Ramzan v. GDS Holdings Limited

Background

GDS Holdings Limited develops, acquires, and operates data centers in China. The alleged fraud involved four facilities: GZ1, GZ2, GZ3, and SZ5. GDS reported occupancy and revenue information for GZ1 and acquisition prices for the other three facilities in Securities and Exchange Commission filings and an earnings presentation.

On July 31, 2018, Blue Orca Capital released a report alleging that GDS had falsely described GZ1’s operations and had overstated the acquisition prices of GZ2, GZ3, and SZ5. The report also questioned GDS’s interest rate on one loan, its unbilled accounts receivable, and the location of much of its cash. GDS denied the allegations. GDS’s share price fell from $34.75 on July 30, 2018, to $21.83 on July 31, 2018.

Hamza Ramzan filed the action, which was later amended after the court appointed Yuanli He as lead plaintiff. The amended complaint named Yuanli He and Michael Zollo as plaintiffs. It asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act against GDS, William Wei Huang, and Daniel Newman.

Legal standards

To survive a motion to dismiss, a complaint must allege enough facts to make the claim plausible. For a private claim under Section 10(b), plaintiffs also must plead facts supporting a strong inference of scienter—meaning an intent to deceive, manipulate, or defraud, or sufficiently extreme recklessness. The heightened pleading rules required plaintiffs to identify particular facts supporting that inference.

Scienter as to the individual defendants

The court held that the amended complaint adequately alleged that Huang and Newman had the opportunity to commit the alleged fraud because they were GDS executives, but it did not allege that either had a motive to do so. The allegations that GDS kept cash outside China, raised capital, took a loan at a high interest rate, and carried substantial unbilled accounts receivable were speculative. They did not show that anyone misappropriated company funds or raised capital for an improper purpose.

The court also rejected the argument that GZ1’s acquisition shortly before GDS’s initial public offering showed fraudulent intent. The court said it could not infer scienter from the timing of those events alone.

The plaintiffs alternatively argued that Huang and Newman acted knowingly or recklessly. The court found that the amended complaint did not identify specific reports or information showing that they knew their public statements were false. General allegations based on their senior positions, access to company information, control over reports, and signatures on certifications under the Sarbanes-Oxley Act were not enough. Signing those certifications could support an inference of scienter only when accompanied by facts showing awareness of, or recklessness toward, misleading statements.

The court emphasized that proving or pleading that a statement was false is different from proving or pleading scienter. The plaintiffs’ allegations of falsity therefore did not substitute for allegations supporting intent to deceive or recklessness.

Scienter as to GDS

The court held that the amended complaint also failed to plead scienter as to GDS. The plaintiffs had not adequately pleaded scienter for Huang or Newman and had not alleged facts concerning the intent of any other GDS personnel.

Section 20(a) claims and disposition

Section 20(a) imposes control-person liability when there is a primary violation of the Exchange Act. Because the plaintiffs had not adequately alleged a primary Exchange Act violation, the court dismissed their Section 20(a) claims.

The court granted defendants’ motion to dismiss. The opinion did not state that the dismissal was with or without prejudice, and it did not address defendants’ additional arguments concerning material misstatements or loss causation.