Buchwald held that the plaintiffs had failed to allege “antitrust injury” – that is, that the injury of which the plaintiffs’ complain was the result of the defendants’ anti-competitive conduct. Judge Buchwald dismissed the antitrust claims with prejudice.

Following her March 29 ruling, various groups of plaintiffs petitioned Judge Buchwald to try to obtain leave to amend their complaints. In her May 3 order, Judge Buchwald expressed skepticism that the plaintiffs could amend their pleadings sufficiently in order to address the concerns that led her to grant to the motion to dismiss. She noted that “although plaintiffs have described the allegations that they intend to add in their second amended complaint with regard to the issue of antitrust injury, we are inclined to think that none of these proposed allegations would change the outcome reached in our Memorandum and Order.”

Judge Buchwald cited a number of factors in support of her skepticism that the plaintiffs would be able to overcome the shortcomings of their prior complaints. First, she noted that as a result of the procedural history of the consolidated case and the revelations of the various regulatory investigations, the plaintiffs have in effect already effectively had opportunities to amend their pleadings. In addition, she noted that “plaintiffs have long been on notice that antitrust injury would be an important issue in this case,” adding that “plaintiffs never specifically argued, until after we issued our Memorandum and Order, that they would be able to satisfy the requirements for antitrust injury through additional allegations.”

Despite her skepticism that the plaintiffs will be able to address the antitrust injury issue in their amended pleadings, she nevertheless granted the plaintiffs leave to file a motion to amend and a proposed amended complaint. She added that “given the obvious magnitude f this litigation, we intend to proceed deliberately in evaluating plaintiffs’ request.”   However, in light of her concerns, as well as the “comprehensive manner” of her prior ruling and “the tremendous amount of resources already expended by defendants,” she said that she will review the proposed amended complaint prior to requiring the defendants to respond to any motion for leave to amend. Judge Buchwald allowed the plaintiffs two weeks in which to file a motion to amend, to which they must attach their proposed amended complaint.

Judge Buchwald’s May 3 order also addresses a number of other requests that other litigants have raised. Several of the defendants had sought to have her reconsider her denial of the motion to dismiss the exchange-based plaintiffs’ Commodity Exchange Act claims. Without ruling on the motion for reconsideration, she requested the parties to confer “regarding whether the exchange-based plaintiffs will be able to adequately allege their CEA claims against each moving defendant in a second amended complaint, in light of our rulings in our Memorandum and Order.”

In light of these other rulings, Judge Buchwald declined the request of several parties to lift the stay that has remained in place. She also decline to rule on the exchange-based plaintiffs’ request for leave to seek an interlocutory appeal, asking for additional briefing on the issue.

As a result of their efforts, the plaintiffs have at least managed to obtain leave to file a motion to amend. On the other hand Judge Buchwald gave them little reason from which to hope that they might overcome her concerns about their prior allegations. Indeed, among the possible outcomes is that Judge Buchwald could simply deny their motion for leave to amend. Nevertheless, Judge Buchwald’s May 3 ruling does raise the possibility, no matter how slight, that the antitrust allegations in the Libor-scandal might go forward after all.

Motion to Dismiss Granted in Securities Suit Against U.S.-Listed Chinese Company: In a May 6, 2013 order, Southern District of New York Judge Katherine B. Forrest granted the motion of China National Offshore Oil Co. (CNOOC) Limited, a U.S.-listed Chinese petroleum company, to dismiss the securities suit pending against the company. (The plaintiffs had previously voluntarily dismissed the claims they had filed against certain individual plaintiffs.) A copy of Judge Forrest’s May 6 order can be found here.

As discussed here, the plaintiffs filed their action in February 2012, alleging that the company had initially failed to disclose and then later down played two oil spills at the company’s production facilities in Bohai Bay. The company moved to dismiss the plaintiffs’ complaint.

Judge Forrest granted the defendants’ motion to dismiss, finding that the plaintiffs’ allegation were “insufficient to support a plausible inference of scienter.” In reaching this conclusion, she observed that “quite simply, there is not a single allegation in the complaint specifically identifying any information known to CNOOC at the time CNOOC made any of its allegedly false statements undermining the accuracy of those statements in any way.” Judge Forrest granted the motion to dismiss with prejudice.

Now This:  The most interesting Muppet in the world. (Hat tip to Cheezburger.com)

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In what is as far as I know the first determination of liability in connection with the recent wave of litigation filed against U.S. listed Chinese companies, a Hong Kong-based arbitration panel has entered an award in favor of an investment unit of C.V. Starr of over $77 million against China MediaExpress Holdings and related persons and entities, based on the panel’s determination that the company was a “fraudulent enterprise.” The panel’s December 19, 2012 award, which can be found here, makes for fascinating reading. (Hat tip to Jan Wolfe, who reported the award and related U.S.-court filings in a January 16, 2013 Am Law Litigation Daily article, here.)

In October 2010, China MediaExpress obtained a U.S. listing through a reverse merger with a U.S. listed publicly traded shell corporation. Prior to the reverse merger, the predecessor entity was owned by Zeng Cheng (“Cheng”) and Ou Wen Lin and Lin’s brother. China MediaExpress allegedly was in the business of providing advertising on inter-city busses. The company’s financial statements showed growing profits and large cash reserves. Starr invested a total of $53.4 million in China MediaExpress in two private transactions in January 2010 and October 2010. 

In early 2011, online analysts published reports questioning China MediaExpress’s financial statements. Shortly thereafter, China MediaExpress’s auditor and CFO resigned, as well as members of its board of directors. (Refer here for background.) Trading in China MediaExpress’s shares was halted. Pursuant to provisions in its stock purchase agreements with China MediaExpress, Starr initiated two Hong Kong arbitration proceedings against China MediaExpress, as well as Cheng, the Lin brothers and related entities. Separately, Starr initiated a securities fraud class action against China MediaExpress, its principals and related entities, and the company’s auditor in the District Court of Delaware. (In addition, certain other shareholders separately filed a securities class action lawsuit against China Media Express in the Southern District of New York, about which refer here.)

The arbitration panel, which was chaired by former Delaware Supreme Court Justice Andrew Moore II, heard evidence in the two consolidated arbitrations in May 2012. On December 19, 2012, the panel delivered its Award.  A copy of the arbitration award was filed in the District of Delaware lawsuit on January 13, 2013 (refer here).

The 49-page award makes for some fascinating reading. Among other things, the panel concluded that the company was “a fraudulent enterprise that caused Starr to lose the total value of its investment.” Cheng, the panel concluded, has “no credibility whatsoever”. Ou Wen gave the impression on the witness stand that “he would say whatever he thought would advance his case.” 

Among many things that troubled the panel was what had happened to the supposedly thriving business that had been represented to Starr. The company attempted to argue that the business had been destroyed by short sellers, a contention the panel described as “ridiculous,” observing that:

To put it bluntly, this claim of Cheng and CME that short sellers destroyed his business is nonsense. It is a fabrication evidently designed to hide the fact that CME never had the business it represented to the world that it had or that, if it did, it has been ravished by dishonest conduct on the part of those who conducted the business. Coupled with the conduct when challenged with the matters raised by [the company’s auditors] and other matters, Cheng’s claim that the short sellers destroyed his business indicates that Starr was correct with it contended that CME was a fraudulent enterprise.

The one specific transaction Cheng offered to explain what happened to all of the cash that the company had reported on its balance sheet was “a land transaction at Shoushan Waterfall.” However, the “evidence concerning this transaction was so implausible and contradictory that it is impossible to accept his claim that any money invested in that transaction was for the benefit of CME and its shareholders even if money of CME was used to finance this transaction.” Overall, the evidence Cheng offered regarding this transaction (which had not been approved by the Board or reported to shareholders and involved a company in which Cheng had an ownership interest) established that Cheng was “in breach of his fiduciary duty.” The evidence concerning the transaction “simply reinforces the conclusion that Cheng was both an unreliable witness and a dishonest businessman.”

As Jonathan Weil said in his January 11, 2013 Bloomberg column about the latest accounting scandal involving a Chinese company, “Chinese stocks may not make for trustworthy investments, but they sure can be entertaining to watch from a distance.”

The arbitration panel’s award represents a devastating judgment against China MediaExpress and its key officials. It remains to be seen how Starr will be able to use this judgment in its separate U.S. securities fraud suit and whether it will be able to collect on the Hong Kong panel’s award. It will also be interesting to see what the claimants in the separate securities class action lawsuit will be able to make of the arbitration award. On the one hand, the panel’s brutally worded conclusions about the company and its principals are damning. On the other hand, the issue preclusive effect of these determinations in separate proceedings involving separate parties and separate evidentiary standards is the kind of thing good lawyers could argue about for a long time.

In any event, whatever the ultimate effect of the arbitration’s panel’s determinations may prove to be, the fact is that, according a statement by Starr’s lawyer quoted in the Am Law Litigation Daily article linked above, the panel’s ruling represents the “first time any of these issues concerning Chinese reverse mergers have been adjudicated.” The implication for other companies involved in these cases – many of which involve allegations even more sensational than were raised here – is ominous.

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On August 24, 2012, in a decision involving a U.S.-listed Chinese company that is of particular interest because of the significance the court attached to the discrepancies between financial figures the defendant company reported to the Chinese government and the figures it reported to the SEC, Southern District of New York Judge George Daniels denied in part the motions to dismiss of the company and two of its senior officials. He did grant the dismissal motions of the company’s outside auditor and principal outside investor, as well as the control person allegations against the company’s directors. A copy of Judge Daniels opinion can be found here.

Background

Duoyuan Global Water (DGW) listed its American Depositary Shares on the NYSE through a June 24, 2009 IPO. In its initial reports following the IPO, DGW reported positive financial results. The first indication of trouble arose when accounting concerns surfaced concerning a separate but affiliated company Duoyuan Printing (which is itself now the subject of a separate securities suit, refer here). Because of the close relationship between the companies (they operate in the same location, and have the same Chairman, among other things), questions arose about DGW. In September 2010, the board’s audit committee retained Skadden Arps to review DGW’s accounting.

In April 2011, an online report critical of DGW appeared on the Muddy Waters research analysis website. Among other things, the report accused DGW of replacing the 2009 report to the Chinese State Administration for Industry and Commerce (SAIC) with a forged version to cover up the fact that revenues had been “astronomically inflated.” That same day the company’s CFO resigned. Shortly thereafter, four members of the board resigned to protest the lack of access that Skadden was being given to company documents. Skadden withdrew its representation as well. As detailed here, securities litigation ensured.

The plaintiffs based their allegations that the company’s IPO documents and subsequent filings contained financial misrepresentations were based largely on discrepancies between financial figures that two of DGW’s subsidiaries had reported in China to the SAIC and figures the company reported in its SEC filings. The plaintiffs also alleged other misrepresentations, including alleged misstatements concerning the number DGW’s distributors and the number of its employees. The plaintiffs asserted claims under both Section 11 of the ’33 Act and Section 10(b) of the ’34 Act. The defendants moved to dismiss.

The August 24 Opinion

In his August 24 opinion, Judge Daniels granted the plaintiffs’ motions to dismiss as to a number of the alleged misrepresentations on which the plaintiffs sought to rely, including the allegations concerning the number of distributors and the number of employees. He denied the motions of the company and its CEO and CFO to dismiss with respect to plaintiffs’ claims of financial misrepresentation based on the discrepancies between the company’s reports to the SAIC and its reports to the SEC.

The defendants had argued that the discrepancy in figures did not mean that the SEC reports were false or misleading, particularly given that the SAIC reports were separately filed by each of two of DGW’s Chinese subsidiaries and the SEC reports were consolidated, and given the difference s between accounting conventions involved in the different reporting protocols.

Judge Daniels found that:

Although Plaintiffs have not proven that the filings were in fact false, the extreme discrepancies alleged in the financial reports, 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. Defendants merely maintaining that the discrepancies are explainable is an insufficient reason to discredit the [amended complaint]. Assuming that that the SAIC filings are true, the CAC states sufficiently that the SEC filings are false. Based on the fact that DGW had more negative disclosures in China and positive disclosures with the SEC, the reasonable conclusion is that there is a fraudulent motive to overstate the numbers yet no fraudulent motive to understate them.

In concluding that the plaintiffs’ allegations in this respect were sufficient not only for purposes of their Section 11 claims but also with regard to their Section 10(b) claims, Judge Daniels further concluded that the plaintiffs had satisfactorily alleged scienter.

In reaching this conclusion, he noted that the company’s CEO and CFO respectively “knew or should have known that the U.S. reported revenues, operating income and net income were much greater than those in the SAIC filings.” In response to the defense objection that the plaintiffs’ have not alleged that the CEO and CFO even had access to the SAIC reports that DGW’s Chinese subsidiaries had filed, Judge Daniels noted that the two officers “were CEO and CFO of a multinational corporation, and as such, were required to be aware of the Company’s financials.”

Judge Daniels noted further that in addition to the two officials’ “executive positions and the large discrepancy between the SEC and SAIC figures,” he also relied on the Muddy Waters report as evidence of the two officials’ scienter, because statements the two provided were “in complete opposition to the alleged facts that were uncovered about DGW by Muddy Waters.” Judge Daniels did note that the Muddy Waters report, while not dispositive, may be relied on as evidence of the two officials’ scienter.

Discussion

Because so many of the suits filed against U.S.-listed Chinese companies involved allegations, like those made here against DGW, of discrepancies between figures reported to the SAIC and to the SEC, Judge Daniels’ opinion potentially could boost the plaintiffs in many of those other cases.

On the other hand, other courts have been less willing than Judge Daniels to assume that the discrepancies meant the lower figures were false. For example, as noted here, in November 2011, the court in the China Century Dragon Media securities case granted the defendants motions to dismiss in a case alleging similar discrepancies between SAIC and SEC reports. The court in that case did allow the plaintiffs leave to amend, in part to provide further explanation what the discrepancies meant the SEC filings were false. The court said that though the SAIC numbers and the SEC numbers were different, that is “merely consistent with” the possibility that the SEC figures were false, but “does not suffice to make that claim plausible.”

Other courts may be more reluctant that Judge Daniels to conclude, based on individual corporate officers’ positions alone, that the officers were aware of the figures reported in China. Judge Daniels seemed particularly willing to make this assumption, even though the figures were filed by separate Chinese subsidiaries. These assumption would be much more convincing if accompanied by allegations concerning the purpose and significance of SAIC reports, in order to show that they were, for example of equal importance as the SEC reports or otherwise so significant that the two officials would have had to have known of their content.

It is also worth noting that it is entirely plausible that, contrary to Judge Daniels assumption, that there might be good reasons to falsify the SAIC reports. Although not many defendants would want to make this argument, it is possible that the SAIC reports were falsified for reasons having to do with the purposes of the SAIC reports – for example if they determine taxes due.

Perhaps the most interesting aspect of Judge Daniels opinion is his willingness to rely on the Muddy Waters research report as support for his conclusion that the plaintiffs has sufficiently pled scienter. Many of the other securities suits involving U.S. listed Chinese companies also rely on reports of online research analysts like Muddy Waters – indeed, some of the complaints in these cases consist of little more that a recapitulation of the analysts’ reports. The plaintiffs in those other cases will certainly take heart from Judge Daniels’ reliance on the Muddy Waters report in this way.

I must confess that I find Judge Daniels reliance on the Muddy Waters report in this regard troublesome. It is well-known that many of the online research analysts also maintained short positions on the shares of the companies they were analyzing and therefore were financially motivated to drive down the company’s share price. There are certainly plausible inferences that might be drawn about motivations of the analysts, but I am uncomfortable with the notion that content from one of these financially motivated third-party online analysts can serve as a basis to establish the state of mind of officials inside the company.

In any event, however, and even though a number of the plaintiffs’ claims and a number of the defendants have been dismissed, the plaintiffs’ case against the company and its two senior executives will be going forward. How the plaintiffs will fare remains to be seen, as they, like other plaintiffs in this case will have to overcome procedural hurdles (refer for example here). As I have previously noted, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest. It remains to be seen if these plaintiffs will be an exception to this pattern.

Special thanks to a loyal reader for providing me with a copy of the August 24, 2012 opinion.

Delaware Supreme Court Affirms Massive Judgment, Attorneys’ Fees in Southern Peru Case: On August 27, 2012, the Delaware Supreme Court affirmed the more that $2 billion judgment and more than $300 million attorneys’ fee awarded in the Southern Peru case. A copy of the Supreme Court’s opinion can be found here (Hat Tip: Delaware Corporate and Commercial Litigation Blog).

As discussed here, the lawsuit relates to Southern Peru’s April 2005 acquisition of Minerva México, a Mexican mining company, from Groupo México, Southern Peru’s controlling shareholder. In October 2011, Chancellor Leo Strine concluded that as a result of a “manifestly unfair transaction,” Southern Peru overpaid for Minerva Mexico. A copy of Chancellor Strine’s 106-page opinion can be found here. Chancellor Strine later adjusted the award applying prejudgment interest and awarded attorneys’ fees. Groupo Mexico appealed.

There are a number of very good write-ups about the Delaware Supreme Court’s opinion affirming the lower court ruling, particularly Alison Frankel’s August 27, 2012 post on here On the Case blog (here) and David Bario’s August 27, 2012 Am Law Litigation Daily article (here).

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In October 2011, when Southern District of New York Judge Miriam Goldman Cedarbaum dismissed the securities class action lawsuit that had been filed against China North Petroleum Holdings, Ltd, it was the first of the many cases recently filed against U.S.-listed Chinese companies to be dismissed (as discussed at length here). However, in an August 1, 2012 opinion (here), the Second Circuit vacated the dismissal and remanded the case to the district court for further proceedings.

The Second Circuit held that the plaintiffs may still pursue their claims even though they had bypassed the opportunity to sell their shares at a profit shortly after the alleged misrepresentations had been disclosed. In reaching this conclusion the Second Circuit rejected a line of lower court decisions that had reached a contrary conclusion on the issue of whether or not price recovery following a stock price drop negates the inference of economic loss and loss causation.

As detailed here, the plaintiffs first filed their action in June 2010. According to their amended complaint, during the class period, the defendants inflated the amount of the company’s proven oil reserves, overstated reported earnings inflated profits and misrepresented the company’s internal controls. An allegedly “bizarre series of events” followed the company’s February 23, 2010 announcement that it would be restating prior financials, including “revelation of illicit bank transfers” made to company officials and “a dizzying number of resignations and replacements” of top executives. Over the next few months additional details were revealed regarding the transfers, ultimately resulting in the resignation of the CEO and several members of the board. The NYSE had halted trading on the company’s shares on May 25, 2010, but when trading resumed on September 9, 2010, the company’s share price “plunged.”

The defendants moved to dismiss the plaintiff’s complaint on loss causation grounds, arguing that the plaintiff had several opportunities to sell its shares at a profit following the allegedly corrective disclosure at the end of the class period, and contending that had the plaintiff “chosen to sell at those post-disclosure dates, it would have turned a profit.”

Judge Cedarbaum agreed. Even though the plaintiff ultimately sold its shares at a loss, she concluded that “that loss cannot be imputed to any of NEP’s alleged misrepresentations,” adding that “a plaintiff who forgoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure.” Because she found that the plaintiff “has not suffered any loss attributable to the misrepresentations alleged in the complaint,” and in reliance on a line of district court cases that had reached a similar conclusion, she granted the defendants’ motion to dismiss. The plaintiff appealed.

In an August 1, 2012 opinion for a three-judge panel written by Judge Chester Straub, the Second Circuit vacated Judge Cedarbaum’s ruling and remanded the case to the district court. The Second Circuit rejected the reasoning of the line of cases on which Judge Cedarbaum had relied in dismissing the case, and held that the fact that the price of the stock recovered soon after the price dropped does not negate the inference of economic loss and loss causation at the pleading stage. The court said that the reasoning on which Judge Cedarbaum had relied was inconsistent with both the traditional measure of securities fraud damages and the 90 day “look back” provision in the PSLRA. The court said:

At this stage in the litigation, we do not know whether the price rebounds represent the market’s reactions to the disclosure of the alleged fraud or whether they represent unrelated gains. We thus do not know whether it is proper to offset the price recovery against [plaintiff’s] losses in determining [plaintiff’s] economic loss. Accordingly the recovery does not negate the inference that [plaintiff] has suffered an economic loss.

The Second Circuit’s ruling is obviously significant in that it establishes that a stock price rebound following a corrective disclosure does not in and of itself eliminate the possibility that the plaintiff might be able to prove an economic loss and loss causation. The plaintiff’s law firm’s August 1, 2012 press release about the Second Circuit’s ruling and its significance can be found here.

The Second Circuit’s ruling is also significant because it revives one of the securities suits filed against a U.S.-listed Chinese company that had been dismissed. Observers have been watching these cases closely, and counted the dismissal as one of the important early milestones in the development of these cases. It should be noted that on remand to the district court, the defendants will still have the ability to assert the many defenses they have raised in the case and which have not yet been ruled upon because of the district court’s prior dismissal on loss causation grounds. The case has a long way to go yet. Nevertheless, the Second Court’s ruling at least allows this plaintiff to live for another day.

As I noted at the time of Judge Cedarbaum’s ruling, because of the unusual movement of this company’s share price, the rulings on loss causation issues here are unlikely to have a significant impact on the other cases involving U.S.-listed Chinese companies. That observation remains true with respect to the Second Circuit’s ruling. However, the Second Circuit’s ruling could prove to be very significant amongst cases in general in which a defendant company’s share price rebounded following an initial price decline..

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Beginning in 2010 and accelerating in 2011, plaintiffs’ lawyers filed a wave of securities class action lawsuits against U.S.-listed Chinese companies, many of which obtained their U.S. listings via reverse merger. These cases have been making their way through the courts, and some have now reached the settlement stage. The settlements seem to share more in common  than the involvement of U.S.-listed Chinese companies – the settlements are also relatively modest.

The latest of these cases to settle is the lawsuit involving Orient Paper and certain of its directors and officers. According to the company’s June 21, 2012 press release, the parties to the suit have agreed to settle the case “in exchange for a $2 million payment from the Company’s insurer.” The settlement is subject to court approval.

As I discussed in a post at the time (refer here), the Orient Paper case was the first of the of the Chinese reverse merger company securities suits to survive a motion to dismiss. On July 20, 2012, Central District of California Judge Valerie Baker Fairbanks denied the defendants’ motion to dismiss.

The Orient Paper case is not the first of this group of securities suits filed against U.S.-listed Chinese companies to settle. For example, on March 15, 2012, the parties to the securities suit involving Tongxin International filed a settlement stipulation in the Central District of California indicating that they had settled the case for $3 million. The Tonxin settlement will be funded by the company’s insurer.

An earlier securities suit involving a U.S. listed Chinese company China Shenghguo Pharmaceutical Holdings, filed back in 2008, settled in 2010 for $800,000. According to the parties’ settlement stipulation (here), $600,000 of the settlement amount is to be funded by the company’s insurer, with the remainder to be funded by the company.

You probably noticed that these three settlements have something in common. They not only all three involve U.S.-listed Chinese companies, but all three of the settlements are relatively small. (By way of comparison, Cornerstone Research reports that the median of all securities class action settlements through 2010 was $8.1 million.)

The relatively small size of the settlements might be a reflection of the merits or of the companies’ relatively small size. I suspect a different factor. In my experience, U.S.-listed Chinese companies generally carry very low D&O insurance limits. The low limit levels mean that when these companies are sued, defense expenses alone could quickly deplete a significant percentage of the total amount of insurance, leaving little remaining with which to try to settle the case. The relatively low level of these settlements and the fact that all three settlements were settled in whole or in substantial part with insurance funds suggests to me that something like that may have happened here.

In 2010 and 2011, when the plaintiffs’ lawyers flooded the courts with these securities suits against U.S.-listed Chinese companies, I wondered at the time why the plaintiffs’ lawyers found these cases so attractive. Even though the factual allegations were in some cases quite sensational, they were always going to be difficult cases to pursue. Service of process on the individual defendants alone would in many cases pose significant challenges. Discovery will also pose substantial challenges, including not just the absence of reliable procedures to effect discovery in China, but also the problems associated with distances, language distances and cultural differences. The plaintiffs in these cases may also face barriers getting a class certified (about which refer here).

But even beyond these procedural difficulties, there was always this fundamental problem that in the end there might be very little insurance money out of which to try to collect any settlement or judgment. Given the modest size of these settlements, the attorneys’ fee awards are or will likely be small as well. Small enough to make you wonder how these cases could be worthwhile for the plaintiffs’ lawyers. Of course, going in, they almost certainly had no way of knowing about the lower insurance levels that the Chinese companies often carry.

I have made this point before --about the relative unattractiveness of these cases for the plaintiffs’ firms – to others in the insurance industry, which provoked the response that perhaps the real targets in these cases are the investment banks, lawyers and accountants who advised these companies and who helped them obtain their U.S. listings. It may be that these outside professionals may represent attractive targets, but with the limitations on the reach of the securities laws to those who are not primary violators, these cases against the outside professionals pose their own sets of issues.

There are many more of these cases against U.S.-listed Chinese companies yet to be resolved. Some of course will be dismissed but the ones that survive the motions to dismiss will likely move toward settlement. As these cases progress, perhaps there will be more sizable settlements and the smaller settlements discussed above will look like early outliers. However, my suspicion is that the relatively low levels of D&O insurance that many of these companies carry will mean that many of the settlements will be similarly diminutive.

Special thanks to the several readers who sent me copies of the Orient Paper settlement press release.

Every Now and Then I Read a Headline and Say—What?: Like this June 21, 2012 New Scientist article: “Tiny Human Liver Grows Inside Mouse’s Head” (here).

Matt is Back! And He’s Still Dancing!: My all-time favorite video is the classic Where the Hell is Matt Video (here). The simplicity of the concept is pure genius. The video consists of short clips of Matt, dancing. In places all over the world, with hundreds and hundreds of people. The background music is awesome too.

The great news is that Matt is still dancing. And even better, he has made a new video. It just came out on June 20, 2012. It is every bit as fun as his prior videos. You have to watch it. (Sorry about the commercial at the beginning, it is short). I would like to add a special shout out to my Cleveland friends, you look fine dancing around the “Free” Stamp.” I hope everyone enjoys this video as much as I did.

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During 2010 and 2011, a number of securities class action lawsuits were filed against U.S.-listed Chinese companies. Plaintiffs’ lawyers seemed eager to pursue these cases despite likely procedural and practical challenges such as likely difficulties in obtaining discovery, as well as language and cultural barriers. And if a recent decision in one of these cases is any indication, you can add to the list of potential difficulties the risk that it may not be possible to obtain class certification, at least where the plaintiffs are unable to establish that the defendant company’s shares trade on an efficient market.

China Agritech, a Delaware holding company with its principal place of business in Beijing, China, obtained its U.S. listing through a reverse merger. In February 2011, online analyst reports raised allegations that the company’s factories were either not in operation or were producing far less than reported. In addition, the online reports claimed that the company’s SEC filings reported far higher levels of net revenue than the company reported to the Chinese State Administration for Industry and Commerce. The company’s share price fell on these reports and, as discussed at greater length here, litigation ensured. The plaintiffs moved to have a class of aggrieved investors certified as a plaintiff class.

In May 3, 2012 order (here), Central District of California Judge R. Gary Klausner denied the plaintiffs’ motion for class certification. The court found that the plaintiffs’ allegations satisfied the class certification requirements of numerosity, commonality, typicality, and adequacy. However, the court found that the plaintiffs’ allegations did not satisfy the requirement that the questions of law or fact common to the class members predominate over questions affecting individual members.

The court’s particular concern had to do with the reliance element of the plaintiffs’ securities class action claims. In most contexts, reliance is an individual issue. However, in a securities class action lawsuit, courts will use the fraud-on-the-market presumption to presume reliance if the defendant company’s shares trade in an efficient market.

In order to determine whether or not China Agritech’s shares trade in an efficient market, the Court consider five factors: (1) the average weekly trading volume of the company’s securities; (2) the number of securities analysts following the company; (3) the extent to which market makers trade in the security; (4) the company’s eligibility to file an SEC Form S-3 (the short form registration statement for the sale of new shares); and (5 )the existence of a cause-effect relationship between unexpected corporate news and a change in the price. As Judge Klausner noted, “several courts have recognized that the fifth factor is the most important.”

Judge Klausner found that the plaintiffs had satisfied a number of these factors. However, the plaintiffs were unable to establish the cause and effect relationship between company disclosures and resulting movements in stock price. He concluded that the plaintiffs “are unable to establish that Agritech stock was traded on an efficient market,” as a result of which “they are unable to rely on the fraud-on-the-market presumption of reliance.” Without the presumption, the plaintiffs “are unable to establish that questions of law or fact common to class members predominate over any questions affecting only individual members.” Accordingly, Judge Klausner denied the plaintiffs’ motions for class certification.

As discussed in a May 22, 2012 memorandum from the Debevoise & Plimption law firm about Judge Klausner’s decision (here), the class certification denial in the China Agritech case “appears to be the first China-focused case to reach the procedural stage at which the court had to consider whether the plaintiffs could satisfy the efficient market test and the other requirements of class certification.” The law firm memo notes that the China Agritech plaintiffs’ failure to satisfy the test “may have a significant impact on other China-focused securities cases if the defendants can show that their securities were as thinly traded as China Agritech’s,” adding that “if a company’s securities are thinly traded and the company is not the subject of press coverage, investors may have different levels of knowledge about the company and their reliance on particular statements cannot be presumed.”

The plaintiffs who brought the case “still can pursue claims on their own behalf,” but their inability to proceed with the proposed class action “significantly limits the potential damages that can be awarded in the case.”

Many of the U.S.-listed Chinese companies that have been the subject of securities class action litigation may be able to raise similar questions of whether or not their shares trade or traded in an efficient market. To the extent the companies can show that their shares did not trade in an efficient market, they may be able to overcome the fraud-on-the-market presumption of reliance,  and the value of the claims against them may be substantially diminished. And as I noted at the outset, there are a host of other potential difficulties that may also impede the plaintiffs’ efforts to pursue these claims. Many of these cases were filed, but not all of them will prove to be valuable for the plaintiffs and their counsel.

Kudos: Everyone here at The D&O Diary congratulates Dan Bailey and his colleagues at the Bailey & Cavalieri firm for their selection as the recipients of one of the 2012 Burton Awards for Legal Achievement. The Burton Awards are a series of prestigious national awards for outstanding achievement in legal writing. As reflected I n the firm’s May 22, 2012 press release (here), the firm is the winner of this year’s competition in the category of Best Law Firm Encyclopedic Handbook, for authoring the book entitled Liability of Corporate Directors and Officers.

Dan as the book's co-author, will accept the awardin a June 12, 2012 ceremony at the Library of Congress. The awards ceremony will feature Retired Supreme Court Justice John Paul Stevens, who will be introduced by Supreme Court Justice Sonia Sotomayor. Our congratulations to Dan and to his colleagues for this recognition for their excellent book.

A complete list of the 2012 Burton Award winnerc can be found here.

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During 2011, plaintiffs filed a wave of securities class action lawsuits against U.S.-listed Chinese companies. There were 39 of these lawsuits filed in 2011 (out of 218 total securities class action lawsuit filings in 2011), as discussed here.  Often the complaints in these lawsuits consisted of little more than a repetition of the allegations that had been raised against the company in an Internet analyst report.

While the Internet reports often raised sensational allegations against the companies, the claimants still faced the problems associated with trying to substantiate these allegations – a challenging task under any circumstances, but even more so given political, legal and cultural differences involved, as well as language and other barriers. It should come as no surprise then that a few of these cases might just peter out.

Although there is no way to know for sure from the bare record, that certainly seems to be the case in the securities class action lawsuit that had been filed in 2011 against Yongye International.

As discussed at greater length here, plaintiffs first filed a securities class action lawsuit against Yongye and certain of its directors and officer in the Southern District of New York in May 2011. The complaint relied on a May 11, 2011 Seeking Alpha article entitled “Yongye International’s Reported Production: SEC Filings Raise Red Flags” (here). The article stated in part “that the company and its joint-venture partner could not have produced, and therefore sold, the reported plant product tonnages given the company’s stated manufacturing capacity and shipments.” Ultimately several class actions were filed, which were later consolidated and lead counsel was appointed. Lead counsel filed an amended complaint in December 2011. The amended complaint again was reliant on the allegations in the Seeking Alpha article.

On March 8, 2012, the company announced (here) that the lead plaintiff’s action had been voluntarily dismissed, with prejudice as to the lead plaintiff. A copy of the court’s March 6, 2012 order of voluntary dismissal can be found here.  It is impossible to tell from the bare record what led up to the voluntary dismissal. However, from the court docket, it can at least be discerned that following a February 1, 2012 hearing in the case, Judge Richard J. Sullivan ordered that the plaintiffs file a further amended complaint by March 5, 2012. It appears that rather than submitting the amended complaint on March 5, the plaintiffs filed a motion to voluntarily dismiss the complaint, with prejudice as to the lead plaintiffs.

It was  noted when these cases were flooding in that not perhaps all of these cases would prove to be meritorious and indeed some of them have been dismissed (refer for example here). On the other hand, other cases have survived the initial dismissal motions (refer for example here). The critical point is that even in those cases in which the plaintiffs’ claims survive the initial pleading threshold, their claims stiff face substantial challenges, not the least of which are problems involved with effecting service of process and in conducting discovery in China, as well as deriving from the geographic distances and language issues involved. (Refer here).

The tactical retreat in the Yongye case, even before the initial rounds of pleading were complete and before the threshold motions had even been filed, suggests at a minimum that the barriers involved in pursuing these cases in some instances may be prohibitive. And, without in any way suggesting that it was in fact the case with the Yongye lawsuit, some of the cases may have been filed in reliance on Internet reports and analysis that could prove difficult to substantiate.

Many of these cases are still only in their earliest stages. It remains to be seen have they will fare. There is the possibility that in many instances the cases against the U.S.-listed Chinese companies will not in the end amount to very much.

The Great Lionel Messi: Even those of you that do not follow International soccer have probably seen stories recently suggesting that FC Barcelona’s talented Argentine striker Lionel Messi may be the greatest soccer player ever. Even Time Magazine recently had an article asking the question. If you are wondering what all the fuss is about – which you might well do if you have only seen pictures of Messi, he looks, as one commentator suggested, like the valet parking attendant to whom you would hesitate to give your car keys – you will want to see this video of Messi’s amazing five-goal performance in Wednesday’s UEFA Champions League qualifier game between Barcelona and Bayer Leverkusen. A couple of the goals are the result of terrific passing but the rest of the goals are pure Messi.

As one commentator noted on the Eurosport blog (here):

To describe Lionel Messi as a good player, a great player, is a statement so facile as to render it pointless. Such is the utter brilliance of the Barcelona forward, we are not just running out of superlatives, as the old cliché has it, we are running out of ways to say we are running out of superlatives. He is a man for which conventional language is no longer sufficient.

But before we roll the videotape, let us pause for a few words in appreciation for APOEL Nicosia, the team from Cyprus that is the gatecrasher in the European club championship. If defending champion Barcelona is the team to beat, APOEL is the underdog team to watch and root for. APOEL knocked out the French powerhouse Lyon on Wednesday, in what one commentator said “ might have been the biggest sports moment in Cyprus’s history.”

Now, for Mr. Messi:

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