Opinion
No. 11 Civ. 2279 (CM)
07-18-2013
In re ADVANCED BATTERY TECHNOLOGIES, INC. SECURITIES LITIGATION THIS DOCUMENT RELATES TO: ALL ACTIONS
CLASS ACTION
DECISION AND ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO FILE A SECOND AMENDED COMPLAINT
McMahon, J.:
Before the Court is the consolidated Plaintiffs' motion for leave to file a Second Amended Complaint ("SAC") in this securities fraud action against Advanced Battery Technologies, Inc. ("ABAT"), two of its officers (together with ABAT, the "ABAT Defendants"), and the auditors Bagell, Josephs, Levine & Co., Friedman LLP, and EFP Rotenberg ("EFP"). Due to their merger, I refer to Bagell, Josephs, Levine & Co. and Friedman LLP together as "Bagell Josephs." I refer to Bagell Josephs and EFP together as the "Auditor Defendants."
In a decision and order dated August 29, 2012, I denied the ABAT Defendants' motion to dismiss Plaintiffs' First Amended Complaint ("FAC") and granted the Auditor Defendants' motion to dismiss, but without prejudice. See In re Advanced Battery Technologies, Inc. Sec. Litig., No. 11 Civ. 2279, 2012 WL 3758085 (S.D.N.Y. Aug. 29, 2012) ("ABAT I"). I gave Plaintiffs 20 days to file a motion for leave to amend and a proposed amended complaint, which they did.
The Auditor Defendants now move, in effect, to dismiss the Second Amended Complaint on the grounds that it would not survive a Rule 12(b)(6) motion. For the reasons set forth herein, I agree with the Auditor Defendants and deny Plaintiffs' motion for leave to file a Second Amended Complaint.
BACKGROUND
The reader is referred to ABAT I for a more thorough description of the background of this case. This decision focuses on the changes that Plaintiffs have made to their allegations with respect to the following "red flags" that the Auditor Defendants allegedly missed or ignored: (1) the discrepancy between ABAT's filings with the Chinese Administration of Industry and Commerce ("AIC") and the Securities and Exchange Commission ("SEC"); (2) ABAT's re-characterization of its ownership interest in a company called Heilonjiang ZhongQuiang Power-Tech Co., Ltd. ("HLJ ZQPT"); and (3) ABAT's failure to disclose that its purchase of a company called Shenzhen ZhongQiang New Energy Science & Technology Co., Ltd. ("Shenzhen") was a "related-party" transaction.
The Auditor Defendants argue that Plaintiffs have not adequately pleaded scienter or loss causation, both of which are required for securities fraud liability. As in ABAT I, 2012 WL 3758085, at *15, I agree with the Auditor Defendants that Plaintiffs have not sufficiently pleaded scienter, and therefore I need not reach the issue of loss causation.
I. The AIC-SEC Discrepancy
One of Plaintiffs' chief allegations in this case is that ABAT grossly overstated its revenue and operating margins in a series of publicly filed documents. In particular, Plaintiffs allege that the revenue and net income that ABAT reported to the AIC differs greatly from that reported in its SEC filings, and that this discrepancy is not attributable to differences between AIC and SEC accounting practices. Plaintiffs allege that this was a red flag signaling ABAT's fraud that Bagell Josephs should have caught.
In ABAT I, I found that the alleged AIC-SEC discrepancy did not "support a strong inference of scienter because it omits a critical premise: that Bagell Josephs was actually aware of the AIC filings and the discrepancies they reflected, and chose to disregard them. Nowhere in the [First Amended] Complaint is it alleged that Bagell Josephs actually reviewed the AIC filings at all." ABAT I, 2012 WL 3758085, at *17. Furthermore, allegations of mere "access to documents that reveal fraudulent financial reporting . . . [are] not sufficient to plead the recklessness necessary to give rise to a strong inference of auditor scienter." Id.
I also found that the First Amended Complaint did not give rise to an inference that Bagell Josephs "must have" reviewed the documents that would have revealed the AIC-SEC discrepancy. Specifically, I noted that "Plaintiffs do not allege, for example, that Bagell Joseph was involved in preparing ABAT's AIC filings, or that it advised ABAT with respect to its overseas subsidiary's accounting. Plaintiffs even fail to allege that no reasonable auditor would fail to obtain these filings and reconcile them with SEC filings." Id. (internal citation omitted).
I concluded that Plaintiffs had alleged no more than negligence (i.e., a "shoddy audit") with respect to the AIC-SEC discrepancy, which was insufficient to support a strong inference of scienter under a "red flag" theory. Id. at *17-18.
In their Second Amended Complaint, Plaintiffs attempt to bolster their allegations with respect to the AIC-SEC discrepancy in two principal ways.
First, Plaintiffs have incorporated the expert opinion of Dr. Barry Jay Epstein (see SAC ¶ 148) into the Second Amended Complaint:
According to Dr. Epstein, no reasonable auditor would have failed to obtain ABAT's AIC filings and reconcile them with ABAT's wildly divergent SEC filings. Bagell Josephs' failure to do so was an extreme departure from the reasonable standards of care it was obligated to meet as ABAT's auditor and constituted a willful disregard of the professional standards and a breach of the
duty to conduct the examination with due professional care and attitude of professional skepticism. . . .(Id. ¶¶ 149, 152; see also id. ¶¶ 164-65, 175) (emphasis in original.)
Had Bagell Josephs undertaken the basic task of reviewing AIC filings it would have discovered that [ABAT] was reporting - for the same entity and operations - significantly lower revenues and assets, and large losses, for those same periods to the AIC. The discovery of the disparate financial reports would have obligated Bagell Josephs to expand its audit work. Had it done so, it would have uncovered a gross and longstanding fraud by the ABAT Defendants.
Second, Plaintiffs allege that "Bagell Josephs employees were personally present at ABAT's Chinese offices during the audit work for ABAT, and presumably relied on the same underlying financial records and data, such as documents necessary to substantiate ABAT's claimed revenues, that had formed the basis for ABAT's AIC filings. However, the same underlying financial records and data inexplicably yielded dramatically different results for ABAT's U.S. SEC filings." (Id. ¶ 166; see also id. ¶¶ 150-51.)
On the basis of the foregoing, Plaintiffs argue that "If Bagell had done its job in China at all, it 'must have' reviewed the AIC filings." (Pls.' Reply. (Docket No. 102) at 5.)
II. The Re-Characterization of ABAT's Interest in HLJ ZQPT
The gist of this allegation is that, from 2004 to early 2010, ABAT misrepresented that HLJ ZQPT was a wholly-owned subsidiary of one of ABAT's wholly-owned subsidiaries, when in fact HLJ ZQPT was actually owned by ABAT Defendant Zhiguo Fu ("Fu") and several other investors and always had been. ABAT corrected the alleged misrepresentation in its 2009 10-K, which was published in March 2010.
In ABAT I, I noted that this allegation was "probably [Plaintiffs'] likeliest candidate for a bona fide red flag." Id. at *21. "The question on [the motion to dismiss the First Amended Complaint therefore was] whether learning that Fu and his co-investors were the record owners of HLJ ZQPT should have led Bagell Josephs to suspect that ABAT was" engaging in the other fraudulent activity alleged by Plaintiffs, inflating its earnings, or that Fu was also the secret owner of Shenzhen, or that Fu had 'secret side deals' with the owners of Wuxi." Id. at *22. In short, I held that the answer to that question was no:
One missed red flag can perhaps be enough to conclude that an accountant's audit was a 'farce.' But in this case, this particular red flag is not sufficiently egregious to raise that inference. . . . Bagell Josephs could have reasonably taken the HLJ ZQPT re-characterization as evidence that ABAT was committed to accurately describing its interests in subsidiaries and revealing any related party transactions, and so was unlikely to be planning or concealing others. Certainly, that inference is at least as compelling as the inference that ABAT came clean about HLJ ZQPT as a ruse to hide other related party deals or adverse earnings information from the public.Id.
Here, too, I concluded that Plaintiffs' allegations amounted to no more than negligence and thus were insufficient to support a strong inference of auditor scienter. Id.
Plaintiffs have added no new allegations to their Second Amended Complaint with respect to the HLJ ZQPT re-characterization. Rather, they claim that their existing allegations "have been strengthened through Dr. Epstein's findings . . . that [Bagell Joseph's alleged failure to review documentation that would have revealed the truth about HLJ ZQPT] represents such a drastic departure from auditors' ordinary standard of care as to be actionable." (Pls.' Reply at 8; see also SAC ¶ 148 ("Dr. Epstein's analyses are incorporated with respect to all allegations regarding the Auditor Defendants set forth below.").)
III. The Shenzhen Transaction
Plaintiffs' sole surviving allegation against EFP is that it failed to disclose that ABAT's acquisition of Shenzhen was an instance of self-dealing. ABAT Defendant Fu, the company's Chairman and CEO, owned Shenzhen and allegedly pocketed a $19 million profit from its sale to ABAT.
In ABAT I, 2012 WL 3758085, at *19-20, I found Plaintiffs' allegations with respect to the Shenzhen transaction meritless as to Bagell Josephs in light of the fact that the critical parts of the transaction all occurred after Bagell Josephs' relationship with ABAT had ended. I also noted that "the only allegation going to . . . Shenzhen [in the First Amended Complaint was] . . . that top management concealed secret interests in ABAT's acquisitions that would enrich them personally. The inference that Bagell Josephs was kept as much in the dark as the investors is more compelling than the inference that Bagell Josephs recklessly disregarded clear signs of fraud." Id. at *21.
As to EFP, I noted that its "duty to familiarize itself with the particulars of that transaction . . . differ in important respects from Bagell Josephs' duty," because "EFP, unlike Bagell Josephs, audited ABAT's 2010 financial statements that announced the Shenzhen acquisition." Id. at *22.
Ultimately, however, I did not reach the merits of any of Plaintiffs' allegations against EFP. Although "Plaintiffs' allegations of scienter against EFP [were] deficient for many of the same reasons" as those against Bagell Josephs, I dismissed Plaintiffs' claims against EFP on standing grounds, because no named plaintiff had purchased ABAT stock after EFP issued its 2010 audit on March 16, 2011, and thus no plaintiff could have been injured by EFP's alleged misconduct. Id. *22-23. I granted Plaintiffs leave to replead in order to identify such a plaintiff, which they have now done - Plaintiff Frederico Schmid. (SAC ¶ 14.)
I concluded my analysis of Plaintiffs' claims against EFP with the following:
[I]n view of the Complaint's additional deficiencies with respect to the issue of EFP's scienter - which, as noted, are largely the same as those identified with
respect to Bagell Josephs - I will not grant leave to replead against EFP unless Plaintiffs demonstrate that amendment would not be futile. . . . [I]f, as I suspect will prove to be the case, they are unable to bolster significantly their allegations, so that they allege more than a negligent audit, amendment will be deemed futile.ABAT I, 2012 WL 3758085, at *23.
Plaintiffs' allegations regarding the Shenzhen transaction in the Second Amended Complaint are essentially identical to those in the First Amended Complaint. (Compare SAC ¶¶ 78-82, 155, 157, 168, 185-87 to FAC ¶¶ 77-84, 144, 149, 157, 159.) The core of Plaintiffs' claim against EFP remains the following:
Had EPF Rotenberg conducted the most basic of audit duties with professional skepticism it was required to apply, for instance, reviewing the relevant documentation concerning the transaction and verified actual counterparties to the Shenzhen transaction, it would have easily uncovered that ABAT had in fact acquired Shenzhen from Defendant Fu, who had himself acquired the company in 2008 for millions less than what ABAT was paying now to acquire it, and that the Shenzhen "acquisition" was in fact a related party transaction designed to siphon millions of dollars from ABAT to Defendant Fu.(SAC ¶187.)
And, as above, "Dr. Epstein's analyses are incorporated with respect to all allegations regarding the Auditor Defendants." (Id. ¶ 148.)
DISCUSSION
I. Standard of Review
Pursuant to Rule 15(a)(2) of the Federal Rules of Civil Procedure, the "court should freely give leave [to amend a pleading] when justice so requires." Leave to replead should be denied, however, when amendment would be "futile." See Port Dock & Stone Corp. v. Oldcastle Ne., Inc., 507 F.3d 117, 127 (2d Cir. 2007). 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). Anderson News, L.L.C. v. Am. Media, Inc., 680 F.3d 162, 185 (2d Cir. 2012) cert. denied, 133 S. Ct. 846, 184 L. Ed. 2d 655 (U.S. 2013).
In light of the foregoing, the parties treat Plaintiff's motion for leave to file a second amended complaint as a motion to dismiss, and so too does the Court. The reader is once again referred to ABAT I for the familiar standard on a motion to dismiss. 2012 WL 3758085, at *6.
II. Auditor Scienter
"Any complaint alleging securities fraud must satisfy the heightened pleading requirements of the PSLRA and Fed. R. Civ. P. 9(b) by stating with particularity the circumstances constituting fraud." ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 196 (2d Cir. 2009). Among the elements of a securities fraud claim that the plaintiff must plead with particularity is the defendant's scienter - i.e., the "defendant's intention 'to deceive, manipulate, or defraud.'" Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313-14 (2007).
Under the PSLRA, the plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2)(A). In Tellabs, the Supreme Court articulated the relevant standard for determining whether a plaintiff has sufficiently pleaded scienter for the purposes of a securities fraud claim:
To determine whether the plaintiff has alleged facts that give rise to the requisite "strong inference" of scienter, a court must consider plausible, nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff. The inference that the defendant acted with scienter need not be irrefutable, i.e., of the "smoking-gun" genre, or even the most plausible of competing inferences. . . . Yet the inference of scienter must be more than merely "reasonable" or "permissible" - it must be cogent and compelling, thus strong in light of other explanations. A complaint will survive . . . only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.551 U.S. at 323-24 (internal citation and quotation marks omitted).
As courts in this District have repeatedly recognized, "The standard for pleading auditor scienter is demanding." In re Beacon Assoc. Litig., 745 F. Supp. 2d 386, 415 (S.D.N.Y. 2010) (quoting In re Scottish Re Grp. Sec. Litig., 524 F. Supp. 2d 370, 385 (S.D.N.Y. 2007)). Meeting this demanding standard requires the plaintiff to either (1) show that the defendant had motive and opportunity to commit fraud, or (2) provide evidence of the defendant's conscious recklessness. See id. at 404 (citing South Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 108-09 (2d Cir. 2009)). Plaintiff has added no allegations with respect to motive to his proposed Second Amended Complaint, so, as in ABAT I, the Court focuses solely on the Auditor Defendants' alleged recklessness.
Where a securities fraud claim against an auditor is premised on the auditor's recklessness, "the strength of the circumstantial allegations must be correspondingly greater." Kalnit v. Eichler, 264 F.3d 131, 142 (2d Cir. 2001). Indeed, the plaintiff must allege reckless conduct so egregious as to approximate an actual intent to aid the fraud being committed by the audited company. See Beacon, 745 F. Supp. 2d at 415 (citing Rothman v. Gregor, 220 F.3d 81, 98 (2d Cir. 2000)); see also Stephenson v. PricewaterhouseCoopers, LLP, 768 F. Supp. 2d 562, 571-72 (S.D.N.Y. 2011). As the Second Circuit explained in Rothman, 220 F.3d at 98,
For recklessness on the part of a non-fiduciary accountant to satisfy securities fraud scienter, such recklessness must be conduct that is highly unreasonable, representing an extreme departure from the standards of ordinary care. It must, in fact, approximate an actual intent to aid in the fraud being perpetrated by the audited company.Or, as another common formulation has it:
[P]laintiff must allege that the accounting practices were so deficient that the "audit amounted to no audit at all, or an egregious refusal to see the obvious, or investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts."In re Tremont Secs. Law, State Law and Ins. Litig., 703 F. Supp. 2d 362, 370 (S.D.N.Y. 2010) (quoting Scottish Re, 524 F. Supp. 2d at 385); see also Beacon, 745 F. Supp. 2d at 415-16; In re IMAX Secs. Litig., 587 F. Supp. 2d 471, 483 (S.D.N.Y. 2008)); In re MRU Holdings Secs. Litig., 769 F. Supp. 2d 500, 518 (S.D.N.Y. 2011).
Negligence alone, or a "shoddy audit," does not suffice to plead auditor scienter. MRU, 769 F. Supp. 2d at 518 (citing Tremont, 703 F. Supp. 2d at 371).
Nor are "'failures to comply with [GAAP] or other such irregularities . . . []sufficient to establish recklessness.'" Stephenson, 768 F. Supp. 2d at 572 (quoting W. Va. Inv. Mgmt. Bd. v. Doral Fin. Corp., 344 Fed. Appx. 717, 720 (2d Cir. 2009)); see also IMAX, 587 F. Supp. 2d at 483. "Only where such allegations are coupled with evidence of corresponding fraudulent intent might they be sufficient." Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir. 2000) (internal citation and quotation marks omitted). For instance, alleged violations of professional standards may support a strong inference of scienter if coupled with so-called "reds flags" that the auditor ignored. See Beacon, 745 F. Supp. 2d at 416 (citing In re AOL Time Warner, Inc. Secs. and "ERISA" Litig., 381 F. Supp. 2d 192, 240 (S.D.N.Y. 2004)). "'A complaint might reach the 'no audit at all' threshold by alleging that the auditor disregarded specific 'red flags' that would place a reasonable auditor on notice that the audited company was engaged in wrongdoing to the detriment of its investors.'" Stephenson, 768 F. Supp. 2d at 573 (quoting Tremont, 703 F. Supp. 2d at 370).
But scienter is not sufficiently alleged simply because an auditor failed to detect a fraud. Rather, a red flag will support a strong inference of scienter only if the auditor was actually aware of its existence, or if the court can reasonably infer that the auditor "must have" been aware of it. See, e.g., In re Philip Servs. Corp. Secs. Litig., 383 F. Supp. 2d 463, 475 (S.D.N.Y. 2004); see also Kalnit, 264 F.3d at 142 (citing In Re Carter-Wallace, Inc. Secs. Litig., 220 F.3d 36, 39 (2d Cir. 2000)). By contrast, "merely alleging that the auditor had access to the information by which it could have discovered the fraud is not sufficient." IMAX, 587 F. Supp. 2d at 484. After all, "an unseen red flag cannot be heeded," Stephenson, 768 F. Supp. 2d at 573; and, as another court put it, "merely because a person has broad access to every book in a library does not mean that the person has read and chosen to ignore facts contained in a particular book in the library." In re aaiPharma Inc. Secs. Litig., 521 F.Supp.2d 507, 513 (E.D.N.C. 2007) (quoted in Tremont, 703 F. Supp. 2d at 370-71).
III. Plaintiffs' Allegations Based on Dr. Epstein's Opinion Fail
As an initial matter, it was arguably inappropriate for Plaintiffs to incorporate expert testimony into their Second Amended Complaint as a means of bolstering their allegations against the Auditor Defendants. Indeed, I would be within my rights to disregard these allegations completely. See Highland Capital Mgmt., L.P. v. Schneider, No. 02 Civ. 8098, 2004 WL 2029406, at *4 (S.D.N.Y. Sept. 9, 2004).
What I would not be within my rights to do is to discount Dr. Epstein's expert opinion at the pleadings stage based on Bagell Josephs' list of securities fraud cases purporting to demonstrate that a reasonable auditor need not necessarily reconcile a company's AIC and SEC filings. (See Bagell Josephs' Opp'n (Docket No. 101), Ex. A.) That list - to the extent it proves anything at all, which is doubtful - is extraneous to the pleadings and therefore completely improper.
However, Plaintiffs' allegations based on Dr. Epstein's expert opinion fail for another reason: all that Dr. Epstein attests to is that the Auditor Defendants violated professional standards, which, standing alone, is insufficient to support a strong inference of recklessness approximating an actual intent to aid ABAT's underlying fraud. Stephenson, 768 F. Supp. 2d at 572. Furthermore, these allegations are pleaded in terms of negligence, and thus necessarily do not rise to the level of recklessness. See Reiger v. Price Waterhouse Coopers LLP, 117 F. Supp. 2d 1003, 1012 (S.D. Cal. 2000) ("Plaintiffs' purported 'red flags' consist of Pricewaterhouse's possession of documentation which, if properly reviewed pursuant to GAAP and GAAS, would have revealed improperly recognized revenue. At most, these allegations raise an inference of gross negligence, but not fraud.") aff'd sub nom. DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385 (9th Cir. 2002). Nothing in the case law suggests that a plaintiff can avoid these rules of law simply by retaining an expert willing to label an auditor's alleged misconduct under the applicable professional standards "extreme" or "willful." Cf. Stephenson, 768 F. Supp. 2d at 574 ("[F]lags are not red merely because the plaintiff calls them red.")
For instance, Plaintiffs make the following allegations: "According to Dr. Epstein, no reasonable auditor would have failed to obtain ABAT's AIC filings and reconcile them with ABAT's wildly divergent SEC filings." (SAC ¶ 149) (emphasis added.) "According to Dr. Epstein, Bagell Josephs should have included ABAT's AIC filings in its compilation of audit evidence, and its failure to do so constituted an extreme departure from the standards of reasonable care for this auditor." (Id. ¶ 164; see also id. ¶¶ 168-69) (emphasis added.) As this Court has held elsewhere, "Merely alleging that [a defendant] 'would' or 'could' or even 'should' have known of [a]fraud if only it had paid attention to the 'red flags' is insufficient to make out a 10(b) claim." In re J.P. Jeanneret Associates, Inc., 769 F. Supp. 2d 340, 377 (S.D.N.Y. 2011) (citing South Cherry, 573 F.3d at 109). Indeed, "the Second Circuit has affirmed the dismissal of a complaint 'replete with allegations that [a firm] 'would' have learned the truth as to those aspects of the [fraudulent] funds if [it] had performed the 'due diligence' it promised' and that '[i]f [the firm] had asked various questions earlier, it would have further questioned the [fraudulent fund's] financial records or recognized the need to ask further questions.'" Stephenson, 768 F.Supp.2d at 573-74 (quoting South Cherry, 573 F.3d at 112).
Nor are Plaintiffs' professional negligence allegations any stronger because they are coupled with allegations of red flags that the Auditor Defendants purportedly ignored. See Beacon, 745 F. Supp. 2d at 416. As discussed below, Plaintiffs have not sufficiently alleged that the Auditor Defendants were aware of the red flags at issue in this case. In other words, Plaintiffs have not sufficiently pleaded a corresponding fraudulent intent on the part of the Auditor Defendants. Novak, 216 F.3d at 309.
IV. Plaintiffs' Allegations Against Bagell Josephs
A. Plaintiffs Have Not Sufficiently Alleged Bagell Josephs' Awareness of the AIC-SEC Discrepancy
Plaintiffs do not allege in the Second Amended Complaint that Bagell Josephs was "actually aware" of ABAT's AIC filings. Plaintiffs rely instead on a theory that Bagell Josephs "must have" reviewed the AIC filings, see Kalnit, 264 F.3d at 142, because, (1) according to their expert, it would have been an extreme departure from professional standards not to do so, and (2) Bagell Josephs sent auditors to ABAT's Chinese offices in connection with ABAT's SEC filing, where they "presumably" (SAC ¶ 166) relied on the same financial information used in the AIC filings. These allegations fail.
As to Plaintiffs' reliance on Dr. Epstein's expert opinion in support of their "must have" theory, the most that Dr. Epstein attests to is that Bagell Josephs should have reviewed ABAT's AIC filings. "Should have" does not mean "must have" - the former is a normative proposition, the latter a positive one. Cf. Hart v. Internet Wire, Inc., 145 F. Supp. 2d 360, 369 (S.D.N.Y. 2001). Accordingly, Dr. Epstein's expert opinion is irrelevant in this context.
Plaintiffs' allegation that Bagell Josephs must have reviewed ABAT's AIC filings when it sent auditors to China also fails, because Plaintiffs have alleged no more than Bagell Josephs' access to the AIC filings, which is insufficient to support a strong inference of auditor scienter. IMAX, 587 F. Supp. 2d at 484. Alleging access to certain documents is just another way of alleging that an auditor could or should have reviewed those documents. Nor are Plaintiffs' entitled to the "presum[ption]" (SAC ¶ 166) that Bagell Josephs' auditors must have relied on the same financials used in the AIC filings in generating ABAT's SEC filing; that, too, is just another way of alleging that Bagell Josephs should have incorporated those documents into its analysis.
In ABAT I, 2012 WL 3758085, at *17, I illustrated circumstances from which I could infer that Bagell Josephs must have reviewed the documents upon which ABAT's AIC filings were based. For example, if Bagell Josephs had prepared ABAT's AIC filings or advised ABAT with respect to its overseas subsidiary's accounting, I could easily infer that Bagell Josephs must have reviewed the relevant documents. Both of these examples are scenarios in which Bagell Josephs necessarily would have reviewed the documents that would have revealed the discrepancy between ABAT's AIC and SEC filings. Plaintiffs' allegations, by contrast, boil down to the following: "If Bagell had done its job in China at all, it 'must have' reviewed the AIC filings." (Pls.' Reply at 5.) Not so. As already stated, "should have" does not mean "necessarily did."
In Scott v. ZST Digital Networks, Inc., No. 11 Civ. 3531, 2012 WL 538279, at *10-11 (C.D. Cal. Feb. 14, 2012), the plaintiff also improperly conflated the "must have" rule with the "should have" standard in connection with an AIC-SEC discrepancy that the auditor defendant allegedly missed. There, the district court held that "Plaintiff's allegations that [the auditor defendant] was an experienced auditor of Chinese issuers' financials, and must have been aware of the existence of the [AIC] filings, 'a mere glance [at which] would have readily lead to the discovery of the discrepancies, is insufficient to constitute the 'reckless indifference' required by the case law." Id. at *10 (citing New Mexico Inv. Council v. Ernst & Young LLP, 641 F.3d 1089, 1095 (9th Cir. 2011)). In other words, the plaintiff asked the court to make the impermissible inferential leap that, because the auditor defendant should have been aware of the AIC-SEC discrepancy based on its experience with Chinese companies, it therefore must have been aware of the discrepancy. Here, Plaintiffs ask this Court to make a similar leap. I cannot under the law.
In sum, because Plaintiffs have not sufficiently alleged that Bagell Josephs was or must have been aware of the financial information underlying ABAT's AIC filings, Plaintiffs have failed to allege a strong inference of scienter under their "red flag" theory of securities fraud liability. Accordingly, I deem Plaintiffs' proposed amendments to their allegations with respect to the AIC-SEC discrepancy futile and deny Plaintiffs' motion for leave to file a Second Amended Complaint as to those allegations.
B. Plaintiffs' Allegations with respect to the HLJ ZQPT Re-Characterization Fail for the Same Reasons Articulated in ABAT I
As noted above, Plaintiffs have added no new allegations to their Second Amended Complaint that are specific to the HLJ ZQPT re-characterization.
Plaintiffs argue that Bagell Josephs "fails to comprehend that the HLJ ZQPT allegation is predicated on Bagell's failure to 'review . . . relevant documentation [which] would have shown that ABAT did not own HLJ ZQPT between 2004 and 2009, despite representations to the contrary in its filings.'" (Pls.' Reply at 8 (quoting SAC ¶ 169.)) Plaintiffs argue further that their "failure-to-review documents claim has been strengthened through Dr. Epstein's findings - reflected in the SAC - that such conduct represents such a drastic departure from auditors' ordinary standard of care as to be actionable." (Id. (citing SAC ¶ 148))
Plaintiffs' reliance on paragraph 169 of the Second Amended Complaint is misplaced, as it is a near verbatim reproduction of paragraph 149 of the First Amended Complaint, which this Court found lacking in ABAT I. In any event, paragraph 169 merely alleges professional negligence, which does not rise to the level of recklessness approximating an intent to aid in ABAT's fraud. See In re Longtop Fin. Technologies Ltd. Sec. Litig., 910 F. Supp. 2d 561, 575 (S.D.N.Y. 2012) ("At its core the Complaint alleges that, had DTTC performed a better audit, it would have uncovered Longtop's fraud. At most this describes negligence by DTTC, not the recklessness approaching actual intent required by the PSLRA."); see also MRU, 769 F. Supp. 2d at 518; Stephenson, 768 F. Supp. 2d at 571-2. And as already discussed supra, Plaintiffs' allegations based on Dr. Epstein's expert opinion fail, and thus do not bolster Plaintiffs' HLJ ZQPT allegations.
Because Plaintiffs have failed to improve - or indeed to change in any meaningful way - their allegations against Bagell Josephs with respect to the HLJ ZQPT re-characterization, I find those allegations deficient for all of the reasons discussed in ABAT I. Accordingly, Plaintiffs' motion for leave to file a Second Amended Complaint as to those allegations is denied.
IV. Plaintiffs' Allegations Against EFP
A. Plaintiffs Have Alleged No More Than EFP's Negligence In Connection With The Shenzhen Transaction
While EFP arguably had more of a "duty to familiarize itself with the particulars of [the Shenzhen] transaction" than Bagell Josephs did in light of the fact that EFP audited ABAT's 2010 financial statements, ABAT I, 2012 WL 3758085, at *22, Plaintiffs' allegations against EFP with respect to that transaction (see, e.g., SAC ¶ 187) are still deficient, because they amount to no more than allegations of professional negligence or shoddy auditing, and therefore do not support a strong inference of auditor scienter. See Longtop, 910 F. Supp. 2d at 575; MRU, 769 F. Supp. 2d at 518; Stephenson, 768 F. Supp. 2d at 571-2. Indeed, Plaintiffs' argument ultimately comes down to the following: "had EFP done the bare minimum and obtained the underlying documentation for Shenzhen, it would have observed that Defendant Zhiguo Fu, the Company's Chairman and CEO, was involved in the transaction and profiting mightily from it." (Pls.' Reply at 9.) This argument echoes those asserted against Bagell Josephs, and fails for the same reasons.
Furthermore, I agree with EFP that the "inference that [EFP, like Bagell Josephs,] was kept as much in the dark as the investors is more compelling than the inference that [EFP] recklessly disregarded clear signs of fraud" with respect to the Shenzhen transaction. ABAT I, 2012 WL 3758085, at *21; see also Tellabs, 551 U.S. at 323-24; W. Va. Inv. Mgmt. Bd. v. Doral Fin. Corp., 344 Fed. Appx. 717, 720 (2d Cir. 2009).
Finally, as with Plaintiffs' allegations against Bagell Josephs, Dr. Epstein's expert opinion does not bolster Plaintiffs' allegations against EFP.
In sum, Plaintiffs' motion for leave to file a Second Amended Complaint as to its allegations against EFP is denied.
CONCLUSION
For the reasons set forth above, Plaintiffs motion for leave to file a Second Amended Complaint is DENIED. Accordingly, no claims remain against the Auditor Defendants and they are dismissed from this case.
Plaintiffs have informed the Court that they have a settlement in principle with the ABAT Defendants. In light of the settlement and the dismissal of the Auditor Defendants from this action, it is my understanding that I need not reach Plaintiffs' class certification motion (Docket No. 94). The parties have one week to apprise the Court if this is not the case, or the motion will be stricken from the Court's calendar.
The Clerk of the Court is directed to remove the motion at Docket No. 96 from the Court's list of pending motions. Dated: July 18, 2013
/s/_________
U.S.D.J. BY ECF TO ALL COUNSEL