United States District Court, S.D. New York
IN RE PUDA COAL SECURITIES INC., et al. LITIGATION. This document relates to: ALL ACTIONS
As Corrected June 25, 2014.
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For Salomon Querub, Howard Pritchard, Lead Plaintiffs: Kevin F. Ruf, LEAD ATTORNEY, PRO HAC VICE, Michael Marc Goldberg, Glancy Binkow & Goldberg LLP, Los Angeles, CA; David E Kovel, John Brandon Walker, Kirby McInerney LLP, New York, NY; Joshua Lon Crowell, Labaton Sucharow, LLP, New York, NY; Laurence Matthew Rosen, The Rosen Law Firm, P.A. (NYC), New York, NY; Lionel Z. Glancy, PRO HAC VICE, Glancy & Binkow Goldberg LLP, Los Angeles, CA; Louis Carey Ludwig, PRO HAC VICE, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, Chicago, IL; Michael Goldberg, PRO HAC VICE, Glancy Binkow & Goldberg, LLP (CA), Los Angeles, CA; Robert Vincent Prongay, PRO HAC VICE, Glancy Binkow & Goldberg LLP, Los Angeles, CA; Robin Bronzaft Howald, Glancy Binkow & Goldberg LLP, New York, NY.
For Hotel Ventures, Lead Plaintiff: Kevin F. Ruf, LEAD ATTORNEY, PRO HAC VICE, Michael Marc Goldberg, Glancy Binkow & Goldberg LLP, Los Angeles, CA; David E Kovel, John Brandon Walker, Kirby McInerney LLP, New York, NY; Joshua Lon Crowell, Labaton Sucharow, LLP, New York, NY; Laurence Matthew Rosen, The Rosen Law Firm, P.A. (NYC), New York, NY; Lionel Z. Glancy, PRO HAC VICE, Glancy & Binkow Goldberg LLP, Los Angeles, CA; Louis Carey Ludwig, PRO HAC VICE, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, Chicago, IL; Michael Goldberg, PRO HAC VICE, Glancy Binkow & Goldberg, LLP (CA), Los Angeles, CA; Robert Vincent Prongay, PRO HAC VICE, Glancy Binkow & Goldberg LLP, Los Angeles, CA; Robin Bronzaft Howald, Glancy Binkow & Goldberg LLP, New York, NY; Sara Esther Fuks, Milberg LLP (NYC), New York, NY.
For Harriet Goldstein, Individually and on behalf of all others similarly situated, Plaintiff: Curtis Victor Trinko, LEAD ATTORNEY, Law Offices of Curtis V. Trinko, LLP, New York, NY; Adriene O. Bell, PRO HAC VICE, D. Seamus Kaskela, Kessler Topaz Meltzer & Check, LLP (PA), Radnor, PA; David M. Promisloff, Kessler Topaz Meltzer & Check, LLP, Radnor, PA; Jennifer Elizabeth Traystman, Law Offices of Curtis V. Trinko, New York, NY; Louis Carey Ludwig, PRO HAC VICE, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, Chicago, IL; Myron Harris, PRO HAC VICE, Philadelphia, PA.
For Thomas Rosenberger, Consolidated Plaintiff: Jeffrey Philip Campisi, Kaplan Fox & Kilsheimer LLP (NYC), New York, NY; Laurence Matthew Rosen, The Rosen Law Firm, P.A. (NYC), New York, NY; Louis Carey Ludwig, PRO HAC VICE, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, Chicago, IL; Robin Bronzaft Howald, Glancy Binkow & Goldberg LLP, New York, NY.
For Steven Weissmann, Consolidated Plaintiff: Laurence Matthew Rosen, The Rosen Law Firm, P.A. (NYC), New York, NY; Louis Carey Ludwig, PRO HAC VICE, Pomerantz Grossman Hufford Dahlstrom & Gross LLP, Chicago, IL; Robin Bronzaft Howald, Glancy Binkow & Goldberg LLP, New York, NY.
For Connie L. Douglass 1996 Revocable Trust, Trinity Global Growth & Income Fund, LP, Greg and Jana Womack Living Trust, Movants: William Bernard Federman, Federman & Sherwood, Oklahoma City, OK.
Samuel Blankenship, Movant, Pro se.
For Donald Wilkinson, Robert Thumith, Movant: Andrei V. Rado, Milberg LLP (NYC), New York, NY.
For Puda Coal Investors Group, Movant: Frederic Scott Fox, Sr, LEAD ATTORNEY, Kaplan Fox & Kilsheimer LLP (NYC), New York, NY.
For Puda Coal Shareholder Group, Movant: David Avi Rosenfeld, Robbins Geller Rudman & Dowd LLP(LI), Melville, NY.
For Cesare Crognale, Movant: Albert Yong Chang, LEAD ATTORNEY, Johnson Bottini, LLP, San Diego, CA.
For Macquarie Capital (USA) Inc., Defendant: Greg A. Danilow, LEAD ATTORNEY, Weil, Gotshal & Manges LLP (NYC), New York, NY; Seth Goodchild, Weil, Gotshal & Manges LLP, New York, NY.
For C. Mark Tang, Lawrence Wizel, Consolidated Defendants: Mark Holland, Mary Kathryn Dulka, Maryana Zubok, Richard Mark Strassberg, Goodwin Procter, LLP(NYC), New York, NY.
For Brean Murray, Carrt & Co., LLC, Consolidated Defendant: Robert S. Wolf, LEAD ATTORNEY, Moses & Singer LLP, New York, NY.
For Moore Stephens Hong Kong, Consolidated Defendant: Brian James Massengill, LEAD ATTORNEY, Mayer Brown LLP (Chicago), Chicago, IL; Bridget Phillips Kessler, Mayer Brown LLP (NY), New York, NY; Dana S. Douglas, Justin Adam McCarty, PRO HAC VICE, Mayer Brown LLP (Chicago), Chicago, IL.
For Moore Stephens, P.C., Consolidated Defendant: Joseph Alexander Baratta, LEAD ATTORNEY, Baratta, Baratta & Aidala LLP, New York, NY; Michael Vincent Cibella, Law Office of Michael V. Cibella, New York, NY; Ottavio Vincenzo Mannarino, Baratta, Baratta & Aidala LLP, New York, NY.
CORRECTED OPINION & ORDER
KATHERINE B. FORREST, United States District Judge.
An accounting firm's worst nightmare might be to wake up one morning and discover that the company that one of its teams had audited for the past several years had in fact disappeared, and that what the team had been auditing had been merely a mirage. A twist that could serve only to heighten this distress might be the discovery that the company had been stolen a few years prior--its operations and related revenues transferred away--but that the engagement team had not discovered this fact. The team had issued a " clean opinion." The accounting error in such a case would be fundamental: all aspects of the financial position of the company would have been entirely misstated, because the operations on which it was based were long gone. This scenario is not the storyline for an auditor's version of a horror film; it is what happened here.
Until April 2011, Puda Coal Inc.'s (" Puda" ) shareholders believed there was value in the securities they held--that Puda continued to own 90% of Shanxi Puda Coal Group Co., Ltd. (" Shanxi Coal" ), a supplier of premium high-grade metallurgical coking coal used in steel manufacturing. However, in September 2009, Puda's chairman, Ming Zhao (" M. Zhao" ), and his brother, Yao Zhao (" Y. Zhao" ), had arranged to transfer Puda's entire interest in Shanxi Coal to M. Zhao personally. This transfer left Puda as a shell company, lacking any operations or other source of revenue. The transfer was reflected in minutes of a shareholder meeting for Shanxi Coal and in documents filed in the Shanxi office of China's State Administration of Industry and Commerce (" SAIC" ).
Moore Stephens Hong Kong (" MSHK" ) audited Puda throughout the class period, and Moore Stephens, P.C. (" MSPC" ) performed an " Appendix K" review. (The Court refers to MSHK and MSPC together as " the Auditors." ) Puda made periodic filings with the Securities and Exchange Commission (" SEC" ), which incorporated audit opinions on its financial statements. Puda also discussed its financial statements in press releases.
In April 2011, the game was up. On April 8, 2011, a research report published by Alfred Little (the " Little Report" ) disclosed the Zhao brothers' transfer of Shanxi Coal. Puda's shares declined 34%; one trading day later, the SEC halted trading of Puda's shares entirely. The first of many lawsuits was filed on April 15, 2011. (ECF No. 1.) A number of lawsuits were filed thereafter and consolidated. Following motion practice and discovery, a Second Consolidated and Supplemental Amended Complaint (" SCAC" ) was filed on April 21, 2014. (ECF No. 352.)
The SCAC alleges violations of the securities laws against a variety of individuals and entities, including Puda's Auditors.
Plaintiffs bring claims against the Auditors pursuant to Section 11 of the Securities Act of 1933 (Count I) and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder (Count IV).
Pending before the Court are eight intertwined motions.
On February 14, 2014, the Auditor defendants both moved for summary judgment as to all claims against them on the basis that plaintiffs have failed to raise triable issues as to the subjective falsity of the alleged misstatements as well as to scienter, and, in the case of MSPC, on the basis that it was not the " maker" of any of the alleged misstatements. On February 14, 2014, MSHK also moved to exclude plaintiffs' sole proposed auditing expert, Anita C.M. Hou, on the basis that she lacks the expertise to opine on any issues of relevance and that the opinions she does offer are irrelevant to any issue in the case. MSPC joined that motion. (ECF Nos. 297, 298.) Those motions became fully briefed on May 7, 2014.
In addition to her expert report, Hou also submitted two declarations in opposition to the Auditors' motions for summary judgment on March 28, 2014. On May 7, 2014, MSHK moved to strike these declarations, and MSPC joined that motion. (ECF No. 364.) That motion became fully briefed on June 6, 2014.
On March 28, 2014, plaintiffs moved to exclude the Auditors' three proposed experts: Alexander H. Mackintosh and Peter S. Nurczynski on the basis that their reports are procedurally inappropriate case-in-chief reports masquerading as " rebuttal" reports, and Wang Weimin, on the basis that he lacks necessary expertise and his opinions are merely ipse dixit. Those motions became fully briefed on May 28, 2014.
Finally, plaintiffs have moved to strike MSHK's reply in support of its Local Civil Rule 56.1 statement of material facts. Defendants opposed this motion on June 6, 2014.
For the reasons set forth below, the Auditors' motions for summary judgment and to exclude Hou and strike her declarations are GRANTED. While essentially rendered moot, plaintiffs' motions regarding Nurczynski, Mackintosh and Weimin are DENIED. Plaintiffs' motion to strike MSHK's reply is also DENIED.
The following facts are undisputed unless otherwise noted.
Puda was incorporated in 2001. (Def. MSHK's Resp. to Pls.' Separate Stmt. of Add'l Material Facts (" MSHK 56.1 Resp." ) ¶ 1.) In 2005, through a reverse merger, Puda acquired a 100% interest in Puda Investment Holding Limited (" BVI" ), which in turn owned 100% of Shanxi Putai Resources Ltd. (" Putai" ). (Id. ¶ 2.) Puda conducted its operations exclusively through Shanxi Coal, a PRC limited-liability company. (Id. ¶ 3.) In November 2007, Putai became a 90% owner of Shanxi Coal, with the remaining 10% held by M. Zhao and Y. Zhao. (Id. ¶ 5; [Corrected] Pls.' Resp. to Def. MSHK's Stmt. of Material Facts (" Pls.' 56.1 Resp." ) ¶ 10.) As of December 31, 2009, M. Zhao and Y. Zhao
owned 60% of Puda and the 10% of Shanxi not owned by Putai. (MSHK 56.1 Resp. ¶ 6.) M. Zhao was the chairman of the boards of Puda and Shanxi Coal in 2009 and 2010; he was also identified as a legal representative on Shanxi Coal's 2009 business license. (Id. ¶ 7.) Y. Zhao was identified as the legal representative of Shanxi Putai Minerals Co. (also " Putai" ) on its 2011 business license. (Id. ¶ 8.) PRC regulations designated the Zhao brothers, as the registered legal representatives of Shanxi Coal and Putai, as the " responsible person who acts on behalf of the [entity], in exercising its functions and powers . . . in accordance with the law or the articles of association." (Id. ¶ 9.) The Zhao brothers' roles as " legal representatives" were necessary to make the subsequent fraudulent transfers. (Id.) In December 2009, Puda's board of directors approved a change in Puda's business strategy, expanding its focus from solely a coal-washing business to include mining. (Pls.' 56.1 Resp. ¶ 11.)
According to the findings of Puda's Audit Committee released in September 2011, in September 2009, M. Zhao " arranged for Shanxi Putai Resources Limited ('Putai'), another subsidiary of [Puda] and the parent company of Shanxi Coal, to transfer its 90% ownership (and thereby [Puda's] indirect 90% ownership) of Shanxi Coal to himself." (Id. ¶ ¶ 15, 16.) The Audit Committee also found that Y. Zhao, M. Zhao's brother, who was the legal representative of Putai, had " authorized the transfer." (Id. ¶ 16.) Y. Zhao also transferred a personal 2% ownership interest that he had in Shanxi Coal to his brother, resulting in M. Zhao having a 99% ownership interest. (Id. ¶ ¶ 16, 17.) The Audit Committee also found that " Liping Zhu, the Company's CEO, President and director on the Board, was aware of the 90% Transfer but did not disclose it to any other director." (Id. ¶ 18.)
In July 2010, now owning 99% of Shanxi Coal, M. Zhao " signed various documents to further transfer 49% of the ownership of Shanxi Coal to CITIC," a state-owned private equity fund in the People's Republic of China (" PRC" ). (Id. ¶ ¶ 17, 19.) Also in July 2010, M. Zhao and Wei Zhang (a Shanxi Coal employee who owned the remaining 1% of Shanxi Coal), together pledged--but did not transfer--their remaining 51% ownership of Shanxi Coal to CITIC. (Id. ¶ 20.)
The transfer of Putai's interest in Shanxi Coal to M. Zhao, M. Zhao's subsequent transfer of 49% of his interest to CITIC, and the 51% pledge by M. Zhao and Wei to CITIC were not disclosed in Puda's 2009 or 2010 financial statements at the time that they were filed with the SEC; those statements indicated that Puda still maintained an indirect 90% interest of Shanxi. (Id. ¶ 22.) Because Puda had no indirect or direct interest in the operations or revenues of Shanxi Coal as of September 2009, but disclosed in its financial statements that it did, its financial statements for those periods were materially misstated and not prepared in accordance with Generally Accepted Accounting Principles (" U.S. GAAP" ). (Id. ¶ 23.)
On April 8, 2011, Alfred Little published a short seller report disclosing the Zhao transfers of Shanxi Coal away from Putai and Puda. (Id. ¶ 15.) On July 7, 2011, the Auditors resigned. (Id. ¶ 29.)
Puda's financial statements contained in its Form 10-Ks for the years 2009 and 2010 included all of the assets, liabilities, revenues, expenses, and net income for Shanxi Coal. (MSHK 56.1 Resp. ¶ 14.) Puda's 2009 annual report disclosed that Shanxi Coal had over $200 million in revenue for the year. (Id. ¶ 13.).
The SAIC administers the registration of enterprises, entities, and individuals engaged in business operations in China. (Id. ¶ 15.) The SAIC issues business licenses for PRC companies. (Id. ¶ 17.) A business license includes information relating to, inter alia, the name and address of the company and its legal representative, the type and scope of its business, and the amount of registered or paid-in capital. (Id. ¶ 17.) A business license typically does not show the identity or ownership interest of particular shareholders. (Id. ¶ 18.) Chinese law requires that such information be contained in the company's " articles of association." (Id. ¶ 19.) Chinese law also requires that a company's transfer of equity must amend the names of shareholders and their capital contributions in its articles of association. (Id.) As of 1983, SAIC required that all companies operating with a PRC business license undergo annual inspections. (Id. ¶ 16.)
When a company first registers with the SAIC, the company files a form with the SAIC disclosing the names of its shareholders, the amounts of their contribution, and the total registered capital. (Id. ¶ 22.) If the company's shares are transferred or the amount of registered shares is altered, the company must notify the SAIC and apply for approval of the changes. (Id.) The SAIC issues the company a new business license if and when such changes are approved. (Id.)
When shareholders makes a capital contribution, a PRC-certified public accountant must issue a " capital verification report" (" CVR" ); when a company registers or changes its capital, it must file a CVR with the SAIC. (Id. ¶ 21.) However, if only the identity or percentage of ownership of shareholders changes, and the total amount of contributed capital remains unchanged, then the company is not required to file the CVR with the SAIC. (Id.) A CVR is typically valid for 90 days from the date of issue. (Id.)
A. Audit Standards
MSHK conducted its audit of Puda pursuant to Public Company Accounting Oversight Board (" PCAOB" ) audit standards. (Id. ¶ 24.) MSHK used a Thompson Reuters Practitioner's Publishing Company Guide to PCAOB Audits (" PPC Guide" ), as the basis for preparing its work papers and conducting audits of Puda. (Pls.' 56.1 Resp. ¶ 60.) As a non-U.S. firm, Moore Stephens is required to have " Appendix K" review procedures performed on its audits of U.S.-registered companies; senior auditors from MSPC based in the U.S. performed that function. (See id. ¶ 73; Decl. of Brian J. Massengill (" Massengill Decl." ) Ex. 2 (Expert Report of Alexander H. Mackintosh (" Mackintosh Rep." )), at 4, 11, 12.) PCAOB audit standards require that MSHK obtain " reasonable assurance," defined as a " high level" of assurance, to support its audit conclusions. (MSHK 56.1 Resp. ¶ ¶ 30, 31.)
MSHK's 2009 and 2010 audits of Puda's financial statements were combined with audits of its internal controls. (Id. ¶ 24.) The MSHK partners and principals on the MSHK engagement team for both the 2009 and 2010 year-end audits had experience auditing both PRC and US-listed companies, and assessing and testing internal controls. (Pls.' 56.1 Resp. ¶ 51.) They also had experience issuing audit reports in accordance with PCAOB standards. (Id.) The partners and principals on the audits were each multilingual in Cantonese, Mandarin, and English. (Id. ¶ 52.) The MSHK audit engagement team for Puda also had access to and used U.S. technical resources in conducting its audit work, specifically with regard to U.S. GAAP and PCAOB standards. (Id. ¶ 61.)
MSPC conducted an Appendix K review relating to Puda and issued MSHK a clearance letter stating that based on its review of, inter alia, the financial statements and MSHK's work papers, the financial statements were prepared in accordance with GAAP and the PCAOB standards. (Id.) MSPC did not provide an audit opinion to Puda directly, nor was any audit opinion included directly in any of Puda's financial statements; MSPC was not a signatory on the audit opinion letter provided by MSHK to Puda and incorporated into its Form 10-K.
MSHK personnel spent substantial time at Shanxi Coal in connection with their work. (Id. ¶ 63.) In connection with the 2009 and 2010 year-end audits, four or five MSHK auditors each spent approximately a month each year at Shanxi Coal's facilities and corporate headquarters in Shanxi Province conducting fieldwork. (Id. ¶ 65.) As part of their work, the team inspected physical assets and took photographs as audit evidence. (Id.) Puda's controller, Irene Cheong, interacted regularly with the MSHK audit team. (Id. ¶ ¶ 66, 67.) The chairman of Puda's Audit Committee testified that he was " very impressed" with the quality of MSHK's work. (Id. ¶ 69.)
B. The 2009 Audit
At the outset of its 2009 audit of Puda, MSHK completed a " Fraud Risk Identification Form." (MSHK 56.1 Resp. ¶ 27.) In its " Information Gathered" section, the form states that " management is dominated by [a] single individual," and that there is a " Potential Fraud Risk" of " Management override of controls." (Id.) The form also sets forth the procedures that MSHK must perform in order to address the risk of " management override of controls" on a page designated as " PCA-AP-2." (Id.) These procedures include " examin[ing] journal entries and other adjustments for evidence of possible material misstatement due to fraud," " review[ing] accounting estimates for bias that could result in material misstatements due to fraud," and " evaluat[ing] the business rationale for significant unusual transactions." (Id.)
In its 2009 audit, MSHK performed the following procedures to confirm that Putai owned 90% of Shanxi Coal:
a. Reviewed a management representation letter from Puda;
b. Reviewed an unsigned " form" of a legal opinion from PRC counsel in connection with a February 2010 public offering;
c. Reviewed minutes of Puda's Audit Committee and board of directors;
d. Made an inquiry to Puda's chief financial officer (" CFO" ), Laby Wu;
e. Reviewed Puda's SEC filings; and
f. Reviewed a share registry maintained by Shanxi Coal.
(Id. ¶ 29.)
MSHK's working papers for 2009 contained a " Section V" relating to auditing " Capital, Reserves and Dividends" for Shanxi Coal. (Id. ¶ 32.) Section V contained an " Audit Program for Capital Stock and Other Equity Accounts." (Id. ¶ 33.) The first item in this audit program required MSHK to review Puda's board minutes and note any equity transactions that had been authorized. (Id.) In its work papers, MSHK noted, " No meeting between directors was held in the current year. No equity transaction was noted in the current year." (Id.) The second audit procedure in Section V concerned transactions in equity accounts and required MSHK to " [c]ompare the balances with those of the prior years or other expectations, considering known changes in client operations and equity financing activity." (Id. ¶ 34.) In its work papers, MSHK noted that it performed the comparison
and that " no change was noted." (Id.) The third audit procedure required in Section V was that MSHK " [t]est significant transactions affecting paid-in capital, contributed capital, or treasury stock." (Id. ¶ 35.) Work papers V10, V12, and V13 reflect steps that MSHK performed in this regard. (Id. ¶ 36.) V10 contains a breakdown of the registered capital of Shanxi Coal and the names of corresponding shareholders. (Id. ¶ 37.) MSHK noted on this work paper that " no movement was noted in the current year." (Id. ¶ 38.)
Work paper V20/1 is an unsigned September 25, 2008 Shanxi Coal shareholder meeting resolution that states, " This unsigned minute is attached as it is [sic] only served as reference purpose since the minute was issued in year 2008 and audited in prior year's audit." (Id. ¶ 42.) The unsigned shareholder resolution also referred to a shareholder dividend to be paid. (Id.) As of March 31, 2009, this dividend had not been paid. (Id. ¶ 44.) Puda's 2009 and 2010 Form 10-Ks disclosed that the dividend had not been paid and that " the Zhao brothers may declare dividend out of Shanxi Coal." (Id. ¶ 44, 45.)
Section Z of MSHK's working papers focused on the consolidation of subsidiaries. (Id. ¶ 46.) Item 4 of the Section Z audit program states that MSHK should " [c]onfirm that all group undertakings have been identified for inclusion in the consolidation with the extent and form of the group's interest in each undertaking noted. Ensure that all undertakings are noted on the group structure Z/8." (Id. ¶ 47.) Ida Law, a member of MSHK's engagement team who led the audit for year-end 2010, testified that this " Item 4" step was intended to confirm that Puda owned 90% of Shanxi Coal. (Id. ¶ 48; see also Pls.' 56.1 Resp. ¶ 56.) When asked during a deposition question what steps MSHK took to check whether Shanxi Coal was still a subsidiary, Law testified, " We . . . already inquired management if there--there are any changes in--in the group structure. And they--their answer is--was no change." (MSHK 56.1 Resp. ¶ 50.)
As part of its audit procedures, MSHK obtained a copy of Shanxi Coal's business license. (Id. ¶ 51.) MSHK intended to obtain a copy of the 2009 business license, but Puda's CFO, Laby Wu, instead emailed a copy of a business license that had been issued in September 2007. (Id. ¶ 52.) That license contained an inspection stamp from the SAIC dated March 27, 2009. (Id.) On its face, the business license states, " The enterprise must participate in the annual inspection between March 1 and June 30 of each year." (Id.) Laby Wu sent MSHK the license on February 10, 2010, prior to the time that the SAIC would have received its next annual inspection. (Id.) No other business license for Shanxi Coal is in the record on this motion.
Goodwin Procter LLP, counsel for certain Puda directors whom plaintiffs have sued in this consolidated lawsuit, produced a Shanxi Coal business license issued on September 9, 2009, showing that the registered capital had increased ...