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From Securities Regulation Daily, March 9, 2016

No shenanigans at games firm

By Rodney F. Tonkovic, J.D.

A fraud action brought against China’s biggest mobile games developer has been dismissed. The complaint alleged that the company made false statements about alleged bribery and related-party transactions that artificially increased the price of its securities. The court granted the developer's motion to dismiss, with leave to replead, after finding that the complaint failed to plead actionable misstatements, omissions, or scienter (In re China Mobile Games & Entertainment Group, Ltd Securities Litigation, March 7, 2016, Wood, K.).

The complaint alleged that China Mobile Games & Entertainment Group, Ltd. botched its public disclosures or made false or misleading statements about bribes, related-party transactions, and lax internal controls. According to the complaint, CMGE engaged in bribery in order to maintain good relations with its distributors. In its SEC filings, the company's president and CEO failed to disclose the bribery, instead assuring investors that all weaknesses were disclosed and that CMGE's disclosure controls and procedures were effective.

Next, before becoming CMGE's president, Shuling Ying, founded Zhongzheng, a company that later entered into an agreement to promote and advertise CMGE's games. The complaint alleged further that CMGE failed to disclose related-party transactions with Zhongzheng. According to the investors, after becoming president of CMGE in late 2013, Ying secretly continued to control Zhongzheng. CMGE, however, failed to disclose any related-party transactions in violation of SEC regulations and GAAP.

No misrepresentations. The court first found that the complaint failed to plead any actionable misstatements or omissions. According to the court, the allegations concerning bribery failed because there were no allegations of contemporaneous falsity. An analyst report and news articles upon which the investors based their allegations were released more than three months after CMGE made the latest SEC filings at issue. The complaint's inability to allege that any bribery occurred during the class period was fatal.

The court then concluded that the complaint failed to plead sufficient facts showing that Ying secretly retained control of Zhongzheng. The investors, the court said, failed to show that there were any related party-transactions to disclose, offering no support for the proposition that Ying continued to control Zhongzheng. The court observed that the public documents in this case showed instead that Ying divested any ownership interest he had in Zhongzheng when he joined CMGE.

No scienter. Finally, the court found that the complaint failed to adequately plead that any of the defendants acted with the requisite scienter. First, the complaint did not describe how the company benefitted in some concrete way from the alleged related-party transactions or bribery. The complaint's conclusory allegations were insufficient to create a strong inference of scienter, the court said.

The complaint also failed to plead circumstantial evidence of conscious misbehavior or recklessness. Here, the investors failed to show that CMGE executives had access to information showing that Ying retained control over Zhongzheng. Finally, the allegations that the related-party transactions and bribery were actively concealed failed because they were too speculative.

The case is No. 14-CV-4471.

Attorneys: Kevin Koon-Pon Chan (The Rosen Law Firm, P.A.) for Darryl Reitan. Andrew Brian Clubok (Kirkland & Ellis LLP) for China Mobile Games & Entertainment Group, Ltd.

Companies: China Mobile Games & Entertainment Group, Ltd.

MainStory: TopStory AccountingAuditing CorporateGovernance DirectorsOfficers FraudManipulation NewYorkNews

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