Dartell v. Tibet Pharmaceuticals, Inc. et al

MOTION for Summary Judgment Corrected Memorandum of Law in Support of Motion for Summary Judgment

D.N.J.July 8, 2016

Robert J. Brener, Esq. (RB-3764)) A. Neil Hartzell, Esq. (admitted pro hac vice) LECLAIRRYAN, A PROFESSIONAL CORPORATION One Riverfront Plaza 1037 Raymond Boulevard, Sixteenth Floor Newark, New Jersey 07102 (973) 491-3600 Robert.Brener@leclairryan.com Attorneys for Defendant L. McCarthy Downs III UNITED STATES DISTRICT COURT DISTRICT OF NEW JERSEY MING YANG, Individually and on Behalf of All Others Similarly Situated, Plaintiff, -against- TIBET PHARMACEUTICALS, INC. HONG YU, TAYLOR Z. GUO, SABRINA Y. REN, WENBO CHEN, YOUHANG PENG, SOLOMON CHEN, ANDERSON & STRUDWICK INCORPORATED, STERNE AGEE GROUP, INC., HAYDEN ZOU, and L. MCCARTHY DOWNS III Defendants. Civil Action No. 14-cv-3538-FSH-MAH ROBIN JOACHIM DARTELL, Individually and on Behalf of All Others Similarly Situated, Plaintiff, -against- TIBET PHARMACEUTICALS, INC. HONG YU, TAYLOR Z. GUO, SABRINA Y. REN, WENBO CHEN, YOUHANG PENG, SOLOMON CHEN, ANDERSON & STRUDWICK INCORPORATED, STERNE AGEE GROUP, INC., HAYDEN ZOU, L. MCCARTHY DOWNS III, and ACQUAVELLA, CHIARELLI, SHUSTER, BERKOWER & CO., LLP, Defendants. Civil Action No. 14-cv-3620 L. MCCARTHY DOWNS, III’S MEMORANDUM OF LAW IN SUPPORT OF HIS MOTION FOR SUMMARY JUDGMENT (CORRECTED) Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 1 of 37 PageID: 4412 Contents PRELIMINARY STATEMENT ..................................................................................................1 ARGUMENT ..................................................................................................................................2 I. STANDARD OF REVIEW ...................................................................................2 II. CERTAIN NAMED PLAINTIFFS LACK STANDING TO BRING THE CLAIM BECAUSE THEY DID NOT PURCHASE THEIR SHARES AS PART OF IPO. .......................................................................................................3 III. DOWNS IS ENTITLED TO SUMMARY JUDGMENT ON COUNT I OF PLAINTIFFS’ CONSOLIDATED COMPLAINT. .....................................8 A. Downs Is Entitled To Summary Judgment On Count 1 Of The Consolidated Complaint Because He Does Not Fall Within The Statutorily Enumerated Categories Of Potential Defendants Under Section 11 Of The Securities Act. .................................................9 B. Downs Is Entitled To Summary Judgment On Count I Because He Conducted Reasonable Due Diligence As Is Required Of Underwriters Under Section 11. .............................................................15 IV. DOWNS IS ENTITLED TO SUMMARY JUDGMENT ON COUNT III OF PLAINTIFFS’ CONSOLIDATED COMPLAINT BECAUSE THERE ARE NO FACTS TO PROPERLY ESTABLISH CONTROL PERSON LIABILITY. ........................................................................................24 A. Downs’ Role as Board Observer Did Not Create Sufficient Control Over The Tibet Board of Directors for Liability Under Section 15(a). ............................................................................................25 B. Downs Was Not A “Culpable Participant” In Any Alleged Violations By Tibet. .................................................................................28 C. Any Claims Premised On Downs’ Alleged Inactions Concerning The Tibet Board’s Conduct Also Fail As A Matter Of Law. ...............30 CONCLUSION ............................................................................................................................31 Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 2 of 37 PageID: 4413 Cases Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986) .............................................................. 2, 3 Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682 (3d Cir. 1991) ...................................... 3 Bauer v. Prudential Fin., Inc., No. CIV.A. 09-1120 (JLL), 2010 WL 2710443 (D.N.J. June 29, 2010) ......................................................................................................................................... 15 Belmont v. M.B. Inv. Partners, Inc., 708 F.3d 470 (3d Cir. 2013) ................................... 28, 30, 31 Chambers Dev. Sec. Litig., 848 F.Supp. 602 (W.D.Pa. 1994) ............................................... 25, 27 Copland v. Grumet, No. Civ. A. 96-3351 MLP, 1998 WL 256654 (D.N.J. Jan. 9, 1998) ....... 9, 13 Dutton v. Harris Stratex Networks, Inc., 270 F.R.D. 171 (D. Del. 2010) .................................... 24 Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) ................................................................. 15, 20 Escott v. BarChris Construction Corp., 283 F.Supp. 643 (S.D.N.Y. 1968) ............... 16, 18, 20, 24 Feit v. Leasco Data Processing Equip. Co., 332 F.Supp. 544 (E.D.N.Y. 1971) ............... 19, 20, 24 Gannon v. Continental Ins. Co., 920 F.Supp. 566 (D.N.J. 1996) ................................................... 4 Gustafson v. Alloyd Co., Inc., 513 U.S. 561 (1995) ....................................................................... 4 Hall v. The Children’s Place Retail Stores, Inc., 580 F.Supp.2d 212 (S.D.N.Y. 2008) ............... 25 Hechinger Inv. Co. v. E. Fleet Retail Finance Group, 274 B.R. 71 (D. Del. 2002) ..................... 26 Herman & MacLean v. Huddleston, 459 U.S. 375 (1983) ............................................................. 9 Hill York Corp. v. American Intern. Franchises, Inc., 448 F.2d 680 (5th Cir. 1971) .................. 25 Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990) ................................................. 28 In re Enzymotec Sec. Litig., No. CV145556JLLMAH, 2015 WL 8784065 (D.N.J. Dec. 15, 2015) ................................................................................................................................................... 25 In re Equity Funding Corp. of Am. Sec. Litig., 416 F.Supp. 161 (C.D. Cal. 1976) ................. 9, 13 In re FleetBoston Fin. Corp. Sec. Litig., 253 F.R.D. 315 (D.N.J. 2008) ........................................ 7 In re Gap Stores Sec. Litig., 457 F.Supp. 1135 (N.D. Cal. 1978) ................................................ 10 In re Global Crossing, Ltd. Sec. Litig., 313 F.Supp.2d 189 (S.D.N.Y. 2003) ................................ 6 Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 3 of 37 PageID: 4414 iii In re Intl. Rectifier Sec. Litig., No. CV91–3357–RMT (BQRX), 1997 WL 529600 (C.D. Cal. Mar. 31, 1997)..................................................................................................................... 20, 24 In re Lehman Bros. Mortgage-Backed Secs. Litig., 650 F.3d 167 (2d Cir. 2011) ................... 9, 13 In re Metropolitan Sec. Litig., 532 F.Supp.2d 1260 (E.D.Wa. 2007) ..................................... 27, 28 In re PMA Capital Corp. Sec. Litig., No. 03-6121, 2005 WL 1806503 (E.D. Pa. July 27, 2005) 10 In re Rezulin Prods. Liab. Litig., 361 F. Supp. 2d 268 (S.D.N.Y. 2005) ....................................... 3 In re Software Toolworks Inc. Sec. Litig., 50 F.3d 615 (9th Cir. 1994) ................................. 15, 19 In re Unicapital Corp. Sec. Litig., 149 F.Suppp.2d 1353 (S.D. Fla. 2001)................................... 11 In re Worldcom Sec. Litig., 346 F.Supp.2d 628, 672 (S.D.N.Y. 2006) ........................... 17, 18, 23 John Nuveen & Co. v. Sanders, 450 U.S. 1005 (1981) ................................................................ 16 Kahn v. Lynch Comm. Systems, Inc., 638 A.2d 1110 (Del. 1994) .............................................. 26 Krim v. pcOrder.com, Inc., 402 F.3d 489 (5th Cir. 2005) .............................................................. 8 Laven v. Flanagan, 695 F.Supp. 800 (D.N.J. 1988) ..................................................................... 19 Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574 (1986) ..................................... 2 Mersay v. First Republic Corp. of America, 43 F.R.D. 465 (S.D.N.Y. 1968) ....................... 11, 12 Phillips v. Kidder Peabody & Co., 933 F.Supp. 303 (S.D.N.Y. 1996) ......................................... 19 Poptech LP v. Stewardship Credit Arbitrage Fund, 792 F.Supp.2d 328 (D.Conn. 2011) ............ 29 Rochez Bros., Inc. v. Rhoades, 527 F.2d 880 (3d Cir. 1975) ....................................................... 28 S.E.C. v. First Jersey Securities, 101 F.3d 1450 (2d Cir. 1996) ................................................... 28 Shapiro v. UJB Financial Corp., 964 F.2d 272 (3d Cir. 1992) ................................................... 3, 7 Special Situations Fund, III, L.P. v. Cocchiola, Civ. 02-3099 (WHW), 2007 WL 2261557 (D.N.J. Aug. 3, 2007) ............................................................................................................................ 13 Statutes 15 U.S.C. § 77b(a)(11) .................................................................................................................. 13 15 U.S.C. § 77k(a) .......................................................................................................... 8, 9, 10, 11 15 U.S.C. § 77k(b) ........................................................................................................................ 15 Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 4 of 37 PageID: 4415 iv 15 U.S.C. § 77k(b)(3)(B) ........................................................................................................ 18, 19 15 U.S.C. § 77k(c) ............................................................................................................ 19, 20, 23 15 U.S.C. § 78c ............................................................................................................................. 11 15 USC § 77o ................................................................................................................................ 15 Other Authorities SEC Release No. 24-18114..................................................................................................... 11, 12 SEC Release No. 34-28869........................................................................................................... 11 Regulations 17 C.F.R. § 240.12b.2 ................................................................................................................... 15 Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 5 of 37 PageID: 4416 PRELIMINARY STATEMENT Defendant L. McCarthy Downs III (“Downs”) submits this memorandum of law in support of his Motion for Summary Judgment pursuant to Fed. R. Civ. P. 56 on all counts of the complaints brought by the class plaintiffs in this Consolidated Class Action Complaint (the “Complaint”). Plaintiffs claim various securities laws violations arising of common stock purchases of Tibet Pharmaceuticals, Inc. (“Tibet” or the “Company”). Having settled with the auditor and the bankruptcy trustee of the underwriter, the successor of the underwriter, and all other employees, officers, directors, agents and attorneys of the underwriter, Plaintiffs continue to pursue their claims against one former employee of the underwriter. But as set forth below, those claims are based on blatant false allegations in the Complaint1 and are otherwise without basis in fact or law. Moreover, the majority of the named Plaintiffs have no standing to bring these claims as they cannot show their share purchase were from the IPO, and not from the secondary market. Plaintiffs, a class of persons who purchased common stock in Tibet after Tibet’s initial public offering (“IPO”) in January 2011, have brought claims pursuant to Sections 11 and 15 of the Securities Act of 1933 (“the Securities Act”) against Downs, alleging that: (1) Downs knew or should have known that the Registration Statement and Prospectus Tibet filed in connection with its January 2011 IPO contained misstatements or omissions in violation of Section 11; and (2) Downs, through his role as a designated Board Observer for the Tibet Board of Directors, was a control person under Section 15 and was thus liable for misstatements and/or omissions Tibet made in the Registration Statement and Prospectus. Contrary to the ¶ 118 of the 1 ¶118 of the Complaint states “[t]he Individual Defendants [including Downs] are signatories of the Registration Statement and Prospectus.” This allegation is completely false as to Downs. [Statement of Undisputed Material Facts, ¶¶ 93-94]; ¶ 139 of the Complaint states that “Individual Defendants [including Downs] were control persons of Tibet by virtue of, among other things, their positions as senior officers and directors of the Company..” This allegation is also completely false as to Downs. [Statement of Facts ¶¶ 123-138]. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 6 of 37 PageID: 4417 2 Complaint, Downs did not sign the Prospectus or Registration Statement and, contrary to ¶ 139 of the Complaint, was never an officer, director or any type of control person of Tibet. In addition, Downs was not an officer or director of the underwriter Anderson & Strudwick (“A&S”) at the time of the IPO but merely an employee of A&S at that time. Downs moves this Court to grant summary judgment in his favor on Counts I and III of the Complaint because: (1) certain Plaintiffs have no standing to bring claims because their share purchases cannot be traced to the IPO; (2) Plaintiff’s claims against Downs for individual liability under Section 11 cannot be sustained given that Downs does not fall within statutory enumerated categories of entities for which liability may enter under Section 11; (3) even if Downs is subject to Section 11 given his work for A&S, there was extensive due diligence conducted into Tibet sufficient to invoke the protections of the due diligence defense under Section 11; and (4) there is no material dispute of fact that Downs was not a “control person” as the term is recognized by the Third Circuit under the federal securities laws, and as such, Downs cannot be liable for violations of Section 15 of the Securities Act. ARGUMENT I. STANDARD OF REVIEW In order to prevail on a motion for summary judgment under Fed. R. Civ. P. 56, a party must establish that there is no genuine issue as to any material fact and that the party is entitled to judgment as a matter of law. Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986) (existence of factual dispute will not defeat summary judgment; rather, the dispute must be genuine and the fact must be material). A question of fact is only genuine “if the evidence is such that a reasonable jury could return a verdict for the non-moving party.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). Plaintiffs, in opposing summary judgment, cannot create a question of fact by presenting a mere scintilla of evidence, or evidence Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 7 of 37 PageID: 4418 3 that is merely colorable, but must instead present evidence sufficient to permit a fact-finder to permissibly decide the issue in the Defendant’s favor at trial. See Liberty Lobby, 477 U.S. at 252 (“The mere existence of a scintilla of evidence in support of the [non-movant's] position will be insufficient; there must be evidence on which the jury could reasonably find for the non- movant”). And “[w]here the nonmoving party would have the burden of proof at trial, ordinarily it is sufficient for the movant to point to a lack of evidence to go to the trier of fact on an essential element of the nonmovant's claim.” In re Rezulin Prods. Liab. Litig., 361 F. Supp. 2d 268, 271 (S.D.N.Y. 2005) (citing Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 106 S. Ct. 2548, 2552 (1986)). II. CERTAIN NAMED PLAINTIFFS LACK STANDING TO BRING THE CLAIM BECAUSE THEY DID NOT PURCHASE THEIR SHARES AS PART OF IPO. Plaintiffs’ claims fail because certain Plaintiffs do not have standing to bring claims pursuant to Section 11 of the Securities Act of 1933. Standing is a threshold inquiry for determination as to whether a party’s claims can be brought under Section 11. In order to bring claims pursuant to Section 11 in this Circuit, Plaintiffs must show they purchased their shares in Tibet as part of the initial public offering, and not from the secondary market trading in those shares. Shapiro v. UJB Financial Corp., 964 F.2d 272, 286 (3d Cir. 1992) (if plaintiff’s “shares were purchased in the secondary market, they would not be linked to a registration statement filed during the class period, and the Section 11 claim would fail.”). The 3rd Circuit has explicitly rejected the tracing principle, a judicially created principle based upon Section 11’s application to “any person acquiring such security.” The 3rd Circuit has held that Sections 11 and 12(2) of the 1933 Act applies only to stocks bought in an initial public offering and not to stocks purchased through secondary market transactions. Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 693 (3d Cir. 1991); Shapiro, 964 F.2d at 286. The Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 8 of 37 PageID: 4419 4 Supreme Court in Gustafson v. Alloyd Co., Inc., 513 U.S. 561 (1995) stated that the word “prospectus” in Section 12(2) of the 1933 Act precludes liability under that section for anything other than a stock purchase on an initial offering. 513 U.S. at 578. According to the Court, the “intent of Congress and the design of the statute require that Section 12(2) liability be limited to public offerings,” and that Section 12 does not provide a remedy to a plaintiff who purchased in the secondary market. Id. See also Gannon v. Continental Ins. Co., 920 F.Supp. 566, 575 (D.N.J. 1996) (plaintiffs who purchase shares of stock on “open market” is by definition not an IPO and therefore does not give rise to claims under Section 11). It is also recognized in this Circuit that whether shares were newly issued or purchased in the secondary market is impossible before discovery. Shapiro, 964 F.2d at 286. This Court determined it was premature to review Plaintiffs’ standing under a similar argument in motions to dismiss [Order, Dkt. No. 132], but given discovery that has taken place, those claims are ripe for review at summary judgment. See Shapiro, 964 F. 2d at 286. There are specific facts that warrant further review regarding Plaintiffs’ ability—or lack thereof—to claim they purchased their shares in Tibet in connection with the January 2011 IPO. In the Registration Statement and Prospectus, the Company reported there were 11,812,500 shares of Tibet outstanding before the IPO, and the IPO resulted in an additional 3,000,000 shares of Tibet being issued. [Statement of Material Undisputed Facts (“SOF”), ¶ 143]. On January 24, 2011, the IPO became effective and commenced trading of nearly 3 million shares offered to the public, at $5.50 per share. [SOF, ¶ 144]. Of these now 14,812,500 outstanding shares post-IPO, 9,058,125 of these shares were subject to a 90-day lock-up period “from the date of effectiveness or commencement of the sales of the public offering.” [SOF, ¶ 145]. On April 24, 2011, a lock-up period expired for the 9,058,125 shares of restricted stock. [SOF, ¶ Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 9 of 37 PageID: 4420 5 146]. An additional 4,252,375 shares were subject to a 190-day lock-up period from the same date. [SOF, ¶ 147] . In a separate issuance after the IPO, Tibet issued 33,334 restricted common shares of stock to a United States-based advisor, Trilogy Capital Partners, Inc.; that issuance closed on September 30, 2011. [SOF, ¶ 148]. Tibet also completed by June 2011 a third issuance to three unnamed investors, who purchased a total of 30,000 shares. [SOF, ¶ 149]. On February 17, 2012, more than one year after the Tibet IPO, and months after the known lock-up periods expired for 89% of all outstanding shares, and months after Tibet issued two additional issuances of stock, news reports of the auction of Tibet’s assets entered the media. [SOF, ¶ 150]. On February 27, 2012, Tibet issued a press release saying Tibet’s CEO offered to buy all outstanding shares of Tibet stock and take Tibet private, and that Tibet would commence an investigation into reports about the auction of its assets. [SOF, ¶ 151]. At this point, the five proposed lead plaintiffs began purchasing shares of Tibet, more than one year after the IPO, after the disclosure of the auction, and after the offer to take Tibet private: February 28, 2012: Plaintiffs Shao, Wu, Yang, and Helton begin purchases. March 12, 2012: Plaintiff Obasi begins purchases. March 16, 2012: Plaintiff Dartell begins purchases. April 27, 2012: Plaintiff Carithers purchases 25,000 shares. [SOF, ¶ 152]. At least the five separate lead plaintiffs named in this matter lack standing to pursue Section 11 or Section 15 claims against Downs because they cannot prove they purchased their stock pursuant to the Registration Statement for the January 24, 2011 IPO issuance and not in Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 10 of 37 PageID: 4421 6 the secondary market, as is their burden. See, e.g., In re Global Crossing, Ltd. Sec. Litig., 313 F.Supp.2d 189, 207 (S.D.N.Y. 2003) (“it is clear that Plaintiffs bear the burden of proving securities are traceable [to the IPO]”). Review of the evidence presented to date clearly establishes Plaintiffs purchased their shares in Tibet in the secondary market, not as part of the original IPO issuance. Plaintiffs Obasi, Shao, Dartell, Wu, Yang, and Shelton all purchased their shares in either February, March, or April of 2012, over one year after the IPO issuance on January 24, 2011. [SOF, ¶ 152]. Of the total 31,000 shares Plaintiff Carithers purchased, 25,000 of those shares were purchased in April 2012. [SOF, ¶ 152]. Contrary to the IPO Issuance, which was offered at $5.50/share offering price, these six plaintiffs purchased their shares at prices ranging between $0.65/share and $1.95/share, significantly less than the offering price. [SOF, ¶ 152]. First, the relevant lock-up periods preventing trading of shares purchased through the IPO had expired months before Plaintiffs purchased their shares. [SOF, ¶¶ 145-147]. As of January 2011, the date of the IPO, the Company reported there were 11,812,500 shares of Tibet outstanding before the IPO, and the IPO resulted in an additional 3,000,000 shares of Tibet being issued. [SOF, ¶ 143]. Of these 14,812,500 outstanding shares post-IPO, 9,058,125 of these shares were subject to a 90-day lock-up period “from the date of effectiveness or commencement of the sales of the public offering.” [SOF, ¶ 145]. An additional 4,252,375 shares were subject to a 190-day lock-up period from the same date. [SOF, ¶ 147]. This meant that the lock-up periods expired either: (1) on April 24, 2011, for the 90-day lock-up; or (2) August 3, 2011, for the 190-day lock-up. [SOF, ¶¶ 145, 147]. Shares were therefore available to be publicly traded after those dates. [SOF, ¶ 146]. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 11 of 37 PageID: 4422 7 Second, Tibet continued to issue shares between the close of the IPO and the date Plaintiffs purchased their shares in the secondary market. For example, in March 2010, Tibet issued a total of 30,000 shares to three unnamed insiders. [SOF, ¶ 149]. Next, Tibet issued 33,334 shares to a firm in the United States, Trilogy Partners. [SOF, ¶ 148]. The relevant SEC Filing – Tibet’s November 14, 2011 10Q for the quarter ending September 30, 2011—noted that as of September 30, 2011, all of the shares had been issued to Trilogy Partners. [SOF, ¶ 148]. Because Tibet had made multiple issuances of stock during 2011, including the IPO, Plaintiffs cannot prove the shares they purchased were part of the IPO, as would be arguable had Tibet only issued the IPO and no other issuances. Cf. In re FleetBoston Fin. Corp. Sec. Litig., 253 F.R.D. 315, 345 (D.N.J. 2008) (“When the issuer made only one offering of securities, a simple exercise in logic connects all purchases of the issuer’s securities to that sole issuance.”). Third, defendant Zou sold over 110,100 of his pre-IPO shares in the secondary market on two different post-IPO dates: (1) February 24, 2012; and (2) March 6, 2012. [SOF, ¶ 153]. This means Zou sold his primary shares into the secondary market before Plaintiffs’ purchase dates in March 2012, thereby establishing there were a significant number of shares available in the secondary market at the time the Plaintiffs purchased their shares in March 2012. [SOF, ¶ 153]. From the evidence above, it is clear that there were millions of outstanding Tibet shares available to be traded in the secondary market before 2012, when Plaintiffs purchased their shares. Plaintiffs have furnished no evidence to establish they purchased their shares through the IPO, as is required by this Circuit. Shapiro, 964 F.2d at 286. (noting that if plaintiff’s shares “were purchased in the secondary market, they would not be linked to a registration statement filed during the class period, and the Section 11 claim would fail.”). This intermingling of shares Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 12 of 37 PageID: 4423 8 from post IPO sales into the secondary market makes it impossible for these Plaintiffs to demonstrate that their shares were traceable to the IPO. See Krim v. pcOrder.com, Inc., 402 F.3d 489, 496 (5th Cir. 2005) (rejecting a probability argument and denying standing to investors who could not demonstrate shares traceable to IPO). Plaintiffs cannot fairly demonstrate in the face of this evidence that the shares in the market in the time they purchased their shares were purchased directly from the IPO. As a result, at least Plaintiffs Obasi, Shao, Dartell, Wu, Yang, and Shelton do not have standing to assert claims against Downs under Section 11.2 Their claims brought under Count I of the Complaint must therefore fail as a matter of law. III. DOWNS IS ENTITLED TO SUMMARY JUDGMENT ON COUNT I OF PLAINTIFFS’ CONSOLIDATED COMPLAINT. Plaintiffs’ claims against Downs are brought under Sections 11 and 15 of the Securities Act. Section 11 allows suit by a person who acquires a security in an offering when the registration statement “contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” See 15 U.S.C. § 77k(a). The purchaser may sue: (1) the issuer; (2) every person who signed the registration statement; (3) every partner or director of the issuer; (4) every person who is named in the Registration Statement as being or about to become a director, a person performing similar functions, or a partner; (5) every person who provided expertized matter set out in the Registration Statement; and (6) every underwriter with respect to such security. See id. Plaintiffs’ claims under Section 11 fail because Downs does not fall within the statutorily enumerated categories of potential defendants under Section 11, and even if he does, Downs enjoys the affirmative due diligence defenses available under Section 11. Further, Downs was 2 To the extent Plaintiff Carithers can trace his shares purchased directly to the IPO, this Court should enter an Order barring Carithers from recovering on all shares of stock he purchased in April 2012 that came more than one year after the lock-up period expired for previously issued shares. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 13 of 37 PageID: 4424 9 not an officer or director of A&S at the time of the IPO, nor was he an officer, director, or control person of Tibet. A. Downs Is Entitled To Summary Judgment On Count 1 Of The Consolidated Complaint Because He Does Not Fall Within The Statutorily Enumerated Categories Of Potential Defendants Under Section 11 Of The Securities Act. Plaintiffs’ claims against Downs under Section 11 of the Securities Act fail as a matter of law because Downs does not fall within the statutorily enumerated categories of potential defendants in Section 11, a threshold requirement for liability under Section 11. 15 U.S.C. § 77k(a). Primary liability under Section 11 is limited to a discrete class of statutorily “enumerated parties.” Herman & MacLean v. Huddleston, 459 U.S. 375, 381 (1983). “A § 11 action can be brought only against . . . the issuer, its directors or partners, underwriters and accountants who are named as having prepared or certified the Registration Statement.” Id. The list of potentially liable parties under Section 11 is narrowly construed, see In re Lehman Bros. Mortgage-Backed Secs. Litig., 650 F.3d 167, 181 (2d Cir. 2011) (Section 11 imposes liability on a limited list of persons) and “claims brought against individuals who do not fall within the class of statutorily enumerated parties must be dismissed.” Copland v. Grumet, No. Civ. A. 96-3351 MLP, 1998 WL 256654, at *14 (D.N.J. Jan. 9, 1998) (citing In re Worlds of Wonder Sec. Litig., 694 F.Supp. 1427, 1435 (N.D.Cal. 1988)). Congress specifically limited the class of persons liable so as not to make every individual who works on an IPO subject to Section 11. See In re Equity Funding Corp. of Am. Sec. Litig., 416 F.Supp. 161, 181 (C.D. Cal. 1976) (imposing liability on parties not named in limited list would circumvent will of Congress). Yet that is what Plaintiffs are trying to do here with Mr. Downs, who was simply an employee of A&S at the time of the IPO. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 14 of 37 PageID: 4425 10 i. Downs Did Not Sign the Registration Statement. Contrary to the false allegation in ¶ 118 of the Complaint [Dkt. No. 50], Downs cannot be held liable under the first category of potential defendants in Section 11 because he did not sign the Registration Statement. [SOF, ¶¶ 95, 135]. See 15 U.S.C. § 77k(a). Nonsigning persons cannot be held liable under Section 11. See In re Gap Stores Sec. Litig., 457 F.Supp. 1135, 1143 (N.D. Cal. 1978) (Section 11 liability “is limited to persons who are signators of the registration statement. . .”); In re PMA Capital Corp. Sec. Litig., No. 03-6121, 2005 WL 1806503, at *19 (E.D. Pa. July 27, 2005) (dismissing Section 11 claims for misstatements in certain registration statements that officer did not sign). It is not disputed that Downs did not sign the Registration Statement. [SOF, ¶ ¶ 95, 135].3 ii. Downs Was Not a Director of Tibet or a “Person Performing Similar Functions” as a Director. Contrary to another false allegation in the Complaint (¶ 139, Dkt. No. 50), the undisputed evidence establishes that Downs was not a director or a “person performing similar functions” as is required under Section 11. See 15 U.S.C. § 77k(a) (Section 11 liability applicable to persons who were “named in the statement, with that party's consent, as being or about to become a director, person performing similar functions, or partner.”) (emphasis added) More important, Downs was not a Board Observer of Tibet at the time of the IPO and therefore cannot --under any theory-- have any responsibility for statements in the Registration Statement or Prospectus. [SOF, ¶ 130]. Moreover, Downs is unaware of any authority to support Plaintiff’s argument that Board Observers named in a Prospectus can be considered persons who “perform[] similar functions” 3 Plaintiffs failed to correct this blatantly false allegation in the Complaint, even after Downs’ Motion to Dismiss stated Downs did not sign the Registration Statement, and after Plaintiffs were presented with myriad evidence, both documentary and oral testimony, that Downs had not signed the Registration Statement. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 15 of 37 PageID: 4426 11 to a director of an issuer. See 15 U.S.C. § 77k(a). In the only reported case that considers the meaning of the phrase “performing similar functions” under Section 11, the U.S. District Court for the Southern District of New York interpreted the phrase as imposing liability on individuals who are “actually directing the affairs of the corporation, but who, for the purpose of avoiding liability, shun[] the formal title ‘director.’” Mersay v. First Republic Corp. of America, 43 F.R.D. 465, 469 (S.D.N.Y. 1968).4 Under traditional corporate law principles, Board Observers do not actually direct the affairs of the corporation. Similarly, the Securities Exchange Act of 1934 imposes certain liabilities on persons “performing similar functions” to a director. See 15 U.S.C. § 78c (defining “director”). The SEC has indicated that in determining whether an advisory director is a director for Section 16 purposes, the person’s title is not determinative. SEC Release No. 34-28869 (“If title were determinative . . . persons with officer titles but no significant managerial or policy-making duties would be subject to the draconian liability of section 16(b). . . [T]he person’s title is not determinative. . .”). The SEC’s interpretative guidance for determining whether a person “performs similar functions” to a director states that persons who are named advisory directors, but do not participate in formulating and deciding policy issues for the corporation, nor have access to inside information, are not directors under Section 16. SEC Release No. 24-18114. By contrast, the SEC advises that those who usually attend board meetings and assist in policy making should be treated as “directors” under Section 16. Id. at Q.3. 4 The one case Plaintiffs have previously cited to support their argument that Downs was “performing similar functions” to a Tibet director is In re Unicapital Corp. Sec. Litig., 149 F.Supp.2d 1353 (S.D. Fla. 2001), but that case is clearly distinguishable. In Unicapital, the individual defendant found to have been a “person performing similar functions to a director” was named in the Prospectus as the President and Chief Executive Officer of the issuer’s largest subsidiary, and the former owner of a company the issuer had purchased that ultimately became the issuer’s subsidiary. Id. at n. 21. A person in this role would have direct, tangible ability to impact the direction of the issuer, and is in stark contrast to the limited nature of a board observer. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 16 of 37 PageID: 4427 12 Applying Mersay and the SEC’s interpretation of Section 16 to this case, Plaintiffs have no evidence to establish that Downs actually directed the affairs of Tibet, assisted in policy making at Tibet, or had any role in directing the day-to-day affairs of Tibet corporation. Downs never attended any Tibet Board Meetings [SOF, ¶¶ 131-132, 133-134]. Plaintiff’s claim, premised solely on a hypothetical that Downs “may . . . significantly influence the outcome of matter submitted to the Board of Directors for approval. . .” (emphasis added), [Complaint, Dkt. No. 37, ¶ 35] ignores the fact that Downs did not exercise control and thus cannot be considered similar to a director. See Mersay, 43 F.R.D. at 469; SEC Release No. 24-18114. As a Board Observer, Downs had the opportunity to attend and be heard at Tibet board meetings. [SOF, ¶ 125]. Downs could not vote or otherwise veto or approve any action by the Board. [SOF, ¶ 124]. Further, A&S did not consider Downs to be an Observer until after the issuance closed in January 2011, meaning Downs did not attend any meetings of the Tibet board before January 2011 or anytime thereafter. [SOF, ¶ 130]. It is undisputed that Downs never participated in any board activities, never attended a board meeting, or otherwise “influenced” the Tibet board at anytime including after January 2011. [SOF, ¶ 132-138]. iii. Downs Did Not Participate in the IPO as an Underwriter, as He Was Only An Employee of A&S. Plaintiffs also claim Downs is strictly liable under Section 11 because he was an “underwriter” for the Tibet IPO issuance. Plaintiffs premise this allegation on the fact that Downs served as one of several of A&S’s Managing Directors and “one of the lead investment bankers who orchestrated Tibet’s IPO.” [Amended Complaint, Dkt. No. 50, ¶ 35]. Plaintiffs’ claim fails because the undisputed evidence establishes Downs was merely an employee of A&S at the time of the Tibet IPO and undertook all actions at the direction of his employer and thus was never an underwriter within the meaning of Section 11. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 17 of 37 PageID: 4428 13 “An underwriter is commonly understood to be a ‘person who buys securities directly or indirectly from the issuer and resells them to the public, or performs some act (or acts) that facilitates the issuer’s distribution.” Special Situations Fund, III, L.P. v. Cocchiola, Civ. 02-3099 (WHW), 2007 WL 2261557, at *3 (D.N.J. Aug. 3, 2007) (quoting In re WorldCom Inc. Sec. Litig., 346 F.Supp.2d 628, 662 (S.D.N.Y. 2004)). Underwriters are defined in the Securities Act as Any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates in the direct or indirect underwriting of any such undertaking . . . . 15 U.S.C. § 77b(a)(11). It would be incongruous for the federal securities laws to extend individual liability to all employees of firms participating in the underwriting process of public issuances. This is surely not the result Congress intended when it executed the 1933 Act. Equity Funding Corp. of Am., 416 F. Supp. at 181. This list is narrowly construed. See In re Lehman Bros. Mortg.-Backed Secs. Litig., 650 F.3d at 181 (affirming dismissal of plaintiffs' claims and stating, "§ 11 ensures accurate disclosures in registration statements by imposing in terrorem liability on a limited list of persons") (emphasis added). "Claims brought against individuals who do not fall within the class of statutorily enumerated parties must be dismissed." Copland, 1998 WL at *14 (citing In re Worlds of Wonder Sec. Litig., 694 F. Supp. 1427, 1435 (N.D. Cal. 1988)) (emphasis added). Moreover, the undisputed evidence is that Downs undertook all actions concerning the Tibet IPO at the request and direction of his employer, A&S. Downs was only an employee at the time of the Tibet IPO. [SOF, ¶ 13]. He was not an officer, director, control person or performing any similar function with A&S at the time of the IPO. [SOF, ¶ 14; Reply Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 18 of 37 PageID: 4429 14 Declaration of Robert J. Brener, (Dkt. No. 120-1) (Virginia State Corporation Commission Records for 2010 and 2011 proving Downs was not officer or director of A&S)]. At the time of the Tibet IPO, Downs was one of at least seven employees of A&S with the title of Managing Director. [SOF, ¶ 4]. Downs’ role was to identify prospective companies for issuances and bring the potential offerings to the A&S Commitment Committee, which was comprised of multiple officers of A&S; while Downs served on the Commitment Committee, he did not have a vote on matters that he introduced to the Committee. [SOF, ¶ ¶ 7-10]. The Commitment Committee of A&S approved the decision to move forward with the Tibet IPO. [SOF, ¶ 33]. The underwriting process for the Tibet IPO involved practically all employees of A&S, not just Downs. [SOF, ¶ 26]. The CEO of A&S was responsible for all A&S employees engaged in the Tibet IPO issuance. [SOF, ¶ 35]. Decisions concerning underwriting due diligence, inclusion of statements in the Prospectus and Registration Statement, and other strategic decisions were the responsibility of A&S only. A&S alone made the decision to proceed with the Tibet IPO and finalize the closing of the issuance. In these circumstances, there is no basis in Section 11 to hold an individual employee liable for the actions of an entire corporation. To the extent that Plaintiffs’ claim that Downs was a control person of A&S, the facts show otherwise. Downs was merely an employee of A&S, and served at all relevant times as one of at least seven employees at the firm with the title of Managing Director. [SOF, ¶¶ 1, 4]. Downs did not serve as the head of investment banking operations, and he was not an officer or director of the Firm [SOF, ¶5]. Downs at all relevant times reported to A&S’ CEO [SOF, ¶ 6]. The officers and directors of A&S – of which Downs was not one – made all decisions to proceed with underwriting public issuances including the Tibet IPO. [SOF, ¶¶ 7-11, 29-33] Only Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 19 of 37 PageID: 4430 15 after A&S approved the Tibet IPO did Downs participate at his employer’s direction with the requisite due diligence for the issuance [SOF, ¶¶29-33]. All decisions and orders were made by Downs’ supervisors, including A&S’ CEO [SOF, ¶ 4-14] Because Downs was only an employee of A&S during the relevant times and otherwise exercised no control over A&S, he cannot be a control person under Section 15 of the Securities Act. 15 USC § 77o (establishing control person liability); 17 C.F.R. § 240.12b.2 (control requires direct or indirect “power to direct or cause the direction of the management and policies of a person…”). To the extent Plaintiffs allege Downs controlled A&S, those claims must fail as a matter of law. B. Downs Is Entitled To Summary Judgment On Count I Because He Conducted Reasonable Due Diligence As Is Required Of Underwriters Under Section 11. Even if Downs falls within a statutorily enumerated category of potential defendants under Section 11 -- which Downs denies -- Downs does enjoy the benefit of the due diligence defenses set forth in the same statute. Section 11 exempts underwriters from liability if they can demonstrate they undertook sufficient due diligence to investigate the statements included in the Registration Statement of an issuance. See 15 U.S.C. § 77k(b); see also Bauer v. Prudential Fin., Inc., No. CIV.A. 09-1120 (JLL), 2010 WL 2710443, at *12 (D.N.J. June 29, 2010). The underwriter of the securities is “accorded a complete defense against civil liability based on the exercise of reasonable investigation and a reasonable belief that the registration statement was not misleading.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208 (1976). The due diligence defense under Section 11 differentiates between statements made in the “expertised” portions of the Registration Statement, such as audited financial statements, and statements made in the “non-expertised” portions. See, e.g., In re Software Toolworks Inc. Sec. Litig., 50 F.3d 615, 623 (9th Cir. 1994). Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 20 of 37 PageID: 4431 16 i. Downs reasonably relied upon the audited financial statements drafted by Acquavella. Plaintiffs allege the Registration Statement and Prospectus overstated Tibet’s assets, misrepresented Tibet’s overall indebtedness, and failed to disclose that at the time of the Tibet IPO, the Company’s subsidiary had defaulted on a $4.54 million loan to a bank in the PRC. [See generally Complaint, Dkt. No. 50]. Plaintiffs therefore allege that the financial statements audited by Acquavella and incorporated into Tibet’s Registration Statement and Prospectus contained misrepresentations and/or omissions in violation of Section 11. [Complaint, Dkt. No. 50, Count I]. Given that the alleged misrepresentations and/or omissions alleged fell within statements made by the experts engaged for purposes of assisting in development of the Registration Statement and Prospectus—the auditor Acquavella—it was reasonable for Downs to rely upon these audited financial statements and believe they were accurate, and is thus warranted in invoking the expertized due diligence defense included in Section 11. For statements made on the authority of an expert, such as audited financial statements, an underwriter can establish its due diligence defense by showing it “had no reasonable ground to believe and did not believe” that the registration statement was inaccurate. 15 U.S.C. §77k(b)(3)(C). In essence, further investigation into the audited financial statements is not required to invoke the defense, because audited financial statements are considered “expertized” for purposes of Section 11. See Escott v. BarChris Construction Corp., 283 F.Supp. 643, 683 (S.D.N.Y. 1968). Under Escott, underwriters do not need to investigate the accuracy of the expertized portion of the Registration Statement – the audited financial statements – and are thus entitled to rely upon the auditor as the preparing expert. Id. The only requirement is that an underwriter has no reasonable ground to believe that any part of the audited financial statements were misleading. Id. See also John Nuveen & Co. v. Sanders, 450 U.S. 1005, 1010 Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 21 of 37 PageID: 4432 17 and n. 4 (1981) (Powell, J. dissenting) (claiming that underwriter is “explicitly absolved” of duty to investigate audited financial statements because “[r]eliance on financial statements is essential to the proper functioning of securities marketing. . .”). Even recent interpretations of the expertized defense under Section 11 impose a heightened investigative obligation on underwriters only where there are “red flags” concerning the reliability of audited financial statements. In re Worldcom Sec. Litig., 346 F.Supp.2d 628, 672, 677 (S.D.N.Y. 2006). In the present matter, Plaintiffs allege the Registration Statement falsely stated both the amount of assets Tibet had, including cash assets, and the amount owed on long-term bank debt, in the audited financial statements for the years ending December 31, 2009 and December 31, 2008, as well as the unaudited financial statements for the month ending September 30, 2010. However, Plaintiffs have not even alleged, let alone set forth sufficient evidence to create a factual dispute, that Downs (if he is an underwriter) had “no reasonable ground to believe and did not believe” that the financial statements prepared by Acquavella—an accounting firm registered with and under the oversight of the Public Company Accounting Oversight Board—to issue such opinions in connection with public offerings. [SOF, ¶ 46]. Acquavella visited Tibet in PRC in the course of their investigation. [SOF, ¶ 52]. Acquavella prepared a comfort letter for A&S that stated Acquavella’s comfort that the financial statements presented fairly Tibet’s consolidated financial position; Downs reasonably relied upon the financial statements and comfort letter, and both were incorporated in the Registration Statement and Prospectus. [SOF, ¶ 57-58]. Acquavella’s notes to the audited financial statements disclosed the details regarding the bank debt, including that it was due in November 2011, that it was secured by some of Tibet’s assets, and that it consisted of two separate loans. [SOF, ¶¶ 96-109]. Downs, as an employee of A&S, did not discover any information that would have led him to otherwise Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 22 of 37 PageID: 4433 18 believe the information included in the audited financial statements concerning Tibet’s bank debt was incorrect. [SOF, ¶ 79]. In fact, Downs also spoke with Acquavella before the IPO closing, and Acquavella told A&S and Downs that Tibet had properly answered all Acquavella’s questions and met the audit requirements for Acquavella to issue its audit letter and provide the comfort letter to A&S. [SOF, ¶¶ 83-87]. Acquavella explicitly told Downs that Aquavella understood the debt had been paid off in November 2010, and it would verify that it had been paid off when it conducted its audit for the year ending December 31, 2010. [SOF, ¶¶ 85-87]. Acquavella confirmed the bank debt had been paid in the 2010 Annual Report filed with the SEC. [SOF, ¶ 88]. In essence, there were no “red flags” that arose during the due diligence that would have otherwise put Downs on alert that the financial statements prepared by Acquavella contained misrepresentations. In re Worldcom Sec. Litig., 346 F.Supp.2d at 672, 677 (underwriters may rely upon information and statements prepared by auditors as long as no “red flags” arise during due diligence). Because no red flags arose, it was reasonable for A&S and Downs to rely on Acquavella’s audited financial statements, and any misstatements contained within are shielded as a result of Section 11’s due diligence defense. Escott, 283 F.Supp. at 683. ii. Given the Absence of Red Flags, Downs’ Due Diligence and Investigation into Statements Made By Tibet Was Reasonable. Even if the Court determines that the Registration Statement and Prospectus contained misstatements and/or omissions concerning the levels of Tibet’s debt and the existence of the bank debt, Downs – in his role as an employee of the underwriter A&S – conducted reasonable and appropriate investigation into Tibet before to the IPO such that Downs should enjoy the due diligence defense that is available to underwriters under Section 11. See 15 U.S.C. § 77k(b)(3)(B). According to Plaintiffs, a reasonable investigation required A&S to examine court Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 23 of 37 PageID: 4434 19 records throughout PRC to determine whether Tibet or any of its subsidiaries had any existing bank judgments levied against it that were otherwise not recognized in the audited financial statements. Plaintiffs in essence want this Court to believe A&S and/or Downs should have conducted a fishing expedition to find evidence of court judgments against Tibet’s subsidiaries. However, the significance of the existence of the bank judgment is only apparent with the benefit of hindsight, after apparent evidence of Tibet’s concealment of the actual amount of the bank debt, the actual date of payment of the debt, and the status of any court actions concerning the debt was revealed after the IPO. Further, Plaintiffs offer no evidence of any red flags that might have caused A&S and/or Downs to believe Tibet had fraudulently concealed the existence of the court judgments or the details concerning its bank debt to Acquavella. In an offering under the Securities Act, underwriters like A&S need not have taken every possible action during their investigation to prevail on their affirmative due diligence defense. Feit v. Leasco Data Processing Equip. Co., 332 F.Supp. 544, 575 (E.D.N.Y. 1971). Rather, the test is whether A&S’s investigation into Tibet was reasonable. 15 U.S.C. § 77k(c). The undisputed facts confirm that it was. Underwriter defendants may avoid liability under Section 11 if the underwriter can prove as to the non-expertized portions of the Registration Statements that it “had, after reasonable investigation, reasonable ground to believe, and did believe, there were no misstatements or omissions of material facts in such portions of the registration statement.” 15 U.S.C. § 77k(b)(3)(B). This is otherwise known as the “due diligence” defense. The adequacy of an underwriter’s due diligence may be decided on summary judgment when the underlying historical facts are undisputed. See, e.g., In re Software Toolworks, Inc., 38 F.3d at 1083; Phillips v. Kidder Peabody & Co., 933 F.Supp. 303, 323 (S.D.N.Y. 1996); Laven v. Flanagan, Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 24 of 37 PageID: 4435 20 695 F.Supp. 800, 811-812 (D.N.J. 1988). Determination of the “reasonableness” of the investigation by an underwriter under Section 11 “depends upon the circumstances of each registration.” Securities & Exchange Comm’n, Adoption of Integrated Disclosure System, 47 Fed. Reg. 11,415. In determining whether an underwriter meets the due diligence test under Section 11, “the standard of reasonable investigation or due diligence shall be that required of a prudent man in the management of his own property.” 15 U.S.C. § 77k(c). See also Hochfelder, 425 U.S. at 208 (1975) (due diligence standard is “[i]n effect . . . a negligence standard.”). “[U]nderwriters must make some reasonable attempt to verify the data submitted to them. They may not rely solely on the company’s officers or on the company’s counsel.” Escott, 283 F.Supp. at 697. The “key to reasonable investigation is . . . independent verification of the registration statement by reference to the original written records.” Feit, 332 F.Supp. at 575. Underwriters are not required to engage in a “completely independent and duplicative process,” but they are required to “examine those documents which are readily available.” Id. at 577. Courts generally consider five factors relevant to the determination of the “reasonableness” of an underwriter’s due diligence: (1) whether the underwriters were familiar with the issuer’s finances, management, and operations; (2) whether the underwriters possessed knowledge of the industry in which the issuer is involved; (3) whether the underwriters conducted interviews of the issuer’s employees; (4) whether the underwriters conducted interviews of and/or confirmed data with third parties, including attorneys and auditors; and (5) whether the underwriters obtained written verification from outside accountants that the information contained in the prospectus Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 25 of 37 PageID: 4436 21 was accurate. In re Intl. Rectifier Sec. Litig., No. CV91–3357–RMT (BQRX), 1997 WL 529600 (C.D. Cal. Mar. 31, 1997).5 The facts concerning A&S’ due diligence in connection with the Tibet IPO are undisputed, and as a result, the extensive underwriting A&S undertook for the Tibet IPO was reasonable and appropriate given the circumstances surrounding the issuance. After the A&S Commitment Committee approved the transaction, Downs and George Nolde, an A&S officer, traveled to China to meet with Tibet. [SOF, ¶ 38]. During this visit, Downs conducted multiple interviews with Tibet personnel (including Taylor Guo, Tibet’s CEO), visited the company’s factory, and observed work being done. [SOF, ¶¶ 39-43]. A&S engaged an outside law firm to act as placement agent counsel and conduct parallel due diligence into Tibet. Those firms had personnel that read and spoke Chinese. [SOF, ¶¶ 37, 44]. This firm had personnel that read and spoke Mandarin, which was necessary to review Tibet’s documents. [SOF, ¶ 55]. Tibet engaged a PCAOB-registered outside auditor, Acquavella, to audit its financial statements and draft a comfort letter that specifically recognized A&S was relying on as part of A&S’s overall due diligence effort; A&S did in fact rely upon the comfort letter that stated the financial statements fairly presented Tibet’s financial position [SOF, ¶ ¶ 57-58, 66-69, 72, 96-109]. Placement agent counsel hired by A&S and the auditor hired by Tibet both traveled to China to similarly investigate Tibet’s operations in PRC. [SOF, ¶¶ 49-52]. A&S conducted multiple interviews prior to closing the issuance with members of Tibet and members of the due diligence team. [SOF, ¶¶ 83-89, 110-121]. 5 The SEC has set forth additional factors for courts to use to weigh the reasonableness of an investigation: (1) the type of issuer; (2) the type of security; (3) the type of person; (4) reasonable reliance on officers, employees, and others whose duties should have given them knowledge of the particular facts; (5) the type of underwriting arrangement; (6) the role of a particular person as an underwriter; (7) the available of information with respect to the registrant; and (8) whether, with respect to a fact or document incorporated by reference, the particular defendant had any responsibility for the fact or document at the time of the filing from which it was incorporated. See 17 C.F.R. § 230.176 (factors affecting the reasonableness of an investigation). Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 26 of 37 PageID: 4437 22 A&S relied upon counsel’s 10b-5 legal opinion letter it provided concerning its review of the statements made in the Prospectus. [SOF, ¶¶ 74-75]. In the letter, placement agent counsel stated: To our knowledge, there are no legal or governmental proceedings pending or threatened against the Company that are of a character required to be disclosed in the Registration Statement or the Prospectus by the Act or the Rules and Regulations, other than those which are described in the Registration Statement or the Prospectus. [SOF, ¶ 75]. Tibet also engaged two other law firms—one in PRC and one in Hong Kong—to provide opinions concerning the disclosures Tibet made in the Prospectus; A&S reasonably relied upon these opinion letters as well. [SOF, ¶ 74]. Counsel in China representing Tibet stated in its opinion letter: None of [Tibet or its subsidiaries of affiliates] has taken any action nor has had any steps taken, nor has legal or administrative proceedings been commenced or threatened for the winding up, dissolution, or liquidation of [Tibet or its subsidiaries of affiliates]. . . [Tibet or its subsidiaries of affiliates] are not in default under or in breach of any term or condition of any agreement or instrument of which such counsel has actual knowledge after due inquiry to which any of [Tibet or its subsidiaries of affiliates] is a party or by which any of their properties, investments or assets are bound, except as disclosed in the Registration Statement. . . . There is not pending or threatened, any action, suit, or proceeding before or by any court, government authority, arbitrational body or agency to which [Tibet or its subsidiaries of affiliates] is or may be a party, or to which any of the investments, properties or assets of any of [Tibet or its subsidiaries of affiliates] is or may be subject which is not disclosed in the Registration Statement that, if adversely determined, would materially affect the ability of [Tibet or its subsidiaries of affiliates] to carry out and implement the business described in the Registration Statement. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 27 of 37 PageID: 4438 23 [SOF, ¶ 76]. The Hong Kong law firm Tibet hired to represent it in connection with the IPO stated in its opinion letter regarding its examination of both Tibet and its Hong Kong subsidiary: (ii) . . . [N]or has any steps taken, nor has legal or administrative proceedings been commenced in Hong Kong for the winding up, dissolution, or liquidation of [the subsidiary. . . (iii) . . . [The subsidiary], in carrying on the aforesaid business, is not in violation of Hong Kong laws or regulations or any order, decree, or regulation of any governmental body or agency in Hong Kong having jurisdiction over it or over any of its properties or assets. There is no action, suit or proceeding to which [the subsidiary] is a party before the High Court and District Court of Hong Kong as at 19 January 2011. [SOF, ¶ 77]. A&S relied upon the opinion letters of all three law firms concerning Tibet’s disclosures in the Prospectus and Registration Statement concerning Tibet’s bank debt. [SOF, ¶¶ 74-78]. Downs did not discover any information during his due diligence that led him to otherwise believe that the information contained in the opinion letters issued was incorrect. [SOF, ¶ 79.] A&S specifically asked Acquavella regarding the bank debt and whether it had been paid off in November 2010; Acquavella stated it had been paid off, and both Tibet and Acquavella confirmed this payoff in the 10K issued for the year ending December 31, 2010. [SOF, ¶¶ 83- 87]. Placement agent counsel compared Tibet’s audited financial statements for the Prospectus with reports submitted by Tibet to China’s State Administration for Industry and Commerce (“SAIC”), and performed a background check on Tibet’s Chairman. The findings of both were reported as satisfactory to NASDAQ and A&S. [SOF, ¶¶ 90-93]. As demonstrated above, the due diligence that A&S conducted in its role as underwriter for the Tibet IPO was reasonable under Section 11. See 15 U.S.C. § 77k(c). The extensive due diligence undertaken shows A&S employed a “high degree of care in investigation and independent verification of the company’s representations.’ In re Worldcom, Inc. Sec. Litig., Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 28 of 37 PageID: 4439 24 346 F.Supp.2d at 675-76. A&S visited Tibet in China, met with the Company, and the CEO, toured its operations and facilities, and observed employees creating pharmaceutical products for distribution. [SOF, ¶¶ 38-43]. A&S consulted with—and relied upon the due diligence and opinion of—multiple third parties who simultaneously investigated different aspects of Tibet’s business. See In re Intl. Rectifier Sec. Litig., 1997 WL at *8 (upholding underwriter’s due diligence after interviews with issuer’s attorneys and auditor). A&S had written confirmation from both Tibet and multiple third parties that the information in the prospectus was correct. See id. A&S did not blindly rely on statements provided by Tibet in investigating Tibet. Feit, 332 F.Supp. at 575 (“independent verification” required). In sum, A&S’s investigation was a “reasonable attempt” to verify the data Tibet submitted to it. Escott, 283 F.Supp. at 697. IV. DOWNS IS ENTITLED TO SUMMARY JUDGMENT ON COUNT III OF PLAINTIFFS’ CONSOLIDATED COMPLAINT BECAUSE THERE ARE NO FACTS TO PROPERLY ESTABLISH CONTROL PERSON LIABILITY. Downs is entitled to summary judgment on Count III of the Plaintiffs’ Consolidated Complaint, a claim for control-person liability under Section 15(a) of the Securities Act, because there is no material dispute of fact that: (1) Downs did not exercise any control over Tibet thus there can be no liability under Section 15; and (2) Downs was not a culpable participant -- and had no role in -- the alleged misstatements or omissions set forth by Tibet in the Registration Statement and Prospectus. To prove a claim for control person liability under Section 15 of the Securities Act, Plaintiffs must establish (1) a primary violation of the federal securities laws by a controlled person or entity; (2) control of the primary violator by the defendant; and (3) that the controlling person was in some meaningful way a culpable participant in the primary violation. Dutton v. Harris Stratex Networks, Inc., 270 F.R.D. 171, 178 (D. Del. 2010) (citing In re Reliance Sec. Litig., 91 F.Supp.2d 706, 731 (D.Del.2000)). Plaintiffs cannot establish a material dispute of fact Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 29 of 37 PageID: 4440 25 concerning any of the above, and Downs is therefore entitled to summary judgment on Count III as a matter of law. A. Downs’ Role as Board Observer Did Not Create Sufficient Control Over The Tibet Board of Directors for Liability Under Section 15(a). Mr. Downs was never invited to, offered the opportunity to attend, or actually attended any Board meetings of Tibet, nor did he travel to China after the IPO by the mandate of his employer, A&S. [SOF, ¶ ¶ 132-134]. Downs was never an officer or director of Tibet. [SOF, ¶¶ 123-138]. Section 15 of the Securities Act provides for joint and several liability on the part of one who controls a violator of Section 11. See 15 U.S.C. § 77o. To succeed on a claim under Section 15, Plaintiffs must prove that Downs controlled Tibet and that Tibet committed a primary violation of the securities laws. In re Enzymotec Sec. Litig., No. CV145556JLLMAH, 2015 WL 8784065, at *21 (D.N.J. Dec. 15, 2015) (citing In re Suprema, 438 F.3d at 284). Issues of control are based upon a factual inquiry, and are determined by the special circumstances of each case. Hall v. The Children’s Place Retail Stores, Inc., 580 F.Supp.2d 212, 235 (S.D.N.Y. 2008). Courts consider all relevant circumstances in determining whether a defendant like Downs is a controlling person under Section 15, including the “potential power” to influence and control the activities of another. In re Chambers Dev. Sec. Litig., 848 F.Supp. 602, 618 (W.D.Pa. 1994) (citing Rochez Bros., Inc. v. Rhodes, 527 F.2d 880, 890-91 (3d Cir. 1975)). The SEC defines “control” for purposes of the federal securities laws as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” 17 C.F.R. § 240.12b-2. It is the Plaintiffs’ burden to establish control for purposes of their Section 15 claim against Downs. Hill York Corp. v. American Intern. Franchises, Inc., 448 F.2d 680, 694 (5th Cir. 1971). Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 30 of 37 PageID: 4441 26 Plaintiffs allege Downs was a control person of Tibet by virtue of his position as a “senior officer and director[] of the Company.” [Amended Complaint, Dkt. No. 50, ¶ 139]. This allegation is false, as Downs was never an officer or director of Tibet. [SOF, ¶¶ 123- 138]. Moreover, this allegation fails to appreciate the distinction between members of the board of directors of a company—which Downs was not—and board observers. For instance, unlike directors of the board of a company, the position of a board observer and the rights and/or duties assigned to that person are strictly a matter of contractual agreement, not through statutory or common law. This means that board observers, unless delineated within the scope of the board observer agreement, are not fiduciaries of the corporation and with that responsible for all the attendant duties a fiduciary owes to the corporation, its shareholders, and all other persons under statutory and common law. It is well established that “fiduciary duties are owed only by directors, officers, or controlling shareholders.” Hechinger Inv. Co. v. E. Fleet Retail Finance Group, 274 B.R. 71, 93 (D. Del. 2002). Directors, officers, and majority shareholders owe a fiduciary duty because they exercise control over the business affairs of a corporation. See, e.g., Kahn v. Lynch Comm. Systems, Inc., 638 A.2d 1110, 1113-14 (Del. 1994). A non-voting Board “observer” exercises no control over the corporation. As an initial matter, Downs never received notice of or any invitation to, nor did he attend any Tibet Board meeting. [SOF, ¶¶ 132-134]. These facts alone should end the inquiry. But there are other facts as well. The Tibet Prospectus declared that the Board Observers— Downs and Zou—could not vote, but “may significantly influence the outcome of matters submitted to the Board of Directors for approval.” [SOF, ¶ 123]. However, Plaintiffs have furnished no evidence to date that establishes that Downs ever could or did influence the outcome of any matters submitted to the Tibet Board. First, it is uncontested that this statement Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 31 of 37 PageID: 4442 27 meant that a Board Observer would have only the opportunity to be heard at meetings of the Tibet Board. [SOF, ¶ 125]. Board Observers did not have a right to vote in a Board meeting or otherwise veto, approve or deny any action by the Tibet Board. [SOF, ¶ ¶126-127]. As a Board Observer, Downs had no right to call meetings of the Board or attend committee meetings of the Board. [SOF, ¶ 127]. However, Downs did not perform any duties or have any responsibilities in his role as Board Observer. Downs did not participate in any Board activities or otherwise influence the Tibet Board, because as stated above the Tibet Board never notified him of or invited him to any meetings. [SOF, ¶¶ 132-134]. Downs did not assume his Board Observer role until after the Tibet IPO issuance closed. [SOF, ¶ 130]. Further, Downs did not sign the Registration Statement in any capacity. [SOF, ¶¶ 95, 135]. Downs never received compensation from Tibet in his role as a Board Observer. [SOF, ¶ 137]. Downs never received any correspondence from Tibet concerning Board activities. [SOF, ¶ 138]. These undisputed facts demonstrate that Downs had no “control” of Tibet under the federal securities laws and could not have had any role in the alleged misleading statements in the Prospectus or Registration Statement. Absent the ability to vote, to call meetings, or to otherwise direct the topics covered by the Tibet Board, Downs’ ability to “influence and control” the actions of Tibet’s Board was relegated to mere participation at Board meetings. [SOF, ¶¶ 123-127]. But no such meetings occurred. See In re Chambers Dev. Sec. Litig., 848 F.Supp. at 618 (courts determine “control” by examining potential power to influence and control); see also In re Metropolitan Sec. Litig., 532 F.Supp.2d 1260, 1296 (E.D.Wa. 2007) (“[a]n individual’s status as an officer or director of the issuing corporation is insufficient, standing alone, to demonstrate the exercise of control. . .”). Downs could not veto or otherwise stop actions by the Tibet Board had he known a potential Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 32 of 37 PageID: 4443 28 violation of the federal securities laws could occur. 17 C.F.R. § 240.12b-2 (“control” for purposes of Section 15 requires a party possess power “to direct or cause the direction of” management). Downs did not exercise any oversight of day-to-day operations of Tibet. In re Metropolitan Sec. Litig., 532 F.Supp.2d at 1296 (control requires a person “oversees day-to-day company operations”). Absent the ability to vote or otherwise exert the influence of a fiduciary, Downs cannot be held to have “controlled” Tibet for purposes of Section 15. Because there is no dispute that Downs never attended any Tibet meetings or exercised any control over Tibet, summary judgment is appropriate on Count III of Plaintiffs’ Consolidated Complaint. B. Downs Was Not A “Culpable Participant” In Any Alleged Violations By Tibet. In addition to not exerting any “control” over Tibet, Downs was also not a “culpable participant” in the alleged violations of the Securities Act by Tibet, a legal prerequisite under this circuit for control person liability to be established under Section 15. See Belmont v. M.B. Inv. Partners, Inc., 708 F.3d 470, 484 (3d Cir. 2013) and cases cited. The Third Circuit, along with the Second Circuit, has adopted the more stringent “culpable participation” standard for claims brought under Section 15, in that Section 15 liability cannot be established merely by demonstrating an individual’s authority to influence or control a primary violator, but must show the defendant was an “active” or “culpable” participant in the acts that constituted the violation of the federal securities laws.6 See id.; Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 890 (3d Cir. 1975) (secondary liability not available under federal securities laws “unless it can be shown that the defendant was a culpable participant in the fraud”). Thus, in order for Downs to be a “culpable participant” in the conduct that violated the federal securities laws, he must have “some actual knowledge” of the conduct or “knowledge must be imputed to [him].” S.E.C. v. 6 Federal courts’ analysis with respect to “control” is the same under Section 15 of the Securities Act and Section 20(a) of the Securities Exchange Act. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1578 (9th Cir. 1990). Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 33 of 37 PageID: 4444 29 First Jersey Securities, 101 F.3d 1450, 1472-73 (2d Cir. 1996). See also Poptech LP v. Stewardship Credit Arbitrage Fund, 792 F.Supp.2d 328, 341 (D.Conn. 2011) (knowledge is first step in proving culpable participation). There is no evidence that Downs was a “culpable participant” in Tibet’s alleged misstatements and/or omissions in the Registration Statement. Plaintiffs cannot dispute the fact that Downs had no knowledge of the alleged misstatements and/or omissions Tibet made within the Registration Statement concerning Tibet’s assets, liabilities, and any potential judgments against it. [SOF, ¶ 79]. Further, Downs cannot be found to be a culpable participant in the alleged misstatements and/or omissions based upon the significant due diligence A&S and firms hired by A&S undertook to determine the details concerning Tibet’s existing bank debt. For example, Downs spoke with representatives from Acquavella before the IPO closing in January of 2011, who informed him that Acquavella understood Tibet’s bank debt had been paid off in November 2011. [SOF, ¶¶ 82-87]. Tibet Pharmaceuticals and Acquavella further confirmed full payoff of the bank debt in the company’s Annual Report and Audit Report issued for the year ending December 31, 2010. [SOF, ¶ 88]. A&S also relied upon investigations by all three law firms to properly investigate Tibet Pharmaceuticals’ bank debt, and these law firms: (1) confirmed Tibet had no pending or threatened legal proceedings against it; and (2) did not disclose to A&S in any written or oral communication that they had any information concerning the possibility that Tibet’s assets may have been frozen. [SOF, ¶¶ 74-78]. Downs himself did not discover any information in the course of his due diligence that led him to otherwise believe that the information contained in the Prospectus, including both the audited and unaudited financial statements Acquavella prepared, and the opinion letters issued by Acquavella and the three law firms, was incorrect. [SOF, ¶ 79]. Kaufman & Canoles Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 34 of 37 PageID: 4445 30 informed A&S that Tibet Pharmaceuticals paid off the bank debt in total in November 2010, prior to the closing of the IPO in January 2011. [SOF, ¶¶ 80]. Local counsel did not disclose to A&S that they suspected Tibet’s assets had been frozen. [SOF, ¶ 78]. Local Counsel did not disclose to A&S that it Tibet had any unpaid bank debts. [SOF, ¶ 78]. Given Downs’ lack of knowledge and exacting attempts to determine the details of Tibet’s bank debt, there is no material dispute of fact concerning Downs’ lack of culpable participation in Tibet’s Section 11 violations. Count III must therefore fail as a matter of law. C. Any Claims Premised On Downs’ Alleged Inactions Concerning The Tibet Board’s Conduct Also Fail As A Matter Of Law. To the extent Plaintiffs premise their claims for Section 15 liability on some unspecified inaction or failure to investigate by Downs, such claims similarly fail as a matter of law. “To impose secondary liability on a controlling person (i.e. Downs) for his inaction, Plaintiffs must prove that the inaction ‘was deliberate and done intentionally to further the fraud.’ ” Belmont, 708 F.3d at 485 (citing Sharp v. Coopers & Lybrand, 649 F.2d 175, 185 (3d Cir. 1981)). The requirement that the inaction be intentional applies both to furthering the violation of the securities laws and to preventing its discovery, and that knowledge of the underlying violation is required in either case. Id. “[I]naction alone cannot be a basis for liability.” Id. (citing Rochez Bros., 527 F.2d at 890). Control person liability claims based on inaction fail if the controlling person “had no knowledge of [the controlled person's] fraudulent acts and did not consciously intend to aid” the controlled person. Id. There are no facts that show the alleged inaction by Downs—which Downs denies took place—was done deliberately and intentionally to further Tibet’s alleged violation of Section 11. Belmont, 708 F.3d at 485. It is undisputed that Downs had no knowledge of Tibet’s misstatements of its assets and long-term debts in its financial statements, and no knowledge of Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 35 of 37 PageID: 4446 31 the existing judgment against Tibet of which Plaintiffs complain. [SOF, ¶ 79]. Indeed, Plaintiffs’ entire crux of allegations against Downs are not that he knew and took no action to correct, but rather he should have done more to investigate Tibet’s financial statements and the potential existence of bank judgments. These allegations directly contradict the requirement Plaintiffs prove both knowledge of Tibet’s underlying Section 11 violations as well as purposeful inaction to correct them. Belmont, 708 F.3d at 485. CONCLUSION For the foregoing reasons, the Court should grant Defendant L. McCarthy Downs III’s Motion for Summary Judgment, enter an Order of Judgment on Counts I and III of Plaintiff’s Complaint in Downs’ favor, and order any such further relief as is just and appropriate. Attorneys for Defendant L. McCarthy Downs, III /s/ Robert S. Brener__________ Robert S. Brener, Esq. LECLAIRRYAN, A Virginia Professional Corporation 1037 Raymond Blvd. Newark, NJ 07102 Phone: (973) 491-3600 Email: Robert.Brener@leclairryan.com /s/ A. Neil Hartzell____________ A. Neil Hartzell, Esq. (admitted pro hac vice) LECLAIRRYAN, A Virginia Professional Corporation One International Place, 11th Fl. Boston, MA 02110 Phone: (617) 502-8209 Email: neil.hartzell@leclairryan.com Dated: June 30, 2016 Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 36 of 37 PageID: 4447 32 CERTIFICATE OF SERVICE I hereby certify that this document filed through the ECF system will be sent electronically to the registered participants identified in the Notice of Electronic Filing (NEF) on June 30, 2016. /s/ Robert J. Brener Robert J. Brener, Esq. Case 2:14-cv-03620-JMV-JBC Document 214 Filed 07/08/16 Page 37 of 37 PageID: 4448