Nurlybayev v. ZTO Express Inc.

Background

Lead Plaintiffs Wong Family Trusts and Dongna Fang brought a proposed class action against ZTO Express (Cayman) Inc., its executive officers and directors, and its underwriters. They asserted claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933, alleging that documents for ZTO’s initial public offering of American Depository Shares omitted important information.

The plaintiffs’ earlier amended complaint challenged ZTO’s reported financial information, its statement that network-transit fees were its principal source of revenue, and a risk disclosure concerning ZTO’s ability to control costs and adjust those fees. The earlier complaint alleged that ZTO had lowered its network-transit fees in April 2016, but the court dismissed those claims on July 17, 2019, finding that the plaintiffs had not plausibly alleged that the omission was materially misleading. The court also dismissed related claims under Items 303 and 503 of Regulation S-K and Sections 12 and 15 of the Securities Act.

The plaintiffs then moved under Federal Rule of Civil Procedure 15(a)(2) for permission to file a second amended complaint. They proposed two groups of new allegations: allegations about ZTO’s April 2016 network-transit-fee reduction, and allegations that ZTO made unusual, immediately vesting share-based payments to Tonglu Tongze Logistics Ltd. in the first half of 2016. The plaintiffs argued that the payments were not disclosed as payments to Tonglu and allowed ZTO to report lower expenses and higher profits and margins before the offering.

Tonglu allegations

The court held that the Tonglu-based claims were barred by the Securities Act’s one-year statute of limitations. More than one year had passed between publication of the information on which the plaintiffs relied and their motion to amend. The court therefore considered whether the new claims related back to the earlier pleadings under Rule 15(c).

The court concluded that they did not. The earlier pleadings did not mention Tonglu or share-based payments, and the new claims depended on different evidence concerning ZTO’s relationship with Tonglu. The earlier allegations therefore did not give the defendants sufficient notice of the Tonglu-based claims within the limitations period.

The court also stated that, even if the claims were timely, it would deny leave to amend as futile. An amendment is futile when it could not survive a motion to dismiss for failure to state a claim. The court found that the plaintiffs had misread ZTO’s Registration Statement: the stated amounts of 703.1 million Renminbi and 418.0 million Renminbi referred to different periods, not a decline from the first half of 2015 to the first half of 2016. The Registration Statement instead showed that payments to Tonglu increased from approximately 320 million Renminbi in the first half of 2015 to 418 million Renminbi in the first half of 2016. The documents also disclosed 122 million Renminbi in first-half 2016 share-based compensation expenses, although they reported those expenses as payments to certain ZTO employees rather than to Tonglu. The court held that the proposed allegations therefore did not plausibly show that ZTO underreported expenses or materially misled investors. The court did not reach the defendants’ other arguments for dismissing the Tonglu-based claims.

Network-transit-fee allegations

The court also found that the proposed allegations about the April 2016 network-transit-fee reduction did not cure the deficiencies identified in the earlier opinion. The proposed complaint still did not state the size of the fee reduction or provide facts showing its effect on ZTO’s profitability. The court found that the plaintiffs’ allegations about a later decline in gross margin were insufficient, particularly because other allegations showed that revenue per parcel increased and that ZTO’s profits and margins increased or stayed the same during relevant periods.

The court further held that the omission did not plausibly make ZTO’s statement that network-transit fees were its principal source of revenue materially misleading. The plaintiffs conceded that statement was true, and they did not allege facts showing that the fee reduction changed the composition of ZTO’s revenues. The court also found that the risk disclosure about possible harm to profitability and cash flow from difficulties controlling costs or adjusting network-transit fees was not plausibly misleading. According to the allegations, ZTO’s profitability and cash flow improved after the fee reduction, and the proposed complaint did not show that the warned-about adverse effects had occurred.

The court denied leave to amend as futile as to the network-transit-fee allegations, including the proposed claims under Items 303 and 503 of Regulation S-K and Sections 12 and 15 of the Securities Act.

Disposition

The court denied the plaintiffs’ motion for leave to amend in its entirety and dismissed the case. It directed the Clerk of Court to enter judgment and close the case. The order resolved docket entry 89.