Leshinsky v. Wang et al

Filing 170

OPINION & ORDER #105156 re: 153 LETTER MOTION for Conference addressed to Judge Paul A. Engelmayer from A. Ross Pearlson, Esq. dated October 10, 2014. filed by Smartheat, Inc., 159 MOTION to Strike Document No. 150 Dec laration of William McGrath. filed by Stream Sicav, 144 MOTION to Certify Class . filed by Tien Chung. For the reasons set out above, plaintiffs' motion for class certification is denied. The Clerk of Court is respectfully d irected to terminate the motions pending at docket numbers 144, 153, and 159. The schedule set out in the body of this opinion is hereby ordered., ( Motions due by 2/17/2015., Responses due by 3/16/2015., Replies due by 3/31/2015.) (Signed by Judge Paul A. Engelmayer on 1/21/2015) (lmb) Modified on 1/21/2015 (ca).

USI-ìC SDNY

DOCUMENT

BLECTRONICALLY FILED

TINITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK

DOC #

X

D¡\TIi îLLED ;!!! t I zo tb

STREAM SICAV and TIEN CHLING, individually and
on behalf of all others similarly situated,
12 Civ.6682 (PAE)

Plaintiffs,

OPINION & ORDER

-vJAMES JUN WANG, SMARTHEAT, INC.,
DOES 1+,

ANd

JOHN

Defendants

X
PAUL A. ENGELMAYER, District Judge:
On March l7,2014,the Court issued an order denying, without prejudice, plaintiffs'

motion for class certification. See Dkt. 114. The Court did so for several reasons, including
because plaintiffs had not yet articulated a credible theory under which injury could be proven on
a classwide basis, because

fact discovery remained ongoing, and because the Supreme Court's

then-forthcoming decision in Halliburton Co. v. Erica P. John Fund,No. 13-317,hadthe
potential to alter the legal analysis governing class certification in putative securities class
actions premised on a fraud-on-the-market theory.

With fact discovery now complete, and with the Halliburto,n decision handed down,

plaintifß have moved again for class certification.

See

Dkt. I44. The Court has carefully

reviewed that motion and the materials submitted in support of it, see Dkt. 145 ("P1. Br."), 46
("P1. Decl."), 156-58, as well as defendants' submissions in opposition,

seeDkt,l49 ("Def.

Br."), 150 ("Def. Decl.").
For the reasons that follow, the Court denies plaintiffs' motion for class certification, on
the grounds that plaintiffs' submission is insufficiently rigorous, and fails to satisfy multiple

requirements for class certification set by Federal Rule of Civil Procedure23, including those

of

typicality, adequacy, and predominance. However, this ruling is without prejudice. The Court

will grant plaintiffs

a

final opportunity, on the schedule set forth below, to establish that class

certifi cation is merited.

By way of background, plaintiffs claim that SmartHeat, Inc. violated federal securities
laws by secretly amending a written lock-up agreement under which certain company insiders
were barred from selling shares of SmartHeat stock until the start of 2012, and which SmartHeat
had publicly touted as a sign of its executives' confidence in the company. Plaintiffs seek to

certify

a class

of "[a]ll persons who purchased or acquired shares of SmartHeat,Inc. stock

between February 24,2010 and May 30,2012."t

Dkt.l44,atL

As explained in its March I7,2014 order, the Court understood plaintiffs, in seeking
class certihcation, to articulate two distinct theories as to how the undisclosed amendment of the

lock-up agreement that enabled insiders to sell their SmartHeat shares caused classwide injury.
See

Dkt. 114. The first theory was that SmartHeat's public statements that certain insiders had

committed to hold their shares had boosted the value of the shares; that purchasers of shares

following the announcement of the lock-up agreement had therefore paid

a

premium to buy the

shares; and that these purchasers had suffered losses when it was revealed that the agreement had
been amended to permit insiders to sell their shares. The Court referred to this as the "revision

theory." As the Court noted, such an approach to proving classwide injury was in line with the
manner in which classwide injury is commonly proven. See id.

I The proposed class excludes defendants, other SmartHeat officers and directors, and their
families and affiliates.
2

But as the Court's order also noted, to be sustainable, this theory required that there have
been a legally cognizable "corrective disclosure"-,i.e., an announcement or other revelation

of

the fact that insiders had been freed to sell their shares-that caused a drop in the trading price

of

SmartHeat's stock. There did not appear to have been any such announcement. Rather, the
share price had gradually dropped to below $1 per share, to the point at which

it had been de-

listed and trading had ceased, with no such revelation of the alleged amendment to the lock-up
agreement having ever been made. The Court therefore held that, before a class could be

certified on this theory, plaintiffs were required to identify some form of corrective disclosure,
for otherwise SmartHeat's failure to disclose the amendment of the lock-up agreement could not
be said to have caused classwide

injury.

See id'

oorevision
In their renewed motion for class certification, plaintiffs have abandoned the

theory" of liability. Presumably, this is because, as the Court anticipated in its earlier order, the
historical record simply does not reveal any disclosure (by SmartHeat or otherwise) while the
stock was still trading of the abandonment of the company's lock-up agreement, let alone that the

company's stock price dropped following such a disclosure.
Instead, plaintiffs now pursue solely the second theory of classwide injury identified in
the Court's March

17

,2014 order. See Pl. Br. 2*3. This theory is that the once-prohibited

insider sales themselves had driven down the stock's trading price. In other words, plaintiffs
contend, the sale of these SmartHeat shares, and the ensuing availability on the market of an
unexpectedly large number of freely tradable SmartHeat shares, drove down the stock's price

during the 27 -monfh class period, so as to injure persons who had previously purchased the
stock. The Court referred to this

as the

"insider sale" theory of liability. Dkt. 114.

a

J

Plaintiffs' "insider sale" theory is an unusual theory of classwide injury. In

a

typical

securities fraud class action, plaintiffs allege that the market reacted negatively on a given day or
several-day period to a corrective disclosure, causing a decline in stock value that simultaneously
harmed all shareholder class members in the same way. See, e.g.,In re Bank of Am. Corp. Sec.,

Derivative, & Employee Ret. Income Sec. Act (ERISA) Litig.,281 F.R.D. 134,143 (S.D.N.Y.
2012); Wagner v. Baruick Gold Corp,, 251 F.R.D . 172,1 19 (S.D.N.Y. 2008). Here, however,

plaintiffs do not allege that their injury resulted from

all

a one-time stock-price drop that affected

class members. Instead, they make an argument based on the mechanics by which trading

of

SmartHeat shares occurred on the NASDAQ market between February 2010 and May 2012.

Specifically, plaintiffs argue that, as a consequence of unlocking insider shares, all sales of
SmartHeat stock during that 27-monthperiod were made at aprice below that which would have
been set had those shares remained locked

up. Although the precise

cause of this long period

of

alleged price diminution is not clear from plaintiffs' papers, plaintifß' expert, Dr. Steven P.
Feinstein, appears to attribute it to factors including the increased number of SmartHeat shares
available for purchase and sale, the percentage increase that the shares unlocked for sale
represented over all other shares, and/or the timing at which previously locked-up shares were

sold in the market. SeePl. Decl., Ex. 1 ("Feinstein Rep'"), at29-34.

In claiming classwide injury on these grounds, plaintiffs face daunting precedent.

Historically, claims of injury due not to corrective disclosures but rather to the mechanics by
which shares of stock were priced during a protracted period of open-market trading have almost
always been held ill-suited to classwide resolution. Instead, as the courts that have considered
such claims have recognized, trade-specific inquiries are almost always needed to ascertain

whether the price a customer paid on a particular trade was, or was not, compromised by a

4

defendant's allegedly unlawful conduct. As these cases have noted, a defendant may be liable as

to some trades but not others, and a judgment of liability (or non-liability) on any particulat ttade
may not bear on (let alone determine) whether there was liability on another. Accordingly,
because of the need for a trade-by-trade inquiry into whether or not there was persistent price

inflation (or deflation), Rule 23(b)(3)'s requirement that common issues predominate over
individualized ones is not met. See, e.g., In re Initial Pub. Offerings Sec. Litig. ("lPO"), 47I

F.3d24,44 (2d Cir. 2006) (finding class certification unwarranted based on claims that
customers suffered price injury based on issuers' practices in allocating IPO shares and trading
such shares in the IPO "aftermarket"); Newton v.

Merrill Lynch,259 F.3d 154, 187 (3d Cir.

2001) (upholding denial of motion for class certification based on claim that buyers and sellers

of shares on NASDAQ were denied best execution by broker-dealer's policy of executing trades
only at the National Best Bid and Offer price); Pearce v, UBS PaineWebber, Inc,, No. 02 Civ.
240g-t7 (cRA), 2004WL5282962,at *10-11 (D.S.C. Aug. 13,2004) (denyingmotionforclass
certification based on claim that broker-dealer added two cents per share to best execution price
charged to customers for NASDAQ stocks); Grandonv, Meruill Lynch,

No' 95 Civ' 10742

(SWK), 2003 WL 22118979, at *9 (S.D.N.Y. Sept. 11, 2003) (denying motion for class
certification based on claim that broker-dealer marked up municipal bond prices by a.6%).
For a number of reasons, the Court holds, a class similarly cannot be certified here on

plaintiffs' insider

l.

sale theory, based on the present record:

Inadequate explication oftheory ofconsistent price-decrease during class period:

Plaintiffs' expert, Dr. Feinstein, opines that it is theoretically possible for the infusion of

a large

number of shares to affect a stock's price over a long period of time. See Feinstein Rep. 29-34.
Perhaps

so: Although the Court is quite skeptical that the existence of

5

a discrete number of even

large sell orders and/or the availability for purchase and sale on a stock market of larger number

of shares would tend to deflate a stock's trading price over
shareholders,2

a long

period of time so as to harm all

it is not the Court's place on a class-certifìcation motion to find against plaintiffs

on this theoretical point. And the Court does not rule out that a colorable showing to this effect
could be made, based on a close analysis of trading patterns of a particular security during a

particular time period.
However, Dr. Feinstein does not undertake a close analysis, or indeed any analysis, of the

trading activity at issue in this case to determine if a credible claim can be made, based on actual
evidence, that the trading price of SmartHeat shares on NASDAQ over the 27-month class

period consistently was reduced by the fact that previously locked-up shares were available for
purchase and sale. Instead, his brief discussion of the point is limited to citing research literature
oosustained
large-scale selling generally has a persistent negative
supporting the proposition that

impact on the subject stock's price." Id, at 31. But there is no showing in his report that there
was "sustained large-scale selling" of the security here throughout the 27-month class period

sufficient to create a persistent negative impact on stock price. There is no attempt, for example,
to identify the number of

oolarge

oometaorders" of SmartHeat stock' Id' at 32
trading orders" or

(citation omitted). Nor is there analysis as to the impact of the release into the market on
particular dates of particular quantities of previously locked-up shares. There is also no analysis
as to the factors that affected

how the market came to price SmartHeat stock on the hundreds of

individual days comprising the class period. And there is no explanation

as

to why the volume

The issue here does not involve the issuance of new shares, which would predictably reduce the
per-share value of outstanding shares. As alleged, the amendment of the lock-up agreement did
not increase the number of outstanding SmartHeat shares, and thus did not affect the portion of
SmartHeat's market capitalization represented by a particular share. It affected only the number
of shares available for purchase and sale on NASDAQ.
2

6

of shares available for sale (as opposed to a stream of negative news about the company)
accounted for the long period of decline in SmartHeat's share price during the class period'
Instead,

plaintiffs' claim of a27-month-long artificial depression in SmartHeat share price is

cursory and wholly theoretical. Absent a concrete presentation of the evidence on which such a

finding could be made in this case, the Court cannot find that price injury to all class members
can be established by common

proof. As in IPO, Newton, Pearce,

and Grandon,the absence

of

common proof of the essential elements of economic injury and loss causation compels a finding
that the common issues do not predominate over individual ones. See Fed. R' Civ. P. 23(bX3).

2.

Adequacy issues with respect to lead plaintiff, Based on plaintiffs' renewed

submission for class certification, there is only one class representative on whom the class case
turns: Tien C, Chung. The Court has substantial questions about Mr. Chung's adequacy as a
class representative. ,See Fed. R. Civ.

P

. 23(ùØ). His sworn certification, dated Jvne 21,2012,

represents that he purchased SmartHeat stock on one occasion: He attests that he bought 3,305
shares of that stock on

April

1, 2010, at a price of $11.99 per share. Se¿

based on an attachment to the report of

Dkt. 108-2. Howevet,

plaintiffs' expert, Dr, Feinstein, which tracks

SmartHeat's trading history, thaf appears to be an impossibility: On April 1,2010, SmartHeat's
closing price was $101.60, and the stock's price did not drop to the vicinity of $12 per share until
more than 14 months later. See Feinstein Rep., Ex. 4, at 57,66.3 lttherefore appears either that

Mr. Chung purchased

a

different security or that his certification, sworn to under penalty of

perjury, was inaccurate. The Court also has not been supplied with any evidence bearing on Mr.

The share prices in the Feinstein Report have been adjusted to reflect a 1O-for-1 reverse stock
split effective February 6,2012. Feinstein Rep. Ex. 4, at73. However, even taking that into
a'ccount, the share priie between March 3I,2010 and April 5,20l0-.the trading days before and
after April 1,2012-was between $10.74 and $9.93, well below the price that Mr' Chung claims
to have paid. Id. at 57.
3

7

Chung's qualifications to lead the class. Beyond his June 21,2012 certification, the only
declaration he has submitted merely recites the procedural history of the case and his duties as
purported class representative. See Pl. Decl., 8x. 3.

3.

Other predominance and typicality issues: Even assuming that Mr. Chung

purchased SmartHeat stock on April 1, 20l0,his claims as class representative would have to be

"typical of the claims . . . of the class," Fed. R. Civ. P. 23(a)(3), such that a finding of liability

as

to him could fairly bind defendants as to the class's claims. Cf, AT&T Mobility LLC v'
Concepcion, 131 S. Ct.1740,1751 (2011) ("For a class-action money judgment to bind
absentees

in litigation, class representatives must at all times adequately represent absent class

members."). And issues common to the class would have to predominate over issues specific to

individual stock purchases (e.g,, Mr. Chung's or those by other class members). For several
reasons, Dr. Feinstein's expert report, on which

plaintiffs' class-certification motion relies,

does

not provide the Court with a concrete, non-speculative basis on which to reach the conclusion
that adetermination of SmartHeat's liability to Mr. Chung would fairly resolve defendants'

liability to the broadly-deflrned

a.
a

class.

There is no explanation in that report as to how or on what concrete basis

factfinder could determine that the price at which Mr. Chung purchased his shares on April

1,

2010 was inflated above what it would have been had the insider shares remained locked up, as

plaintiffs

appear

to claim, To the contrary, the gist of Dr. Feinstein's report is that the price of

SmartHeat stock was lower during the class period because the previously locked-up shares were

in fact for sale. And plaintiffs allege that defendant Wang covertly sold a total of 380,000 shares
beginning on February 24,2010. Dkt. 52 ("SAC") 1[7. If anything, then, a logical inference
from Dr. Feinstein's report would appear to be that there was an unexpectedly high volume of

8

selling activity due to insider sales between February 24 and April 1, 2010, which presumably
drove the stock's trading price down by the time of Mr. Chung's purchase.

b.

Nor is there any explanation in that report

as

to how or on what concrete

basis a factfinder could determine that the decline in SmartHeat's share price after

April

was due, in material part, to sales of previously locked-up shares or to the higher volume

1, 2010

of

tradable shares as a result of the fact that once-locked-up shares were now tradable. There is no
attempt made to distinguish the portion, if any, of the stock's decline during the class period
attributable to insider sales from the decline caused by other company-specific factors'

c.

Most important, there is no explanation as to how, concretely, the

evidence pertaining to Mr. Chung's April 1, 2010 purchase could support the conclusion that

similar stock price inflation and deflation affected the holdings of other purchasers of SmartHeat
stock on all other stock-purchase dates during the 27-month-long class period. The class period
commenced five weeks before Mr. Chung's purchase and lasted for 26 months afterward. On

February 24,2010,the stock closed at$123.70; on April I,20l0,the stock closed at $101.60;
and on May 30, 2012,the stock closed at $4.04.

,See

Feinstein Rep., Ex, 4, at

57,73' Dt'

Feinstein's report theorizes that it is possible that the release of previously locked-up shares into
a

trading market could have a long-term price impact. But there is no attempt made to show that

common proof in this case couldestablish a price injury to Mr. Chung that would serve as a fair

proxy to prove the fact of such injury to purchasers of SmartHeat stock on each day during the
lengthy class period.

4.

Logistical inconsistencies within plaintffi' pleadings: Even assuming that there

were a showing that common proof could establish both price inflation on the date of Mr'

Chung's purchase and all dates (before and after) when other class members bought SmartHeat

9

stock-i.e., that defendants' liability to the entire

class could be extrapolated from defendants'

liability to Mr. Chung-plaintiffs' definition of the class appears inconsistent with aspects of
plaintiffs' pleadings. Plaintiffs allege that the lock-up agreement,
the start of 2012. SAC

as announced, was to last

until

I 13. If so, there is no apparent basis for including, within the class,

persons who purchased SmartHeat stock between January 2012 and May 30, 2012, during which

period a purchaser would have been on notice that the previously locked-up shares were freely
tradable. And there is no apparent basis for including, within the class, persons who continued to
hold SmartHeat stock after January 20l2,when a shareholder undisputedly would be on notice
that the stock price could be affected by a higher volume of tradable shares. Notably, this latter
category includes Mr. Chung.

5.
elements of

Lack of explanation as to how damages would

be

proven: Even assuming that all

liability (including injury) were established as to Mr. Chung andthathis claims were

representative such that resolution of defendants' liability as to him would resolve defendants'

liability

as to the remainder

of the class, plaintiffs have not shown or explained, concretely, how

damages would be calculated as to any individual purchaser. Individvalized damages inquiries
are not necessarily inconsistent

with class certification. See Wallace v' IntraLinks,302 F.R.D.

310, 31S (S.D.N.Y,2014). However, to evaluate the Rule 23 elements of predominance and
superiority , see Fed. R. Civ. P. 23(bX3), the Court must understand, concretely, how plaintiffs
propose to reliably establish damages. See Comcast Corp. v.

Behrend,l33 S. Ct' 1426,1433

(2013) (Absent a sound model "establishing that damages are capable of measurement on a
classwide basis," plaintiffs "cannot show Rule 23(bX3) predominance: Questions of individual
damage calculations

will inevitably overwhelm questions common to the class."); In re

U'5.

Foodserv. Inc. pricing Litig.,72gF.3d 108, 123 n.8 (2d Cir.2013) ("[C]ourts should examine

10

the proposed damages methodology at the certification stage to ensure that

it is consistent with

the classwide theory of liability and capable of measurement on a classwide basis.").

6.

Lack of citations to admissible evidence: The period for fact discovery closed on

October 27,2014, see Dkt.140, but the authority cited for virtually all factual representations in

plaintiffs' class certification papets are the allegations made in plaintiffs' class action complaint.
See, e.g., Pl. Br.

4-5 (citing only the SAC for the propositions that, inter alia, SmartHeat officers

entered a lock-up agreement in January 2009, secretly amended the agreement in February 2070,
and sold 380,000 shares between February and August 2010). And defendants dispute many

of

plaintiffs' factual claims (e,g., whether the lock-up agreement was secretly amended, when the
insider sales occurred, etc.). Although the Court's role at the class-certification stage is not to
resolve factual disputes, the Court must ensure that there is a basis in admissible evidence for
each factual representation made in support of class certification to assure that a class is not

certified based on conjecture as opposed to provable facts. See, e.g., Cuevas v' Citizens Fin.
Grp., 1nc.,526F. App'x
conduct a

lg,2l-22 (2dCir.2013)

(summary order) ("[T]he district court must

origorous analysis' in determining whether
[Rule 23's] requirements have been met.

In making this determination, the 'district judge is to assess all of the relevant evidence admitted
at the class certification stage' and resolve all material disputed facts." (quoting Comcast, 133 S.
Ct. at 1432)).

For these reasons, on the present record, the Court cannot, and does not, find that the
Rule 23 requirements of commonality, typicality, adequacy, predominance, or superiority have
been established

"'by a preponderance of the evidence."'

See

Amara v. CIGNA Corp', No'

13

Civ.447,2014WL7272283,at*7 (2dCir. Dec. 23,2014) (quoting Malarkeyv. Texaco, Inc.,
983 F.2d 1204,1214 (2d Cir. 1993). For a class to be certified in this case, a far more rigorous,

11

and afar more convincing, submission must be made, The Court, accordingly, denies

plaintiffs'

motion for class certification. The denial is without prejudice-the Court will give plaintiffs one

final opportunity to seek class certification.
Should plaintiffs seek to move again for class certification, a revised motion in support of
class certification, accompanied by all supporting documentation, is due February 17,2015. The

Court expects that any such submission will attempt to satisfactorily address the shortcomings
and questions identified above.

If plaintiffs file a new certification motion, defendants' opposition papers will be due
March 16,2015. In the most recent round of class-certification briefing, it appears that
defendants did not depose either the class representative, Mr. Chung, or plaintiffs' expert, Dr'

Feinstein. The Court would benefit from such depositions and from defendants' close attention
to the issues raised above. Should defendants pursue these depositions, the Court expects the
parties to schedule them for sufficiently soon after the February

17

,2015 due date for plaintiffs'

motion so as to enable defendants to meet their March 17,2015 filing deadline.

Plaintiffs' reply brief will be due March 31,2015, If defendants' opposition to class
certification includes submissions from an expert4 or other declarant whom plaintiffs wish to

Plaintiffs move to strike the Declaration of William McGrath (Dkt. 150), which defendants
filed as part of their attempt to show that the market for SmartHeat shares was not effìcient. See
Dkt. 159. Defendants concede that McGrath is not an expert witness and that the Court may
strike any portions of his declaration that constitute improper lay opinion. Dkt' 165, at 5; see
atso Fed, R. pvi¿. 701 ("If awitness is not testifying as an expert, testimony in the form of an
opinion is limited to one that is . . . not based on scientific, technical, or other specialized
knowledge."), Accordingly, the Court strikes McGrath's calculations and his subjective
assessments of, for example, the nature of SmartHeat's trading volume, whether analysts
provided objective coverage, and whether SmartHeat stock reacted rationally to publicly
àisclosed information. This leaves only: (a) the first sentence of paragraph 1, which identifies
McGrath's credentials based on personal knowledge, (b) the sentences in paragraphs 2 and 15
that authenticate the exhibits attached to McGrath's declaration, and (c) the eight exhibits, which
are all publicly available documents. If and when a new round of class-certification briefing
4

t2

depose, the Court

will, on motion from plaintiffs,

extend the due date of the reply brief by one

week to enable plaintiffs to conduct that deposition and incorporate it into their reply.
In the event plaintiffs elect not to seek class certification, they are to notify defendants

promptly, and the parties are to make a joint submission, due February 17,2015, as to the future
course of this litigation.

CONCLUSION
For the reasons set out above, plaintiffs' motion for class certification is denied. The

Clerk of Court is respectfully directed to terminate the motions pending at docket numbers 144,
153, and 159. The schedule set out in the body of this opinion is hereby ordered.

SO ORDERED

l^X,(
Paul A. Engelmayer
United States District Judge

Dated: January 21,2015
New York, New York

occurs, the Court would benefit from an expert declaration from defendants on the points
addressed in this opinion. Defendants arc at liberty, but are not required, to pursue the argument
they articulated heie through the McGrath Declaration that the market for SmartHeat shares was

not efficient.
13