Xu v. Gridsum Holding Inc.

Background

A proposed class of Gridsum shareholders sued Gridsum Holding Inc., several current and former officers and directors, PricewaterhouseCoopers Zhong Tian LLP (PwC), and the underwriters of Gridsum’s 2016 initial public offering. The plaintiffs asserted claims under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. They alleged that the defendants made misleading statements or omissions in Gridsum’s 2015 registration statement, its 2016 annual report, and related documents.

Gridsum’s 2015 and 2016 financial statements were later restated. The plaintiffs relied in part on changes involving revenue, accounts receivable, taxes, deferred revenue, accounts payable, and other financial items. They also alleged that Gridsum improperly recognized consignment transactions as revenue and failed to disclose concerns that PwC had raised about management’s representations.

Securities Act claims

The court held that the plaintiffs had not adequately pleaded a material misstatement in the 2015 registration statement. Although several individual financial items changed substantially in percentage terms after the restatement, the court concluded that the plaintiffs had not explained why the changes would have significantly altered the total information available to a reasonable investor. The court also concluded that the plaintiffs had not adequately identified additional undisclosed weaknesses in Gridsum’s accounting controls.

The court therefore granted the motions by the underwriters, Gridsum, and the relevant defendants to dismiss the Securities Act claims under Sections 11 and 15. The court stated that the plaintiffs were granted leave to replead those claims. The court separately dismissed the Section 15 control-person claim against Thomas Adam Melcher because the plaintiffs had not adequately pleaded an underlying Securities Act violation.

Exchange Act claims

The court found that the plaintiffs adequately alleged material misstatements and the required state of mind, known as scienter, concerning Gridsum’s 2016 financial statements and its April 2018 press release. The court relied in part on allegations that Gridsum’s reported figures conflicted with its own revenue-recognition policies and generally accepted accounting principles, that the restated financial figures were substantial, and that PwC had said it could no longer rely on management’s representations.

The court also found that the plaintiffs adequately alleged that the 2016 financial statements were false and that the April 2018 press release omitted PwC’s concerns. It denied Gridsum’s motion to dismiss the Exchange Act claims and denied Melcher’s motion to dismiss the Section 20 control-person claim. The court dismissed the Section 10 claim against Melcher because the plaintiffs did not allege that he signed or otherwise made the 2016 financial statements or the April 2018 press release.

PwC’s personal-jurisdiction motion

PwC argued that the court lacked personal jurisdiction because it had not been properly served. The plaintiffs did not oppose that ground. The court granted PwC’s motion, but instead of dismissing the claims against PwC, it quashed the attempted service filed at docket number 107. The court stated that proper service could potentially allow the court to exercise personal jurisdiction over PwC.

Alternative service

The plaintiffs asked to serve several defendants through their attorneys because efforts to serve them in China or Hong Kong had not been completed. The court denied the motion for alternative service in its entirety. It found that the plaintiffs had not shown sufficient diligence: some service attempts were made by delivering papers to Gridsum’s Beijing office rather than to the individuals or an adult at their homes, service on Ravi Sarathy was attempted in Beijing even though he was in Hong Kong, and service had not yet been attempted on PwC or Xiang Fan.

The court also found no showing that Chinese or Hong Kong authorities had obstructed service. It stated that the plaintiffs could renew the motion if they later provided proof of diligence. The court further found that service on Fan through Gridsum’s counsel would not be appropriate without evidence that Fan was communicating with Gridsum or that counsel.

Disposition

Judge Edgardo Ramos granted the motions of the underwriters, Gridsum, and Melcher to dismiss the Securities Act claims under Sections 11 and 15; denied Gridsum’s and Melcher’s motions to dismiss the Exchange Act claims under Sections 10 and 20, except that the Section 10 claim against Melcher was dismissed; granted PwC’s motion to dismiss all counts against it and quashed the specified service; and denied the plaintiffs’ motion for alternative service. The plaintiffs were directed to seek permission by May 1, 2020, to file a Third Amended Complaint reasserting the Securities Act claims or inform the court that they would proceed under the Second Amended Complaint.