(Article from Securities Law Alert, February 2016)
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On February 3, 2016, the Southern District of New York held that a corporate executive’s scienter could be imputed to the corporation even though the executive had personally profited from undisclosed related party transactions with the corporation. Dragon State Int’l v. Keyuan Petrochemicals, 2016 WL 439022 (S.D.N.Y. 2016) (Crotty, J.). The court determined that plaintiffs had adequately pled corporate scienter because the executive’s misconduct allegedly benefited the corporation.
Court Finds Plaintiffs Adequately Alleged Scienter as to the Company’s CEO, and Determined That the CEO’s Scienter Could Be Imputed to the Company
Plaintiffs alleged that Keyuan International had falsely represented both in public filings and the company’s stock purchase agreement (“SPA”) that it “had not engaged in undisclosed related party transactions.” The company later acknowledged that it had in fact engaged in “hundreds of millions of dollars in previously undisclosed related party transactions” with entities connected to Keyuan’s CEO, Chungfeng Tao.
The court found that the allegations were sufficient to raise a strong inference of scienter as to Tao. The court explained that because Tao signed Keyuan’s SPA and its public filings, “Tao constituted a ‘maker’ of statements contained therein and was bound to disclose all required information.” Moreover, “Tao was [allegedly] closely tied to sizeable undisclosed related party transactions that substantially impacted Keyuan’s sales.” The court found that a strong inference of scienter arises where, as here, “the complaint alleges that defendant ‘knew facts or had access to information suggesting that their public statements were not accurate’” (quoting Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000)).
The court further held that these same allegations were also sufficient to establish Keyuan’s corporate scienter. The court explained that in order to plead corporate scienter under Second Circuit precedent, “the pleaded facts must create a strong inference that someone whose intent could be imputed to the corporation acted with the requisite scienter” (quoting Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital, 531 F.3d 190 (2d Cir. 2008)). Notably, the court rejected Keyuan’s contention that its CEO’s “alleged misconduct [could not] be imputed to the company since Tao was motivated by self-interest, and to Kenyan’s detriment.” The court found that the complaint “allege[d] a possible motive (quoting Keyuan’s own public filings) for Tao’s misconduct that would benefit Keyuan: the company [had] engaged in related party transactions ‘to overcome the restrictions regarding the use of certain bank loans or to satisfy the banks’ internal requirements to demonstrate the usage of the loans.” The court therefore held that Keyuan’s CEO’s scienter could “be imputed to Keyuan.”