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Albert Snellink, Zachary Lewy, Sampson Daruvalla, and William v. Gulf Resources

May 15, 2012

ALBERT SNELLINK, ZACHARY LEWY, SAMPSON DARUVALLA, AND WILLIAM SPIEGELBERG, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED,
PLAINTIFFS,
v.
GULF RESOURCES, INC., XIAOBIN LIU, MIN LI, AND MING YANG, DEFENDANTS.



The opinion of the court was delivered by: Otis D. Wright, II United States District Judge

ORDER DENYING MOTION TO DISMISS PLAINTIFFS' AMENDED CLASS ACTION COMPLAINT [33]

Pending before the Court is Defendant Gulf Resources, Inc.'s motion to dismiss Plaintiffs' amended class action complaint ("AC") under Federal Rule of Civil Procedure 12(b)(6). (Dkt. No. 33.) Having considered the papers filed in support of and in opposition to the instant motion, the Court deems the matter appropriate for decision without oral argument. Fed. R. Civ. P. 78; L.R. 7-15.

I.FACTUAL BACKGROUND

Plaintiffs brought this class action against Gulf and some of its directors and officers for violations under the federal securities laws. During the period between March 16, 2009 and April 26, 2011, Plaintiffs purchased Gulf's common stock. (AC ¶ 1.) Gulf is a Delaware Corporation with its principal executive offices located in the People's Republic of China. (Id. ¶ 23.)

Gulf conducts operations through its two subsidiaries, Shouguang City Haoyuan Chemical Co., Ltd. ("SCHC") and Shouguang Yuxing Chemical Industry Co., Ltd. ("SYCI"), both of which are organized under Chinese law. (Id. ¶ 24.) SCHC manufactures bromide and crude salt. (Id.) SYCI manufactures industrial chemical products used in oil and gas field exploration, oil field drilling, wastewater processing, as well as papermaking chemical agents and inorganic chemicals. (Id.) All of Gulf's revenue and income is generated by SCHC and SYCI. (Id. ¶ 25.) Gulf's common stock was actively traded under the ticker "GFRE" on the NASDAQ and the OTC BB (Over-The-Counter Bulletin Board). (Id. ¶ 26.) Defendant Ming Yang was Chairman of Gulf's Board of Directors and was the legal representative of SCHC and SYCI; Defendant Xiaobin Liu was Gulf's Chief Executive Officer and one of its Directors; Defendant Min Li was Gulf's Chief Financial Officer.*fn1 (Id. ¶¶ 27--28, 31-- 32.)

According to Plaintiffs, Gulf deceived the investing public through its SEC filings by making false and misleading statements, withholding relevant business and financial information, and engaging in accounting fraud. In particular, Plaintiffs point out the following six issues.

First, a review of SCHC and SYCI's filings to the State Administration for Industry and Commerce ("SAIC") and to the State Administration of Taxation ("SAT") suggests that Gulf maintained two different sets of accounting books.*fn2 (Id. ¶ 97.) SCHC and SYCI's SAIC filings provide inventory and sales figures that are in line with those of their competitors. (Id. ¶¶ 91--92.) Assuming the SCHC and SYCI figures are correct, and given the fact that all of Gulf's revenue comes from these two subsidiaries, Gulf grossly overstated its financial position in its SEC filings. (Id. ¶¶ 96--97.) Further, the enormous discrepancy in the financial information between Gulf's SEC filings and the SAIC and SAT filings of SCHC and SYCI cannot be attributed to the insignificant differences between Chinese and U.S. accounting rules. (Id. ¶¶ 98--101.)

Second, Gulf's reported inventory and sales figures are incredible. (Id. ¶¶ 84-- 85.) Gulf's figures suggest that it realized a 50% profit margin based on an inventory turnover rate between 59 to 209 times in the years 2008--2010. (Id. ¶¶ 85--86.) Gulf's data appears false on its face when similarly situated competitors operate under a inventory turnover rate of 7 times and a profit margin below 20%. (Id. ¶¶ 87--90.)

Third, Gulf stated that it was one of the largest bromine producers in China, but Gulf nor its subsidiaries are listed among the top 30 Chinese bromine producers in a 2010 market report. (Id. ¶¶ 75--79.) According to Gulf's SEC filings, its bromine output would have placed Gulf as the number one producer, accounting for over 40% of China's bromine production in 2010. (Id. ¶¶ 79--82.)

Fourth, Gulf failed to disclose related party transactions by hiding the fact that Shouguang City Rongyuan Chemical Co., Ltd. ("Rongyuan"), Gulf's biggest customer in 2010 and its second biggest customer in 2008 and 2009, is a company related to Gulf. (Id. ¶¶ 104--108.) Rongyuan's SAIC filing shows that Yang and another Gulf Director own over 90% of Rongyuan. (Id. ¶¶ 110--111.) Rongyuan's website and contact information suggest that it is a subsidiary of Shandong Haoyuan Industry Group Ltd. ("Haoyuan"), which is owned by Yang and his wife. (Id. ¶¶ 109, 111--116.) Yang is also the founder and Chairman of the Board of Haoyuan. (Id. ¶ 106.) Moreover, Gulf hid the fact that Shouguang Hongye Trading Co., Ltd. ("Hongye"), one of Gulf's largest suppliers of raw materials, is owned and controlled by Haoyuan, Yang, and his family. (Id. ¶¶ 60--62.)

Fifth, Gulf concealed the fact that Haoyuan, owned by Yang and his wife, is a direct competitor of SYCI. (Id. ¶¶ 116--119.) The relationship between Gulf and Haoyuan is further evidenced by the fact they use the same address in its filings- Gulf's SEC filings and Haoyuan's SAIC filings. (Id. ¶¶ 120--121.)

Finally, Gulf's SEC filings did not disclose that Liu, Gulf's Chief Executive Officer, was previously employed as the Chief Financial Officer of China Finance, a firm affiliated with listing a number of fraudulent Chinese companies in the United States. (Id. ¶¶ 122--128.)

Plaintiffs further claim that the alleged fraud was publically disclosed in a report issued by Glaucus Research on April 26, 2011. (Id. ¶ 15.) The revelation by the Glaucus report caused Gulf's stock price to fall $1.16 per share or over thirty percent on heavy trading volume, causing substantial financial damages to investors. (Id. ¶ 17.) Plaintiffs also state that prior to 2011, Yang and his family sold shares of Gulf, reaping between $11--$20 million. (Id. ¶¶ 29--30.)

Plaintiffs also aver that Gulf acted with scienter, and the material misrepresentations caused Plaintiffs' losses in connection with their purchase of Gulf's securities. (Id. ¶¶ 149--58.)

Gulf brought this Rule 12(b)(6) motion, contending that Plaintiffs' AC should be dismissed for failure to state a claim. Gulf argues Plaintiffs fail to meet the heightened pleading standard required in securities actions because they lack sufficient facts to show falsity, scienter, and loss causation.

II.LEGAL STANDARD

Dismissal under Rule 12(b)(6) can be based on "the lack of a cognizable legal theory" or "the absence of sufficient facts alleged under a cognizable legal theory." Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir. 1990). A complaint need only satisfy the minimal notice pleading requirements of Rule 8(a)(2)-a short and plain statement-to survive a motion to dismiss for failure to state a claim under Rule 12(b)(6). Porter v. Jones, 319 F.3d 483, 494 (9th Cir. 2003); Fed. R. Civ. P. 8(a)(2). For a complaint to sufficiently state a claim, its "[f]actual allegations must be enough to raise a right to relief above the speculative level." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). While specific facts are not necessary so long as the complaint gives the defendant fair notice of the claim and the grounds upon which the claim rests, a complaint must nevertheless "contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009).

Iqbal's plausibility standard "asks for more than a sheer possibility that a defendant has acted unlawfully." Id. Rule 8 demands more than a complaint that is merely consistent with a defendant's liability-labels and conclusions, or formulaic recitals of the elements of a cause of action do not suffice. Id. The determination whether a complaint satisfies the plausibility standard is a "context-specific task that requires the reviewing court to draw on its judicial experience and common sense." Id. at 679.

When considering a Rule 12(b)(6) motion, a court is generally limited to the pleadings and must construe "[a]ll factual allegations set forth in the complaint . . . as true and . . . in the light most favorable to [the plaintiff]." Lee v. City of L.A., 250 F.3d 668, 688 (9th Cir. 2001). Conclusory allegations, unwarranted deductions of fact, and unreasonable inferences need not be blindly accepted as true by the court. Sprewell v. Golden State Warriors, 266 F.3d 979, 988 (9th Cir. 2001). Yet, a complaint should be dismissed only if "it appears beyond doubt that the plaintiff can prove no set of facts" supporting plaintiff's claim for relief. Morley v. Walker, 175 F.3d 756, 759 (9th Cir. 1999).

III.DISCUSSION

To assert a claim under section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, the complaint must satisfy the dual pleading requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009). Under Rule 9(b), claims alleging fraud are subject to a heightened pleading requirement, which requires that a party "state with particularity the circumstances constituting fraud." Fed. R. Civ. P. 9(b). PSLRA was enacted to prevent plaintiffs from asserting baseless securities fraud claims. Under PSLRA, any securities fraud claim shall "[s]pecify each statement alleged to have been misleading, [and the] reasons why the statement is misleading." 15 U.S.C. § 78u-4(b)(1). If an allegation regarding the statement or omission is made on information and belief, the plaintiff must state with particularity all facts on which that belief is formed.

15 U.S.C. § 78u-4(b)(1); Gompper v. VISX, Inc., 298 F.3d 893, 895 (9th Cir. 2002). For each alleged misleading statement, PSLRA further requires the complaint state with "particularity facts giving rise to a strong inference that the defendant ...


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