In an interesting July 31, 2014 opinion (here), the Second Circuit vacated the dismissal of the securities class action lawsuit that had been filed against JinkoSolar Holdings Co. Ltd, and certain of its directors and officers, as well as against its offering underwriters. This ruling will be of interest to many readers because it involves a U.S.-listed Chinese company, but it is also of interest because the allegations involve alleged misrepresentations regarding the company’s environmental compliance.
JinkoSolar is a manufacturer of solar technology products with operations based in China. In May 2010, the company conducted an Initial Public Offering of American Depositary Shares on the New York Stock Exchange. In November 2010, the company completed a secondary offering. The company raised a total of $84.19 million in the two offerings.
In April and May 2011, the company had a series of communications with the Chinese environmental authorities regarding hazardous waste disposal issues at its Zhenjian plant. The company did not disclose these communications to its shareholders. In August and September 2011, residents living near the plant became concerned about a large scale fish-kill near the plant. In mid-September, the media began reporting on locals’ demonstrations outside the company’s plants. In two press releases in late September, the company announced that it had suspended operations at the plant and also revealed the earlier communications with the environmental authorities. As the news came out, the price of the company’s ADSs declined 41%
In October 2011, holders of the company’s ADSs filed a securities class action lawsuit in the Southern District of New York against the company, eight directors and officers of the company; and the company’s offering underwriters. The plaintiffs’ complaint asserted claims under both the ’33 Act and the ’34 Act. In support of their allegations, the plaintiffs relied on statements in the company’s offering prospectuses in which the company explained its environmental compliance efforts and the consequences to the company if it were found to be in violation of the applicable environmental requirements. The defendants moved to dismiss.
As discussed here, in a January 22, 2013 ruling, Southern District of New York Judge J. Paul Oetken granted the defendants’ motion to dismiss. Judge Oetken held that the defendants’ statements regarding the company’s storage of hazardous chemicals, about the Chinese and local environmental regulation and about the costs of environmental compliance were not misleading. However, Judge Oetken found the paragraph in the company’s prospectuses about its pollution abatement equipment and its 24-hour environmental monitoring team “a more complicated matter” and a “close call.” Because he concluded that the investors would not read these statements as guaranteeing compliance, Judge Oetken concluded that the statements were not materially misleading. The plaintiffs appealed.
The July 31, 2014 Opinion
In a July 31, 2014 opinion written by Judge Ralph K. Winter, Jr. for a unanimous three-judge panel, the Second Circuit vacated the dismissal based on its finding that JinkoSolar’s “failure to disclose ongoing serious pollution problems rendered misleading statements describing measures taken to comply with Chinese environmental regulations.”
The appellate court said that though the statements in JinkoSolar’s prospectuses that the company is subject to a wide variety of environmental compliance and about the high cost of compliance are not misstatements, “they are relevant to materiality of the prospectuses’ description of JinkoSolar’s potential to cause serious pollution problems and the steps it was taking to avoid these problems.”
Regarding the description in the prospectuses of the steps the company said it was taking, the appellate court said, “we believe the complaint sufficiently alleges that the failure to disclose that the prophylactic steps were then failing to prevent serious ongoing pollution problems rendered that description misleading.”
Specifically, the court said that the prospectuses’ description of pollution-preventing equipment and 24-hour monitoring teams “gave comfort to investors that reasonably effective steps were being taken to comply with the applicable environmental regulations.” However, the court said, “investors would be misled” by these statements “if in fact the equipment and 24-hour team were then failing to prevent substantial violations of the Chinese regulations.”
In that regard, the appellate court noted that in June 2010, JinkoSolar had submitted a report to Chinese environmental authorities about “existing problems.” The report describes problems of a nature that is “sufficient, if proven, to allow a trier of fact, absent contrary evidence, to draw the inference that the problems ‘existing’ as of June 8, 2010, were both present and substantial at the time of the May13, 2010 offering.”
The Court said that “at the time the statements regarding pollution presentation and compliance measures were made, a reasonable investor could conclude that a substantial non-compliance would constitute a substantial threat to earnings, if not to the entire venture. Indeed, the prospectus said as much.” The court concluded by saying that “a trier of fact could find that the existence of ongoing and substantial pollution problems – here the omitted facts – was of substantial importance to investors.”
This case is one of the many securities class action lawsuits that were filed against U.S.-listed Chinese companies in 2011. However, unlike many of the other Chinese companies that were hit with securities suits then, which had obtained their U.S. listings through reverse merger transactions, this company obtained its U.S. listing through a full-blown IPO, meaning that it had been required to file a detailed prospectus as part of its offering process.
The company’s prospectus contained detailed disclosures regarding the company’s environmental compliance challenges. Indeed, in his opinion, Judge Oetkin had referred to what he called the “disquieting frankness of the company’s disclosures regarding its environmental compliance risks.” He also noted “how cautious” the company was in its environmental compliance risk factors in its prospectuses.
Notwithstanding this acknowledged caution and frankness, the appellate court still concluded that the company’s statements about its environmental compliance efforts were materially misleading. It is interesting to me that in reaching this conclusion, the court was willing to make the logical jump that statements about “existing problems” made in a June 8, 2010 report to Chinese regulators could be read by a finder of fact to infer that the problems existed at the time of May 13, 2010 offering.
I can easily imagine a different court concluding that the in order to support a jump like this, the plaintiffs are required to plead facts to show that the problems in the June report were in fact existing at the time of the May offering. Instead, the Second Circuit found the allegations sufficient for a trier of fact to conclude that the problems existed at the time of the offering based only on an “inference.”
For many readers, the most interesting thing about this case will be that it involves a U.S.-listed Chinese company defendant. However, for me, the most interesting thing about this case is that it involves alleged misrepresentations with respect to environmental compliance. As I have previously noted on this blog (refer, for example, here), these kinds of cases, involving alleged misrepresentation of environmental issues, do arise periodically.
The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures. The typical D&O liability insurance policy will contain an exclusion for loss arising from claims for pollution and environmental liabilities. However, many of these exclusions also contain a provision carving back coverage for shareholder claims. This case shows the importance of this kind of coverage carve back. The carve back ensures that directors and officers hit with this kind of shareholder suit filed in wake of an environmental incident are able to rely on their D&O insurance to defend themselves against the shareholder suit.
In recent years, a number of D&O insurance carriers have introduced policy forms that eliminate the pollution exclusion altogether but that also incorporate into the policy’s definition of “Loss” a provision stating that Loss will not include environmental remediation or cleanup costs. Unless the insured company’s primary D&O insurance policy omits the environmental exclusion in this way, it will be indispensable for the standard environmental liability exclusion be revised in order to preserve coverage for securities claims and derivative claims based on alleged misrepresentations or misconduct relating to environmental issues. These considerations are likely to become increasingly important as environmental disclosure issues become of greater regulatory concern (about which refer here).
With all of that said about the environmental disclosure issues, there is a sense in which it is particularly noteworthy that this case involves a Chinese company, in that this is the relatively unusual securities suit involving a U.S.-listed Chinese company where the plaintiffs have managed to make much headway. Although some of the U.S. securities suits have managed to survive motions to dismiss, many others have not. Even the cases that have survived motions to dismiss have proved challenging for plaintiffs as they have faced numerous procedural hurdles (refer for example here). In addition, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest.
(On the other hand, as noted here, E&Y did recently agree to settle a Canadian securities case relating to Sino-Forest, and a Hong Kong arbitration panel did just make a more than $70 million award based on its determination that China MediaExpress Holdings is a “fraudulent enterprise.” Notably, and arguably ironically, neither of these big recoveries involved one the many U.S.-based securities suits filed against Chinese companies.)
One final note. This case is yet another example of a phenomenon I have frequently noted on this blog, which is how often securities class action litigation follows in the wake of regulatory or investigative activity. Indeed, this lawsuit reflects a particular aspect of this phenomenon, which is the increasing incidence of U.S.-based securities litigation arising in the wake of regulatory action outside the U.S. As I noted in a prior post, and as both U.S. and non-U.S. regulators focus increased regulatory scrutiny on operations outside the U.S., the likelihood is that regulatory investigative and enforcement actions will continue to increase. As these regulatory and investigative actions increase, the likelihood is that the follow-on civil litigation will continue to increase as well.
Very special thanks to Stanley Bernstein of the Bernstein Liebhard law firm for sending me a copy of the Second Circuit’s opinion. The Bernstein LIebhard firm represents the plaintiffs in the JinkoSolar securities class action lawsuit.