Investor's Securities Fraud suit survives Morrison Claim by "Chinese" Company

In Starr Investments Caymen II, Inc. v. China MediaExpress Holdings, Inc., (2014 WL 4180331), plaintiff stockholder Starr Investments brought numerous claims based in securities fraud, state law fraud and corporate governance, against CMEH, previous directors, an independent accounting firm, investment companies and their control persons, and a Hong Kong audit firm and partner employed by the plaintiff.  Starr moved for default judgment against CMEH and all other defendants moved to dismiss pursuant to Fed. R. Civ. P. 12(b)(6). Starr had purchased CMEH stock in 2010.  In 2011, analysts alleged CMEH was engaged in an illegal pump and dump scheme to inflate stock prices.  The company’s auditor confirmed the inflated status, resigned, and the SEC deregistered the company.  Starr brought suit soon after in U.S. District Court in Delaware.

Although most claims were fact-based against each defendant, almost all were subject to the application of Morrison v. Nat’l Australia Bank Ltd. (561 U.S. 247).  The defendants argued that the transactions at issue were public sales, not sales through the listed stock exchange, and not subject to the §10(b) claims.  The Court rejected the argument, explaining Morrison’s holding, that §10(b) claims apply to sales of securities listed on an American stock exchange, not solely sales that occur via the stock exchange.  The defendants also attempted to characterize CMEH as a Chinese company, but the company was incorporated in Delaware and never listed stock on a foreign exchange.  The motions to dismiss based on Morrison were denied.

As to the remaining motions, the Court examined the allegations under the heightened pleading standards of both Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act.  Most allegations were for violations of §10(b), Rule 10b-5, and §20(a), but also included claims for negligent misrepresentation, common law fraud, aiding and abetting fraud and breach of fiduciary duties, and conspiracy to commit fraud.

The Court dismissed the §10(a), Rule 10b-5, and §20(a) claims against the former directors for insufficient pleadings, but the state law claims survived lower pleading standards.  The Court found the pleadings sufficient against the accounting firm, based on allegations of GAAS violations and ignorance of fraud red flags, but dismissed the claims for negligent misrepresentation and aiding and abetting.  The §10(b) claim against the investment companies and their directors were dismissed because Starr failed to plead any misrepresentation made by those defendants.  Finally, the Court found the pleadings against the Hong Kong audit firm superior to those implicating the accounting firm.  The allegations for negligent misrepresentation were sufficient, as the defendant must have intended that Starr rely on the information they sought by employing the defendant.  However, the claims against the individual partner were dismissed. The Court explained that a partner is not considered a “maker” of a false statement issued by the firm, unless he signs the statement personally.

The Court granted the Plaintiff’s motion for Entry of Default Judgment and granted in part and denied in part all other motions as stated above.