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The wave of new securities class action lawsuits
involving accounting scandals at U.S-listed Chinese firms is already a well-established
phenomenon. But in the latest twist on the tale, Deer Consumer Products, one of the U.S.-listed
Chinese companies most recently sued based on allegations of accounting fraud,
has gone on the warpath and is publicly alleging that the lawsuit against the
firm is part of an elaborate scheme by "illegal" short sellers to manipulate
the company's share price. And according to press reports, a different
Chinese firm that also has been hit with a lawsuit also have raised
the question whether short sellers might be behind the accounting fraud
The latest story involving Deer Consumer Products began
on April 30, 2011, when plaintiffs' lawyers announced in a press
release that they had filed a securities class action lawsuit in the
Central District of California against the company and certain of its directors
and officers. Among other the plaintiffs' attorney's press release states
Deer misrepresented its financial performance, business
prospects, and financial condition to investors, citing inconsistent Chinese
regulatory filings. The Complaint also alleges that Deer improperly recognized
revenue in violation of Generally Accepted Accounting Principles ("GAAP"). On
March 9, 14, and 17, 2011, analyst Alfred Little issued a series of reports
disclosing defendants' alleged fraud, which caused the stock price to drop,
On May 2, 2011, Deer Consumer Products issued its
own press release (here)
in which the company asserted that it has "evidence of continuing illegal short
selling" in its stock, and also asserted that its "common stock has been
manipulated in collusion among 'naked' short sellers." The press release goes
on to assert that the class action lawsuit itself is "part of the attempted
Now, it is nothing new for companies to assert that the
bad news circulating about them is based on rumors from profit-motivated short
sellers. But the Deer Consumer Products takes this common gripe quite a bit
further. The company asserts that the supposed analyst, Alfred Little, whose reports are the source of the rumors and
are relied on in the complaint is "a fictitious character" whose phony identity
is "a disguise used by one or more illegal short sellers in the short sale
scheme." The purported reports of Alfred Little were "published in collusion
with short sellers" to "intentionally create fear in the general public to
drive down DEER's share price."
The press release goes on to assert that all of the
allegations in the supposed Alfred Little reports are false and that the
company intends to seek sanctions against the law firm that filed the lawsuit.
Deer is not the first U.S.-listed Chinese company to
charge that the allegations of accounting fraud originated with short sellers.
U.S. shareholders in another U.S- listed Chinese company that has also
been hit with a securities class action lawsuit, China Agritech, are also
alleging that stories circulating about the company and that are behind the
lawsuit are the result of the actions of short sellers. (Background on the
China Agritech lawsuit can be found here).
A very interesting April 26, 2011 Bloomberg
article entitled "Wall Street Scion Lost in China Agritech as Shorts Cry
contains the allegations of one U.S. investor in China Agritech that "someone
blatantly lied to short the stock." The U.S. investor, Jesse Glickenhaus,
troubled by an analyst's
report that the company was a scam with no real operations, went to China
himself and toured company facilities with company executives, to verify the
existence of claimed business operations and facilities.
Or at least Glickenhaus thinks he toured company
facilities. In yet another twist to the story, after Glickenhaus published his
account of his Chinese factories tours on his own investment company's website,
other short sellers asserted that Glickenhaus had been duped, and
that rather than touring the company's factory, Gliockenhaus had been taken to
a state-owned plant at a different address than the one listed in China
With all of these levels of confusion and disinformation,
it is hard to tell who is scamming whom and what version of the truth actually
corresponds to reality. Are the Chinese companies scamming investors by
misrepresenting their true financial condition? Or are investors being misled
by short sellers who have an incentive to cast doubt on the companies and drive
down the share price?
You do start to wonder why any investors would
invest in U.S.-listed Chinese companies. The Bloomberg article about
Glickenhaus provides some of the answers. Glickenhaus is the 29-year old
grandson of his investment firm's founder, who invested in China Agritech
without even knowing that the company had obtained its U.S. listing through a
reverse merger. He seemed particularly persuaded by the fact that the Carlyle
Group had previously invested in the company.
Even if he was not duped during his recent China visit
about China Agritech's operations, Glickenhaus seems like a remarkably
uncritical investor. He remains committed to the company and to his investment
even though the company has fired two auditors in four months and still has not
filed its 2010 financial data. Carlyle's representative on the company's board
has also resigned. Glickenhaus does concede that "in the future, if I
find a company in China, I'll probably stick to those that have had a major,
well-known auditor for several years."
Whether the accounting fraud allegations have substance
or are the product of short-sellers' profit-motivated imaginations, it is clear
that the existence of the allegations is continuing to drive securities class
action litigation against U.S.-listed Chinese companies. In addition to the new
lawsuit against Deer, plaintiffs' lawyers have in the last week and a half also
filed lawsuits against these other U.S.-listed Chinese companies: Gulf
Resources (refer here);
ZST Digital Networks (refer here);
and SkyPeople Fruit Juice (refer here).
Interestingly, the same law firm that filed the Deer lawsuit filed these three
others as well.
Another U.S.-listed company with its fish farming
operations in China but its headquarters in Washington State, HQ Sustainable
Maritime Operations, was also hit with a securities lawsuit last week (refer here).
With the arrival of these latest lawsuits, a total of 19
new securities class action lawsuits have been filed against Chinese companies
so far in 2011. That is out of a total of about 79 lawsuits this year,
meaning that the China-related lawsuits represent about one-quarter of all2011
YTD class action securities lawsuits. That is on top of the ten lawsuits
that were fled against Chinese companies in 2010.
Signs are that there are more lawsuits yet to come, as
well. Plaintiffs' firms have issued press releases that they are investigating
other China-linked companies, including Longtop Financial (refer here)
and Sino-Clean Energy (refer here).
Interestingly, the press release announcing the Sino-Clean investigation was
issued by the same law firm that filed the Deer lawsuit described above, and
the press release also references an analyst report by Alfred Little (the same
analyst whom Deer claims is fictitious).
In addition to the securities class action lawsuit
describe above, investors have also filed at least one shareholder derivative
recently involving a Chinese company. On April 27, 2011, plaintiffs filed a
derivative lawsuit in the District of Wyoming against Duoyuan Printing, as
nominal defendant, and certain of its directors and officers, alleging that the
individuals breached their fiduciary duties b, among other things, issuing
false and misleading statements regarding the company's financial results. A copy
of the complaint can be found here. The company
itself is a Wyoming corporation with its principal place of business in China.
An April 4, 2011 speech by SEC Commissioner Luis Aguilar (here) reported
that there were 150 reverse merger transactions between 2007 and the present in
which Chinese companies merged with U.S.-domiciled shells to obtain a listing
on a U.S. exchange. I am sure not all of these 150 companies have accounting
problems (or will otherwise be targeted by short sellers). But I am guessing
that before all is said and done, a lot more of them may wind up as defendants
in class action lawsuits filed in U.S. courts.
In any event, it does seem like the SEC is finally
getting around to doing something about all of this. On April 29, 2011,
the SEC announced (here)
that it had halted a Ponzi scheme involving China Voice Holding Company in
which company officials were using proceeds from later offerings to pay off
those who invested in earlier offerings.
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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