Securities litigation filings in U.S. courts dropped 20 percent in 2012, a new study shows—largely because of a decline in the number of suits filed against Chinese companies.
A January report from the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research finds that only 10 securities suits were filed last year against Chinese companies that listed in the United States via so-called reverse mergers. Many results of such deals—in which a Chinese company acquires and merges itself into an already listed U.S. company—have been plagued by accusations of fraudulent disclosures, triggering a wave of securities litigation beginning in 2010. Some 31 suits were filed in 2011, the peak of the trend. 
Despite fewer cases being filed, plenty of litigation remains in the pipeline. "New filings have been lower in 2012," says Jerome Fortinsky, a New York–based litigation partner at Shearman & Sterling, which is representing Chinese reverse-merger defendants like China Electric Motor Inc. and ZST Digital Networks in ongoing securities litigation.* "But for lawyers, activity levels are still very high because the litigation process takes about two to three years."
Defense lawyers say that for most of their Chinese reverse-merger clients, the securities cases are their first time dealing with American-style litigation. “Many of these cases are filed to take advantage of Chinese companies that don’t know how to respond to litigation, especially in the U.S.,” says Samuel Williamson, a Shanghai-based partner at Kirkland & Ellis, which represented Bain Capital in settling shareholder cases brought against China Fire & Security Group Inc., a Beijing-based industrial fire safety product manufacturer that underwent a reverse merger in 2006 and that Bain acquired in 2011.

But plaintiffs attorney Lawrence Rosen, who has filed more than 30 securities suits against U.S.–listed Chinese companies over the past few years, says those defendants are hardly victims. In his view, the main issue is widespread self-dealing by Chinese executives, not mere ignorance about the U.S. legal system. “In China, CEOs can own the company’s customers, suppliers, and even the factory that sells it services,” says Rosen.
His Rosen Law Firm is currently preparing a class action against Focus Media Holdings Ltd., a Shanghai-based advertising company that has already been the target of several other lawsuits. (Focus Media has denied allegations that its accounting practices were improper.) Rosen has also filed similar suits against Perfect World Co. Ltd., a Beijing-based online gaming company; China Gerui Advanced Materials Group Ltd., a Henan-based steelmaker; and AutoChina International Ltd., a Hebei automobile investments holdings firm, whose motion to dismiss the suit was dismissed last month by the U.S. District Court for the District of Massachusetts. (Perfect World has said that it complied with all applicable U.S. securities regulations and stock exchange rules.)
Some defense lawyers say that the size of recent settlements has also been dropping, especially when compared to typical securities class settlements in the United States. Sean Prosser, a San Diego–based partner at Morrison & Foerster, says there were three China-related securities litigation settlements in 2012 for $600,000, $2 million, and $3 million. That compares to an average settlement for U.S. federal securities class actions of $31 million in 2011, according to a study by NERA Economic Consulting. And that was down from $42 million in 2009. For the first half of 2012, the average settlement was $71 million.

Mimi Yang, a Shanghai-based litigation counsel at Ropes & Gray, attributes the smaller settlements to the difficulty of litigating against Chinese companies. She calls it the "China discount," explaining, “It is very hard to enforce a U.S. judgment on China soil."
Shearman’s Fortinsky agrees. "Chinese defendants who do not have assets in the U.S. are in a position where they can think about simply not engaging in the litigations," he says. "If they only have interests in China, or have no interest in expanding in the U.S., they can simply choose not to engage in litigation."
But Rosen counters that smaller settlement amounts are to be expected, since most U.S.–listed Chinese companies have smaller market capitalizations.
"Defense lawyers like to tell you [the China cases are not lucrative], but 15 cents on the dollar is a very average settlement rate," he says. And while he acknowledges that it’s harder to enforce judgments in China, he contends that many Chinese companies have subsidiaries based outside the country, as well as U.S.–based directors who can be held responsible.
The glut of lawsuits has also resulted in collateral damage for investment banks that took U.S.–listed Chinese companies public and for the auditors that performed checks on disclosure. Plaintiffs lawyers have sought compensation from these outside advisers, many of which are based in the U.S. and are more accessible targets. “Basically anyone who has signed on the SEC filings can be held accountable,” says Yang.
In December, audit firm Ernst & Young, represented by Morrison & Foerster, agreed to pay $118 million to settle class action claims arising from the work it performed for Sino-Forest Corp., the now-bankrupt Canadian-listed company that is perhaps the best-known Chinese reverse merger company to have been accused of putting forward falsified disclosures.

The trouble is not over for Ernst & Young and other major accounting firms. Last month the Securities and Exchange Commission brought civil charges against the China affiliates of five large U.S. accounting firms—BDO China Dahua Co. Ltd., Deloitte Touche Tomatsu Certified Public Accountants Ltd., Ernst & Young Hua Ming, KPMG Huazhen, and PricewaterhouseCoopers Zhong Tian CPAs Ltd.—over their refusal  to produce audit work papers and other documents related to Chinese companies under investigation by the SEC for fraud. Most of the audit firms have said they are cooperating with the government, The New York Times has reported.

The volume of litigation has no doubt given Chinese companies second thoughts about listing in the U.S. In fact, more than 50 have delisted in the past two years. Several of those have relisted in Asian markets such as Hong Kong or Shanghai.
But certain Chinese companies, especially in the technology sector, may still see greater liquidity in the U.S., thanks to the larger U.S. investor and analyst community. It’s also still easier to list in America than Asia, where the major exchanges have lengthy track record requirements. For those reasons, Yang and Prosser think Chinese companies won’t be deterred from America for long.

But they also believe that it may take longer for American investors to regain confidence in Chinese companies.
"How receptive is the U.S. market going to be to Chinese listings? That’s the real question," says Prosser.
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*Correction, 1/30/13: An earlier version of this article mistakenly stated that Shearman & Sterling represented China Media Express Holdings Ltd. in shareholder litigation. The third paragraph has been altered to remove the reference.