Jeff Feyko v. Yuhe International Inc et al

Filing 128

ORDER GRANTING IN PART AND DENYING IN PART MOTIONS TO DISMISS AND STRIKE 79 , 80 , 81 , 82 , 83 by Judge Dean D. Pregerson: For the reasons stated, the Court DENIES the Defendants motions, with the exception of GRANTING dismissal of the Section 11 claim against the Underwriter Defendants, GRANTING Dismissal of the Section 10(b) claim against Gang, and GRANTING dismissal of the Section 12(a)(2) and Section 11 claims of all subclass members whose Yuhe shares are only traceable to the second offering. Dismissal is without prejudice, except as to the Section 12(a)(2) claims. (lc). Modified on 3/5/2013 (lc).

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UNITED STATES DISTRICT COURT

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CENTRAL DISTRICT OF CALIFORNIA

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JEFF FEYKO, individually and
on behalf of all others
similarly situated,

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Plaintiff,
v.
YUHE INTERNATIONAL, INC.,
GAO ZHENTAO and HU GANG.,

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Defendants.
___________________________

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Case No. CV 11-05511 DDP (PJWx)
ORDER GRANTING IN PART AND
DENYING IN PART MOTIONS TO
DISMISS AND STRIKE
[Docket Nos. 79-83]

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I. Background

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Lead Plaintiff aAd Partners LP alleges that it purchased

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shares of common stock of Yuhe International, Inc. (“Yuhe”), during

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the class period, including in the October 20, 2010 secondary

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offering of Yuhe shares.

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Complaint (“CAC”) ¶ 17, Docket No. 70.)

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Defendants in this case (collectively “Defendants”).

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Defendants” are comprised of Yuhe (“Yuhe”), and the “Individual

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Defendants”: Zhentao Gao (“Gao”), Yuhe’s CEO, Chairman of the

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Board, and largest shareholder, Hu Gang (“Gang”), Yuhe’s CFO; and

(Supplemental Consolidated Class Action
There are three groups of
The “Yuhe

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Jiang Yingjun (“Yingjun”), Yuhe’s Chief Accounting Officer.

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¶¶ 19-21.)

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Wagoner & Bradshaw (“the Auditor Defendant”), which was Yuhe’s

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independent auditor from March 12, 2008 to December 7, 2009, and

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from March 9, 2010 to June 17, 2011.

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is called the “Underwriter Defendants.”

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Partners, LLC (“Roth”);

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Global Hunter Securities, LLC, and they were the underwriters for

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Yuhe’s October 20, 2010 public offering, with Roth serving as the

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The second group is comprised only of Child, Van

(Id. ¶ 27.)

The third group

They are Roth Capital

Brean Murray, Carret & Co., LLC; and

“book-running manager of the Offering”.

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(Id.

(Id. ¶¶ 23, 25-26.)1

The CAC alleges four claims, with the first and second falling

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under the Securities Exchange Act of 1934 and the third and fourth

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under the Securities Act of 1933.

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alleges the Yuhe Defendants violated Section 10(b) of the Exchange

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Act.

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control persons, who violated Section 20(a) of the Exchange Act.

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The third claim alleges that all Defendants violated Sections 11

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and 15 of the Securities Act.

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alleges that the Underwriter Defendants violated Section 12(a)(2)

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of the Securities Act.

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claims against them.

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Defendants have also moved to strike Lead Plaintiff’s CAC.

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reasons stated below, the Court DENIES the Defendants’ motions,

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with the exception of GRANTING dismissal of the Section 11 claim

Lead Plaintiff’s first claim

The second claim alleges the Individual Defendants were

Lead Plaintiff’s fourth claim

All Defendants have moved to dismiss all

The Yuhe Defendants and the Underwriter
For the

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Rodman & Renshaw, LLC (“Rodman”) was also an underwriter, and was also
named as a defendant in this action. (Id. at ¶ 24.)
However, Rodman has filed
for bankruptcy. (Docket No. 126.) Pursuant to section 326 of the Bankruptcy
Code, the instant action is stayed as to Rodman only. The Court notes that Lead
Plaintiff has not objected to staying the action against Rodman.

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against the Underwriter Defendants, GRANTING Dismissal of the

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Section 10(b) claim against Gang, and GRANTING dismissal of the

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Section 12(a)(2) and Section 11 claims of all subclass members

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whose Yuhe shares are only traceable to the second offering.

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Dismissal is without prejudice, except as to the Section 12(a)(2)

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claims.

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Yuhe sells broiler chickens.

(CAC ¶ 18.)

On December 31,

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2010, Yuhe filed a Form 8-K announcing that it entered into an

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agreement with Waifang Dajiang (“Dajiang”) to purchase thirteen

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breeder farms, and that Yuhe had already paid the first of two

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installments on those farms.

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on January 4, 2010, attached a press release that was entitled

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“Yuhe International, Inc. Increases Number of Breeder Farms to 27.”

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(Id. ¶ 45.)

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purchasing these thirteen breeder farms, we are able to quickly

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increase our production capacity of day-old broilers.”

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acquisition was touted as increasing Yuhe’s “capacity by 60%.”

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(Id. ¶ 46.)

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auditor, Grant Thornton, resigned on March 5, 2010.

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Yuhe’s Form-10k Annual Report for 2009 was filed on March 31, 2010,

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and repeated that Yuhe contracted to purchase thirteen breeder

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farms from Dajiang, and had paid 80% of the total consideration by

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December 31, 2009.

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Form 10-K, and Gao and Gang signed its Sarbanes-Oxley

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certification.

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number of Yuhe’s SEC filings indicated that it had acquired the

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thirteen breeder farms from Dajiang.

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59.)

(Id. ¶ 44.)

Another Form 8-K, filed

Gao was quoted in this press release as stating, “By

(Id.)

The

On March 11, 2010, Yuhe reported that its independent

(Id. ¶ 49.)

(Id. at ¶ 50.)

(Id. ¶ 47.)

Gao, Gang, and Yingjun signed the

Between March and October 2010 a

(Id. at ¶¶ 46, 48, 49, 53-

Yuhe’s October 20, 2010 Prospectus Supplement incorporated
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(Id. at ¶¶ 71-72.)

It

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many of the SEC filings discussed above.

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also incorporated the Auditor Defendant’s opinion, which contained

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various alleged misrepresentations about the Dajiang acquisition.

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(Id. at ¶¶ 90-101.)

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Yuhe sold $4,140,000 newly-issued shares at $7 each pursuant to its

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second offering.

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were awarded shares pursuant to this offering.

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From October 20, 2010, to November 2, 2010,

(Id. at ¶¶ 60,61.)

The Underwriter Defendants
(Id.)

On May 16, 2011, Yuhe filed Form 10-Q with the SEC, with Gao

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and Gang signing its accompanying Sarbanes-Oxley certifications,

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which reaffirmed that Yuhe acquired thirteen breeder farms from

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Dajiang in December 2009, and had already paid Dajiang over $12

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million in this transaction.

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(Id. ¶ 67.)

On June 8, 2011, GeoInvesting spoke with Mr. Xuejing Zheng

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(“Zheng”), Chairman and General Manager of Dajiang.

(Id. ¶ 76.)

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Zheng told GeoInvesting that Yuhe never purchased breeding farms

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from Dajiang, nor had the two discussed such an acquisition.

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¶ 77.)

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because it heard that Dajiang and Yuhe actually engaged in

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acquisition negotiations with Yuhe in 2009.

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admitted that the two did talk, but that it was only once, and that

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Dajiang “did not proceed with this deal.”

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that the only deal Yuhe proposed was a fake deal: “They told us to

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make a fake deal–it’s like I lease your facilities to make a fake

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deal for my US listing. . . .”

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omitted).)

(Id.

The next day, GeoInvesting again spoke with Zheng, in part

(Id. ¶ 78.)

(Id.)

Zheng

Zheng also stated

(Id. ¶ 78 (internal quotation mark

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On June 13, 2011, GeoInvesting released transcripts of its

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conversations with Zheng, and Yuhe’s stock price dropped 12.77%

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that day.

(Id. ¶¶ 75-76, 103-104.)
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The next day, Yuhe held a

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conference call, where it asserted that Zheng was asked misleading

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questions, and that Zheng would cooperate with Yuhe to clear up the

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“misunderstandings.”

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that day.

(Id. ¶ 80.)

Yuhe’s stock closed at $4.35 on

(Id. ¶ 105.)

The next day, GeoInvesting had another conversation with

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Zheng, where he insisted Dajiang and Yuhe never reached an

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agreement: “Did not reach the agreement. After the failure to do a

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deal with us, I don’t know why Yuhe claims this in the United

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States. Maybe for cheating money or for cheating to list in the

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United States?”

(Id. ¶ 81.)

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conversation on June 16, and Yuhe’s stock dropped to $1.96 per

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share that day.

GeoInvesting released this

(Id. ¶ 107.)

On June 17, 2011, Yuhe hosted a conference call, where its

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representatives stated that the contract with Dajiang had been

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retracted, and that the funds for that transaction were put into a

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different company.

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(Gao), CFO, and CAO said on the conference call about what happened

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with the Dajiang deal, why it was not disclosed, and what the

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company did with the money it previously asserted was already paid

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in that deal:

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C

(Id. ¶ 83.)

Below are excerpts of what the CEO

CAO: “[W]e worried that the cancellation of the contract and

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refunded cash would provoke negative reactions from the

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capital market.”

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C

had previously promised.”

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CEO: “[M]anagement was under huge pressure to deliver what we

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CFO: “The contract retract happened after our previous auditor
Grant Thorton resigned [March 5, 2010], so CEO worried that a

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retracted contract would increase negative investor sentiments

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and adversely affected [sic] the share price.”

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CEO: “[I]f the Company just put these [sic] money aside for

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cash reservation of purchasing additional breeder farms other

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than those farms from Dajiang, it wouldn’t impact the

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financials or the Company and hence no volatility in the share

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price.”

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C

When one individual on the call “pointed out that as of May
16, 2011, Yuhe represented that it had possession of the

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thirteen Dajiang breeding farms,” the CEO responded: “After

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the incident, the management was under huge pressure to

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deliver what we had previously promised. . . The CEO takes

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full responsibility for not disclosing the change in a timely

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manner. . . .”

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(Id. ¶¶ 47, 83.)
On June 17, 2011, the Auditor Defendant resigned, in light of

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the “Company’s management’s misrepresentation and failure to

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disclose material facts surrounding certain acquisition

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transactions and off-balance sheet related party transactions.”

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(Id. ¶ 84.)

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company’s “false public disclosures, which persisted for well over

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a year, related to the Company’s purported acquisition of farms

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Dajiang.”

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II. Legal Standard

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On June 28, 2011, NASDAQ delisted Yuhe, citing the

(Id. ¶ 85.)

A complaint will survive a motion to dismiss when it contains

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“sufficient factual matter, accepted as true, to state a claim to

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relief that is plausible on its face.”

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662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544,
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Ashcroft v. Iqbal, 556 U.S.

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570 (2007)).

When considering a Rule 12(b)(6) motion, a court must

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“accept as true all allegations of material fact and must construe

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those facts in the light most favorable to the plaintiff.”

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v. Hayes, 213 F.3d 443, 447 (9th Cir. 2000).

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need not include “detailed factual allegations,” it must offer

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“more than an unadorned, the-defendant-unlawfully-harmed-me

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accusation.”

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allegations that are no more than a statement of a legal conclusion

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“are not entitled to the assumption of truth.”

Iqbal, 556 U.S. at 678.

Resnick

Although a complaint

Conclusory allegations or

Id. at 679.

In

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other words, a pleading that merely offers “labels and

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conclusions,” a “formulaic recitation of the elements,” or “naked

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assertions” will not be sufficient to state a claim upon which

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relief can be granted.

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quotation marks omitted).

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Id. at 678 (citations and internal

“When there are well-pleaded factual allegations, a court should

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assume their veracity and then determine whether they plausibly

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give rise to an entitlement of relief.”

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must allege “plausible grounds to infer” that their claims rise

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“above the speculative level.”

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“Determining whether a complaint states a plausible claim for

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relief” is a “context-specific task that requires the reviewing

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court to draw on its judicial experience and common sense.”

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556 U.S. at 679.

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III. Analysis

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Plaintiffs

Twombly, 550 U.S. at 555-56.

Iqbal,

A. Yuhe Defendants’ Motion to Dismiss the Section 10(b)

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Id. at 679.

Claim
To state a claim for securities fraud under Section 10(b) of
the Securities Exchange Act and Rule 10b-5 promulgated thereunder,
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plaintiffs must plead particularized facts demonstrating “(1) a

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material misrepresentation or omission of fact, (2) scienter, (3) a

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connection with the purchase or sale of a security, (4) transaction

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and loss causation, and (5) economic loss.”

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Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009) (citations and

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internal quotation marks omitted).

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Zucco Partners, LLC v.

The Yuhe Defendants argue Lead Plaintiff’s Section 10(b) claim

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should be dismissed for several reasons.

First they argue that

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“allegations based on the” GeoInvesting report “should be

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rejected.”

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Yuhe Defendants’ argument on this point closely parallels its

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motion to strike, it will be discussed in the analysis of that

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motion.

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from one to dismiss, the Yuhe Defendants’ motion to dismiss

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argument fails for the same reason its motion to strike argument

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fails.

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(See generally Docket No. 82 at 7:3-9:20.)

Because the

Although the standard for a motion to strike is different

The Yuhe Defendants next state that the CAC does not plead
(Id. at 9:21-10:13, 16:8-17:5.)

In

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material misrepresentations.

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alleging a Section 10(b) claim under the Private Securities and

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Litigation Reform Act, a plaintiff must meet heightened standards

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for alleging falsity and scienter.

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Plaintiff must “specify each statement alleged to have been

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misleading, the reason or reasons why the statement is misleading,

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and, if an allegation regarding the statement or omission is made

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on information and belief, the complaint shall state with

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particularity all facts on which that belief is formed.”

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78u–4(b)(1).

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In re Am. Apparel, Inc. S'holder Litig., 855 F. Supp. 2d 1043, 1071

In alleging falsity, a

15 U.S.C.

A statement must be false when made to be actionable.

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(C.D. Cal. 2012).

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depends on the significance the reasonable investor would place on

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the withheld or misrepresented information. . . .

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material if a reasonable investor would have considered it useful

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or significant.”

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Cir. 2011) (internal quotation marks and citations omitted).

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“Questions of materiality ... involv[e] assessments peculiarly

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within the province of the trier of fact. . . . Thus, the ultimate

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issue of materiality [is] appropriately resolved as a matter of law

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only where the omissions are so obviously important to an investor,

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that reasonable minds cannot differ. . .”

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Initiatives, Inc., 585 F.3d 1167, 1178 (9th Cir. 2009), aff'd, 131

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S. Ct. 1309 (U.S. 2011) (internal quotation marks and citations

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omitted).

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“For purposes of securities fraud, materiality

A statement is

United States v. Jenkins, 633 F.3d 788, 802 (9th

Siracusano v. Matrixx

Lead Plaintiff has pled that a material misrepresentation

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occurred.2

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was ever reached between Yuhe and Dajiang, thus making all Yuhe’s

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SEC filings, at least one of which all of the Individual Defendants

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signed, reporting the contrary false.

As discussed, Zheng told GeoInvesting that no agreement

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Putting the statements that Zheng made to GeoInvesting aside,

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Lead Plaintiff has still shown that there was a misrepresentation.

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Although the Individual Defendants stated in the June 17, 2011

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conference call that they had a contract with Dajiang, the CEO

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makes clear that the contract was cancelled by in March 2010: “From

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The Court is under no obligation to evaluate every misrepresentation that
was made in the CAC, because Plaintiff can survive a motion to dismiss by
alleging a single material misrepresentation. See Cunha v. Hansen Natural Corp.,
No. EDCV 08-1249-GW JCX, 2011 WL 8993148 (C.D. Cal. May 12, 2011) (holding that
"there is no reason that [the Court] must address parts of the CAC that do not
work.")

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March 2010 to the present, the company had completed the

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acquisition of eleven breeder farms with the cash refunds from

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Dajiang.”

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through May 2011 Yuhe represented to the SEC on a number of

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occasions that it had an agreement with Dajiang, and on one such

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occasion, all of the Individual Defendants signed a document

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containing the misrepresentation.

However, and as discussed, from March 2010

(Id. ¶ 83.)

The Court does not find that these misrepresentations were

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(CAC ¶ 83.)

immaterial as a matter of law.

Materiality is rarely appropriate

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to decide at the motion to dismiss stage.

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1178.

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misrepresentations were immaterial is that Yuhe began purchasing

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other breeding farms when the Dajiang deal failed.

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the complaint states, eleven were acquired from March 2010 to June

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2011.

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does not moot the materiality of the Dajiang misrepresentations.

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Siracusano, 585 F.3d at

The Yuhe Defendants’ best argument that the

(Id.)

(CAC ¶ 83.)

As

However, acquiring different farms at a later date

The Yuhe Defendants also assert that Lead Plaintiff cannot

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show scienter.

The scienter requirement is satisfied when “a

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complaint . . . allege[s] that the defendant made false or

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misleading statements either intentionally or with deliberate

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recklessness.”

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11-15860, 2012 WL 6634351, at *4 (9th Cir. Dec. 21, 2012)

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(quotation marks omitted).

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person would deem the inference of scienter cogent and at least as

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compelling as any opposing inference one could draw from the facts

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alleged.”

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(9th Cir. 2009) (quotation marks omitted).

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the complaint’s allegations must be read “holistcally.”

In re VeriFone Holdings, Inc. Sec. Litig., No.

Scienter is shown “only if a reasonable

Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 991

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To determine scienter,
In re

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VeriFone, 2012 WL 6634351, at *5.

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made clear that courts do not need to consider whether each

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allegation of scienter creates a strong inference of that mental

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state, because a holistic review will suffice.

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in a holistic analysis, but noting a dual analysis, where

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allegations are analyzed individually and then holistically, is

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“permissible”).

Id. at *6 (engaging

Lead Plaintiff has sufficiently alleged scienter as to Gao,

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The Ninth Circuit has recently

and thus has also successfully alleged it as to Yuhe.

See Glazer

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Capital Mgmt., LP v. Magistri, 549 F.3d 736, 744 (9th Cir. 2008).

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The CEO, Gao, proposed a “fake deal” to Zheng in order to lure

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American investment.

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Yingjun, both made remarks at the June 17 conference call

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indicating that they intentionally did not reveal that the Dajiang

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deal was “retract[ed]”:

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•

(CAC ¶ 78.)

Moreover, Gao and the CAO,

CAO: “[W]e worried that the cancellation of the contract and

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refunded cash would provoke negative reactions from the

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capital market.”

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•

had previously promised.”

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CEO: “[M]anagement was under huge pressure to deliver what we

•

CFO: “The contract retract happened after our previous auditor

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Grant Thorton resigned, so CEO worried that a retracted

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contract would increase negative investor sentiments and

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adversely affected [sic] the share price.”

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•

CEO: “[I]f the Company just put these [sic] money aside for

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cash reservation of purchasing additional breeder farms other

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than those farms from Dajiang, it wouldn’t impact the

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financials of the Company and hence no volatility in the share

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price.”

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(Id. ¶ 83.)
There is also sufficient scienter regarding Yingjun.

On the

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June 17, 2011, conference call he expressed taking part in a scheme

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to hide the fact that the Dajiang deal fell through, which on that

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call was claimed to have occurred by March 2010: “Since we had a

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contract signed with Dajiang and the contract was disclosed, we

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worried that the cancellation of the contract and refunded cash

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would provoke negative reactions from the capital market.”

(Id.)

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The heightened scienter standard is not met for Gang, the CFO,

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though.

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Dajiang deal from Gang.

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provide enough information about Gao’s duties as CFO for the Court

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to infer that he would have had knowledge of something the CEO

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actively hid from him.

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Defendants’ job duties generally, and not specifically discussing

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Gao’s).

The CAC avers that the CEO hid the breakdown of the
(Id.)

Additionally, the CAC does not

(See id. ¶ 116) (describing the Individual

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B. The Section 11 Claim Against All Defendants

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The CAC states that all Defendants are liable under Section 11

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of the Securities Act, because there were materially false

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statements about the Dajiang acquisition in the Prospectus and

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Prospectus Supplement for Yuhe’s second stock offering.

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129-44.)

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Lead Plaintiff does not have standing to pursue a Section 11

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claim.3

(CAC ¶¶

The Yuhe Defendants and the Underwriter Defendants argue

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The Underwriter Defendants also argue that the Section 11 claim should be

(continued...)
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Section 11 of the Securities act “provides a cause of action

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to any person who buys a security issued under a materially false

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or misleading registration statement.”

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Sec. Litig., No. 11-15599, 2013 WL 11887, at *1 (9th Cir. Jan. 2,

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2013).

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show they “have purchased shares in the offering made under the

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misleading registration statement,” or if they purchased their

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shares in the aftermarket standing will be found “provided they can

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trace their shares back to the relevant offering.”

In re Century Aluminum Co.

To have standing to sue under Section 11 plaintiffs must

Id.

The latter

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approach is “often impossible,” and conclusory allegations in the

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complaint that the shares are traceable will not suffice.

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*1-2.

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Id. at

The CAC alleges that on October 20, 2010 there was a second

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offering for Yuhe stock at a price of $7 per share.

(CAC ¶ 60.)

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It is also alleged that Lead Plaintiff bought shares “pursuant to

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the October 20, 2010 Prospectus Supplement,” and that it purchased

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stock “pursuant to the offering.”

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plaintiffs purchase stock pursuant to an offering or a prospectus,

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it means that they have purchased stock from its issuer.

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Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d 965, 983 (N.D. Cal.

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2007); In re Nat'l Golf Properties, Inc., No. CV 02-1383GHK(RZX),

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2003 WL 23018761, at *2.

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traceable to a particular offering will not suffice, because it is

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difficult to trace the chain of custody of stock in the

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aftermarket.

(CAC ¶¶ 17, 60, 130, 139.)

When

See In re

A conclusory statement that stock is

In re Century Aluminum Co. Sec. Litig., 2013 WL

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28

3

(...continued)

stricken for this same reason. The Underwriter Defendants motion to strike
argument, thus, fails for the same reason its motion to dismiss argument does.

13

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11887, at *2 (9th Cir. Jan. 2, 2013).

However no such difficulty

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exists when stock is purchased pursuant to a prospectus or

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offering, so Plaintiff’s allegations in paragraphs 17, 60, 130, and

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139 will suffice.

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members of the Subclass who purchased Yuhe stock that is traceable

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to the secondary offering, and since Lead Plaintiff does not

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provide any detailed analysis as to how these Subclass members’

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shares can be traced to the relevant offering, the Court dismisses

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the Section 11 claims of these subclass members.

Nevertheless, since Plaintiff seeks to represent

(CAC ¶ 1; See

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generally CAC); See In re Century Aluminum Co. Sec. Litig., 2013 WL

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11887, at *1-2.

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The Yuhe Defendants next state that Lead Plaintiff’s Section

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11 claim sounds in fraud, and that Lead Plaintiff has not alleged

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sufficient facts to prove such a claim.

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complaint ‘sounds in fraud’ we must normally determine, after a

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close examination of the language and structure of the complaint,

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whether the complaint ‘allege[s] a unified course of fraudulent

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conduct’ and ‘rel[ies] entirely on that course of conduct as the

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basis of a claim.’”

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1161 (9th Cir. 2009) (citation omitted).

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seriously contest whether the Section 11 claim against the Yuhe

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Defendants sounds in fraud; it only argues that it satisfied its

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pleading obligations should the Court find that it does.

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No. 111 at 22:14-19.)

“To ascertain whether a

Rubke v. Capitol Bancorp Ltd, 551 F.3d 1156,
Lead Plaintiff does not

(Docket

Lead Plaintiff has, thus, conceded that this

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14

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claim against the Yuhe Defendants sounds in fraud.4

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L.R. 7-12.

Cent. Dist.

A Section 11 claim that sounds in fraud does not need to meet

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the “heightened pleading requirements of the PSLRA,” but under Rule

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9(b) the claim must “set forth what is false or misleading about a

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statement, and why it is false.”

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(citations omitted).

8

Supplement incorporated by reference a number of previous SEC

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filings that falsely claimed, among other misrepresentations, that

Rubke, 551 F.3d at 1161

As discussed, the October 20, 2010 Prospectus

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Yuhe had an agreement with Dajiang.

(CAC ¶¶ 71-72.)

Therefore,

11

Lead Plaintiff has met its burden regarding alleging a Section 11

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claim that sounds in fraud.

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is entitled to a loss causation affirmative defense as a matter of

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law.

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[defendant] needed to prove that the depreciation in value . . .

16

resulted from factors other than the . . . material misstatement.”

17

In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1422 (9th Cir.

18

1994) (internal quotations and citation omitted).

19

“fact-intensive” nature of a causation analysis, it usually must be

20

established in summary judgment or trial, not a motion to dismiss.

21

In re Countrywide Fin. Corp. Sec. Litig., 588 F. Supp. 2d 1132,

22

1171 (C.D. Cal. 2008).

The Auditor Defendant argues that it

“To establish a ‘loss causation’ defense under Section 11(e),

Because of the

The burden for proving loss causation is

23
24
25
26
27
28

4

Although Lead Plaintiff’s Section 11 claim against the Yuhe Defendants
sounds in fraud, this ruling does not automatically apply to the other
Defendants. Mallen v. Alphatec Holdings, Inc., 861 F. Supp. 2d 1111, 1125 (S.D.
Cal. 2012); In re Fuwei Films Sec. Litig., 634 F. Supp. 2d 419, 437 (S.D.N.Y.
2009). The Underwriter Defendants do not argue this point. The Auditor
Defendant seems to argue it in the reply brief, (Docket No. 120 at 2:8-25), but
the Court need not consider new arguments first raised in a reply brief. See
Zamani v. Carnes, 491 F.3d 990, 997 (9th Cir. 2007) (affirming district court's
decision to reject points raised for the first time in reply).

15

1

“heavy,” and the defense “can be used as a ground for dismissal on

2

a Rule 12(b)(6) motion to dismiss only if the merits of the defense

3

are apparent on the [complaint’s] face. . .”

4

Litig., No. CV 03-7063 NM, 2005 WL 3090882 (C.D. Cal. July 21,

5

2005) (internal quotation marks and citations omitted).

In re DDi Corp. Sec.

6

The Auditor Defendant is alleged to have reported Yuhe’s

7

finances in a way that falsely made it look like Yuhe had purchased

8

the Dajiang farms, when Yuhe had not.

9

Principally, the Auditor Defendant argues: “[T]he conclusion is

(CAC ¶¶ 91-92.)

10

inescapable that the decline in the value of Yuhe’s shares was due

11

to the combination of [the Auditor Defendant’s] resignation driven

12

by events that occurred in connection with the report of

13

GeoInvesting . . .”

14

Auditor Defendant’s resignation and the GeoInvesting Report are not

15

so separable from the Auditor Defendant’s alleged misstatements.

16

GeoInvesting’s report exposed Yuhe’s misrepresentation about

17

acquiring breeder farms from Dajiang, a misrepresentation that the

18

Auditor Defendant’s analysis of Yuhe’s finances further propagated.

19

Because the Auditor Defendant’s alleged misrepresentation is

20

interrelated to Yuhe’s, because Yuhe’s stock dropped when that

21

misrepresentation was exposed, and because causation is rarely

22

appropriate at the motion to dismiss stage, the Court cannot find

23

that the Auditor Defendant is entitled to the loss causation

24

defense as a matter of law.

25

(Docket No. 80 at 10:1-5.)

However, the

The Auditor Defendant also seeks dismissal of Lead Plaintiff’s

26

Section 11 claim on grounds that the CAC has not alleged facts

27

sufficient to prove negligence.

28

However, Section 11 only requires a plaintiff to prove “(1) that

(Docket No. 80 at 5:18-20.)

16

1

the registration statement contained an omission or

2

misrepresentation, and (2) that the omission or misrepresentation

3

was material, that is, it would have misled a reasonable investor

4

about the nature of his or her investment.”

5

1161 (internal quotation marks and citation omitted).

6

generally holds “the issuer of the securities . . . absolutely

7

liable.”

8

However, experts, like the Auditor Defendant here, “who have

9

prepared portions of the registration statement are accorded a ‘due

Rubke, 551 F.3d at
Section 11

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208 (1976).

10

diligence’ defense.

In effect, this is a negligence standard.”

11

Id.

12

Accordingly, with respect to the Auditor Defendant, Lead Plaintiff

13

“need not affirmatively plead negligence.”

14

Offering Sec. Litig., 241 F. Supp. 2d 281, 396 (S.D.N.Y. 2003).5

15

The Auditor Defendant only argues that the CAC does not allege

16

negligence.

17

alleges it acted reasonably, which would be required to establish

The expert must prove it acted with due diligence.

Id.

In re Initial Pub.

It fails, because it does not argue that the CAC

18
19
20
21
22
23
24
25
26
27
28

5

At oral argument, the parties discussed whether Lead Plaintiff had to
plead that the Auditor Defendant and the Underwriter Defendants were negligent.
Cases often state that non-issuer defendants will be liable for negligence.
See, e.g., In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d
Cir. 2010). However, this language indicates that a Section 11 claim against
non-issuer defendants will ultimately come down to negligence, because these
defendants may avoid liability if they prove they acted diligently. Thus, the
burden is not on Plaintiff to plead negligence. A recent case from the Second
Circuit is illustrative of this point. After holding that non-issuers “may be
held liable for mere negligence,” the Second Circuit clarified in a footnote
that:
More specifically, section 11 provides several due diligence
defenses available to non-issuer defendants, see 15 U.S.C. §
77k(b), and section 12(a)(2) contains a “reasonable care”
defense, id. § 77l (a)(2). . . . Generally speaking, defendants
bear the burden of demonstrating the applicability of each of
these defenses, which are therefore unavailing as a means of
defeating a motion to dismiss pursuant to Rule 12(b)(6).
Id. at 359, n.7.

17

1

an affirmative defense at the motion to dismiss stage.

2

California Library Ass'n, 955 F.2d 1214, 1219 (9th Cir. 1990)

3

(holding that “[f]or a complaint to be dismissed because the

4

allegations give rise to an affirmative defense ‘the defense

5

clearly must appear on the face of the pleading.’”).

6

McCalden v.

The Underwriter Defendants assert that the face of the CAC

7

establishes their due diligence defense.

They argue that their

8

work on the offering and prospectus relied on the auditors’

9

financial statements and certified expert opinions, which they were

10

entitled to do, and which, thus, justifies their dismissal.

11

underwriter need not conduct due diligence into the ‘expertised’

12

parts of a prospectus, such as certified financial statements.”

13

re Software Toolworks Inc., 50 F.3d 615, 623 (9th Cir. 1994).

14

underwriter “need only show that it ‘had no reasonable ground to

15

believe, and did not believe ... that the statements therein were

16

untrue or that there was an omission to state a material fact

17

required to be stated therein or necessary to make the statements

18

therein not misleading.’”

19

the due diligence defense, courts look to plaintiffs to point to

20

red flags that should have indicated to the underwriter that the

21

financial statements were not trustworthy.

22

Id.

“An

In
An

Although an underwriter must prove

See id. at 623-24.

While In re Software Toolworks was decided at the summary

23

judgment stage, in In re Countrywide a district court allowed a

24

defendant underwriter to establish the due diligence defense at the

25

motion to dismiss stage, because “underwriters may reasonably rely

26

on auditors' statements, absent red flags that the underwriters

27

were in a position to see.”

28

unpublished decision in this district has disagreed with In re

588 F.Supp.2d at 1175.

18

At least one

In re China Intelligent Lighting and Electronics,

1

Countrywide.

2

Inc. Sec. Litig., No. CV-112768-PSG (SSx), at * 11.

3

court did not fully address the very basis of In re Countrywide’s

4

ruling: that underwriters occupy a special place in Section 11

5

jurisprudence because they are allowed to rely on auditors’ work,

6

absent red flags.

However, this

The Court here agrees with In re Countrywide.

The CAC is essentially silent about the underwriters, other

7
8

than identifying them.

(CAC ¶¶ 23-26.)

Lead Plaintiff’s

9

opposition argues that various red flags should have alerted the

10

Underwriter Defendants to the misleading statements in the Auditor

11

Defendant’s work.

12

auditor, Grant Thornton, resigned.

13

disclosure regarding Grant Thornton’s resignation would have

14

alerted the Underwriter Defendants to the Dajiang deal being

15

fraudulent.

16

Auditor Defendant’s production of an audit opinion in twenty-two

17

days after Grant Thornton’s resignation should have been a red

18

flag.

19

performed too quickly.

20

much information the auditors had to analyze, and how many auditors

21

they devoted to the audit, among other factors.

22

does not allege sufficient information about these matters.

23

Moreover, the Auditor Defendant was Yuhe’s auditor from March 12,

24

2008 until December 7, 2009, when Grant Thornton assumed that role.

25

(Id. ¶ 47.)

26

later, the Auditor Defendant was reappointed.

27

emphasis on the twenty-two day time span is not particularly

28

probative, because the Auditor Defendants were likely already

Most notable among these are that the prior

(See id. ¶ 47.)

However, nothing in the

Lead Plaintiff also suggests that the

However, nothing before the court shows that the audit was
Such a determination would depend on how

However, the CAC

After Grant Thrornton’s resignation three months

19

(Id.)

Thus the

1

familiar with Yuhe.

The Section 11 claim against the Underwriter

2

Defendants is, therefore, dismissed without prejudice.

3

C. The Section 12(a)(2) Claim

4

The Underwriter Defendants ask this Court to dismiss Lead

5

Plaintiff’s Section 12(a)(2) claim.

“Section 12(a)(2) provides for

6

civil liability of securities sellers to purchasers if the seller

7

used certain instruments, including a prospectus, containing untrue

8

statements or material omissions.”

9

980; 15 U.S.C. § 77l(a)(2).

In re Levi, 527 F. Supp. at

Section 12 “permits suit against a

10

seller of a security by prospectus only by ‘the person purchasing

11

such security from him,’ thus specifying that a plaintiff must have

12

purchased the security directly from the issuer of the prospectus.”

13

Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1081 (9th Cir.

14

1999)(quoting 15 U.S.C. § 77l (a)(2)).

15

shares in the aftermarket will not have standing under Section 12,

16

even if he can trace those shares back to the relevant offering.

17

In re DDi Corp., 2005 WL 3090882, at *17 (C.D. Cal. July 21, 2005).

18

When plaintiffs purchase stock pursuant to an offering or a

19

prospectus, it means that they have purchased stock from its

20

issuer.

21

Golf Properties, Inc., 2003 WL 23018761, at *2.

22

A plaintiff who purchased

In re Levi Strauss, 527 F. Supp. 2d at 983; In re Nat'l

Paragraphs 17, 139, and 146 make clear that Lead Plaintiff and

23

at least some class members purchased stock “pursuant to” the

24

offering and “pursuant” to the prospectus.

25

Plaintiff has stated a claim on behalf of itself and all class

26

members who purchased pursuant to the offering, and that is all

27

that is needed to survive a motion to dismiss.

28

Strauss & Co. Sec. Litig., 527 F. Supp. 2d at 983; In re Nat'l Golf
20

Accordingly, Lead

See In re Levi

1

Properties, 2003 WL 23018761, at *2.

However, to the extent

2

members of the subclass hold shares that are only traceable to the

3

second offering, (see CAC ¶ 1), their claims are dismissed with

4

prejudice.

5

July 21, 2005).

In re DDi Corp., 2005 WL 3090882, at *17 (C.D. Cal.

6

D. Defendant Yuhe’s Motion to Strike

7

Yuhe has moved to strike paragraphs 2-4, 75-81, and 107 from

8

the CAC.

(Docket No. 83 at 5:23-25.)

Because these paragraphs

9

improperly rely on an outside report, Yuhe argues, they violate

10

Plaintiffs Rule 11 duty to conduct an independent investigation on

11

matters alleged in the complaint.

12

5:25.)

13

(See generally id. at

3:19-

Portions of a CAC that do not comport with Rule 11's

14

independent investigation requirement may be stricken.

See In re

15

Connetics Corp. Sec. Litig., 542 F. Supp. 2d 996, 1004-05 (N.D.

16

Cal. 2008); Fraker v. Bayer Corp., No. CVF08-1564 AWI GSA, 2009 WL

17

5865687 (E.D. Cal. Oct. 6, 2009).

18

who files pleadings with a court “certifies that to the best of the

19

person's knowledge, information, and belief, formed after an

20

inquiry reasonable under the circumstances: . . . the factual

21

contentions have evidentiary support or, if specifically so

22

identified, will likely have evidentiary support after a reasonable

23

opportunity for further investigation or discovery.”

24

P. 11(b).

25

for an attorney to “personally ... validate the truth and legal

26

reasonableness of the papers filed,” Pavelic & LeFlore v. Marvel

27

Entm't Group, 493 U.S. 120, 126 (1989), and “to conduct a

Under Rule 11(b), an attorney

Fed. R. Civ.

Rule 11(b) recognizes a “nondelegable responsibility”

28
21

1

reasonable factual investigation,” Christian v. Mattel Inc., 286

2

F.3d 1118, 1127 (9th Cir. 2002).

3

Yuhe states that GeoInvesting was a short-seller “seeking to

4

benefit from the publication of negative information” about Yuhe,

5

and that reliance on the GeoInvesting Report is insufficient to

6

satisfy Rule 11(b)’s independent investigation requirement.

7

(Docket No. 119 at 1:20-22, 2:7-9.)

8

states that multiple sources informed their allegations in the

9

challenged portions of the CAC.

10
11
12
13
14
15
16
17

Lead Plaintiff, however,

Lead Plaintiff states:

The paragraphs Yuhe seeks to strike, on Rule 11
grounds no less, contain facts obtained from a Form
8-K Yuhe filed on June 20, 2011 attaching its June 14,
2011 press release, including five documents Yuhe
disseminated to investors in support of its purported
purchase of Dajiang’s thirteen breeder farms (¶79);
excerpts from four publicly-available transcripts of
telephone calls wherein the Chairman of Dajiang
repeatedly denies [to a GeoInvestiang investigator]
that it sold its breeder farms to Yuhe and never
received any money from it (¶¶76, 77, 78, and 81); and
an investigatory report by GeoInvesting LLC (¶¶2, 75)
along with a few website postings regarding its
participation in an investor conference call with Yuhe
(¶¶3, 4, 80).

18

(Docket No. 112 at 1:11-20.)

19

Plaintiff’s argument, they have conceded it.

20

12; See also Figueroa v. Baja Fresh Westlake Vill., Inc., CV 12-

21

769-GHK SPX, 2012 WL 2373254, at *2 (C.D. Cal. May 24, 2012);

22

Richter v. Mut. of Omaha Ins. Co., CV 05-498 ABC, 2007 WL 6723708,

23

at *5 (C.D. Cal. Feb. 1, 2007) aff'd, 286 F. App'x 427 (9th Cir.

24

2008); Westerfield v. Wade, No. CV05-6645 ABCCWX, 2006 WL 5668264,

25

at *4 (C.D. Cal. Oct. 4, 2006).

26

Since Yuhe does not respond to
Cent. Dist. L.R. 7-

This leaves some paragraphs where the GeoInvesting report,

27

supplemented by Lead Plaintiff’s attorney’s “multiple”

28

conversations with GeoInvesting about the “basis for its
22

1

investigatory report and its communications with Mr. Zheng,” is the

2

only source.

3

Defendants argue that the GeoInvesting Report is not reliable, and

4

their principle case for the point is Zucco Partners, LLC v.

5

Digimarc Corp., 552 F.3d 981, 995 (9th Cir. 2009).

6

of Zucco they cite deals with the appropriate way for a court to

7

analyze a pleadings that rely on a confidential witness.

8

the present case, the Yuhe Defendants do not argue, nor could they,

9

that the GeoInvesting report is a confidential source.

(Markert Decl. ¶ 113, Docket No. 113.)

The Yuhe

But the portion

Id.

In

While the

10

Yuhe Defendants argue that the GeoInvesting report is not credible,

11

because, among other reasons, GeoInvesting was a short seller with

12

an interest in diminishing Yuhe’s stock value, the effects

13

GeoInvesting’s motive is “a factual dispute not appropriate for

14

resolution at this stage.”

15

Sec. Litig., No. CV 10-9239 CAS JCX, 2011 WL 4978483, at *4 (C.D.

16

Cal. Oct. 11, 2011) (refusing to analyze motives of a short seller)

17

(quoting Henning v. Orient Paper Inc ., No. CV 10–5887 VBF, 2011 WL

18

2909322, at *4 (C.D.Cal. Jul.20, 2011).

19

See In re China Educ. Alliance, Inc.

The Yuhe Defendants seek to distinguish In re China Educ. by

20

arguing that in the instant case particular facts in the

21

GeoInvesting report suggest that it is unreliable.

22

the Yuhe Defendants note that: GeoInvesting gathered its

23

information in part by speaking to an individual, Mr. Zheng, under

24

false pretenses, and, further, that Mr. Zheng gave contradicting

25

statements at one point as to whether Yuhe ever talked with Dajiang

26

about acquiring farms.

27

allegedly used false pretenses to speak with Zheng, does not mean

28

it did not learn the truth from him.

Particularly,

However, just because GeoInvesting

23

Additionally, it is not clear

1

Zheng gave contradictory statements.

2

negotiations happened, when he later stated they did occur, he said

3

the negotiation was for a “fake deal.”

4

statements could be seen as consistent, as a negotiations for a

5

fake deal might be considered as a non-negotiation.

6

analysis into the “truth” of the GeoInvesting report would be

7

inappropriate, because doing so would implicate a factual dispute

8

that should not be decided at this stage.

9

2909322, at *4.

10
11

Although he first denied that

(CAC ¶ 78.)

Zheng’s

Any further

See Henning, 2011 WL

Accordingly, the Yuhe Defendants’ motion to strike is DENIED.
IV. Conclusion

12

For the reasons stated, the Court DENIES the Defendants’

13

motions, with the exception of GRANTING dismissal of the Section 11

14

claim against the Underwriter Defendants, GRANTING Dismissal of the

15

Section 10(b) claim against Gang, and GRANTING dismissal of the

16

Section 12(a)(2) and Section 11 claims of all subclass members

17

whose Yuhe shares are only traceable to the second offering.

18

Dismissal is without prejudice, except as to the Section 12(a)(2)

19

claims.

20
21

IT IS SO ORDERED.

22
23
24

Dated: March 5, 2013
DEAN D. PREGERSON
United States District Judge

25
26
27
28
24