Citations
- 33 F. Supp. 3d 401
Full opinion text
ORDER
RAMOS, District Judge:
This case arises from allegations of an independent auditor’s alleged failure to detect fraud at ChinaCast Education Corporation, Inc. (“ChinaCast” or the “Company”), an educational services company in the People’s Republic of China (“China”). ChinaCast entered the U.S. capital markets through a reverse merger in 2006, and for several years, its common stock was traded on the NASDAQ. In 2012, the Company disclosed that, unbeknownst to its investors, and without consent from its Board of Directors, certain rogue employees, led by the Company’s former Chairman and CEO, Ron Chan, had engaged in wide-ranging fraudulent activities, including, inter alia, misappropriation of proceeds from a stock offering, misrepresentation of ChinaCast’s ownership interests, and pledging substantial portions of the Company’s term deposits to cover debts of third parties. After a series of public announcements revealing the fraud, China-Cast’s stock price plummeted. Am. Compl. ¶¶ 5, 6, 45,172-84, Doc. 4.
Plaintiffs in this action consist of an assortment of investors who, in the aggregate, purchased more than 20 million shares of common stock issued by China-Cast. Id. ¶ 6. But rather than sue the Company, Plaintiffs contend that China-Cast’s Shanghai-based outside auditor, De-loitte Touche Tohmatsu CPA, Ltd. (“DTTC”), and its U.S. affiliate, Deloitte & Touche LLP (“Deloitte U.S.”) (collectively, “Deloitte Defendants”), as well as certain former ChinaCast officers and directors (the “Individual Defendants”), violated provisions of the Securities Exchange Act of 1934 (the “Exchange Act”) and committed common law fraud by issuing and approving false statements in ChinaCast’s public filings with the U.S. Securities and Exchange Commission (“SEC”). Plaintiffs claim that ChinaCast’s audited financial statements “carried the imprimatur of De-loitte — one of the ‘Big Four’ global accounting firms — whose name investors rely on as an independent auditor and gatekeeper of accurate financial reporting.” Id. ¶ 1. Yet, “[h]ad Deloitte done even the most basic of audits,” they “would have known that ChinaCast was a house of cards.” Id. ¶ 10.
Plaintiffs assert causes of action for: violations of Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated thereunder, against DTTC and Individual Defendants (First and Third Causes of Action); violations of Section 20(a) of the Exchange Act against Deloitte U.S. (Second Cause of Action); violations of Section 18 of the Exchange Act against all Defendants (Fourth Cause of Action); and common law fraud under New York law against Deloitte Defendants (Fifth Cause of Action). Id. ¶¶ 51-171, 70, 85, 208.
Before the Court are Deloitte Defendants’ respective motions to dismiss Plaintiffs’ claims under Rule 12(b)(6) of the Federal Rules of Civil Procedure. Docs. 14, 32. For the reasons set forth below, the motions are GRANTED; however, the Court dismisses the First Amended Complaint (“FAC”) without prejudice.
1. BACKGROUND
A. The Parties
1. Plaintiffs
Plaintiffs are a group of investment funds, entities and individuals who purchased ChinaCast securities between March 31, 2008 through and including March 30, 2012. Am. Compl. ¶ 1. Some of the Plaintiffs are closely associated with ChinaCast’s current management. Individual Plaintiff Doug Woodrum is the Chief Financial Officer (“CFO”) of China-Cast. Bendinger Decl. Ex. 2 (Apr. 2, 2012 Form 8-K), Doc. 34. In addition, China-Cast Board Member Ned Sherwood co-founded and manages ZS Fund L.P., the general partner of Plaintiff ZS EDU L.P.; Mr. Sherwood beneficially owns shares held by Plaintiff ZS EDU L.P.; shares owned by Plaintiff MRMP Managers LLC are for the benefit of Mr. Sherwood’s children; and Mr. Sherwood was the China-Cast board designee of Plaintiff Fir Tree Funds. Bendinger Decl. Ex. 11 (Nov. 15, 2011 Schedule 14A Information at 5).
Plaintiffs claim that, collectively, they invested more than $96 million on more than 20 million shares of ChinaCast stock and, as a result of the Defendants’ conduct, suffered “tens of millions” of dollars in investment losses. Am. Compl. ¶ 6.
2. Deloitte Defendants
“Deloitte” holds itself out as a global accounting firm comprised of member and network firms that conduct “integrated cross-border audits.” Id. ¶ 51. Deloitte U.S. is a Delaware limited liability partnership located in New York, New York. Id. ¶ 32. DTTC is a Chinese auditing firm with headquarters in Shanghai, China. Id. ¶ 31.
B. Factual Allegations 1. ChinaCast Expands Its Business
ChinaCast is a Delaware corporation with principal offices in China, and has described itself as “a leading for-profit, post-secondary education and e-learning services provider in China.” Bendinger Decl. Ex. 2 (Apr. 2, 2012 Form 8-K). The Company was initially formed as a special purpose acquisition company called Great Wall Acquisition Corporation (“Great Wall”) on August 20, 2003. Am. Compl. ¶ 39. In 2006, Great Wall identified Chi-naCast Communications Holdings Limited (“CCH”), an e-learning company incorporated in Bermuda and listed on the Stock Exchange of Singapore (“SGX”), as a desirable acquisition target. Id. ¶ 40. Starting in 2000, the Chinese Ministry of Education granted licenses to approximately 68 universities to conduct undergraduate and post-graduate courses by distance learning. By 2003, CCH signed with more than 15 universities to use its satellite interactive distance learning network, serving over 50,000 students nationally. Thereafter, CCH expanded its business by signing additional K-12, IT and management training customers. Bendinger Decl. Exs. 3, 6 (2009 and 2010 Form 10-Ks at 2). On December 22, 2006, Great Wall obtained a majority of the outstanding shares of CCH and subsequently changed its name to ChinaCast Education Corporation. Am. Compl. ¶ 45. In 2007, China-Cast acquired all remaining outstanding shares of CCH and terminated the SGX listing, effecting a “reverse merger” onto the NASDAQ exchange. Id. ¶¶ 4, 45; see also Bendinger Decl. Exs. 3, 6 (2009 and 2010 Form 10-Ks at 2).
Plaintiffs allege that “ChinaCast’s business did not make it a complicated company to audit.” Am. Compl. ¶ 4. ChinaCast’s financial statements report that it majority-owns approximately twenty-five subsidiaries and variable interest entities. Its principal subsidiary is ChinaCast Technology (BVI) Limited, which, since 1999, has provided funding for satellite broadband Internet services through the satellite operating entities ChinaCast Company Ltd. — Beijing Branch and ChinaCast Li Xiang Co. Ltd. (“CCLX”). Bendinger Decl. Ex. 3 (2010 Form 10-K at F-10-13). In 2007, ChinaCast engaged in limited business operations, and its primary assets were cash and term deposits. Am. Compl. ¶4. ChinaCast exclusively provided “distance learning” services from its inception until it acquired its first physical university in 2008. Id. ¶ 47. Between 2007 and 2010, the Company completed only “one or two major transactions per year.” Id. In its 2008 Form 10-K, ChinaCast reported that, on April 11, 2008, its wholly owned subsidiary, Yu Pei Information Technology (Shanghai) Limited (“YPSH”), acquired an 80% interest in Hai Lai Education Technology Limited (“Hai Lai”), which, in turn, owned the Foreign Trade Business College of Chongqing Normal University (“FTBC”), a traditional brick and mortar university. Id. ¶ 78.
After procuring Hai Lai in 2008, China-Cast organized itself into two distinct groups: (1) the e-learning and training service group, encompassing all of the Company’s business prior to the acquisition; and (2) the traditional university group, which offered bachelor and diploma programs to Chinese students. Id. ¶ 48; Bendinger Decl. Exs. 2-3 (Form 10-Ks at 2-3).
During the next two years, ChinaCast acquired two additional fully accredited universities: Lijang College of Guangxi Normal University (“Lijang College”) and Hubei Industrial University Business College (“Hubei Industrial University”). Am. Compl. ¶¶ 49-50. ChinaCast’s 2009 Form 10-K reported that, on October 5, 2009, the Company completed the acquisition of East Achieve Limited, the holding company which beneficially owned 100% of Li-jang College. Id. ¶ 89. ChinaCast’s 2010 Form 10-K reported that, on August 23, 2010, the Company completed the acquisition of Wintown Enterprises Limited, the holding company that beneficially owned 100% of Hubei Industrial University. Id. ¶ 117.
ChinaCast’s 10-K and 10-Q filings state that the Company paid a majority of the consideration for the acquisition of each of fits three physical universities. Id. ¶¶ 79-81, 90-91, 118-19. These payments represented some of the most, if not the most, significant transactions on the Company’s annual cash flow statements. Id. ¶¶ 82, 92, 118-20.
2. DTTC Audits ChinaCast’s Financial Statements, 2007-2010
As of 2010, DTTC had worked with Chi-naCast and its predecessor entity for more than ten years. Id. ¶ 31. Between 2007 and 2010, DTTC served as ChinaCast’s independent public auditor of record. Id. ¶ 51. DTTC’s duties included reviewing the Company’s condensed financial information for each fiscal quarter and performing integrated audits of ChinaCast’s consolidated financial statements in accordance with U.S. Public Company Accounting Oversight Board (“PCAOB”) standards and Generally Accepted Accounting Principles (“GAAP”). Id. ¶¶ 2, 31.
In making their decisions to invest in ChinaCast, Plaintiffs “read, reviewed and relied on” ChinaCast’s public filings with the SEC, “including but not limited to its quarterly reports on Form 10-Q ... [and] annual reports on 10-KSB and 10-K, which included its audited year-end financial statements.” Id. ¶¶ 9, 57, 70. Plaintiffs claim that “Defendants knew that Plaintiffs purchased ChinaCast securities in direct, eyeball reliance on” ChinaCast’s audited financial statements, 10-Q and 10-K filings. Id. Particularly because China-Cast’s operations occurred abroad, Plaintiffs relied upon the fact that Deloitte, a “top global accounting firm,” had a long-term relationship with ChinaCast and, through DTTC, represented that its audits comported with U.S. accounting standards; they trusted the Deloitte “stamp of approval.” Id. ¶¶ 2-3, 9.
a. Statements Regarding Compliance with Accounting Principles and Standards; Financial Condition of Company
DTTC certified ChinaCast’s audited financial statements and issued unqualified audit opinions for fiscal years 2007 through and including 2010, filed with the SEC on Form 10-K. Id. ¶ 8. In each of its audit opinions, DTTC stated (1) that it conducted its audit in accordance with PCAOB standards; and (2) that, in its opinion, “the consolidated financial statements present fairly, in all material respects, the financial position of the Company ... and the re-suits of its operations and its cash flows,” in conformity with GAAP. Id. ¶¶ 52, 56, 70, 85, 109; see also, e.g., Bendinger Decl. Ex. 3 (2010 Form 10-K at F-2).
b. Statements Regarding Internal Controls
DTTC was not engaged to perform an audit of the Company’s internal controls over financial reporting for the 2007 fiscal year. Bendinger Decl. Ex. 4 (2007 Form 10-K at F-2). For fiscal years 2008 and 2009, DTTC made, inter alia, the following representations regarding ChinaCast’s internal controls in the Company’s Form 10-K filings:
• “We conducted our audit in accordance with the standards of the [U.S. PCAOB]. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.... We believe that our audit provides a reasonable basis for our opinion.”
• “Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management of override controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.”
• “In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of [the end of the year].... ”
• “We have also audited, in accordance with [PCAOB standards], the consolidated financial statements and financial statement schedule [for the year] ... [and] express[ ] an unqualified opinion on those financial statements and financial statement schedule.”
Bendinger Decl. Ex. 5 (2008 Form 10-K at 29-30); Ex. 6 (2009 Form 10-K at 44); Am. Compl. ¶¶ 70, 85.
DTTC expressed an adverse opinion on the Company’s internal control over financial reporting as of December 31, 2010 based on a “[l]ack of sufficient skilled resources in the finance team to meet the demands of rapidly expanded businesses” and “[l]ack of contemporaneous documentation of certain decisions made by the Board of Directors.” Bendinger Decl. Ex. 3 (2010 Form 10-K at F-2, 46).
c. Deloitte U.S.’s Role
Plaintiffs claim that Deloitte U.S. may be held responsible for DTTC’s audit opinions, as well as ChinaCast’s audited financial statements, because DTTC would not sign, and the Company did not submit, any SEC filings until Deloitte U.S. reviewed and approved them. Am. Compl. ¶¶ 32, 53-54. Deloitte U.S. controlled DTTC’s audits of ChinaCast because it “had final authority over all U.S. GAAP matters,” “directly communicated with ChinaCast’s audit committee on key issues,” provided consultation and “was involved in” all of ChinaCast’s financial filings. Id. ¶¶ 32, 53, 187. Deloitte U.S.’s “involve[ment] in” making the- decision to direct ChinaCast to write-off certain pre-paid expenses during the audit of its financial statements for the 2010 fiscal year exemplifies the manner in which Deloitte U.S. provided directions to DTTC throughout the “Deloitte-China-Cast engagement.” Id. ¶ 54. In that instance, Deloitte U.S.’s Washington, D.C. office “was directly involved in” communicating with and responding to concerns voiced by the SEC regarding the write-off, and it reviewed and approved an amendment to ChinaCast’s 2010 Form 10-K addressing the SEC’s comments. Id.
3. New Management Exposes the Fraud
Ron Chan, not sued herein, was appointed CEO of CCH in 1999 at CCH’s inception. In connection with the CCH acquisition, the Company and CCH had agreed that Chan and certain other individuals would serve as directors of ChinaCast. ChinaCast appointed Mr. Chan to the position of Chairman and CEO on February 2, 2007. On the same date, ChinaCast appointed Daniel Tseung and Individual Defendants Yin Jianping, Justin Tang and Richard Xue to serve as directors. Ben-dinger Decl. Ex. 4 (2007 Form 10-K at 27).
After a highly contentious proxy battle initiated by Ned Sherwood in December 2011, ChinaCast’s shareholders voted to elect a new slate of directors in early 2012. The new board included two inside directors (Mr. Chan and Individual Defendant Santos) and four outside directors (Mr. Sherwood, Daniel Tseung, Derek Feng and Stephen Markscheid) (the “Board”). Bendinger Decl. Ex. 2 (Apr. 2, 2012 Form 8-K). On March 26, 2012, the Board removed Ron Chan from his position as the Chairman and CEO and replaced him with Derek Feng. Am. Compl. ¶ 173. Individual Defendant Sena, who had signed a “loyalty pledge” to Chan, resigned from his position as CFO on the same day. Id. ¶¶ 189, 193. On March 29, 2012, the Board also removed Xiangyuan Jiang, the Company’s former chief investment officer and president — China, another close ally of Mr. Chan. Bendinger Decl. Ex. 14 (Apr. 19, 2012 Form 8-K).
In an open letter to shareholders issued on April 2, 2012, the Board revealed that Mr. Chan and his cohorts had mounted “significant resistance” to the implementation of changes to the management team. Bendinger Decl. Ex.' 2 (Apr. 2, 2012 Form 8-K). As further explained in the letter, Ron Chan’s contumacious conduct — -which included thwarting the 2011 audit of the Company’s financial statements — left the Board with no choice but to terminate him:
Ron Chan and his accomplices have refused to provide the necessary financial information so as to allow the Company’s auditors (Deloitte) access to the Shanghai offices in order to complete their field work and enable the Company to issue its 2011 audited financial statements within the time periods required by the SEC. Additionally, this group of uncooperative managers has improperly declined to pay outstanding invoices for the services of Deloitte and various other outside advisors and service providers. Despite repeated efforts ... it became clear last week that there would be no cooperation forthcoming. Consequently, our Board had to take extraordinary measures by terminating Ron Chan.
Id. Perhaps unsurprisingly, Mr. Chan and other terminated executives “chose[] to unlawfully resist their terminations by refusing to return key company property, including corporate chops necessary to run the business in China,” and Chan told Derek Feng that “he had no intention to relinquish the corporate chops.” Id.
The Board further reported that it had “uncovered questionable activities and transactions which raise the specter of possible illegal conduct by Ron Chan and his accomplices and may have led to the frustration of the audit of the Company’s financial statements.” Id.; Am. Compl. ¶ 174. In addition to initiating legal action against Ron Chan, the Company reported that it notified the SEC and the NASDAQ of these incidents. Notwithstanding the gravity of Mr. Chan’s misdeeds, the Company concluded its letter by reiterating that ChinaCast “is a strong company with great assets, a dedicated employee base and a skilled and independent Board of Directors.” Bendinger Decl. Ex. 2 (Apr. 2, 2012 Form 8-K).
NASDAQ suspended trading in China-Cast’s stock on the same day, due to the Company’s failure to file an annual report for 2011. Am. Compl. ¶ 174; see also Complaint, SEC v. Chan Tze Ngon and Jiang Xiangyuan, No. 13 Civ. 6828(TPG) (S.D.N.Y. Sept. 26, 2013). Trading did not resume until more than two months later, on June 25, 2012. Id.; Am. Compl. ¶ 180.
On April 19, 2012, the Company issued a statement confirming that ChinaCast had fallen victim to financial fraud, and provided progress reports on its internal investigation during the following months. Am. Compl. ¶ 177. Among other things, the Company relayed that Ron Chan and his allies “remov[ed] or destroyed] a substantial portion of the financial documents that were located in the finance offices of the Company’s Shanghai headquarters,” and that they “stole some of the computers believed to be utilized by the finance department” after forcibly gaining entry. Bendinger Decl. Ex. 13 (May 14, 2012 Form 8-K); Ex. 14 (Apr. 19, 2012 Form 8-K at 2). Additionally, the Company noted that current management did not have access to all of the Company’s accounts, and that it was trying to obtain access to additional bank records in order to investigate the transfer of approximately $120 million from two of ChinaCast’s subsidiaries, CCT Shanghai and YPSH, from July 2011 to April 2012, without the Board’s knowledge or consent. Bendinger Decl. Ex. 13 (May 14, 2012 Form 8-K at 4). .
Ultimately, on December 21, 2012, Chi-naCast “instructed investors to no longer rely on the Company’s audited financials for 2009 and 2010.” Am. Compl. ¶¶ 177-82. The Company reported that it had uncovered the following fraudulent activities (see id.):
• Non-bank borrowings. Without the Board’s knowledge or consent, the Company took out a series of short-term, high-interest rate loans from a number of companies, friends and family members related, and unrelated, to prior management. As a result, previously issued financial statements understated borrowings on “various dates” from at least the fourth quarter of 2009 to the third quarter of 2011. Some individuals also filed claims against the Company for non-repayment of debts that the Company’s previously issued financial statements failed to disclose. The Company reported that it was only able to obtain bank records and legal documentation to corroborate some of these undiscovered borrowings, and had not determined the volume of loans that remained outstanding.
• Interest in a purported majority-owned subsidiary. ChinaCast’s financial statements previously reported that it had a majority indirect ownership interest in CCT HK, but according to documents obtained from the Hong Kong Companies Registry, Ron Chan has owned 50% of CCT HK since 2003. The Company only owns an approximately 49.2% indirect equity interest in CCT HK; thus, it should not have been consolidated as a majority-owned subsidiary in the Company’s previously issued financial statements. The Company reported that it was continuing to investigate how Mr. Chan acquired his ownership stake in CCT HK without the Board’s knowledge or consent.
• December 2009 stock offering proceeds. Without the Board’s knowledge or consent, Ron Chan transferred at least $35 million of the $44 million in proceeds from the Company’s 2009 public common stock offering to entities outside the Company’s group structure (i.e., CCT HK).
• 2009 and 2010 year-end cash equivalents and term deposits. Without the Board’s knowledge or consent, prior management pledged at least $36 million of the $75 million classified as term deposits on its year-end 2009 balance sheet to guarantee the debts of various third parties, many of whom appear to operate outside of the scope of ChinaCast’s business. Correcting for these secret pledges, the cash available from term deposits as of December 31, 2009 would have been reduced from $75 million to $38 •million or less. Similarly, without the Board’s knowledge or consent, prior management pledged at least $91 million of the $107 million classified as term deposits on the Company’s 2010 year-end balance sheet to cover the debts of various third parties. Adjusting for these pledges, the cash available from term deposits as of December 31, 2010 would have been reduced from $107 million to $16 million or less.
• January 2010 stock issuance proceeds. The Company’s previously issued financial statements reported that Thriving Blue Limited, a BVI company owned by Ron Chan and Individual Defendants Sena and San- • tos, paid $5 million to purchase 692,-520 shares of common stock, but new management was unable to confirm from statements for the Company’s known bank accounts that it ever received the $5 million.
• College Acquisitions. The Board reported that it would be continuing to investigate its suspicions that Chi-naCast never made the payments that it claimed to have spent on the acquisition of its three brick and mortar universities.
ChinaCast’s stock price dropped dramatically after the news of the fraud emerged: in early 2012, it traded at more than $6.00 per share; on December 21, 2012, it closed at ten cents per share; and on March 15, 2018 it closed at 14 cents per share. Id. ¶¶ 6,172, 183.
On March 25, 2013, the Company announced that its financial statements in annual and quarterly reports for fiscal years 2007 through 2010, and the first three quarters of 2011, should not be relied upon, and that, effective March 19, 2013, the Board dismissed DTTC from its position as the Company’s independent accountant. Bendinger Decl. Ex. 15 (Mar. 25, 2013 Form 8-K). Internal and government investigations regarding the extent of the fraud perpetrated by Ron Chan and his accomplices remain ongoing.
C. Plaintiffs’ Claims
Plaintiffs filed the FAC on March 15, 2013. Doc. 4. Plaintiffs assert claims against DTTC for violations of Section 10(b), Rule 10b-5 and Section 18 of the Exchange Act, as well as a common law fraud claim under New York law. Proceeding on the theory that Deloitte U.S. controlled DTTC’s audits, Plaintiffs assert similar claims against Deloitte U.S. for violations of Section 18 and Section 20(a) of the Exchange Act, as well as common law fraud.
At bottom, Plaintiffs contend that, had the Deloitte Defendants performed any audit at all, they would have discovered the rampant fraud at ChinaCast much earlier. The FAC describes a number of failures to comply with PCAOB and GAAP standards, as well as “red flags” that should have placed the Deloitte Defendants on notice of the fraud. Consequently, Plaintiffs assert that DTTC’s statements for the years 2007 through 2010, that it conducted its audits in accordance with PCAOB standards and that ChinaCast’s audited financial statements were GAAP compliant, and for the years 2008 and 2009, that the Company’s internal controls over financial reporting were effective, were materially false. See Bendinger Decl. Exs. 3-6 (2007-2010 Form 10-Ks at F-2); Ex. 5 (2008 Form 10-K at 30); Ex. 6 (2009 Form 10-K at 44-45). Plaintiffs also seek to impose liability under Section 18 for false statements in ChinaCast’s 10-K and 10-Q filings that Deloitte Defendants allegedly “caused to be made.” Am. Compl. ¶¶ 234-47.
a. Violations of Accounting Standards
PCAOB standards include generally accepted accounting standards (“GAAS”), the “authoritative standards” with which auditors must comply. Id. ¶ 153. Plaintiffs claim that Deloitte Defendants “knowingly or recklessly” violated basic rules and principles found in the interpretive “Statements on Auditing Standards,” known within the accounting industry as “AU,” which provide as follows:
• “The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” (AU § 110.2);
• “Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit.” (AU § 150.02);
• “Due professional care requires the auditor to exercise professional skepticism. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence.” (AU § 230.07);
• “The auditor’s assessment of the risks of material misstatement due to fraud should be ongoing throughout the audit. Conditions may be identified during fieldwork that change or support a judgment regarding the assessment of the risks, such as ... [discrepancies in the accounting records, including ... [unsupported or unauthorized balances or transactions.” (AU § 316.68);
• “The books of original entry, the general and subsidiary ledgers, related accounting manuals, and records such as work sheets and spreadsheets supporting cost allocations, computations, and reconciliations all constitute evidence in support of the financial statements.” “[Without adequate attention to the ... accuracy of the underlying accounting data, an opinion on financial statements would not be warranted.” (AU § 326.16);
• “The independent auditor’s direct personal knowledge, obtained through physical examination, observation, computation, and inspection, is more persuasive than information obtained , indirectly.” (AU § 326.21(c));
• “During the performance of confirmation procedures, the auditor should maintain control over the confirmation requests and responses. Maintaining control means establishing direct communication between the intended recipient and the auditor to minimize the possibility that the results will be biased because of interception and alteration of the confirmation requests or responses.” (AU § 330.28); and
• Representations from management “are not a substitute for the application of those auditing procedures necessary to afford a reasonable basis for an opinion regarding the financial statements under audit.” (AU § 333.02).
In addition, Plaintiffs assert that De-loitte Defendants “knowingly or recklessly” violated the following fundamental GAAP principles (see id. ¶¶ 155-56):
• Financial reporting should be reliable in that it represents what it purports to represent;
• A company’s financial statements must be reliable, transparent, truthful, and accurately reflect the financial performance of the company;
• Nothing should be left out of the information that may be necessary to ensure that it validly represents underlying events and conditions;
• Conservatism should be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered;
• Companies must accurately present the financial results of the corporation’s operations, and disclose net income as a reflection of all items of profit and loss recognized during the period;
• Companies must accurately state the income received by the corporation in a reported period, according to standards for the reporting of comprehensive income and its components in a full set of general-purpose financial statements; and
• Revenue recognized by a corporation in its financial statements must accurately reflect business operations of the company.
b. “Red Flags”
Had Deloitte Defendants complied with basic accounting principles, Plaintiffs assert that they would have discovered the following “red flags” symptomatic of fraud:
First, from 2007 through 2010, more than half of ChinaCast’s total assets consisted of term deposits, and, for each year, ChinaCast failed to disclose that it had pledged a substantial portion of such term deposits to secure the obligations of third parties that lacked any legitimate business relationship with ChinaCast. DTTC’s failure to verify the unencumbered nature of ChinaCast’s term deposits violated “at least” GAAS standards AU §§ 150.02, 330.28 and 333.02. Plaintiffs deem the “encumbered nature of the term deposits” a “massive red flag that DTTC could not possibly have missed had it undertaken procedures to verify these assets,” such as by contacting the banks that held them.. Am. Compl. ¶¶ 5, 153, 165, 169; Pis.’ Opp. DTTC Mot. 9, Doc. 38.
Second, Plaintiffs claim that DTTC falsely certified ChinaCast and CCT HK’s financial statements on a consolidated ba- ‘ sis, in violation of GAAS standards AU §§ 150.02 and 333.02, because if DTTC had confirmed the ownership of CCT HK “by simply reviewing records readily obtainable from the Hong Kong Companies Registry,” it would have discovered that Ron Chan personally owned 50% of CCT HK since 2003. Am. Compl. ¶ 5; Pis.’ Opp. DTTC Mot. 9.
Third, with respect to the audited financial statements for the year ending December 31, 2009, Plaintiffs claim that DTTC failed to confirm that the Company actually received the proceeds from a $44 million stock offering. A “simple review” of account statements from the banks that held ChinaCast’s proceeds would have revealed that Ron Chan looted the majority of the proceeds from this offering ($35 million) by “almost immediately” wiring them to CCT HK, which the Company did not majority-own. Am. Compl. ¶¶ 103-05. In turn, Chan transferred the money outside of CCT HK in December 2009. Id. ¶ 104. This “red flag” would have been exposed if DTTC had complied with GAAS standards §§ 150.02, 330.28 and 333.02. Id. ¶¶ 153, 159,170; Pis.’ Opp. DTTC Mot. 10.
Fourth, with respect to ChinaCast’s audited financial statements for the year ending December 31, 2010, Plaintiffs claim that DTTC violated GAAS by failing to confirm that the Company actually received a $5 million payment for stock sold to a BVI company owned by Ron Chan (Thriving Blue Limited). Although “this transaction was a significant, related-party transaction at above-market price,” DTTC failed to review ChinaCast’s bank records to confirm the receipt of funds and as a result, failed to discover that the Company never received payment for its shares. Plaintiffs assert that DTTC similarly failed to confirm that any of the Company’s bank accounts received a $29.3 million payment from Wu Shi Xin, the purported sole stockholder of Wintown Enterprises Limited, for a stock purchase agreement entered on June 2, 2010. Am. Compl. ¶ 5; Pis.’ Opp. DTTC Mot. 10.
Fifth, Plaintiffs allege that for fiscal years 2008 to 2010, DTTC failed to uncover the fact that ChinaCast never made any of the “massive cash payments” that it reported as consideration paid for the acquisition of each of its three universities. These “ ‘red flags’ would have been obvious to any auditor who reviewed the Company’s bank statements,” but because of DTTC’s failure to obtain sufficient audit evidence to support its opinions, the lack of payment escaped DTTC’s notice. Am. Compl. ¶¶ 161-64; Pis.’ Opp. DTTC Mot. 11.
Sixth, Plaintiffs claim that ChinaCast’s trial balances reveal massive outflows of cash to, and unexplained inflows from, parties that had no legitimate business relationship to the Company, such as metal factories and a pawn shop. Trial balances for one ChinaCast subsidiary show tens of millions of dollars of cash transfers to “more than one hundred” individuals and entities, most of which lacked any relationship to the Company’s business. The gist of this allegation is that DTTC’s failure to review ChinaCast’s trial balances — which were provided directly to DTTC for purposes of year-end audits in 2007, 2008 and 2009 — amounts to “total audit failure.” Am. Compl. ¶¶5, 133-49, 153, 158, 160; Pis.’ Opp. DTTC Mot. 11.
D. The Instant Motions
On November 1, 2013, Deloitte U.S. moved to dismiss all claims asserted against it on several grounds, including: (1) with respect to all claims, the FAC impermissibly utilizes group pleading and conclusory allegations; (2) with respect to Section 20(a), Plaintiffs fail to plead the elements of control and culpable participation; (3) with respect to Section 18, Plaintiffs fail to plead reliance, and cannot hold Deloitte U.S. liable because it did not “cause” ChinaCast to make any statement; and (4) with respect to common law fraud, Plaintiffs fail to adequately plead their claim. See Deloitte U.S. Mem. L. Supp. Mot. Dismiss, Doc. 15 (“Deloitte U.S. Mot. Dismiss”).
On January 24, 2014, DTTC also moved to dismiss Plaintiffs’ suit. DTTC contends that: (1) with respect to Section 10(b) and Rule 10b-5, Plaintiffs fail to establish an inference of scienter and fail to allege an actionable misrepresentation by DTTC; (2) with respect to Section 18, Plaintiffs fail to plead with sufficient particularity that DTTC made any misstatement, that DTTC subjectively believed any of its opinions to be false, or that Plaintiffs actually relied on any misstatement by DTTC; and (4) with respect to common law fraud, Plaintiffs fail to state a claim. See DTTC Mem. L. Supp. Mot. Dismiss, Doc. 34 (“DTTC Mot. Dismiss”). In particular, DTTC emphasizes that the most compelling inference from Plaintiffs’ allegations is that Chan successfully concealed the fraud from the Company’s auditors as well as the Board. Id.
II. LEGAL STANDARD
A. Rule 12(b)(6) Motions to Dismiss:
General Legal Standard
When ruling on a motion to dismiss pursuant to Rule 12(b)(6), the Court must accept all factual allegations in the complaint as true and draw all reasonable inferences in the plaintiffs favor. Koch, 699 F.3d at 145; see also, e.g., Ruotolo v. City of New York, 514 F.3d 184, 188 (2d Cir.2008). However, the Court is not required to credit “mere conclusory statements” or “threadbare recitals of the elements of a cause of action.” Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)); see also id. at 681, 129 S.Ct. 1937 (citing Twombly, 550 U.S. at 551, 127 S.Ct. 1955). “To survive a motion to dismiss, a complaint must contain sufficient factual matter ... to ‘state a claim to relief that is plausible on its face.’ ” Id. at 678, 129 S.Ct. 1937 (quoting Twombly, 550 U.S. at 570, 127 S.Ct. 1955). A claim is facially plausible “when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. (citing Twombly, 550 U.S. at 556, 127 S.Ct. 1955). More specifically, the plaintiff must allege sufficient facts to show “more than a sheer possibility that a defendant has acted unlawfully.” Id. Federal Rule of Civil Procedure 8 “marks a notable and, generous departure from the hyper-technical, code-pleading regime of a prior era, but it does not unlock the doors of discovery for a plaintiff armed with nothing more than conclusions.” Id. at 678-79, 129 S.Ct. 1937. If the plaintiff has not “nudged [his] claims across the line from conceivable to plausible, [the] complaint must be dismissed.” Twombly, 550 U.S. at 570, 127 S.Ct. 1955.
B. Heightened Pleading Standard under Rule 9(b) and the PSLRA
A complaint alleging securities fraud must satisfy the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 (“PSLRA”) by stating the circumstances constituting fraud with particularity. See, e.g., ECA & Local 134, IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 196 (2d Cir.2009) (citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319-20, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007)). These requirements apply whenever a plaintiff alleges fraudulent conduct, regardless of whether fraudulent intent is an element of a claim. Rombach v. Chang, 355 F.3d 164, 170 (2d Cir.2004) (quoting Fed.R.Civ.P. 9(b)) (“By its terms, Rule 9(b) applies to ‘all averments of fraud.’ ”).
Specifically, Rule 9(b) requires that a securities fraud claim based on misstatements must identify: (1) the allegedly fraudulent statements, (2) the speaker, (3) where and when the statements were made, and (4) why the statements were fraudulent. See, e.g., Anschutz Corp. v. Merrill Lynch & Co., Inc., 690 F.3d 98, 108 (2d Cir.2012) (citing Rombach, 355 F.3d at 170). Conditions of a person’s mind- — such as malice, intent or knowledge — may be alleged generally, however. Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir.2001) (citing Fed.R.Civ.P. 9(b)). Like Rule 9(b), the PSLRA requires that securities fraud complaints “ ‘specify’ each misleading statement,” set forth the reasons or factual basis for the plaintiffs belief that the statement is misleading, and “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 345, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005) (quoting 15 U.S.C. §§ 78u-4(b)(l), (2)); see also, e.g., Slayton v. Am. Express, Co., 604 F.3d 758, 766 (2d Cir.2010).
These heightened pleading standards, when viewed together with the more general standards applicable to Rule 12(b)(6) motions to dismiss under Twombly and Iqbal, make clear that “plaintiffs must provide sufficient particularity in their allegations to support a plausible inference that it is more likely than not that a securities law violation has been committed.” In re Lululemon Sec. Litig., No. 13 Civ. 4596(KBF), 14 F.Supp.3d 553, 570, 2014 WL 1569500, at *9 (S.D.N.Y. Apr. 18, 2014) (citing ECA & Local 131IBEW, 553 F.3d at 196).
III. DISCUSSION
A. Group Pleading
Deloitte U.S. first argues that Plaintiffs’ use of the term “Deloitte” to refer collectively to Deloitte U.S. and DTTC fails to provide notice as to which allegations pertain to which Deloitte entity. Deloitte U.S. Mot. Dismiss 9. Plaintiffs claim that their allegations need not separate the particular roles of the De-loitte entities because they have adequately pleaded that Deloitte U.S. had involvement in, and control over, DTTC’s audits of ChinaCast. Pis.’ Opp. Deloitte U.S. Mot. 16-17, Doc. 25. Plaintiffs also note that the FAC supplements widespread use of “Deloitte,” which is a term that the FAC defines to include both DTTC and Deloitte U.S., with at least 33 individualized references to Deloitte U.S. and 54 individualized references to DTTC. Id. at 16.
The Court finds that, while the term “Deloitte” is imprecise, the complaint nonetheless makes sufficiently clear that Plaintiffs’ object is to hold Deloitte U.S. liable principally on a theory of vicarious liability for the actions of DTTC. Am. Compl. ¶¶ 8, 32, 53, 54, 59; In re Parmalat Sec. Litig., 375 F.Supp.2d 278, 288-89 (S.D.N.Y.2005) (describing defendant accounting firms’ objections to group pleading as “well-taken,” but determining that complaint gave sufficient notice of theory of liability as to each member accounting firm).
Cases such as Rocker Management, LLC v. Lemout & Hauspie Speech Products N.V., No. 00 Civ. 5965(JCL), 2005 WL 1365772, at *8 (D.N.J. Jun. 8, 2005), cited by Deloitte U.S., are distinguishable. While Rocker held that “lumping together” distinct offices of another global accounting firm, KPMG, violated Rule 9(b)’s particularity requirements, in that case, the plaintiffs failed to allege that the U.S.based KPMG entity issued any audit opinions or made any statements regarding the subject audits. . Id. Here, Plaintiffs allege that DTTC was required to obtain sign-off from Deloitte U.S. for all of ChinaCast’s SEC filings, and on at least one occasion, Deloitte U.S. directed DTTC to write off certain pre-paid expenses from the Company’s 10-K, then directly communicated with the SEC regarding the write-off. Am. Compl. ¶ 54. Plaintiffs’ pleadings, although sub-optimal, apprise each Deloitte entity of the nature of their participation in the alleged fraud. Thus, the Court will not dismiss Plaintiffs’ claims against De-loitte Defendants on the grounds of group pleading. In re Parmalat, 375 F.Supp.2d at 288-89; see also In re MF Global Holdings Ltd. Sec. Litig., 982 F.Supp.2d 277, 310-11 (S.D.N.Y.2013) (describing goals of Rule 8(a), Rule 9(b) and PSLRA) (citation omitted).
B. Section 10(b) and Rule 10b-5 (First Cause of Action; All Plaintiffs against DTTC)
1. Applicable Law
Section 10(b) of the Securities Exchange Act of 1934 prohibits using or employing, “in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance,” 15 U.S.C. § 78j(b) (1934), while SEC Rule 10b-5, promulgated thereunder, creates liability for a person who makes “any untrue statement of a material fact or to omit[s] to state a material fact ... in connection with the purchase or sale of any security.” In re OSG Sec. Litig., 971 F.Supp.2d 387, 397 (S.D.N.Y.2013) (quoting 17 C.F.R. § 240.10b-5 (1951)).
To state a private civil claim under Section 10(b) and Rule 10b-5, a plaintiff must plead that: (1) the defendant made a material misrepresentation or omission, (2) with scienter, i.e., a wrongful state of mind, (3) in connection with the purchase or sale of a security, and (4) that the plaintiff relied on the misrepresentation or omission, thereby (5) causing economic loss. Dura, 544 U.S. at 341-42, 125 S.Ct. 1627; see also, e.g., Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 153 (2d Cir.2007); Kalnit, 264 F.3d at 138.
DTTC challenges the adequacy of Plaintiffs’ allegations concerning whether it (1) made a material misrepresentation or omission or (2) acted with scienter. The Court constrains its discussion accordingly and, for organizational clarity, addresses scienter first.
2. Discussion
a. Pleading Requirements for Scienter
“[WJhile § 10(b) has been described and may have been contemplated as a ‘catchall’ provision, ‘what it catches must be fraud.’ ” In re Livent, Inc. Noteholders Sec. Litig., 151 F.Supp.2d 371, 413 (S.D.N.Y.2001) (quoting Chiarella v. U.S., 445 U.S. 222, 234-35, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980)). Section 10(b) and Rule 10b-5 require plaintiffs to allege a state of mind demonstrating “an intent to deceive, manipulate or defraud,” also known as scienter. Ganino v. Citizens Utils. Co., 228 F.3d 154, 168 (2d Cir.2000) (citing Ernst & Ernst v. Hochfelder, 425 , U.S. 185, 193, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976)); see also, e.g., In re Philip Servs. Corp. Sec. Litig., 383 F.Supp.2d 463, 469 (S.D.N.Y.2004). To satisfy the PSLRA’s pleading requirements for scien-ter, a plaintiff must allege facts with particularity that would give rise “to a strong inference that the defendant acted with the required state of mind.” ECA & Local 134 IBEW, 553 F.3d at 198. As Supreme Court precedent dictates, a “strong inference” that a defendant acted with a certain intent is one that is “more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Tellabs, 551 U.S. at 314, 127 S.Ct. 2499 (emphasis added). This inquiry goes beyond the ordinary Rule 9(b) framework and requires courts to consider “not only inferences urged by the plaintiff ... but also competing inferences rationally drawn from the facts alleged.” Id. “The relevant inquiry for the Court ‘is whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.’ ” In re Magnum Hunter Res. Corp. Sec. Litig., No. 13 Civ. 2668(KBF), 2014 WL 2840152, at *17 (S.D.N.Y. June 23, 2014) (emphasis in original) (citing Tellabs, 551 U.S. at 322-23, 127 S.Ct. 2499).
A plaintiff may establish scien-ter by alleging facts that either (1) show that the defendant had both the “motive 'and opportunity” to commit the alleged fraud, or (2) “constitute strong circumstantial evidence of conscious misbehavior or recklessness.” Lerner v. Fleet Bank, N.A., 459 F.3d 273, 290-91 (2d Cir.2006); see also, e.g., Ho v. Duoyuan Global Water, Inc., 887 F.Supp.2d 547, 574 (S.D.N.Y.2012). When a plaintiff fails to allege a motive to commit fraud, the plaintiffs allegations that indicate a defendant’s recklessness “must be correspondingly greater.” Kalnit, 264 F.3d at 142 (internal citations omitted); accord S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 109 (2d Cir.2009). Here, Plaintiffs solely proceed on the theory that DTTC acted recklessly with respect to the falsity of its statements.
To state a claim based on recklessness, plaintiffs may either specifically allege defendants’ knowledge of facts or access to information contradicting defendants’ public statements, or allege that defendants failed to check information that they had a duty to monitor. In re Longtop Fin. Techs. Ltd. Sec. Litig., 910 F.Supp.2d 561, 574 (S.D.N.Y.2012) (“Longtop /”) (citing In re Gildan Activewear, Inc. Sec. Litig., 636 F.Supp.2d 261, 272 (S.D.N.Y.2009)). To the extent that plaintiffs assert that defendants had access to contrary facts, the complaint must “specifically identify the reports or statements containing this information.” Id. at 574-75 (citing Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 197 (2d Cir.2008) (quoting Novak, 216 F.3d at 309)); In re IMAX Sec. Litig., 587 F.Supp.2d 471, 483-84 (S.D.N.Y.2008). Nonetheless, it is well-settled that “fraud by hindsight” is not a cognizable theory of relief; “fraud is always obvious in retrospect, but it is not reckless to lack clairvoyance.” Longtop I, 910 F.Supp.2d at 579; see also, e.g., Meridian Horizon Fund, LP v. KPMG (Cayman), 487 Fed.Appx. 636, 640-41 (2d Cir.2012) (summary order).
The pleading requirements for auditor scienter are particularly stringent. In re Advanced Battery Technologies, Inc. Sec. Litig., No. 11 Civ. 2279(CM), 2012 WL 3758085, at *15 (S.D.N.Y. Aug. 29, 2012) (“ABAT /”) (“Courts in this District have repeatedly recognized [that] “[t]he standard for pleading auditor scienter is demanding.” ”); see also, e.g., Stephenson v. PricewaterhouseCoopers, LLP, 768 F.Supp.2d 562, 571-72 (S.D.N.Y.2011); In re Marsh & Mclennan Companies, Inc. Sec. Litig., 501 F.Supp.2d 452, 488 (S.D.N.Y.2006) (quoting Rothman v. Gregor, 220 F.3d 81, 98 (2d Cir.2000)). As the Second Circuit described in Rothman,
For recklessness on the part of a non-fiduciary accountant to satisfy securities fraud scienter, such recklessness must be conduct that is highly unreasonable, representing an extreme departure from the standards of ordinary care. It must, in fact, approximate an actual intent to aid in the fraud being perpetrated by the audited company.
Allegations of a negligent or “shoddy audit” fail to establish fraudulent intent. In re MRU Holdings Sec. Litig., 769 F.Supp.2d 500, 518 (S.D.N.Y.2011); In re Puda Coal Sec. Inc., Litig., No. 11 Civ. 2598(KBF), 30 F.Supp.3d 230, 248, 2014 WL 2915880, at *13 (S.D.N.Y. Jun. 26, 2014) (“Facts merely supporting an inference that an audit could have been done better constitute ‘fraud by hindsight’ and do not support the requisite scienter.”). Rather, a plaintiff must allege that the auditor employed accounting practices “so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts.” In re Scottish Re Group Sec. Litig., 524 F.Supp.2d 370, 385 (S.D.N.Y.2007) (citation omitted) (alteration in original); Marsh & Mclennan, 501 F.Supp.2d at 488-89 (quoting S.E.C. v. Price Waterhouse, 797 F.Supp. 1217, 1240 (S.D.N.Y.1992)). “This standard requires more than a failure to follow GAAP.” In re Scottish Re, 524 F.Supp.2d at 385. Allegations of “ ‘accounting practices amounting at best to a pretended audit, or of grounds supporting a representation so flimsy as to lead to the conclusion that there was no genuine belief back of it,’ ” may support a finding of auditor scienter. Dobina v. Weatherford Int’l Ltd., 909 F.Supp.2d 228, 254 (S.D.N.Y.2012) (citations omitted).
“A complaint might reach [the] ‘no audit at all’ threshold by alleging that the auditor disregarded specific ‘red
flags,’ ” which are facts that “would place a reasonable auditor on notice that the audited company was engaged in wrongdoing to the detriment of its investors.” Longtop I, 910 F.Supp.2d at 574-75 (citation omitted); see also, e.g., In re IMAX, 587 F.Supp.2d at 483-84. A plaintiff must allege that the auditor had actual awareness of the red flags, “either because they are alleged to have had actual knowledge or because the red flags were so obvious that the auditor must have been aware of them.” Stephenson v. Citco Grp. Ltd., 700 F.Supp.2d 599, 622-23 (S.D.N.Y.2010), aff'd on other grounds sub nom. Stephenson v. PricewaterhouseCoopers, LLP, 482 Fed.Appx. 618 (2d Cir.2012); see also MRU Holdings, 769 F.Supp.2d at 518-19. It is insufficient to simply allege that the auditor had access to the information by which it could have discovered the fraud. Meridian Horizon Fund, LP v. Tremont Grp. Holdings, Inc., 747 F.Supp.2d 406, 413 (S.D.N.Y.2010). “Notably, if an auditor is ‘not aware of facts indicating that a transaction was suspicious, or part of a fraud, the auditor’s failure to investigate the transaction — even if negligent — does not provide a basis for a fraud claim.’ ” Iowa Pub. Employee’s Ret. Sys. v. Deloitte & Touche LLP, 919 F.Supp.2d 321, 332 (S.D.N.Y.2013) (quoting In re CBI Holding Co., Inc., 419 B.R. 553, 566-67 (S.D.N.Y.2009)) (“auditor access is not tantamount to auditor awareness ” (emphasis in original)), reconsideration denied, 973 F.Supp.2d 459 (S.D.N.Y.2013), aff'd, 558 Fed.Appx. 138 (2d Cir.2014).
As one court observed, “[a]n auditor is a watchdog, not a bloodhound. As a matter of commercial reality, audits are performed in a client-controlled environment.” Whalen v. Hibernia Foods PLC, No. 04 Civ. 3182(HB), 2005 WL 1799370, at *3 (S.D.N.Y. Aug. 1, 2005) (quoting Bily v. Arthur Young & Co., 3 Cal.4th 370, 11 Cal.Rptr.2d 51, 834 P.2d 745, 762 (Cal.1992)). Accordingly, the law imposes limits on § 10(b) liability for failure to uncover fraud perpetrated by others. Novak, 216 F.3d at 309. (“the failure of a non-fiduciary accounting firm to identify problems with the defendant-company’s internal controls and accounting practices does not constitute reckless conduct sufficient for § 10(b) liability”).
Blanket allegations of accounting irregularities or failure to follow GAAP, standing alone, cannot pass muster; it is well-established that such allegations must be coupled with “red flags” in order to support a strong inference of scienter. Id.; see also, e.g., W.Va. Inv. Mgmt. Bd. v. Doral Fin. Corp., 344 Fed.Appx. 717, 720 (2d Cir.2009) (summary order); In re SAIC, Inc. Sec. Litig., No. 12 Civ. 1353(DAB), 2013 WL 5462289, at *8 (S.D.N.Y. Sept. 30, 2013), on reconsideration, No. 12 Civ. 1353(DAB), 2014 WL 407050 (S.D.N.Y. Jan. 30, 2014); In re Bear Steams Companies, Inc. Sec., Derivative, & ERISA Litig., 763 F.Supp.2d 423, 511 (S.D.N.Y.2011); Varghese v. China Shenghuo Pharm. Holdings, Inc., 672 F.Supp.2d 596, 610 (S.D.N.Y.2009); In re Refco, Inc. Sec. Litig., 503 F.Supp.2d 611, 657-58 (S.D.N.Y.2007). Likewise, on its own, the magnitude of an alleged fraud fails to establish scienter. Pennsylvania Pub. Sch. Employees’ Ret. Sys. v. Bank of America Corp., 874 F.Supp.2d 341, 362-63 (S.D.N.Y.2012). Courts may infer circumstantial evidence of scienter from an auditor’s failure to uncover a large-scale fraud, “just as failing to detect a large boulder in front of your face qualifies as circumstantial evidence of blindness,” Longtop I, 910 F.Supp.2d at 578, but “scienter is not sufficiently alleged simply because an audit failed to detect a fraud.” ABAT I, 2012 WL 3758085, at *16.
b. Plaintiffs’ Allegations Fail to Establish Scienter
Plaintiffs contend that DTTC “recklessly” issued (1) unqualified audit opinions certifying that ChinaCast’s financial statements were prepared in accordance with GAAP and that DTTC conducted the audits in accordance with PCAOB standards for fiscal years 2007 through 2010 and (2) unqualified opinions on the Company’s internal controls over financial reporting for fiscal years 2008 and 2009. Am. Compl. ¶¶ 52, 83, 85, 151-52, 207-08; DTTC Mot. Dismiss 22-23 (citing 2007-2010 Form 10-Ks at F-2). The Court can infer that DTTC made these statements with fraudulent intent, Plaintiffs claim, because DTTC effectively performed “no audit at all.” Pis.’ Opp. DTTC Mot. 5-9, 12. Plaintiffs argue that their allegations create an inference of recklessness based on (1) “red flags” and basic accounting failures; (2) the magnitude of the alleged fraud; and (3) the fact that new management quickly discovered the fraud by looking at “the very same records” that DTTC had in its possession. Id.
The Second Circuit has held that a “reckless disregard for the truth” signifies “conscious recklessness — i.e., a state of mind approximating actual intent, and . not merely a heightened form of negligence.” S. Cherry St., 573 F.3d at 109 (emphasis in original). Viewed collectively, Plaintiffs’ allegations come close, but ultimately fall short of this especially stringent standard.-
i. “Red flags” and Accounting Violations
Plaintiffs argue that the auditor need not actually have seen the red flags if they instead establish that a reasonable auditor would have recognized them during a properly-conducted audit. Pis.’ Opp. DTTC Mot. 5 (citing, e.g., In re Longwei Petroleum Inv. Holding Ltd. Sec. Litig., No. 13 Civ. 214(HB), 2014 WL 285103, at *6 (S.D.N.Y. Jan. 27, 2014); Whalen, 2005 WL 1799370, at *3). However, the law is clear that “[a]n unseen red flag cannot be heeded,” Stephenson, 768 F.Supp.2d at 573, and, as another court put it, “the fact that ‘a person has broad access to every book in a library does not mean that the person has read and chosen to ignore facts contained in a particular book in the library.’ ” Athale v. SinoTech Energy Ltd., No. 11 Civ. 053KAJN), 2014 WL 687218, at *7 (S.D.N.Y. Feb. 21, 2014) (quoting In re aaiPharma Inc. Secs. Litig., 521 F.Supp.2d 507, 513 (E.D.N.C.2007)).
The cases cited by Plaintiffs are not to the contrary. In Whalen, the court found that the complaint raised an inference that' the auditor “knew or should have known about the company’s alleged fraudulent accounting practices” based on plaintiffs’ specific allegations of awareness of suspicious facts: a former finance manager directly told PwC that the audited company’s “cash situation had become so severe [that] the Managing Director ... was paying suppliers out of his personal bank account,” and the audited company fell behind on payments to the auditor itself, causing PwC to delay its audit — evidence of cash flow problems in the auditor’s “own backyard.” 2005 WL 1799370, at *4. Here, the Company’s financial filings show only that ChinaCast failed to pay outstanding bills to DTTC after the fraud became public.
Similarly, in Longwei, the Court determined that the plaintiffs adequately alleged the auditors’ scienter based on their pleading of red flags, the massive scale of the fraud, auditors’ failure to follow GAAS, and “the fact that the[] [auditors] had been rebuked for audit deficiencies in the past by the [PCAOB].” 2014 WL 285103, at *5. The Court also identified specific indicia known to the auditors' — record revenues far outpacing competitors, the revenues’ sudden upward trajectory, and a particular investment — which “should have prompted further investigation.” Id.
As with all allegations at the motion to dismiss stage, courts must view allegations of red flags “in the aggregate.” In re Refco, 503 F.Supp.2d at 658 (citing Yoder v. Orthomolecular Nutrition Inst., Inc., 751 F.2d 555, 562 (2d Cir.1985)). Taken as a whole, Plaintiffs’ allegations here amount to a theory that, had DTTC performed a higher quality audit, i.e., one that complied with GAAS and PCAOB standards, it would have unearthed red flags indicative of ChinaCast’s pervasive wrongdoing. Yet, it is well-established that an accusation that a defendant “merely ought to have known” is insufficient to allege recklessness. Kuriakose v. Fed. Home Loan Mtg. Corp., 897 F.Supp.2d 168, 184 (S.D.N.Y.2012); Athale, 2014 WL 687218, at *7; Iowa Pub. Emps. Ret. Sys., 919 F.Supp.2d at 332; Perry v. Duoyuan Printing, Inc., No. 10 Civ. 7235(GBD), 2013 WL 4505199, at *7 (S.D.N.Y. Aug. 22, 2013); AJBAT I, 2012 WL 3758085, at *16; Stephenson, 768 F.Supp.2d at 568. Pleading the existence of red flags does not amount to an allegation that the facts and circumstances at issue would have put a reasonable auditor on notice of potential fraud. Longtop I, 910 F.Supp.2d at 576.
Of Plaintiffs’ red flags, only one involves an allegation that DTTC had possession of the source documents evidencing suspicious activity: the allegation that ChinaCast’s trial balances for the years 2007 through 2009 reveal “massive outflows” of cash to, and unexplained inflows from, parties that had “no legitimate business relationship” to the Company. Am. Compl. ¶ 5. Plaintiffs allege that the trial balances for CCT Shanghai, one of its subsidiaries, reveal transactions with non-education related businesses and thus render false the Company’s statement in its Form 10-K filings that “CCT Shanghai does not perform any activities or have any operations outside the scope of’ its satellite business. Id. ¶ 135. However, DTTC correctly notes that this statement did not appear in the Company’s financial statements — the portion of the 10-K audited by DTTC. DTTC Mot. Dismiss 18.
Additionally, the Court finds persuasive DTTC’s argument that, in accordance with professional accounting standards, auditors routinely employ sampling procedures. Id. at 16 (citing AU ¶ 350.07). Because Plaintiffs do not allege that DTTC was required to test the specific CCT Shanghai trial balances that they identify, their allegations amount to no more than an allegation of a lapse in professional judgment. “PCAOB standards specifically instruct auditors to ‘select’ a sample of the audited company’s journal entries for testing based on the auditor’s ‘professional judgment.’ ” Id. (citing AU ¶¶ 316.58(2), 316.61). Plaintiffs only allege that a “limited sample” of the CCT Shanghai trial balances revealed dealings with a pawn shop (Am. Compl. ¶ 138), and generally claim that the trial balances “include” evidence of other transactions with unre