United States District Court, C.D. California
LARRY BROWN ET AL.
CHINA INTEGRATED ENERGY INC. ET AL
Attorneys for Plaintiffs: Not Present.
Attorneys for Defendants: Not Present.
Honorable BEVERLY REID O'CONNELL, United States District Judge.
CIVIL MINUTES -- GENERAL
Proceedings: (IN CHAMBERS)
ORDER RE: MOTION TO CERTIFY CLASS ; MOTION TO EXCLUDE PLAINTIFFS' EXPERT WITNESS ; MOTION TO EXCLUDE DEFENDANTS' EXPERT WITNESS 
Pending before the Court are three motions: (1) Plaintiffs' motion for class certification, (Dkt. No. 301); (2) Defendants' motion to exclude the expert report and testimony of Dr. Jay Hartzell, (Dkt. No. 315); and (3) Plaintiffs' motion to exclude the report and testimony of Dr. Andrew Roper, (Dkt. No. 321). The Court held a hearing on these matters on October 10, 2015, during which it heard testimony from Dr. Roper and Dr. Hartzell. After considering the parties' papers, the deposition and hearing testimonies, and the expert declarations, the Court finds that both Dr. Roper and Dr. Hartzell are sufficiently qualified to opine on the matter of market efficiency. In light of their varying testimony and the facts of this case, the Court further concludes that Plaintiffs have demonstrated that the fraud-on-the-market presumption should apply, and that they have consequently satisfied the elements necessary for class certification. Accordingly, both parties' motions to exclude the other's expert witness are DENIED, and Plaintiffs' motion for class certification is GRANTED.
A. Factual History
This is a putative securities fraud class action brought under the Securities Act of 1933 and the Securities Exchange Act of 1934 as amended by the Private Securities Litigation Reform Act of 1995. Plaintiffs assert claims against China Integrated Energy Corporation (" China Integrated Energy"), some of its officers and directors, and its independent auditor, accounting firm Sherb & Co. (See Consolidated Class Action Compl. (" Compl.") ¶ ¶ 28-41.) Collectively, these individuals and entities are referred to as " Defendants."
Plaintiffs seek to represent a class of individuals who purchased or otherwise acquired common stock in China Integrated Energy between March 31, 2010, and April 21, 2011. (Pls.' Mot. (Dkt. No. 301) at 1; Compl. ¶ 52.) China Integrated Energy is a Delaware corporation operating in the People's Republic of China. (Compl. ¶ 2.) It purports to sell finished oil products, heavy oil products, and biodiesel fuel. (Compl. ¶ 2.) It also operates retail gas stations. (Compl. ¶ 2.)
According to Plaintiffs, the class period began on March 31, 2010, when China Integrated Energy issued its 2009 financial results. (Compl. ¶ 52.) They allege that the report was materially false and misleading because it overstated China Integrated Energy's 2009 revenue and net income. (Compl. ¶ 55.) Plaintiffs also assert that Defendants prepared two sets of financial statements: one presumably accurate set that Defendants filed with Chinese regulators, and another false and misleading set that they filed with the Securities and Exchange Commission (" SEC"). ( See Compl. ¶ ¶ 55-59.)
The discrepancy between the financial statements filed in China and those filed with the SEC came to light on March 16, 2011. ( See Compl. ¶ ¶ 58, 130.) On that day, Sinclair Upton Research published a report alleging that China Integrated Energy's SEC filings overstated revenues as compared with revenues reported in the Chinese filings. (Compl. ¶ ¶ 58, 130.) The report also asserted that China Integrated Energy had been funneling money to corporations owned by the son of Defendant Xincheng Gao. (Compl. ¶ 130.) In response to this report, China Integrated Energy's share price fell from $5.95 to a closing price of $5.00, nearly a 16% drop. (Compl. ¶ 130.)
The next day, analysts at Roth Capital Partners downgraded China Integrated Energy's shares from a " BUY" status to a " NEUTRAL" status. (Compl. ¶ 132.) They also reported that they had independently obtained the Chinese filings referenced in Sinclair Upton Research's report, and confirmed the prior report's accuracy. (Compl. ¶ ¶ 58, 132.) China Integrated Energy's share price fell again, from $5.00 to $3.52, a 24.6% drop. (Compl. ¶ 133.)
A week later, on March 23, 2011, China Integrated Energy issued a letter to shareholders, apparently in an attempt to rebut the reports' allegations. (Compl. ¶ 134.) It vigorously denied it had made any misstatements in its financial statements and SEC filings, and denied all other accusations in the Sinclair Upton Research report. (Compl. ¶ ¶ 134-38.) Notwithstanding this rebuttal attempt, China Integrated Energy's share prices continued to fall. ( See Compl. ¶ 140.)
On March 28, 2011, additional damaging information surfaced when another analyst firm, Alfred Little, issued a detailed report reviewing China Integrated Energy's Chinese filings and audited financial statements and calling the company a " complete hoax." (Compl. ¶ 141.) This report caused a 29% drop in share price, from $3.76 to $2.66, on March 28, 2011. (Compl. ¶ 143.)
In response to the accusations and resultant drop in share price, China Integrated Energy hired law firms and auditors to conduct an internal investigation. ( See Compl. ¶ 151.) Ultimately, these firms and auditors resigned, citing management's refusal to cooperate in the investigation. ( See Compl. ¶ ¶ 152-55.) On April 26, 2011, the company's outside auditor, KPMG, resigned and cautioned investors that the SEC filings it assisted in preparing should no longer be relied upon. (Compl. ¶ ¶ 156-57.)
On April 20, 2011, NASDAQ halted trading in China Integrated Energy's shares. (Compl. ¶ 145.) On November 21, 2011, NASDAQ decided to remove the company's shares from listing. (Compl. ¶ 150.)
B. Procedural History
Between March 25, 2011 and May 25, 2011, various plaintiffs filed five separate lawsuits, which were ultimately consolidated into one. ( See Dkt. Nos. 43-44.) On December 20, 2011, these plaintiffs filed a consolidated class action complaint. (Dkt. No. 59.) In their consolidated complaint, Plaintiffs allege four causes of action: (1) violations of Section 10(b) of the Securities Exchange Act of 1934 and related Rule 10b-5, (Compl. ¶ ¶ 176-84); (2) violations of Section 20(a) of the Securities Exchange Act (against company officers only), (Compl. ¶ ¶ 185-98); (3) violations of Section 11 of the Securities Act of 1933, (Compl. ¶ ¶ 199-209); and (4) violations of Section 15 of the Securities Act (against company officers only), (Compl. ¶ ¶ 210-13).
On August 15, 2013, Plaintiffs filed a motion for class certification, naming Puerto Rico Teachers Retirement System and Bristol Investment Fund Ltd. as the lead plaintiffs. (Dkt. No. 183.) In support of their motion, Plaintiffs offered the expert declarations of Michael Marek, (Dkt. No. 185-3), and Kenneth McGraw, (Dkt. No. 205). On April 14, 2014, Defendants filed a motion to exclude the declarations of Marek and McGraw. (Dkt. No. 226.) After holding a hearing on these matters, the Court granted Defendants' motion to exclude Plaintiffs' expert declarations on August 4, 2014 and consequently denied Plaintiffs' motion for class certification. (Dkt. No. 271.)
On November 3, 2014, Plaintiffs then renewed their motion for class certification, (Dkt. No. 301), which they supported with a report by a new expert witness, Dr. Jay Hartzell, (Dkt. No. 301-3). Defendants opposed this motion on December 22, 2014, (Dkt. No. 314), and then filed a motion to exclude the testimony of Dr. Hartzell on January 5, 2015, (Dkt. No. 315). Similarly, Plaintiffs filed a motion to exclude the expert testimony of Defendants' expert, Dr. Andrew Roper, on January 19, 2015. (Dkt. No. 321.) The Court then heard oral argument on these matters on February 10, 2015.
II. LEGAL STANDARD
A. Motion to Strike Expert Report
The proponent of the expert testimony has the burden of proving that the proposed expert testimony is admissible under Federal Rule of Evidence 702, Daubert, and its progeny. Lust ex rel. Lust v. Merrell Dow Pharm., Inc., 89 F.3d 594, 598 (9th Cir. 1996). The pertinent admissibility requirements must be met by a preponderance of the evidence, pursuant to Federal Rule of Evidence 104(a). Bourjaily v. United States, 483 U.S. 171, 175, 107 S.Ct. 2775, 97 L.Ed.2d 144 (1987). Federal Rule of Evidence Rule 702 provides,
A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if:
(a) the expert's scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or determine a fact in issue;
(b) the testimony is based on sufficient facts or data;
(c) the testimony is the product of reliable principles and methods; and
(d) the expert has reliably applied the principles and methods to the facts of the case.
Fed. R. Evid. 702. The Supreme Court in Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 113 S.Ct. 2786, 125 L.Ed.2d 469 (1993), announced that the key inquiry in evaluating expert scientific testimony centers on reliability; trial judges are to act as gatekeepers in excluding unreliable expert scientific testimony. Six years later, in Kumho Tire Co. v. Carmichael, 526 U.S. 137, 119 S.Ct. 1167, 143 L.Ed.2d 238 (1999), the Supreme Court extended this reliability analysis to all expert testimony, rather than just scientific testimony.
The Supreme Court in Daubert sought to guide trial courts by offering several nonexclusive, nondispositive factors that a trial court may consider in evaluating expert testimony: (1) whether the expert's technique or theory can be or has been tested; (2) whether the technique or theory has been subjected to peer review and publication; (3) the technique or theory's rate of error; (4) the existence and maintenance of standards and controls; and (5) the technique or theory's general acceptance. See Daubert, 509 U.S. at 593-94. Further, " [t]he inquiry envisioned by Rule 702 . . . is a flexible one." Id. at 594. In fact, the Supreme Court in Daubert emphasized that, in making this inquiry into reliability of expert testimony, trial judges are accorded significant discretion. Id.; see also Gen. Elec. Co. v. Joiner, 522 U.S. 136, 141, 118 S.Ct. 512, 139 L.Ed.2d 508 (1997) (holding that the trial court's decision in admitting or excluding expert testimony will be reviewed for abuse of discretion). See generally Datalex (Ir.) Ltd. v. PSA, Inc., CV01-06482DDPVBKX, 2003 WL 25667620 (C.D. Cal. Jan. 30, 2003) (denying a motion to exclude expert testimony after applying the nondispositive factors from Daubert ).
B. Motion for Class Certification
A party seeking class certification bears the burden of establishing that the prospective class satisfies Federal Rule of Civil Procedure 23(a). Ellis v. Costco Wholesale Corp., 657 F.3d 970, 979-80 (9th Cir. 2011). Under Rule 23(a), the party seeking certification must establish all four of the following: (1) numerosity, (2) commonality, (3) typicality, and (4) adequacy of representation. Fed.R.Civ.P. 23(a). This requires proof that:
(1) the class is so numerous that joinder of all members is impracticable; (2) there are questions of law or fact common to the class; (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and (4) the representative parties will fairly and adequately protect the interests of the class.
Id.; accord Wal-Mart Stores, Inc. v. Dukes, 131 S.Ct. 2541, 2548, 180 L.Ed.2d 374 (2011). Additionally, a party seeking certification bears the burden of demonstrating that it has met at least one of the requirements of Rule 23(b). See Valentino v. Carter-Wallace, 97 F.3d 1227, 1234 (9th Cir. 1996). Certification should only be granted if, " after a rigorous analysis, " the court determines that the prospective class satisfies the requirements of Rule 23(a). Wal-Mart Stores, 131 S.Ct. at 2551 (quoting Gen. Tel. Co. of Sw. v. Falcon, 457 U.S. 147, 161, 102 S.Ct. 2364, 72 L.Ed.2d 740 (1982)) (internal quotation marks omitted). The same principles apply to a Rule 23(b) analysis. See Comcast Corp. v. Behrend, 133 S.Ct. 1426, 1432, 185 L.Ed.2d 515 (2013).
When reviewing motions for class certification, district courts are generally bound to take the substantive allegations of the complaint as true. In re Coordinated Pretrial Proceedings in Petroleum Prods. Antitrust Litig., 691 F.2d 1335, 1342 (9th Cir. 1982) (citing Blackie v. Barrack, 524 F.2d 891, 901 n.7 (9th Cir. 1975)). But " Rule 23 does not set forth a mere pleading standard. A party seeking class certification must affirmatively demonstrate his compliance with the Rule." Wal-Mart Stores, 131 S.Ct. at 2551. Thus, " sometimes it may be necessary for the court to probe behind the pleadings before coming to rest on the certification question." Id. (quoting Falcon, 457 U.S. at 161) (internal quotation marks omitted). Ultimately, district courts have " broad discretion to determine whether a class should be certified and to revisit that certification throughout the legal proceedings before the court." United Steel, Paper & Forestry, Rubber, Mfg. Energy, Allied Indus. & Serv. Workers Int'l Union, AFL-CIO, CLC v. ConocoPhillips Co., 593 F.3d 802, 810 (9th Cir. 2010).
In support of their renewed motion for class certification, Plaintiffs proffer the expert report of Dr. Jay Hartzell. (Dkt. No. 301-3.) They rely on Dr. Hartzell to testify that China Integrated Energy's stock was traded in an efficient market. Demonstrating market efficiency is crucial to Plaintiffs' motion. This is because Plaintiffs must prove reliance; that is, they must prove that they relied on Defendants' misrepresentations in purchasing China Integrated Energy's securities. Proof of reliance ensures an adequate connection between Defendants' wrongful conduct (the misrepresentations) and Plaintiffs' resultant injury (buying shares worth less than they were priced). Erica P. John Fund Inc. v. Halliburton Co., 131 S.Ct. 2179, 2184, 180 L.Ed.2d 24 (2011) ( Halliburton I ). But proving direct reliance on misrepresentations is somewhat difficult. A plaintiff establishes direct reliance by showing that it was aware of the defendant's statement and thereafter engaged in a relevant transaction such as purchasing stock. Id. at 2185. Even more difficult would be proving direct reliance individually for each member of a putative class. See Halliburton I, 131 S.Ct. at 2185; Basic Inc. v. Levinson, 485 U.S. 224, 245, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). And even were it feasible to prove direct reliance individually for each member of the class, class certification would be improper under Rule 23(b)(3) because individual issues would predominate over common ones. See Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S.Ct. 1184, 1199, 185 L.Ed.2d 308 (2013).
Accordingly, Plaintiffs attempt to invoke a rebuttable presumption of reliance on behalf of the entire class as a whole, based on the " fraud-on-the-market" theory. " According to that theory, 'the market price of shares traded on well-developed markets reflects all publicly available information, and hence, any material misrepresentations.'" Halliburton I, 131 S.Ct. at 2185 (quoting Basic, 485 U.S. at 245). As such, the theory presumes that, by trading based on share price, an investor necessarily relies on any misrepresentations inherently incorporated into it. But the " fraud-on-the-market" theory applies only to the extent that the shares were traded in an efficient market. Id. Thus, demonstrating market efficiency is in essence a lynchpin to Plaintiffs' motion for class certification: market efficiency is essential to " fraud-on-the-market"; " fraud-on-the-market" is essential to demonstrating reliance on behalf of the class as a whole; and demonstrating reliance on behalf of the class as a whole is necessary to show that individual issues do not predominate over common ones, as required by Rule 23(b)(3). See Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398, 2412, 189 L.Ed.2d 339 (2014) ( Halliburton II ) (reiterating that a plaintiff must prove " the prerequisites for invoking the [ Basic ] presumption--namely, publicity, materiality, market efficiency, and market timing . . . before class certification"). As a result, Plaintiffs must demonstrate market efficiency to prevail upon their motion.
In addition to providing the expert report of Dr. Hartzell, Plaintiffs support their theory of market efficiency by submitting the declaration of Plaintiffs' counsel, Ian Berg, along with evidence related to the five factors bearing on the issue of market efficiency discussed in Cammer v. Bloom, 711 F.Supp. 1264, 1286-87 (D.N.J. 1989). Although Plaintiffs correctly argue that expert testimony is not required to demonstrate market efficiency, " many courts have considered it when addressing [the Basic presumption], which may often benefit from statistical, economic, and mathematical analysis." In re Countrywide Fin. Corp. Sec. Litig., 273 F.R.D. 586, 609 (C.D. Cal. 2009) (quoting Unger v. Amedisys Inc., 401 F.3d 316, 323 (5th Cir. 2005)). And while Mr. Berg's evidence may be sufficient in situations such as in Countrywide where " efficiency is very nearly a nonissue, " here Defendants have provided expert witness testimony rebutting a finding of market efficiency. Accordingly, given the importance of their testimony to determining the matter of market efficiency--and consequently Plaintiffs' motion for class certification--the Court will first discuss Plaintiffs' motion to exclude Dr. Roper and Defendants' motion to exclude Dr. Hartzell as expert witnesses. The Court will then consider Plaintiffs' renewed motion for class certification.
A. Plaintiffs' Motion to Exclude the Testimony of Dr. Andrew Roper
Because Defendants' motion to exclude the testimony of Dr. Jay Hartzell relies on testimony proffered by their own expert, Dr. Andrew Roper, the Court will first consider Plaintiffs' motion to exclude the testimony of Dr. Roper. (Dkt. No. 321.) In the Court's previous motion, the Court accepted the expert testimony of Dr. Roper in the field of market efficiency, observing that:
Roper is vice-president of a financial and economic consulting firm and a lecturer at Stanford University Law School. At Stanford, he teaches a course on fraud-on-the-market theory, market efficiency, and application of economic analyses, including event studies, to assess economic and legal questions arising within securities class actions. Prior to joining his consulting firm, Roper was a professor of finance at the School of Business at University of Wisconsin--Madison. There, he taught courses on financial economics, which included securities markets, market efficiency, investment strategy, and the application of reliable economic analyses in empirical finance. He holds a master's degree in economics from University of California, Davis, and a Ph.D. in finance from Duke University. Throughout his career, Roper has published articles in leading peer-reviewed journals on economic and financial topics. His articles have ...