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From Securities Regulation Daily, July 8, 2013

Plaintiffs were subject to unique defenses, so class certification was denied

By Rodney F. Tonkovic, J.D.

A motion to certify a class in a securities fraud action against an automotive parts manufacturer was denied. The district court concluded that the unique defenses to which the named plaintiffs were subject defeated the adequacy, typicality, and predominance requirements of Rule 23. The court found further that there was insufficient proof that the securities at issue traded in an efficient market (George v. China Automotive Systems, Inc., July 3, 2013, Forrest, K.).

Shareholders alleged that China Automotive Systems, Inc., which was headquartered in China and entered the U.S. market through a reverse merger, made false and misleading statements in its SEC filings regarding the accounting for certain convertible notes. The complaint alleged that China Automotive classified the notes as equity, despite a change in accounting rules requiring that they be classified as liabilities, resulting in a significant misstatement of earnings during 2009 and most of 2010. When the misclassification was revealed, a significant drop in stock price followed, and the net income for the relevant period was later restated.

Rule 23(a) factors. The numerosity and commonality requirements of Rule 23(a) were uncontested on this motion. The defendants argued that the named plaintiffs could not meet the rule’s typicality and adequacy requirements because their claims were subject to unique defenses.

The corrective disclosure revealing the alleged fraud occurred in March 2011. According to the court, each of the three lead plaintiffs made multiple purchases of China Automotive securities following that disclosure. The three named plaintiffs also engaged in significant “in-and-out” trading activity during the class period. Here, the court noted the existence of Second-Circuit precedent holding that post-disclosure purchases and “in-an-out” trading could defeat typicality and adequacy.

In this case, the court concluded that the plaintiffs were subject to unique defenses. The plaintiffs made post-disclosure purchases and engaged in “in-and-out” trading. Either of these facts would require the plaintiffs to expend considerable time and resources addressing their trading patterns and investment decisions, a “situation the case law does not condone,” the court stated. The court accordingly found that class certification must be denied on these bases.

Predominance. The court then concluded that the plaintiffs failed to meet the predominance requirement of Rule 23(b). According to the court, the plaintiffs were unable to establish that China Automotive’s securities traded on an efficient market. The plaintiffs were thus unable to rely on the fraud-on-the-market presumption of reliance, and reliance would need to be proven on an individualized basis. Class certification was accordingly also denied on this basis.

The court explained that the plaintiff’s expert’s analysis of the issue of market efficiency was flawed. According to the court, none of the expert’s five analyses demonstrated an efficient market by a preponderance of the evidence, and all suffered from significant methodological flaws. In fact, the court observed, the expert’s results were more supportive of a finding of market inefficiency.

The case is 11 Civ. 7533 (KBF).

Attorneys: Jeremy Alan Lieberman (Pomerantz Haudek Block Grossman & Gross LLP) and Peretz Bronstein (Bronstein, Gewirtz & Grossman) for Nancy George, Robert George and Randall Whitman. John Erik Schreiber (Winston & Strawn LLP) for China Automotive Systems, Inc., Hanlin Chen and Qizhou Wu. Lee Gordon Dunst (Gibson, Dunn & Crutcher, L.L.P.) for Schwartz Levitsky Feldman LLP.

Companies: China Automotive Systems, Inc.; Schwartz Levitsky Feldman LLP

MainStory: TopStory FraudManipulation NewYorkNews

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