In what is by far the largest settlement in the current
wave of securities litigation involving Chinese companies, Ernst &Young,
which served as the outside auditor for Sino-Forest, has agreed to pay C$117
million to settle the securities suit that Sino-Forest investors filed
in Ontario against the accounting firm. (At current exchange rates, the
Canadian dollar and the U.S. dollar are valued roughly equally.) According to
the plaintiffs' lawyers' December 3, 2012 press release (here),
E&Y's settlement of the Sino-Forest suit "is the largest settlement by
an auditor in Canadian history, by a large margin, and is one of the
largest-ever auditor settlements worldwide."
As discussed here, the plaintiffs' lawyers first
filed their suit in Ontario Superior Court of Justice on behalf of
Sino-Forest shareholders in June 2011, following press reports and online
reports that the company had substantially overstated the size and value of its
forestry holdings in China's Yunnan province. The allegations first emerged in a
June 2, 2011 report by online-research firm Muddy Waters, which accused
Sino-Forest of outright fraud. Floyd Norris's June 9, 2011 New York Times
article about E&Y's involvement in the Sino-Forest scandal can be found here.
Earlier this year, Sino-Forest filed for bankruptcy protection.
As detailed in the claimants' amended
statement of claim, the lawsuit named as defendants Sino-Forest, its senior
officers and directors, its auditors, its underwriters and a consulting
company. The plaintiffs previously settled with the consulting company in an
agreement that did not involve any monetary payments (refer here).
An overview of the Ontario litigation, including links to key documents, can be
The plaintiffs' lawyers' December 3 press release emphasizes that the
plaintiffs' claims against the remaining defendants (including in particular
the individual directors and officers and the offering underwriters, as well as
another auditor) remain pending.
Perhaps coincidentally (or perhaps not), on December 3,
2012, the Ontario Securities Commission filed charges against Ernst & Young
that the firm had failed to conduct their audits of Sino-Forest "in accordance
with relevant industry standards." The OSC's Statement of Allegations against
E&Y can be found here.
A December 3, 2012 Financial Post article discussing both the OSC
allegations and the separate civil suit settlement can be found here.
And in yet another apparent coincidence, on December 3,
2012, the SEC initiated administrative proceedings against the China affiliates
of each of the Big Four accounting firms (including E&Y's Chinese
affiliate) and another large U.S. accounting firm for refusing to produce audit
work papers and other documents related to China-based companies under
investigation by the SEC for potential accounting fraud against U.S. investors.
The SEC's December 3 press release about the administrative action can be found
E&Y's settlement of the Sino-Forest suit is noteworthy
in several respects, and not just because it is the largest auditor settlement
in Canadian history. It is also noteworthy because it is the largest settlement
so far of any kind in connection with the wave of securities suits that were
filed in the U.S. and in Canada against Chinese companies in recent years. As I
noted in a prior post (here),
in general the securities suits involving U.S.-listed Chinese companies that
have reached the settlement stage have only resulted in modest settlements,
well below the range of median settlements for U.S. securities class action
lawsuits generally. However, those modest settlements have involved only the
corporate entity defendant and its directors and officers, and the
settlements typically involved only the remaining amounts of D&O insurance.
From the earliest stages of the wave of securities suits
involving Chinese companies, I had been told that owing to the logistical
challenges and other shortcomings in the lawsuits against the Chinese
companies, the true targets were really not the companies themselves, but
rather their outside advisors. Up to this point, I have been skeptical that the
plaintiffs might succeed in getting traction in their claims against the
outside advisors. Clearly, the massive E&Y settlement in the Sino-Forest
case demonstrates that the claims against these companies outside advisors
canhave significant value, at least in some cases. In any event, these
cases have suddenly become much more interesting to watch.
Dismissal Granted in U.S.-Listed Chinese
Company Securities Suit: The securities suits involving Chinese
companies are only valuable to the plaintiffs if they are able to get to the
case to the settlement stage. Many of these cases have been dismissed at the
preliminary motions stage, and on December 3, 2012, the defendants' motions to
dismiss were grated in the securities suit pending in the Western District of
Washington against L&L Energy, a U.S. company owning Chinese mining
operations, and certain of its directors and officers. The motion was granted
with leave to amend. A copy of the December 3 opinion can be found here.
As detailed here, the plaintiffs
had raised a number of allegations against L&L, asserting among other things
that the company had misrepresented its revenues in its filings with the SEC.
In making these allegations the plaintiffs relied on discrepancies between the
financial figures the company reported in its SEC filings and the figures the
company's subsidiaries reported in China with the State Administration for
Industry and Commerce (SAIC).
In rejecting the plaintiffs' allegations based on this
discrepancy, Western District of Washington Robert Lasnik noted
that the two kinds of financial reports involved a number of different
reporting requirements and protocols. Based on these differences in the
reporting requirements, Judge Lasnik concluded that while "one might draw the
inference that the amounts reported to the SAIC and the SEC are inconsistent ...
because the inputs and consolidation methods varied in material respects, the
inference is not particularly strong." He concluded that "the bare allegations
supporting the plaintiffs' assertions that the SEC numbers, rather than the
SAIC numbers, are fabrications fail to raise the necessary strong inference of
This decision is just the latest to consider securities
fraud allegation based on allegations that the financial figures a Chinese
company reported to the SEC were different than those reported to the SAIC. As
I noted here,
in August 2012, the court denied the motion to dismiss in the securities suit
involving Duoyuan Global Water, a case that also involved the same kinds of
alleged reporting discrepancies. However, as noted here,
in November 2011, the court in the China Century Dragon Media case, like Judge
Lasnik in this case, granted the defendants motion to dismiss in another
lawsuit involving alleged reporting discrepancies.
Clearly, the track record is mixed; the one thing that is
for sure is that the mere fact of the reporting discrepancies alone may not be
sufficient for plaintiffs' to survive the initial pleadings stage.
Special thanks to a Doug Greene of the Lane
Powell law firm for forwarding a copy of the L&L Energy opinion. Lane
Powell represents the defendants in the L&L Energy case.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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