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From Securities Regulation Daily, December 5, 2017

Fraud complaint re: Alibaba’s failure to disclose meeting with Chinese regulators revived

By Amy Leisinger, J.D.

A Second Circuit panel has revived a fraud complaint against Chinese e-commerce giant Alibaba for its failure to disclose the existence of a meeting with Chinese regulators months before the company’s initial public offering in the United States. In a summary order, the panel stated that the complaint adequately alleged materiality by demonstrating a dramatic drop in stock price following disclosure of the meeting and scienter by detailing facts showing at least a reckless disregard of a duty to disclose (Christine Asia Co. Ltd. v. Ma, December 5, 2017, per curiam).

Chinese regulators and IPO. In July 2014, the Chinese State Administration for Industry and Commerce called a meeting with Alibaba to provide the company with administrative guidance (an informal regulatory tool designed to encourage self-regulation) regarding potential violations of Chinese law on Alibaba’s platforms. The SAIC’s administrative guidance to Alibaba consisted of a list of concerns it identified when it reviewed Alibaba’s operations, including the sale of counterfeit and prohibited items, consumer protection issues, and lax internal controls, and noted the possibility of large potential fines.

In conjunction with its September 2014 U.S. IPO, Alibaba filed a registration statement that disclosed the pitfalls confronting e-commerce, the Chinese regulatory environment, and the attendant risks to Alibaba’s business. The registration statement also included disclosures addressing the likelihood that China would continue to issue new laws and regulations that could adversely affect Alibaba. Alibaba did not disclose the meeting with the SAIC or the administrative guidance.

Failure to state a claim. The Southern District of New York court found that the fraud complaint filed by purchasers of Alibaba’s American Depository Shares failed to plead that the company or its executives made material omissions or misstatements or acted with scienter, noting that Alibaba’s registration statement was unusually comprehensive in disclosing that the U.S. had designated two of its marketplaces as "notorious markets" and that it had been the subject of regulatory inquiries. The court was not persuaded that Alibaba was required to disclose the existence of its meeting with SAIC, as the company received non-binding administrative guidance—in essence, "a reminder that the authorities in a country far different from ours were looking over its shoulder." The court concluded that there was no need or duty to disclose.

Materiality, scienter adequately alleged. The Second Circuit panel found that the complaint adequately alleged scienter in misstatements or omissions of material fact. The complaint asserts that the concealed information regarding the meeting was "highly material" to investors because, following the meeting, Alibaba knew that it would either have to give up an important source of its revenue or risk large fines, the panel noted. In addition, the panel stated, when the information was revealed after the IPO, Alibaba’s stock dropped 13 percent, further evidencing materiality. Alibaba and its executives had a duty to accurately disclose the seriousness of potential problems in order to make the company’s public disclosures not misleading, according to the panel.

The panel also found that the complaint adequately pleaded strong circumstantial evidence of scienter. Several high-level Alibaba officers and managers attended the secret meeting, and, given the potential impact of the SAIC’s threat of fines and the imminent IPO, it is "virtually inconceivable" that the rest of the individual defendants did not know, the panel stated. The failure to disclose the meeting concealed the truth about the potential threat, and this omission constitutes at least a reckless disregard of a duty to disclose, according to the panel.

As such, the panel vacated the judgment of the district court and remanded the case for further proceedings.

The case is No. 16-2519-cv.

Attorneys: Robert K. Kry (Molo Lamken LLP) for Christine Asia Co Ltd. James G. Kreissman (Simpson Thacher & Bartlett LLP) for Jack Yun Ma.

Companies: Christine Asia Co Ltd.

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