308 F. Supp. 3d 411
D. Mass.2018Background
- ShengdaTech, a Nevada company operating via Chinese subsidiaries, sold $130M of convertible notes in a 2010 private placement; Miller and Jura purchased about $8.7M of those notes after receiving a PPM that incorporated Shengda's 2008–2009 Form 10-Ks and KPMG-HK audit reports.
- KPMG-HK audited Shengda for 2008–2009 (and began 2010), issued audit opinions stating (1) audits were conducted in accordance with PCAOB standards and (2) Shengda’s financials conformed with U.S. GAAP; those reports were included in the PPM.
- In March 2011 KPMG-HK began independent confirmations and discovered numerous falsifications and forgeries; KPMG-HK informed Shengda’s audit committee, later resigned (Apr. 2011), and Shengda disclosed discrepancies; Shengda defaulted and filed bankruptcy in August 2011.
- Miller sued Morgan Stanley and KPMG-HK; this opinion addresses KPMG-HK’s motion to dismiss Miller’s Third Amended Complaint as to two counts against KPMG-HK: § 18 of the Exchange Act and negligent misrepresentation under Massachusetts common law.
- The court accepts the TAC allegations as true for pleading-stage review but applies PSLRA/Rule 9(b) heightened pleading standards to the § 18 claim and, for negligent misrepresentation, applies Rule 9(b) because the claims sound in fraud.
- The court finds only one potentially actionable misstatement (omission) — KPMG-HK’s 2008 internal-control report failed to identify a known material weakness regarding related-party transactions — but dismisses Miller’s § 18 claim for failure to plead loss causation and dismisses negligent misrepresentation for lack of justifiable reliance/duty.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether KPMG-HK’s statements that audits complied with PCAOB standards were false | KPMG-HK failed to follow PCAOB/GAAS (did not investigate related-party misstatements, ignored red flags, inadequate confirmations, internal control failures) so the PCAOB-compliance statement was objectively false | KPMG-HK conducted reasonable audits; many alleged omissions are hindsight, discretionary, or not required by PCAOB; many red-flag allegations are speculative | Court treats PCAOB-compliance statement as factual; finds only the 2008 internal-control report omitted a known material weakness (so that omission may be actionable), but most GAAS-violation allegations fail as insufficiently particularized |
| Whether KPMG-HK’s GAAP opinion (that Shengda’s statements "fairly presented" results) was false | Shengda’s financials were materially overstated and related-party transactions undisclosed, so the GAAP opinion was untrue/unsupported | GAAP opinions are subjective; KPMG-HK had a reasonable basis and was not shown to hold a disbelieving state of mind when issuing opinions | Court treats GAAP conformance as opinion; Miller adequately pleads objective falsity of the financials but fails to plead subjective falsity (what KPMG-HK actually believed) sufficiently, so GAAP opinion is not actionable under § 18 |
| Loss causation for the § 18 claim (did KPMG-HK’s omission cause Miller’s losses?) | The March 2011 disclosure and subsequent events revealed the fraud and caused bonds to become illiquid and lose value | The March 2011 press release did not reveal the specific 2008 omission; other market events and later disclosures bear on loss; causal link is too attenuated | Court: Miller pleaded loss but failed to plead a sufficient causal nexus between the actionable omission (2008 internal-control omission) and Miller’s alleged losses; § 18 claim dismissed for lack of loss causation |
| Negligent misrepresentation: duty/justifiable reliance (privity/limited group) | KPMG-HK consented to use of its audit reports in the PPM, so it knew investors would rely and owed a duty to that (limited) investor group | Auditor had no direct relationship with Miller; no allegation KPMG-HK issued reports intending to influence these specific investors at the time of the audit; permission to Morgan Stanley came later | Court applies Massachusetts law (Nycal/Cumis): Miller failed to plead that KPMG-HK prepared the reports for a limited, known group including Miller or otherwise had actual/near-privity knowledge; negligent misrepresentation claim dismissed |
Key Cases Cited
- Ashcroft v. Iqbal, 556 U.S. 662 (pleading standard; plausibility)
- Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (PCAOB origins and role)
- Dura Pharm., Inc. v. Broudo, 544 U.S. 336 (loss causation principles)
- Ernst & Ernst v. Hochfelder, 425 U.S. 185 (state of mind differences among securities claims)
- In re Stone & Webster, Inc. Sec. Litig., 414 F.3d 187 (PSDRA §18 pleading requirements)
- In re Cabletron Sys., Inc., 311 F.3d 11 (particularity and fraud-related pleading)
- Plumbers' Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762 (opinion statements and falsity analysis)