Among 2010 securities class action lawsuit filing trends are two phenomena that emerged in the second-half of the year – the flurry of lawsuits filed against for-profit education companies and the proliferation of suits involving companies domiciled in China. These two filing trends converged in a single case filed last week against a Chinese for-profit education company.


According to their December 2, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit against China Education Alliance, Inc. and certain of its directors and officers. The complaint, which was filed in the Central District of California, can be found here.


According to the complaint, the company provides educational resources and training through its Internet websites and training facilities in China. The complaint seeks to hold the defendants liable for misrepresenting the company’s financial performance. According to the press release, the complaint alleges that


contrary to the Company’s annual reports filed with the SEC for fiscal 2008, which reported $24.9 million of revenue, an annual report for the Company’s main operating subsidiary filed with the Chinese authorities reported less than a million of revenue for 2008. This discrepancy, along with other accounting inconsistencies, and contradictions about the Company’s online education and training center operating segments, has raised red flags of fraud. When this adverse information was released to the market on November 29, 2010 the price of China Education Alliance stock fell substantially damaging investors.


In my prior post discussing the recent outbreak of securities suits targeting Chinese companies, I noted that a recurring theme in the suits is the allegation that the companies had reported different financial information to Chinese authorities than they reported in their SEC filings. The new complaint against China Education Authority echoes this recurring allegation.


The complaint also cites sources reporting that the company’s Internet sites are not functional and its training centers appear to be inactive, suggesting that the company may not even be an operating business as claimed in its U.S. public filings. (These allegations, which make for rather interesting reading, are detailed in paragraph 37 of the complaint.)


In any event, the plaintiffs’ firm that filed the suit against China Education Alliance apparently has concluded that suing Chinese companies is a growth business. In addition to the new suit against China Education Alliance, the same firm also filed a separate lawsuit in the Southern District of New York last week against Mecox Lane Limited, a Chinese company that just completed its U.S. debut in an IPO on Nasdaq in October 2010.


According to the plaintiffs’ firm’s December 4, 2010 press release (here), the online apparel company’s share price declined significantly on November 29, 2010 when the company disclosed that "contrary to the company’s registration statement filed with the SEC, the company’s gross margins had been adversely impacted by increased costs and expenses, which made it impossible for Mecox to achieve the results defendants projected at the time of the IPO."


The extent to which the plaintiffs’ firm that filed these suits perceived an opportunity in suing Chinese companies is underscored in firm’s press release about the new Mecox Lane lawsuit. Among other things the press release cites about the firm, it also states that the firm "has substantial experience litigating matters involving companies based in the People’s Republic of China."


In any event, of the roughly 162 new securities class action lawsuits filed so far this year, nine of them (or about 5.5%) have involved Chinese companies. Seven of these nine have been filed just since September 17, 2010.


Ten of the 162 YTD 2010 securities suits (or about 6%) have involved for-profit education companies. All of those suits have been filed since mid-August.


The plaintiffs’ firm that filed these suits may well be on to something, as all signs suggest that problems involving Chinese companies may continue to emerge. According to a December 3, 2010 Audit Integrity memo (here, registration required), "many U.S.-listed Chinese companies have little to no intrinsic value."


The Audit Integrity memo adds that "many of these companies have relied on the ‘China’ brand in order to go public," but "the vast majority of these companies are thinly capitalized and are in lines of business that are neither unique nor innovative." Many of the Chinese company stocks "may prove to be valueless" and in many cases the companies "appear to be manipulating their financial results."


Even though the U.S. Supreme Court’s June 2010 decision in the Morrison case may restrict the scope of suits that may be filed against foreign domiciled companies in certain respects, foreign companies may still be sued under U.S. securities laws in connection with securities transactions taking place in the U.S.


Since many Chinese companies have pursued U.S. listings in recent years, these companies are susceptible to securities suits in the U.S., at least as to investors who purchased their shares on U.S. exchanges. The Audit Integrity analysis suggests that many more Chinese companies could well find themselves as U.S. securities suit targets, in addition to the nine companies that have been sued so far this year.


Message From the Fringe: Our San Francisco correspondent filed this report via text message Friday evening: "There’s a wookie in the BART station."