Citations
- 929 F. Supp. 2d 740
Full opinion text
MEMORANDUM
WILLIAM J. HAYNES, JR., Chief Judge.
TABLE OF CONTENTS
A. ANALYSIS OF THE AMENDED COMPLAINT...............................745
1. The Parties ............................................................745
2. Fushi’s Financial Reports................... 747
a. Fushi’s SWAP Transaction................ 747
b. Fushi’s Acquisition Practices............... 751
c. The Restatements........................ 755
d. Fushi’s Internal Controls.................. 759
e. Sarbanes-Oxley Certifications............. 760
f. Misstatements and Omissions.............. 762
3. Individual Defendants...................... 765
a. Defendant Fu............................ 765
b. Other Individuals ........................ 767
4. Loss Causation.............................. 768
5. Fraud on the Market......................... 768
B. CONCLUSIONS OF LAW...................... 769
1. PSLRA Standards........................... 774
2. Plaintiffs’ Section 10b-5 Claims.............. 775
a. Defendants’ Misrepresentation and Omissions 776
b. Materiality.............................. 781
c. Plaintiffs’ Scienter Allegations............. 783
d. Dura’s Injury Requirement................ 787
3. Plaintiffs’ Section 20(a) Claims.............. 788
C. RELIEF....................................... 790
Plaintiffs, North Port Firefighters’ Pension-Local Option Plan (“North Port”) and City of Lakeland Employees Pension Plan, filed this action under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“1934 Act”), 15 U.S.C. § 78a et seq. (2010), and Rule 10(b) promulgated thereunder, 17 C.F.R. § 240.10b-5 (2010), on behalf of themselves and a class of shareholders against the Defendants, Fushi Copperweld, Inc. (“Fushi”) and the following Fushi corporate officers: Li Fu, Joseph J. Longever, Craig H. Studwell, and Wenbing Christopher Wang. In earlier proceedings, the Court appointed City of Lakeland Employees Pension Plan (“Lake-land Employees”) as the Lead Plaintiff. Lakeland Employees then filed an amended complaint. (Docket Entry No. 57, Amended Complaint). Plaintiffs assert jurisdiction under 15 U.S.C. § 78aa of the 1934 Act.
In sum, Plaintiffs allege that from August 14, 2007 to May 4, 2011, when Plaintiffs purchased or held Fushi stock, the Defendants engaged in a scheme to portray Fushi as more financially successful than its actual financial condition. Defendants allegedly disseminated or approved false statements about Fushi’s financial condition and acquisitions. Plaintiffs alternately allege that the Defendants deliberately disregarded false statements about Fushi to investors. Plaintiffs also allege that the Defendants’ alleged misrepresentations and failures to disclose material facts rendered the Defendants’ earlier statements about Fushi’s finances false. Plaintiffs’ specific assertions are that the Defendants’ fraudulent scheme and course of business included the improper use of derivatives to inflate artificially Fushi’s net income. In addition, Plaintiffs allege that the Defendants improperly treated unqualified acquisitions as “bargain purchases” and such improper accounting treatment deceived the investing public about Fushi’s business by artificially inflating the price of Fushi’s stock. Plaintiffs allege these improper practices violated Generally Accepted Accounting Principles (“GAAP”). Defendants also allegedly failed to disclose that the Defendant Fu had ownership interests in these acquisitions. These statements and omissions caused Plaintiffs to purchase Fushi’s securities at inflated prices. Plaintiffs assert that subsequent disclosures about the accounting violations involving Fushi’s derivatives and acquisitions led to the collapse of Fushi’s stock price, damaging the Plaintiffs. Plaintiffs seek a declaration of this action as a proper class action pursuant to Fed.R.Civ.P. 23, class damages, reasonable costs and attorney’s fees, and injunctive or other equitable relief.
Before the Court is the Defendants’ motion to dismiss (Docket Entry No. 65), contending, in essence, that Plaintiffs fail to state a claim under Sections 10(b) or 20(a) of the 1934 Act or Rule 10b-5 thereunder. In sum, Defendants’ specific contentions are that:
(1) Plaintiffs’ 10(b) claims against Defendants do not satisfy the pleading requirements of Fed.R.Civ.P. 8(a)(2) and 9(b) or the Private Securities Litigation Reform Act (“PSLRA”) for failure to allege any material misstatement of fact;
(2) Plaintiffs’ factual allegations do not support a strong inference of scienter in Fushi’s accounting errors;
(3) Plaintiffs’ allegations of reckless disregard are not entitled to a presumption of truth for scienter purposes;
(4) Plaintiffs’ allegations of confidential witnesses and insider trading do not support a strong inference of scienter;
(5) Plaintiffs’ allegations of motive and opportunity fail to meet the PLSRA’s pleading requirements;
(6) Plaintiffs fail to plead facts of loss causation;
(7) Plaintiffs’ failure to plead viable Section 10(b) claims requires a dismissal of Plaintiffs’ Section 20(a) claims; and
(8)Plaintiffs fail to plead control person liability under Section 20(a) as to any of the individual defendants.
(Docket Entry No. 69, Defendants Memorandum in Support of Motion to Dismiss).
In their response, Plaintiffs assert, in sum: (1) that their complaint adequately pleads that Defendants made false, misleading, and material misstatements and omissions about Fushi’s financial condition; (2) that under the applicable law, the totality of circumstances gives rise to a strong inference of scienter; and (3) that Plaintiffs’ sufficiently plead loss causation. (Docket Entry No. 76, Plaintiffs’ Memorandum in Opposition to Defendants’ Motion to Dismiss). The Court set oral argument, that was reset upon the parties’ request.
Based upon the amended complaint and the parties’ submissions and applying the holistic approach, the Court concludes, in sum, that Plaintiffs’ amended complaint states plausible securities claims given Plaintiffs’ factual allegations of the Defendants’ admitted improper use of a SWAP to inflate the value of Fushi stock, the Defendants’ admitted improper accounting treatment of bargain acquisitions, the Defendants’ failure to disclose the Defendant Fushi’s ownership interests in those acquisitions and insiders’ false statements about the Defendants’ financial practices.
A. ANALYSIS OF THE AMENDED COMPLAINT
1. The Parties
According to Plaintiffs’ amended complaint, Plaintiffs purchased Fushi shares during the Class Period from August 14, 2007 through May 4, 2011. (Docket Entry No. 57, Amended Complaint at ¶ 16). Plaintiffs allege that all persons who purchased or otherwise acquired Fushi securities during the Class Period were injured by the Defendants’ false statements about Fushi’s financial condition. This purported class excludes Defendants, Fushi’s officers and directors, members of the individual Defendants’ immediate families and any entity in which the Defendants have or had a controlling interest. Id. at ¶ 164.
Fushi is based in Dalian, China and produces bimetallic wire products that are sold primarily to customers in the telecommunications, electrical utility, and transportation industries throughout the world. Id. at ¶ 2. Fushi’s common stock was listed and traded on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) under the symbol FSIN during the Class Period. Id. at ¶ 1. Fushi’s business is conducted principally through wholly owned subsidiaries: Fushi International (“Dalian”), Bimetallic Cable Co. Ltd. and Copperweld Bimetallics, LLC (“Copperweld”). Id. at ¶ 25. Fushi acquired 100% of Copperweld in 2007. Id. During the Class Period, Fushi had approximately 600 employees, of whom 54% were in manufacturing. Id. The remaining employees were engineers or salespersons. Id.
Defendant, Li Fu (“Fu”), served as Fushi’s chief executive officer from December 2005 through November 2009 and thereafter as Fushi’s co-chief executive officer. Id. at ¶ 18. Since December 2005, Fu also served as Chairman of the Fushi’s Board. Id. During the Class Period, Fu prepared and signed Fushi’s 10-K Forms, filed with the Securities and Exchange Commission (“SEC”). Fu attested his review of the filings’ contents for any untrue statements of a material fact or omissions that would render the statements misleading. Id. Plaintiffs allege that Fu also issued press releases and participated in Fushi’s conference calls (through an interpreter) with investors and was the primary person with knowledge about the Fushi’s business, financial reports, and business practices. Id.
Since November 2009, Defendant Joseph J. Longever (“Longever”) served as Fushi’s co-chief executive officer and as a Fushi director since June 2010. Id. at ¶ 19. Longever, a Franklin, Tennessee resident, served as Fushi’s chief commercial officer from July 2009 to November 2009. Id. Longever prepared and signed Fushi’s 10-K Forms during the Class Period and attested to their accuracy. Id. Longever also issued press releases and participated in conference calls with investors as a person with knowledge about Fushi’s business, financial reports, and business practices. Id.
Defendant Wenbing Christopher Wang (“Wang”) served as Fushi’s president and director since January 2008. Id. at ¶ 20. Wang was also Fushi’s chief financial officer from December 2005 to August 2009 and was interim chief financial officer from February to October 2010. Id. Defendant Wang also prepared and signed the Fushi’s SEC 10-K Forms during the Class Period and reviewed and attested to their accuracy. Id. Wang also issued press releases and participated in conference calls with investors representing himself as a primary person with knowledge about the Company’s business, financial reports, and business practices. Id.
As to the other individual defendants, beginning in October 2010. Defendant Craig H. Studwell (“Studwell”) served as Fushi’s chief financial officer and executive vice president. Id. at ¶ 21. Defendant Beihong Linda Zhang (“Zhang”) was Fushi’s executive vice president and chief financial officer from September 2009 until her resignation in March 2010. Id. at ¶ 22.
2. Fushi’s Financial Reports
According to Plaintiffs’ amended complaint, beginning on August 14, 2007, Fushi issued a press release of its 2007 second quarter financial results. Id. at ¶ 67. In sum, Defendants reported Fushi’s $26 million in revenue and $7 million with $0.28 diluted earnings per share (“EPS”) for that quarter. Li Fushi issued press releases at the end of each quarter and year with this same financial information on November, 14, 2007, March 12, May 14, August 12, and November 13, 2008, March 12, May 11, August 5, and November 6, 2009, March 10, May 4, August 4, and November 2, 2010. Id. at ¶¶ 70, 72, 76, 79, 82, 85, 89, 92, 95, 101, 105, 109, 112. Collectively, these press releases also contain the cited figures of revenue and earnings.
Revenue Net Income Diluted EPS
3d 2007 $32 million $8.2 million $0.33
4th 2007 $265 million $6.4 million $0.23
Full Year 2007 $128 million $485 million $1.06
1st 2008 $54 million $7.6 million $0.26
2d 2008 $625 million $7.3 million $0.25
3d 2008 $63.8 million $9 million $0.31
4th 2008 $41 million $4.6 million $0.15
Full Year 2008 $221 million $285 million $1.00
1st 2009 $353 million $3.1 million $0.11
2d 2009 $483 million $1.6 million $0.06
3d 2009 $47.7 million $9.2 million $0.31
4th 2009 $51.7 million $10 million $0.34
Full Year 2009 $183 million $24 million $0.84
1st 2010 $595 Million $7.4 million $0.21
2d 2010 $69 million $13.4 million $0.35
3d 2010 $665 million $13 million $0.34
Id. at ¶¶ 70, 72, 76, 79, 82, 85, 89, 92, 95, 101,105,109,112.
With the exception of the November 14, 2007 press release, the Defendants also hosted conference calls with investors after the press releases for these time periods. Id. at ¶¶ 73, 77, 80, 83, 86, 90, 93, 96, 102, 106, 110, 113. In each call, Defendants commented on Fushi’s financial standing at that time and gave reasons for any changes in Fushi’s value over the period. Id. Plaintiffs allege that Defendant Wang spoke during the November 13, 2008, March 12, 2009, and March 10, May 4, August 4, and November 2, 2010 conference calls; that Defendant Zhang spoke during the November 6, 2009 call; and Defendant Longever spoke during the March 10, 2010 call. Id. at ¶¶ 83, 86, 96, 102,104,106,108,110,113.
a. Fushi’s SWAP Transaction
On April 10, 2007 and in its August 14, 2007 SEC10-Q Form, (effective January 24, 2007), Fushi disclosed its “Derivative Financial Instrument,” that is a cross currency interest swap (“SWAP”), a derivative transaction. Fushi described this SWAP as “a cross currency hedge” and a “cash flow hedge” that was “to hedge the risk of rising interest rates on their variable interest rate debt.” Id. at ¶ 34; 69. The SWAP’S stated purpose was to address Fushi’s interest rate risk on Fushi’s variable rate interest payments in U.S. dollars on its $40 million high yield debt. Id. at ¶ 34. Under the SWAP, Merrill Lynch Capital Services, Inc. (“Merrill Lynch”) agreed to pay Fushi the variable rate interest in U.S. dollars. Id. Fushi would use that rate to pay its debt holders of Fushi’s $40 million high yield notes. In exchange, Fushi agreed to pay Merrill Lynch a fixed rate of interest in Renminbi (“RMB”), the official currency of China. Id. Plaintiffs allege that Fushi reference to the SWAP as a “cash flow hedge” enabled Defendants to inflate Fushi’s net income by $5.6 million or 24% in 2007. Id. at ¶ 39.
Fushi’s report also stated that this “Derivative Financial Instrument,” or SWAP would be treated “in accordance with FAS No. 133, ‘Accounting for Derivatives Instruments and Hedging Activity,’ which requires the derivative to be carried on the balance sheet at fair value and to meet certain documentary and analytical requirements to qualify for hedge accounting treatment.” Id. at ¶ 69. Fushi asserted that this “derivative qualifies for hedge accounting under FAS 133 and, accordingly, changes in the fair value is reported in accumulated other comprehensive income, net of related income tax effects.” Id. Plaintiffs cited the following statements from Fushi’s Form 10-Q for the second quarter of 2007 about the April 10 SWAP as false:
The Company uses a cross currency hedge, a derivative financial instrument, to hedge the risk of rising interest rates on their variable interest rate debt. This type of derivative financial instrument is known as a cash flow hedge. The Company accounts for this interest rate swap in accordance with FAS No. 133, “Accounting for Derivatives Instruments and Hedging Activity,” which requires the derivative to be carried on the balance sheet at fair value and to meet certain documentary and analytical requirements to qualify for hedge accounting treatment. The above derivative qualifies for hedge accounting under FAS 133 and, accordingly, changes in the fair value is reported in accumulated other comprehensive income, net of related income tax effects. Amounts included in accumulated other comprehensive income are reclassified into earnings w hen the hedged transaction effects earnings.
At the inception of the transaction, the Company documents the relationship between hedging instruments and hedged items, as well as its risk management objective and the strategy for undertaking various hedge transactions. This process includes linking all derivatives designated to specific firm commitments of forecast transactions. The Company also documents its assessment, both at inception and on an ongoing basis, of whether the derivative financial instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.
Id. at ¶ 36 (emphasis in complaint).
Defendants note their disclosures about the nature, risks and the accounting treatment for this SWAP in Fushi’s SEC Form 10-Q for the quarter that ended June 30, 2007:
The Company’s operations are exposed to a variety of global market risks, including the effect of changing interest rates. This exposure is managed, in part, with the use of financial derivatives.
To hedge exposures associated with the Guaranteed Senior Secured Floating Rate Notes due 2012 (2012 Note), on April 10, 2007, the Company entered into a cross currency swap transaction (the SWAP) with Merrill Lynch Capital Services, Inc. (“MLCS”). The Swap, with a notional principal value of $40 million, converts the LIBOR + 7% per annum USD variable interest rate to an 8.3% per annum RMB fixed interest rate.... Under the terms of the cross currency swap, the Company receives variable interest rate payments in USD and makes fixed interest rate payments in RMB with a settlement netted in USD, thereby creating the equivalent of fixed-rate debt. MLCS requires the Company to deposit $1,000,000 with them to secure the agreement. The deposit may be increased to $3,000,000 if the exchange rate for RMB to USD falls below 6.5, and to $5,000,000 if the exchange rate falls below 5.5. This swap is designated and qualified as a cash flow hedge.
(Docket Entry No. 66-4 at 30-32) (emphasis added).
According to Plaintiffs, for the SWAP to be “highly effective,” GAAP standards require that at the inception of the SWAP, Fushi must expect that the changes in the variable rate of interest in U.S. dollars would be almost fully offset by the changes in the RMB/U.S. rate of exchange on the fixed rate interest, over the term of the SWAP. (Docket Entry No. 57, Amended Complaint at ¶ 38). Plaintiffs allege that “at the inception of the SWAP, as well as on an ongoing basis Fushi could not possibly expect that the changes in the LIBOR [London Interbank Offered Rate] would be almost fully offset by the changes in the RMB/U.S. exchange rate.” Id. Thus, Plaintiffs allege that “[n]o rational person in the business could expect, for example, that a rise in the LIBOR would necessarily be accompanied by an offsetting change in the RMB/U.S. exchange rate, hand-in-hand.” Id.
Plaintiffs’ allegations are reflected in statements in Fushi’s SEC Form 8-K, dated March 24, 2011, that its SWAP did not qualify under stated accounting standards, as Defendants earlier told investors. In a word, Fushi explained that this SWAP did not qualify for cash flow hedge accounting treatment because the SWAP did not provide an effective hedge against Fushi’s variable rate interest payments on its high yield debt. The amended complaint states:
On April 10, 2007, the Company entered into a cross currency swap transaction (the “SWAP”) with Merrill Lynch Capital Services, Inc. Under the terms of the SWAP, the Company received variable interest rate (based on LIBOR [London Interbank Offered Rate, a rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market] plus 7% per annum and adjustable to LIBOR plus 5% per annum after a qualifying IPO) payments in USD [U.S. dollars] based on a notional amount of USD 40 million and made fixed interest rate payments in RMB which were translated into USD at foreign exchange rates on each settlement date. The fixed interest rate payment was based on the notional amount of RMB 310,900,000 at a fixed interest rate of 8.3% per annum. The SWAP required semi-annual payments in arrears on July 24 and January 24 and would mature on the earlier of (1) cash settlement defined as early termination or (2) January 24, 2012.
The Company originally intended to use the SWAP to hedge both variable interest risk of its outstanding high yield notes of USD 40 million, which bore interest at LIBOR plus 7% and adjustable to LIBOR plus 5.6% per annum after a qualifying IPO, and foreign currency risk of its operating subsidiaries in the People’s Republic of China. However, since the Company was not exposed to foreign currency risk on the high yield notes, the SWAP did not qualify for hedge accounting and all changes in fair value of the SWAP should have been recognized in earnings.
Due to the complexities of accounting for derivatives, the Company had misapplied the U.S. GAAP and designated the SWAP as cash flow hedge against the USD 40 million high yield notes. The changes in fair value of the SWAP had been inappropriately accounted for in other comprehensive income rather than recognized in earnings prior to the SWAP being terminated on March 31, 2010.
Id. at ¶ 34 (emphasis in complaint). Plaintiffs allege that Fushi was never exposed to foreign currency risk on its high yield notes. Id. at ¶ 45.
Plaintiffs also allege that “Fushi knew that the SWAP would cause the Company to be exposed to an additional foreign currency risk: on those interest payments in RMB” and “knew, therefore, that the SWAP could not possibly comport with the GAAP requirement that the SWAP be ‘highly effective’ at the inception of the transaction.” Id. at 141. This foreign currency risk is based upon the interest payments in RMB. Id. This risk is reflected in Fushi’s 2007 10-K Form that states: “[i]f the RMB depreciates against the U.S. Dollar, the value of our RMB revenues and assets as expressed in our U.S. Dollar financial statements will decline.” Id. In their amended complaint, Plaintiffs proffer a chart to depict Fushi’s SWAP with Merrill Lynch. Id. at ¶ 43. Under the SWAP transaction, (1) Merrill Lynch agreed to pay Fushi the variable rate interest in U.S. dollars; (2) Fushi used such payment to pay the debt holders of Fushi’s $40 million high yield notes; and (3) Fushi agreed to pay Merrill Lynch a fixed rate of interest in RMB. Id. at ¶ 44. Plaintiffs allege that the high yield notes and interest that Merrill Lynch paid Fushi were both in U.S. dollars. Id. at ¶ 45.
Moreover, the Plaintiffs allege that Fushi’s reporting currency and functional currency in the United States were both in U.S. dollars. Id. at ¶ 45. Under such a transaction there is not any reasonable expectation that changes in the variable rate of interest in U.S. dollars would be almost fully offset by changes in the RMB/ U.S. rate of exchange on the fixed rate interest over the SWAP’S term. Id. at ¶ 44. Fushi’s statement in its March 24, 2011 Form 8-K acknowledged that:
[T]he Company was not exposed to foreign currency risk on the high yield notes, the SWAP did not qualify for hedge accounting and all changes in fair value of the SWAP should have been recognized in earnings.
Id. at ¶ 45.
Plaintiffs assert that at its inception and thereafter, Fushi knew that under this SWAP, changes in the LIBOR would be almost fully offset by the changes in the RMB/U.S. exchange rate. Id. at ¶ 46. Thus, the Defendants’ improper accounting must have been either intentional or was done with reckless disregard of the actual facts and was not the product of an innocent mistake or mere error. Id. Plaintiffs further allege that as a result of the improper accounting of this SWAP, Fushi’s financial statements were materially false and misleading from 2007 through the first quarter of 2010. Id. at ¶ 30.
Plaintiffs allege that Fushi knew or recklessly disregarded the fact that this SWAP was not qualified to use cash flow hedge because all criteria in Financial Accounting Standards (“FAS”) 133 had to be met. Id. at ¶¶ 28-29, 37. Specifically, Plaintiffs cite the section titled Accounting for Certain Derivative Instruments and Certain Hedging Activities. Id. at ¶ 36. Fushi allegedly did not comply with this requirement that “[b]oth at [the] inception of the hedge and on an ongoing basis, the hedging relationship is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge.” Id. (quoting FAS No. 133, ¶ 28b).
Plaintiffs allege that Defendants knew that treatment, disclosure, and reporting of the SWAP as a “cash flow hedge,” was false and also knew that charges against net income could be improperly dodged. Id. at ¶ 39. Plaintiffs assert that this error was not due to complex accounting requirements because Fushi’s SWAP used a “plain vanilla” foreign currency/ cross currency interest rate swap that do not involve complex accounting rules. Id. at ¶42. For the characteristics of a plain vanilla swap, Plaintiffs allege:
(a) Party A holds interest-bearing debt in the functional currency (U.S. dollars in Fushi’s case), and seeks to hedge against foreign currency risk by engaging in a cross currency swap transaction with Party B, which holds interest-bearing debt in a foreign currency (RMB in Merrill Lynch’s case);
(b) The parties exchange the principal on the notional amounts at market rates, typically using the same exchange rate for the transfer at the inception of the transaction as is employed at the end of the swap transaction;
(c) The two specified principal amounts are set so as to be approximately equal (based on the exchange rate at the time of the initial transaction);
(d) Party A pays interest at the agreed upon rate to Party B on the notional foreign currency principal that was transferred to Party A;
(e) Party B pays interest at the agreed upon rate to Party A on the notional U.S. currency principal that was transferred to Party B;
(f) At the termination of the swap, or maturity, the parties exchange the principal amounts, so that Party A receives its original principal in U.S. dollars and Party B receives its original principal in the foreign currency;
(g) The more the actual market foreign currency exchange rates have deviated from the contracted rates, the greater the potential for loss or gain; and
(h) The longer the term of the contract, the greater the potential volatility and loss or gain because of changes in foreign currency exchange rates over time.
Id.
With this SWAP, in 2007, Plaintiffs allege that Fushi was able to inflate net income by $5.6 million or 24% while evading reporting substantial losses that would otherwise have materially and adversely affected the Company’s bottom line net income. Id. at ¶ 47. Fushi’s restatements resulted in a decrease in Fushi’s net income of $5.6 million in 2007; an increase in net income of $2.7 million in 2008; a decrease in net income of $2.1 million in 2009; and a decrease in net income of $5.0 million for the quarter ended March 31, 2010. Id. at ¶ 30. The cumulative financial impact of Fushi’s improper SWAP accounting during the period from January 24, 2007 through March 31, 2010 represents an overstatement net income of $10.0 million. Id.
b. Fushi’s Acquisition Practices
On January 21, 2010, acting through its subsidiary Fushi International (Dalian) Bimettalic Cable Co. Ltd., Fushi announced its “ ‘definitive agreement to acquire Dalian Jinchuan Electric Cable Co., Ltd. (“Dalian Jinchuan”) for approximately $10.2 million,’ ” with “ ‘the transaction to be finalized during the course of the first quarter 2010.’ ” Id. at ¶ 98. Fushi described Dalian Jinchuan as “ ‘a leading Northeastern Chinese manufacturer of low- and medium-voltage power cables using copper, aluminum and copper-clad center conductors, [and had] reported 2008 revenues as audited under Chinese GAAP of approximately $18 million.’ ” Id. Fushi also stated that “‘[t]he purchase price of $10.2 million may be made, at the option of the Company, in cash and restricted stock of the Company over the next year.’ ” Id. In addition, Fushi also announced that “ ‘[u]pon closing, the Company expects the acquisition of Dalian Jinchuan to be immediately accretive to earnings.’ ” Id.
Defendants note that in Fushi’s SEC Form 10-Q issued on November 8, 2010, Fushi made the following disclosures about the Jinchuan acquisition: (1) The Company paid $5,075 million in cash to acquire Jinchuan, with additional payments of up to $5,075 million to be paid depending upon whether Jinchuan reached certain performance targets for 2010. See (Docket Entry No. 66-10 at 3, March 24, 2011 Form 8-K); (2) The Company retained an independent appraisal of Jinchuan by Liaoning Hongxing Appraisal, LLC (“Liaoning Hongxing”) that appraised the fair value of Jinchuan’s net assets at $13,455,950, approximately $3.3 million above the purchase price. (Docket Entry No. 66-11 at 50); and (3) in reliance upon this independent appraisal, the Company recognized a $3.3 million gain flowing from its “bargain acquisition” of Jinchuan. Id.
Fushi’s February 1, 2010 press release announced the closing of a public offering of 7,475,000 shares of Fushi common stock at $8 per share, yielding net proceeds of $55.4 million (including the underwriters’ over-allotment of 975,000 shares of common stock). (Docket Entry No. 57, Amended Complaint at ¶ 99). In reference to this offering, Fushi’s May 4, 2010 press release stated:
During the quarter, the Company successfully completed a secondary offering of 7.5 million shares of common stock, generating net proceeds of over $55 million. A portion of these proceeds was used to retire the Company’s long-term debt, and the one-time loss in retiring this debt totaled $2.4 million ($1.6 million net of tax), or $0.07 per diluted share ($0.04 net of tax). Simultaneously, the Company terminated the cross currency interest rate swap, a derivative the Company used as a hedging instrument related to this long-term debt, and as a result recognized a realized loss of $6.7 million ($4.4 million net of tax), or $0.19 per diluted share ($0.12 net of tax) during the period. The termination of this swap enabled the Company to mitigate the risk of an appreciation in the renminbi. Lastly, during the first quarter the Company completed its previously announced acquisition of Dalian Jinchuan Jinchuan and recognized a onetime non-cash gain of $3.3 million, or $0.09 per diluted share as the fair market value of Dalian assets exceeded the purchase price.
Id. at ¶ 105. Plaintiffs assert that the cash from this stock offering was used to continue Defendants’ debt reductions while maintaining cash reserves around $79 million. Id. at ¶ 100.
On May 26, 2010, Fushi announced that its agreement to acquire 100% of Hongtai, a leading manufacturer of bimetallic wire in Southeast China, for approximately $3.9 million, with $1.3 million in cash and $2.6 million in restricted stock. Id. at ¶ 108. Fushi stated its expectation that the transaction would be finalized during the second quarter of 2010. Id. Fushi described Hongtai as “ ‘a leading manufacturer of bimetallic wire in Southeast China, principally [CCA] and copper-clad aluminum magnesium.’ ” Id. Hongtai’s net assets were stated to be at $5.7. million, approximately $1.8 million above the market price and with reliance upon this independent appraisal, Fushi recognized a $1.8 million gain flowing from its “bargain purchase” of Hongtai. (Docket Entry No. 66-11 at 52-3, November 8, 2010 Form 10-Q). Defendants cited the Liaoning Hongxing appraisal of the Jinchuan and Hontai acquisitions. Id.
On December 3, 2010, financial analysts at Jefferies & Company reported Fushi’s decreasing stock value citing “the discovery of potential accounting irregularities at a different Chinese-based U.S. traded company that is audited by the same firm [Fushi] uses.” (Docket Entry No. 57, Amended Complaint at ¶ 115). The Jefferies analyst also noted that Fushi acted to offset this concern and “reiterated to [Jefferies] its confidence in its accounting policies and their application.” Id. (emphasis omitted). Based upon these accounting irregularities, Plaintiffs allege that Fushi’s SEC reports, statements on conference calls, and press statements about its financial conditions were materially misleading and did not fairly represent Fushi’s actual financial condition during the Class Period. Id. at ¶ 75, 88, 104,116.
Plaintiffs allege that Fushi did not reassess whether the assets acquired and liabilities assumed were correctly identified, as required by FAS No. 141R, ¶ 38. Id. at ¶ 53. Plaintiffs allege Fushi violated GAAP by (1) materially overstating “the fair value of certain property, plant and equipment” that Fushi acquired in its purchases of Dalian Jinchuan Jinchuan and Hongtai; (2) improperly treated these acquisitions as “bargain” purchases under Fushi’s purchase price accounting; and (3) improperly recognized gains on these transactions. Id. (citing Form 8-K, Mar. 24, 2011). According to the amended complaint, a “bargain” purchase occurs when the fair value of the acquired net assets in a business combination exceeds the consideration the acquirer paid. Id. at ¶ 49. Plaintiffs allege that such bargain purchases are rare and unusual, citing FAS No. 141R on the accounting rules regarding such purchases:
The Boards [i.e., the FASB and then International Accounting Standards Board or “IASB”] consider bargain purchases to be anomalous transactions-business entities and their owners generally do not knowingly and willingly sell assets or businesses at prices below their fair values.
FAS No. 141R, ¶ 371. A bargain purchase might happen, for example, in a business combination that is a forced sale in which the seller is acting under compulsion.
FAS No. 141R, ¶ 37. Circumstances in which they [bargain purchases] occur include a forced liquidation or distress sale (for example, after the death of a founder or key manager) in which owners need to sell a business quickly, which may result in a price that is less than fair value.
FAS No. 141R, ¶ B371. The appearance of a bargain purchase without evidence of the underlying reasons would raise concerns in practice about the existence of measurement errors. FAS. No. 141R, ¶ B372.
Id. at ¶¶ 50-51 (emphasis in complaint).
Plaintiffs assert that the Financial Accounting Standards Board (“FASB”) distinguishes between a “bargain” purchase and measurements errors:
The Boards [FASB and IASB] acknowledged concerns raised by constituents that a requirement to recognize gains on a bargain purchase might provide an opportunity for inappropriate gain recognition from intentional errors resulting from the acquirer’s:
a. Understating or failing to identify the value of items of consideration that it transferred
b. Overstating values attributed to particular assets acquired
c. Understating or failing to identify and recognize particular liabilities assumed.
The Boards think that problems surrounding intentional measurement errors by acquirers generally are best addressed by means other than setting standards specifically intended to avoid abuse. Strong internal control systems and the use of independent valuation experts and external auditors are among the means by which both intentional and unintentional measurement errors are minimized. Standard specifically designed to avoid abuse would inevitable lack neutrality. (See paragraph B51 for a discussion of the need for neutrality in accounting and accounting standards.) However, the Boards share constituents’ concerns about the potential for inappropriate gain recognition resulting from measurement bias or undetected measurement errors. Thus, the Boards decided, as specified in paragraph 38, to require the acquirer to reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed before recognizing a gain on a bargain purchase. The acquirer then must review the procedures used to measure the amounts this Statement requires to be recognized at the acquisition date for all the following:
a. The identifiable assets acquired and liabilities assumed
b. The noneontrolling interest in the acquiree, if any
c. For a business combination achieved in stages, the acquirer’s previously held equity interest in the acquiree
d.The consideration transferred.
The objective of that review is to ensure that appropriate consideration has been given to all available information in identifying the items to be measured and recognized and in determining their fair values. The Boards believe that the required review will mitigate, if not eliminate, undetected errors that might have existed in the initial measurements. FAS No. 141R, ¶¶ B374-75.
Id. at ¶ 51 (emphasis added).
Plaintiffs also cite FASB procedures describe how to determine if a “bargain” purchase is legitimate or permissible:
Before recognizing a gain on a bargain purchase, the acquirer shall reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and shall recognize any additional assets or liabilities that are identified in that review. The acquirer shall then review the procedures used to measure the amounts this Statement requires to be recognized at the acquisition date for all of the following:
a. The identifiable assets acquired and liabilities assumed
b. The noncontrolling interest in the acquiree, if any
c. For . a business, combination achieved in stages, the acquirer’s previously held equity interest in the acquiree
d. The consideration transferred.
The objective of the review is to ensure that the measurements appropriately reflect consideration of all available information as of the acquisition date. FAS No. 141R, 138.
Id. at ¶ 52.
Plaintiffs assert that GAAP expressly warns financial statement preparers that “bargain” purchases are “anomalous” and advises that the fair value measurements for such purchases should be investigated and rechecked for overstatements of net assets. Id. at ¶ 31. Plaintiffs assert that Fushi did not heed FASB’s warnings about bargain purchases and did not maintain internal control systems to minimize intentional and unintentional errors. Id. Plaintiffs allege that Fushi knew the valuations of these acquired net assets were likely materially inflated. Id. Thus, Plaintiffs allege that the Defendants’ statements of the value of these acquisitions were false or the Defendants recklessly disregarded the facts and circumstances of the values of these acquisitions. Id. As a result, Plaintiffs allege that Fushi’s statements in documents, including its 2007 Form 10-K about effective internal control over financial reporting during the relevant time period, were false and misleading. Id. at ¶ 30. Plaintiffs further allege that Fushi was motivated to treat the purchases as “bargain” purchases to recognize gains of $3.3 million in the first quarter and $1.8 million in the second quarter of 2010. Id. at ¶ 31. Plaintiffs characterize these Fushi gains as “bogus,” because Fushi was required to restate its financial statements as a result of the allegedly false and misleading financial statement resulting from the purchases. Id. at ¶ 31-32. These restatements allegedly reduced Fushi’s earnings by $3.3 million in the first quarter and $1.8 million in the second quarter of 2010, resulting in a $5.1 million overstatement of Fushi’s gains. Id. Plaintiffs allege that Fushi failed to recognize approximately an additional $1.7 million of goodwill ($1.1 million from Dalian Jinchuan and $0.6 million from Hongtai) on its balance sheets for the second quarter of 2010. Id.
c. The Restatements
Between 2007 and January 24, 2011, Fushi’s independent accounting firm was Frazer Frost, LLP. Plaintiffs allege that on January 24, 2011, Fushi announced that its replacement of Frazer Frost with KPMG as Fushi’s registered independent public accounting firm. Id. at ¶ 142. Frazer Frost allegedly served as Fushi’s accounting firm in each of the years that were restated. Id. In its January 24, 2011 SEC Form 8-K Fushi announced that “Frazer’s report on the Company’s financial statements for the fiscal years ended December 31, 2008 and 2009 contained no adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principal.” (Docket Entry No. 66-5 at 2). In addition, Fushi’s report stated, “[djuring the period from January 1, 2008 through the date of Frazer’s dismissal, there were no disagreements with Frazer on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Frazer, would have caused Frazer to make reference to the subject matter of the disagreements in connection with Regulation S-K.” Id.; see also (Docket Entry No. 57, Amended Complaint at ¶ 142).
Fushi allegedly emphasized that this change was not the result of a disagreement with Frazer Frost and Frazer Frost’s prior reports on Fushi’s financial statements were accurate. Id. Plaintiffs allege that KPMG immediately discovered that Fushi’s prior financial statements for 2007-2009 and the first three quarters of 2010 were false. Id. at ¶ 143. Plaintiffs assert that this quick discovery supports an inference of scienter against the Defendants. Id. Plaintiffs also cite former high-level Fushi executive who has knowledge of Fushi’s executive team’s operation during the Class Period and Fushi’s accounting staffs alleged discomfort with their instructions. Id. at ¶ 134. Plaintiffs allege that an executive in accounting told another former Fushi executive that Fushi’s accounting personnel were uncomfortable with the accounting treatments at Fushi, including Fu’s sole authority to authorize payment or to move money. Id. The former executive allegedly stated that accounting personnel were worried about going to jail if they conducted the accounting as directed by the Defendants. Id.
On March 11, 2011, after the closure of the market, Fushi announced its reevaluation of its accounting treatment of its SWAP and its “bargain purchase” acquisitions of Dalain Jinchuan and Hongtai. Id. at ¶ 117. In addition Fushi announced its inability to meet SEC rules to file its Form 10-K by the deadline Id. As discussed below, Fushi announced its projected positive financial performance and provided a reason for its stock value decrease. Fushi also stated that “since the Company was not exposed to foreign currency risk on the high yield notes, the SWAP did not qualify for hedge accounting and all changes in fair value of the SWAP should have been recognized in earnings.” (Docket Entry No. 66-15 at 2, March 24, 2011 Form 8-K). As to the acquisitions, Fushi announced that “[djuring the year-end closing process, management of the Company identified certain errors in the original purchase price allocation with respect to the fair value of certain property, plant and equipment the Company acquired in the Hongtai and Jinchuan acquisitions.” Id. In its March 11, 2011 Form 8-K, Fushi stated that although the accounting treatments in question related only to non-cash and non-operating items, the Company’s review would result in a delay in the filing of the Company’s annual Form 10-K. Id. 66-14 at 5, Mar. 22, 2011 Form 8-K.
On March 11, 2012 Fushi stock closed at $9.42 and for the next two months fell to $5 to $7 a share. (Docket Entry No. 69, Defendants’ Memorandum in support of Motion to Dismiss at 33). Defendants note the Tsunami that struck Japan on March 11, 2012 that had an adverse effect on the Asian stock, but on March 14, 2012, Fushi’s stock price was $8.98 a share. Id. On March 29, 2011, Fushi disclosed that restatements of its financial statement would be forthcoming for 2007 through the first three quarters of 2010. These restatements revealed that in 2007, Fushi’s income was overstated 24%; in 2009 by 10% and the second quarter by 9%. Fushi states that its net income was understated in 2008 by 9% and 19% for the first and third quarters of 2010. Id. at 16.
Plaintiffs allege that in its press release about its reevaluations of the application of GAAP and certain accounting treatments of its SWAP and acquisitions for its 2007-2009 financial results and the financial statements, the Defendants stated:
These accounting treatments are related to the ability to realize deferred income tax assets, qualification of cash flow hedge for cross-currency interest swap, and bargain purchase gains recognized in 2010 acquisitions. As a result of the additional time needed to study these items, the Company expects to file a Notification of Late Filing under Rule 12b-25 of the Securities Exchange Act of 1934 with the SEC for an extension of its Annual Report on Form 10-K for the year ended December 31, 2010.
Mr. Joe Longever, co-Chief Executive Officer of Fushi Copperweld, commented, “In the process of preparing our financial statements for the year ended December 31, 2010, management reevaluated the application of GAAP in certain past accounting treatments, which are non-cash and non-operating items. While it is unfortunate that these reconsiderations are causing a delay in our filing, we stress the fact that these are all non-cash adjustments related to various corporate-level account treatments and will not materially affect our non-GAAP, core operating results such as revenue, gross profit and operating income.”
(Docket Entry No. 57, Am. Compl. at ¶ 117). Fushi’s press release also assured investors of the strength of Fushi’s business as reflected in Defendant Longever’s statement:
“We ended a good year on a very strong note, with financial results that we expect will exceed our previous expectations, including our first ever profitable fourth quarter at Fayetteville despite seasonal weakness. Volume increases at Fayetteville were driven by stronger demand, particularly for grounding products that serve the utility industry, and from more diverse market demand in Europe, South America, the Middle East and North Africa. While our business in China was affected by the continued slowdown of the 3G build-out, our diversified business model, product line and global market opportunity helped to offset this factor. Record copper prices also positively contributed to our performance as buyers increasingly look for a quality substitute for pure copper applications.”
“Looking ahead, we are excited by our prospects for 2011. With an improving macroeconomic environment, stronger production coming from Fayetteville, added capacity in Dalian Jinchuan to serve the broader Asian market opportunity, a solid initial response to our CCS product offering in China, and increasing global demand for our products serving the utilities industry, we believe we are well positioned to prosper and grow. As a result, we expect our utilization, volumes, and operating profit will continue to improve in 2011 and beyond.”
Id. at ¶ 118. In response to the announcement of the restatements, Fushi stock allegedly dropped 2.3% that Plaintiffs attribute to the exposure of the artificial inflation of the stock price. Id. at ¶ 124. Fushi’s stock closed on March 11, 2011 at $9.42 and opened on March 14, the next trading day, at $8.98 and remained at $8’s for the ensuing two months, but fell to the $5 to $7 range until closing at $8.27 on February 9, 2012. (Docket Entry No. 69, Defendants’ Memorandum in Support of Motion to Dismiss at 33).
Financial analysts Rodman & Renshaw allegedly noted the first quarter results as disappointing:
1Q11 EPS of $.18 missed our EPS estimate of $.28 by $.10. The company reported earnings significantly below our expectations on lower than expected gross margins, additional audit fees and advisory expenses related to the proposed management buyout offer, and a higher than anticipated effective tax rate for the quarter.... Consequently, the company posted a 39.3% [year-over-year] decline in non-GAAP net income to $7.0 million or $0.18% per fully diluted share. GAAP net income declined 24.7% [year-over-year] to $6.8 million or $0.18 per fully diluted share.
(Docket Entry No. 57, Amended Complaint at ¶ 127 (emphasis added)). Plaintiffs assert that as a result of this disappointment, the value of Fushi stock dropped an additional 3.4%. Id. at ¶ 131.
Plaintiffs allege that by March 14, financial analysts responded to this news of Fushi’s delay in filing of the Form 10-K as a “concern.” Id. at ¶ 119. Plaintiffs allege that financial analysts at Jeffries issued a second report after the market closed that day, downgrading Fushi from “BUY” to “HOLD” because of “concern over the company’s need to review accounting.” Id. Plaintiffs allege that with this news, Fushi shares dropped 18%, but did not collapse completely because of the alleged artificial inflation caused by the misleading statements. Id. at ¶ 120.
Plaintiffs allege that on March 29, 2011, Fushi filed a Form 8-K with the SEC disclosing that Fushi’s audit committee had concluded that the previously reported financial statements for the years ended December 31, 2009, 2008, and 2007 and its unaudited interim financial statements for the quarters ended March 31, 2010, June 30, 2010, and September 30, 2010 should be restated and should no longer be relied upon. Id. at ¶ 121. Fushi stated that this restatement was due to the misapplication of the GAAP to the SWAP and the acquisitions of Dalian Jinchuan and Hongtai. Id. Plaintiffs cite Jeffries analysts’ statements that “we do consider [the restatements] material to earnings, as they all exceed 8%.” Id. at ¶ 123.
According to Plaintiffs, a result of the accounting errors was that Fushi’s net income was overstated in 2007 (by 24%), 2009 (by 10%), and the second quarter of 2010 (by 9%); was understated in 2008 (by 9%); overstated in the first and third quarters of 2010 by 19%. Id. at ¶33. Plaintiffs note that Fushi missed its projected non-GAAP income by 39%. Id. at ¶ 127. The value of plant and equipment was overstated by approximately 4% over the first three quarters of 2010, and goodwill was undervalued by 100% during that time period with the net effect on the value of total assets of a 1% overstatement. Id. at ¶ 33; (Docket Entry No. 66-16 at 50; 66-17 at 35; 66-19 at 41). Defendants note that for the putative class period, the total overstatement of Fushi’s net income is 4%. (Docket Entry No. 69, Defendants’ Memorandum at 23).
Plaintiffs assert that Defendants’ decision to adjust Fushi’s previous financial statements is an admission that the financial results originally issued during the Class Period and its public statements regarding those results were materially false and misleading and that the financial statements reported during the Class Period were incorrect based on information available to the defendants at the time the results were originally reported. (Docket Entry No. 57, Amended Complaint at ¶ 122).
Plaintiffs allege that on May 2, 2011, in spite of the delay and allegedly because of the positive statements about 2011, financial analysts at Roth Capital Partners (“Roth”) expected Fushi to meet expectations for the first quarter of 2011. Id. at ¶ 125. On May 4, 2011, Fushi issued a press release on its first quarter 2011 financial results, with $65.9 million reported revenue and $6.8 million, or $0.18 diluted EPS, below the alleged analyst estimate of $0.23. Id. at ¶ 126.
Fushi’s release attributed its lack of performance to customers not stocking Fushi products at the same levels as past quarters and customers were drawing down on their inventories. Id. Defendant Longever’s actual statement was:
Our first quarter is typically our slowest period of the year, and our result for the period reflect this seasonality combined with an improving but still uncertain economic environment, as the continued slowdown in the Chinese 3G build-out and our sales mix again reflects a shift to more utility customers. We have also seen a break from typical buying patterns, with customers continuing to draw down on their inventories and restocking at only minimal levels. While infrastructure spending priorities to shift raw material pricing remains volatile, we continue to see customers attracted to out unique products for their technological superiority and economic value.
... Looking ahead, we expect these conditions to continue, namely a slowly improving global economic recovery marked by resurgence in some markets and continued struggling in others.
Id. at 146 (emphasis added). Plaintiffs assert that this characterization about inventory is refuted by former Fushi employees. According to Plaintiffs, a former high-level Fushi executive reports that during the Class Period that Fushi’s customers do not keep inventory on hand nor have warehouses for inventory, and only purchase products for immediate use. Id. at ¶ 128. A former Fushi sales representative employed during the Class Period also allegedly stated that customers did not sit on inventory. Id.
d. Fushi’s Internal Controls
Plaintiffs assert that Fushi’s failure to implement a ‘Western style” of internal controls contributed to the Defendants’ alleged wrongdoing. Id. at ¶55. Quoting Fushi’s SEC Form 10-K from 2007, Plaintiffs allege an awareness of the deficiency on the part of Fushi: “PRC [People’s Republic of China] companies have historically not adopted ... a Western style of management and financial reporting concepts and practices, ... which includes strong corporate governance, internal controls and, computer, ... financial and other control systems.... [T]here have been historical deficiencies with our internal controls ....” Id. at ¶ 56. Plaintiffs cite three deficiencies in Fushi’s internal control structure: (1) lack of independent evaluation and analysis of the substance and nature of the underlying transactions; (2) lack of assessments and responses to the risks of inaccurate financial reporting; and (8) failures to monitor the accuracy of the data for the SWAP and the acquisitions of Dalian Jinchuan and Hongtai. Id. at ¶ 57. Plaintiffs assert that Fushi’s failure was contrary to the 1934 Act Rules 13a-15(f) and 15d-15(f) that require management of public companies to establish and maintain adequate internal control over financial reporting. Id. at ¶ 65. Rule 13a-15(f) of the 1934 states:
[T]he term internal control over financial reporting is defined as a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Id.
Plaintiffs allege that during the class period, Fushi represented that its internal controls of financial reporting were effective because of its utilization of Committee of Sponsoring Organizations of the Tread-way Commission (“COSO”) criteria in Fushi’s “Internal Control-Integrated Framework.” Id. at ¶ 56. Plaintiffs assert that in fact, Fushi failed to comply with essential components of COSO. Id. at ¶ 57. In particular, Plaintiffs allege that Defendants Fu, Longever, and Wang falsely stated that internal controls were in place to ensure the reliability of Fushi’s financial reporting and that those internal controls were in accordance with COSO standards. Id. Plaintiffs’s specific allegations on Fushi’s deficiencies and the Defendants’ violation of COSO standards are the lack of the following:
Risk Assessment — Risks are analyzed, considering likelihood and impact, as a basis for determining how they should be managed. Risks are assessed on an inherent and a residual basis.
Risk Response — Management selects risk responses — avoiding, accepting, reducing, or sharing risk — developing a set of actions to align risks with the entity’s risk tolerances and risk appetite. Control Activities — Policies and procedures are established and implemented to help ensure the risk responses are effectively carried out.
Information and Communication — Relevant information is identified, captured, and communicated in a form and time-frame that enable people to carry out their responsibilities. Effective communication also occurs in a broader sense, flowing down, across, and up the entity. Monitoring — The entirety of enterprise risk management is monitored and modifications made as necessary. Monitoring is accomplished through ongoing management activities, separate evaluations, or both.”
Id. (emphasis in complaint).
Plaintiffs assert that Fushi’s internal control failure were egregious because: (1) the SWAP and the two “bargain” purchases were highly unusual transactions for Fushi; (2) the pertinent GAAP standards for those transactions are not complex; and (3) Fushi’s accounting treatments of the transactions “conveniently” resulted in material overstatements of Fushi’s net income during the relevant period, particularly in the year of those transactions. Id. at ¶ 58. Plaintiffs further allege that according to a former high-level executive at Fushi, Defendant Fu maintained sole control over Fushi’s finances and expenditures and thereby caused the violations of the COSO internal control principles requiring segregation of duties and independent checks for these transactions. Id. at ¶ 59.
e. Sarbanes-Oxley Certifications
Defendant Wang filed Fushi’s August 14, 2007 Form 10-Q for the preceding quarter with details of Fushi’s financial results for the quarter with certifications required by the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). Defendants Fu and/or Wang signed each certification that stated:
1. I have reviewed this report on Form 10-Q of Fushi International, Inc;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d — 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter [the registrant’s fourth fiscal quarter in the case of an annual report] that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s abili