Srinivasan Venkataraman v. Kandi Technologies Group, Inc.

Background

Srinivasan Venkataraman brought a proposed securities-fraud class action against Kandi Technologies Group, Inc. and Individual Defendants Xiaoming Hu, Cheng Wang, Bing Mei, Liming Chen, Jerry Lewin, and Henry Yu. He alleged violations of Section 10(b) of the Securities Exchange Act and Securities and Exchange Commission Rule 10b-5, as well as Section 20(a) liability against the Individual Defendants.

Kandi designs, manufactures, and distributes electric vehicles and off-road vehicles. During the proposed class period, Kandi owned 50% of a joint venture that sold parts to manufacture electric vehicles. The joint venture sold vehicles to Zhejiang ZuoZhongYou Electric Vehicle Service Co., Ltd., referred to as the Service Company. Kandi owned 9.5% of the Service Company, and Hu owned another 13%. The complaint alleged that transactions involving the joint venture and Service Company helped Kandi and the Service Company obtain government electric-vehicle subsidies through a “double dip.”

The Second Amended Complaint alleged that Kandi’s public filings failed to disclose the full extent of its related-party transactions and falsely stated that its internal financial controls were effective. Kandi later announced that it would restate financial statements for 2014, 2015, and the first three quarters of 2016. The restatement included corrections involving related-party accounts, cash-flow classifications, and Kandi’s investment in a joint venture, although Kandi stated that the restatement would not affect reported net income.

Motion and legal standards

The defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint adequately states a legal claim, and Rule 9(b), which requires fraud allegations to be stated with particularity. They also relied on the heightened pleading requirements of the Private Securities Litigation Reform Act. On a motion to dismiss, the court generally accepts well-pleaded facts as true and draws reasonable inferences for the plaintiff, but it does not accept conclusory legal statements as facts.

For a Section 10(b) and Rule 10b-5 claim, the plaintiff had to allege a material misstatement or omission, a required wrongful state of mind known as scienter, a connection to the purchase or sale of securities, reliance, and loss caused by that reliance. For a Section 20(a) claim, the plaintiff had to allege a primary securities-law violation, control of the primary violator, and meaningful participation in the alleged fraud.

The court also considered the federal time limits for private securities-fraud claims: a two-year limitations period after discovery of the facts constituting the violation and a five-year statute of repose after the violation. The court explained that discovering possible fraud, sometimes called “storm warnings,” does not by itself begin the two-year period unless the plaintiff discovered, or reasonably should have discovered, the facts constituting the violation, including scienter.

Section 10(b) claims

The court held that many alleged misstatements could not support a claim. Statements made before June 10, 2015, were barred by the five-year statute of repose. Statements made only during internal meetings or to Kandi’s auditor did not adequately allege reliance because they were not alleged to have been made to the plaintiff or publicly to the market. Statements in Kandi’s 2017 and 2018 annual reports were corrective statements and were not alleged to be false. Allegations based on statements discussed in the Hindenburg Report also failed because the complaint did not identify the statements, when they were made, or who made them with enough specificity.

The court found that the complaint adequately identified actionable alleged misstatements in Kandi’s public filings from the second quarter of 2015 through the third quarter of 2016. These included statements about related-party transactions and statements about the effectiveness of Kandi’s internal controls, including certifications concerning the accuracy of the financial statements and disclosure of fraud or material weaknesses.

The allegations were sufficient to show that Kandi’s statements about related-party transactions were false to the extent they concealed transactions with the Service Company. The court rejected allegations concerning transactions with Kandi USA because more specific allegations in the complaint stated that those transactions had been disclosed. The court also held that allegations about Kandi’s internal-control statements were sufficient to plead falsity concerning weaknesses related to reporting related-party transactions. The complaint did not adequately identify specific false statements concerning other accounting problems later addressed in the restatement.

Scienter

The court found a strong inference of scienter as to Kandi and Hu based on their alleged ownership interests in the Service Company and their alleged personal or corporate benefits from the subsidy arrangement. The complaint also alleged that Kandi was investigated and later fined and sanctioned by the Chinese government for collecting illegitimate subsidies, which supported an alleged motive to conceal the transactions.

The complaint did not allege a comparable motive for the other Individual Defendants. However, it adequately alleged recklessness or conscious misbehavior by Chen, Lewin, Yu, and Wang. The complaint stated that they attended Audit Committee meetings where Kandi identified the Service Company as a related party and discussed millions of dollars in sales and receivables involving that company. The court concluded that their alleged knowledge of the transactions and Kandi’s reporting requirements, combined with their approval or certification of reports that omitted the transactions, sufficiently supported scienter.

The court found no adequate scienter allegations against Mei. Mei became Kandi’s CFO after the alleged 2015 and 2016 conduct and shortly before Kandi began restating its prior financial statements. The complaint contained no substantive allegations about Mei, and any alleged statements made during Mei’s tenure were not identified with sufficient specificity.

Statute of limitations

The court rejected the defendants’ argument that the claims were untimely. Kandi’s March 2017 restatement announcement and the filing of another securities lawsuit were, at most, warnings that could have prompted investigation. They did not disclose enough information about the defendants’ knowledge or intent to establish scienter. The court also noted that the more specific scienter allegations in the earlier related proceeding appeared in an amended complaint filed less than two years before this action was filed.

Section 20(a) claims and disposition

Because the complaint adequately pleaded a primary Section 10(b) violation involving Hu, Chen, Lewin, Yu, and Wang, the related Section 20(a) claims survived against those defendants. The Section 20(a) claim was dismissed as to Mei because the complaint did not adequately allege Mei’s culpability.

The court’s final disposition was that the defendants’ motion to dismiss was granted in part and denied in part. The Section 10(b) claim survived against Kandi, Hu, Chen, Lewin, Yu, and Wang only insofar as it was based on alleged misstatements about related-party transactions, including related statements about the accuracy of financial statements, disclosure of fraud, and the adequacy of internal controls. The Section 20(a) claim survived against Hu, Chen, Lewin, Yu, and Wang to the same extent. The Section 10(b) and Section 20(a) claims were dismissed to the extent they relied on other alleged misstatements, and all claims against Mei were dismissed. The Clerk of Court was directed to terminate Mei as a defendant.