It’s been three years since investors began flooding the courts with securities claims against Chinese companies that obtained their U.S. listings through reverse mergers. (Typically, they acquired shell companies with a spot on an American exchange.) In the first reverse merger result on the merits, Maurice "Hank" Greenberg’s C.V. Starr & Co. Inc. won $77.5 million in a December Hong Kong arbitration award against the three founding shareholders of China MediaExpress Holdings Inc., which claimed to sell TV advertising on Chinese intercity buses.
Unfortunately for plaintiffs in these types of reverse merger cases, the disputes are more likely to end in a meager settlement than a mega-award. At about the same time the Starr award became public in January, Orient Paper Inc. sought approval from a Los Angeles federal district court judge to settle for a mere $2 million. Orient Paper is one of six Chinese businesses accused of U.S. securities fraud to announce settlements in the past year. Remarkably, each settlement has fallen within a tight range. "We’re starting to see a critical mass of settlements between $2 million and $3 million," says Shearman & Sterling’s Jerome Fortinsky. Shearman counts more than 75 sets of disputes in U.S. forums related to allegations of securities violations by Chinese parties, including more than 50 reverse merger companies. "And that may exert a gravitational pull on other settlements down the road," he says.
How did Greenberg, who made his name by building the AIG Group, obtain such a different result? Greenberg bought a large block of shares in a private placement, so his lawyers at Skadden, Arps, Slate, Meagher & Flom had the bargaining power to demand not only an arbitration, but a tribunal chaired by a Delaware lawyer with at least 14 years of experience. John Gardiner, Skadden’s cohead of international arbitration, had no trouble convincing former Delaware Supreme Court Justice Andrew Moore II that China MediaExpress was a fraudulent enterprise based on the adverse inference doctrine: The company’s refusal to produce any meaningful evidence told Justice Moore that the $200 million said to be in the company’s coffers on the eve of its collapse was either imaginary or misappropriated.
To be sure, Greenberg’s big purchase enabled him to bypass a lot of briefing on whether a class action is certifiable in the context of a market for small-cap securities. And suing in arbitration made it a whole lot likelier that the case would go to trial. But in principle, the merits of the plaintiff’s case would be just as strong in a U.S. forum, and a settlement ought to reflect that strength.
What really makes the Greenberg case unusual is that his lawyers say they can enforce the award against the defendants’ assets outside China. Obviously, if the merits of a claim are strong and the award is collectible, then no one will settle for $2–3 million. The challenge for the remaining plaintiffs, in both the China MediaExpress case and others, will be to establish the liability of a deep-pocketed party with assets outside China. That’s why Boies, Schiller & Flexner, which represents Starr in a parallel Delaware case based on a later purchase of public securities, is going after the investment promoters and auditors. (The higher stakes at play are shown by Ernst & Young’s $118 million December settlement of a Canadian class action arising out of its audit of Sino-Forest Corporation, which had been accused of fraudulently overstating its assets.)
Hank Greenberg’s landmark victory against China MediaExpress may not be a universal template. But Skadden’s litigators have at least established that private-placement investors may hold a Chinese company accountable in arbitration. That matters because Skadden’s corporate partners are busy reversing the reverse merger trend. Not surprisingly, the rate of Chinese companies going private has accelerated as the litigation wave has crested. Skadden, which worked on about half the deals, counts 49 Chinese going-private transactions announced since 2010, including 27 last year. No one expects these businesses to form the fraud wave of the future. But by keeping the market for private Chinese securities honest, the Starr award gives fearful investors the confidence to keep piling on.