In re New Oriental Education & Technology Group Securities Litigation, 988 F. Supp. 2d 406

Background

New Oriental, a Cayman corporation operating in China via a VIE (NOC) structure, issued ADS on NYSE and consolidated NOC into its financial statements for 2009–2012.
Plaintiffs (class: ADS purchasers Oct. 19, 2009–July 17, 2012) allege New Oriental, CEO Michael Yu, and CFO Louis Hsieh misled investors about (a) the GAAP basis for consolidating NOC and (b) the company’s brand-protection practices (a small “brand cooperation” program).
Key contractual bases for consolidation: service agreements (fees/percentages), an equity pledge, and an exclusive option to acquire NOC shares; plaintiffs allege these agreements were insufficient to confer the rights/control New Oriental claimed.
Accounting standards shifted: FIN 46R governed 2009–2010 (quantitative focus on residual returns); SFAS 167 governed 2011 (qualitative focus on power to direct activities most significant to economic performance).
July 17–18, 2012 disclosures (SEC investigation announcement; Muddy Waters report) triggered large stock drops; plaintiffs allege these disclosures revealed concealed consolidation risk and caused losses.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Material misstatement re: consolidation under FIN 46R/SFAS 167	New Oriental misrepresented that contractual arrangements gave it right to majority of NOC residual returns / power to direct key activities	Agreements and practice gave New Oriental sufficient economic benefits/control; plaintiffs lack particularized contract proof	Denied dismissal: plaintiffs plausibly alleged materially misleading basis for consolidation (2009–2011)
Improper consolidation → misstated assets/revenue	Consolidation inflated assets (62–67%) and revenues (≈97%) because NOC should not have been consolidated	Alleged GAAP violations alone insufficient; plaintiffs must plead scienter	Denied dismissal: GAAP-based accounting allegations coupled with pleaded scienter survive pleading stage
Failure to disclose brand cooperation (franchise-like)	Nondisclosure concealed transfer of brand control and reputational risk	Program was quantitatively trivial (0.009%–0.045% revenues) and not qualitatively significant	Granted dismissal as to brand-cooperation claim: not material qualitatively or quantitatively
Scienter (intent/recklessness)	Defendants must have known of obvious contract defects given consolidation’s centrality and defendants’ roles (esp. Yu as controlling NOC shareholder)	Reliance on Deloitte audits, formation of special committee, and lack of restatement rebut scienter	Denied dismissal: plaintiffs pleaded strong inference of recklessness/conscious misbehavior that is at least as compelling as opposing inferences
Loss causation	July 17 SEC-investigation disclosure (and subsequent Muddy Waters report) revealed concealed consolidation problem and caused stock decline	July 17 announcement did not correct any specific misstatement	Denied dismissal: July 17 announcement is a sufficient corrective disclosure to plead loss causation

Key Cases Cited

Bell Atl. Corp. v. Twombly, 550 U.S. 544 (pleading plausibility standard)
Ashcroft v. Iqbal, 556 U.S. 662 (legal conclusions not entitled to assumed truth at pleading stage)
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (standard for evaluating competing scienter inferences)
ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (PSLRA/Rule 9(b) pleading elements for securities fraud)
Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (loss causation requirement)
Basic Inc. v. Levinson, 485 U.S. 224 (materiality/’total mix’ standard)
Novak v. Kasaks, 216 F.3d 300 (GAAP allegations require accompanying scienter to state securities fraud)
Chill v. Gen. Elec. Co., 101 F.3d 263 (recklessness standard in securities fraud)
Litwin v. Blackstone Group, L.P., 634 F.3d 706 (qualitative materiality analysis under SAB 99)
Hutchison v. Deutsche Bank Sec. Inc., 647 F.3d 479 (qualitative materiality and market-reaction considerations)