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Second Circuit Affirms Dismissal Of Securities Class Action Against Foreign Auditor Based On Omnicare
05/31/2016On May 20, 2016, the United States Court of Appeals for the Second Circuit affirmed the dismissal on summary judgment claims against a Hong Kong-based auditor brought under Section 10(b) of the U.S. Securities Exchange Act of 1934 (the “Exchange Act”) and Section 11 the Securities Act of 1933 (the “Securities Act”), holding that plaintiffs had not demonstrated that the auditor had either recklessly issued “clean” audit opinions or did not believe the opinions were true when issued. In re Puda Coal Securities Litigation, Inc., — F.3d —, 2016 WL 2942415 (2d Cir. 2016). In so holding, the Court clarified that “audit reports are statements of opinion subject to the Omnicare standard for Section 11 claims,” and held absent evidence of subjective disbelief or actionable omissions of information regarding the basis for the opinion, there could be no claim under Section 11.
Until April 2011, Puda Coal, Inc. (“Puda”) was a publicly traded, U.S.-listed company headquartered in China. Its sole asset was a 90% stake in Shanxi Puda Coal Group Co., Ltd. (“Shanxi Coal”). In September 2009, Puda’s chairman transferred Puda’s entire interest in Shanxi Coal to himself, leaving Puda a shell company without any operations or revenue. Puda’s financial statements for 2009 and 2010 nonetheless included Shanxi Coal as an asset. The auditor, Moore Stephens, issued “clean” opinions for the 2009 and 2010 financial statements. On April 8, 2011, a research report disclosed the transfer. Plaintiffs filed suit shortly thereafter, claiming that Moore Stephens violated Section 11 of the Securities Act and Section 10(b) of the Exchange Act.
In June 2014, Judge Katherine Forrest of the Southern District of New York granted Moore Stephens’s motion for summary judgment. Judge Forrest held that the plaintiffs had not shown that the auditor was reckless (in part because the court excluded testimony from plaintiffs’ auditing expert because the proffered expert had no experience with the relevant auditing standards) and thus could not show actionable fraud under Section 10(b). Judge Forrest also dismissed the Section 11 claims because plaintiffs could not show that Moore Stephens believed its “clean” opinions were false. Instead, the evidence showed that the auditor had been “dupe[d]” as well.
In affirming, the Second Circuit found that the District Court had properly stricken the testimony of plaintiffs’ auditing expert, and that the plaintiffs could not show that Moore Stephens had been reckless. The Court then noted that Moore Stephens’ audit opinions were labeled “opinions” and involved considerable judgment, and were therefore statements of opinion subject to Omnicare. Accordingly, the Court stated that the audit opinions could only be actionable as false or misleading under Section 11 if “(i) the issuer of the opinion held a subjective belief inconsistent with the opinion, or (ii) the opinion omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, if those facts conflict with what a reasonable investor would take from the statement of opinion itself.” In re Puda Coal reconfirms that plaintiffs in the Second Circuit must overcome substantial hurdles to pursue federal securities law claims based on statements of opinion.
