(CN) – A federal judge advanced claims that a Chinese chemical company violating securities laws and duped investors with fake accounting figures.
Albert Snellink, Zachary Lewy, Sampson Daruvalla and William Spiegelberg represent a class of investors in Gulf Resources, a Chinese company that manufactures chemicals through its subsidiaries Shouguang City Haoyuan Chemical and Shouguang Yuxing Chemical Industry. Gulf chairman Ming Ling, CEO Xiaobin Liu and CFO Min Li are also named as defendants.
The investors claim that the group made false and misleading statements about Gulf’s finances, withheld relevant business and financial information, and engaged in accounting fraud in its filings with the Securities and Exchange Commission. They claim that Gulf maintained two different sets of accounting books for Chinese state reporting and U.S. government filings, in which the company “grossly overstated its financial position,” according to their amended complaint.
The investors say Gulf and its directors induced them to buy stocks through impossible sales and inventory figures, and failed to mention that Gulf directors own many of the company’s top customers. Gulf also allegedly hid the fact that Liu, the CEO, had worked as CFO of China Finance, a firm affiliated with listing a number of fraudulent Chinese companies in the U.S., according to the complaint.
The individual defendants have not yet been served and haven’t appeared in court, but Gulf moved to dismiss for failure to state a claim and failure to meet the heightened pleading standard required in securities action.
U.S. District Judge Otis Wright II refused Tuesday.
“Taking these allegations as true, the court finds that plaintiffs have adequately pleaded falsity,” Wright wrote
With regard to scienter, which involves a person’s knowledge of law breaking, Wright noted that other courts have found a strong inference of intent and knowledge of wrongdoing when U.S.-listed Chinese companies made SEC filings.
“In comparison with these cases, this case has even more facts: significantly different U.S. and Chinese financial filings; high turnover rates and profit margin compared to competitors; related party transactions disclosed in 2010 but not in 2009; concealment of related party competitor; concealment of the CEO’s employment history,” the decision states.
“Viewing these facts holistically, the court is compelled to find scienter.”
Wright also rejected Gulf’s explanation that its discrepancies were unintentional and arise from the differences in accounting rules between China and the United States.
“The discrepancies are so great that a mere accounting difference cannot be a plausible reason,” he wrote.
“In sum, when plaintiffs’ allegations are viewed collectively, the court finds that the inference that Gulf acted with intent is ‘at least as compelling as any opposing inference one could draw from the facts alleged,'” the judge added, citing Tellabs Inc. v. Makor Issues and Rights. “Plaintiffs have adequately pleaded scienter, but whether they can prove their allegations and establish scienter is another questions.”
The plaintiffs also adequately pleaded loss causation by tying their economic loss to an April 2011 report by Glaucus Research, the court found.
Wright explained that the report, which publicly disclosed fraud by Gulf and its directors, caused the company’s stock price to fall 30 percent in a day.