Long v. Fanhua, Inc.

Background

Long Miao brought a proposed securities class action against Fanhua, Inc., Chunlin Wang, Peng Ge, and Qiuping Lai. He alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 against Fanhua, Wang, and Ge, and control-person claims under Section 20(a) against the individual defendants. The proposed class consisted of people, other than the defendants, who purchased Fanhua’s U.S.-traded securities from April 20, 2018, through January 16, 2019.

Miao alleged three categories of misleading statements or omissions. First, he claimed Fanhua failed to disclose that Lai benefited from two asset dispositions. Second, he challenged disclosures about the 521 Development Plan, under which Fanhua planned to repurchase 8.5 million American Depositary Shares from a principal shareholder at $29 per share as part of an employee incentive program. Third, he alleged that Fanhua falsely stated it had not guaranteed third parties’ payment obligations, while allegedly guaranteeing principal and returns for investment products issued by entities associated with Lai.

Miao relied heavily on reports by short sellers. The allegations about the alleged guarantees were based entirely on a short-seller report’s account of statements from anonymous interviewees. The opinion states that Miao’s counsel did not allege any independent investigation or contact with those interviewees. The defendants moved to dismiss under Federal Rules of Civil Procedure 12(b)(6) and 9(b), which address failure to state a claim and the requirement that fraud be pleaded with particularity.

Court’s analysis

The court held that Miao had withdrawn the claims concerning the alleged related-party dispositions. The complaint had alleged that Fanhua sold certain insurance agencies for RMB 30,712, but the cited filing stated the amount in thousands—RMB 30,712,000. The court also found that the complaint’s theory that Cheche was controlled by Lai was not supported by sufficient allegations. The court treated those claims as withdrawn and later determined that their deficiencies were substantive, making amendment futile.

The court rejected the claims concerning the 521 Development Plan because the complaint did not identify an actionable false statement or omission. Fanhua had disclosed that 8.5 million shares would be purchased from a principal shareholder at $29 per share. The court found that Fanhua’s existing disclosures identified the relevant principal shareholders and that the investor conference call the next trading day identified Master Trend Limited as the seller and disclosed Lai’s connection to it. The court also held that statements about the plan’s cost and cash impact were not misleading because the repurchase price and relevant financial information had been disclosed. Miao’s view that Lai was the plan’s primary beneficiary, without more, did not make Fanhua’s disclosures false or misleading.

The court held that the financial-guarantee allegations failed the heightened pleading requirements for securities fraud. The anonymous sources were described only generally, their statements were not adequately tied to the class period, and the complaint did not provide enough detail about the alleged guarantees. The court also found no independent corroboration, investigation by Miao’s counsel, or direct contact with the sources. The court separately held that the complaint did not create a strong inference of scienter, meaning an intent to deceive or sufficiently serious recklessness. The defendants’ senior positions, signatures on certifications, prior history involving Lai, and Fanhua’s later decision to investigate did not cure the lack of specific allegations showing that the relevant defendants knew about or recklessly disregarded the alleged guarantees.

Because Miao failed to plead a primary Section 10(b) violation, the court dismissed the Section 20(a) control-person claims as well. The court did not reach the defendants’ alternative arguments concerning loss causation.

Disposition

Judge Paul A. Engelmayer granted the motions to dismiss and dismissed the First Amended Class Action Complaint in its entirety. The dismissal was with prejudice as to all claims except Miao’s claims concerning financial guarantees. The court denied leave to amend the related-party-transaction and 521 Development Plan claims because amendment would be futile. It granted leave to amend the financial-guarantee claims, provided that Miao filed an amended complaint by March 20, 2020. The court stated that if he did not do so, dismissal of those claims would also be with prejudice. The clerk was directed to terminate the pending motions.