## Facts

- Puda Coal, Inc., a U.S.-listed company with operations in China, represented that its principal asset was a 90% ownership interest in Shanxi Puda Coal Group Co., Ltd. (Shanxi Coal).
- In September 2009, Puda’s chairman transferred Puda’s entire 90% interest in Shanxi Coal to himself without disclosure to U.S. investors, effectively leaving Puda as a public shell.
- Despite the transfer, Puda’s 2009 and 2010 SEC filings continued to report Shanxi Coal’s assets, liabilities, and revenues as consolidated financial results.
- Moore Stephens Hong Kong (MSHK) audited Puda’s 2009 and 2010 financial statements and issued unqualified audit opinions stating the statements were fairly presented under U.S. GAAP and audited under PCAOB standards.
- Moore Stephens, P.C. (MSPC), a U.S. affiliate, did not sign the audit opinions and performed limited supporting functions.
- In April 2011, a report based on Chinese corporate filings disclosed the 2009 transfer; Puda’s stock price dropped sharply and trading was quickly halted.
- Investors brought a consolidated securities class action asserting, among other claims, Section 10(b)/Rule 10b-5 and Section 11 claims against the auditor defendants.
- The opinion addressed cross-motions for summary judgment by the auditor defendants.

## Issues

1. Whether MSHK could be held liable under Section 10(b) and Rule 10b-5 for its audit opinions as actionable misstatements attributable to it under the “maker” standard.
2. Whether the evidentiary record supported a triable issue that MSHK acted with scienter (intent or recklessness) rather than negligence in failing to detect the 2009 asset transfer.
3. Whether MSPC could be held primarily or secondarily liable for the misstatements in Puda’s filings or for MSHK’s audit opinions.

## Decision

- Summary judgment was granted to MSHK on the Section 10(b)/Rule 10b-5 claims because plaintiffs failed to produce evidence from which a reasonable jury could find scienter.
- The court treated MSHK as the maker of its own audit opinions (which were issued in its name and signed), but found scienter dispositive and unmet.
- Summary judgment was granted to MSPC because it did not issue or sign the audit opinions, made no statements to investors, and the record did not support primary or secondary liability theories.
- All federal securities claims against the auditor defendants were dismissed.

## Legal Principles

- For Section 10(b)/Rule 10b-5, an auditor’s liability for an audit opinion requires proof of scienter; even serious audit failures amounting to negligence do not suffice.
- Auditor recklessness requires an extreme departure from ordinary care that makes the risk of misleading investors so obvious that the auditor must have been aware of it, approximating actual intent to assist the fraud.
- An auditor is generally the “maker” of its own audit opinion when it has ultimate authority over that opinion; incorporation of the opinion into an issuer’s SEC filings does not make the auditor the maker of the issuer’s other statements.
- An affiliated entity that does not author, sign, or otherwise communicate the challenged statement to investors is not a primary violator absent evidence it made the statement or exercised the requisite control for secondary liability.

## Conclusion

The court entered summary judgment for the auditor defendants because the record, while supporting criticism of the audits, did not permit a reasonable inference that the signing auditor acted with the scienter required for Section 10(b), and the U.S. affiliate neither made actionable statements nor had evidentiary support for primary or secondary liability.


In re Puda Coal Sec. Inc. Litig., 30 F. Supp. 3d 230 (S.D.N.Y. 2014)