District Of New Jersey Grants In Part And Denies In Part Motion To Dismiss Securities Class Action Alleging Misleading Disclosures And Market Manipulation Against A Chinese Manufacturer Of Commercial Vehicle Parts
On June 12, 2020, Judge Kevin McNulty of the of United States District of New Jersey granted in part and denied in part a motion to dismiss a putative securities fraud class action asserting violations of Sections 9(a), 10(b), and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 against a Chinese manufacturer of wheels for commercial vehicles (the “Company”) as well as the Company’s CEO and CFO (collectively, “Defendants”). He v. China Zenix Auto Int’l Ltd. et al., Civ. No. 2:18-cv-15530, 2020 WL 31695006 (D.N.J. June 12, 2020). Plaintiffs alleged that, in an effort to prevent the Company from being de-listed by the New York Stock Exchange (the “NYSE”), certain of the Company’s employees engaged in improper trading that artificially inflated the Company’s stock price. Plaintiffs further alleged that the Company’s ongoing statements regarding its compliance with NYSE listing requirements were materially misleading, because these statements did not disclose that it achieved compliance only as a result of improper trading. The Court denied Defendants’ motion to dismiss as to the Section 10(b) claims against the Company and the CEO, but granted the motion to dismiss the Section 10(b) claims against the CFO for failure to adequately allege scienter. The Court dismissed the Section 9(a) claims for failure to adequately allege a series of purportedly manipulative transactions.
In 2011, the Company completed an initial public offering of American Depository Shares (“ADS”). In 2015, the NYSE informed the Company that its ADS price had dropped below $1.00 over a period of 30 trading days, and that it would be de-listed if at the end of the six-month cure period, the price remained below $1.00 for the previous 30 trading days. In 2015 and 2016, the Company issued press releases announcing it had cured the violation. However, in its 2017 Annual Report, the Company announced that the NYSE had launched an investigation into trading conducted by a number of Company employees in the Company’s stock during certain periods in 2015 and 2016. Subsequently, in June 2018, the NYSE announced it had decided to de-list the Company for engaging in conduct “contrary to the public interest.”
With respect to Section 10(b), plaintiffs alleged that the Company made materially misleading statements about the risk of being de-listed in its disclosures, because the Company failed to disclose that: (1) it knew its employees were trading the ADS improperly; (2) this trading was the reason the Company was able to satisfy NYSE’s listing requirements; and (3) the Company was aware that it faced a material risk of being de-listed because of the NYSE’s investigation into the improper trading. Plaintiffs also alleged that the improper trading activity constituted market manipulation in violation of Section 9(a).
The Court held that plaintiffs adequately pleaded that, when the Company disclosed it had “cured” its violations in 2015 and 2016, its failure to also disclose the improper trading scheme that enabled the Company’s compliance was materially misleading. With respect to the 2017 Annual Report, although the Company disclosed the existence of an NYSE investigation, the Court found that this disclosure was nonetheless misleading, because it failed to disclose “that the trading practices being investigated had in fact occurred; that they were in fact improper; and that the Company knew it.” The Court noted that the NYSE’s decision to de-list the Company in 2018 was a “key subsequent fact” that supported plaintiffs’ allegation that Company employees participated in improper trading in 2015 and 2016.
With respect to scienter, the Court held that a variety of facts supported the inference that the CEO, and the Company on the basis of respondeat superior, acted with the requisite scienter, most importantly that: (1) the CEO was also the founder and Chairman of the Board of Directors; (2) he beneficially owned approximately 70% of the Company’s ordinary shares whereas no one else held more than one percent of the shares; and (3) he ran the Company like a “family business,” making family members officers and senior executives. In contrast, plaintiffs did not adequately allege the CFO’s scienter, because they alleged nothing beyond the fact he held the position of CFO during the relevant time.
Notably, even though the Court found the allegations of the Company’s knowledge of its employees’ improper trading were sufficient to support plaintiffs’ 10(b) claim, the Court dismissed plaintiffs’ Section 9(a) market manipulation claims predicated on allegations of this same improper trading. The Court noted that, while “a vague description of an improper trading scheme” was sufficient to demonstrate that the Company’s disclosures were misleading, a claim under Section 9(a) requires an “explanation of who traded, or when and how they traded.” Moreover, the Court noted that, to state a Section 9(a) claim, plaintiffs were required to allege more than the CEO’s or CFO’s knowledge of the improper trading. Specifically, plaintiffs were required to allege the culpable participation of the CEO and CFO in the improper trading, which they failed to do.