In re: Advanced Battery Techs., Inc., No. 14-1410 (2d Cir. 2015)
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The district court dismissed a suit brought by Sanderson, individually and on behalf of all others similarly situated, alleging that auditors (defendants) committed securities fraud by falsely representing that they performed their audits of Advanced Battery Technologies in accordance with professional standards and that the company’s filings accurately reflected its financial condition from the 2007 through the 2010 fiscal years. The court found that the complaint failed adequately to plead scienter as required by the Private Securities Litigation Reform Act of 1995, 15 U.S.C. 78u‐4. Sanderson sought to correct these deficiencies by moving to file an amended complaint. The court denied the motion, concluding that even the new allegations failed to “rise to the level of recklessness.” The Second Circuit affirmed, finding that the factual allegations did not give rise to a strong inference of either fraudulent intent or conscious recklessness, rather than mere negligence.
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14 1410 cv In re: Advanced Battery Technologies 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT August Term, 2014 (Argued: October 21, 2014 Decided: March 25, 2015) Docket No. 14 1410 cv _____________________________________ In re ADVANCED BATTERY TECHNOLOGIES, INCORPORATED _____________________________________ RUBLE SANDERSON, individually and on behalf of all others similarly situated, Plaintiff Appellant, v. BAGELL, JOSEPHS, LEVINE & CO., LLC, FRIEDMAN LLP, EFP ROTENBERG, LLP, Defendants Appellees.* _____________________________________ Before: WALKER, CABRANES, and LOHIER, Circuit Judges. Lead Plaintiff Ruble Sanderson appeals from an order of the United States District Court for the Southern District of New York (McMahon, J.) denying plaintiffs’ motion for leave to file an amended complaint. Sanderson * The Clerk of Court is directed to amend the official caption to conform with the above. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 claims that certain auditor defendants committed securities fraud by recklessly making false statements in their audit reports relating to the financial statements of Advanced Battery Technologies, Inc. After dismissing the initial complaint because it failed adequately to plead that the auditor defendants acted with the requisite scienter, the District Court denied as futile Sanderson’s motion to amend. We AFFIRM. MURIELLE J. STEVEN WALSH, Pomerantz LLP, New York, NY (Marc I. Gross, Star M. Tyner, Pomerantz LLP, New York, NY; William B. Federman, Federman & Sherwood, Oklahoma City, OK; Laurence Mathew Rosen, The Rosen Law Firm, P.A., New York, NY, on the brief), for Plaintiff Appellant. WILLIAM J. KELLY (Peter J. Larkin, on the brief), Wilson, Elser, Moskowitz, Edelman & Dicker LLP, White Plains, NY, for Defendants Appellees Bagell, Josephs, Levine & Co., LLC, and Friedman LLP. GABRIEL MARK NUGENT (Paul Andrew Sanders, on the brief), Hiscock & Barclay, LLP, Syracuse, NY, for Defendant Appellee EFP Rotenberg, LLP. LOHIER, Circuit Judge: 30 Lead Plaintiff Ruble Sanderson, individually and on behalf of all others 31 similarly situated, appeals from an order of the United States District Court 32 for the Southern District of New York (McMahon, J.) denying the plaintiffs’ 2 1 motion for leave to file a second amended complaint (the “Proposed 2 Complaint”). As relevant here, the District Court dismissed the previous 3 complaint against defendants Bagell, Josephs, Levine & Co., Friedman LLP, 4 and EFP Rotenberg, LLP (collectively, the “Auditor Defendants”) because it 5 failed adequately to plead scienter as required by the Private Securities 6 Litigation Reform Act of 1995 (“PSLRA”), 15 U.S.C. § 78u 4. Sanderson 7 sought to correct these deficiencies by moving to file the Proposed Complaint. 8 That complaint claims that the Auditor Defendants committed securities 9 fraud by falsely representing that they performed their audits of Advanced 10 Battery Technologies, Inc. (“ABAT”) in accordance with professional 11 standards and that ABAT’s filings accurately reflected its financial condition 12 from the 2007 through the 2010 fiscal years. Concluding that the Proposed 13 Complaint failed to remedy the deficiencies identified in the initial complaint, 14 the District Court denied the motion to amend as futile. We affirm. 15 BACKGROUND 16 I. The Allegations in the Proposed Complaint 17 We accept as true the facts alleged in the Proposed Complaint because 18 Sanderson appeals from the denial of leave to amend on the ground of 3 1 futility. See Panther Partners Inc. v. Ikanos Commc’ns, Inc., 681 F.3d 114, 116 2 n.1 (2d Cir. 2012). 3 ABAT is a Delaware corporation whose primary operations and 4 subsidiaries are located in China. It principally “design[s], manufacture[s], 5 and market[s] . . . rechargeable polymer lithium ion (PLI) batteries” for use in 6 consumer products, such as portable computers, as well as electric vehicles. 7 In 2004 ABAT became obligated to file financial statements with the Securities 8 and Exchange Commission (“SEC”) when it decided to list its stock on a 9 United States exchange through a reverse merger. At all relevant times, 10 ABAT contemporaneously filed financial statements with China’s State 11 Administration of Industry and Commerce (“AIC”), a regulatory agency to 12 which Chinese companies must submit such statements as part of an annual 13 examination. 14 Between May 15, 2007, and March 29, 2011, ABAT’s SEC filings painted 15 a favorable financial picture that included “increasing revenues, gross profits 16 and net income.” These financial figures, however, contrasted with the 17 figures reported in ABAT’s contemporaneous filings with the AIC in China. 18 In particular, from 2007 to 2009 ABAT reported losses to the AIC while it 4 1 reported significant profits to the SEC. The differences were indisputably 2 material. Taking 2007 as an example, ABAT reported to the AIC that its 3 revenues were approximately $145,000 and that it suffered an operating loss 4 of $1 million, while it reported to the SEC revenues of $31.9 million and a 5 profit of $10.2 million. 6 The Proposed Complaint alleges that these and other discrepancies in 7 the financial figures reported to the AIC and SEC cannot be explained by 8 differences between those agencies’ reporting requirements and practices 9 alone. If anything, it claims, Chinese accounting rules more generously 10 recognize revenue than Generally Accepted Accounting Principles (“GAAP”) 11 in the United States. 12 In addition to presenting two very different financial pictures to 13 regulators in China and the United States, ABAT is alleged to have 14 misrepresented or failed to fully disclose material facts about two 15 transactions. 16 First, in December 2010 ABAT announced that it would purchase 17 Shenzhen Zhongqiang New Energy Science & Technology Co., Ltd. 18 (“Shenzhen Zhongqiang”) for $20 million, even though Shenzhen 5 1 Zhongqiang had generated revenues of less than $450,000 in 2009 and had 2 suffered losses each year since its inception in 2007. The Proposed Complaint 3 alleges that in announcing the Shenzhen Zhongqiang acquisition ABAT failed 4 to disclose that its Chairman and Chief Executive Officer, Zhiguo Fu, owned 5 Shenzhen Zhongqiang and had paid a mere $1 million for the company in 6 2008. The transaction allegedly enabled Fu to siphon funds from ABAT for 7 his own personal use. 8 9 Second, ABAT allegedly misrepresented the nature of its ownership interest in one of its purported subsidiaries, Heilongjiang ZhongQiang 10 Power Tech Co., Ltd. (“ZQ Power Tech”). In its SEC filings for 2007 and 11 2008, ABAT identified ZQ Power Tech as a wholly owned subsidiary of 12 Cashtech, which was itself a wholly owned ABAT subsidiary. ABAT’s 2009 13 SEC filings revealed that ZQ Power Tech was actually owned by Fu and other 14 investors. On April 6, 2011, moreover, ABAT responded to allegations of 15 fraud by “effectively admit[ting] that it did not actually own [ZQ Power 16 Tech] from 2004 through 2009.” Although it sought to justify initially 17 accounting for ZQ Power Tech as a wholly owned subsidiary because Fu and 18 his co investors had transferred to ABAT all of the “benefits and obligations” 6 1 of ZQ Power Tech, ABAT explained that it ultimately “decided that it would 2 be more appropriate to explain the relationship in detail.” 3 The remaining defendants in this matter are two auditing firms, to 4 which we refer as the Auditor Defendants. ABAT’s outside auditors from 5 2006 through December 14, 2010, were defendants Bagell, Josephs, Levine & 6 Co., and its successor, Friedman LLP (together, “Bagell Josephs”).1 Defendant 7 EFP Rotenberg, LLP (“EFP”) served as ABAT’s auditor from December 14, 8 2010, through the filing of the Proposed Complaint in September 2012. 9 The relevant audit opinions issued during these periods certified that 10 ABAT’s financial statements conformed with GAAP and “present[ed] fairly, 11 in all material respects, the financial position of [ABAT].” They also 12 represented that the audits themselves were conducted “in accordance with 13 the standards of the Public Company Accounting Oversight Board.” The 14 Proposed Complaint alleges that these statements were materially false and 15 misleading and that the Auditor Defendants “ignored or recklessly 16 disregarded numerous red flags that should have alerted them to ABAT’s 17 fraudulent financial statements.” As relevant here, the Proposed Complaint 1 In 2010 Bagell, Josephs, Levine & Co. merged into Friedman LLP. 7 1 identifies the following “red flags”: (1) the contrasting set of financial filings 2 to the AIC and the SEC, (2) the Shenzhen Zhongqiang related party 3 transaction, (3) the mischaracterization of the ownership of ZQ Power Tech, 4 (4) the unreasonably high profits that ABAT reported, and (5) the mere fact 5 that ABAT became listed on a United States exchange through a reverse 6 merger. It focuses in particular on the first two of these “red flags.” As to 7 both, the Proposed Complaint alleges that Bagell Josephs auditors visited 8 ABAT’s offices in China, had “ready access to ABAT’s financial records” 9 there, and “presumably relied on the same underlying financial records and 10 data . . . that had formed the basis for ABAT’s AIC filings.” Finally, an 11 accounting expert’s opinion concludes that the Auditor Defendants’ failure to 12 uncover or appreciate the significance of these “red flags” constituted “an 13 extreme departure from the reasonable standards of care [they were] 14 obligated to meet as ABAT’s auditor[s].” 15 In 2011 ABAT’s fraudulent conduct and its reporting of significantly 16 lower revenue and profit in its AIC filings as compared to its SEC filings was 17 exposed in reports by third party publications. A March 2011 report 8 1 discussed ABAT’s financial statements. Almost immediately after that report 2 was published, the price of ABAT shares plunged nearly forty eight percent. 3 II. Procedural History 4 Starting in April 2011, five related securities fraud actions were filed 5 against ABAT and certain ABAT executives (collectively, the “ABAT 6 Defendants”). After these actions were consolidated, lead plaintiff Sanderson 7 filed a Corrected First Amended Consolidated Class Action Complaint (the 8 “Consolidated Complaint”) to add Bagell Josephs and EFP as defendants. 9 Both the ABAT Defendants and the Auditor Defendants moved to dismiss the 10 11 Consolidated Complaint. The District Court denied the motion as to the ABAT Defendants but 12 granted it as to the Auditor Defendants.2 The court held that the 13 Consolidated Complaint’s allegations that the auditors failed to conform their 14 audits to professional standards established at best an inference of negligence, 15 not recklessness or intentional misconduct. It also determined that all but one 16 of the purported “red flags” were either not red flags or not alleged to have 17 been known to the Auditor Defendants. It concluded that the remaining 2 Sanderson and the ABAT Defendants subsequently settled. 9 1 alleged “red flag” — the recharacterization of the ownership of ZQ Power 2 Tech — was “not sufficiently egregious” to support the requisite scienter. 3 Lastly, the court held that the named plaintiffs lacked standing to sue EFP 4 because they purchased their ABAT shares before EFP issued its audit. 5 Sanderson moved for leave to amend by filing the Proposed Complaint 6 to cure the standing and scienter deficiencies identified by the District Court. 7 The District Court denied the motion, concluding that even the new 8 allegations failed to “rise to the level of recklessness.” 9 10 DISCUSSION We consider only whether the Proposed Complaint adequately pleaded 11 facts giving rise to a strong inference that the Auditor Defendants acted with 12 “scienter, a mental state embracing intent to deceive, manipulate, or defraud.” 13 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007) (quotation 14 marks omitted); see Novak v. Kasaks, 216 F.3d 300, 306 07 (2d Cir. 2000) 15 (quoting 15 U.S.C. § 78u 4(b)(2)). In determining whether the facts alleged in 16 the Proposed Complaint establish “the requisite ‘strong inference’ of scienter, 17 a court must consider plausible, nonculpable explanations for the defendant’s 18 conduct, as well as inferences favoring the plaintiff.” Tellabs, 551 U.S. at 324. 10 1 In other words, it is not enough “to set out ‘facts from which, if true, a 2 reasonable person could infer that the defendant acted with the required 3 intent.’” S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 110 (2d Cir. 4 2009) (quoting Tellabs, 551 U.S. at 314). The inference of scienter must be 5 “cogent and at least as compelling as any opposing inference one could draw 6 from the facts alleged.” Tellabs, 551 U.S. at 324. 7 Sanderson argues that the Proposed Complaint adequately and with 8 sufficient particularity alleges facts that constitute strong circumstantial 9 evidence of conscious recklessness. Because Sanderson does not allege any 10 motive for the Auditor Defendants to defraud and premises his claim entirely 11 on a theory of recklessness, “the strength of the circumstantial allegations 12 must be correspondingly greater.” Kalnit v. Eichler, 264 F.3d 131, 142 (2d Cir. 13 2001). In the securities fraud context, recklessness “must be conduct that is 14 highly unreasonable, representing an extreme departure from the standards 15 of ordinary care,” Rothman v. Gregor, 220 F.3d 81, 98 (2d Cir. 2000) (quotation 16 marks omitted), “not merely a heightened form of negligence,” Novak, 216 17 F.3d at 312 (quotation marks omitted). And for an independent auditor, the 18 conduct “must, in fact, approximate an actual intent to aid in the fraud being 11 1 perpetrated by the audited company,” Rothman, 220 F.3d at 98 (quotation 2 marks omitted), as, for example, when a defendant conducts an audit so 3 deficient as to amount to no audit at all, or disregards signs of fraud so 4 obvious that the defendant must have been aware of them, see Gould v. 5 Winstar Commc’ns, Inc., 692 F.3d 148, 160 61 (2d Cir. 2012). Mere 6 “allegations of GAAP violations or accounting irregularities,” Novak, 216 7 F.3d at 309, or even a lack of due diligence, see S. Cherry St., 573 F.3d at 112, 8 will not state a securities fraud claim absent “evidence of corresponding 9 fraudulent intent,” Novak, 216 F.3d at 309 (quotation marks omitted). 10 In asking us to assess the allegations in the Proposed Complaint, 11 Sanderson leaves unchallenged the District Court’s partial dismissal of the 12 initial Consolidated Complaint and appeals only its denial of leave to amend. 13 With that in mind, we consider de novo only whether the Proposed 14 Complaint alleges non conclusory facts that, if taken as true, would raise a 15 strong inference of scienter as to each of the Auditor Defendants. 16 I. Bagell Josephs 17 Sanderson argues that the amendment would not be futile because the 18 Proposed Complaint now alleges that when Bagell Josephs audited ABAT’s 12 1 SEC filings, it had access to ABAT’s conflicting AIC filings and financial 2 information, and adds a reference to the accounting expert’s opinion that “no 3 reasonable auditor would have failed to obtain ABAT’s AIC filings.” 4 Sanderson also invokes the allegations in the Proposed Complaint relating to 5 the one “red flag” recognized as such by the District Court: that Bagell 6 Josephs ignored obvious signs that ABAT misrepresented the ownership of 7 ZQ Power Tech. 8 We agree with the District Court that these allegations together still fail 9 to constitute strong circumstantial evidence of recklessness. As Sanderson 10 conceded at oral argument, none of the accounting standards on which he 11 relies — the Generally Accepted Auditing Standards, Statements on Auditing 12 Standards, or GAAP — specifically requires an auditor to inquire about or 13 review a company’s foreign regulatory filings. Such a legal duty could arise 14 under certain circumstances. But without more than exists here — including 15 the accounting expert’s conclusory statement — we do not view these 16 standards as imposing a general duty to inquire the breach of which would 17 constitute recklessness. 18 Sanderson alternatively argues that the Auditor Defendants had a duty 13 1 to review ABAT’s AIC filings in view of ABAT’s unusually high profit 2 margins reported in its SEC filings and because ABAT, based largely in 3 China, employed a reverse merger to access our capital markets. We briefly 4 address each argument in turn. First, in our view, ABAT’s report of high 5 profit margins in its SEC filings triggered, at most, a duty to perform a more 6 rigorous audit of those filings. They did not obligate Bagell Josephs to review 7 ABAT’s AIC filings. And “the fact that [Bagell Josephs] did not automatically 8 equate record profits with misconduct cannot be said to be reckless.” Chill v. 9 Gen. Elec. Co., 101 F.3d 263, 270 (2d Cir. 1996). Second, as for the impact of 10 ABAT’s reverse merger, Sanderson does not allege that heightened scrutiny 11 of Chinese companies that used reverse mergers in the United States began 12 prior to mid 2011 — in other words, after the relevant audits in this case. 13 Accordingly, we are not persuaded that these allegations signify that Bagell 14 Josephs’s failure to review ABAT’s Chinese regulatory filings in connection 15 with its audits from 2007 through 2010 represented an “extreme departure 16 from the standards of ordinary care” tantamount to fraud. See Rothman, 220 17 F.3d at 98. 18 Nor are we persuaded to infer recklessness from the allegations that 14 1 Bagell Josephs had access to and “presumably relied on” the raw financial 2 data underlying ABAT’s AIC filings in China in 2008 but failed to see that the 3 data contradicted ABAT’s SEC filings. Sanderson urges that the only non 4 speculative inference to be drawn from these allegations is that Bagell 5 Josephs’s failure to spot the discrepancies was reckless. We disagree: a 6 somewhat more compelling inference is that ABAT maintained two sets of 7 data — one for its Chinese regulators and another for its regulators in the 8 United States — and fed Bagell Josephs false data to complete its audits.3 This 9 contrary inference coheres with the allegation that ABAT initially concealed 10 rather than disclosed important facts about ZQ Power Tech and the Shenzhen 11 Zhongqiang transaction. 12 13 Power Tech create an inference that Bagell Josephs acted with the requisite 14 recklessness. As alleged, Bagell Josephs’s failure to discover that ABAT 15 owned merely a beneficial, rather than a legal, interest in ZQ Power Tech 16 before ABAT disclosed the proper ownership does not give rise to a strong 17 inference of scienter. This is true even when we consider this allegation Finally, Sanderson argues that the allegations of fraud relating to ZQ 3 Indeed, ABAT also may have fed Chinese regulators false data. 15 1 together with all the other facts alleged in the Proposed Complaint. See 2 Tellabs, 551 U.S. at 322 23. At most, we can infer that Bagell Josephs was 3 negligent in failing to uncover ZQ Power Tech’s true ownership prior to the 4 disclosure. 5 For these reasons we agree that, as alleged in the Proposed Complaint, 6 Bagell Josephs’s failure to detect ABAT’s fraudulent reporting is not conduct 7 “approximat[ing] an actual intent to aid in the fraud being perpetrated by the 8 audited company.” Rothman, 220 F.3d at 98 (quotation marks omitted). 9 10 II. EFP Sanderson argues that the Proposed Complaint adequately pleads 11 scienter on the part of EFP because it references the accounting expert’s 12 opinion and includes allegations that EFP “would have” discovered the 13 fraudulent nature of the Shenzhen Zhongqiang acquisition had it performed 14 “the most basic of audit duties.” 15 Having already rejected the first argument in connection with Bagell 16 Josephs, we address only the second. We have previously suggested that 17 conditional allegations of the sort “that [a defendant] ‘would’ have learned 18 the truth” about a company’s fraud “if [it] had performed the ‘due diligence’ 16 1 it promised” are generally insufficient to establish the requisite scienter for 2 private securities fraud claims “under the PSLRA’s heightened pleading 3 instructions.” See S. Cherry St., 573 F.3d at 110, 112 (quotation marks and 4 alteration omitted). Nonetheless, Sanderson attempts to bolster the allegation 5 by claiming that Shenzhen Zhongqiang’s inflated purchase price should have 6 alerted EFP that the transaction was a sham. But the Proposed Complaint 7 fails to allege that EFP knew that ABAT paid an inflated price for Shenzhen 8 Zhongqiang. As alleged, EFP’s failure to uncover and appreciate the 9 significance of the inflated price therefore does not represent “an extreme 10 departure from the standards of ordinary care.” Rothman, 220 F.3d at 98. 11 Nor do these factual allegations give rise to a strong inference of either 12 fraudulent intent or conscious recklessness, rather than mere negligence. 13 14 CONCLUSION We AFFIRM the judgment of the District Court. 17
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