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ChinaCast Investors’ Suit Revived by 9th Circuit

PASADENA, Calif. (CN) - The Ninth Circuit found on Friday that a CEO's $120 million embezzlement may be imputed to his company, reversing a federal judge's dismissal.

The circuit's 17-page opinion calls the case an example of "textbook securities fraud," in which the CEO and founder of ChinaCast Education, Ron Chan, both embezzled from the corporation and misled its investors.

A federal judge dismissed ChinaCast shareholders' complaint, finding that the shareholders failed to plead intent to defraud, but the circuit disagreed.

Writing for the three-judge panel, Circuit Judge Margaret McKeown said that Chan's actions can be properly imputed to ChinaCast because "Chan acted with apparent authority on behalf of the corporation, which placed him in a position of trust and confidence and controlled the level of oversight of his handling of the business."

McKeown said it is obvious that Chan possessed scienter, or intent to defraud, but "the question is whether Chan's scienter can be imputed to his corporate employer."

She said that it could, even though Chan "unquestionably lined his own pockets at the expense of ChinaCast's interests."

"But herein lies the rub: ChinaCast's formulation ignores that the adverse-interest rule doesn't apply in every instance where there is a faithless fraudster within the corporate ranks," McKeown said.

ChinaCast received a 2011 audit detailing "material internal control weaknesses," but "turned a blind eye and failed to take significant action or heighten oversight," McKeown said.

"Had they done so, they may have prevented much of the decimation of ChinaCast's bottom line and share value," she said.

McKeown also pointed out that Chan was "hardly a random corporate bureaucrat or mid-level manager," but ChinaCast's founder and CEO - "the one person on whom the board undoubtedly should have kept close tabs."

And since the investors' complaint alleges "that third-party shareholders understandably relied on Chan's representations, which were made with the imprimatur of the corporation that selected him to speak on its behalf and sign Securities and Exchange Commission filings," McKeown said, Chan's intent to defraud can be imputed to ChinaCast in these circumstances.

The panel reversed the district court's dismissal of the case, noting that at the pleading stage a "key inquiry" is "whether the complaint sufficiently alleges scienter attributable to the corporation."

"As the litigation proceeds, whether the plaintiff is an innocent third party and whether the presumption of reliance is rebutted remain open questions," McKeown said.

Neither side responded to request for comment on Friday morning.

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