United States District Court, D. Nevada
IN RE: SHENGDATECH, INC., Debtor.
HANSEN, BARNETT & MAXWELL, P.C., et al., Defendants. SHENGDATECH LIQUIDATING TRUST, Plaintiff, Adv. No. 13-ap-05046-BTB Bankr. No. 11-bk-52469-BTB
ROBERT C. JONES, District Judge.
This withdrawn adversary proceeding arises out of the alleged professional negligence, breach of contract, and fraudulent conveyance by an auditor for failing to detect the diversion of a corporation's assets and manipulation of its books by its highest officer. Pending before the Court is a Motion to Dismiss (ECF No. 41). For the reasons given herein, the Court grants the motion.
I. FACTS AND PROCEDURAL HISTORY
Plaintiff, Shengdatech Liquidating Trust ("the Trust"), is the successor-in-interest to Shengdatech, Inc.'s claims and causes of action following a Plan of Reorganization approved by the United States Bankruptcy Court for the District of Nevada and a Liquidating Trust Agreement. ( See Am. Compl. ¶¶ 4, 17, May 28, 2014, ECF No. 29). The Trust seeks to recover from an outside auditor, Hansen, Barnett & Maxwell, P.C. ("Hansen"), for failing to detect and report Shengdatech's senior management's "looting" of corporate funds in 2007 and 2008. ( See id. ¶¶ 4, 15, 16).
Shengdatech, now defunct, was a Nevada corporation operating in the People's Republic of China. ( Id. ¶ 4). Shengdatech manufactured a specialty additive "widely applied in the paint, paper, plastic, and rubber industries" and used in materials such as PVC. ( Id. ¶ 23). The company traded on the NASDAQ beginning in 2007. ( Id. ¶ 25).
Shengdatech's Board of Directors was controlled by a majority of non-management directors. ( Id. ¶ 5). Xiangzhi Chen ("Chen") was Shengdatech's Chairman of the Board of Directors, Chief Executive Officer, and its largest shareholder, owning about 42 percent of the company's outstanding shares. ( Id. ¶¶ 11, 24).
B. Hansen's Auditing Work
Hansen, a Utah accounting firm, was Shengdatech's outside auditor from December 2006 to November 2008. ( Id. ¶ 26). Shengdatech's Board of Directors retained Hansen to perform audits of Shengdatech's internal financial reporting controls for the 2007 fiscal year, its 2007 Financial Statements, and its 2008 Quarterly Financial Statements. ( Id. ¶ 62). The engagement letter for Hansen's services required Hansen to comply with the standards of the Public Company Accounting Oversight Board ("PCAOB"). ( Id. ¶¶ 61-62).
In connection with its audit of Shengdatech's internal financial reporting controls for 2007, Hansen issued an unqualified opinion "that [Shengdatech] maintained effective internal controls over financial reporting." ( Id. ¶ 30). In its audit of the 2007 Financial Statements, "Hansen issued an unqualified audit opinion... stating that [the statements] fairly presented [Shengdatech's] financial condition and the results of its operations in accordance with [accounting principles generally accepted in the United States, ] U.S. GAAP." ( Id. ). Hansen's review of the 2008 Quarterly Financial Statements also did not reveal any concerns. ( Id. ¶ 32).
Shengdatech paid Hansen $295, 375 for its audit of the 2007 Financial Statements and $45, 000 for reviewing the 2008 Quarterly Financial Statements. ( Id. ¶ 91). In November 2008, Shengdatech fired Hansen and hired KPMG Hong Kong ("KPMG HK") as its outside auditor. ( Id. ¶ 77).
C. KPMG HK's Auditing Work
KPMG HK similarly issued unqualified opinions on Shengdatech's 2008 and 2009 Financial Statements. ( Id. ¶ 33). Like those of Hansen, these opinions stated that the financial statements "fairly presented [Shengdatech's] financial condition and the results of its operations in accordance with U.S. GAAP." ( Id. ). Despite identifying a "material weakness" in Shengdatech's internal control over financial reporting for 2008, KPMG HK found Shengdatech's internal financial controls in 2009 to be sufficient. ( Id. ¶¶ 33, 77). KPMG HK's review of the 2009 and 2010 Quarterly Financial Statements raised no additional concerns. ( Id. ¶ 35).
D. Events Precipitating Shengdatech's Filing for Bankruptcy
In March 2011, however, KPMG HK notified Shengdatech's Audit Committee of "potentially serious discrepancies and unexplained issues" in its audit of the company's 2010 Financial Statements. ( Id. ¶¶ 37-38). Many of the problems initially discovered stemmed from KPMG HK's inability to confirm Shengdatech's recorded sales. ( Id. ¶ 38). These problems led the Audit Committee to form a Special Committee to conduct an internal investigation. ( Id. ¶ 39).
In the coming weeks, KPMG HK discovered and reported to the Special Committee more discrepancies in the financial statements, including irregularities in customer and bank confirmations. ( Id. ¶¶ 41, 43). For example, one communication from a customer confirmed that the customer had not purchased anything from Shengdatech in 2010 while Shengdatech's records indicated the customer had purchased the equivalent of over $1.2 million in goods in 2010. ( Id. ¶ 41). In another example, Shengdatech's account balance at the Bank of China Tai'an Branch was $67.61 while Shengdatech's records indicated the balance was $50, 054.18. ( Id. ).
Other irregularities included the fact that two of Shengdatech's top recorded suppliers in 2010 refused to allow KPMG HK to perform site visits, and one of the suppliers informed KPMG HK that it had not conducted business with Shengdatech in quite some time. ( Id. ¶ 43). More discrepancies appeared in certain bank transactions in 2008 and 2009 in which Chen was involved. ( Id. ¶ 43, n.2).
As a response to the alarming irregularities in Shengdatech's financial statements, the Special Committee implemented a Cash Control Plan which required Shengdatech's management, specifically Chen, to transfer all of its cash assets into accounts over which the Audit Committee would have sole control. ( Id. ¶ 44). After initially refusing to cooperate, Chen eventually transferred $14 million of cash assets into the accounts, at least $95 million shy of the amounts Shengdatech reported having in the years 2008, 2009, and 2010. ( Id. ). Upon request by the Special Committee, Chen was unable to verify the location of the remaining funds. ( Id. ¶ 45).
The discovery of the serious discrepancies in Shengdatech's financial statements caused Shengdatech to unravel in 2011: on May 5, Shengdatech filed a Form 8-K with the Securities and Exchange Commission ("SEC") and "issued a press release disclosing KPMG HK's resignation and warning investors against continued reliance upon KPMG HK's audit reports on the 2008 and 2009 Financial Statements, " ( id. ¶ 49); in June, Shengdatech defaulted on notes issued pursuant to various Offering Memoranda, ( id. ¶ 51); on August 11, the SEC initiated a regulatory proceeding against Shengdatech involving possible violations of federal securities laws, ( id. ¶ 52); on August 19, the Special Committee fired the management team for Shengdatech, including Chen, ( id. ¶ 53); also on August 19, Shengdatech filed for bankruptcy in the United States Bankruptcy Court for the District of Nevada, ( id. ); and on December 15, NASDAQ delisted Shengdatech, ( id. ¶ 55).
The Trust succeeded to all of Shengdatech's claims and causes of action pursuant to the Plan of Reorganization approved by the United States Bankruptcy Court on October 2, 2012 and a Liquidating Trust Agreement executed on October 17, 2012. ( Id. ¶¶ 17-18).
E. The Present Case
On August 15, 2013, the Trust brought an adversary proceeding in the Bankruptcy Court naming three defendants: Hansen, KPMG International Cooperative ("KPMG International"), and KPMG LLP ("KPMG USA"). The Court granted KPMG International and KPMG USA's motion to withdraw the reference in ...