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Desta v. Wins Finance Holdings Inc.

United States District Court, C.D. California

February 28, 2018


          Present: The Honorable CHRISTINA A. SNYDER Judge.




         On April 20, 2017, plaintiff Michael Desta commenced this putative class action alleging violations of the Securities Exchange Act of 1934, 15 U.S.C. § 78(a) et seq. (“the Exchange Act”) against defendants Wins Finance Holdings Inc. (“Wins”), Jianming Hao (“Hao”), Renhui Mu (“Mu”), Junfeng Zhao (“Zhao”), and Peiling He (“He”).[1] Dkt. 1. On June 26, 2017, the Court appointed Brian Gabrich, Christopher Ikeocha, and Raymond Mentor as lead plaintiffs and approved their selection of counsel pursuant to Section 21D(a)(3)(B) of the Exchange Act, 15 U.S.C. § 78u4(a)(3)(B). Dkt. 21.

         On August 25, 2017, plaintiffs filed an Amended Class Action Complaint asserting (1) violation of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rules 10b- 5(a) and (c) promulgated thereunder, 17 C.F.R. § 240.10b-5(a) & (c); and (2) violation of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). Dkt. 32. (“Compl.”) The gravamen of the complaint is that defendants falsely stated Wins maintained its principal executive offices in the United States in order to satisfy the criteria for inclusion in the Russell 2000 Index. Id. ¶¶ 2-6. Plaintiffs allege that the class period runs from February 23, 2016 to June 7, 2017, inclusive. Id. ¶ 1.

         On October 24, 2017, defendants filed a motion to dismiss the complaint for failure to state a claim for securities fraud pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure and the heightened pleading requirements imposed by the Private Securities Litigation Reform Act of 1995 (“PSLRA”). Dkt. 33 (“Mot.”). On December 22, 2017, plaintiffs filed an opposition. Dkt. 36 (“Opp'n”). On January 22, 2018, defendants filed a reply. Dkt. 40 (“Reply”). The Court held a hearing on February 12, 2018. Having carefully considered the parties' arguments, the Court rules as follows.


         The following factual background is based on the allegations in the complaint and supporting exhibits.

         Founded in 2006, Wins is a Cayman Islands company with operations located primarily in Jinzhong City, Shanxi Province and Beijing, China. The company principally provides financial guarantee, financial leasing and financial advisory services to Chinese small and medium enterprises (“SMEs”), to which commercial banks in China have been reluctant to lend due to higher credit risks and lack of credit support. Compl. ¶¶ 7-8, 37. On October 28, 2015, Wins went public on the Nasdaq stock exchange via a reverse merger with Sino Mercury Acquisition Corp., a blank-check company formed by former Wins President and Board member Richard Xu (“Xu”) for the specific purpose effectuating the merger. Id. ¶ 48.

         Wins struggled to keep its Nasdaq listing due to lack of investor interest, evidenced by the stock's low trading volume and a scarcity of shareholders. Id. ¶¶ 12, 51. On December 15, 2015, Wins disclosed that it received a notice from Nasdaq's Listing Qualifications Department stating that the Nasdaq staff had determined that the company would be subject to delisting for failure to meet the exchange's initial 300 round lot shareholder requirement. Id. ¶ 52. Nasdaq Listing Rule 5505(a)(3) requires that a company applying to list its primary equity security on Nasdaq have at least “300 Round Lot Holders, ” i.e., at least 300 beneficial holders with ownership of 100 shares or more. Id. ¶ 53. Although Wins successfully appealed the delisting determination before the Nasdaq Listing Qualifications Panel, the company was still faced with the “imminent risk” that it could be delisted due to the lack of outside shareholders. Id. ¶ 55. To keep its listing, Wins had a continuing duty to maintain 300 round lot holders during the entire course of its listing on Nasdaq. Id. ¶ 55 (citing Nasdaq Listing Rule 5550(a) (“[a] Company that has its Primary Equity Security listed on the Capital Market must continue to” have “[a]t least 300 Public Holders.”).

         Faced with the risk of being delisted, defendants “set their eyes on the Russell 2000 Index.” Id. ¶ 13. The Russell 2000 Index, maintained by FTSE Russell, is a small-cap stock market index of the bottom 2, 000 stocks in the Russell 3000 Index, which consists of the 3, 000 largest U.S. public companies and nearly 100 percent of the capitalization of the U.S. stock market. Id. Pursuant to the Russell U.S. Equity Indexes Constructions and Methodology, FTSE Russell uses objective criteria, including a company's market value, headquarters and location of assets, among other factors, to assign companies to the U.S. equity market. Id. ¶ 16. The Russell 2000 Index is by far the most common benchmark for “small-cap” mutual funds and Exchange Traded Funds (“ETFs”). Id. ¶ 13. These funds are usually passively managed by holding all of the securities in the same proportions as the index. Id. Accordingly, if Wins were to be included in the Russell 2000 Index, all of the funds tracking the index would automatically purchase Wins shares. Id. ¶ 14. Wins would be guaranteed sufficient beneficial holders to comply with Nasdaq's initial listing requirements of having 300 round lot holders and the continued listing requirement of having 300 public holders. Id. ¶¶14, 52.

         From the date the company went public to February 22, 2016, Wins reported in its filings with the U.S. Securities & Exchange Commission (“SEC”) that its principal executive offices were located at 1F, Building 7, No. 58 Jianguo Road, Chaoyang District, Beijing 100024, People's Republic of China (“PRC”). Id. ¶ 38. Because the company's principal executive offices were not in the United States, Wins was not eligible for inclusion in the Russell 2000 Index. Id. ¶¶ 15, 61, 65-67. The Russell 2000 Index is redetermined annually; and because Wins went public in October 2015, the earliest opportunity for the company to be included in the index was June 2016, when its composition was redetermined by FTSE Russell. Id. ¶17. On February 23, 2016, Wins represented in an SEC filing that its principal executive offices were located at 7 Times Square, 37th Floor, New York, NY 10036. Id. ¶ 64. On June 10, 2016, Wins was included in the newly reconstituted Russell 2000 Index and the stock's trading volume spiked. Id. ¶18. The average daily trading volume of Wins stock from June 13, 2016 to August 5, 2016 was five times that of the period from Wins' initial listing to June 10, 2016, the date that Wins was first included in the Russell 2000 Index. Id. ¶ 19.

         On December 12, 2016, Seeking Alpha published an article by Anthony Thorpe (“Thorpe”) titled “Wins Finance and the Case of the Missing Headquarters, ” which called into question whether Wins actually had its principal executive offices located in the United States. Id. ¶ 20, Ex. 1. Thorpe writes that a fellow contributor, “Fuzzy Panda Shorts”, visited Wins' office in New York but found “no records” showing the company was located at the listed address. Id. Thorpe writes that he discovered an investment firm named ForeFront Capital Advisors, LLC (“ForeFront”), owned by former Wins director Bradley Reifler (“Reifler”), was located at Wins' listed address. Id. Following the article's publication, Wins' stock price fell $45.50 per share or over 32 percent over two trading days to close at $92.50 per share on December 13, 2016. Id. ¶ 92. However, the Seeking Alpha article did not mention the significance of Wins having its principal executive offices located in the United States, or that the purpose and effect of the address listing was to have Wins included in the Russell 2000 Index. Id. ¶ 93.

         On January 9, 2017, in a Form 6-K filed with the SEC, Wins changed the location of its principal executive offices back to the address in Beijing. Id. ¶ 94. However, Wins remained on the Russell 2000 Index, and thus continued to benefit from artificial investor demand and continued trading at an inflated price. Id. ¶ 95.

         On March 30, 2017, Seeking Alpha published an article by “Fuzzy Panda Shorts” titled “Wins Finance - Active SEC Investigation And Manipulation Of A Russell Index”-which stated that the address and phone number in Wins' SEC filings were “false” and that the company used the New York address to “trick” FTSE Russell into including Wins in the Russell 2000 Index so as to create artificial demand for Wins shares and inflate its stock price. Id. ¶ 96, Ex. 2. The author also indicated that she had submitted a Freedom of Information Act (“FOIA”) request to the SEC for information on any investigations into Wins, and based on the response, it appeared that certain SEC enforcement activities against the company were ongoing. Id. On the same day, Bloomberg published a thoroughly reported article titled “This Chinese Stock Soared 4, 500% on Nasdaq and No One Knows Why”, which described unusual trading activity in Wins' stock, the correlation between the company's address change and its inclusion in the Russell 2000 Index, and indicated that there were no signs of any business at the New York address listed in the company's SEC filings. Id. ¶ 97, Ex. 3. Wins' share price fell $135.61 per share or over 48 percent over the next two trading days to close at $144.99 per share on March 31, 2017. Id. ¶ 98.

         The absence of business activity at the New York address was confirmed by a confidential witness who is a senior employee of Forefront. Id. ¶ 50. The confidential witness stated that during the class period there was one temporary desk for Xu at the office but no space for other Wins employees. Id. ¶ 74. According to the confidential witness, no one answered phone calls for Wins, and Xu “would just come in, but not for long, then leave. . . . once every month or, probably closer to every other month.” Id. ΒΆ 75. The confidential witness was not familiar with any Wins executives or employees; he only saw former president Xu at the office. Although Xu was no ...

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