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From Securities Regulation Daily, August 12, 2014

CFO knew of, but failed to disclose related-party transactions

By Rodney F. Tonkovic, J.D.

A district court declined to dismiss claims brought against the chief financial officer of a China-based petrochemical company. The plaintiffs claimed that Keyuan Petrochemicals, Inc. (Keyuan) and its chief financial officer failed to disclose related-party transactions in offering documents and regulatory filings. The court denied the motion to dismiss the complaint's Exchange Act fraud and controlling persons claims (Vanleeuwen v. Keyuan Petrochemicals, Inc., August 8, 2014, Crotty, P.).

Background. Keyuan manufactures and sells petrochemical products in China. According to the complaint, Keyuan engaged in over $121 million in undisclosed transactions during 2009 and 2010 with entities owned and controlled by Keyuan's CEO. When Keyuan became publicly-listed in the U.S. in May 2010, its CFO, Aichun Li, certified that Keyuan had made no undisclosed related-party transactions. After an auditor raised concerns, in October 2011 Keyuan disclosed for the first time the 2009 and 2010 related-party transactions. The company later filed restatements for the affected quarters to include the transactions.

The complaint relied, in part, on allegations made in an SEC action brought in early 2013 against Keyuan and Li for failing to disclose the related-party transactions in SEC filings. Li later consented to a permanent injunction and a civil penalty.

Fraud. The court rejected Li's arguments that she had no duty to disclose the related-party transactions and that she did not act with scienter. Li asserted that she was not accountable for not disclosing the transactions, but the court found that she had signed and certified various registration statements that failed to disclose the transactions and was therefore a "maker" of these statements or omissions. As a "maker" of the statements, the court said, Li was bound to disclose all required information.

The court then found that the complaint sufficiently alleged that Li was aware of the related-party transactions but repeatedly failed to disclose them. For example, the complaint alleged that an audit manager warned Li about the transactions, but failed to take steps to ensure that they were properly disclosed. While Li argued that it was inappropriate for the plaintiffs to rely on the SEC's complaint to establish scienter, the court saw nothing improper in using that information as evidence to support private claims under the PSLRA.

Controlling persons. Finally, the plaintiff adequately pleaded that Li was a controlling person. Li not only signed misleading financial documents, she also oversaw Keyuan's financial reporting process. The court's finding that the complaint adequately alleged scienter also satisfied the culpability element of the controlling persons claim.

The case is No. 13 Civ. 6057.

Attorneys: Phillip C. Kim (The Rosen Law Firm PA) for Neil Vanleeuwen. Robert David Weber (DLA Piper US LLP) for Keyuan Petrochemicals, Inc.

Companies: Keyuan Petrochemicals, Inc.

MainStory: TopStory FraudManipulation NewYorkNews

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