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.