Monday, October 26, 2015
Ninth Circuit Revives Securities Class Action
From Staff and Wire Service Reports
A corporate chief executive’s $120 million embezzlement may be imputed to his company for purposes of a securities fraud class action, the Ninth U.S. Circuit Court of Appeals ruled Friday.
Judge M. Margaret McKeown called the an example of “textbook securities fraud,” in which the CEO and founder of ChinaCast Education, Ron Chan, both embezzled from the corporation and misled its investors.
The plaintiffs alleged that executives of ChinaCast, an educational firm based in China, issued statements that were false and or misleading, and/or did not reveal material adverse facts related to the firm’s business, prospects and operations.
They specifically claimed that ChinaCast allowed the wrongful transfer of no less than $120 million from two bank accounts owned by two of ChinaCast’s subsidiaries, and that the company allowed for wrongful transfer of its assets, including two private colleges, to third parties without authorization.
They also alleged that loans were made to third parties for non-company purposes with the company’s assets used as collateral, that ChinaCast’s internal controls were not adequate and that the company allowed for wrongful transfer of its assets.
U.S. trading in ChinaCast stock was halted in April 2012 with the share price at $4.24. It was subsequently disclosed that Chan had been removed as chairman/CEO the previous month, and that the company’s chief financial officer had resigned.
U.S. District Judge John Walter of the Central District of California dismissed the shareholders’ complaint, finding they failed to plead intent to defraud. The ruling was based on the “adverse interest exception,” which holds that such intent will not be imputed “from the fraud of a rogue agent.”
The appellate panel reversed. The exception, McKeown wrote, “doesn’t apply in every instance where there is a faithless fraudster within the corporate ranks.”
McKeown explained that Chan’s actions can be properly imputed to ChinaCast because “Chan acted with apparent authority on behalf of the corporation, which placed him in a position of trust and confidence and controlled the level of oversight of his handling of the business.”
Thus, she concluded, Chan’s fraud was attributable to the corporation, even though Chan “unquestionably lined his own pockets at the expense of ChinaCast’s interests.”
ChinaCast received a 2011 audit detailing “material internal control weaknesses,” but “turned a blind eye and failed to take significant action or heighten oversight,” McKeown said.
“Had they done so, they may have prevented much of the decimation of ChinaCast’s bottom line and share value,” she said.
McKeown also pointed out that Chan was “hardly a random corporate bureaucrat or mid-level manager,” but ChinaCast’s founder and CEO— “the one person on whom the board undoubtedly should have kept close tabs.”
And since the investors’ complaint alleges “that third-party shareholders understandably relied on Chan’s representations, which were made with the imprimatur of the corporation that selected him to speak on its behalf and sign Securities and Exchange Commission filings,” McKeown said, Chan’s intent to defraud can be imputed to ChinaCast.
She noted that the district judge dismissed the case at the pleading stage, cautioning:
“As the litigation proceeds, whether the plaintiff is an innocent third party and whether the presumption of reliance is rebutted remain open questions,” McKeown said.
Judges Stephen Reinhardt and Milan D. Smith Jr. concurred in the opinion.
Neither side responded to request for comment on Friday morning.
The case is In re ChinaCast Education Corporation Security Litigation, 12-57232.
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