United States District Court, S.D. New York
BHUSHAN ATHALE, Individually and on Behalf of All Other Similarly Situated, Plaintiff,
SINOTECH ENERGY LIMITED, ET AL, Defendants.
MEMORANDUM & ORDER
ALISON J. NATHAN, District Judge.
This is a securities class action brought on behalf of a class of SinoTech Energy Limited ("SinoTech" or "Company") shareholders, against (1) SinoTech; (2) a number of SinoTech officers and directors (collectively, "Individual Defendants"); (3) UBS AG, UBS Securities LLC, Citigroup Global Markets, and Lazard Capital Markets, which served as financial advisors to and assisted SinoTech in its IPO (collectively, "Underwriter Defendants"); and (4) Ernst & Young Hua Ming ("EYHM"), which served as SinoTech's auditor. See Compl. ¶¶ 30-44. EYHM moves to dismiss, pursuant to Rules 8, 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, for failure to state a claim upon which relief can be granted. For the reasons that follow, EYHM's motion to dismiss is GRANTED.
A. Factual Background
The following facts are taken from the Second Consolidated Amended Complaint, Dkt. No. 70, and assumed be to be true for purposes of deciding the motion to dismiss.
On November 3, 2010, SinoTech, a provider of enhanced oil recovery ("EOR") based in the People's Republic of China ("China"), conducted an initial public offering ("IPO") in the United States. Pl. Opp. 1; Compl. ¶¶ 1-2. The IPO grossed $167 million, with 19.7 million of SinoTech's American Depository Shares ("ADSs" or "shares") trading on the NASDAQ Stock Market at $8.50 per share. Pl. Opp. 1; Compl. ¶¶ 1, 52. By March 22, 2011, the shares were trading at $8.69 per share. Compl. ¶ 6.
On March 31, 2011, SinoTech filed its Annual Report with the SEC on Form 20-F. Compl. ¶ 116. The Form 20-F stated that SinoTech had sales of $45.3 million for the fiscal year ending September 30, 2010. Compl. ¶ 116. The Form 20-F further indicated that 46.8 percent of sales came from its lateral hydraulic drilling ("LHD") section, 42.8 percent came from its molecular deposition film ("MDF") section, and another 10.4 percent of total sales came from its consulting section. Compl. ¶ 116. SinoTech further reported that the value of its property and equipment, less accumulated depreciation, was $64, 286, 601; more than 99 percent of this figure was categorized as "[p]roduction equipment ( i.e., the LHD units)." Compl. ¶¶ 116, 164. The Form 20-F also stated that there existed as of January 11, 2010 a contract with Tianjin New Highland ("TNH"), to purchase six units of LHD equipments for a total price of $41, 248, 200, or $6, 874, 700 per unit, $37, 123, 380 of which had been paid as of September 30, 2010. Compl. ¶ 118.
The same day, EYHM, which had been engaged as SinoTech's registered accounting firm since February 28, 2011, issued an "unqualified audit opinion of the Company's financial statements for the period ended September 30, 2010." Compl. ¶¶ 43, 120. That opinion stated that EYHM had "audited the accompanying consolidated balance sheet... and the related consolidated statements of operations and comprehensive income, shareholders' equity, and cash flows for the year ended September 30, 2010." Compl. ¶ 120. EYHM noted that the "financial statements are the responsibility of the Company's management" and indicated that its only "responsibility [was] to express an opinion on the financial statements based on [its] audit." Compl. ¶ 120. EYHM further noted that it conducted the audit in accordance with Public Company Accounting Oversight Board ("PCAOB") standards, but warned that it was "not engaged to perform an audit of the Company's internal control over financial reporting" and therefore expressed no opinion as to the effectiveness of SinoTech's internal control over financial reporting. Compl. ¶ 120. The opinion concluded that, "the consolidated financial statements... present fairly, in all material respects, the consolidated financial position of SinoTech... at September 30, 2010, and the consolidated results of its operations and its cash flows for the year ended September 30, 2010, in conformity with U.S. generally accepted accounting principles ["GAAP"]." Compl. ¶ 120.
On August 16, 2011, a group of online short-seller analysts known as Alfred Little issued a report ("Report"), accusing SinoTech of fraudulent financial reporting. Compl. ¶¶ 7, 144; Compl. Ex. A at 30. The Report "included government documents, pictures, video, phone conversations, and a detailed investigation regarding SinoTech and... the two FOR technologies upon which SinoTech's Class Period operations were reportedly based." Compl. ¶ 7. The Report indicated that the Company's "sole import agent accounting for over $100 million worth of oil drilling equipment [LHD] orders appears to be an empty shell with no sign of operation, a limited import history and negligible revenue base." Compl. ¶¶ 117, 144.1. Additionally, the Report alleged that SinoTech's "sole chemical supplier [for the MDF business] appears to be an empty shell, with little or no revenues, a deserted office and no signs of production activity." Compl. ¶¶ 117, 144.2. Moreover, Alfred Little contended that some of the Company's "largest subcontracting customers, providing the vast majority of CTE's revenues, appear to be shell companies with unverifiable operations and minimal revenues." Compl. ¶¶ 117, 144.3. The Report concluded that SinoTech's stock was "theoretically worth less than $0.63 per share but [that] investors [would] likely recover nothing." Compl. ¶ 144.7.
In addition to the Report's allegations, Plaintiffs contend that, as of September 30, 2010, SinoTech "owned no more than 10 LHD units in service that were worth approximately $10.72 million in total." Compl. ¶¶ 117, 121. Plaintiffs also allege that information relating to the purported LHD sales contracts was materially misleading, and that, inter alia, TJN had ordered only two LHD units, at a price of between $600, 000 and $1.28 million per unit, as of January 11, 2010. Compl. ¶ 119. As a result, Plaintiffs contend that SinoTech's 2010 financial statements overstated reported property and equipment assets by roughly $50 million and total assets by more than 40 percent. Compl. ¶ 173.
On the same day as the Report's release, SinoTech's ADSs fell from its previous closing price of $4.02 per share to $2.35 per share and NASDAQ halted trading. Compl. ¶¶ 8-9, 145-46. On September 15, 2011, NASDAQ sent a letter to SinoTech announcing that it would delist the Company's securities. Compl. ¶¶ 12, 152. On September 23, 2011, amidst a flurry of executive departures and resignations, EYHM resigned as SinoTech's auditor and repudiated its March 31, 2011 audit opinion, announcing that it had "los[t] confidence in the accuracy and reliability of the Company's previously filed financial statements." Compl. ¶¶ 15, 43, 122. Effective January 17, 2012, SinoTech's stock was formally delisted from NASDAQ. Compl. ¶ 18. The Company then listed its shares on the OTC market's "Pink Sheets, " where its price fell to $0.02 per share. Compl. ¶ 18.
On April 23, 2012, the SEC filed a lawsuit against SinoTech and individual defendants. Compl. ¶ 20. The complaint in that action stated that the Company "grossly overstated the value of [its] primary operating assets in financial statements, specifically the lateral hydraulic drilling units ("LHD units") that are central to its business... acquired far fewer LHD units [than publicly advertised], lied about the number it acquired, and grossly overstated the value of the units." Compl. ¶ 20. The SEC Complaint further indicated that an individual defendant had "misappropriated at least $40 million of SinoTech's cash between June 30, 2011 and August 2011" and then "stood by silently in August 2011 as SinoTech attempted to counter public accusations of fraud by claiming the company held $93 million in its bank accounts." Compl. ¶ 22. On May 2, 2012, the SEC issued an Order Instituting Administrative Proceedings and Notice of Hearing Pursuant to § 12(j) of the Exchange Act. Compl. ¶ 24. SinoTech did not contest or challenge the SEC's actions, and on May 30, 2012, the SEC revoked registration of the Company's registered securities. Compl. ¶ 24.
B. Allegations in Complaint
This class action was filed on August 19, 2011, against SinoTech, the Individual Defendants, and the Underwriter Defendants. Dkt. No. 1. EYHM was named as a defendant in the Second Consolidated Amended Complaint ("SCAC"), which was filed on July 2, 2012, and which alleges that EYHM violated § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Compl. ¶ 202. The claim against EYHM "stem[s] from the untrue statements of material fact made in [EYHM's] audit opinion contained in the annual report filed by SinoTech on a Form 20-F on March 11, 2011." Pl. Opp. 8; see also Compl. ¶¶ 168-84. The Complaint additionally alleges that EYHM is liable under § 10(b) and Rule 10b-5 for false or misleading forward-looking statements made by the SinoTech Defendants during the Class Period. Compl. ¶¶ 197-99.
Plaintiffs allege that EYHM "acted with scienter in that they either knew or recklessly disregarded that the public documents and statements issued or disseminated in the name of [SinoTech] were materially false or misleading." Compl. ¶ 192. In support, the Complaint states that EYHM "participated in the scheme in order to generate lucrative fees for conducting the audit of SinoTech's financial statements." Compl. ¶ 193.
The Complaint further alleges that EYHM "personnel were regularly present at SinoTech's offices and had continual access to, and knowledge of, SinoTech's internal accounting records, its confidential financial and non-public business documents and employees." Compl. ¶ 169. By contrast, Plaintiffs allege, "Alfred Little was able to discern [the fraudulent reporting] without any [such] access." Compl. ¶¶ 169, 180. From this, Plaintiffs infer that EYHM "knew of or recklessly disregarded adverse facts concerning the Company's improper financial reporting during the Class Period." Compl. ¶ 170. Plaintiffs allege that it follows that EYHM "knowingly, or recklessly, issued a false unqualified audit opinion on the Company's 2010 financial statements" and failed to adhere to generally accepted auditing standards ("GAAS"), GAAP, and SEC rules and regulations for auditors. Compl. ¶¶ 171-74, 182-83. Plaintiffs specifically point to EYHM's noncompliance with Auditing Standards ("AS") Nos. 12 and 15,  see Compl. ¶¶ 175, 177; ...