United States District Court, S.D. New York
Decided March 26, 2014.
As Corrected June 9, 2014.
[Copyrighted Material Omitted]
[Copyrighted Material Omitted]
For United States Securities And Exchange Commission, Plaintiff: Alfred A. Day, LEAD ATTORNEY, PRO HAC VICE, U.S. Securities and Exchange Commission (DC), Washington, DC, USA; Ansu Nath Banerjee, PRO HAC VICE, U.S. Securities & Exchange Commission, Washington, DC, USA.
For China Northeast Petroleum Holdings Limited, Defendant: Michael J. Coffino, LEAD ATTORNEY, PRO HAC VICE, The Crone Law Group, San Francisco, CA, USA; Jaime Jane Santos, Coffino Law Group, San Francisco, CA, USA.
For Wang Hongun, also known as Hongjun Wang, Defendant: Joseph N Akrotirianakis, PRO HAC VICE, Hobart Linzer LLP, Los Angeles, CA, USA.
For Jiang Chao, also known as Chao Jiang, Defendant: Michael Li-Ming Wong, PRO HAC VICE, Thad Davis, Gibson, Dunn & Crutcher, LLP, San Francisco, CA, USA.
For Jiang Mingfu, also known as Mingfu Jiang, Relief Defendant: Geoffrey Hunter Coll, Schiff Hardin LLP, New York, NY, USA.
MEMORANDUM AND ORDER
NAOMI REICE BUCHWALD, UNITED STATES DISTRICT JUDGE.
Plaintiff, the Securities and Exchange Commission (the " SEC" or " plaintiff" ), brings this action against China Northeast Petroleum Holdings Limited (" CNEP" or the " Company" ), its former CEO Wang Hongjun (" Wang" ), its former director Ju Guizhi (" Ju" ), and its former Vice President of Corporate Finance and Secretary Jiang Chao (" Chao" ), as well as against relief defendants Sun Jishuang (" Sun" ) and Jiang Mingfu (" Mingfu" ). The SEC's complaint (the " Complaint" ) asserts the following claims: (1) securities fraud against all defendants under Section 17(a)
of the Securities Act of 1933 (" Securities Act" ), Section 10(b) of the Securities Exchange Act of 1934 (" Exchange Act" ), and Rule 10b-5; (2) books and records liability against CNEP, Wang, and Ju for violations of Exchange Act Sections 13(a), 13(b)(2), and 13(b)(5), and of Rules 13a-1, 13a-11, 13a-13, and 13b2-1; (3) aiding and abetting liability against all individual defendants for violations of Exchange Act Sections 10(b), 13(a), and 13(b)(2), and of Rule 10b-5; and (4) control person liability against Wang and Ju under Section 20(a) of the Exchange Act.
Presently before the Court are three motions to dismiss the Complaint for failure to state a claim pursuant to Federal Rule of Procedure 12(b)(6) -- one filed by CNEP, a second by Wang and Sun, and a third by Chao. The SEC has also moved to serve defendant Ju by alternative means. For the reasons set forth below, defendants' motions to dismiss are denied, and plaintiff's motion to serve Ju by alternative means is also denied.
I. Factual Background
CNEP is a Nevada corporation that engages in principally oil exploration, drilling, and production in China. Cmplt. ¶ ¶ 2, 11. It was formed in April 2004 through a reverse merger with a U.S. shell corporation and began trading on the NYSE Amex LLC (" NYSE" ) on June 15, 2009. Id. ¶ 12. However, CNEP was delisted from the NYSE on July 16, 2012 and, as of the filing of the Complaint on November 27, 2012, its common stock traded over-the-counter at $0.22 per share. Id. ¶ 14.
In addition to the Company, there are three individual defendants. The first, Wang, was the chairman of CNEP's Board of Directors, CEO, and President of the Company from at least January 1, 2009 through May 23, 2010, at which time he resigned from his position as chairman and was placed on leave from his position as CEO and President. Id. ¶ 15. During the time period referenced in the Complaint, Wang was the single largest shareholder of CNEP stock, owning 26% of the outstanding shares according to a December 31, 2009 10-K report. Id. The second individual defendant is Ju Guizhi (" Ju" ). One of CNEP's founders, she is also Wang's mother and served as a director of the Company from November 2009 through May 2010. Id. The SEC claims that Ju was heavily involved in the day-to-day operations of CNEP despite her lack of title, and as of February 15, 2012, she also served as General Manager of two CNEP subsidiaries. Id. ¶ 16. Jiang Chao (" Chao" ), the former Vice President of Corporate Finance and Secretary of CNEP, is the third individual defendant. Id. ¶ 17. All three defendants are Chinese nationals, although Wang resides part-time in California and Chao resides in Jersey City, New Jersey. Id. ¶ ¶ 15, 17.
The SEC also includes two relief defendants in its Complaint. The first is Sun, who is Wang's wife and the alleged recipient of $300,000 in improperly diverted funds. Id. ¶ 18. Although she has served as the Treasurer/Cashier of CNEP since November 2010, she was not working in that capacity at the time of the $300,000 transfer. Id. The second relief defendant is Mingfu, Chao's father. Id. ¶ 19. The SEC alleges that he improperly received $910,000 from the Company while not serving CNEP in any capacity. Id.
B. Allegations in the Complaint
Shortly after CNEP company stock began trading on the NYSE in June of 2009, the Company filed a Form S-3 registration statement that registered public offerings
of up to $40 million of securities. Id. ¶ 20. Wang signed the statement, and it stated that CNEP would " use the net proceeds from the sale . . for general corporate purposes, which may include working capital, capital expenditures, acquisitions of new technologies or businesses, and investments." Id. Chao then appeared at road shows and made presentations to investors in support of CNEP's upcoming public offering. Id. ¶ 21.
On September 16, 2009 the Company announced the public offering of CNEP stock in a Form 8-K signed by Wang. Id. ¶ 22. This 8-K included a press release, with Chao listed as the contact person, which stated that the Company would " use the net proceeds from the offering to fund its future business expansion plan, and for general working capital purposes." Id. On December 15, 2009, CNEP filed another Form 8-K, also signed by Wang, which announced a second offering of CNEP stock. Id. ¶ 23. In the associated press release, which again listed Chao as the Company's contact person, CNEP represented that it planned to " use the net proceeds from the offering to redeem its 8% Senior Debenture . . . and for general working capital purposes." Id. Combined, the September 2009 and December 2009 offerings raised approximately $31.9 million. Id. ¶ ¶ 5, 24.
It is undisputed that there were at least three related-party transfers during this time period. First, on November 3, 2009, Chao authorized the transfer of $500,000 from CNEP's U.S. Bank Account (the " CNEP Account" ) to the personal bank account of his father, Mingfu. Id. ¶ 26. Next, on November 19, 2009, Chao effected a transfer of $300,000 from the CNEP Account to Sun, Wang's wife. Id. ¶ 28. And finally, on December 16, 2009, Chao authorized an additional transfer from the CNEP Account to Mingfu, this time for the sum of $410,000. Id. ¶ 26. Prior to the Company's public offerings, the CNEP Account balance was approximately $84,000, far lower than the sum of the monies sent to Mingfu and Sun. Id. ¶ 30. Furthermore, the parties agree that none of these transfers were explicitly disclosed to CNEP's shareholders, either in the Form 8-Ks, the press releases accompanying those statements, or in any other periodic SEC disclosures. See Tr. of Oral Arg. at 8:21-9:1, Mar. 12, 2014 (Chao's counsel's concession that none of CNEP's SEC filings explicitly reference the transfers to Sun and Mingfu).
The SEC further alleges that these related-party transactions were not isolated incidents. At the behest of the Company's Audit Committee, CNEP retained a Hong Kong-based accounting firm to review all related-party transactions that took place in 2009. In July 2010, the accounting firm released a report identifying at least 176 undisclosed, related-party transactions between CNEP and Wang or Ju in 2009 alone. Cmplt. ¶ ¶ 35-36. The value of these transactions was approximately $59 million, and they included approximately $28 million of transactions directly or indirectly from CNEP's account to Wang or Ju. Id. ¶ ¶ 36, 39. This $28 million represents 43% of CNEP's reported annual revenue for 2009. Id. ¶ 41. Neither the volume nor the magnitude of these transactions was fully disclosed to the investing public, whether in the Company's offering documents, the associated press releases, or its periodic SEC filings. Id. ¶ 42, 50-51.
II. Procedural Posture
Based on the aforementioned conduct, the SEC filed a seven-claim complaint against CNEP, Wang, Ju, and Chao on November 29, 2012. The first two counts allege that all defendants are liable for securities fraud violations of the Securities
Act and the Exchange Act based on their failure to disclose the foregoing related-party transactions in any of their SEC filings, as well as for raising funds from investors with the intent of diverting those funds to corporate insiders without a business justification. Id. ¶ ¶ 56-63. The next two counts claim that CNEP, Wang, and Ju are liable for books and records violations pursuant to the Exchange Act and a number of associated rules for their knowing falsification of the Company's accounting reports. Id. ¶ ¶ 64-72. The fifth and sixth counts charge the individual defendants with aiding and abetting CNEP's primary violations of the Exchange Act. Id. ¶ ¶ 73-78. And the seventh and final claim asserts that Wang and Ju, as control persons of the Company, are liable for its primary Exchange Act violations. Id. ¶ ¶ 79-82.
Defendants responded to the civil complaint with three separate motions to dismiss -- one on behalf of CNEP, a second on behalf of Wang and relief defendant Sun, and the third on behalf of Chao -- all of which were filed on April 12, 2013. Ju did not file a motion to dismiss; in fact, she has not yet been served and has not appeared in this litigation. After the SEC's recent failed attempt to serve Ju in China, plaintiff filed a motion to serve her by alternative means on October 21, 2013.
I. Pleading Standards
A. Motion to Dismiss
When deciding a motion to dismiss for failure to state a claim pursuant to Federal Rule of Civil Procedure 12(b)(6), the Court must accept as true all factual allegations in the complaint and draw all reasonable inferences in plaintiff's favor. Harris v. Mills,572 F.3d 66, 71 (2d Cir. 2009); Kassner v. 2nd Ave. Delicatessen, Inc., 496 F.3d 229, 237 (2d Cir. 2007). Nevertheless, a plaintiff's " [f]actual allegations must be enough to raise a right of relief above the speculative level." Bell A. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) (internal citation omitted). Once the Court accepts all of the plaintiff's factual allegations as true, those allegations must demonstrate " more than a sheer possibility that a defendant has acted unlawfully" in order to pass muster under Rule 12(b)(6) Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 ...