Scott v. ZST Digital Networks, Inc.

896 F.Supp.2d 877

Robert SCOTT

v.ZST DIGITAL NETWORKS, INC. et al.

No. CV 11–03531 GAF (JCx).

United States District Court, C.D. California.

Aug. 7, 2012.

Laurence M. Rosen, Rosen Law Firm, Los Angeles, CA, for Plaintiff.

Stephen D. Hibbard, Shearman & Sterling LLP, San Francisco, CA, Andrew J. Rodgers, Christopher R. Fenton, Edward G. Timlin, Shearman & Sterling LLP, New York, NY, for Defendants.

ORDER RE: MOTIONS TO DISMISS

GARY ALLEN FEESS, District Judge.

I.INTRODUCTION

Shareholders of ZST Digital Networks, Inc. (“ZST” or the “Company”) bring this securities class action against the Company, a number of its senior officers, and its outside accountants and investment banks, alleging that Defendants' submission of conflicting financial information to American and Chinese regulatory bodies violated federal securities laws. ZST is a Delaware corporation with its principal place of business in Henan Province, People's Republic of China (“PRC”), where it develops digital and optical networking equipment used by local cable operators. ZST reports its annual financial results to both the Securities and Exchange Commission (“SEC”) and to a PRC governmental agency, the State Administration of Industry and Commerce (“SAIC”). According to the complaint, ZST reported financial results to the SEC indicating revenues of over $50,000,000 in 2008 and over $100,000,000 in 2009, while reporting results to the SAIC that were a minuscule fraction of those figures. Plaintiffcontends that the financial data submitted to one of these regulatory bodies was false, and that the submissions violated both the Securities Act of 1933 and the Securities Exchange Act of 1934.

The Court has previously addressed motions to dismiss filed by Defendants ZST, Kempisty & Company, P.C. (“Kempisty”), and WestPark Capital, Inc. (“WestPark”) and Rodman & Renshaw, LLC (“Rodman & Renshaw”). (Docket No. 93, February 14, 2012 Order, 2012 WL 538279.) The Court dismissed the Securities Act claims with leave to amend, finding that Plaintiff had failed to adequately allege standing. (Id. at 17–19.) The Court also dismissed the Exchange Act claims as against Kempisty, with leave to amend, finding that Plaintiff had failed to adequately allege auditor liability. (Id. at 13–14.)

Plaintiff filed an amended class action complaint on March 9, 2012. (Docket No. 94.) Defendants now move to dismiss various claims contained in the amended complaint. (Docket Nos. 120, 124, 125, 136.) For the reasons set forth below, the Court finds that Plaintiff has not, and cannot properly allege standing under the Securities Act. Moreover, the Court concludes that the Exchange Act claims are adequately pleaded as against Defendants WestPark and Rappaport, but fail as a matter of law against Defendants Anthony Pintsopoulos, Kevin Deprimio, Jason Stern, the Amanda Rappaport Trust, and the Kailey Rappaport Trust. Accordingly, the motions are GRANTED in part and DENIED in part.

II.BACKGROUND

The action is brought on behalf of all persons who either [1] purchased or otherwise acquired ZST securities pursuant or traceable to the Company's Registration Statement issued in connection with its October 20, 2009 initial public offering of securities (“IPO”); or [2] purchased or otherwise acquired ZST securities from October 20, 2009 through April 21, 2011 (the “Class Period”), except for certain excluded persons and entities. (AC ¶ 42.) The amended complaint alleges that Defendants violated Sections 11 and 15 of the Securities Act of 1933 (the “Securities Act”) and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) by submitting to the SEC financial reports that were materially false and misleading, and which omitted facts to conceal adverse material information about the business operations and future prospects of ZST. ( Id. ¶¶ 1–9, 183.)

In deciding a motion to dismiss, the Court must accept all well-pleaded factual allegations in the complaint as true. Blake v. Dierdorff, 856 F.2d 1365, 1368 (9th Cir.1988).

The complaint alleges that ZST maintained two materially different sets of financial records during the Class Period, one for reporting financial results in China to the SAIC, and another for reporting financial results in the United States to the SEC. ( Id. ¶ 1.) Because financial reports submitted to the SAIC, unlike those filed with the SEC, are not publicly available, the discrepancies between the two sets of records was not known to the investing public until April 21, 2011, when that fact was disclosed via a two-part Internet report entitled “ZST Digital Networks Unfolded: A Mutual Fund Manager Seeks the Truth.” ( Id. ¶¶ 2, 84.) The report disclosed that ZST had reported revenue of over $55 million to the SEC in 2008, and revenue of only $20,000 to the SAIC for the same fiscal year, and that the Company had reported losses of $130,000 to the SAIC, rather than the $6 million profit reported to the SEC. ( Id. ¶ 85.) Following publication of the report, ZST's per share stock price immediately dropped from $4.36, the closing price on the day prior, to $2.68, the closing price on April 21. ( Id. ¶ 86.)

The disclosure of this information revealed that ZST's Registration Statement, filed with the SEC in connection with the IPO, contained materially different financial reporting than statements filed by the Company's wholly-owned subsidiary, Zhengzhou ZST, to China's SAIC. ( Id. ¶¶ 87–94.) According to the amended complaint, ZST's annual SAIC reports were audited by Chinese certified accountants, and contained “lengthy audit opinions verifying the veracity of the reports.” ( Id. ¶ 64.) Furthermore, although one unaffiliated with the company must submit requests to the SAIC and pay certain fees to obtain such reports, the amended complaint alleges that they are “readily available” to a company's authorized agents, such as its auditors or underwriters. ( Id. ¶¶ 66–67.)

The amended complaint asserts that: [1] if ZST's SEC reports were materially inaccurate, various Defendants are liable under both the Securities Act and the Exchange Act for the material misstatements contained therein; [2] if ZST's SAIC reports were inaccurate, various Defendants are liable under the Securities Act for representing in the Registration Statement that ZST's Chinese subsidiary had been and would continue to faithfully comply with all Chinese laws, and/or failing to disclose in the Registration Statement that the Company was submitting contradictory financial reports to the SAIC. ( Id. ¶ 9.)

Plaintiff asserts four causes of action, under Sections 11 and 15 of the Securities Act, and Sections 10(b) and 20(a) of the Exchange Act, and names a number of Defendants, including ZST (the “Issuer Defendant”); several of the Company's executives and officers (the “Individual Issuer Defendants”), who allegedly signed various SEC filings containing the misstatements and/or omissions; Rodman & Renshaw and WestPark, two investment banks which served as underwriters for the Company's IPO (the “Underwriter Defendants”); several of WestPark's executives and officers; and the Company's outside accountant, Kempisty & Company, P.C., which audited the financial statements submitted to the SEC (“Kempisty” or the “Auditor Defendant”). ( Id. ¶¶ 14–41.)

III.DISCUSSION

A. Pleading Standards under Federal Rules of Civil Procedure 12(b)(6) and 9(B), and the PSLRA

A complaint may be dismissed if it fails to state a claim upon which relief can be granted. SeeFed.R.Civ.P. 12(b)(6). On a motion to dismiss under Rule 12(b)(6), a court must accept as true all factual allegations pleaded in the complaint, and construe them “in the light most favorable to the nonmoving party.” Cahill v. Liberty Mut. Ins. Co., 80 F.3d 336, 337–38 (9th Cir.1996) Dismissal under Rule 12(b)(6) may be based on either (1) a lack of a cognizable legal theory, or (2) insufficient facts under a cognizable legal theory. SmileCare Dental Grp. v. Delta Dental Plan of Cal., Inc., 88 F.3d 780, 783 (9th Cir.1996) (citing Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 534 (9th Cir.1984)).

Under Federal Rule of Civil Procedure 8(a)(2), a complaint must contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” Fed.R.Civ.P. 8(a)(2). The Supreme Court has interpreted this rule to allow a complaint to survive a motion to dismiss only if it “contain [s] sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’ ” Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. (citing Twombly, 550 U.S. at 556, 127 S.Ct. 1955). “[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct,” the complaint has not sufficiently established that the pleader is entitled to relief. Id. at 1950.

While a complaint generally need not contain detailed factual allegations, “a plaintiff's obligation to provide the grounds of his entitlement to relief requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do.” Twombly, 550 U.S. at 555, 127 S.Ct. 1955 (citation, alteration, and internal quotation marks omitted). Similarly, a court need not “accept as true allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” Sprewell v. Golden State Warriors, 266 F.3d 979, 988 (9th Cir.2001). In other words, “the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions.... While legal conclusions can provide the framework of a complaint, they must be...