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In re China North East Petroleum Holdings Limited Securities Litigation

United States District Court, S.D. New York

January 15, 2015


Jeremy A. Lieberman, Esq., Marc I. Gross, Esq., Shaheen Rushd, Esq., Anthony F. Maul, Esq., POMERANTZ HAUDEK GROSSMAN & GROSS LLP, New York, New York, Attorneys for Lead Plaintiff Acticon AG.

Thomas P. Mazzucco, Aaron K. McClellan, Nicholas C. Larson, James A. Lassart, MURPHY, PEARSON, BRADLEY & FEENEY, San Francisco, California, Attorneys for Defendants China North East Petroleum Holdings Limited, Wang Hong Jun, Guizhi Ju, and Zhang Yang.



This putative class action is brought on behalf of all persons who purchased China North East Petroleum Holdings, Ltd. ("China North") securities during the period from May 15, 2008 through and including May 26, 2010 (the "class period"). In the Consolidated Class Action Complaint ("Complaint") dated January 15, 2011, lead plaintiff Acticon AG ("Acticon") brings claims against defendants China North, its former directors Wang Hung Jun, Guizhi Ju, Zhang Yang, Edward M. Rule, Li Jing Fu and Yu Li Guo (collectively "the individual defendants"), Robert C. Bruce ("Bruce") and Ralph E. Davis Associates, Inc. ("Davis") for alleged violations of §§ 10(b) & 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) & 78t(a), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5.

Defendants moved in three groups to dismiss Acticon's Complaint. In October 2011, I dismissed the case on the ground that Acticon had failed to demonstrate loss. The Second Circuit reversed, holding that Acticon had satisfactorily pled loss causation, and remanded the case for further proceedings. I subsequently dismissed the claims against Davis and Bruce for failure to plead scienter. I now re-examine the present motion by China North and the individual defendants to dismiss for failure to state a claim pursuant to Rule 12(b)(6). That motion is granted because of Acticon's failure to plead scienter.


China North is a Nevada corporation engaged in the exploration and production of crude oil in northern China. China North's shares are publicly traded on the NYSE MKT exchange. The individual defendants are the following current and former officers of China North: China North's former Chairman and Chief Executive Officer, Wang Hung Jun ("Wang"); Wang's mother, Guizhi Ju ("Ju"), who also formerly served on China North's Board of Directors; Wang's brother-in-law, Yu Li Guo ("Yu"), who also formerly served on China North's Board of Directors; China North's former Chief Financial Officer, Zhang Yang ("Zhang"); China North's current Chairman, Edward M. Rule ("Rule"); and China North's current Chief Executive Officer, Li Jing Fu ("Li").

Acticon alleges that defendants made misstatements in China North's financial disclosures, which later required restatement. According to the Complaint, these misstatements artificially inflated the price of China North's securities, the value of which subsequently declined following China North's corrective disclosures. The first two alleged misstatements relate to China North's accounting practices; the final alleged misstatement was about China North's internal controls.

First, Acticon alleges that China North incorrectly accounted for certain warrants. According to the Complaint, China North entered into a Purchase Agreement in which LotusBox Investments agreed to pay China North $15 million cash in exchange for, inter alia, warrants exercisable under certain conditions for China North stock. Acticon contends that under GAAP regulations, these warrants should have been classified as liabilities, but that the company instead accounted for the warrants as equity instruments. The effect of this accounting error was that China North failed to recognize a loss on the warrants, and therefore the company's net income, as reported in its financial statements, was inflated by $9.8 million.

Second, Acticon alleges that defendants incorrectly calculated the value of China North's oil properties and, as a result, the company failed to take a necessary impairment.[1] When China North later issued a restatement correcting the value of its oil properties, the price of China North's stock declined.

In addition to the aforementioned accounting misstatements, Acticon also alleges that defendants made material misstatements about the strength of China North's internal controls. In various public disclosures, including China North's 2008 Form 10-K, defendants certified the strength of China North's internal controls, acknowledging that it was management's responsibility to "provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of the company's assets that could have a material effect on the financial statements" and certifying that "internal control over financial reporting was effective." A subsequent forensic audit of China North performed by accounting firm John Lees Associates (JLA) uncovered a number of allegedly illicit money transfers from the company to then-directors Wang and Ju.[2] Acticon cites these money transfers and the fact that China North had no policy barring such transfers as evidence of the lack of internal controls at China North.


On a motion to dismiss pursuant to Rule 12(b)(6), the factual allegations in the complaint are accepted as true, and all reasonable inferences are drawn in the plaintiff's favor. McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 191 (2d Cir. 2007). The complaint need only include "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009).

In order to state a claim for relief under Section 10(b) and Rule 10b-5, a plaintiff must also allege with particularity facts necessary to meet the heightened pleading requirements of Fed.R.Civ.P. 9(b) and the PSLRA. In order to survive a motion to dismiss, Rule 9(b) requires that "the circumstances constituting fraud" must be stated "with particularity." "Allegations that are conclusory or unsupported by factual assertions are insufficient" to meet the heightened pleading requirement of Rule 9(b). ATSI Commnc'ns Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007). The PSLRA further requires that to adequately plead scienter a complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2)(A). To establish the requisite scienter in the securities fraud context, ...

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