Paul v. China Mediaexpress Holdings, Inc.

MARC PAUL, Plaintiff, v. CHINA MEDIAEXPRESS HOLDINGS, INC., a Delaware corporation, Defendant.

C.A. No. 6570-VCP

COURT OF CHANCERY OF THE STATE OF DELAWARE

Submitted: October 11, 2011

Decided: January 5, 2012

MEMORANDUM OPINION

Michael Hanrahan, Esq., Gary F. Traynor, Esq., Paul A. Fioravanti, Jr., Esq., PRICKETT, JONES & ELLIOTT, P.A., Wilmington, Delaware; Eric L. Zagar, Esq., Robin Winchester, Esq., Richard H. Kim, Esq., KESSLER TOPAZ MELTZER & CHECK, LLP, Radnor, Pennsylvania; Attorneys for Plaintiff Marc Paul.

Albert H. Manwaring, IV, Esq., James G. McMillan, III, Esq., PEPPER HAMILTON LLP, Wilmington, Delaware; Eugene R. Licker, Esq., Laura M. Vasey, Esq., LOEB & LOEB LLP, New York, New York; Attorneys for Defendants China MediaExpress Holdings, Inc. and Zheng Cheng.

PARSONS, Vice Chancellor.

This is an action to inspect the books and records of a corporation under 8 Del. C. § 220. A shareholder brought this action after a series of reports and events, including the resignation of the company's independent auditor, raised suspicions that the company had engaged in fraud and falsified its financial statements. The company opposes the shareholder's demand on the ground that the shareholder has not established a proper purpose to inspect its books and records. Furthermore, the company argues that this action should be stayed pending resolution of a motion to stay these and other proceedings that is pending in a related federal court action.

For the reasons stated in this Memorandum Opinion, I find that the shareholder has established proper purposes to inspect the books and records of the company. Those purposes are to investigate (1) fraud and mismanagement and (2) the ability of the board to act independently and in good faith. Therefore, I grant the shareholder's demand as to the documents discussed in this Memorandum Opinion, but only to the extent the documents are necessary for one of his proper purposes. I also deny the company's request to stay this action.

I. BACKGROUND

A. The Parties

Plaintiff, Marc Paul, is a resident of Tennessee and a shareholder of Defendant, China MediaExpress Holdings, Inc. ("CME" or the "Company"). Paul acquired stock in CME through personal online brokerage accounts he maintains for himself and his family.

Defendant, CME, is a Delaware corporation with its principal place of business in Hong Kong, China. CME is engaged in the business of television advertising on intercity and airport express buses in China. Until recently, CME was publicly listed on the NASDAQ Stock Market. CME obtained its listing on NASDAQ through a merger with TM Entertainment and Media, Inc. ("TM Entertainment") in 2009.

B. Facts

This action arises from various allegations of fraud and mismanagement made against CME beginning in January 2011. Around that time, Citron Research, a financial analyst firm, released a report alleging that CME was engaging in fraudulent accounting practices and that most of CME's business could be a fraud.¹ The next week, two shortsellers, Bronte Capital and Muddy Waters LLC, released reports making similar allegations that CME's financial statements and operations were fraudulent.² Zheng Cheng, CME's Chairman, CEO, and President, responded to the allegations on February 7, 2011, denying any fraud and accusing the shortsellers of acting in concert to promote their own objective of driving down the Company's stock price.³

On March 2, 2011, Muddy Waters released a follow-up report further elaborating on its basis for believing that CME was a fraud and that CME's management wasengaged in a cover-up.⁴ Then, on March 11, the Company's independent auditor, Deloitte Touche Tohmatsu ("DTT") formally resigned. In a press release following DTT's resignation, CME acknowledged that DTT had stated in its resignation letter that it was "no longer able to rely on the representations of management," that certain issues raised in the audit should be addressed through an independent investigation, and that the issues may have adverse implications for prior periods' financial reports.⁵ That same day, the Company requested that NASDAQ temporarily suspend trading in its stock.⁶

Following the resignation of DTT, CME's situation quickly degenerated. Jacky Lam, a director and the Company's CFO, resigned on March 13, 2011, citing concerns over senior management's failure to respond properly to information which he had "learned in the past few days" following the resignation of DTT.⁷ Dorothy Dong, another CME director, resigned shortly after Lam, citing similar concerns over senior management's response to accounting irregularities related to DTT's resignation.⁸

On April 4, 2011, NASDAQ notified the Company that it was suspending trading in the Company's stock effective April 12. Shortly thereafter, another director, Marco Kung, resigned from the board, citing concerns over senior management's response toissues related to DTT's resignation.⁹ Following Kung's resignation, the Company announced that it was not in compliance with NASDAQ Rule 5605(c)(2)(A), which requires that a listed company's audit committee be comprised of at least three independent board members.¹⁰ On May 2, 2011, the Audit Committee of the board retained the DLA Piper law firm to conduct an internal investigation of the concerns raised by DTT.¹¹ NASDAQ delisted CME's shares on May 19.¹²

1. The federal proceedings

As a result of the events unfolding at CME during the spring of 2011, Starr Investments Cayman II, Inc. ("Starr"), a CME investor, filed a complaint against CME, DTT, Cheng, and Lam in the United States District Court for the District of Delaware on March 18, 2011 (the "Federal Action").¹³ In its complaint, Starr alleges various violations of state law and federal securities laws, including: (1) violation of § 10(b) of the Exchange Act and Rule 10b-5; (2) violation of § 20(a) of the Exchange Act against Cheng and Lam; (3) common law fraud; (4) breach of fiduciary duty against Cheng and Lam; (5) aiding and abetting a breach of fiduciary duty against DTT; and (6) negligentmisrepresentation.¹⁴ The federal defendants moved to dismiss that case on June 13, 2011, three days before Plaintiff filed his Complaint in this action. In response to the federal defendants' motion to dismiss, Starr filed an amended complaint in the Federal Action on July 5. On September 30, the federal defendants moved to dismiss Starr's amended complaint. Pursuant to the Private Securities Litigation Reform Act ("PSLRA"), discovery in the Federal Action is stayed pending the district court's resolution of the federal defendants' motion to dismiss.¹⁵

C. Procedural History

On or about May 17, 2011, while the Federal Action was proceeding, Paul served pursuant to 8 Del. C. § 220. CME did not respond to the demand. As a result, Paul filed the Complaint in this action on June 16. CME answered the Complaint on July 6, and a trial date was set for October 11, 2011.

On September 27, 2011, CME moved in the Federal Action to stay discovery in this action pursuant to the Securities Litigation Uniform Standards Act ("SLUSA").¹⁶Then, at a pretrial teleconference on October 4, less than a week before the scheduled trial in this action, CME requested a continuance of the trial date until after the district court has decided the SLUSA motion. Due to the imminent trial date, the limited scope of the trial, and CME's failure to raise the issue of a continuance or stay more promptly in this Court, I denied CME's request.¹⁷ At trial, however, both parties were given the opportunity to address CME's related request that this Court defer ruling on Paul's § 220 demand pending the district court's decision. The district court has not yet ruled on the SLUSA motion.

D. Parties' Contentions

In this books and records action under 8 Del. C. § 220, Plaintiff asserts two purposes for his request to inspect the books and records of CME. They are: (1) to investigate "possible mismanagement and breaches of fiduciary duties by the directors and officers of the Company, including, but not limited to, mismanagement and breaches of fiduciary duties in connection with the Company's lack of oversight and possible participation in fraudulent conduct involving the Company's customer contracts, revenues and net income"; and (2) to "determin[e] whether the Company's directors are independent and have acted, and are capable of acting, in good faith with respect to the Company's potential misconduct."¹⁸

CME opposes Paul's inspection demands on the basis that he has failed to state a proper purpose.¹⁹ CME also argues that, in any case, these proceedings should be stayed pending resolution of the SLUSA motion in the Federal Action.

II. ANALYSIS

A. 8 Del. C. § 220

It is well-established that "[stockholders of Delaware corporations enjoy a qualified common law and statutory right to inspect the corporation's books and records."²⁰ Under the common law, "[i]nspection rights were recognized . . . because, '[a]s a matter of self-protection, the stockholder was entitled to know how his agents were conducting the affairs of the corporation of which he or she was a part owner.'"²¹This common law right was codified in Delaware under 8 Del. C. § 220, which provides in pertinent part that:

Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from: (1) The corporation's stock ledger, a list of its stockholders, and its other books and records . . . .²²

Therefore, in asserting the right to inspect the books and records of a company, a shareholder must prove that he (1) is a stockholder of the company, (2) has made a written demand on the company, and (3) has a proper purpose for making the demand.

Here, it is undisputed that Plaintiff is a shareholder of CME and has made a valid written demand. The Company, however, resists Paul's...