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Alibaba Securities Class Action Revived On Appeal

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  • Posted on: Jan 17 2018

Last month, the Second Circuit reinstated a securities class action against Alibaba Group Holding Ltd. (“Alibaba” or the “Company”) and four of its senior executives for making materially false and misleading statements and omissions in connection with the Company’s September 2014 initial public offering (“IPO”). In June 2016, Chief Judge Colleen McMahon of the U.S. District Court for the Southern District of New York dismissed the complaint because the plaintiffs failed to state a claim for which relief could be granted under the Securities Exchange Act of 1934 (the “Exchange Act”) (Here.). In a summary order issued on December 5, 2017, the Second Circuit vacated the judgment and remanded the case for further proceedings (here), concluding, among other things, that Judge McMahon misapplied Rule 12(b)(6) in dismissing the plaintiffs’ claims.

The Plaintiffs alleged that the Chinese e-commerce giant and several of its officers and directors knowingly or recklessly concealed that the Company was the subject of an “administrative proceeding” by a Chinese regulatory agency. According to the plaintiffs, the State Administration for Industry and Commerce (“SAIC”) warned the Company that it lacked appropriate internal controls, was operating in contravention of Chinese laws and regulations, and could be subject to substantial financial fines. The plaintiffs maintained that the defendants’ failure to disclose the pendency of the “administrative proceeding” rendered the Company’s registration statement, filed in connection with the IPO, materially false and misleading, despite its cautionary disclosures.

According to the complaint, Chinese regulators summoned Alibaba executives to a secret meeting two months before the IPO in which they threatened to levy daily fines if the Company continued to host a marketplace for third parties to sell counterfeit goods. This information was not revealed until four months after the IPO, when the SAIC published on its website a white paper about the “guidance” it had provided to Alibaba.  Within two days of the publication of this information, the price of Alibaba’s stock dropped 13 percent, wiping out $33 billion in market capitalization. Notably, the white paper was later withdrawn.

The plaintiffs alleged that the facts underlying the white paper were material to investors and that they should have been disclosed in Alibaba’s registration statement. The district court disagreed:

Then there is the problem of the White Paper itself. Considering that the White Paper was posted on the SAIC’s website only briefly before being quickly withdrawn, Plaintiffs reliance on its contents is tenuous at best. Plaintiffs argue that the quick withdrawal of the White Paper suggests Alibaba’s sway over Chinese regulators; it also supports the equally, if not more, compelling inference that the posting was unauthorized and, hence, not to be trusted. That competing inference is lent further credence by the fact that the SAIC never subsequently initiated any formal enforcement action against Alibaba, and that the SEC, which investigated Alibaba’s compliance with US securities laws after the White Paper’s posting, never moved forward with a formal investigation or leveled any charges.

Further, a principal basis alleged in the Consolidated Complaint for giving credit to the White Paper was that Alibaba “confirmed the authenticity of the White Paper and the harsh position taken by the SAIC.” In fact, that allegation is contradicted by the document to which the Consolidated Complaint refers — the press release issued by Alibaba immediately after the White Paper was posted. In that press release, the only thing Alibaba confirmed was the date of the Meeting. It not only denied the rest, but it announced that it had filed a complaint with the SAIC protesting the posting of the White Paper.

But even assuming the White Paper were to be believed, nothing in it suggest that the July 16 Meeting constituted some sort of formal enforcement proceeding. It says that the meeting met SAIC’s “pre-set goal[s]” by making Alibaba “clearly aware of e-commerce regulatory agencies’ severe concern and censure as to the long existing misconduct on the platforms in [sic] Alibaba family,” cautioning it against self-congratulation, and prompting it “to pay great attention to the severity of the problems and to promptly take measures to redress the problem.” Making Alibaba aware of concerns and prompting it to pay attention to problems it had plainly disclosed is not tantamount to the institution of a formal regulatory proceeding.

Citation omitted.

The Second Circuit found that revelation of the information likely would have had a negative effect on Alibaba’s IPO. The Court criticized the district court for improperly discrediting “significant allegations” upon which the plaintiffs’ claims relied, such as the facts underlying the white paper. For example, the Court noted that the district court gave too much weight to Alibaba’s contention that the white paper was “unauthorized” and untrustworthy because the SAIC quickly withdrew the paper. Under Rule 12(b)(6), said the Court, the district court should have credited the plaintiffs’ “proffered reasonable inference that the withdrawal resulted from Alibaba’s influence over Chinese regulators.”

Thus, “[a]ccepting Plaintiffs’ allegations as true,” the Court concluded that Alibaba “had a duty to disclose these facts, in a manner that accurately conveyed the seriousness of the problems Alibaba faced, so as not to render Defendants public disclosures ‘inaccurate, incomplete, or misleading.’”

The Second Circuit also concluded that the plaintiffs alleged “strong circumstantial evidence” of scienter – that is, Alibaba acted with the requisite state of mind in withholding information about its secret meeting with the SAIC. The Court reasoned: “Considering the high-level nature of the meeting, the seniority of the attendees, its conduct in secret, and the huge potential impact of the SAIC’s threat made at the meeting on Alibaba and its imminent IPO, it is virtually inconceivable that this threat was not communicated to the senior level of Alibaba’s management, i.e. the individual Defendants.” Consequently, “Defendants’ subsequent failure to disclose the meeting concealed the true facts about the threat to the company that had been communicated by the” Chinese government, thus “powerfully support[ing] a strong inference that the Defendants acted with scienter.”

The Court also found that the plaintiffs adequately alleged corporate scienter against Alibaba because they adequately alleged scienter against the individual defendants.

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