United States District Court, C.D. California
Present: The Honorable CHRISTINA A. SNYDER Judge.
CIVIL MINUTES - GENERAL
(IN CHAMBERS) - DEFENDANTS' MOTION TO DISMISS
CONSOLIDATED CLASS ACTION COMPLAINT (Dkt. 33, filed October
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”). 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.
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.
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.
following factual background is based on the allegations in
the complaint and supporting exhibits.
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.
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.”).
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.
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.
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.
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.
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.
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. ¶ 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 ...