-
Southern District Of New York Grants Motion To Dismiss Putative Securities Class Action Against Chinese Private-Sector Education Company
12/13/2023On December 6, 2023, Judge John G. Koeltl of the U.S. District Court for the Southern District of New York granted a motion to dismiss a putative securities class action brought against an operator of private schools in Western China. Dagan Invs., LLC v. First High-Sch. Educ. Grp. Co., 2023 BL 442686, No. 22-cv-3831 (S.D.N.Y. Dec. 6, 2023). Plaintiff, on behalf of a purported class of U.S. investors, alleged that the Company violated Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 by making material misstatements and omissions about the likelihood and severity of impending Chinese government regulations impacting the private education sector.
According to the complaint, the Company was founded in 2012 and operates private high schools and middle schools in China. Plaintiff alleges that by December 31, 2019, the Company was one of the largest operators by enrollment of private high schools in China. On January 13, 2021, the Company filed a draft Registration Statement with the SEC in anticipation of an IPO, which was declared effective on March 10, 2021. On March 11, 2021, the Company submitted final offering materials and launched its IPO. The Company allegedly sold 7.5 million American Depository Shares at $10 per ADS.
Meanwhile, according to plaintiff, the regulatory climate in China regarding the private education sector was shifting. On March 4, 2021, the Chinese government held its first 2021 “Two Sessions” meeting at which Chinese government officials proposed regulations governing the education industry. Between March 6 and March 9, 2021, these discussions were allegedly covered in various Chinese and English language news outlets. According to plaintiff, on July 3, 2021, the Chinese government issued a sweeping overhaul of the education sector which effectively shut down future growth in the private education industry. By May 10, 2022, the Company’s ADSs closed at below $1 per ADS—a greater than 90 percent decline relative to the IPO price.
Plaintiff brought a putative securities class action making two principal allegations. First, plaintiff alleged that the offering materials contained actionable and material omissions by failing to warn investors that the regulations contemplated at the Two Sessions meeting posed a material adverse threat to the Company and failing to disclose alleged related trends and risks. Second, plaintiff alleged that the Company made material misstatements in its offering materials by (i) attributing the Company’s success in part to “favorable government policies” and by (ii) claiming that a well-known and elite school in China (the “School”) was involved in the Company’s IPO.
The Court granted the Company’s motion to dismiss, holding that: (i) plaintiff failed to plausibly allege that the offering materials contained actionable omissions or misstatements; (ii) even if there were omissions or misstatements, they were not material; and (iii) plaintiff’s claims were barred by the statute of limitations.
First, the Court found no actionable omissions and misstatements. As to the alleged omissions, the Court held that plaintiff had not adequately pled that the Company was under any duty to disclose the omitted facts because the adverse regulations were announced after the Registration Statement became effective, and the Company was under no duty to “predict with certitude” what changes Chinese lawmakers might make in the future. Similarly, the Court held that the Company had no duty to disclose “trends” or “risks” which had not yet come to pass. As to the alleged misstatements, the Court held that the offering materials’ representation that favorable government policies were an ingredient of the Company’s initial success was not false or misleading because it was circumscribed by statements elsewhere in the Registration Statement specifically cautioning about the possibility of adverse regulatory action in the future. As to the claim about the School, the Court found that the offering materials simply did not assert that it was involved in the Company’s IPO, but rather it accurately stated that the Company and the School had a “cooperative relationship.”
With respect to materiality, the Court found that there was no such substantial likelihood that a reasonable investor would have viewed the alleged omitted facts as having altered the total mix of information available, because the relevant information was already in the public domain at the time of the IPO. The Court emphasized that a variety of both Chinese and English language news outlets reported on the possibility of a regulatory crackdown on the private education sector after the Two Sessions meeting and before the Registration Statement became effective and the Company went public.
Finally, the Court held that the statute of limitations barred plaintiff’s claims because plaintiff knew or should have known of its claims as soon as the Registration Statement became effective on March 11, 2021. The Court held that, by that point, the possibility of a regulatory crackdown was already in the public domain. Because plaintiff did not commence this action until May 11, 2022, more than one year later, the Court held the action must be dismissed on statute of limitations grounds.
