Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd.
| Decision Date | 21 July 2014 |
| Docket Number | No. 13 Civ. 1094ER.,13 Civ. 1094ER. |
| Citation | 33 F.Supp.3d 401 |
| Court | U.S. District Court — Southern District of New York |
| Parties | SPECIAL SITUATIONS FUND III QP, L.P. ; Special Situations Cayman Fund, L.P. ; Columbia Pacific Opportunity Fund, L.P. ; Fir Tree Value Master Fund, L.P. ; Fir Tree Capital Opportunity Master Fund, L.P.; Lake Union Capital TE Fund L.P. ; Ashford Capital Management, Inc. ; ZS EDU L.P.; MRMP Managers LLC; WHI Growth Fund QP, LP; Douglas N. Woodrum; Robert A. Horne; Howard S. Berl; Brightlight Capital Partners LP ; and Tortus Capital Master Fund, LP, Plaintiffs, v. DELOITTE TOUCHE TOHMATSU CPA, LTD. ; Deloitte & Touche LLP; Antonio Sena; Justin Tang; Yin Jianping ; Richard Xue; Michael Santos ; John and Jane Does 1–10; and ABC Corps. 1–10, Defendants. |
Amiad Moshe Kushner, Lowenstein Sandler LLP, New York, NY, Lawrence M. Rolnick, Sheila A. Sadighi, Thomas E. Redburn, Jr., Lowenstein, Sandler, Brochin, Kohl, Fisher, Boylan & Meanor, Roseland, NJ, for Plaintiffs.
Gary Frederick Bendinger, Sidley Austin LLP, Jesse James, Savvas Antonios Foukas, William R. Maguire, Hughes Hubbard & Reed LLP, New York, NY, David Andrew Gordon, Sidley Austin LLP, Chicago, IL, Elizabeth Leanne Howe, Michael Dana Warden, Sidley Austin LLP, Washington, DC, for Defendants.
This case arises from allegations of an independent auditor's alleged failure to detect fraud at ChinaCast Education Corporation, Inc. (“ChinaCast” or the “Company”), an educational services company in the People's Republic of China (“China”). ChinaCast entered the U.S. capital markets through a reverse merger in 2006, and for several years, its common stock was traded on the NASDAQ. In 2012, the Company disclosed that, unbeknownst to its investors, and without consent from its Board of Directors, certain rogue employees, led by the Company's former Chairman and CEO, Ron Chan, had engaged in wide-ranging fraudulent activities, including, inter alia, misappropriation of proceeds from a stock offering, misrepresentation of ChinaCast's ownership interests, and pledging substantial portions of the Company's term deposits to cover debts of third parties. After a series of public announcements revealing the fraud, ChinaCast's stock price plummeted. Am. Compl. ¶¶ 5, 6, 45, 172–84, Doc. 4.
Plaintiffs in this action consist of an assortment of investors who, in the aggregate, purchased more than 20 million shares of common stock issued by ChinaCast. Id. ¶ 6. But rather than sue the Company, Plaintiffs contend that ChinaCast's Shanghai-based outside auditor, Deloitte Touche Tohmatsu CPA, Ltd. (“DTTC”), and its U.S. affiliate, Deloitte & Touche LLP (“Deloitte U.S.”) (collectively, “Deloitte Defendants”), as well as certain former ChinaCast officers and directors (the “Individual Defendants”),1 violated provisions of the Securities Exchange Act of 1934 (the “Exchange Act”) and committed common law fraud by issuing and approving false statements in ChinaCast's public filings with the U.S. Securities and Exchange Commission (“SEC”). Plaintiffs claim that ChinaCast's audited financial statements “carried the imprimatur of Deloitte—one of the ‘Big Four’ global accounting firms—whose name investors rely on as an independent auditor and gatekeeper of accurate financial reporting.” Id. ¶ 1. Yet, “[h]ad Deloitte done even the most basic of audits,” they “would have known that ChinaCast was a house of cards.” Id. ¶ 10.
Plaintiffs assert causes of action for: violations of Section 10(b) of the Exchange Act, and Rule 10b–5 promulgated thereunder, against DTTC and Individual Defendants (First and Third Causes of Action); violations of Section 20(a) of the Exchange Act against Deloitte U.S. (Second Cause of Action); violations of Section 18 of the Exchange Act against all Defendants (Fourth Cause of Action); and common law fraud under New York law against Deloitte Defendants (Fifth Cause of Action). Id. ¶¶ 51–171, 70, 85, 208.
Before the Court are Deloitte Defendants' respective motions to dismiss Plaintiffs' claims under Rule 12(b)(6) of the Federal Rules of Civil Procedure. Docs. 14, 32. For the reasons set forth below, the motions are GRANTED; however, the Court dismisses the First Amended Complaint (“FAC”) without prejudice.
Plaintiffs are a group of investment funds, entities and individuals who purchased ChinaCast securities between March 31, 2008 through and including March 30, 2012.3 Am. Compl. ¶ 1. Some of the Plaintiffs are closely associated with ChinaCast's current management. Individual Plaintiff Doug Woodrum is the Chief Financial Officer (“CFO”) of ChinaCast. Bendinger Decl. Ex. 2 (Apr. 2, 2012 Form 8–K), Doc. 34. In addition, ChinaCast Board Member Ned Sherwood co-founded and manages ZS Fund L.P., the general partner of Plaintiff ZS EDU L.P.; Mr. Sherwood beneficially owns shares held by Plaintiff ZS EDU L.P.; shares owned by Plaintiff MRMP Managers LLC are for the benefit of Mr. Sherwood's children; and Mr. Sherwood was the ChinaCast board designee of Plaintiff Fir Tree Funds. Bendinger Decl. Ex. 11 (Nov. 15, 2011 Schedule 14A Information at 5).
Plaintiffs claim that, collectively, they invested more than $96 million on more than 20 million shares of ChinaCast stock and, as a result of the Defendants' conduct, suffered “tens of millions” of dollars in investment losses. Am. Compl. ¶ 6.
“Deloitte” holds itself out as a global accounting firm comprised of member and network firms that conduct “integrated cross-border audits.” Id. ¶ 51. Deloitte U.S. is a Delaware limited liability partnership located in New York, New York. Id . ¶ 32. DTTC is a Chinese auditing firm with headquarters in Shanghai, China. Id. ¶ 31.
ChinaCast is a Delaware corporation with principal offices in China, and has described itself as “a leading for-profit, post-secondary education and e-learning services provider in China.” Bendinger Decl. Ex. 2 (Apr. 2, 2012 Form 8–K). The Company was initially formed as a special purpose acquisition company called Great Wall Acquisition Corporation (“Great Wall”) on August 20, 2003. Am. Compl. ¶ 39. In 2006, Great Wall identified ChinaCast Communications Holdings Limited (“CCH”), an e-learning company incorporated in Bermuda and listed on the Stock Exchange of Singapore (“SGX”), as a desirable acquisition target. Id. ¶ 40. Starting in 2000, the Chinese Ministry of Education granted licenses to approximately 68 universities to conduct undergraduate and post-graduate courses by distance learning. By 2003, CCH signed with more than 15 universities to use its satellite interactive distance learning network, serving over 50,000 students nationally. Thereafter, CCH expanded its business by signing additional K–12, IT and management training customers. Bendinger Decl. Exs. 3, 6 (2009 and 2010 Form 10–Ks at 2). On December 22, 2006, Great Wall obtained a majority of the outstanding shares of CCH and subsequently changed its name to ChinaCast Education Corporation. Am. Compl. ¶ 45. In 2007, ChinaCast acquired all remaining outstanding shares of CCH and terminated the SGX listing, effecting a “reverse merger” onto the NASDAQ exchange. Id. ¶¶ 4, 45; see also Bendinger Decl. Exs. 3, 6 (2009 and 2010 Form 10–Ks at 2).
Plaintiffs allege that “ChinaCast's business did not make it a complicated company to audit.” Am. Compl. ¶ 4. ChinaCast's financial statements report that it majority-owns approximately twenty-five subsidiaries and variable interest entities. Its principal subsidiary is ChinaCast Technology (BVI) Limited, which, since 1999, has provided funding for satellite broadband Internet services through the satellite operating entities ChinaCast Company Ltd.—Beijing Branch and ChinaCast Li Xiang Co. Ltd. (“CCLX”).4 Bendinger Decl. Ex. 3 (2010 Form 10–K at F–10–13). In 2007, ChinaCast engaged in limited business operations, and its primary assets were cash and term deposits. Am. Compl. ¶ 4. ChinaCast exclusively provided “distance learning” services from its inception until it acquired its first physical university in 2008. Id. ¶ 47. Between 2007 and 2010, the Company completed only “one or two major transactions per year.” Id. In its 2008 Form 10–K, ChinaCast reported that, on April 11, 2008, its wholly owned subsidiary, Yu Pei Information Technology (Shanghai) Limited (“YPSH”), acquired an 80% interest in Hai Lai Education Technology Limited (“Hai Lai”), which, in turn, owned the Foreign Trade Business College of Chongqing Normal University (“FTBC”), a traditional brick and mortar university. Id. ¶ 78.
After procuring Hai Lai in 2008, ChinaCast organized itself into two distinct groups: (1) the e-learning and training service group, encompassing all of the Company's business prior to the acquisition; and (2) the traditional university group, which offered bachelor and diploma programs to Chinese students. Id. ¶ 48; Bendinger Decl. Exs. 2–3 (Form 10–Ks at 2–3).
During the next two years, ChinaCast acquired two additional fully accredited universities: Lijang College of Guangxi Normal University (“Lijang College”) and Hubei Industrial University Business College (“Hubei Industrial University”). Am. Compl. ¶¶ 49–50. ChinaCast's 2009 Form 10–K reported that, on October 5, 2009, the Company completed the acquisition of East Achieve Limited, the holding company which beneficially owned 100% of Lijang College. Id. ¶ 89. ChinaCast's 2010 Form 10–K reported that, on August 23, 2010, the Company completed the acquisition of Wintown Enterprises Limited, the holding company that beneficially owned 100% of Hubei Industrial University. Id. ¶ 117.
ChinaCast's 10–K and 10–Q filings state that the Company paid a majority of the consideration for the acquisition of each of its three physical universities. Id. ¶¶ 79–81, 90–91, 118–19. These payments represented some of the most, if not the most, significant transactions on the Company's annual cash flow statements. I...
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