Xu v. Gridsum Holding Inc.

Background

This was a proposed shareholder class action involving Gridsum Holding Inc., its officers and directors, its former accounting firm, and the underwriters for Gridsum’s 2016 initial public offering. The plaintiffs alleged violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The claims concerned alleged misstatements and omissions in Gridsum’s initial-public-offering materials, financial statements, and later disclosures.

The court had previously dismissed certain Securities Act claims but allowed the plaintiffs to replead them. It had also previously allowed Exchange Act claims concerning Gridsum’s 2016 financial statement and an April 2018 press release to proceed. The plaintiffs then filed a Third Amended Complaint. The court considered motions to dismiss filed by Gridsum and Thomas Melcher, PricewaterhouseCoopers Zhong Tian LLP, and Perry Lin Chui. The underwriter defendants joined the motion filed by Gridsum and Melcher.

Securities Act claims

The plaintiffs added claims based on Gridsum’s interim financial statement for the first half of 2016. They alleged that the statement understated income-tax liability, failed to disclose an allegedly unfavorable offshore capital structure, and failed to disclose Gridsum’s plan to launch a sentiment-tracking product. They also renewed claims that Gridsum failed to disclose additional weaknesses in its internal financial controls.

The court held that the new claims were barred by the Securities Act’s three-year statute of repose. A statute of repose sets a firm deadline after which a claim cannot be brought. The court rejected the plaintiffs’ argument that an earlier related complaint had placed the defendants on notice of these specific claims. The earlier allegations had referred generally to inaccurate financial statements and weak internal controls but had not identified the tax-structure, tax-liability, product-launch, or related revenue-recognition allegations later asserted.

The court also concluded that the new claims would fail even if they were not time-barred. It found that the alleged tax understatement was not adequately alleged to be material in relation to Gridsum’s overall operations. The plaintiffs also did not adequately allege that Gridsum had a duty to disclose the business plans or that the product-launch information was known or reasonably anticipated to be materially misleading when the offering documents were issued. The allegations about additional internal-control weaknesses were too conclusory and did not adequately explain how those weaknesses differed materially from the weaknesses Gridsum had already disclosed.

Because the Section 11 claims were dismissed, the court also dismissed the related Section 15 control-person claim against Melcher. The court dismissed the newly alleged Exchange Act claims against Gridsum and Melcher that were based on the same allegations concerning the registration statement, as well as the related Section 20(a) claim against Melcher.

Claims against Chui and PwC

Chui argued, among other things, that the claims against him should be dismissed for lack of personal jurisdiction. The court did not decide that issue because all claims against Chui arose from the registration statement and were dismissed on the merits of the pleading. The court granted Chui’s motion to dismiss and dismissed the Section 11, Section 15, Section 10(b), and Section 20(a) claims identified in the conclusion against him.

The court addressed PwC’s claims after noting that PwC had accepted service of the Third Amended Complaint. It dismissed the Section 11 claims because the plaintiffs had not adequately alleged material misstatements in the registration statement. It also dismissed the Section 10(b) claims concerning PwC’s 2015 audit opinion because that opinion could not support a fraud claim after the related Section 11 allegations failed.

As to PwC’s 2016 audit opinion, the court assumed for purposes of its analysis that the alleged statements could support a claim but held that the plaintiffs had not adequately pleaded scienter, meaning an intent to deceive or sufficiently reckless conduct. The plaintiffs alleged audit deficiencies, conditional failures to perform procedures, violations of auditing standards, and possible warning signs. The court found that these allegations could suggest negligence or an inadequate audit, but did not create the required strong inference that PwC acted fraudulently. The court therefore dismissed the Section 10(b) claims against PwC.

Disposition and claims that remained

The court granted the defendants’ motions to dismiss. Specifically, it dismissed the Section 11 claims against Gridsum, Melcher, the underwriter defendants, PwC, and Chui; the Section 15 claims against Chui and Melcher; the Section 10(b) claims against Chui and PwC; the newly alleged Section 10(b) claims against Gridsum and Melcher concerning the registration statement; the related Section 20(a) claim against Melcher; and the Section 20(a) claims against Chui.

The court stated that its ruling did not change its earlier decision denying dismissal of the Section 10(b) claims against Gridsum and Melcher concerning Gridsum’s 2016 financial statement and April 2018 press release, or the related Section 20(a) claim against Melcher. Those claims remained pending under the earlier ruling. The court directed Gridsum, Melcher, Ravi Sarathy, Guosheng Qi, and Michael Peng Zhang to respond to the Third Amended Complaint, and directed the clerk to terminate the motions and several defendants listed in the order.

Judge Edgardo Ramos issued the opinion and order.