In Acticon AG v. China North East Petroleum Holdings Limited (“China North”), 2015 BL 278511 (2d Cir. 2015), Acticon AG appealed the district court’s grant of the China North, Wang Hong Jun, Ju Guizhi, Robert C. Bruce, and other defendants’ collectively (“Defendants) motion to dismiss in a securities fraud case. Upon appeal, the Second Circuit vacated the Southern District of New York’s decision in part, affirmed in part, reversed in part, and remanded the case for further proceedings.

 According to the allegations, China North is an oil exploration company operating in the United States and incorporated in Nevada. Acticon filed a civil complaint in the South District of New York against China North, Wang, Ju, and other defendants. It alleged violations of the Securities Exchange Act of 1934 (“Act”), and in particular brought claims under Section 10(b) of the Act and SEC Rule 10b-5 alleging fraud involving scienter. Furthermore, Acticon alleged violations of Section 20(a) of the Act and sought controlling person liability against Wang and Ju.

To raise a strong inference of scienter under Section 10(b) through motive and opportunity, a plaintiff must allege the defendant or its officers benefited from the fraud in a concrete and personal way. When the defendant is a corporate entity, the facts presented must create a strong inference that someone whose intent could be imputed to the corporation, acted with scienter.

Section 20(a) imposes secondary liability for a company’s violations of the Act on executives who are controlling persons in the company. To adequately plead Section 20(b) violations, a plaintiff must show: (1) a primary violation by the controlled person; (2) control of the primary violator by the defendant; and (3) that the defendant was, in some meaningful sense, a culpable participant in the controlled person’s fraud.

The court affirmed the dismissal of the fraud claims requiring a showing of scienter against Ju because there were no allegations he reviewed or signed any of the allegedly false SEC filings. Conversely, the court held Acticon sufficiently alleged scienter against Wang, finding he had both the opportunity and motive to commit the fraud. “As China North's former CEO, Wang signed all of the relevant SEC filings attesting to the company's internal controls, while allegedly simultaneously looting China North's treasury and engaging in unauthorized transfers of company funds.” 

 The court did not analyze the sufficiency of the 20(a) allegations and instead, instructed the district court to do so on remand. The court noted that Wang “may be liable as an individual who controlled China North” and Ju may also be liable “as a director of China North and an alleged participant in the unauthorized transfer”. 

 Finally, the court affirmed the dismissal of claims arising from Section 10(b) of the Act.  for the failure to recognize internal control problems and GAAP violations.  Such failures do not generally “’constitute reckless conduct’”.  Further, the court held that inferences of scienter by defendant Bruce were “weakened by allegations describing his affirmative efforts to uncover fraud by China North.”  

On remand, the district court could permit amendments to the complaint with respect to Wang, Ju, and China North.  As for the other defendants, we affirm the district court's denial of leave to amend. "’[W]here amendment would be futile, denial of leave to amend is proper.’"

The primary materials for this post can be found on the DU Corporate Governance Website.