United States District Court, S.D. New York
In re SHENGDATECH, INC. SECURITIES LITIGATION.
OPINION AND ORDER
LORNA G. SCHOFIELD, District Judge.
Shareholders of ShengdaTech, Inc. ("ShengdaTech" or the "Company") brought suit against ShengdaTech and its officers and directors for securities fraud. This consolidated action is now before the Court on the motion of Defendants A. Carl Mudd and Sheldon B. Saidman to dismiss the Third Consolidated Amended Class Action Complaint. For the following reasons, their motion is granted.
I. Relevant Events
The following facts are taken from the Third Consolidated Amended Class Action Complaint (the "Complaint" or "TAC") and certain public documents filed in other courts or with the SEC that are attached to or referenced in the Complaint and motion papers, of which the Court takes judicial notice.
Defendant ShengdaTech, a corporation headquartered in China, is a manufacturer of nano-precipitated calcium carbonate, an additive used in products such as tires, ink, paint, latex, paper and polyethylene products. ShengdaTech became a publicly traded company in January 2007 after a reverse merger with a dormant public shell company incorporated in Nevada. Defendants Mudd and Saidman became members of ShengdaTech's five-member Board of Directors in February 2007, and both served on its three-member Audit Committee, which Defendant Mudd chaired. Both Defendants Mudd and Saidman signed ShengdaTech's Forms 10-K for the years ending 2006 to 2009.
In or around May 2010, an unidentified member of the Audit Committee met with a lead audit partner from KPMG HK, which had been ShengdaTech's auditor since late 2008, to discuss its review of ShengdaTech's financial statements for the first quarter of 2010. The KPMG HK partner mentioned to the Audit Committee member that during its audit of ShengdaTech's 2009 financial statements, it received more third party audit confirmations than it had requested. The Audit Committee member asked that KPMG HK "look more closely at [the] confirmations when auditing the 2010 [f]inancial [s]tatements."
In early and mid-March 2011, in writing and by telephone, KPMG HK informed the Audit Committee of significant discrepancies between its findings and ShengdaTech's records with respect to ShengdaTech's customers, sales, suppliers and bank balances, and that "ShengadaTech management had misdirected, intercepted and/or otherwise interfered with  confirmation requests and responses." On March 15, 2011, ShengdaTech announced that it had appointed a Special Committee of the Board, comprised of the three members of the Audit Committee (including Defendants Mudd and Saidman), to investigate those discrepancies. ShengdaTech also announced that (i) the Audit Committee had retained O'Melveny & Myers LLP as independent legal counsel to conduct the internal investigation; (ii) it had notified the SEC about the commencement of the investigation; and (iii) it would not timely file its 2010 Form 10-K. On April 29, 2011, KPMG HK resigned its position as ShengdaTech's auditor. KPMG HK put the ShengdaTech Board on notice of its intent to resign in a letter in which it expressed its view that:
[S]enior management of the Company had not taken, and the Company's Board of Directors had not caused senior management to take, timely and appropriate remedial actions with respect to discrepancies and/or issues relating to the Company's financial records that were identified during the course of the audit for the year ended December 31, 2010.
In a Form 8-K filed on May 5, 2011, ShengdaTech announced that KPMG HK's audit reports on the Company's year-end financial statements for 2008 and 2009 should no longer be considered reliable. Later that month, the Special Committee retained the law firm Skadden, Arps, Slate, Meagher & Flom LLP ("Skadden") to take over the internal investigation. On August 19, 2011, Skadden presented to the Special Committee its preliminary report, in which it "confirmed material irregularities and/or inaccuracies in the financial records of the Company." On the same day, the Special Committee authorized and directed ShengdaTech to file a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code.
II. Allegations Implicating Defendants Mudd & Saidman
In addition to the Audit Committee, Defendants Mudd and Saidman also sat on the Board's Compensation Committee and Nominating and Corporate Governance Committee. The 2009 Form 10-K stated that both Defendants were qualified to serve on the ShengdaTech Board because of their "extensive knowledge" of ShengdaTech. For their positions, they were compensated as follows: Defendant Mudd received $75, 000 in cash annually for 2008 and 2009, plus $58, 945 in options for 2008; and Defendant Saidman received $35, 000 in cash annually for 2008 and 2009.
Defendant Mudd, the Chairman of the three-person Audit Committee, is a Certified Public Accountant. He is considered an "audit committee financial expert" under SEC rules, a designation demonstrating his "thorough understanding of the Audit Committee's oversight role, expertise in accounting matters[, ] a deep understanding of financial statements, and the ability to ask the right questions to determine whether the [C]ompany's financial statements were complete and accurate." The Audit Committee was "directly responsible for the appointment, retention, compensation, and oversight" of KPMG HK's work, and met with KPMG HK on a quarterly basis between May 2008 and March 2011.
The 2008 Form 10-K, signed by Defendants Mudd and Saidman among others, was filed on April 1, 2009. During 2008, the Audit Committee met nine times, with the rate of attendance exceeding 75 percent for all three Audit Committee members. In connection with the 2008 Form 10-K, KPMG HK issued an audit report in which it stated that "ShengdaTech, Inc. and subsidiaries have not maintained effective internal control over financial reporting as of December 31, 2008...." The Complaint alleges that statements made in the 2008 Form 10-K were "materially false and misleading when made because they misrepresented and failed to disclose" a number of facts known to or recklessly disregarded by Defendants, including that they overstated ShengdaTech's sales, income, cash accounts, the amount of goods purchased from suppliers and the number of customers; that ShengdaTech's financial statements did not conform with U.S. GAAP; that ShengdaTech was participating in undisclosed related-party transactions; and that ShengdaTech was materially lacking in its internal controls over its financial reporting.
The Complaint alleges that for the period ending December 31, 2008, while ShengdaTech reported net sales of $82.4 million and net income of $36.03 million to the SEC, it reported net sales of $9.5 million and a net loss of $2 million to the Chinese Administration of Industry and Commerce ("AIC"), the business regulatory agency in China.
The three Forms 10-Q filed in March, June and September 2009, which Defendants Mudd and Saidman did not sign, each stated that management had concluded at the end of the respective quarters that "the Company's disclosure controls and procedures were not effective... due to the fact that the material weaknesses in the Company's internal control over financial reporting described in [the 2008 Form 10-K] ha[d] not been remediated... although steps ha[d] been taken toward remediation...."
The 2009 Form 10-K, signed by Defendants Mudd and Saidman among others, was filed on March 15, 2010. During 2009, the Audit Committee met seven times, with all three members attending all meetings. Both the 2009 Form 10-K and KPMG HK's audit report in connection with it represented that the Company's internal control over financial reporting was effective as of December 31, 2009. As with the 2008 Form 10-K, the Complaint alleges that statements made in the 2009 Form 10-K were "materially false and misleading when made because they misrepresented and failed to disclose" a number of facts known to or recklessly disregarded by Defendants, including that they overstated ShengdaTech's sales, income, cash accounts, the amount of goods purchased from suppliers and the number of customers; that ShengdaTech's financial statements did not conform with U.S. GAAP; that ShengdaTech was participating in undisclosed related-party transactions; and that ShengdaTech was materially lacking in its internal controls over its financial reporting.
The Complaint alleges that for the period ending December 31, 2009, while ShengdaTech reported net sales of $102.1 million and net income of $23.1 million to the SEC, it reported net sales of ...