In re Puda Coal Securities Inc., Litigation

Shareholders of Puda Coal Securities Inc. (Puda) (plaintiffs) brought multiple lawsuits against Puda’s directors, former chairman Ming Zhao, his brother and chief executive officer Yao Zhao, auditors Moore Stephens Hong Kong and Moore Stephens P.C., and underwriters of Puda securities offerings (collectively, defendants). Puda had owned 90 percent of Shanxi Puda Coal Group Co., Ltd (Shanxi Coal), a supplier of coal used in steelmaking located in Shanxi, China. In September 2009, the Zhaos transferred Puda’s entire interest in Shanxi Coal to Ming Zhao personally, leaving Puda a shell without operations or revenue. Shanxi Coal shareholder-meeting minutes and documents filed in administrative offices in Shanxi reflected the transfer, but Puda’s shareholders remained unaware of it until April 2011. The auditors audited Puda throughout that time period and complied with United States accounting standards but did not discover the transfer. Instead, the auditors issued a clean audit opinion long after Puda’s operations were gone. Meanwhile, Puda made periodic filings with the United States Securities and Exchange Commission (SEC) incorporating audit opinions on its financial statements, which Puda discussed in press releases. Puda purported to have assets worth $366 million, and it traded its stock on the New York Stock Exchange. When a researcher published a report disclosing the transfer, Puda’s shares dropped 34 percent. One trading day later, the SEC halted all trading of Puda’s shares. The first of many shareholder lawsuits ensued a week later. After the cases were consolidated into a shareholder class action, the auditors moved for summary judgment, arguing that they did not know the statements in the audit opinion were false, they were not the “maker” of the statements, and they lacked the requisite scienter, or knowledge, required for liability.