In what is by far the largest settlement in the current wave of securities litigation involving Chinese companies, Ernst &Young, which served as the outside auditor for Sino-Forest, has agreed to pay C$117 million to settle the securities suit that  Sino-Forest investors filed  in Ontario against the accounting firm. (At current exchange rates, the Canadian dollar and the U.S. dollar are valued roughly equally.) According to the plaintiffs’ lawyers’ December 3, 2012 press release (here), E&Y’s settlement of the Sino-Forest suit “is the largest settlement by an auditor in Canadian history, by a large margin, and is one of the largest-ever auditor settlements worldwide.”


As discussed here, the plaintiffs’ lawyers first filed their suit in Ontario Superior Court of Justice on behalf of Sino-Forest shareholders in June 2011, following press reports and online reports that the company had substantially overstated the size and value of its forestry holdings in China’s Yunnan province. The allegations first emerged in a June 2, 2011 report by online-research firm Muddy Waters, which accused Sino-Forest of outright fraud. Floyd Norris’s June 9, 2011 New York Times article about E&Y’s involvement in the Sino-Forest scandal can be found here. Earlier this year, Sino-Forest filed for bankruptcy protection.


As detailed in the claimants’ amended statement of claim, the lawsuit named as defendants Sino-Forest, its senior officers and directors, its auditors, its underwriters and a consulting company. The plaintiffs previously settled with the consulting company in an agreement that did not involve any monetary payments (refer here). An overview of the Ontario litigation, including links to key documents, can be found here.  The plaintiffs’ lawyers’ December 3 press release emphasizes that the plaintiffs’ claims against the remaining defendants (including in particular the individual directors and officers and the offering underwriters, as well as another auditor) remain pending.


Perhaps coincidentally (or perhaps not), on December 3, 2012, the Ontario Securities Commission filed charges against Ernst & Young that the firm had failed to conduct their audits of Sino-Forest “in accordance with relevant industry standards.” The OSC’s Statement of Allegations against E&Y can be found here. A December 3, 2012 Financial Post article discussing both the OSC allegations and the separate civil suit settlement can be found here.


And in yet another apparent coincidence, on December 3, 2012, the SEC initiated administrative proceedings against the China affiliates of each of the Big Four accounting firms (including E&Y’s Chinese affiliate) and another large U.S. accounting firm for refusing to produce audit work papers and other documents related to China-based companies under investigation by the SEC for potential accounting fraud against U.S. investors. The SEC’s December 3 press release about the administrative action can be found here.


E&Y’s settlement of the Sino-Forest suit is noteworthy in several respects, and not just because it is the largest auditor settlement in Canadian history. It is also noteworthy because it is the largest settlement so far of any kind in connection with the wave of securities suits that were filed in the U.S. and in Canada against Chinese companies in recent years. As I noted in a prior post (here), in general the securities suits involving U.S.-listed Chinese companies that have reached the settlement stage have only resulted in modest settlements, well below the range of median settlements for U.S. securities class action lawsuits generally. However, those modest settlements have involved only the corporate entity defendant  and its directors and officers, and the settlements typically involved only the remaining amounts of D&O insurance.


From the earliest stages of the wave of securities suits involving Chinese companies, I had been told that owing to the logistical challenges and other shortcomings in the lawsuits against the Chinese companies, the true targets were really not the companies themselves, but rather their outside advisors. Up to this point, I have been skeptical that the plaintiffs might succeed in getting traction in their claims against the outside advisors. Clearly, the massive E&Y settlement in the Sino-Forest case demonstrates that the claims against these companies outside advisors  canhave significant value, at least in some cases. In any event, these cases have suddenly become much more interesting to watch.


Dismissal Granted in U.S.-Listed Chinese Company Securities Suit: The securities suits involving Chinese companies are only valuable to the plaintiffs if they are able to get to the case to the settlement stage. Many of these cases have been dismissed at the preliminary motions stage, and on December 3, 2012, the defendants’ motions to dismiss were grated in the securities suit pending in the Western District of Washington against L&L Energy, a U.S. company owning Chinese mining operations, and certain of its directors and officers. The motion was granted with leave to amend.  A copy of the December 3 opinion can be found here.  


As detailed here, the plaintiffs had raised a number of allegations against L&L, asserting among other things that the company had misrepresented its revenues in its filings with the SEC. In making these allegations the plaintiffs relied on discrepancies between the financial figures the company reported in its SEC filings and the figures the company’s subsidiaries reported in China with the State Administration for Industry and Commerce (SAIC).


In rejecting the plaintiffs’ allegations based on this discrepancy, Western District of Washington Robert Lasnik noted that the two kinds of financial  reports involved a number of different reporting requirements and protocols. Based on these differences in the reporting requirements, Judge Lasnik concluded that while “one might draw the inference that the amounts reported to the SAIC and the SEC are inconsistent … because the inputs and consolidation methods varied in material respects, the inference is not particularly strong.” He concluded that “the bare allegations supporting the plaintiffs’ assertions that the SEC numbers, rather than the SAIC numbers, are fabrications fail to raise the necessary strong inference of falsity.”


This decision is just the latest to consider securities fraud allegation based on allegations that the financial figures a Chinese company reported to the SEC were different than those reported to the SAIC. As I noted here, in August 2012, the court denied the motion to dismiss in the securities suit involving Duoyuan Global Water, a case that also involved the same kinds of alleged reporting discrepancies. However, as noted here, in November 2011, the court in the China Century Dragon Media case, like Judge Lasnik in this case, granted the defendants motion to dismiss in another lawsuit involving alleged reporting discrepancies.


Clearly, the track record is mixed; the one thing that is for sure is that the mere fact of the reporting discrepancies alone may not be sufficient for plaintiffs’ to survive the initial pleadings stage.


Special thanks to a Doug Greene of the Lane Powell law firm for forwarding a copy of the L&L Energy opinion. Lane Powell represents the defendants in the L&L Energy case.


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