United States District Court, S.D. New York
MEMORANDUM AND ORDER
P. KEVIN CASTEL, District Judge.
The United States Securities and Exchange Commission ("SEC") brings this action for twelve violations of the Securities and Exchange Act of 1934 ("Exchange Act"), rules promulgated thereunder, and the Sarbanes-Oxley Act of 2002 against Subaye Inc. ("Subaye"), a China-based company formerly listed on the NASDAQ exchange, and James T. Crane, Subaye's former CFO. The SEC's allegations relate to the collapse of Subaye. After the exposure of alleged fraud, the value of the company's stock fell precipitously from a market capitalization of over $200 million in 2010 to a near-worthless level by mid-2011. The complaint charges Crane with securities fraud, accounting violations, violations of Exchange Act rules governing SEC filings, and aiding and abetting the securities law violations of Subaye. Defendant Crane moves to dismiss the securities fraud and aiding and abetting claims. For the reasons set forth below, defendant's motion is denied.
A. Subaye and Crane
The following facts are derived from the SEC's complaint and are accepted as true for the purposes of this motion. All reasonable inferences are drawn in favor of the SEC, as the non-movant.
Subaye is a Delaware corporation whose primary operations were in China. (Complaint ¶ 18) From 2008 through 2010, Subaye claimed to be in the business of providing advertising and entertainment media services to small-to-medium businesses in China; beginning in September 2010, the company claimed to have discontinued this business and shifted to a "bundled cloud computing" business model offering a combined package of online video and cloud computing services. (Complaint ¶ 3) Subaye's stock trades in the United States securities markets, currently in the over-the-counter market; from March 15, 2010 through November 11, 2011, the company's stock was listed on the NASDAQ exchange. (Complaint ¶ 18) As a registered public company, Subaye was required to file periodic and other reports with the SEC, including audited quarterly and annual financial statements. Id.
James Crane was a Massachusetts-licensed CPA and the founder of J. Crane CPA, P.C., a Massachusetts-based accounting firm formerly registered with the Public Company Accounting Oversight Board ("PCAOB"). (Complaint ¶ 19) Crane served as the CFO of Subaye from October 29, 2007 until March 10, 2011, and lived in China during his employment there. Id . Crane is currently believed to reside in California. Id.
As required, Subaye filed annual and quarterly reports with the SEC describing its business and financial condition. (Complaint ¶ 20) These reports were drafted and signed by Crane. Id . As part of each Form-10-K, Crane filed a certification, pursuant to Exchange Act rules 13a-14 and 15a-14(a), that, based on Crane's knowledge, the form "did not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading." (Complaint ¶ 25) These certifications also stated that, based on Crane's knowledge, "the financial statements and other financial information contained in each report fairly presented in all material respects the financial condition, results of operations[, ] and cash flows of Subaye." Id.
In compliance with SEC requirements, Subaye retained an independent auditor to conduct annual audits and quarterly reviews for each of its financial statements. Id . Until late 2010, DNTW Chartered Accounts, LLP ("DNTW"), a Canada-based accounting firm, filled this role. Id . According to DNTW, Crane was the only Subaye employee fluent in English, and DNTW relied almost exclusively on communications with Crane in conducting quarterly reviews and annual audits of Subaye. Id . Crane was responsible for Subaye's SEC filings for fiscal years 2008, 2009, and 2010. (Complaint ¶ 20)
The descriptions of Subaye's business provided in their SEC filings changed dramatically from year to year. In its 2008 Form 10-K, Subaye (then known as MyStarU.com, Inc.) described its website, www.subaye.com, as a "premier provider of online video in China, " with 34, 545 members paying a monthly membership fee of about $100. (Complaint ¶ 22) The company reported total revenues of over $29 million. Id . In its 2009 Form 10-K, Subaye claimed to be developing "what Subaye believes is the first online shopping mall in the world that will utilize 3D imaging throughout the online customer interface." (Complaint ¶ 23) There, Subaye reported revenues of just under $48 million and claimed that it had 63, 311 members. Id.
The company's 2010 Form 10-K indicated a drastic change in strategy, as Subaye stated that it had "fully committed" its business model to something it called a "second generation cloud computing product." (Complaint ¶ 26) The company would "no longer offer Online Video as a separate product, " instead offering online video as part of its new "Bundled Cloud Computing Product." Id . Subaye reported revenues of $39.1 million for fiscal year 2010 and represented that it had increased its monthly fee to $410. Id . Subaye also reported that it had increased the size of its sales force from 212 representatives in September 2009 to 1, 405 in September 2010. (Complaint ¶ 28)
On January 26, 2011, Crane filed an Amended Form 8-K/A with the SEC, attaching a presentation that Crane reported was prepared for an investor conference. (Complaint ¶ 29) This presentation repeated claims made in the 2010 Form 10-K, including Subaye's revenues, number of employees, and marketing expenses. Id . The presentation also claimed that the company had over 14, 600 customers and projected revenues of $71.3 million for fiscal year 2011. Id.
B. Subaye's Disputes with its Auditors
On December 23, 2010, the same day that it filed its Form 10-K for fiscal year 2010, Subaye announced in a press release that it had dismissed DNTW and replaced the firm with Pricewaterhouse Cooper Hong Kong ("PWC HK"). (Complaint ¶ 30) The dismissal followed two exchanges between Crane and DNTW regarding the treatment of certain accounting entries; on behalf of Subaye, Crane sought to have these items listed as assets, while DNTW ultimately required Subaye to characterize them as expenses.
The more recent of these two exchanges involved a $22.1 million "marketing expense" reported in the 2010 Form 10-K. Crane had previously told DNTW that $18.8 million of cash collected from customers was being held by Subaye's third party sales agents to be used for future marketing expenses; he sought to characterize this money as an asset. (Complaint ¶ 32) When DNTW requested proof of the existence of this cash, Crane could not provide any bank statements; instead, he produced the employment contracts of the third party sales agents. Id . In response to DNTW's questions seeking to corroborate the existence of the cash and Subaye's control over it, Crane explained that "There is no control over the accounts. This is something I suggested they do but confirmed yesterday that it was not agreed to by the agents." Id . Crane ultimately agreed with DNTW that the $18.8 million could not be called cash under the circumstances; the $18.8 million was therefore treated as part of the company's marketing expenses in the 2010 Form 10-K. Id . Subaye never issued any restatement of its past financials, which had treated this item as an asset called "cash held in trust." (Complaint ¶ 32)
Prior to this dispute, Crane and DNTW had communicated at length regarding certain inventory deposits. The audited financial statements accompanying Subaye's 2009 Form 10-K reported $8.1 million of "Deposits for Purchase of Inventorial Assets" as an asset on the company's balance sheet. (Complaint ¶ 35) Crane told DNTW that these deposits related to the future launch of the company's online 3D mall, that they were intended to ensure Subaye's ability to maintain an inventory once the mall launched, and that they were refundable. Id . However, by the fourth quarter of 2010 the deposits were reduced to $2.8 million; Subaye claimed that $3.4 million of the deposits had been written off, with only $1.9 million having been refunded. (Complaint ¶ 36) The remaining $2.8 million was treated as an expense in ...