January 14, 2013

BNA Securities Regulation & Law Report
Yin Wilczek
Reproduced with permission from Securities Regulation & Law Report, 45 SRLR 83 (Jan. 14, 2013). Copyright 2013 by The Bureau of National Affairs, Inc. (800-372-1033) <http://www.bna.com>

The Securities and Exchange Commission has run into more procedural problems in its enforcement activities against China-based defendants, telling the U.S. District Court for the Southern District of New York Jan. 8 that it has yet to serve a complaint on two individuals charged with alleged wrongdoing at Puda Coal Inc. (PUDA) (SEC v. Zhao , S.D.N.Y., No. 12 Civ. 1316 (KBF), 1/8/13).

The SEC in February 2012 filed a lawsuit against Puda's chairman, Ming Zhao, and former chief executive officer, Liping Zhu, alleging that they engaged in a corporate theft scheme that erased hundreds of millions of dollars in shareholder value and left the issuer an empty shell (35 SLD, 2/23/12). Both defendants reside in the People's Republic of China.

The SEC, in a Dec. 19 letter to the court that was filed in the docket Jan. 8, said its complaint and summonses have yet to be served on the defendants by Chinese authorities.

Hague Convention

The SEC said that pursuant to Hague Convention procedures, it sent translated versions of its complaint and summonses in April 2012 to the Chinese Ministry of Justice. According to the latest report from the ministry, the documents must now be served by the local Chinese court upon the defendants in accordance with Chinese law, the SEC said.

“Given that the Ministry of Justice is now responding to [the SEC Office of International Affairs'] requests for information, we believe it is appropriate to give the Hague process a bit more time,” the SEC said. “Nonetheless, we do not believe that the Hague process should be relied upon indefinitely.”

Should Chinese authorities not effect service by April 13--one year after they received the documents from the SEC--“the Commission plans to file an ex parte motion to serve defendants by alternative means pursuant to Rule 4(f)(3) of the Federal Rules of Civil Procedure,” the commission said.

Rule 4(f)(3) allows a summons to be served upon foreign defendants “by other means not prohibited by international agreement, as the court orders.”

Procedural Problems

The SEC has encountered significant roadblocks in its enforcement crackdown against errant PRC-based companies listed on U.S. exchanges, including the inability to access audit work papers and other documents located in that country. The agency currently is litigating the access issue in legal and administrative actions against major China-based auditors.

The SEC's court action against Deloitte's Shanghai affiliate also revolves around the question of whether court documents were properly served on the defendant.

Meanwhile, attorneys told BNA that litigation involving China-based issuers presents many complexities, not only for the SEC but also for private plaintiffs.

Like the SEC, private litigants face special challenges in financial fraud cases in which the China-based issuer's independent auditor is either a defendant or an important fact witness, said Daniel Sommers, a Washington-based partner at Cohen Milstein Sellers & Toll PLLC. Private plaintiffs too are finding it impossible in many cases to obtain the audit work papers of these China-based auditing firms, he said.

In addition, plaintiff investors seeking to exercise 1933 Securities Act and 1934 Securities Exchange Act remedies “must deal with significant challenges in securing service of process, obtaining both informal and formal discovery, and ultimately in enforcing U.S. court judgments in China,” Sommers said. “I expect that all of these issues will continue to be front burner topics not only in legal and regulatory forums, but also as a part of our nation's overall foreign policy and diplomatic relationship with China.”