BOSTON (CN) - Security software maker NQ Mobile pumped up its stock price by exaggerating its financial performance and its market share in China, a class action claims in Federal Court.
Lead plaintiff Michael Kostuk Jr. calls NQ Mobile, a Chinese developer of antivirus and anti-malware software, "a massive fraud," in the lawsuit, which cites an Oct. 24 report by securities research firm Muddy Waters, regulatory filings and other public information.
The price of NQ shares dropped by 47 percent on Thursday, Oct. 24, knocking $500 million off its market capitalization, after Muddy Waters released its report, and fell another 20 percent on Friday, Reuters reported. NQ threatened to sue Muddy Waters, whose owner, Carson Block, Reuters described as a short seller.
NQ, whose portfolio includes mobile security, mobile games and advertising, has two global headquarters, in Dallas and Beijing. It is led by two chief executive officers: co-founder Henry Lin in China and former Samsung Electronics Co. Chief Strategy Officer Omar Khan, a Massachusetts Institute of Technology graduate.
Most of the company's 400 employees work in Beijing and about 60 percent of its revenue comes from China, Bloomberg Businessweek reported in August.
NQ Mobile was listed on the New York Stock Exchange in 2011 in an $89 million offering underwritten by Piper Jaffray. It raised an additional $69 million in a secondary offering last year, according to regulatory filings.
The company completed the sale of $172.5 million in convertible bonds this month. Morgan Stanley and Deutsche Bank unit Deutsche Bank Securities bought $22.5 million of that offer, Reuters reported.
Morgan Stanley & Co. International and Deutsche Bank Securities are also named as defendants.
Neither bank, however, acted as an underwriter for NQ Mobile's initial public offering.
The complaint states: "On Oct. 24, 2013, it was reported by a securities brokerage firm (Muddy Waters) that:
"a) NQ is a massive fraud. At least 72 percent of NQ's purported 2012 China security revenue is factitious. NQ's largest customer by far is really NQ. Their research estimates that NQ's real market share in China is only about 1.5 percent versus the approximately 55 percent it reports. It did estimate that its China paying user base is less than 250,000 versus the six million NQ claims.
"b) NQ's Antivirus 7.0 is unsafe to sell to consumers and its spyware makes users' phone vulnerable to cyber attack. NQ makes a weak attempt to protect users' private data as it's uploaded through the Chinese government's firewall to NQ's server. Phones [are] vulnerable to MITM attacks because NQ fails to adhere to basic security protocols. MW engaged top-flight security software engineers to analyze this product.
"c) NQ's purported international revenue of $36.5 million is likely less than its PRC revenue. NQ claims to generate international revenue in obscure markets and through mysterious counterparts that seem to seldom pay.
"d) NQ's future is as bleak as its past. The recent pivot to advertising and gaming is merely an attempt to change to a fraud that NQ hopes will be less obvious. NQ cannot monetize users that it does not have.
"e) NQ's acquisitions are highly likely to be corrupt.
"f) NQ's cash balance[s] are generally fictitious. In NQ's 2012 20-F, PwC classified all cash and term deposits as Level 2 assets. NQ's purported movements of cash from its IPO almost certainly did not occur due to PRC FX controls. Therefore, the term deposits are likely forgeries." (Parentheses in complaint.)
NQ Mobile's share price sank by $10.91 per share last Thursday after Muddy Waters released its report, to close at $12.09 per share, according to the complaint.
Kostuk, who claims he bought NQ Mobile securities at an inflated price, claims the nose dive cost hundreds of thousands of investors money.
He seeks to represent all shareholders who bought NQ Mobile stock between May 5, 2011 and Oct. 24, 2013.
Millions of NQ Mobile shares were traded publicly during that period, including 29 million shares of common stock on Oct. 24, according to the complaint.
NQ Mobile's shares, traded as an American depositary receipt on the New York Stock Exchange, almost doubled in July this year, making NQ Mobile one of the best-performing stocks on the Bloomberg index of 55 Chinese-owned companies listed in the United States.
As of Aug. 9, the stock was up 175 percent in 2013, according to Bloomberg Businessweek.
Kostuk claims that NQ Mobile knowingly misrepresented its financial condition, operations and prospects in SEC filings, press releases and other public statements.
He claims the London-based Morgan Stanley & Co. International and Deutsche Bank Securities had access to information about NQ Mobile's true financial state, but failed to warn investors or stop the dissemination of false information.
NQ Mobile announced this month that it had granted up to $150 million in convertible senior notes due in 2018 to Morgan Stanley & Co. International and Deutsche Bank Securities, according to the complaint.
Deutsche Bank declined to comment on the lawsuit.
NQ Mobile did not reply to a request for comment.
Morgan Stanley & Co. International declined to comment.
NQ Mobile on Friday responded to Muddy Water by publishing a list of 14 bank accounts in mainland China and Hong Kong that showed deposits totaling the equivalent of about $295 million, according to Reuters.
The company called the Muddy Waters allegations "false and inaccurate," but said its board of directors has formed a special committee to review the allegations.
Kostuk seeks class certification and damages for securities violations.
He is represented by Evans Carter of Framingham, Mass., who did not reply to a request for comment.
A similar class action has been filed in Manhattan Federal Court.
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