In re Hebron Technology Co., Ltd. Securities Litigation

Background

Lead plaintiff Edward A. Dahlke and plaintiff Michael Clynes brought a proposed class action against Hebron Technology Co., Ltd. and its officers Anyuan Sun and Changjuan Liang. The plaintiffs alleged that Hebron failed to disclose that three transactions were related-party transactions: the Loong Fang PIPE Transaction, the Beijing Hengpu Acquisition, and the Nami Holding (Cayman) Acquisition.

The plaintiffs asserted claims under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 against all defendants. They also asserted claims under Section 20(a), which imposes potential liability on controlling persons, against Sun and Liang. The plaintiffs alleged that Hebron’s public statements and filings were misleading because they did not identify the three transactions as involving parties under common control or otherwise qualifying as related parties. They also challenged statements about Hebron’s disclosure controls and the officers’ certifications concerning those controls.

Hebron moved to dismiss the Consolidated Second Amended Complaint under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint adequately states a legal claim. The individual defendants had not been served and had not appeared, but the court considered whether the same pleading deficiencies required dismissal of the claims against them as well.

Legal standards

The court explained that securities-fraud claims must satisfy heightened pleading requirements under Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act. The complaint therefore had to identify the allegedly misleading statements or omissions with particularity and plead facts creating a strong inference that the defendants acted with intent to deceive, manipulate, or defraud, or with conduct approaching that level of recklessness.

A claim under Section 10(b) and Rule 10b-5 requires a material misstatement or omission, fraudulent intent, a connection with the purchase or sale of a security, reliance, economic loss, and a causal connection between the alleged fraud and the loss. A Section 20(a) claim requires an underlying violation by the controlled person; without a viable primary securities-fraud claim, the control-person claim also fails.

The court held that the relevant related-party standards in Financial Accounting Standards Board Accounting Standards Codification 850 and Item 7.B of Securities and Exchange Commission Form 20-F were materially the same for the allegations at issue. They required facts showing control, significant influence, or common control. The court also rejected Hebron’s argument that allegations based on a short-seller’s report must automatically be disregarded. Instead, it assessed those allegations together with the other facts pleaded.

Analysis of the alleged transactions

For the Loong Fang PIPE Transaction, the complaint relied on the fact that Shan Jiang later became a supervisor at two companies owned by Benefactum, in which Hebron’s controlling shareholder Bodang Liu owned 99%. The court held that the complaint did not allege a relationship between Loong Fang and Liu when the transaction occurred. Shan Jiang assumed the later positions three and four months after the transaction, and the complaint did not plead facts showing that Liu controlled Loong Fang at the relevant time. The court therefore found no adequately pleaded related-party relationship or actionable omission concerning that transaction.

For the Beijing Hengpu Acquisition, the plaintiffs relied on Xiaoyun Huang’s alleged connections to Liu and on Peng Jiang’s positions at Beijing Hengpu and entities affiliated with Hebron. The court found that the allegations about Huang did not show that Liu controlled Huang in his capacity at HongKong D&L or that Liu controlled Beijing Hengpu. The allegations about Peng Jiang’s titles as a director and manager did not adequately establish that he controlled Beijing Hengpu, and his positions at NiSun Shanghai and Shanghai Fintech did not establish that he controlled Hebron. The court dismissed the claims based on this transaction because the complaint did not plausibly allege the required control or common-control relationship.

For the Nami Holding (Cayman) Acquisition, the plaintiffs relied on confidential witnesses, a WeChat article, and an online curriculum vitae. The court found that the confidential-witness allegations were too general, did not show that the witnesses were in a position to know who exercised control, and concerned periods substantially before the transaction. The court treated the fact that the WeChat article had been revised as adequately pleaded, but did not accept the allegation that the revision was an effort to conceal wrongdoing. It also found that the online curriculum vitae did not establish the author’s knowledge, employment status near the transaction date, or the document’s authenticity. The remaining allegations showed cooperation or close connections, but not the formal control, significant influence, or common control required to plead a related-party transaction.

Disclosure-control allegations and fraudulent intent

The plaintiffs separately alleged that Hebron’s statements about ineffective disclosure controls and the officers’ certifications were misleading. The court held that the plaintiffs had not defended this theory in their opposition to dismissal and therefore had abandoned it. The court also held that the theory failed on the merits because it depended entirely on the alleged disclosure violations, each of which had already been inadequately pleaded.

The court separately held that the complaint did not adequately plead fraudulent intent. Sun’s alleged personal exposure as a guarantor of Hebron’s debt was speculative and was not tied to an imminent or realized risk of default. Liang’s alleged relationship with Liu did not, without more, show an intent to deceive. The defendants’ executive positions, Hebron’s size, the replacement of its auditor, Sun’s later resignation, and the importance of the financial-services segment did not collectively create a strong inference of fraudulent intent. The court also noted that the individual defendants did not sell stock during the alleged class period and that Hebron’s internal investigation weighed against the plaintiffs’ theory.

Disposition

The court held that the Consolidated Second Amended Complaint failed to state claims under Section 10(b) and Rule 10b-5 because it did not adequately plead an actionable misstatement or omission or the required fraudulent intent. It dismissed those claims against all defendants. Because the plaintiffs had not pleaded an underlying Section 10(b) violation, the court also dismissed the Section 20(a) claims against Sun and Liang.

Judge Engelmayer denied the plaintiffs’ request for permission to file another amended complaint. He found that the deficiencies were substantive and that the plaintiffs had already received two opportunities to amend, including notice that the second amended complaint would be their final opportunity. The court dismissed the Consolidated Second Amended Complaint in its entirety, with prejudice as to all claims, directed the clerk to terminate the pending motions, and closed the case.