Sanderson v. Bagell, Josephs, Levine & Co.
2015 U.S. App. LEXIS 4879
| 2d Cir. | 2015Background
- Advanced Battery Technologies, Inc. (ABAT), a China-based lithium-ion battery maker, reported substantially different financial results to the U.S. SEC (2007–2010) than to China’s AIC (e.g., 2007: SEC revenues ~$31.9M, AIC revenues ~$145k).
- ABAT disclosed two suspect transactions: a $20M acquisition of Shenzhen Zhongqiang (allegedly owned by ABAT’s CEO, Zhiguo Fu, purchased earlier for ~$1M) and mischaracterized ownership of ZQ Power‑Tech (initially reported as a wholly owned subsidiary but later admitted not to be).
- Bagell, Josephs, Levine & Co. (later merged into Friedman LLP) audited ABAT through Dec. 14, 2010; EFP Rotenberg, LLP audited thereafter. Audit opinions certified GAAP conformity and that audits met PCAOB standards.
- Lead plaintiff Sanderson sued auditors for securities fraud, alleging they ignored multiple “red flags,” including AIC/SEC discrepancies and the related‑party acquisition, and thus acted with scienter (conscious recklessness).
- The district court dismissed the auditors for failure to plead scienter under the PSLRA and denied leave to file a Second Amended Complaint as futile; the Second Circuit AFFIRMED.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether amended complaint pleads scienter as to Bagell Josephs | Bagell Josephs had access to ABAT’s conflicting AIC filings and ignored red flags (AIC/SEC discrepancies, ZQ Power‑Tech ownership), showing conscious recklessness | No duty to review foreign regulatory filings; at worst negligence; plausible that ABAT gave auditors false underlying data | Dismissal affirmed — allegations support negligence, not the strong inference of scienter required under Tellabs |
| Whether amended complaint pleads scienter as to EFP | EFP would have uncovered the sham Shenzhen Zhongqiang deal if it had done basic audit work; expert opined such failures were extreme departures | Conditional allegations that auditor "would have" learned the truth are insufficient; no allegation EFP knew price was inflated | Dismissal affirmed — conditional/due‑diligence allegations insufficient to plead recklessness or fraudulent intent |
| Whether auditors had duty to obtain/review AIC filings | Plaintiff: auditing standards and abnormal profits/reverse‑merger context required review of AIC filings | Defendants: no independent, pre‑existing duty to obtain foreign regulator filings; standards do not compel such review absent more | Held: No general duty proven; failure to review AIC filings does not by itself establish recklessness |
| Whether ZQ Power‑Tech ownership issue is a strong red flag | Plaintiff: misstated subsidiary ownership was a recognized red flag that auditors ignored | Defendants: the mischaracterization was not so egregious as to show recklessness; at most a negligence inference | Held: Mischaracterization insufficiently egregious to create a strong inference of scienter |
Key Cases Cited
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (establishes the "strong inference" scienter standard for securities fraud)
- Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000) (GAAP violations alone do not establish scienter)
- Panther Partners Inc. v. Ikanos Commc’ns, Inc., 681 F.3d 114 (2d Cir. 2012) (standard for reviewing denial of leave to amend as futile)
- Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001) (circumstantial allegations of motive/intent must be strong when motive is not pleaded)
- Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000) (recklessness defined as extreme departure from ordinary care approximating intent to deceive)
- S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98 (2d Cir. 2009) (conditional allegations that a defendant "would have" learned the truth are generally insufficient)
- Chill v. Gen. Elec. Co., 101 F.3d 263 (2d Cir. 1996) (high profits alone do not automatically indicate fraud)
- Gould v. Winstar Commc’ns, Inc., 692 F.3d 148 (2d Cir. 2012) (auditor recklessness shown when audits are so deficient they amount to no audit or disregard obvious signs of fraud)