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Pehlivanian v. China Gerui Advanced Materials Group, Ltd.

United States District Court, S.D. New York

March 29, 2017

ARAM J. PEHLIVANIAN, Individually and On Behalf of All Others Similarly Situated, Plaintiff,
v.
CHINA GERUI ADVANCED MATERIALS GROUP, LTD., MINGWANG LU, EDWARD MENG, YI LU, HARRY EDELSON, J.P. HUANG, KWOK KEUNG WONG, YUNLONG WANG, and MAOTONG XU, Defendants.

          OPINION AND ORDER

          Edgardo Ranios, U.S.D.J.

         This case arises out of alleged violations of the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”) by China Gerui Advanced Materials Group, Ltd. (“China Gerui” or the “Company”) and eight of its current and former Directors and Officers (“Individual Defendants” and collectively, “Defendants”). By way of his Third Amended Complaint (“TAC”), lead plaintiff, Aram J. Pehlivanian (“Pehlivanian” or “Plaintiff”), brings suit on behalf of a class of all those who purchased or otherwise acquired China Gerui securities between March 17, 2009 and June 16, 2016 (the “Class Period”), and sustained losses upon the revelation of alleged corrective disclosures (the “Class”). Pending before this Court is China Gerui and Individual Defendant Harry Edelson's (“Edelson”) motion to dismiss the TAC with prejudice pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. For the reasons set forth below, the motion is GRANTED.

         I. Background

         a. Factual Background

         i. The Defendants

         China Gerui is a steel processing company based in China and incorporated under the laws of the British Virgin Islands that produces high-precision, ultra-thin, cold-rolled steel products for sale internationally and domestically. TAC ¶¶ 2, 8.

         As of the date of this Order, the only Individual Defendant that has been served is Edelson. See Docs. 9, 54, 66 (extending the deadline to serve the Individual Defendants, excluding Edelson, to December 1, 2016).[1] Edelson was a director of China Gerui from 2009 until March 2016, when he resigned. TAC ¶¶ 12, 46 & n.5. He previously served as Chief Executive Officer and Chairman of the Board of Directors of China Gerui's predecessor corporation. Id. ¶ 12. Edelson has received $10, 000 a month from China Gerui since 2010 for his services promoting awareness of the Company within the investment community, participating in road shows and investor conferences, and providing the Company with office space and communications facilities. Id.

         The other seven Individual Defendants are: (1) Mingwang Lu (“Lu”), Chairman of China Gerui's Board of Directors and Chief Executive Officer; (2) Edward Meng (“Meng”), China Gerui's Chief Financial Officer and previously its Director of Investor Relations; (3) Yi Lu (“Y. Lu”), China Gerui's Chief Operating Officer and a Director; (4) J.P. Huang (“Huang”), a China Gerui Director who serves on the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee; (5) Kwok Keung Wong (“Wong”), a former China Gerui Director who served on the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee; (6) Yunlong Wang (“Wang”), a China Gerui Director who took Wong's place on the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee; and (7) Maotong Xu (“Xu”), a China Gerui Director and the Chair of the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee. Id. ¶¶ 9-16.

         ii. Defendants' Allegedly False and Misleading Statements

         Plaintiff claims that over the past five years, Defendants have made a number of material misstatements to the investing public in order to “hide” China Gerui's “horrible financial performance” and the “serious problems being experienced with its business operations, use of capital, financial condition and fiscal strategy.” TAC ¶ 3.[2] Plaintiff's allegations of fraud center on five events: (1) the Company's purchase of land use rights to 25.94 acres of land located in China from an entity called Zhengzhou No. 2 Iron and Steel Company Limited (“Zhengzhou”) for $42.6 million (the “Land Transaction”), id. ¶¶ 18, 51-53;[3] (2) the Company's relationship with Cambelle-Inland, LLC (“Cambelle”), a U.S.-China investment firm, id. ¶¶ 25, 54-55; (3) the Company's purchase of a collection of antique Chinese porcelain for $234 million (the “Porcelain Acquisition”), id. ¶¶ 61-70; (4) the Company's retention of UHY Vocation HK CPA Limited (“UHY”) as its auditor, id. ¶¶ 21, 100; and (5) the Company's regulatory filings with the SEC in the United States and the State Administration for Industry and Commerce (“SAIC”) in China, id. ¶¶ 86-89. Each of these events is more fully described below.

         The Land Transaction.

         On July 11, 2011, China Gerui announced, in its 2010 annual report, that it had started the process of acquiring title to 25.94 acres of land use rights from Zhengzhou. Id. ¶ 51. The Company's existing production facilities and warehouses were already located on a portion of that land, as the Company had been subleasing 6.69 acres. Id. The Company stated that it had prepaid, as of December 31, 2010, approximately $2.1 million to Zhengzhou, but that the final price was to be further determined “based on market-based valuation of the land value and calculation of associated value-added tax.” Id. The stated purpose of the transaction was “operation risk mitigation.” Id.

         On May 7, 2012, in its 2011 annual report, the Company again stated that it was in the process of transferring title to the 25.94 acres of land use rights. Id. ¶ 52. The Company also announced that it had increased its prepayment to approximately $12.7 million. Id. On April 30, 2013, in its 2012 annual report, the Company announced that on February 26, 2013, it had entered into an agreement with Zhengzhou, whereby the Company would acquire the land use rights to the 25.94 acres in exchange for $42.6 million. Id. ¶ 53.[4]

         Plaintiff alleges that the Land Transaction was a “complete fraud, and could not have possibly taken place under the normal governmental oversight exercised in the United States.” Id. ¶ 90. Although the TAC does not clarify in what way the transaction was a fraud, Plaintiff does set forth a few relevant facts. First, according to a Chinese law firm/title company that Plaintiff retained, title to the land use rights was never actually transferred from Zhengzhou to the Company. Id. ¶ 91, Ex. D. Second, Zhengzhou's filings with the SAIC show that neither Zhengzhou's assets nor its profits were ever valued near $43.6 million from 2012 through 2015-the time period during which Zhengzhou purportedly owned and then sold the land use rights to the Company. Id. ¶¶ 92-93, Ex. E.[5] Third, at the time of the “transfer, ” Defendant Lu, China Gerui's Chairman and CEO, owned 40% of Zhengzhou. Id. ¶ 51.

         Relationship with Cambelle.

         On May 1, 2013, China Gerui entered into an agreement with Cambelle for business-related advice and consulting services. Id. ¶ 54. On May 13, 2013, Defendant Lu commented on the engagement, stating that the Company planned to “globalize [its] business through accretive acquisitions while continuing to focus on organic growth opportunities, ” and that this strategy would enable the Company, “[d]uring the next few years, . . . [to] create a blend of revenue across a broader customer base, both domestically . . . and internationally.” Id. ¶ 55. Plaintiff claims that this statement was “false when made or became false sometime after it was made, ” because as of at least November 14, 2014, Cambelle was no longer performing work for the Company. Id. ¶ 95.

         The Porcelain Acquisition.

         On September 4, 2014, the Company announced, during an earnings conference call, that it had purchased for $234 million a collection of antique Chinese porcelain appraised at $905 million. Id. ¶¶ 61-62. Defendant Lu explained that Company management and the Board of Directors decided to take advantage of the Company's rich cash position to make the alternative investment. Id. ¶ 62. Lu explained that the Company's intention was to sell all 206 pieces in the collection over time at a substantial return, and to use the profits from the sale to support the Company's steel operations while the steel industry “gains stronger fundamental balance.” Id. ¶¶ 62-63.

         Defendant Meng, the Company's CFO, provided more detail regarding the porcelain collection. He noted that the porcelain came from a private entrepreneur who was under financial pressure from his personal business, that the collection was appraised and authenticated by “Class A certified China arts appraisers, ” and that the prices of the individual pieces in the collection compared favorably with those of similar pieces. Id. ¶ 67. Both Lu and Meng acknowledged that the Porcelain Acquisition, paid for from the Company's existing cash accounts, would put short-term pressure on the Company's cash position. Id. ¶¶ 64-65. Both executives expressed optimism, however, regarding the potential rewards from the investment. Id.

         On the date the Porcelain Acquisition was announced, September 4, 2014, China Gerui's stock price declined approximately 20%, from $0.61 per share (pre-split)[6] on September 3, 2014, to $0.49 per share (pre-split). Id. ¶ 71. Approximately three weeks later, on September 26, 2014, Lu sent a letter to shareholders discussing the Company's ongoing growth strategy, but the letter made no mention of the recent porcelain purchase. Id. ¶ 72. On January 6, 2015, the Company issued a press release, in which it stated that the Company was “vigorously pursuing opportunities with established domestic and international auction houses to liquidate the antique collection in part or in its entirety.” Id. ¶ 74.

         Plaintiff claims that Defendants have failed to disclose a number of facts regarding the Porcelain Acquisition, namely: when or from whom the porcelain was purchased; where the collection was being stored; whether the collection was insured; who appraised and authenticated the collection; what material actions were being taken to “vigorously pursu[e] opportunities” to liquidate the collection; and which “established domestic and international auction houses” were being used to liquidate the collection. Id. ¶¶ 69, 74.

         Plaintiff also claims that the Porcelain Acquisition was “a complete fraud.” Id. ¶ 96. As with the Land Transaction, the TAC does not clarify in what way the acquisition was a fraud. However, Plaintiff sets forth a few salient facts. First, Plaintiff alleges that no certificates of authenticity for the porcelain collection were ever offered or disclosed by Lu. Id. ¶ 38. Second, Plaintiff alleges that Lu has a “background in art fraud.” Id. Namely, in 2002, Lu was allegedly involved in a widely publicized scheme to sell fake paintings of a famous Chinese painter. Id. ¶ 37. Third, Plaintiff alleges that art experts he consulted have “clearly indicated” that a large percentage of the artwork offered for sale in China are forgeries. Id. ¶ 38. Fourth, Plaintiff alleges that the Company attempted to obtain insurance for the porcelain collection but was denied coverage. Id. ¶ 99. Finally, Plaintiff alleges that the Company's filings for the SAIC “do not leave room” for spending $234 million on the porcelain collection, “let alone acquiring an asset worth” $905 million. Id. ¶ 98, Ex. G.[7]

         Retention of UHY.

         On April 30, 2015, the Company filed Form NT 20-F with the SEC, stating that its 2014 annual report would be filed late. Id. ¶ 75. The Company further stated that it anticipated that it would file the report “within the fifteen-day grace period provided by Exchange Act Rule 12b-25.” Id. ¶ 76. Ultimately, the Company never filed its 2014 annual report. Id. ¶ 77.

         Plaintiff alleges that the Company's April 30, 2015 statement was “false when made, ” because “it no longer had an auditor, ” which it would need to properly file its report with the SEC. Id. ¶ 100. Plaintiff does not indicate on what date the Company allegedly lost its auditor. However, the TAC alleges elsewhere that UHY was the Company's public auditor “from ...


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