RAMOS, District Judge.
In this securities fraud action, a group of investors who purchased stock in ChinaCast Education Corporation, Inc. ("ChinaCast" or the "Company"), an educational services company in the People's Republic of China ("PRC"),
In an Order issued on July 21, 2014 (the "July 2014 Order"), this Court dismissed Plaintiffs' First Amended Complaint ("FAC") without prejudice. Id. at 3. Presently before the Court is Plaintiffs' motion for leave to file a Second Amended Complaint ("SAC"). Doc. 46. DTTC and Deloitte U.S. (the "Deloitte Defendants") oppose Plaintiffs' motion and urge the Court to dismiss their proposed SAC with prejudice on the grounds that it would not survive a motion to dismiss. Deloitte U.S.'s Mem. L. Opp'n (Doc. 51) at 1; DTTC's Mem. L. Opp'n (Doc 53) at 2-3. For the reasons stated herein, Plaintiffs' motion for leave to file a Second Amended Complaint against DTTC and Deloitte U.S. is DENIED.
The Court presumes familiarity with its July 2014 Order, which recounts the background and history of this litigation, Order at 3-20,
In their prior complaint, Doc. 4, Plaintiffs' allegations against the Deloitte Defendants boiled down to the argument that if DTTC had performed an audit that complied with U.S. Public Accounting Oversight Board ("PCAOB") standards and Generally Accepted Accounting Principles ("GAAP"),
In the July 2014 Order, the Court distinguished the Deloitte Defendants' audits of ChinaCast from cases in which auditors, for example, demonstrably possessed documents evidencing fraud, conclusively identified and yet ignored suspect transactions, or actively aided in the development of deficient accounting practices. The Court explained that Plaintiffs' allegations were insufficient to establish scienter, a crucial element of their claims, which requires particularized allegations demonstrating fraudulent intent and not merely negligent performance or non-compliance with industry standards. Taken collectively, the Court concluded, "Plaintiffs' red flags and alleged accounting violations ... fail[ed] to tip the scale from negligence to recklessness." Id. at 38. Rather, the "competing inference"—that CEO Chan "effectively concealed the fraud" from ChinaCast's auditors as well as from its investors—was more forceful and compelling than Plaintiffs' allegations that the Deloitte Defendants
In their motion for leave to file an amended complaint, Plaintiffs assert that the proposed SAC cures the prior deficiencies by adding "new, detailed allegations demonstrating that DTTC and Deloitte U.S. were aware of many aspects of the fraud, that DTTC actually colluded with and facilitated some of ChinaCast's fraudulent accounting decisions, and that both [Deloitte] Defendants deliberately disregarded numerous red flags that no reasonable auditor would have ignored." Pl.'s Mem. L. Supp. Mot. at 1 (Doc. 47). The Deloitte Defendants maintain that the proposed SAC, like its predecessor: (1) does not state a Section 10(b) or Rule 10b-5 claim because Plaintiffs do not adequately plead scienter or any actionable misrepresentation; (2) does not state a "control person" claim under Section 20(a) as against Deloitte U.S. because Plaintiffs establish no primary violation by DTTC and no control or culpable participation by Deloitte U.S.; (3) does not state a claim under Section 18 as a matter of law; and (4) does not state a claim for common law fraud under New York law, which has a scienter requirement similar to that of the Exchange Act. See Doc. 51; Doc. 53.
Rule 15 of the Federal Rules of Civil Procedure instructs courts to "freely give leave" to replead "when justice so requires." Fed.R.Civ.P. 15(a)(2). Upon granting a motion to dismiss, the "usual practice" in this Circuit is to permit amendment of the complaint. Ronzani v. Sanofi S.A., 899 F.2d 195, 198 (2d Cir.1990); see also, e.g., Acito v. IMCERA Grp., Inc., 47 F.3d 47, 55 (2d Cir.1995) ("Leave to amend should be freely granted, especially where dismissal of the complaint was based on Rule 9(b).").
However, courts need not grant leave to amend where amendment "would be futile because the proposed amended complaint [does] not cure the original complaint's deficiencies." Mortimer Off Shore Servs., Ltd. v. Fed. Republic of Germany, 615 F.3d 97, 99 (2d Cir.2010). "Amendment is considered futile when the proposed new pleading would not withstand a motion to dismiss for failure to state a claim pursuant to Rule 12(b)(6)." In re Advanced Battery Technologies (ABAT), Inc. Sec. Litig., No. 11 Civ. 2279(CM), 2013 WL 3784134, at *5 (S.D.N.Y. July 18, 2013) (citation omitted), aff'd, 781 F.3d 638 (2d Cir.2015). In effect, to prevail on their motion, Plaintiffs' proposed SAC must withstand the scrutiny applicable on a motion to dismiss. See id. ("[T]he parties treat Plaintiff's motion for leave to file a second amended complaint as a motion to dismiss, and so too does the Court.").
When ruling on a motion to dismiss pursuant to Rule 12(b)(6), the Court must accept all factual allegations in the complaint as true and draw all reasonable inferences in the plaintiff's favor. Koch v. Christie's Int'l PLC, 699 F.3d 141, 145 (2d Cir.2012). However, the Court is not required to credit "mere conclusory statements" or "[t]hreadbare recitals of the elements of a cause of action." Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)); see also id. at 681, 129 S.Ct. 1937 (citing Twombly, 550 U.S. at 551, 127 S.Ct. 1955). "To survive a motion to dismiss, a complaint must contain sufficient factual matter... to `state a claim to relief that is plausible on its face.'" Id. at 678, 129 S.Ct. 1937 (quoting Twombly, 550 U.S. at 570, 127 S.Ct. 1955). A claim is facially plausible "when the plaintiff pleads factual content
Beyond the requirements of Rule 12(b)(6), a complaint alleging securities fraud must satisfy the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA") by stating the circumstances constituting fraud with particularity. See, e.g., ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 196 (2d Cir.2009) (citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319-20, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007)). Specifically, Rule 9(b) requires that a securities fraud claim based on misstatements must identify: (1) the allegedly fraudulent statements, (2) the speaker, (3) where and when the statements were made, and (4) why the statements were fraudulent. See, e.g., Anschutz Corp. v. Merrill Lynch & Co., Inc., 690 F.3d 98, 108 (2d Cir.2012) (citing Rombach v. Chang, 355 F.3d 164, 170 (2d Cir. 2004)). Like Rule 9(b), the PSLRA requires that securities fraud complaints "`specify' each misleading statement," set forth the reasons or factual basis for the plaintiff's belief that the statement is misleading, and "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 345, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005) (quoting 15 U.S.C. §§ 78u-4(b)(1), (2)); see also, e.g., Slayton v. Am. Express, Co., 604 F.3d 758, 766 (2d Cir.2010).
To state a private civil claim under Section 10(b) and Rule 10b-5, a plaintiff must plead that: (1) the defendant made a material misrepresentation or omission, (2) with scienter, i.e., a wrongful state of mind, (3) in connection with the purchase or sale of a security, and (4) that the plaintiff relied on the misrepresentation or omission, thereby (5) causing economic loss. Dura, 544 U.S. at 341-42, 125 S.Ct. 1627; see also, e.g., Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 153 (2d Cir.2007); Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir.2001). In its July 2014 Order, the Court found that Plaintiffs' First Cause of Action failed both because their allegations did not establish scienter, and because they had failed to plead a material misstatement or omission. Order at 42.
Scienter is "a mental state embracing intent to deceive, manipulate, or defraud." Tellabs, 551 U.S. at 319, 127 S.Ct. 2499 (citation omitted); Novak v. Kasaks, 216 F.3d 300, 306-07 (2d Cir.2000) (quoting 15 U.S.C. § 78u-4(b)(2)). In a securities fraud action against an independent auditor, the auditor's conduct must amount to more than "a heightened form of negligence," id. at 312, and, instead, represent "an extreme departure from the standards of ordinary care, ... approximat[ing] an actual intent to aid in the
Where, as here, a court is asked to determine whether facts alleged in a proposed complaint "establish `the requisite strong inference of scienter,'" the court "must consider plausible, nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff." Id. (quoting Tellabs, 551 U.S. at 324, 127 S.Ct. 2499). "[I]t is not enough `to set out facts from which, if true, a reasonable person could infer that the defendant acted with the required intent.' The inference of scienter must be cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id. (quoting S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 110 (2d Cir.2009); Tellabs, 551 U.S. at 324, 127 S.Ct. 2499).
In the FAC, Plaintiffs contended that DTTC's scienter was evidenced by its allegedly reckless issuance of audit opinions certifying that ChinaCast's financial statements had been prepared in accordance with GAAP and that DTTC had conducted its audits in accordance with PCAOB standards for fiscal years 2007 through 2010, as well as its unqualified opinions on ChinaCast's internal controls over financial reporting for fiscal years 2008 and 2009. Order at 29. Plaintiffs argued that scienter was supported by their allegations of (1) "red flags" and accounting failures; (2) the magnitude of the alleged fraud; and (3) the fact that new management had quickly discovered the fraud by examining the same records that DTTC had possessed. Id. at 30. The Court concluded that Plaintiffs' allegations on this score amounted to no more than a theory that "had DTTC performed a higher quality audit, i.e., one that complied with GAAS and PCAOB standards, it would have unearthed red flags indicative of ChinaCast's pervasive wrongdoing." Id. at 31. Ultimately, Plaintiffs' allegations failed because accusations that a defendant "merely ought to have known" are insufficient to allege recklessness. Id. (collecting cases). Moreover, the Court explained, allegations of red flags do not amount to allegations "that the facts and circumstances at issue would have put a reasonable auditor on notice of potential fraud." Id. at 32.
In the instant motion, Plaintiffs aver that the SAC includes twelve new or enhanced allegations of "red flags," accounting failures, and active collusion by DTTC: (1) DTTC and its audit engagement partner colluded in the fraud; (2) DTTC knew of and disregarded ChinaCast's lack of a majority-ownership in CCT HK; (3) DTTC improperly used a technique known as "sampling" in its audits of the Company; (4) DTTC actively facilitated the cover-up of Ronald Chan's $35 million embezzlement from the Company; (5) DTTC ignored obvious impropriety on the general ledger of subsidiary ChinaCast Technology (Shanghai) Limited ("CCT SH" or "CCT Shanghai"); (6) DTTC ignored the appearance of fictitious revenue on the books of CCT SH and another subsidiary, ChinaCast Technology ("CCT BVI") Limited ("CCI BVI"); (7) DTTC deliberately did not inquire into whether or not ChinaCast's term deposits had been pledged to third parties; (8) DTTC neglected to examine ChinaCast's failure to receive payment for stock sales; (9) DTTC was aware of internal control deficiencies and significant problems with the 2009 audit; (10) DTTC was alerted to the fraud by ChinaCast's failure to pay DTTC for its 2009 audit work; (11) DTTC and Deloitte U.S. refused to cooperate with the investigation
Six of these allegations were included in the FAC and have been reframed but not strengthened. Plaintiffs now describe DTTC's actions as deliberate misdeeds or intentional omissions rather than mere lapses in performance or judgment, but have added only conclusory assertions rather than actual facts supporting fraudulent intent. The other six allegations, although genuinely new, either do not describe red flags at all or lack a genuine factual basis. Taken collectively and evaluated alongside the allegations contained in the FAC, Plaintiffs' supplementary allegations cannot meet the rigorous standard established by Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and the PSLRA. Ultimately, the proposed SAC fares no better than its precursor: Plaintiffs' primary contention remains that the Deloitte Defendants conducted a shoddy audit.
Among Plaintiffs' primary allegations is that DTTC improperly certified ChinaCast's financials, including those of CCT HK, on a consolidated basis.
In the FAC, Plaintiffs alleged that DTTC would have unmasked Chan's massive embezzlement had they reviewed certain bank account statements showing that he had wired to CCT HK, which he majority-owned, $35 million of the proceeds from a $44 million stock offering and subsequently transferred that money from CCT HK to an entity outside of the Company. FAC ¶¶ 5, 102-05, 170, 240. The Court held that this allegation was "not truly a red flag" absent facts suggesting that "DTTC knew, or should have known, that Ron Chan majority-owned CCT HK...." Order at 35.
Plaintiffs now maintain that DTTC "set the stage for" Chan's embezzlement and "active[ly] facilitat[ed]" its cover-up. SAC ¶¶ 16-17, 35. They allege that "Deloitte willfully and/or recklessly approved the consolidation of CCT HK into the Company's consolidated financials, while not disclosing to shareholders that CCT HK was in fact 50% owned by [Chan]," which "resulted in" Chan's embezzlement. Id. ¶¶ 301-02. They claim that DTTC's scienter is evident from the fact that it deliberately excluded—"with remarkably convenient timing" for Chan's embezzlement—CCT HK from its 2009 Sarbanes-Oxley Internal Control Testing "because it needed plausible deniability" for its wrongful consolidation of CCT HK with ChinaCast. Id. ¶¶ 16-17, 301-02; Doc. 47 at 8-9.
As an initial matter, these assertions rely heavily on the allegation that DTTC "knew" of CCT HK's ownership, which allegation is not itself sufficient, as just explained. Plaintiffs' allegations with respect to the Internal Control Testing, meanwhile, amount to an attack on DTTC's judgment, Doc. 53 at 15, but one not sufficient to support fraudulent intent. Plaintiffs also ascribe fraudulent intent to DTTC's December 2012 statement to Woodrum that "it did not have in its working papers" a copy of the 2009 CCT HK Bank of China account, ostensibly revealing that DTTC "either never obtained the bank statements ... or did not want to admit that it had them given what they showed." SAC ¶¶ 198-99, 320; Doc. 47 at 8-9. But auditors are not obligated to retain every document they read in the course of an audit. Plaintiffs' new allegations with regard to DTTC's role in Chan's embezzlement, like their allegations concerning the CCT HK consolidation, are insufficient to support fraudulent intent as opposed to negligence or poor judgment.
In the FAC, Plaintiffs alleged that DTTC had violated GAAS standards by failing to verify the "unencumbered" nature of ChinaCast's term deposits, a substantial portion of which were later revealed to have been "pledged to secure the obligations of third parties" lacking any legitimate business relationship with the Company. FAC ¶¶ 5, 67-68, 153, 165, 169. Because pledged term deposits "could not be transferred, spent, or used as collateral to secure the Company's borrowings," the cash balances on the Company's balance
In the SAC, Plaintiffs now accuse the Deloitte Defendants of "willfully and/or recklessly ignor[ing] debt cards that disclosed third-party pledges," "willfully and/or recklessly craft[ing] its bank confirmations to specifically omit a request that the banks confirm that the term deposits were not pledged," and "deliberately and/or recklessly fail[ing] to physically inspect any of the original term deposit certificates, which also disclosed that they were ... pledged to third parties." SAC ¶ 299. Although Plaintiffs argue that DTTC's decision not to examine ChinaCast's term deposits "bespeaks a deliberate desire to avoid learning the truth," Doc. 47 at 14, the SAC includes no facts indicating that DTTC knew of and disregarded any issue with the term deposits or specifically altered its auditing procedures to avoid learning of one. Again, where Plaintiffs previously could not establish scienter based on DTTC's failure to act, they now accuse DTTC of deliberately not acting, but do not plead facts supporting deliberateness.
In the FAC, Plaintiffs claimed that DTTC had violated GAAP by failing to confirm that the Company had actually received a $5 million payment for stock sold to Thriving Blue Limited, a BVI company owned by Chan, FAC ¶¶ 5, 182, or $29.3 million owed for a private stock offering to Wu Shi Xin. Id. ¶¶ 5, 113-15. They alleged that although these were "significant, related-party transaction[s] at... above-market price[s], Deloitte failed to confirm that any of the Company's bank accounts ever actually received payment for the stock," which they had not. Id. ¶ 5. Again, the Court found, Plaintiffs had failed to allege anything more than DTTC's departure from PCAOB and GAAP standards. Order at 37.
Plaintiffs now claim that DTTC intentionally chose not to confirm ChinaCast's receipt of the missing payments. SAC ¶¶ 44, 221-23, 310-11. The only new allegation offered in the SAC to support such intent is that when ChinaCast's new CFO Douglas Woodrum demanded to see a copy of the payment voucher confirming that the Thriving Blue Limited payment had been made, DTTC's Jennie Jiang told him that, if he wanted to see the voucher, he should ask the bank for it. Doc. 47 at 15. This detail does not transform DTTC's alleged failure to follow auditing standards into an intent commit fraud.
Plaintiffs purport to add four paragraphs to the SAC alleging the Deloitte Defendants' inappropriate use of sampling. See Doc. 47 at 7 (citing SAC ¶¶ 264-67). The first three paragraphs simply describe Auditing Standard 15 and its guidance to auditors regarding the appropriate circumstances for using "audit sampling" as opposed to testing all transactions in a particular set. SAC ¶¶ 264-66. The fourth paragraph, the only one containing factual allegations specific to DTTC, SAC ¶ 267, was also included in the FAC as ¶ 158, where it was offered as support for Plaintiffs' claim that Deloitte had "failed to obtain reasonable assurance that ChinaCast's financial statements were free from material misstatements." FAC at 42-43.
Plaintiffs' opposition papers allege more than what Plaintiffs actually present in the SAC, arguing that Auditing Standard 15, as applied to DTTC's audit of ChinaCast, required DTTC "to test 100% of ChinaCast's major transactions each year ... such as the stock purchases and `brick and mortar' university purchases," and that its "failure to do so constitutes a clear violation of PCAOB standards," that, "when combined with the allegations of fraudulent intent with which the SAC is replete, constitutes recklessness." Doc. 47 at 7.
Ultimately, Plaintiffs' argument regarding DTTC's use of sampling is substantively indistinguishable from the allegations deemed insufficient in this Court's July 2014 Order: Allegations that auditors "merely ought to have known" are "insufficient to allege recklessness." Order at 31 (quoting Kuriakose v. Fed. Home Loan Mtg. Corp., 897 F.Supp.2d 168, 184 (S.D.N.Y.2012)); id. at 37 (observing that Plaintiffs' claim that "had DTTC confirmed that ChinaCast paid the consideration for its brick-and-mortar universities, it may have uncovered suspicious activity, fall short of alleging that DTTC must have reviewed the documents containing these red flags, and then disregarded them."). DTTC's allegedly inappropriate use of sampling does not constitute recklessness alone or when combined with the rest of the SAC.
Presented separately from Plaintiffs' allegation regarding DTTC's improper use of sampling, the SAC revisits Plaintiffs' allegation that the trial balances of CCT Shanghai presented obvious red flags, DTTC's ignorance of which demonstrates scienter. The Court discussed this allegation at length in its July 2014 Order. See Order at 32-34 ("Of Plaintiffs' red flags, only one involves an allegation that DTTC had possession of the source documents evidencing suspicious activity: the allegation that ChinaCast's trial balances for the years 2007 through 2009 reveal `massive outflows' of cash to, and unexplained inflows from, parties that had `no legitimate business relationship' to the Company.") (citing FAC ¶ 5). As discussed above, the Court concluded that because Plaintiffs had not alleged that DTTC was required to test the specific trial balances Plaintiffs identified and had failed to state what proportion of the trial balances consisted of evidence of transactions with unrelated parties, their allegations amounted to "no more than an allegation of a lapse in professional judgment." Id. at 32.
In the SAC, Plaintiffs now allege that CCT Shanghai's trial balances on their face contained evidence of fraud that DTTC could have overlooked only through willful or reckless ignorance: "[T]he general ledger itself disclosed the Company's fraud before any testing was required." SAC ¶¶ 22, 171. Plaintiffs argue that the appearance of any third party transactions on CCT Shanghai's general ledger should have tipped off DTTC, because, "CCT SH was not an operating entity." Id. ¶¶ 172-73. Rather, CCT SH's "business was essentially to collect revenues," so "the vast majority of transactions Deloitte would have expected to see [on its] general ledger would have been inter-company transactions." Id.; Doc. 47 at 10.
The assertion that these third-party transactions were obvious evidence of fraud is implausible. The Company's 2009 Form 10-K explains that CCT SH provides "technical services ... relating to the provision of computer, telecommunications and information technology products and services, including the provision of Internet service and content" and "supplies... ancillary equipment together with certain associated software and technical documentation." 2009 ChinaCast Form 10-K at 8-9, F-11 (Bendinger Decl., Ex. 4). The appearance of transactions with third parties for goods and services on the ledger of an entity that provided technical services would not constitute clear indicia of wrongdoing, Order at 33, even if, as Plaintiffs allege, CCT SH's role in the provision of those services was that as a mere "passthrough" entity or "shell." Pl.'s Reply (Doc. 56) at 6. Plaintiffs' allegations regarding DTTC still are "not so egregious as to render [its] audit a farce." In re Priceline.com Inc. Sec. Litig., 342 F.Supp.2d 33, 57 (D.Conn.2004).
In the SAC, Plaintiffs claim that DTTC and Deric Chiu ("Chiu"), the engagement partner for its ChinaCast audits until 2010, "knowingly assisted the Company in reporting materially misstated related party transactions" on the Company's 2007, 2008, and 2009 Forms 10-K. SAC ¶¶ 29-32, 307-09. Specifically, in each of those years, ChinaCast reported an approximately $16 million "non-current advance" to ChinaCast Company Ltd. ("CCL"), a subsidiary owned by then-director Yin Jian Ping, despite the fact that both ChinaCast and DTTC "knew that [Yin] would not and/or could not repay the advance." Id. ¶¶ 29, 307. Although not characterized as such on ChinaCast's 10-Ks, Plaintiffs describe this "non-current advance" as a "receivable" due from CCL. Id. They contend that, after Yin resigned as a Company director in 2009, Chiu and DTTC helped ChinaCast conceal the fact they had advanced money to CCL that would never be recovered and, in 2010, re-categorize the advance as "an amount to be paid back to CCL as a `prepayment' of a VSAT (satellite) license renewal fee"—in other words, as a payable rather than a receivable. Id. ¶¶ 30-32. Plaintiffs describe the role played by Chiu in reporting this item as indicative of DTTC's "active[] collu[sion] with ChinaCast management to deceive shareholders about material transactions by characterizing them falsely in the Company's financial statements." Doc. 47 at 5.
However, Plaintiffs' allegations are belied by the 10-Ks themselves, which describe ChinaCast's "non-current advances" to CCL and its relationship with CCL and other "satellite operating entities" as having been structured to enable the Company's compliance with Chinese law and its participation in the Chinese satellite communication market, which requires a so-called "VSAT license."
CCT BVI, ChinaCast's principal subsidiary, was a British Virgin Islands offshore entity that purportedly owned all of CCT HK, through which it provided funding for satellite broadband Internet services. SAC ¶¶ 15, 98, 230. Plaintiffs allege that Defendants' recklessness is demonstrated by their knowledge of "tens of millions of dollars in fictitious revenue that ChinaCast booked at the end of 2010 at CCT BVI" from ChinaCast's E-learning and training service Group ("ELG"). Doc. 47 at 13-14. According to Plaintiffs, because CCT BVI was a holding company with "no revenue generating operations of its own," SAC ¶ 230, "the only `revenue' that should have appeared on its general ledger would have consisted of inter-company transfers from CCT SH and the other ELG segment subsidiaries." Doc. 47 at 13-14. Therefore, the fact that ChinaCast's 2010 consolidated financial worksheets, which "Deloitte reviewed and kept in its audit files[,] inexplicably showed operating revenues—i.e., revenues from invoices issued directly to customers—booked on the general ledger of BVI," was a red flag that Deloitte could not have missed. Id. at 13. These allegations are also implausible in light of ChinaCast's 2010 Form 10-K, which states that CCT BVI is "a technology enabler in the satellite communication [industry]" in addition to being an investment holding company, and that ChinaCast's education customers may "engage" ChinaCast subsidiaries, including CCT BVI, "directly to provide ... satellite broadband services." 2010 ChinaCast Form 10-K at F-11 (Bendinger Decl., Ex. 8).
Plaintiffs also argue that the allegedly fictitious revenue raises an unmistakable red flag because it did not appear on CCT BVI's bank statements. SAC ¶ 232; Doc. 47 at 14. However, the allegation that DTTC could have discovered this red flag had it reviewed the bank statements is insufficient to establish scienter, because Plaintiffs do not allege that DTTC knew of the red flags contained in the bank statements and ignored them.
In the SAC, Plaintiffs also allege that problems apparent in the course of Deloitte's 2009 audit process presented undeniable red flags, DTTC's ignorance of which and failure to mention in its unqualified 2009 audit opinion demonstrate scienter. SAC ¶¶ 201-09. Plaintiffs describe how DTTC's Jennie Jiang sent several emails to ChinaCast board members noting that ChinaCast's failure to provide certain records would impact DTTC's ability to finalize its financial statements before the 10-K filing deadline. Id. ¶ 201. Her
Plaintiffs additionally allege that DTTC should not have "represented that [its 2009] audit [had been] conducted `in accordance with the standards of the [PCAOB]" and that ChinaCast's "consolidated financial statements present[ed] fairly, in all material respects, the financial position of the Company ... in conformity with accounting principles generally accepted in the United States." Id. ¶ 206. Plaintiffs allege that, "Deloitte knew [these statements] to be false" and "could not in good faith give an unqualified clean audit report," due to red flags like the transactions on the CCT SH general ledger and the absence of the $35 million embezzled by Chan. Id. ¶¶ 207-08. However, the Court has already addressed Plaintiffs' argument that DTTC was necessarily aware of these red flags, and found that argument lacking. As previously explained, that DTTC ultimately issued a clean audit opinion without referencing the CCT SH ledger or Chan's $35 million embezzlement constitutes at most negligence. Moreover, DTTC's statement that the audit was conducted in accordance with PCAOB standards, even if false, does not support an intent to participate in the ChinaCast fraud. Again, the facts pleaded might support the claim that DTTC did not live up to those standards, but they do not support the proposition that DTTC knew this was so and lied about it.
In addition to highlighting ChinaCast's failure to timely provide DTTC with certain documents in conjunction with the 2009 audit, Plaintiffs now also allege that ChinaCast's failure to pay DTTC for its work on that 2009 audit was, in and of itself, a red flag. Doc. 47 at 18; SAC ¶¶ 239-40. Plaintiffs cite an email exchange between DTTC's Jennie Jiang and ChinaCast's former CFO Antonio Sena, in which Jiang warned that DTTC's 2009 audit fee had not been paid, which might preclude DTTC from performing further audit work for 2010, and advised that the outstanding payments were a "red flag" for Deloitte. Id. Notably, Plaintiffs do not allege that the bill was never paid, only that it was paid late. Although the late payment may have raised eyebrows, it was not, alone, enough to raise a clear warning that fraudulent activity was underfoot. Compare Whalen v. Hibernia Foods PLC, No. 04 Civ. 3182, 2005 WL 1799370, at *4 (S.D.N.Y. Aug. 1, 2005) (noting the significance of allegations "that [an independent auditor] was told ... that [a] company's cash situation had become so severe [that a manager] was paying suppliers out of his personal bank account" and that the company fell behind in payments to the auditor itself, prompting the auditor to delay its own audit). As the Court observed in its July 2014 Order, "the Company's financial filings show only that ChinaCast failed to pay outstanding bills to DTTC after the fraud became public." Order at 31.
Plaintiffs add a single paragraph to the SAC alleging that Deloitte refused to cooperate with ChinaCast's new management
The final new allegation contained in the FAC addresses the findings of FTI Consulting ("FTI"), an outside entity brought in by ChinaCast's Audit committee in mid-2011 to conduct an independent verification of the Company's cash balances. SAC ¶ 241. In the course of its examination, Plaintiffs allege, FTI "turned up numerous significant red flags, which Deloitte either already knew of and deliberately or recklessly ignored, or, if Deloitte had no such actual knowledge, then it in fact had never conducted any audit at all, while deliberately falsely representing that it had conducted its audits in accordance with PCAOB standards." Id. ¶¶ 241-55. Among these alleged red flags were multiple instances in which FTI sought bank documents only to be informed that they had been withdrawn or collected by ChinaCast employees or that the banks could not provide the records to anyone outside of the Company.
As an initial matter, allegations about the magnitude of the purported red flags uncovered by FTI are the same in substance as allegations that this Court has already found insufficient, namely that the "magnitude of the alleged fraud" supports scienter, and that new management quickly discovered the fraud. Order at 38-40. Moreover, and particularly given FTI's ultimate approval of ChinaCast's 2011 cash balances, which does not support Plaintiff's illustration of a subsequent audit that uncovered accounts riddled with fraud, the difficulties experienced by FTI in finding records supports just as easily the inference that the ChinaCast fraud was concealed from its auditors, as well as its investors.
This Court previously held that the FAC came close "but ultimately [fell] short" of pleading auditor scienter. Order at 30.
In half of the new or expanded allegations in the SAC, Plaintiffs attempt to convert allegations of negligent omissions—i.e., had Deloitte taken a certain step, they would have discovered an aspect of the ChinaCast fraud—into allegations of deliberate or willful repudiation of duty—i.e., Deloitte refused to take a certain step in order to avoid learning of an aspect of the ChinaCast fraud. However, adverbs are not facts, and the addition of terms such as "deliberately" or "willfully" does not prove scienter. Nor does speculation, and Plaintiffs' conclusory allegations that DTTC "must have taken" certain steps or decided, for nefarious reasons, not to take others do not fill the factual void.
As to the other half of Plaintiffs' allegations, Plaintiffs endeavor to state claims using facts, communications, or events that are just as likely to undercut as to support an inference of scienter, or that provide no insight at all into the Deloitte Defendants' state of mind. Although, in retrospect, certain actions or statements may be interpreted or characterized as demonstrating awareness of fraud, "fraud by hindsight" is not a cognizable theory of relief; indeed, "fraud is always obvious in retrospect, but it is not reckless to lack clairvoyance." In re Longtop Fin. Techs. Ltd. Sec. Litig., 910 F.Supp.2d 561, 579 (S.D.N.Y.2012) ("Longtop I"); see also, e.g., Meridian Horizon Fund, LP v. KPMG (Cayman), 487 Fed.Appx. 636, 640-41 (2d Cir.2012) (summary order). Because Plaintiffs cannot establish scienter, they cannot state a claim under Section 10(b) or Rule 10b-5, and their motion for leave to file an amended complaint is DENIED as to these claims as against the Deloitte Defendants.
In its July 2014 Order, the Court held that in addition to scienter, Plaintiffs also could not establish a material misstatement or omission. Order at 42. To bring a fraud claim based on an alleged misstatement in an opinion, a plaintiff must plausibly assert that "defendants did not [subjectively] believe the statements... at the time they made them." City of Omaha, Neb. Civilian Employees' Ret. Sys. v. CBS Corp., 679 F.3d 64, 67 (2d Cir.2012).
Plaintiffs argue that "[b]ecause the SAC adequately alleges that DTTC acted with scienter, it also adequately alleges DTTC's subjective disbelief in its own audit opinions." Doc. 47 at 24. They claim that DTTC's subjective disbelief in its own audit opinions is established through its allegations regarding "Chiu's active facilitation of ChinaCast's false characterization of the uncollectable CCL receivable as a payable, DTTC's knowledge that ChinaCast did not own a majority interest in CCT HK, and ChinaCast's failure to pay DTTC for its work in connection with the 2009 audit." Id. As explained above, however, these allegations are insufficient to establish scienter. They likewise do not establish that DTTC subjectively knew its audit opinions to be false. Plaintiffs still cannot allege that DTTC "either did not in fact hold [its] opinion[s] or knew that it had no reasonable basis for [them]." Longtop I, 910 F.Supp.2d at 580 (quoting In re Lehman Bros. Sec. and Erisa Litig., 799 F.Supp.2d 258, 302 (S.D.N.Y.2011)). As the Supreme Court recently explained, "[A] sincere statement of pure opinion is not an `untrue statement of material fact,' regardless whether an
Section 20(a) of the Exchange Act, which imposes liability upon "control persons" of a primary violator, requires a plaintiff to 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." In re OSG Sec. Litig., 12 F.Supp.3d 622, 641 (S.D.N.Y.2014) (citation omitted). As with the FAC, Plaintiffs' failure to establish a primary violation of Section 10(b) precludes them from stating a claim under Section 20(a). See id. ("Where there is no primary violation, there can be no `control person' liability under Section 20(a).") (citations omitted). However, even if Plaintiffs had established a primary violation, the SAC, like the FAC, does not state with particularity any facts that would enable the Court to conclude that Deloitte U.S. culpably participated in any fraudulent activity. Indeed, culpable participation under Section 20(a) "must be [pleaded] with the same particularity as scienter under section 10(b)." Lapin v. Goldman Sachs Grp., Inc., 506 F.Supp.2d 221, 246 (S.D.N.Y.2006).
Although, in the SAC, Plaintiffs add several paragraphs addressing Deloitte U.S.'s involvement with ChinaCast, these paragraphs add little or nothing of substance to buttress Plaintiffs' Section 20(a) claim. The sole "new `fact'" in the SAC concerning Deloitte U.S.'s role, as opposed to DTTC's, is the allegation that in 2007 Deloitte U.S.'s technical department was "looking into" an accounting issue related to the consolidation of ChinaCast's financial statements. Doc. 51 at 2 (quoting SAC ¶ 125). As previously mentioned, this allegation does not establish that Deloitte U.S. was "looking into" the specific issue of CCT HK's consolidation. Moreover, even if Plaintiffs had pleaded that Deloitte U.S. representatives were "looking into" the CCT HK consolidation, that would be just as consistent with innocent conduct, if not more so, as with fraud. This allegation does not indicate that Deloitte U.S. "culpably participated" in any fraudulent activity.
To state a claim under Section 18, a plaintiff must plead that (1) the defendant "made or caused to be made" a false or misleading statement, (2) upon which the plaintiff actually relied, (3) resulting in loss to the plaintiff. In re Alstom SA, 406 F.Supp.2d 433, 478 (S.D.N.Y.2005). Although Plaintiffs need not allege scienter to state a Section 18 claim, id. at 480, they must allege "actual reliance on specific statements in covered Exchange Act filings." In re Marsh & Mclennan Companies, Inc. Sec. Litig., 501 F.Supp.2d 452, 493 (S.D.N.Y.2006) (citing 15 U.S.C. § 78r(a); Heit v. Weitzen, 402 F.2d 909, 916 (2d Cir.1968)). If a plaintiff establishes reliance, a defendant may rebut Section 18 liability by proving "that he acted in good faith and had no knowledge that such statement was false or misleading." See 15 U.S.C. § 78r(a).
In the FAC, Plaintiffs asserted that DTTC and Deloitte U.S. had "made or caused materially false and misleading statements to be made" in ChinaCast's 2009 and 2010 Forms 10-K and certain of its 2010 and 2011 Forms 10-Q, as well as in DTTC's audit opinions. Order at 49-50, 52-53. This Court dismissed Plaintiffs' Section 18 claim to the extent that it was based on allegedly false portions of financial statements in ChinaCast's 10-Q filings, finding that, as a matter of law, such statements cannot incur Section 18 liability. Id. at 53. Additionally, the Court concluded that Plaintiffs could not demonstrate the Deloitte Defendants' liability under Section 18 based on the theory that they had caused ChinaCast to make false statements in their SEC filings, including audited financial statements; rather, Plaintiffs could seek liability only for the Deloitte Defendants' own opinions. Id. at 53-55. With regard to Deloitte U.S., the Court found that Plaintiffs had proffered no facts to support a contention that Deloitte U.S. had "caused to be made" any misrepresentations in DTTC's audit opinions. Id. at 18. With regard to DTTC, the Court concluded that Plaintiffs had not alleged the element of reliance, as they had had "fail[ed] to identify any specific transactions that ensued as a result of Plaintiffs' purported `eyeball' reliance on DTTC's audit opinions," which deficiency was "fatal" to Plaintiffs' Section 18 claim. Id. at 53-58. Plaintiffs were required to, and could not, allege reliance beyond identifying the statements on which they ostensibly relied, and could not causally link specific statements in specific audit opinions to purchases of ChinaCast stock. Id. at 58.
The SAC, like its prior iteration, states simply that certain of the Section 18 Plaintiffs made stock purchase decisions in reliance on the Company's 2009 and 2010
To state a claim for common law fraud under New York law, a plaintiff must allege that "(1) defendant made a representation as to a material fact; (2) such representation was false; (3) defendant[] intended to deceive plaintiff; (4) plaintiff believed and justifiably relied upon the statement and was induced by it to engage in a certain course of conduct; and (5) as a result of such reliance plaintiff sustained pecuniary loss[.]" Stephenson v. PricewaterhouseCoopers, LLP, 482 Fed.Appx. 618, 622 (2d Cir.2012), as amended (June 13, 2012) (summary order) (citing Ross v. Louise Wise Servs., Inc., 8 N.Y.3d 478, 488, 836 N.Y.S.2d 509, 868 N.E.2d 189 (N.Y.2007)). New York law also requires plaintiffs to plead scienter, In re Wachovia Equity Sec. Litig., 753 F.Supp.2d 326, 380 (S.D.N.Y.2011) (citing Wynn v. AC Rochester, 273 F.3d 153, 156 (2d Cir.2001)), which is "essentially the same" at common law "as ... under federal securities law." Saltz v. First Frontier, LP, 782 F.Supp.2d 61, 75 (S.D.N.Y.2010) (citation omitted), aff'd, 485 Fed.Appx. 461 (2d Cir.2012). Moreover, claims of common law fraud, like federal securities claims, must satisfy the requirements of Rule 9(b). Pasternack v. Lab. Corp. of Am., No. 10 Civ. 4426(PGG), 2011 WL 3478732, at *5 (S.D.N.Y. Aug. 1, 2011) (quoting Healthcare Fin. Grp., Inc. v. Bank Leumi USA, 669 F.Supp.2d 344, 348 (S.D.N.Y.2009)). Because, as explained above, Plaintiffs have not pleaded facts giving rise to a strong inference of scienter with regard to either DTTC or Deloitte U.S, their motion for leave to file an amended complaint alleging common law fraud as against the Deloitte Defendants is DENIED.
For the reasons set forth above, Plaintiffs' motion for leave to file an amended complaint is DENIED, and their proposed claims against the Deloitte Defendants are DISMISSED with prejudice. The Clerk of the Court is respectfully directed to terminate the motion, Doc. 46.
It is SO ORDERED.
Plaintiffs also assert that DTTC's knowledge of Chan's majority-ownership is evidenced by a 2012 interaction between Plaintiff Woodrum and Deloitte in which Woodrum confronted Deloitte about Chan's interest in CCT HK. SAC ¶ 126. Plaintiffs state that "Deloitte first claimed that it had a trust agreement by which Chan had transferred his 50% economic interest in CCT HK to BVI," but could not locate that agreement when called upon to produce it. Id. They state matter-of-factly: "That is because it never existed. Indeed, Deloitte's John McKay eventually admitted to Woodrum that CCT HK should never have been consolidated into the Company's consolidated financials." Id. Even if true, this statement is insufficient to establish a strong inference of fraudulent intent. As DTTC argues, this "alleged inability to produce a document [that DTTC] stated it had says nothing about scienter, but alleges negligence at best." Doc. 53 at 12 n. 13.
