U.S. Judge Allows Shareholder Suits Against China Accountants

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The fourth time was the charm for shareholders suing the auditors of Shenzhen-based China Expert Technology.

China Expert shareholders have been trying unsuccessfully to sue the company’s accounting firms for failing to detect an alleged $132 million fraud. U.S. District Judge Alvin Hellerstein in New York has previously dismissed the suit three times, saying the shareholders’ claims were inadequate.

But Hellerstein reversed course and on Tuesday said he would allow the lawsuit against China Expert’s outside auditors, PKF Hong Kong, PKF New York and BDO McCabe Lo Ltd, to proceed.

“Enough has been alleged to make out a plausible claim for relief,” Hellerstein declared in a handwritten order. He did not rule on the merits of the case, but instead simply allowed shareholders’ claims to proceed to the next phase.

A wave of accounting scandals has hit China-based companies listed on U.S. stock exchanges in the past two years, with allegations of fraud engulfing companies such as China MediaExpress Holdings Inc., RINO International and Orient Paper.

Investor lawsuits alleging securities fraud in U.S. courts have followed, and since the beginning of 2010, shareholder lawsuits against more than 30 China-based companies have been filed. These proposed class-actions are in the early procedural phases. The China Expert suit dates from 2007, and is at a slightly more advanced stage.

Hellerstein’s ruling allowing investors to pursue China Expert’s auditors is one of the first of its kind and signals a potentially lucrative channel for shareholders. The ruling was filed Tuesday.

Accounting firms are deep-pocketed targets that could pay large judgments or settlements. That is in contrast to the China-based companies themselves, which, given their shaky finances and structures, could provide more stumbling blocks for plaintiffs.

Many China-based companies have limited insurance coverage. Plaintiffs could also face difficulty in collecting judgments against entities which have most of their operations in China.

Shareholders’ claims against China Expert, for example, lie dormant. The company never responded to the investor group’s allegations in court and was found to be in default in 2008. The plaintiffs have not sought a monetary judgment against the company, preferring to pursue their case against the former auditors.

To prove that case, the class-action plaintiffs still face many hurdles, including showing that the auditors knew of the alleged fraud.

In court papers, the auditors said it was likely that the company “actively misled its auditors by concealing its alleged fraud.”

Thomas Manisero of law firm Wilson Elser Moskowitz Edelman & Dicker, who represents PKF New York, Michael Tu of Orrick, Herrington & Sutcliffe, who represents PKF Hong Kong, and James Farrell of law firm Latham & Watkins, which represents BDO McCabe, did not return calls or emails seeking comment.

The case is Carlos Munoz v. China Expert Technology et al, Southern District of New York, No. 07-10531.

(Reporting by Carlyn Kolker, editing by Matthew Lewis)