THIS MATTER is before me on Defendant Elsa Sung’s Motion to Dismiss (ECF No. 51) and Defendant Frazer, LLP’s Motion to Dismiss (ECF No. 63). I have reviewed the arguments, the record, and the relevant legal authorities. For the reasons provided, the Motions are granted.
I. Background
Lead Plaintiffs, Christopher Brody and Tara Lewis, bring this federal securities class action on behalf of themselves and a putative class of all persons or entities (collectively, “Plaintiffs”) who purchased or acquired Jiangbo Pharmaceuticals, Ine.’s (“Jiangbo” or the “Company”) securities on the open market between June 8, 2010, through and including May 31, 2011 (the “Class Period”). Plaintiffs bring this action against Jiangbo, its external auditor, Frazer, LLP (“Frazer”), and certain of its officers, including its former Chief Financial Officer (“CFO”), Elsa Sung (collectively, “Defendants”).
Jiangbo is a holding company incorporated in Florida, which operates, controls, and owns the pharmaceutical business of Laiyang Jiangbo Pharmaceutical Co., Ltd. (“Laiyang Jiangbo”), which operates entirely in the People’s Republic of China. (CAC ¶¶ 9, 11). Laiyang Jiangbo researches, develops, manufactures, and sells pharmaceutical products, health supplements, and. herbal-based medicinal compounds in China. (CAC ¶ 11).
Moving Defendant Elsa Sung was Jiangbo’s CFO from October 2007 until she resigned effective March 31, 2011. (CAC ¶ 73). After her resignation, she served as a part-time consultant to the Company. Jiangbo Pharms., Inc., Current Report (Form 8-K), at 2 (Mar. 18, 2011). According to Plaintiffs, as CFO, Sung was responsible for Jiangbo’s day-to-day operations. (CAC ¶ 73).
Moving Defendant Frazer
The CAC identifies what Plaintiffs contend are materially false and misleading statements or omissions in Jiangbo’s various press releases, SEC filings, and financial statements, which they allege overstated the Company’s cash balances, failed
A. Jiangbo’s Debt Issuances
To raise capital, in November 2007, Jiangbo borrowed $5 million from Pope Investments, LLC (“Pope”) through the private sale of convertible notes (the “2007 Debentures”). (CAC ¶ 47). In May 2008, Jiangbo raised an additional $30 million through the sale of convertible notes to certain investors including Pope (the “2008 Debentures”). (CAC ¶ 48).
According to Jiangbo’s public filings, in December 2009, Jiangbo became delinquent on interest payments on the 2007 and 2008 Debentures purportedly as a result of a delay in its ability to transfer cash out of China, partially due to the country’s recently imposed stricter foreign exchange restrictions and regulations. Jiangbo Pharms., Inc., Quarterly Report (Form 10-Q), at 24 (May 23, 2011). In February 2010, Pope entered into a waiver agreement with Jiangbo to waive the default in exchange for certain renegotiated payment terms, which extended the deadline for the Company to make the interest payments to February 25, 2010. Id. Jiangbo was unable to meet the waiver agreement’s terms. Id. On January 19, 2011, Jiangbo and Pope entered into a Letter Agreement, which included renegotiated payment terms and extended the due date of the 2007 Debenture to February 28, 2011. Id. On February 28, 2011, and May 30, 2011, Jiangbo defaulted on the 2007 and 2008 Debentures, respectively. Jiangbo Pharms., Inc., Proxy Statement (Schedule 14A), at 12 (May 31, 2011). According to its public filing, the defaults were due to delays in the Company’s ability to transfer cash out of China. Id.
B. Jiangbo’s 2010 and Early 2011 Results
On May 17, 2010, Jiangbo filed with the SEC its quarterly report on Form 10-Q for the-third quarter of fiscal year (“FY”) 2009 (ended March 31, 2010). (CAC ¶ 148). The filing reported cash in the amount of $96 million. (Id.) Chairman of the Board of Directors Wubo Cao and CFO Sung certified that the information in the report did not contain untrue statements or omissions of material fact, and fairly presented the Company’s financial condition, its operations results, and its cashflows. (CACTI 149).
During a conference call on May 17, 2010, Sung stated that Jiangbo’s cash position for the quarter ended March 31, 2010, was $108 million. (CAC ¶ 150). On May 20, 2010, Jiangbo issued a press release and filed a corresponding Form 8-K that Sung signed, which repeated the financial results reported three days earlier, including $96.5 million in cash and an additional $11.5 million in restricted cash. (CAC ¶ 151).
On September 28, 2010, Jiangbo filed ■with the SEC an annual report on Form 10-K for FY 2010 (ended June 30, 2010), which Sung, among others, signed. (CAC ¶ 153). The SEC filing states that, as of June 30, 2010, Jiangbo had cash and cash equivalents in the amount of $108.6 million. (CAC ¶ 154). Sung and Jiangbo’s Chief Executive Officer (“CEO”) Linxian Jin certified that the information in the report did not contain untrue statements or omissions of material fact, and fairly presented the Company’s financial condition, its opera
On September 30, 2010, Jiangbo issued a press release and filed a corresponding Form 8-K that Sung signed, which repeated the financial results reported two days earlier, including $108.6 million in cash. (CAC ¶ 157). During a conference call on September 30, 2010, Sung described Jiangbo’s “strong cash balance” and “unique flexibilities” to pursue new opportunities in the pharmaceutical industry. (CAC ¶ 158).
On November 15, 2010, Jiangbo filed with the SEC a quarterly report on Form 10-Q for the first quarter of FY 2011 (ended September 30, 2010), which Sung and Jin signed. (CAC ¶ 160). The SEC filing reported net revenues in the amount of $27.7 million for the quarter, net income of $10.6 million, and cash of $123.9 million. (Id.) Sung and Jin certified that the information in the report did not contain untrue statements or omissions of material fact, and fairly presented the Company’s financial condition, its operations results, and its cash flows. (CAC ¶ 161).
On November 16, 2010, Jiangbo issued a press release and filed a corresponding Form 8-K that Sung signed, which repeated the financial results reported the previous day, including $123.9 million in cash. (CAC ¶ 162). During a conference call on the same day, Sung reiterated that Jiangbo’s cash position was $123 million, and stated that the company “was continuing to evaluate ways to deploy capital in order to enhance shareholder value.” (CAC ¶ 163). According to Plaintiffs, in reaction to these announcements, on November 16, 2010, Jiangbo’s shares closed at $7.08 per share, up $0.40, or 6%, from the previous day’s close on heavy trading volume of 258, 512 shares. (CAC ¶ 164).
On February 22, 2011, Jiangbo filed with the SEC a quarterly report on Form 10-Q for the second quarter of FY 2011 (ended December 31, 2010), which Sung and Jin signed. (CAC ¶ 167). The SEC filing reported cash of $135 million. (Id.) Sung and Jin again certified that the information in the report did not contain untrue statements or omissions of material fact, and fairly presented the Company’s financial condition, its operations results, and its cash flows. (CAC ¶ 168).
On February 23, 2011, Jiangbo issued a press release and filed a corresponding Form 8-K that Sung signed, which stated that the Company “continued to generate robust cash flow from operations and ... ended the period with over $135.0 million in cash and cash equivalents.” (CAC ¶ 169). During a conference call on the same day, Sung described Jiangbo’s “increased revenue and strong cash flow,” and stated that, from a management perspective, the Company’s stock was undervalued. (CAC ¶ 170). According to Plaintiffs, in reaction to these announcements, on February 23, 2011, Jiangbo’s shares closed at $6.32 per share, up $0.27, or 4.5%, from the previous day’s close on heavy trading volume of 160,380 shares. (CAC ¶ 171).
Plaintiffs maintain that these statements concerning Jiangbo’s results were false because (i) they overstated Jiangbo’s cash balances, (ii) they failed to disclose a RMB 200 million ($31 million) transfer to Shandong Hilead Biotechnology Co., Ltd. (“Hi-lead”), an entity controlled by Chairman of the Board Wubo Cao (the “Hilead transaction”), and (iii) Cao’s, Jin’s, and Sung’s certifications did not fairly present the Company’s financial condition or its oper
C. SEC and Audit Committee Investigations and Events Leading up to Trading Halt
On June 8, 2010, Jiangbo’s stock began trading on the NASDAQ. (CAC ¶ 16). Plaintiffs allege that six months later, in December 2010, the SEC began a nonpublic informal investigation into Jiangbo. (CAC ¶ 17). In February 2011, Jiangbo’s Audit Committee began a non-public internal investigation into the issues raised by the SEC. (CAC ¶ 18). Two independent members of the Audit Committee, Michael Marks and John Wang, led the internal investigation. (CAC ¶¶ 23-30).
Plaintiffs point to several events between March and May 2011, which led to NASDAQ’s decision to halt trading of Jiangbo stock on May 31, 2011. On March 18, 2011, Jiangbo disclosed that Sung had resigned as CFO, to be effective on March 31, 2011, although the Company did not have a successor for the position. (CAC ¶ 127). On March 26, 2011, the SEC informed Jiangbo that it had begun a nonpublic formal investigation. (CAC ¶ 129). In response, the Audit Committee retained Cadwalader Wickersham & Taft LLP (“Cadwalader”), a law firm, and Ernst & Young (China) Advisory Limited (“E & Y”), an accounting firm, to assist in the investigation. (CAC ¶¶ 26, 140). On April 4, 2011, Jiangbo disclosed that it had retained a new independent auditor to replace Frazer “following the notification by [Frazer] that it did not intend to stand for re-appointment as the company’s principal accountant for the next fiscal year.” (CAC ¶ 130).
On May 23, 2011, Jiangbo disclosed that it failed to make a $3.5 million principal payment due on the 2007 Debenture. (CAC ¶ 132). It also disclosed that it was likely that the sole holder of the 2007 Debenture would institute legal proceedings against the Company, which “would be materially adverse to the Company’s ability.to continue its business as it is presently conducted.” (Id.)
Jiangbo’s Form 10-Q filed on May 23, 2011, and signed by Jin and Sung, reported cash of $146 million. (CAC ¶ 174). Sung and Jin certified that the information in the filing did not contain untrue statements or omissions of material fact, and fairly presented the Company’s financial condition, its operations results, and its cash flows. (CAC ¶ 175). On May 24, 2011, Jiangbo issued a press release and filed a corresponding Form 8-K that Sung and Jin signed, which stated that the Company “continued to generate robust cash flow from operations and ended the period with over $146 million in cash and cash equivalents, some of which we plan to deploy on strategic acquisitions .... ” (CAC ¶ 176). During a conference call on May 25, 2011, Jin stated that the Company was trying to negotiate with the debenture holders and noted that “so far the management hasn’t thought of the procedures of seeking bankruptcy protection.” (CAC ¶¶ 134,135,177).
- Plaintiffs maintain that these statements concerning Jiangbo’s results were false because, among other things, (i) they overstated Jiangbo’s cash balances, (ii) they failed to disclose the Hilead transaction, (iii) Jin’s and Sung’s certifications did not fairly present the financial condition of the
On May 27, 2011, Jiangbo disclosed for the first time the existence of an SEC investigation through a Form 10-Q/A. (CAC ¶¶ 137, 138). On May 31, 2011, NASDAQ halted trading in Jiangbo’s stock, which last traded at $3.08. (CAC ¶ 139). Plaintiffs allege that this action wiped out virtually all remaining value in Jiangbo’s shares. (Id.) The shares began trading again on August 4, 2011, at $0.25, down $2.83, or 92%, from their last traded price on the NASDAQ. (Id.) On November 10, 2011, shortly before Plaintiffs filed their Consolidated Amended Complaint, Jiangbo stock closed at $0.14.
D. Audit Committee Resignation Letter
On June 7, 2011, Jiangbo filed a Form 8-K with the SEC disclosing that Marks and Wang resigned from the Audit Committee. (CAC ¶ 140). The Form 8-K attached a resignation letter, which described the reasons for their resignation (the “Resignation Letter” or the “Letter”). (CAC Ex. A). The Resignation Letter provided that Jiangbo’s Chairman of the Board and members of his management team “have exhibited repeatedly their unwillingness to cooperate in even the most basic requests from the investigation team, despite numerous and repeated explanations by the Audit Committee and Cadwalader to explain the importance of this investigation and the expectations of the SEC.” (CAC Ex. A, at 1). It goes on to identify in detail the instances of senior managements’ uncooperative responses to the independent internal investigation from April 19 to June 3, 2011, including refusals to provide documents relevant to the financial audit or to allow E & Y to perform a walk-through of the Company. (See CAC Ex. A, at 2-21). Marks and Wang concluded:
The recent and consistent history of the Company’s lack of cooperation with respect to the internal investigation is therefore more than likely to continue, and has made it impossible for Cadwalader and E & Y to continue the internal investigation in a credible and appropriate manner. Under such circumstances, the independent members of the Audit Committee can no longer serve the interests of shareholders by remaining on the Board.
(CAC Ex. A, at 22).
The Resignation Letter also provided that
the manner and timing of the Company’s payments to the Audit Committee’s advisers (Cadwalader and E & Y) raise additional serious concerns regarding the veracity and correctness of banking information provided by the Company, and regarding the Company’s ability and willingness to pay for necessary costs related to the internal investigation.
(CAC Ex. A, at 1). It noted that Jiangbo did not pay Cadwalader and E & Y from the Company’s principal operating account, despite providing documentation to the Audit Committee reflecting an adequate cash balance to make the payments. (CAC Ex. A, at 21). Rather, Jiangbo made payments from a smaller Company account or from personal bank accounts belonging to an individual Jiangbo employee. (CAC Ex. A, at 20-21). Jiangbo also made several delayed or partial, piecemeal payments to Cadwalader. (CAC Ex. A, at 22). Marks and Wang concluded:
The explanation for the timing and manner of payment is either a troubling indication that the Company does not have free access to its cash balances, or a misleading excuse meant to hide the fact that the Company is unwilling to timely and fully honor its obligations to the Audit Committee.
(CAC Ex. A, at 22). As a result of all of the foregoing, Cadwalader and E & Y withdrew their respective engagements, with the Audit Committee’s consent, and Marks and Wang, the independent members of the Committee, resigned. (CAC Ex. A, at 1).
In light of the Resignation Letter, Plaintiffs maintain that certain statements included in Jiangbo’s May 23 and 24, 2011 Forms 10-Q and 8-K were false because, in addition to the reasons discussed in section I.C, supra, the filings failed to disclose: (i) that Cao and the Company’s management were not cooperating with the SEC or the Audit Committee’s investigation and were not promptly paying the Audit Committee’s advisors from Company accounts; and (ii) that Marks and Wang notified the Board of Directors on May 23, 2011, that they did not intend to stand for re-election at the upcoming annual meeting scheduled for June 27, 2011. (CAC ¶ 178).
E. Alleged GAAP Violations
Plaintiffs allege that Defendants used improper accounting practices in violation of Generally Accepted Accounting Principles (“GAAP”) and SEC reporting requirements to artificially inflate Jiangbo’s assets, stockholders’ equity, and earnings during the Class Period. (CAC ¶ 181). Plaintiffs allege Jiangbo’s managers were responsible for preparing financial statements that conform with GAAP, but failed to do so. (CAC ¶ 183). In particular, Sung, among others, signed certifications attesting to the adequacy of Jiangbo’s internal controls over financial reporting to ensure that the Company’s financial statements were prepared in accordance to GAAP, and certified that Jiangbo’s 2010 Form 10-K fairly presented the Company’s financial condition and operations results. (CAC ¶ 187). According to Plaintiffs, Sung fraudulently certified Jiangbo’s financial statements despite knowing they were “recklessly prepared and egregiously misstated.” (Id.)
Plaintiffs allege that Jiangbo overstated or incorrectly calculated its accounts receivable in violation of GAAP. They note that Jiangbo’s accounts receivable disclosure for the quarter ended March 31, 2011, showed accounts receivable reduced by accumulated depreciation, which is not a GAAP-compliant calculation. (CAC ¶ 188). Further, Plaintiffs allege that Jiangbo’s collection of accounts receivable progressively worsened during the Class Period. (CAC ¶ 189). A June 9, 2011 analyst report noted that Jiangbo had reduced the pace of its collections, and its collections were at a slower rate than its industry peers. (Id.)
Plaintiffs claim that as accounts receivable age, their probability of collection decreases, but instead of increasing its allowance for doubtful accounts, Jiangbo decreased it. (CAC ¶¶ 189, 190). Plaintiffs allege that Defendants knowingly ignored Jiangbo’s decreasing collections and intentionally understated its allowance for doubtful accounts. (CAC ¶ 190). Defendants materially overstated Jiangbo’s assets and earnings throughout the Class Period, therefore violating GAAP. (CAC ¶ 191).
F. Alleged GAAS Violations
Plaintiffs allege that Frazer failed to comply with Generally Accepted Auditing Standards (“GAAS”), standards the
According to Plaintiffs, Frazer (i) knew or recklessly disregarded that Jiangbo’s financial statements had not been prepared in conformity with GAAP, and therefore did not present fairly the Company’s financial position, (ii) failed to perform sufficient procedures to audit Jiangbo’s cash and accounts receivable, and (iii) did not exercise due professional care regarding its audit procedures in light of Jiangbo’s admitted internal control deficiencies. (CAC ¶¶ 195, 196). Jiangbo disclosed in its FY 2010 Form 10-K: “During our assessment of the effectiveness of internal control over financial reporting as of June 30, 2010, management identified significant deficiencies and determined that our internal controls over financial reporting were not effective as of that date.” (CAC ¶ 196). The significant deficiencies related to (i) weaknesses in accounting and finance personnel’s GAAP experience and expertise, (ii) lack of resources to perform internal audit functions properly, and (iii) insufficient segregation of duties in the financial reporting process. Jiangbo Pharms., Inc., Annual Report (Form 10-K), at 54-55 (Sept. 28, 2010).
Plaintiffs allege that, had Frazer conducted its audit in compliance with GAAS, it would have discovered Jiangbo’s overstated cash and understated allowance for doubtful accounts. (CAC ¶¶ 198-202). Plaintiffs identify each investigatory step Frazer failed to take, including conducting inspections, observations, inquiries, and confirmations to obtain sufficient competent evidence to support a reasonable basis for its opinions regarding Jiangbo’s financial statements under audit. (CAC ¶¶ 199-208). Plaintiffs also claim that Frazer violated GAAS by failing to issue an adverse opinion stating Jiangbo’s 2010 financial statements were not fairly presented or stating that it could not issue any opinion at all. (CAC ¶¶ 209-212).
Finally, Plaintiffs claim that Frazer had a financial incentive to commit fraud — it wanted to continue receiving its substantial audit and audit-related fees from Jiangbo. (CAC ¶ 213). Frazer’s willingness to ignore accounting irregularities made it an attractive auditor candidate for Chinese companies. (CAC ¶216). According to Plaintiffs, Frazer has failed to follow professional auditing standards while acting as the independent auditor for several different Chinese companies. (CAC ¶¶ 214,-215).
II. Legal Standards
A. Pleading Standards
A plaintiff must articulate “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly,
When considering a motion to dismiss filed under Rule 12(b)(6), the court must accept all of the plaintiffs allegations as true and construe them in the light most favorable to the plaintiff. Pielage v. McConnell,
Securities fraud claims must meet the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure, which requires a complaint “to state with particularity the circumstances constituting fraud.” Mizzaro v. Home Depot, Inc.,
(1) precisely what statements were made in what documents or oral representations or what omissions were made, and (2) the time and place of each such statement and the person responsible for making (or, in the case of omissions, not making) same, and (3) the content of such statements and the manner in which they misled the plaintiff, and (4) what the defendants obtained as a consequence of the fraud.
Id. (quoting Tello v. Dean Witter Reynolds, Inc.,
Additionally, the Private Securities Litigation Reform Act of 1995 (“PSLRA”), Pub.L. 104-67, 109 Stat. 737, imposes two extra requirements on plaintiffs pleading securities fraud. First, a plaintiff “must specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1)(B). “[W]here the false or misleading information is conveyed in prospectuses, registration statements, annual reports, press releases, or other ‘group-published information,’ it is reasonable to presume that these are the collective actions of the officers.” Phillips v. Scientific-Atlanta, Inc.,
B. Elements of Securities’ Claims
Plaintiffs assert claims under Section 10(b) of the Exchange Act, which prohibits:
[A]ny person, directly or indirectly ... [from] ... us[ing] or employing], in connection with the purchase or sale of any security registered on a national securities exchange ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 788(b). SEC Rule 10b-5, in turn, makes it unlawful for any person, directly or indirectly:
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
17 C.F.R. § 240.10b-5. A securities fraud claim under Section 10(b) or Rule 10b-5 has six elements: “(1) a material misrepresentation or omission; (2) made with scienter; (3) a connection with the purchase or sale of a security; (4) reliance on the misstatement or omission; (5) economic loss; and (6) a causal connection between the material misrepresentation or omission and the loss, commonly called ‘loss causation.’ ” Mizzaro,
Plaintiffs also assert claims under Section 20(a) of the Exchange Act, which imposes joint and several liability for “[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter.” 15 U.S.C. § 78t(a). To state a Section 20(a) claim, Plaintiffs must allege three elements: (1) that Jiangbo committed a primary violation of the securities laws; (2) that the individual defendants had to power to control Jiangbo’s general business affairs; and (3) that the individual defendants “had the requisite power to directly or indirectly control or influence the specific corporate policy which resulted in primary liability.” Mizzaro,
III. Analysis
A. Sung’s Motion to Dismiss
In Count I, Plaintiffs allege Defendants, including Sung, violated Section 10(b) and Rule 10b-5. As to this claim, Sung argues that Plaintiffs fail to state a claim against her for primary liability under Section 10(b) and Rule 10b-5 because they fail to sufficiently plead facts to establish that the statements they challenge were false. Specifically, she contends that the following claims were not pled with requisite particularity: that Jiangbo overstated it cash balances; that Jiangbo failed to properly disclose the Hilead transaction; and that Jiangbo overstated the value of the Company’s accounts receivable. She argues that she cannot be held liable for any statements the Company made after she resigned as CFO. Sung further argues that Plaintiffs have not pled adequate facts to give rise to a strong inference that she acted with scienter or to establish loss causation.
In Count II, Plaintiffs allege that all of the individual defendants, including Sung, violated Section 20(a). As to this claim, Sung argues that Plaintiffs fail to state a claim against her for control person liability because they have failed to establish a
1. Allegations of Cash Overstatement
Sung argues that Plaintiffs fail to state a claim against her for primary liability under Section 10(b) and Rule 10b-5 because they fail to plead with requisite particularity that Jiangbo’s reported cash balances were in fact false, i.e., they fail to show that Jiangbo overstated its cash balances. She contends that Plaintiffs’ claim on this ground is based solely on speculation. She argues that Plaintiffs do not state facts regarding (i) the amount by which the reported cash balances were overstated, (ii) whether the amount of the overstatements was material, (iii) who authorized or participated in the overstatements, or (iv) whether Sung knew about the overstatements and, if so, how she knew.
Plaintiff identifies precisely what statements Defendants, including Sung, made, the time and place of each statement, and the content of each statement. Plaintiff states that Defendants’ fraudulent and misleading statements inflated the value of Jiangbo’s securities throughout the Class Period, and Plaintiffs relied on those statements to their detriment. Plaintiffs specify each statement relating to cash balances, which they contend were false or misleading. They provide the reason why the statements were misleading, i.e., they overstated the Company’s actual cash balances. They also state with particularity facts that form the basis for their allegation that Defendants overstated Jiangbo’s cash balances. The CAC alleges that (i) the Audit Committee had “serious concerns” about veracity and correctness of the Company’s banking information, (ii) Jiangbo’s senior managers refused to cooperate with the SEC and the Audit Committee investigations, and (iii) Jiangbo defaulted on debenture obligations in the amounts of $6 million and $3.5 million despite reporting cash balances of over $100 million.
These facts provide a sufficient basis, at this stage of litigation, to support Plaintiffs’ allegations that Jiangbo’s cash balances were overstated. Cf. Hubbard v. BankAtlantic Bancorp, Inc.,
In her Motion, Sung maintains that Jiangbo defaulted on the 2007 and 2008 Debentures because it could not easily move money out of China. Sung notes that the challenged SEC filings contained the following disclosure:
The PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain eases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current structure, our income is primarily derived from payments from Laiyang Jiangbo. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries and our affiliated entity to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions.
See, e.g., Jiangbo Pharms., Inc., Annual Report (Form 10-K), at 29 (Sept. 28, 2010).
The existence of Chinese regulations that may have prevented Jiangbo from remitting sufficient currency from China to the United States may form the basis of a viable defense. However, the existence of this potential defense does not preclude Plaintiffs from moving forward with their claim at this stage of litigation. Cf. In re Paincare Holdings See. Litig.,
2. Non-disclosure of Hilead Transaction
Plaintiffs allege that Defendants failed to properly disclose a related-party payment Jiangbo made to Hilead in the amount of RMB 200 million ($31 million). Sung argues that Plaintiffs fail to allege facts regarding the Hilead transaction with necessary particularity. Specifically, Plaintiffs fail to allege when the transaction occurred, who authorized the transfer,
“A defendant’s omission to state a material fact is proscribed only when the defendant has a duty to disclose.” Ziemba v. Cascade Int’l, Inc.,
Having reviewed the CAC’s allegations, I agree that Plaintiffs fail to allege sufficient facts to state a claim for relief based on the alleged non-disclosure of the Hilead transaction. Plaintiff argues that Defendants, including Sung, had a duty to disclose the Hilead transaction because it was a related-party transaction exceeding $120,000. Plaintiffs allege it was a related-party transaction because Jiangbo’s Chairman of the Board, Wubo Cao, controlled Hilead. Plaintiffs fail to allege, however, that Jiangbo was a party to the transaction or when the transaction occurred. Because the CAC does not contain any factual allegations to establish that Jiangbo was a party to the transaction, Plaintiffs fail to establish that Defendants had a duty to disclose it under Item 404(a). By failing to state when the transaction occurred, Plaintiffs also fail to sufficiently allege that Defendants had a duty to disclose the transaction at the time they made the statements Plaintiffs challenge in the CAC.
3. Allegedly Overstated Value of Accounts Receivable
Plaintiffs allege that Jiangbo’s financial statements did not comport with GAAP because they overstated or incorrectly calculated the Company’s accounts receivable. They also allege that, although Jiangbo’s rate of collection of accounts receivable decreased, Defendants decreased the Company’s allowance for doubtful accounts instead of properly increasing it. Sung argues that Plaintiffs’ allegations that Defendants overstated Jiangbo’s accounts receivable balance in violation of GAAP lack the particularity that the PLSRA requires. Plaintiffs do not provide any opposition to Sung’s arguments.
To substantiate a claim that Defendants overstated accounts receivable, the CAC “must include details about when and to what level the accounts receivable should have been changed, why the allowance made by the corporation was unreasonable in light of the [bad debt] experienced, and how many accounts were uncollectible.” Cole v. Health Mgmt. Assocs., Inc., No. 2:07cv00484,
The CAC does not contain sufficient facts to show that the reported accounts receivable were false or that the Company failed to properly write off uncollectible receivables. Plaintiffs provide only one instance of incorrect accounting, which Sung argues was a typographical error (the statement reported that accounts receivable were reduced by “accumulated depreciation” instead of “allowance of doubtful accounts”), and notes that she did not sign the filing and therefore is not responsible for it. Otherwise, Plaintiffs’ allegations are simply general, vague, and conclusory.
4. Post-resignation Statements
Sung argues that she cannot be held liable for any statements Jiangbo made after her resignation as CFO became effective on March 31, 2011. Sung served as a part-time consultant for the Company after that date. Plaintiffs do not respond to this argument.
In certain circumstances, a company’s false and misleading public statements made be imputed to corporate officers presumed to be involved in the company’s daily business:
Under the group pleading doctrine, the identification of the individual sources of statements is unnecessary when the fraud allegations arise from misstatements or omissions in group-published documents, such as annual reports, prospectuses, registration statements, press releases, or other group published information that presumably constitute the collective actions of those individuals involved in the day-to-day affairs of the corporation.
In re Pegasus Wireless Corp. Sec. Litig., No. 07-81113,
Plaintiffs allege that Sung acted as CFO until March 31, 2011, and as a senior executive officer, she was responsible for Jiangbo’s day-to-day operations. (CAC ¶ 73). Plaintiffs make one conclusory allegation that each of the defendants “enjoyed significant personal contact and familiarity with the other defendants and was advised of, and had access to, other members of the Company’s management team, internal reports, and sales at all relevant times.” (CAC ¶ 269). They do not allege that Sung was involved in Jiangbo’s day-to-day affairs after she resigned as CFO. They do not allege that, as a part-time consultant, she was directly involved in controlling the content of any challenged statements.
5. Allegations of Scienter
To withstand dismissal, a complaint must state with particularity facts giving
This heightened pleading standard does not alter the substantive intent requirements to establish a Section 10(b) and Rule 10b-5 claim. In the Eleventh Circuit, a Section 10(b) or Rule 10b-5 violation requires a showing of either an “intent to deceive, manipulate, or defraud” or “severe recklessness.” Thompson v. RelationServe Media, Inc.,
Viewed as a whole, the CAC alleges the following facts to support an inference of scienter as to Sung: (i) Sung willfully refused to cooperate with, and obstructed, the SEC’s and the Audit Committee’s investigations; (ii) Sung resigned within weeks of Jiangbo’s disclosure that Frazer did not intend to stand for re-appointment as the Company’s principal accountant; (iii) the magnitude and nature of misstatements support scienter; (iv) there were multiple GAAP and GAAS violations and “red flags,” which consisted of Jiangbo’s internal control weaknesses and the existence of an SEC investigation; (v) Sung executed three Sarbanes-Oxley (“SOX”) certifications, which stated that the' Company’s internal controls and procedures ensured that she knew about any material information relating the Jiangbo; (vi) as CFO, Sung was responsible for the accuracy of the Company’s financial statements; and (vii) Sung misrepresented her professional qualification in Jiangbo’s 2010 Form 10-K because it stated she was a licensed CPA, but her license was actually inactive.
Sung points to the following facts, which she contends supports the opposite inference, that she did not act with scienter: (i) Jiangbo received unqualified audit opinions from Frazer for its FY 2009 and 2010 financial statements; (ii) Jiangbo has not restated any of its financial statements; (iii) Sung never sold a single share of Jiangbo stock during the Class Period and therefore did not profit from any alleged fraud; (iv) Jiangbo’s debtholders agreed during the Class Period to accept equity in the Company; and (v) Sung conducted her work primarily from Florida, while all of
Having considered the complaint allegations collectively and all inferences in favor of either party, I find that the CAC fails to allege sufficient facts to establish a strong inference of scienter as to Sung. Assuming Plaintiffs allegations regarding overstated cash balances are true, the inference that Sung intentionally or with severe recklessness failed to disclose Jiangbo’s true financial condition is not as compelling as the competing inference that Sung failed to disclose Jiangbo’s true financial condition because she either was unaware of, or, at most, was grossly negligent in failing to discover the true amount of the Company’s cash balances. Plaintiffs’ allegations are insufficient to show that Sung knew of any fraud or that the alleged false or misleading information contained in the Company’s public statements were so obvious that she must have been aware of it.
Plaintiffs’ “must have known” theory fails because they do not allege sufficient facts about the fraud to establish that Sung, even as the CFO, should have detected it.
Additionally, Plaintiffs do not allege sufficient facts about the allegedly overstated cash balances to show that the amounts were so off base that Sung should have suspected they were incorrect or paid particular attention to them. Cf. Mizzaro,
Plaintiffs argue that the CAC’s allegations establish scienter as to Sung because there were multiple GAAP and GAAS violations and “red flags,” consisting of Jiangbo’s internal control weaknesses and the existence of an SEC investigation. Plaintiffs allege that, in light of these violations and red flags, Sung’s execution of SOX certifications, which stated that the Company’s internal controls and procedures were adequate to ensure that she knew about any material information relating the Jiangbo, demonstrate scienter. A certifier is only reckless if she “had reason to know, or should have suspected, due to the presence of glaring accounting irregularities or other ‘red flags,’ that the financial statements contained material misstatements or omissions.” Garfield v. NDC Health Corp.,
As to Plaintiffs’ remaining arguments regarding Sung’s and Frazer’s resignations, non-cooperation with the internal investigation, and CPA license, I do not find that, as pled, they support an inference of scienter. Although Sung resigned from the Company, Plaintiffs fail to allege any facts to suggest that she left because of accounting improprieties or for any other nefarious reason. See In re Sportsline.com Sec. Litig.,
Lastly, the fact that Sung stated she was a licensed CPA when in fact her license had expired appears to be irrelevant. Plaintiffs did not identify this as one of the false and misleading statements on which its action is based. Further, Plaintiffs do not allege any facts to support its contention that this misrepresentation is material, i.e., that a reasonable person “would attach importance” to whether she was a CPA “in determining his course of action.” SEC v. Merchant Capital, LLC,
Even though Plaintiffs sufficiently allege that Jiangbo’s financial statements may have contained materially false or misleading information regarding its cash balances, they have not alleged sufficient facts to yield a strong inference of scienter as to Sung. This is not to say, of course, that the CAC may not plead scienter sufficiently as to other individual defendants, or that an amendment would not cure the deficiencies noted herein. Further facts regarding the magnitude of the fraud and Sung’s knowledge or involvement in the Company’s operations and preparation of the financial statements may well be sufficient to show scienter in this case.
6. Allegations of Loss Causation
To state a claim under Section 10(b), a plaintiff must establish “loss causation,” which is “a causal connection between the material misrepresentation and the loss.” Dura Pharms., Inc. v. Broudo,
“[A] person who misrepresents the financial condition of a corporation in order to sell its stock becomes liable to a relying purchaser for the loss the purchaser sustains when the facts become generally known and as a result share value depreciates” Dura Pharms.,
Plaintiffs allege that, through a series of disclosures regarding Jiangbo’s several, and then final, defaults on the 2007 and 2008 Debenture,
7. Control Person Liability
Section 20(a) holds controlling persons “liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable” under the Exchange Act. 15 U.S.C. § 78t(a). Because Plaintiffs have failed to establish a predicate violation of Section 10(b) or Rule 10b-5 as to Sung, their Section 20(a) claim against her cannot stand.
B. Frazer’s Motion to Dismiss
Frazer joins in and adopts Sung’s motion with respect to her argument that
1. Allegations of Scienter
The heightened pleading standard and framework for analyzing a complaint’s allegations with respect to scienter are stated above. When claiming that an auditor acted with knowledge or severe reckless disregard, a plaintiff must show “that the accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decision if confronted with the same facts.” In re Eagle Building Techs., Inc., Sec. Litig.,
“GAAP and GAAS violations provide evidence of scienter when accompanied by additional facts and circumstances that raise an issue of fraudulent intent.” Id. at 1331 (internal quotation marks omitted). Such facts and circumstances include the magnitude of the fraud, the extent of the auditor’s involvement with the corporation, the existence of GAAS violations, a lack of internal controls of which the auditor should have been aware, knowledge of the existence of a government investigation into the company, the existence of other “red flags” that would have exposed the fraud, but which the auditor ignored, a motive to commit or participate in the fraud, or conflicts of interest that might compromise the auditor’s independence. See In re Sunterra Corp. Sec. Litig.,
collectively, I find that the CAC’s allegations fail to give rise to a strong inference of scienter with respect to Frazer. Although Plaintiffs allege the ex-exof GAAS and GAAP violations, these alone will not establish the requisite state of mind in a securities fraud action. The additional facts and circumstances alalin the CAC are insufficient to show Frazer acted with knowledge or reckless disregard.
Plaintiffs’ allegations about the overstated cash balances do not show that they constituted a “drastic overstatement” of financial results, which may, in some cases, give rise to a strong inference of scienter when combined with the existence of GAAP and GAAS violations.
Plaintiffs also fail to allege the existence of glaring red flags that should have placed Frazer on notice of the alleged fraud. Because the SEC only notified Jiangbo of its informal investigation in December 2010, Frazer did not know about it when it conducted its audit of the year ended June 30, 2010, which resulted in a clean audit report disclosed on September 28, 2010. Although Jiangbo admitted to internal controls weaknesses, they were confined to three areas — lack of personnel’s expertise in GAAP, lack of resources to perform an internal audit, and insufficient segregation of financial reporting duties. In contrast, when the court in In re Hamilton Bankcorp relied on lack of internal controls as one of several red flags to support scienter, the plaintiffs had alleged nineteen specific problem areas, supported by a separate report.
Plaintiffs also point to the fact that Frazer decided not to stand for reappointment as Jiangbo’s principal accountant for the next fiscal year effective just
Finally, Plaintiffs’ allegations that Frazer had a conflict of interest or motive to commit or cover the fraud fall flat. A conflict of interest exists “as a result of a special financial relationship between corporation and auditor whereby the auditor has a stake in the corporation’s success.” In re Sunterra Corp.,
In sum, the CAC fails to establish that Frazer’s audit amounted to “no audit at all or an egregious refusal to see the obvious or investigate the doubtful.” In re Hamilton Bankcorp.,
2. Allegations of Loss Causation
I have found that the Plaintiffs have sufficiently pled loss causation, and I will
IV. Conclusion
For the foregoing reasons, it is ORDERED and ADJUDGED that Defendant Sung’s Motion to Dismiss is GRANTED and Defendant Frazer’s Motion to Dismiss is GRANTED.
Because Plaintiffs have not been previously put on notice of the deficiencies in the CAC, and it is not clear that any amendment would necessarily be futile, I will allow Plaintiffs to have an opportunity to amend their complaint. See Bryant v. Dupree,
Notes
. Plaintiffs have voluntarily dismissed claims against CFO Oncall, Inc., a firm specializing in financial consulting services, which employed Elsa Sung, and Frost, PLLC, an accounting firm. (ECF No. 85).
. When Jiangbo engaged Frazer, it was known as Moore Stephens Wurth Frazer and Torbert LLP ("Moore Stephens”). (CAC ¶ 89). As a result of a merger, on January 1, 2010, Moore Stephens became Frazer Frost LLP. (CAC ¶ 93). On May 1, 2011, Frost PLLC unwound its merger with Frazer LLP. (CAC ¶ 100). The firms resumed their existence as separate entities. (Id.) For ease of reference, I will refer to the accounting firm as "Frazer” in this Order.
. Additionally, Sung points out that Jiangbo actually increased its allowance for doubtful
. Moreover, Plaintiffs might not be able to establish Sung’s liability with respect to statements made after March 31, 2011, when Sung was no longer an officer with the Company. See, e.g., In re Sensormatic Electronics Corp. Sec. Litig., No. 018346-Civ-Hurley,
. Because Plaintiffs do not allege when the Hilead transaction occurred, I will not infer that it occurred when Sung signed Jiangbo’s financial statements. See FindWhat Investor Grp. v. FindWhat.com,
. Although Plaintiffs identify one instance of a glaring accounting inaccuracy with respect to Jiangbo's March 31, 2011 accounts receivable disclosure, it appeared in a financial statement after Sung resigned as CFO.
. Sung argues that this was "old news” because in May 2010 Jiangbo disclosed that it had become delinquent on the interest payments for the 2007 and 2008 Debentures. The debtholders ultimately agreed to waive the non-payment. In January 2011, the Company disclosed a new delinquency, which was again waived. On May 23, 2011, the Company disclosed a final default under the 2007 and 2008 Debenture. On May 25, 2011, Jin made statements about the possibility of bankruptcy. The 2011 statements do not consist of information that was already publicly available.
. Plaintiffs allege the existence of a massive fraud, relying on facts about the Company's overstated cash balances, the non-disclosed Hilead transaction, a sizeable related-party transaction, and the overstated accounts receivable. Because the Plaintiffs have not provided even an approximate date in which the Hilead transaction occurred, I cannot deter-
. Plaintiffs also point to other disclosures regarding resignations and the existence of an SEC and internal investigation, each of which was followed by a drop in stock price. None of these disclosures revealed any improprieties, although at least one court has found that the announcement of an informal SEC inquiry may be sufficient to show loss causation, see In re Bradley Pharms., Inc. Sec. Litig.,