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In re China Valves Tech. Sec. Litig.

United States District Court, S.D. New York

October 21, 2013

In re: CHINA VALVES TECHNOLOGY SECURITIES LITIGATION; This document applies to: All actions

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[Copyrighted Material Omitted]

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[Copyrighted Material Omitted]

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For Lead Plaintiff Bristol Investment Fund, Ltd.: William Bernard Federman, FEDERMAN & SHERWOOD; Byron T. Ball, THE BALL LAW FIRM, LLP.

For China Valves Technology, Inc. and Individual Defendants, Defendant: Alfred Robert Pietrzak, Joel M. Mitnick, Daniel A. McLaughlin, SIDLEY AUSTIN LLP.

For Moore Stephens Wurth Frazer and Torbett, LLP, Defendant: Lawrence A. Steckman, EATON & VAN WINKLE LLP.

OPINION

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MEMORANDUM OPINION

Lewis A. Kaplan, United States District Judge.

Lead plaintiff Bristol Investment Fund, Ltd. (" Bristol" ) and plaintiff Joseph Gibbons (" Gibbons" ) (collectively, " plaintiffs" ) filed an amended consolidated class action complaint (" CCAC" ) after this Court dismissed Bristol's amended complaint in full. Familiarity with the Court's prior opinion is presumed.[1] The Court now considers motions of defendants China Valves Technology, Inc. (" China Valves" or the " Company" ), its named officers and directors (" Individual Defendants" ), and the Company's auditors, Moore Stephens Wurth Frazer and Torbet, LLP (" Independent Auditors" ), to dismiss the CCAC.

Bristol and Gibbons allege that China Valves and the Individual Defendants improperly failed to disclose material facts concerning the related party nature of two of the Company's acquisitions and a third transaction, and materially overstated China Valves' financial results in the registration statement made effective on December 14, 2009 (the " Registration Statement" ) and in the subsequent prospectus supplements (collectively, " Offering Documents" ) in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the " Exchange Act" )[2] and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the " Securities Act" ).[3] They allege also that the Auditor Defendants are liable under Section 11 of the Securities Act and Section 10(b) of the Exchange Act for material misstatements made in the audit opinions that were incorporated in at least some of the Offering Documents.

Background

I. The Parties

A. Plaintiffs

Bristol, which was designated lead plaintiff on June 29, 2011,[4] alleges that it purchased China Valves securities " at artificially inflated prices during the [Relevant] Period and purchased 100,000 shares pursuant and/or traceable to the Company's Registration Statement declared effective on December 14, 2009 and Prospectus Supplement filed with the SEC on January 5, 2011." [5] It alleges also that it purchased several thousand shares on January 12 and 13, 2011, although it does not allege that these purchases were pursuant and/or traceable to a Registration Statement.[6]

The CCAC adds as a plaintiff Joseph Gibbons, who is alleged to have " purchased China Valves securities on November 16, 2010 at artificially inflated prices." [7] The

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CCAC does not allege that this or any other purchase was pursuant and/or traceable to a Registration Statement. Accordingly, Gibbons cannot raise a claim under the Securities Act.

B. Defendants

China Valves is a Nevada corporation with its principal place of business in Kaifeng City, China.[8] It purports to develop, manufacture, and sell metal pressure valves to customers in China.[9] At all relevant times, its common stock has traded on NASDAQ under the symbol " CVVT." [10]

The Individual Defendants are ten officers and directors of China Valves.[11] Defendant Siping Fang is the Company's founder and chairman who, from the beginning of the Relevant Period through October 11, 2010, was the Company's chief executive officer.[12] He signed the 2009 10-K and Registration Statement.[13] Defendant Jianbao Wang served as China Valves' chief executive officer from October 11, 2010 through the end of the Relevant Period.[14] Defendants Gang Wei, Renrui Tang, and Ichi Shih served as the Company's chief financial officer at various times during the Relevant Period.[15] Defendant Binjie Fang served as China Valves' chief operating officer from January 2008 through the end of the Relevant Period, was a director, and signed the Company's 2009 10-K and Registration Statement.[16] Defendants Zengbiao Yu, Peter Li, and William Haus were directors and members of China Valves' audit committee; each signed the 2009 10-K and Registration Statement.[17] Defendant Bin Li is a 34 percent shareholder of the Company.[18]

The Auditor Defendants issued an audit opinion dated March 15, 2009 with respect to the Company's financial statements for 2007 and 2008 and consented to its incorporation into the Offering Documents.[19] It issued another such opinion with respect to the financial statements incorporated into the Company's Form 10-K for 2009.[20]

II. Substantive Allegations

A. Changsha Valve Transaction

On December 14, 2009, Able Delight Investment Limited (" Able Delight" ) agreed to purchase Watts Valve (Changsha) Company (" Changsha Valve" ), a subsidiary of Watts Water Technologies, Inc. (" Watts Water" ).[21] Two months later, on February 8, 2010, China Valves announced in a press release and 8-K that it had entered into an asset purchase agreement with Changsha Valve/Able Delight for $15 million.[22]

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Plaintiffs allege that defendants omitted two material facts regarding the Changsha Valve transaction in their public statements and SEC filings. First, they allege that the defendants failed to disclose that the deal was a related-party transaction in which Qing Lu, the wife of China Valves' 34 percent shareholder Bin Li, formed Able Delight at China Valves' behest.[23] Second, they allege that the defendants failed to disclose that Changsha Valve was the subject of an investigation for possible Foreign Corrupt Practices Act (" FCPA" ) violations when China Valves purchased it.[24] Plaintiffs allege additionally that China Valves misstated the purchase price, which the Company's filing with China's State Administration for Industry and Commerce (" SAIC" ) listed as $6.07 million -- $8.93 million less than the amount that the company announced to the public.[25]

China Valves filed an amended 8-K on November 18, 2010 (" November 8-K" ), explaining that it acquired Changsha Valve through Able Delight, that it had arranged for Qing Lu to form Able Delight, that the $8.93 million difference in the publicly announced price and the SAIC price represented money used to satisfy Changsha Valve's third-party debts, and that it paid Qing Lu $50,000 for her assistance.[26] The 8-K did not disclose that Qing Lu and Bin Li are married.[27] The CCAC further alleges that the SEC requested various information from China Valves regarding this transaction.[28] This request prompted China Valves to explain that it structured the transaction as it did because Qing Lu is a Canadian citizen and Watts Water preferred that a foreign owned entity purchase Changsha Valve.[29] China Valves later added that Watts Water preferred not to sell Changsha Valve to a public company.[30]

Plaintiffs allege that defendants had motive and opportunity to conceal the related-party nature of the transaction " because [it was] highly suspicious and would raise the ire of analysts and investors" and that defendant Siping Fang had a motive to inflate the company's financial results due to certain performance-based salary incentives.[31]

Plaintiffs further allege that China Valves failed to disclose that Changsha Valve was under investigation for FCPA violations at the time of the acquisition.[32] Watts Water disclosed the investigation in its November 4, 2009 10-Q,[33] but China Valves did not disclose it in its own filings until November 21, 2011, at the SEC's prompting.[34] The SEC had issued already a cease and desist order against Watts Water by then, having found multiple FCPA violations.[35] Although the FCPA investigation did not result in any financial penalties for China Valves, plaintiffs allege that the omission was material because FCPA violations can artificially inflate revenues by securing, for example, more business

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and higher earnings through corrupt activity than a company otherwise would achieve.[36] This, in turn, may make the company's business prospects and earnings potential without corruption uncertain. Plaintiffs allege as well that the FCPA violations could have resulted in liability for and penalties against China Valves.[37] Plaintiffs allege additionally that defendants knew about the possible FCPA violations at Changsha Valve based on the facts that China Valves conducted its own investigation[38] and that Watts Water previously had disclosed the issue to the SEC.[39]

B. Hanwei Valve Transaction

Plaintiffs challenge also the manner in which defendants purchased Shanghai Pudong Hanwei Valve, Co., Ltd. (" Hanwei Valve" ). China Valves announced its intent to purchase Hanwei Valve on February 11, 2010, and subsequently described the transaction in its April 9, 2010 8-K as an asset purchase for $21 million.[40] This description of the transaction, however, did not match that in China Valves' SAIC filings. There, China Valves disclosed that it purchased Shanghai Hanhuang Valve, the 50 percent owner of Hanwei Valve, on March 1, 2010.[41] Plaintiffs allege that, in consequence of this initial 50 percent purchase, China Valves' later purchase of the other half of Hanwei Valve was a related-party transaction.[42] Moreover, plaintiffs allege that China Valves labeled the transaction an equity acquisition for $7.47 million completed on October 2010 in its SAIC filings.[43]

Plaintiffs further allege that defendants knew or recklessly disregarded all of these facts,[44] that the individual defendants (excepting Bin Li) had a duty to monitor this transaction,[45] and that Siping Fang, Ichi Shih, Binjie Fang, Peter Li, William Haus, and Zengbiao Yu knew about the misstatements or were reckless in failing to discover them because they were required to review the Company's 2009 report included in its 10-K.[46] Plaintiffs' motive and opportunity allegations summarized above apply to this transaction as well.

C. The Binjie Fang Receivable

The final related-party transaction that plaintiffs allege is a $322,725 loan to Binjie Fang from Zenghou City ZD Valve Co. Ltd. (" ZD Valve" ), a China Valves subsidiary, recorded at the end of 2009.[47] Binjie Fang is the legal representative of ZD Valve, a director and chief operating officer of China Valves, and the son of Siping Fang, China Valves' founder, chairman, and ex-chief executive officer.[48]

D. China Valves' 2008 and 2009 Financial Statements

Plaintiffs allege also that China Valves misstated its financial results in 2008 and 2009. They ...


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