NAOMI REICE BUCHWALD, District Judge.
Plaintiff, the Securities and Exchange Commission (the "SEC" or "plaintiff"), brings this action against China Northeast Petroleum Holdings Limited ("CNEP" or the "Company"), its former CEO Wang Hongjun ("Wang"), its former director Ju Guizhi ("Ju"), and its former Vice President of Corporate Finance and Secretary Jiang Chao ("Chao"), as well as against relief defendants Sun Jishuang ("Sun") and Jiang Mingfu ("Mingfu").
Presently before the Court are three motions to dismiss the Complaint for failure to state a claim pursuant to Federal Rule of Procedure 12(b)(6) — one filed by CNEP, a second by Wang and Sun, and a third by Chao. The SEC has also moved to serve defendant Ju by alternative means. For the reasons set forth below, defendants' motions to dismiss are denied, and plaintiff's motion to serve Ju by alternative means is also denied.
CNEP is a Nevada corporation that engages in principally oil exploration, drilling, and production in China. Cmplt. ¶¶ 2, 11. It was formed in April 2004 through a reverse merger with a U.S. shell corporation and began trading on the NYSE Amex LLC ("NYSE") on June 15, 2009. Id. ¶ 12. However, CNEP was delisted from the NYSE on July 16, 2012 and, as of the filing of the Complaint on November 27, 2012, its common stock traded over-the-counter at $0.22 per share. Id. ¶ 14.
In addition to the Company, there are three individual defendants. The first, Wang, was the chairman of CNEP's Board of Directors, CEO, and President of the Company from at least January 1, 2009 through May 23, 2010, at which time he resigned from his position as chairman and was placed on leave from his position as CEO and President. Id. ¶ 15. During the time period referenced in the Complaint, Wang was the single largest shareholder of CNEP stock, owning 26% of the outstanding shares according to a December 31, 2009 10-K report. Id. The second individual defendant is Ju Guizhi ("Ju"). One of CNEP's founders, she is also Wang's mother and served as a director of the Company from November 2009 through May 2010. Id. The SEC claims that Ju was heavily involved in the day-to-day operations of CNEP despite her lack of title, and as of February 15, 2012, she also served as General Manager of two CNEP subsidiaries. Id. ¶ 16. Jiang Chao ("Chao"), the former Vice President of Corporate Finance and Secretary of CNEP, is the third individual defendant. Id. ¶ 17. All three defendants are Chinese nationals, although Wang resides part-time in California and Chao resides in Jersey City, New Jersey. Id. ¶¶ 15, 17.
The SEC also includes two relief defendants in its Complaint. The first is Sun, who is Wang's wife and the alleged recipient of $300,000 in improperly diverted funds. Id. ¶ 18. Although she has served as the Treasurer/Cashier of CNEP since November 2010, she was not working in that capacity at the time of the $300,000 transfer. Id. The second relief defendant is Mingfu, Chao's father. Id. ¶ 19. The SEC alleges that he improperly received $910,000 from the Company while not serving CNEP in any capacity. Id.
Shortly after CNEP company stock began trading on the NYSE in June of 2009, the Company filed a Form S-3 registration statement that registered public offerings
On September 16, 2009 the Company announced the public offering of CNEP stock in a Form 8-K signed by Wang. Id. ¶ 22. This 8-K included a press release, with Chao listed as the contact person, which stated that the Company would "use the net proceeds from the offering to fund its future business expansion plan, and for general working capital purposes." Id. On December 15, 2009, CNEP filed another Form 8-K, also signed by Wang, which announced a second offering of CNEP stock. Id. ¶ 23. In the associated press release, which again listed Chao as the Company's contact person, CNEP represented that it planned to "use the net proceeds from the offering to redeem its 8% Senior Debenture ... and for general working capital purposes." Id. Combined, the September 2009 and December 2009 offerings raised approximately $31.9 million. Id. ¶¶ 5, 24.
It is undisputed that there were at least three related-party transfers during this time period. First, on November 3, 2009, Chao authorized the transfer of $500,000 from CNEP's U.S. Bank Account (the "CNEP Account") to the personal bank account of his father, Mingfu. Id. ¶ 26. Next, on November 19, 2009, Chao effected a transfer of $300,000 from the CNEP Account to Sun, Wang's wife. Id. ¶ 28. And finally, on December 16, 2009, Chao authorized an additional transfer from the CNEP Account to Mingfu, this time for the sum of $410,000. Id. ¶ 26. Prior to the Company's public offerings, the CNEP Account balance was approximately $84,000, far lower than the sum of the monies sent to Mingfu and Sun. Id. ¶ 30. Furthermore, the parties agree that none of these transfers were explicitly disclosed to CNEP's shareholders, either in the Form 8-Ks, the press releases accompanying those statements, or in any other periodic SEC disclosures. See Tr. of Oral Arg. at 8:21-9:1, Mar. 12, 2014 (Chao's counsel's concession that none of CNEP's SEC filings explicitly reference the transfers to Sun and Mingfu).
The SEC further alleges that these related-party transactions were not isolated incidents. At the behest of the Company's Audit Committee, CNEP retained a Hong Kong-based accounting firm to review all related-party transactions that took place in 2009. In July 2010, the accounting firm released a report identifying at least 176 undisclosed, related-party transactions between CNEP and Wang or Ju in 2009 alone. Cmplt. ¶¶ 35-36. The value of these transactions was approximately $59 million, and they included approximately $28 million of transactions directly or indirectly from CNEP's account to Wang or Ju. Id. ¶¶ 36, 39. This $28 million represents 43% of CNEP's reported annual revenue for 2009. Id. ¶ 41. Neither the volume nor the magnitude of these transactions was fully disclosed to the investing public, whether in the Company's offering documents, the associated press releases, or its periodic SEC filings. Id. ¶ 42, 50-51.
Based on the aforementioned conduct, the SEC filed a seven-claim complaint against CNEP, Wang, Ju, and Chao on November 29, 2012. The first two counts allege that all defendants are liable for securities fraud violations of the Securities
Defendants responded to the civil complaint with three separate motions to dismiss — one on behalf of CNEP, a second on behalf of Wang and relief defendant Sun, and the third on behalf of Chao — all of which were filed on April 12, 2013. Ju did not file a motion to dismiss; in fact, she has not yet been served and has not appeared in this litigation. After the SEC's recent failed attempt to serve Ju in China, plaintiff filed a motion to serve her by alternative means on October 21, 2013.
When deciding a motion to dismiss for failure to state a claim pursuant to Federal Rule of Civil Procedure 12(b)(6), the Court must accept as true all factual allegations in the complaint and draw all reasonable inferences in plaintiff's favor. Harris v. Mills, 572 F.3d 66, 71 (2d Cir.2009); Kassner v. 2nd Ave. Delicatessen, Inc., 496 F.3d 229, 237 (2d Cir.2007). Nevertheless, a plaintiff's "[f]actual allegations must be enough to raise a right of relief above the speculative level." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) (internal citation omitted). Once the Court accepts all of the plaintiff's factual allegations as true, those allegations must demonstrate "more than a sheer possibility that a defendant has acted unlawfully" in order to pass muster under Rule 12(b)(6). Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009). If a plaintiff has "not nudged [its] claims across the line from conceivable to plausible, [the] complaint must be dismissed." Twombly, 550 U.S. at 570, 127 S.Ct. 1955.
"It is well-settled in this Circuit that a complaint alleging securities fraud must satisfy the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure." Ganino v. Citizens Utils. Co., 228 F.3d 154, 168 (2d Cir.2000). Rule 9(b) provides that, "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." Fed.R.Civ.P. 9(b). "This pleading constraint serves to provide a defendant
Section 10(b) of the Exchange Act makes it unlawful for any person "[t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b) (2012). "Section 10(b) of the Exchange Act is designed to protect investors by serving as a `catchall provision' which creates a cause of action for manipulative practices by defendants acting in bad faith." In re Openwave Sys. Sec. Litig., 528 F.Supp.2d 236, 249 (S.D.N.Y.2007) (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 206, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976)). Rule 10b-5 implements section 10(b) by making it unlawful:
17 C.F.R. § 240.10b-5 (2013).
Similarly, Section 17(a) of the Securities Act makes it unlawful, in the offer or sale of securities:
15 U.S.C. § 77q(a) (2012).
"In order to establish primary liability under § 10(b) and Rule 10b-5, a plaintiff is required to prove that in connection with the purchase or sale of a security the defendant, acting with scienter, made a material misrepresentation (or a material omission if the defendant had a duty to speak) or used a fraudulent device." S.E.C. v. First Jersey Sec, Inc., 101 F.3d 1450, 1467 (2d Cir.1996); see also S.E.C. v. Mattera, No. 11 Civ. 8323(PKC), 2013 WL 6485949, at *8 (S.D.N.Y. Dec. 9, 2013). "The elements of a claim under § 17(a) of the Securities Act, and under § 10(b) of the Exchange Act and SEC Rule 10b-5 are `[e]ssentially the same.'" S.E.C. v. Constantin, 939 F.Supp.2d 288, 302 (S.D.N.Y.2013) (quoting S.E.C. v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir.1999)). The only meaningful analytical
The parties do not dispute that the statements at issue were made "in connection with the purchase or sale of a security," but defendants assert that the SEC inadequately pled (1) that defendants acted with the requisite scienter and (2) that the statements at issue were material misrepresentations at all. In addition, defendants contend that, even if plaintiff has adequately pled liability based on misstatements or omissions, the SEC has not sufficiently pled "scheme liability" under Rule 10b-5(a) and (c).
"The requisite state of mind in a section 10(b) and Rule 10b-5 action is an intent `to deceive, manipulate, or defraud.'" ECA & Local 134 IBEW Joint Pension Trust of Chi. v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir.2009) (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007)). "[I]n order to state a claim for securities fraud, plaintiffs ha[ve] to allege facts giving rise to `a strong inference of fraudulent intent.'" Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir.2000) (quoting Acito v. IMCERA Grp., Inc., 47 F.3d 47, 52 (2d Cir.1995)). A "strong inference of fraudulent intent" may be established either "(a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Lerner v. Fleet Bank, N.A., 459 F.3d 273, 290-91 (2d Cir.2006) (quoting Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir.1994)) (internal quotation marks omitted); see also S.E.C. v. Syron, 934 F.Supp.2d 609, 631 (S.D.N.Y.2013).
To raise a strong inference of scienter under the motive and opportunity prong, a plaintiff must allege that the defendant "benefitted in some concrete and personal way from the purported fraud." ECA, 553 F.3d at 198 (quoting Novak, 216 F.3d at 307-08) (internal quotation marks omitted). "Motives that are common to most corporate officers, such as the desire for the corporation to appear profitable and the desire to keep stock prices high to increase officer compensation, do not constitute `motive' for purposes of this inquiry." Id.; see also Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir.2001) (finding it insufficient for plaintiff to allege merely the existence of motives "that are generally possessed by most corporate directors and officers").
In each of their motions to dismiss, Wang and Chao assert that the SEC has not adequately pled a strong inference of scienter under either prong. First, Wang claims that "[t]he only allegations of [his] motive apparent from the Complaint are that he desired to act in the best interests of CNEP." Def. Wang Hongjun & Relief Def. Sun Jishuang's Mem. Supp. Joint Mot. to Dismiss ("Wang Mem.") at 11. But this argument is wholly without merit. As a threshold matter, while related-party transactions are not per se unlawful, we view them with "extreme skepticism," especially when they go undisclosed. McCurdy v. S.E.C., 396 F.3d 1258, 1261 (D.C.Cir.2005). But even absent this presumption, based purely on the facts alleged in the Complaint, Wang had a clear, twofold motive for filing substantially misleading documents with the SEC: (1) to funnel offering proceeds into his own account and that of his relatives, and (2) to conceal this conduct from the investing public and the government. When a plaintiff pleads that a defendant raised shareholder money using misleading documents and then partook in a series of undisclosed related-party transactions, "the inference that [the defendant] did so with fraudulent intent is not merely strong, it is inescapable." In re Advanced Battery Techs., Inc. Sec. Litig., No. 11 Civ. 2279(CM), 2012 WL 3758085, at *11 (S.D.N.Y. Aug. 29, 2012). And as the single most influential figure in the Company and the signatory on the relevant SEC documents, Wang surely had the opportunity to engage in the fraud alleged. Therefore, we find that the SEC has satisfactorily pled scienter as to Wang.
Chao also asserts that his scienter was pled insufficiently. However, he couches his argument in the notion that the SEC "fails to specify what, if any, concrete benefit [Chao] received from his father's alleged receipt of money." Def. Jiang Chao's Mem. Supp. Mot. to Dismiss ("Chao Mem.") at 12 (emphasis in original). Such a formalistic interpretation of the "concrete and personal benefit" standard is completely untenable. To endorse this approach would allow any defendant to avoid consequences — at the pleadings stage, no less — by simply transferring proceeds into family members' accounts rather than into his own. Cf. S.E.C. v. Cavanagh, 155 F.3d 129, 137 (2d Cir.1998) (recognizing that a defendant should not be able to evade penalty "by the simple procedure of giving [property] to friends and relatives"). Even the least clever fraudster could escape liability under Chao's proposed interpretation of our securities laws. Therefore, we find that when, as here, the SEC pleads that a corporate insider's family member is the recipient of shareholder funds, this constitutes a sufficiently concrete and personal benefit to infer motive. See Marcus v. Frome, 329 F.Supp.2d 464, 473 (S.D.N.Y. 2004) (discussing a family's alleged receipt of stock as a concrete and personal benefit for scienter purposes). In addition, as the person with signature authority over the
Once we establish that plaintiff has pled scienter as to the individual defendants, it is clear that the SEC has done so with regard to CNEP as well. The Company asserts that a "compelling inference of non fraudulent intent is drawn from the Board of Directors' lack of knowledge of the transactions complained of" by the SEC. Mem. Supp. Mot. of CNEP to Dismiss ("CNEP Mem.") at 11. We recognize that the Complaint states that the Board of Directors "was not apprised of and did not approve" the transfer of funds to corporate insiders. Cmplt. ¶ 6; see also id. ¶¶ 29, 42. But if this were the end of the inquiry, it would eviscerate securities fraud as we know it. In reality, it is beyond cavil that the Board need not be aware of misconduct for a company to be liable. Corporate scienter is derivative of that of its individual agents; there is no requirement that those agents must be members of the Board of Directors. See Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 195 (2d Cir.2008). As we have previously discussed, the SEC has adequately pled scienter with regard to both Wang and Chao. Putting aside Chao and whether he may properly be considered an agent of the Company, Wang, as the CEO, President, and largest individual shareholder, is clearly an officer whose intent could be imputed to the corporation. See, e.g., id. at 195; In re Moody's Corp. Sec. Litig., 599 F.Supp.2d 493, 516 (S.D.N.Y.2009) ("As CEO of the Company, his scienter is imputed to [the corporation]."). Thus, plaintiff has also satisfactorily pled scienter as to CNEP.
Defendants also maintain that the SEC failed to plead that the failure to disclose the related-party transactions at issue actually constitutes a material misstatement or omission. First, defendants contend that the "Complaint does not offer any sufficient explanation of why the related-party transactions should be considered material." Wang Mem. at 15. Second, defendants assert that the offering statements were not misleading at all, as the Company actually spent the proceeds as advertised. See CNEP Mem. at 10 ("[T]he record is rife with specific contrary facts that show the Company did spend not only what it promised to spend, but actually more, on the expressly stated purposes."); Chao Mem. at 9 ("[The] broad and open ended commitment regarding the use of funds is not misleading, as investors are aware that such proceeds may be used to fund a variety of business expenses and that the company has flexibility in committing funds."). For the reasons discussed below, we find these contentions to be without merit.
A statement is material for § 10(b) purposes if a substantial likelihood exists that a reasonable investor would consider the information important in making an investment decision. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988); N.J. Carpenters Health Fund v. Royal Bank of Scotland Grp., PLC, 709 F.3d 109, 126 (2d
Here, it is hard to imagine that the allegations in the Complaint would not be important to a reasonable investor. Plaintiff has alleged 176 related-party transactions which together amounted to approximately $59 million of related-party activity. Cmplt. ¶ 3. Given the number of transactions and their value, the materiality of these exchanges is apparent. Moreover, even if these transactions were fewer and of lesser value, "[w]hat reasonable investor would not wish to know that the money raised by stock sales would ... be diverted to [corporate] officers?" S.E.C. v. Research Automation Corp., 585 F.2d 31, 35 (2d Cir.1978). Therefore, the failure to disclose the related-party transactions reference in the Complaint was material.
Next, we address CNEP's contention that the offering documents were not misleading at all because the Company actually spent more than the amount raised via the public offerings on expanding its operations and repaying debt. CNEP Mem. at 10-11. But the fact that the Company continued to make legitimate expenditures at the same time that it was engaging in related-party activity does not absolve CNEP of the responsibility to include these related-party transactions in its SEC filings. There is no dispute that shortly after the first public offering, over $1 million was sent to the CEO's wife and to the Vice President of Corporate Finance's father. See Tr. of Oral Arg. at 7:16-8:14. Regardless of any other expenditures, legitimate or otherwise, the absence of the related-party information from CNEP's SEC filings necessitates the conclusion that those filings are misleading as a matter of law.
Defendant Chao disputes the notion that the related-party transactions were never disclosed. He asserts that the initial registration statement stated only that CNEP would use the proceeds "for general corporate purposes, which may include working capital," Cmplt. ¶ 20, which is sufficiently broad to encompass the related-party transfers at issue. See Chao Mem. at 9. However, Chao's suggested definition is so broad as to render the phrase "general corporate purposes" meaningless. Any common-sense understanding of "general corporate purposes" does not include funneling shareholder funds to company insiders and their family members, and the transfers are not otherwise referenced in the Company's SEC filings. By definition, this represents an omission under our securities laws, the materiality of which we have already established. Thus, we find that plaintiff has pled the existence of material misstatements or omissions under § 10(b), Rule 10b-5, § 17(a).
Defendants contend that, even if we were to find that the SEC sufficiently pled misstatement and omission liability under Rule 10b-5(b), plaintiff also improperly attempts to plead scheme liability under subsections (a) and (c). "[T]he three subsections of Rule 10b-5 are distinct, and courts must scrutinize pleadings to ensure
In this case, the core misconduct alleged by the SEC is that defendants raised money under false pretenses and then channeled the proceeds to corporate insiders. The misstatements and omissions previous discussed were essential both to the plan's commencement and its concealment, and we acknowledge that without the misstatements and omissions, the plan could not have succeeded. However, the SEC has competently pled the existence of a larger scheme, one that went beyond mere misrepresentations to investors, whereby defendants enriched themselves and their families at shareholders' expense. While the misstatements and omissions certainly furthered that scheme, they do not comprise the scheme in its entirety. Therefore, we find that the SEC has adequately pled the existence of a fraudulent scheme.
Finally, both Wang and Chao attempt to distance themselves from the alleged scheme, maintaining that they were not sufficiently involved in the insider transfers at issue to be held liable. See Wang Mem. at 17 ("[T]he Complaint fails to plead that Mr. Wang had any involvement in any of these allegedly improper transfers."); Chao Mem. at 10-11 ("Plaintiff attempts to bootstrap a scattershot of factual allegations asserted against other defendants onto its claim against [Chao].... [W]here, as here, the defendant's alleged role in the creation of fraudulent statements is purely ministerial, liability does not attach.").
First, Wang's assertion is easily dismissed. Plaintiff pled that $28 million of the alleged related-party transactions flowed from CNEP to Wang or Ju, which included cash loans of at least $3.8 million to Wang himself. See Cmplt. ¶¶ 39-40. Moreover, given that he was the CEO, largest shareholder, the signatory on both 8-K filings, and the individual who "exerted actual control over CNEP," it strains credulity to believe that Wang was not involved in the allegedly improper transfers of funds. Id. ¶ 15, 22-23.
Second, Chao's assertion distorts his own involvement in the scheme. The Complaint alleges that he conducted meetings and made presentations to raise money for the September offering after having assisted in drafting and reviewing the allegedly fraudulent registration statement. Id. ¶ 21-22. After the public offerings, Chao continued to act as the face of this scheme, serving as the contact person in both of the press releases that accompanied the Form 8-Ks. Id. ¶ 22-23. In addition to this outward-facing role, Chao also worked internally to effectuate the scheme — as a person with signature authority over the CNEP Account, he authorized the transfer of nearly $1 million to his very own father, an individual who held no position with CNEP. Id. ¶ 25-26. Thus, the SEC has pled that Chao did more than perform ministerial actions
In sum, the SEC has more than adequately alleged violations of Exchange Act § 10(b), Rule 10b-5, and Securities Act § 17(a) on the basis of defendants' misstatements and omissions, and their participation in a fraudulent scheme. Defendants' respective requests to dismiss Counts One and Two of the Complaint are hereby denied.
Section 13(b)(5) of the Exchange Act provides that "[n]o person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record, or account" of any issuer required to file reports. 15 U.S.C. § 78m(b)(5) (2012). Rule 13b2-1 implements § 13(b)(5) by ensuring that "[n]o person shall directly or indirectly, falsify or cause to be falsified, any book, record or account subject to section 13(b)(2)(A) of the Securities Exchange Act."
Both Wang and Ju are charged with books and records violations, but only Wang has moved to dismiss these charges.
Disclosure of related-party transactions is governed by Statement of Financial Accounting Standards No. 57 ("FAS 57") and Item 404 of Regulation S-K ("Item 404"). FAS 57 requires "disclosures of material related-party transactions." Related Party Disclosures, FAS No. 57 ¶ 2 (Fin. Accounting Standards Bd. 1982). Item 404 requires disclosures of related-party transactions when "the amount involved exceeds $120,000, and in which any related person had or will have a direct or indirect material interest." 17 C.F.R. § 229.404(a)
With regard to Wang's claim that he lacked the requisite scienter, it is true that the SEC must allege "a knowing violation of the reporting requirement[s]" to state a claim. Escala, 2009 WL 2365548, at *14. However, the "securities laws do not require that a defendant know the precise accounting treatment that would have been applied before [he] can have the requisite scienter; the SEC need only demonstrate that [a defendant] knew of facts that contradicted the substance of the reported accounting." S.E.C. v. Espuelas, 767 F.Supp.2d 467, 476 (S.D.N.Y.2011) (alteration in original) (quoting S.E.C. v. Lucent Tech. Inc., 610 F.Supp.2d 342, 362 (D.N.J.2009)) (internal quotation marks omitted). As the undisputed central figure of the Company and, according to the Complaint, the personal recipient of millions of dollars in offering proceeds, Wang would certainly have known that the CNEP accounting reports omitted essential details about the allocation of corporate funds; his lack of accounting training or expertise is no bar to liability. See S.E.C. v. Espuelas, 698 F.Supp.2d 415, 432 (S.D.N.Y.2010) (noting that a defendant need not "have accounting knowledge or accounting expertise to have actual knowledge of an accounting violation"). Therefore, we find that the SEC has adequately pled Wang's books and records liability, and Counts Three and Four may proceed.
Section 20(e) of the Exchange Act addresses aiding-and-abetting liability: "[A]ny person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this chapter, or of any rule or regulation issued under this chapter, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided."
First, on the question of scienter, we have already discussed Wang's knowledge in the context of his books and records violations. See Part III supra. For those same reasons, we also find that the SEC has competently pled his knowledge of the Company's books and records violations. With regard to the securities fraud violations, CNEP is liable on a primary basis because of the conduct of Wang, who was acting as CNEP's agent when he signed and filed the allegedly misleading documents. It would be nonsensical to find that Wang somehow lacks knowledge of conduct for which he himself was responsible. See S.E.C. v. Subaye, Inc., No. 13 Civ. 3114(PKC), 2014 WL 448414, at *11 (S.D.N.Y. Feb. 4, 2014) (finding that when a corporate officer "drafted, signed, and certified" false and misleading SEC filings, that conduct supported claims of both primary and aiding-and-abetting liability against the officer).
We also find that the SEC has pled scienter as to Chao. The requisite scienter for liability under Section 20(e) is knowledge. See Stanard, 2009 WL 196023, at *30 ("Courts have been clear in requiring a showing of `actual knowledge of the violation by the aider and abettor.'") (quoting S.E.C. v. Cedric Kushner Promotions, Inc., 417 F.Supp.2d 326, 334 (S.D.N.Y.2006)). To meet this burden, a "defendant's general awareness of its overall role in the primary violator's illegal scheme is sufficient knowledge for aiding and abetting liability." S.E.C. v. Espuelas, 905 F.Supp.2d 507, 518 (S.D.N.Y.2012) (citations omitted) (internal quotation marks omitted).
Here, plaintiff pleads that Chao was involved in the scheme from start to finish: he first raised capital from investors, then controlled the money in the CNEP Account, and ultimately disbursed over $900,000 to his own father without explicitly disclosing these transfers to the public. Cmplt. ¶¶ 21, 25-26. As the VP of Corporate Finance and Secretary, Chao may have had "a title that ... actually exceed[ed] his experience and responsibilities," but his conduct evinces his knowledge more clearly than a title ever could. Tr. of Oral Arg. at 13:16-17. Furthermore, any argument that Chao's position in the Company was less significant than it appears is not one that is properly considered in a motion to dismiss. Therefore, we conclude that the Complaint alleges facts sufficient to infer that Chao had "general awareness of [his] overall role" in the fraudulent scheme, thus satisfying the knowledge prong for aiding-and-abetting liability.
On the issue of substantial assistance, the adequacy of plaintiff's pleadings as to both Wang and Chao is plain. To demonstrate substantial assistance, "the SEC must show that the defendant in some sort associated himself with the venture, that he participated in it as in something that he wished to bring about, and that he sought by his action to make it
Section 20(a) of the Exchange Act confers liability on any individual "who, directly or indirectly, controls any person liable under any provision of this chapter... unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." 15 U.S.C. § 78t(a) (2012). "To establish a prima facie case of control person liability, a plaintiff must show (1) a primary violation by the controlled person, (2) control of the primary violator by the defendant, and (3) that the defendant was, in some meaningful sense, a culpable participant in the controlled person's fraud." ATSI Commc'ns, 493 F.3d at 108; Monroe Cnty. Emps.' Ret. Sys. v. YPF Sociedad Anonima, No. 13 Civ. 842(SAS), 15 F.Supp.3d 336, 351, 2014 WL 661442, at *7 (S.D.N.Y. Feb. 20, 2014).
The SEC has asserted control person liability against only Wang and Ju, and only Wang has filed a motion to dismiss this count. He concedes that he was a control person of CNEP, but suggests that this count warrants dismissal because there was no primary violation. See Wang Mem. at 20. Having already found that plaintiff has amply and specifically pled that the Company violated multiple sections of the Exchange Act, Wang's argument must fail; control person liability has been pled.
Along with CNEP, Wang, and Chao, Ju is named as a defendant in the SEC Complaint filed on November 29, 2012. While all other defendants have been served and appeared before this Court, the SEC has not yet been able to effectuate service on Ju. Plaintiff first attempted to serve her at the house of Wang and Sun, her son and daughter-in-law. See Pl.'s Mem. Supp. Mot. to Serve Def. Ju Guizhi by Alternative Means ("Pl.'s Mem.") at 3. Once that attempt failed, the SEC mailed requests to waive formal service, pursuant to Federal Rule of Civil Procedure 4(d), to the following: (1) CNEP's counsel in this matter, who previously represented Ju in a separate lawsuit filed in this district; (2) CNEP's audit committee counsel; (3) CNEP's offices in New York and California; and (4) CNEP's registered agent for service of process. Id. The first two recipients acknowledged receipt of the waiver request but indicated that they were not authorized to waive service; the second two requests were returned as undeliverable. Id.
On March 11, 2013, the SEC attempted to serve Ju under the Hague Convention on the Service Abroad of Judicial and Extra-Judicial Documents in Civil and Commercial Matters (the "Hague Convention"). Id. at 4. Plaintiff sent the documents to be served on Ju to the Chinese Ministry of Justice and requested that they be delivered to an address that the SEC provided; this address was copied by plaintiff from a document that Ju filed with the SEC back on November 25, 2009. Id. On September 27, 2013, the SEC received a return from
At this point, the SEC maintains that it "is not aware of any other means of serving Ju under Chinese or international law," as China does not allow direct service of process via mail or hand delivery. Id. The SEC further asserts that despite its inability to serve Ju through the aforementioned methods, it has reason to believe she has actual notice of the lawsuit based on her alleged communication with Wang and Sun's former counsel in this matter. Id. at 3. Therefore, in its motion to serve Ju by alternative means, the SEC first requests a court order, pursuant to Federal Rule of Civil Procedure 4(f)(3), confirming that defendant Ju has already been adequately served. Id. at 7. In the event that the Court denies this request, the SEC proposes that we authorize service through either (1) delivering the requisite documents to the house of Ju's daughter-in-law in California, (2) serving CNEP's counsel in this matter, or (3) emailing the documents to her son. See id. at 7-8; Pl.'s Reply Supp. Mot. to Serve Def. Ju Guizhi by Alternative Means ("Pl.'s Reply") at 5.
In evaluating plaintiff's motion, we must determine whether the SEC's previous attempts to serve Ju and proposed methods to serve her in the future comport with Federal Rule of Civil Procedure 4(f), which governs the service of individuals outside the United States. As relevant here, Rule 4(f) allows for service "(1) by any internationally agreed means of service that is reasonably calculated to give notice ... [and] (3) by other means not prohibited by international agreement, as the court orders." Fed.R.Civ.P. 4(f). Since both the United States and China are signatories to the Hague Convention, subsection (1) applies. However, because the SEC was unable to effectuate service on Ju using Hague Convention protocol, the focus of our inquiry is subsection (3).
First, the SEC's previous efforts do not constitute adequate service under Rule 4(f). Plaintiff concedes that its previous attempts to serve Ju or get her to waive service were unsuccessful, but it suggests that Rule 4(f) has been satisfied because these attempts resulted in her actual knowledge of this lawsuit. Pl.'s Mem. at 3, 7. However, a defendant's "actual knowledge is no substitute for service." S.E.C. v. Anticevic, No. 05 CV 6991(KMW), 2009 WL 361739, at *4 (S.D.N.Y. Feb. 13, 2009); see also Arista Records LLC v. Media Servs. LLC, No. 06 Civ. 15319(NRB), 2008 WL 563470 (S.D.N.Y. Feb. 25, 2008)(recognizing "persuasive authority for requiring service anew, even if a defendant has notice of the pendency of the action"). Thus, even if Ju has actual knowledge of this litigation, this awareness does not abrogate the requirement of proper service under the Federal Rules. We therefore deny plaintiff's request that we issue an order acknowledging that Ju has already been served by alternative means.
Finding the SEC's previous efforts to serve Ju insufficient, we now turn to their proposed alternative methods of service, namely delivering the documents to either Ju's daughter-in-law or to CNEP's current counsel. The court enjoys broad discretion in fashioning alternative methods of service under Rule 4(f)(3). See RSM Prod. Corp. v. Fridman, No. 06 Civ. 11512(DLC), 2007 WL 1515068, at *1 (S.D.N.Y. May 24, 2007) ("The decision whether to allow alternative methods of serving process under Rule 4(f)(3) is committed to the sound discretion of the district court.") (citation and internal quotation marks omitted).
In cases such as this one, where service is first attempted pursuant to an international agreement, "there will undoubtedly be many instances where significant efforts to make service under the Hague Convention should be required by a court before alternative service is ordered." Id. (emphasis added). When courts have allowed for alternative service, they have done so when "plaintiffs have been unable, despite diligent efforts, to serve the defendant in the [foreign country] according to the Hague [ ] Convention procedures." S.E.C. v. Shehyn, No. 04 Civ.2003(LAP), 2008 WL 6150322, at *3 (S.D.N.Y. Nov. 26, 2008) (alteration in original) (emphasis added); see also Madu, Edozie & Madu, P.C. v. SocketWorks Ltd. Nigeria, 265 F.R.D. 106, 115 (S.D.N.Y.2010) ("A district court may require the parties `to show that they have reasonably attempted to effectuate service on the defendant(s) and that the circumstances are such that the district court's intervention is necessary.'") (quoting Export-Import Bank v. Asia Pulp & Paper Co., Ltd., No. 03 Civ. 8554(LTS)(JCF), 2005 WL 1123755, at *4 (S.D.N.Y. May 11, 2005)).
Here, there is no evidence that the SEC undertook such diligent efforts. It made one attempt to serve Ju pursuant to the Hague Convention, and did so using an address that was more than three years old at the time. There is no indication that the SEC ever contacted the two subsidiaries for which Ju acted as General Manager through February 15, 2012; no indication that it engaged the Chinese authorities after the first attempt at service under the Hague Convention could not be completed; and no indication that the SEC conducted a meaningful investigation to ascertain Ju's whereabouts. Plaintiff's request that we authorize alternative service ultimately "strikes this Court as a measure of convenience rather than necessity." In re Sinohub, Inc. Sec. Litig., No. 12 Civ. 8478(WHP), 2013 WL 4734902, at *2 (S.D.N.Y. Aug. 14, 2013).
Moreover, even if this Court were convinced that the SEC had been assiduous in its attempts to effectuate service on Ju, we would still be unwilling to authorize the alternative methods of service it proposes. "Service pursuant to Rule 4(f)(3) must comply with constitutional notions of due process and constitute `notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.'" Shehyn, 2008 WL 6150322, at *3 (quoting Mullane v. Cent. Hanover Bank & Trust Co., 339 U.S. 306, 314, 70 S.Ct. 652, 94 L.Ed. 865 (1950)).
With regard to the first proposal — service on Ju's daughter-in-law — there is no reason to believe that those two are in communication at all. Absent some substantive evidence that Ju and Sun are in contact with one another, this Court will not endorse the notion that documents delivered to a home in California are "reasonably calculated" to reach an unknown
Second, while courts have authorized service under Rule 4(f)(3) to an unserved party's counsel, such a method is only appropriate when there is "adequate communication between the individual and the attorney." In re GLG Life Tech Corp. Sec. Litig., 287 F.R.D. at 267. This communication requirement remains essential when a party looks to serve an individual through his corporate rather than his personal attorney. See In re Sinohub, 2013 WL 4734902, at *3 ("Where a defendant's level of communication with [its corporate] counsel is too attenuated, service through counsel does not comport with due process."); Madu, Edozie & Madu, 265 F.R.D. at 116-17 (finding that the absence of communication between corporate counsel and individual defendants rendered service on those defendants through said counsel inadequate). In this case, there has been no showing that CNEP's counsel is in touch with Ju, and CNEP's counsel has represented to the Court that he would be unable to deliver the service documents to her. See Decl. of Michael J. Coffino in Supp. of Mem. of Law in Opp'n to Pl.'s Mot. to Serve Def. Ju Guizhi by Alternative Means ¶ 6. Based on the lack of evidence suggesting any recent communication between Ju and CNEP's counsel, this proposed method of service is inadequate.
Finally, the SEC maintains in its reply that we should allow it to serve Ju by sending the requisite documents to her son's email account. Pl.'s Reply at 5. "Service by email alone comports with due process where a plaintiff demonstrates that the email is likely to reach the defendant." F.T.C. v. Pecon Software Ltd., 2013 WL 4016272, at *5 (S.D.N.Y. Aug. 7, 2013). But if "the SEC presents no evidence that e-mails to [the proposed] addresses today are likely to reach Defendants," then plaintiff's motion for alternative service via email should be denied. S.E.C. v. China Intelligent Lighting and Elecs., Inc., No. 13 Civ. 5079(JMF), 2014 WL 338817, at *1 (S.D.N.Y. Jan. 30, 2014). Thus, while email may be an acceptable alternative method of service, it would only be permissible in this case if the SEC provides evidence that an email to Ju's son would likely be relayed to Ju herself, a conclusion which would be counterintuitive given the lack of incentive for Wang to ensure service on his own mother.
The only argument that the SEC offers for why an email to Wang is an appropriate method of service is that CNEP's counsel recently attempted to serve Ju by this very approach in another action. However, there is nothing to suggest that service in this manner actually succeeded or that Ju responded to that motion in such a way as to demonstrate receipt of process. The bare assertion that this method has been tried in another context does not mean that it is valid for our purposes. Considering the lack of additional evidence, the SEC has failed to establish that an email to Wang is likely to reach Ju.
Therefore, we decline to authorize alternative service on Ju through the methods proposed by the SEC. Its previous attempts at service have been insufficiently diligent, and even if we were satisfied with plaintiff's efforts, the alternative methods it proposes are not "reasonably calculated" to apprise Ju of this lawsuit. Thus, they do not pass constitutional muster, and the SEC's motion is denied.
For the foregoing reasons, we deny the respective motions to dismiss filed by
