A federal judge in New York has dismissed for the third time a $10 million securities fraud suit against Chinese firm DeHeng Law Offices and one of its former partners.
The case stemmed from a 2008 deal in which the plaintiffs, several U.S. investment funds, attempted to acquire a Chinese distributor of hospital equipment. The plaintiffs claimed their investment of around $10 million was stolen by a man associated with and possibly married to former DeHeng partner Helen Lv (pronounced Lü).
But U.S. District Judge Louis Stanton in the Southern District of New York ruled in a July 31 decision that the plaintiffs had not adequately pleaded that either DeHeng or its former partner had acted with scienter, or knowledge of wrongdoing, in the alleged fraud, he said.
The complaint had been filed last September by Plaintiffs Pope Investments, Jayhawk Private Equity Fund, and five other investment funds, who alleged that in 2008 they were trying to acquire Shanghai Atrip Medical Technology Co. Ltd. (SMT), a Chinese company that distributes hospital equipment and operates dialysis centers. They made use of a complex variable interest entity structure in which a U.S.–listed company they controlled called Aamaxen Transport Group Inc. (AAXT) would own SMT through a series of offshore vehicles and a wholly owned foreign enterprise in China.
The funds’ $12.5 million investment was to be channeled through these entities, too, less about $1.4 million to pay for professional fees. Part of those fee payments included an unstated amount to DeHeng, which was hired as Chinese counsel to both SMT and AAXT, as well as the various entities, with Lv serving as lead adviser.
According to the complaint, Lv provided a legal opinion letter stating that the VIE structure was sound. But the plaintiffs claim they were misled about the ownership of one of the vehicles involved in the transaction. That entity, Kamick Assets Ltd., turned out to be controlled by a man named Shao Ganghua, the suit alleged. Shortly after the deal closed in April 2008, the suit claimed, Shao used his control of Kamick to clean out a bank account containing the plaintiffs' $10 million investment. In a subsequent investigation in 2008 aimed at recovering the money, the plaintiffs said they found documents identifying Shao as Lv’s husband. They also claimed that some of the money had been diverted to a company in which Lv was listed as a director.
Stanton had twice dismissed the action. In November 2011, he ruled that the plaintiffs had not pleaded intent to defraud with particularity. In August of last year, the judge found they had not adequately alleged that the securities fraud at issue had taken place in the United States. In both instances, however, he granted the plaintiffs leave to replead the case.
In his most recent decision, Stanton said the plaintiffs had failed to allege how DeHeng came to learn about the alleged theft so that it could knowingly mislead its client. The judge also said the plaintiff’s claim that DeHeng was motivated by a desire to collect its fees was insufficient in a securities fraud claim since all firms are assumed to want to increase their profitability.
DeHeng might have been found vicariously liable for DeHeng’s but the judge ruled that the plaintiffs also failed to sufficiently allege Lv's participation in a fraudulent scheme.
“It is not enough to point to circumstances which are not inconsistent with her guilt,” Stanton wrote. “There must be facts from which one can plausibly infer her knowledge and participation in Shao's plan to misappropriate the AAXT investment.”
While the plaintiffs claimed that Shao had consulted with Lv at DeHeng about his intention to embezzle the money and that Lv had helped devise a plan to aid that embezzlement, Stanton said plaintiffs had alleged little beyond the fact that ‘Lv was one of the lead DeHeng attorneys assigned by DeHeng to represent the group.’”
“There is no support except speculation that Shao informed Lv about his intention to embezzle the money,” the judge wrote. “For all that appears, she was totally ignorant of Shao's plans (and this is plaintiffs' third opportunity to show something to the contrary).”
Though he dismissed the case for lack of scienter, the judge did rule that the plaintiffs had adequately alleged a U.S. securities law transaction, denying DeHeng’s motion to dismiss for lack of jurisdiction. The Chinese law firm had argued that the case was barred under the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank Ltd., which states that only transactions that involve the purchase of securities in the United States are covered by U.S. securities law.
The fact that the AAXT shares were purchased in the U.S. met the Morrison test, the judge said. “A fraudulent misrepresentation which induces a domestic securities transaction suffices for a 10b-5 violation, regardless of whether the misrepresentation concerned a domestic or foreign event,” he wrote.
Segal McCambridge Singer & Mahoney New York counsel acted for the plaintiffs, with help from Kansas-based firm Shapiro & McMullen. Sullivan & Worcester New York partner Harry H. Rimm represented the 1,000-lawyer DeHeng, one of China’s largest firms, in the suit.