Company Seeks Dismissal of Complaint Alleging Tax Misstatements

PEIFA XU, Individually and On Behalf of All Others Similarly Situated,
Plaintiff,
v.
GRIDSUM HOLDING INC., GUOSHENG QI, MICHAEL PENG ZHANG, RAVI SARATHY, GUOFA YU, PERRY LIN CHUI, XIANG FAN, YANCHUN BAI, XUDONG GAO, THOMAS ADAM MELCHER, PETER ANDREW SCHLOSS, PRICE WATERHOUSECOOPERS ZHONG TIAN LLP, GOLDMAN SACHS (ASIA) L.L.C., CITIGROUP GLOBAL MARKETS INC., and STIFEL, NICOLAUS & COMPANY INCORPORATED,
Defendants.

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

Oral Argument Requested

MEMORANDUM OF LAW IN SUPPORT OF DEFENDANT GRIDSUM HOLDING INC. AND THOMAS MELCHER'S MOTION TO DISMISS THE THIRD AMENDED CLASS ACTION COMPLAINT

Dated: June 8, 2020

Michael C. Tu (admitted pro hac vice)
mtu@orrick.com
ORRICK, HERRINGTON & SUTCLIFFE LLP
777 South Figueroa Street, Suite 3200
Los Angeles, California 90017
Telephone: (213) 612-2433

William J. Foley
wfoley@orrick.com
ORRICK, HERRINGTON & SUTCLIFFE LLP
51 West 52nd Street
New York, New York 10019
Telephone: (212) 506-5124

Attorneys for Defendants
Gridsum Holding Inc. and Thomas Melcher

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TABLE OF CONTENTS

Clause

I. INTRODUCTION

II. FACTUAL BACKGROUND

III. PROCEDURAL BACKGROUND

IV. LEGAL STANDARD

V. DISCUSSION

VI. CONCLUSION

TABLE OF AUTHORITIES

Cases

In re Allbrand Appliance & Television Co., 875 F.2d 1021 (2d Cir. 1989)

In re Am. Bank Note Holographics, Inc. Sec. Litig., 93 F. Supp. 2d 424 (S.D.N.Y. 2000)

In re AmTrust Fin. Servs. Sec. Litig., 2019 WL 4257110 (S.D.N.Y. Sept. 9, 2019)

Ashcroft v. Iqbal, 556 U.S. 662 (2009)

Aslanidis v. U.S. Lines, Inc., 7 F.3d 1067 (2d Cir. 1993)

ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007)

Barilli v. Sky Solar Holdings, Ltd., 2019 WL 2250445 (S.D.N.Y. May 23, 2019)

Bensinger v. Denbury Res. Inc., 31 F. Supp. 3d 503 (E.D.N.Y. 2014)

Caldwell v. Berlind, 543 F. App'x 37 (2d Cir. 2013)

California Pub. Emps.' Ret. Sys. v. ANZ Sec., Inc., 137 S. Ct. 2042 (2017)

Coronna v. Cty. of Suffolk, 2008 WL 2371421 (E.D.N.Y. June 9, 2008)

CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014)

Dodds v. Cigna Sec., Inc., 12 F.3d 346 (2d Cir. 1993)

Doe v. Solera Capital LLC, 2019 WL 1437520 (S.D.N.Y. Mar. 31, 2019)

Drexel Burnham Lambert Grp., Inc. v. Microgenesys, Inc., 775 F. Supp. 660 (S.D.N.Y. 1991)

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)

Fed. Deposit Ins. Corp. for Colonial Bank v. First Horizon Asset Sec. Inc., 291 F. Supp. 3d 364 (S.D.N.Y. 2018)

Friedman v. Endo Int'l PLC, 2018 WL 446189 (S.D.N.Y. Jan. 16, 2018)

Fries v. N. Oil & Gas, Inc., 354 F. Supp. 3d 384 (S.D.N.Y. 2018)

Hirsch v. Arthur Andersen & Co., 72 F.3d 1085 (2d Cir. 1995)

Hutchison v. Deutsche Bank Secs. Inc., 647 F.3d 479 (2d Cir. 2011)

IndyMac Mortg.-Backed Sec. Litig., 793 F. Supp. 2d 637 (S.D.N.Y. 2011), aff'd in part sub nom. Police & Fire

Ret. Sys. of City of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013)

In re Integrated Res. Real Estate Ltd. P'ships Sec. Litig., 815 F. Supp. 620 (S.D.N.Y. 1993)

Int'l Audiotext Network, Inc. v. Am. Tel. & Tel. Co., 62 F.3d 69 (2d Cir. 1995)

Ironworkers Local 580 — Joint Funds v. Linn Energy, LLC, 29 F. Supp. 3d 400 (S.D.N.Y. 2014)

Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135 (2011)

In re Lehman Bros. Sec. & Erisa Litig., 800 F. Supp. 2d 477 (S.D.N.Y. 2011)

In re Lehman Bros. Sec. & ERISA Litig., 903 F. Supp. 2d 152 (S.D.N.Y. 2012)

Mackensworth v. S.S. Am. Merch., 28 F.3d 246 (2d Cir. 1994)

Manela v. Gottlieb, 784 F. Supp. 84 (S.D.N.Y. 1992)

In re Morgan Stanley Tech. Fund Sec. Litig., 643 F. Supp. 2d 366 (S.D.N.Y. 2009)

Olsen v. Steris Corp., 2018 WL 10676902 (E.D.N.Y. June 18, 2018)

In re Optionable Sec. Litig., 577 F. Supp. 2d 681 (S.D.N.Y. 2008)

P. Stolz Family P'ship L.P. v. Daum, 355 F.3d 92 (2d Cir. 2004)

Panther Partners, Inc. v. Ikanos Commc'ns, Inc., 538 F. Supp. 2d 662 (S.D.N.Y. 2008), aff'd, 347 Fed. App'x 617 (2d Cir. 2009)

Pehlivanian v. China Gerui Advanced Materials Grp., Ltd., 153 F. Supp. 3d 628 (S.D.N.Y. 2015)

Peifa Xu v. Gridsum Holding Inc., 2018 WL 4462363 (S.D.N.Y. Sept. 17, 2018)

Police & Fire Ret. Sys. of City of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013)

Resnik v. Swartz, 303 F.3d 147 (2d Cir. 2002)

Rombach v. Chang, 355 F.3d 164 (2d Cir. 2004)

Rosen ex rel. Egghead.Com, Inc. v. Brookhaven Capital Mgmt., Co., 179 F. Supp. 2d 330 (S.D.N.Y. 2002)

San Leandro Emergency Med. Grp. Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801 (2d Cir. 1996)

Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., 33 F. Supp. 2d 401 (S.D.N.Y. 2014)

Tabak v. Canadian Solar Inc., 549 Fed. App'x 24 (2d Cir. 2013)

In re Travelzoo Inc. Sec. Litig., 2013 WL 1287342 (S.D.N.Y. Mar. 29, 2013)

Statutes and Rules

Federal Rule of Civil Procedure 9(b)

Federal Rule of Civil Procedure 15(c)

Federal Rule of Evidence 2011

Securities Act of 1933, 15 U.S.C. § 77a et seq.

Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq.

Other Authorities

Gary A. Porter & Curtis L. Norton, Using Financial Accounting Information: The Alternative to Debits and Credits (5th ed. 2008)

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I. INTRODUCTION

On March 30, 2020, the Court dismissed plaintiffs' claims under the Securities Act of 1933 (“Securities Act”) against Gridsum Holding Inc. (“Gridsum” or the “Company”) and Thomas Melcher, and provided a detailed analysis concerning why the claims were insufficient as a matter of law. Dkt. No. 201 (the “Dismissal Order”). Plaintiffs responded with a Third Amended Complaint (“TAC”) that ignores the deficiencies described in the Dismissal Order, re-alleges word-for-word the same allegations as before, and adds two new claims that are considerably weaker than the ones that were dismissed. Having previously pursued Securities Act claims premised solely on Gridsum's revision of certain 2015 financial information, plaintiffs now hang their hat on the purported claims that (i) an unaudited pro forma six-month financial statement included with the Registration Statement was false or misleading because it “materially understated” the Company's 2016 half-year income tax expense and omitted the basis for that expense, and (ii) that the Registration Statement failed to disclose certain aspects of some prospective business plans related to a new product offering. Dkt. No. 209, ¶¶ 7-9. These new claims — which were not pled in any of the three prior complaints in this lawsuit even though the underlying facts have long been publicly disclosed — are “too little, too late” and should be dismissed for the following reasons.

First, these new claims are plainly time-barred by both the Securities Act's statute of repose and statute of limitations. The new claims are not premised on Gridsum's 2019 revision of certain prior financial statements, as the plaintiffs' previously dismissed allegations were. Under the Securities Act's absolute statute of repose, any claims or alleged misrepresentations must be asserted within “three years after the security was bona fide offered to the public.” 15 U.S.C. §77m. The Registration Statement was filed on September 22, 2016, more than three years and seven months before the filing of the TAC. These new alleged misrepresentations regarding the Company's income tax expense and capital restructuring plans are also barred by the Securities Act's statute of limitations, which requires that all claims must be asserted within one year of when a plaintiff discovers an alleged misstatement or should have discovered it through the exercise of reasonable diligence. Here, that date is determinable as a matter of law because the TAC alleges that Gridsum's disclosure of its post-IPO 2016 full-year tax liabilities on March 15, 2017 is supposedly what renders false Gridsum's earlier statements about its pre-IPO first-half of 2016 tax liabilities.¹ Thus, the limitations period for these new claims ran on March 15, 2018 — before the initial complaint was filed in this action.

Second, even if these new claims were timely, they should be dismissed because they do not allege anything that is actionably false or misleading. With respect to the supposed “material understatement,” the TAC concedes there was no misstatement at all because the difference between the pre-IPO half-year numbers reported in the Registration Statement and the later full-year numbers was caused by a one-time capital restructuring expense that occurred after the IPO and Registration Statement. TAC ¶ 93. Neither the accounting rules nor common sense support the strained allegation that the tax liability reported in Gridsum's unaudited pro forma statement for the first six months of 2016 could be false or misleading because it does not include a tax expense that has not yet occurred and is not part of the period covered by that statement. Yet that is the basis for this allegation. With respect to the purported failure to disclose future plans for the capital structuring that would result in the expense and a new product launch, it is well established that Gridsum had no “duty to disclose” its prospective business plans, even if they were known to defendants at the time of the IPO. See Friedman v. Endo Int'l PLC, 2018 WL 446189, at *6 (S.D.N.Y. Jan. 16, 2018) (“[A] company has no . . . duty to disclose changes to its business plans — unless the company 'had “hyped” a specific plan, thereby inducing investors to believe that alternative[ ] [plans] were excluded.'”) (citation omitted).

Third, even if plaintiffs' new claim regarding the expense timely and adequately alleged an actionable misstatement, it is objectively immaterial when evaluated under this Court's own analysis, which held that materiality is to be determined “in the context of the company's 'total operations.'” Dismissal Order at 16. The alleged understatement of the 2016 tax expense would amount to only 2.03% of Gridsum's 2016 net revenues, well below the 4.5% net revenue amount that the Court has already concluded to be immaterial. Dismissal Order at 15.²

Finally, the TAC makes no attempt whatsoever to amend the previously dismissed claim under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) against Mr. Melcher, simply restating the same allegations as if the Dismissal Order never happened.

The TAC is the fourth attempt by plaintiffs to comb through the Registration Statement and Prospectus in search of a Securities Act claim that is not there. There are similarly no new allegations regarding the previously dismissed Section 10 claim against Mr. Melcher. Any further amendment would be futile. The Securities Act claims against the moving defendants, and the Section 10 claim against Mr. Melcher, should be dismissed with prejudice.

II. FACTUAL BACKGROUND

Gridsum and Mr. Melcher incorporate the “Background” section from their memorandum in support of their motion to dismiss the Second Amended Complaint (the “SAC”), Dkt. No. 145 at 4-7, and include below additional background relevant to the TAC's new allegations.

A. Gridsum's IPO And Offering Materials

Gridsum's IPO Registration Statement was declared effective on September 22, 2016, and the Prospectus (together with the Registration Statement, the “Offering Materials”) was filed on September 23, 2016. TAC ¶¶ 71-73. The filing commenced Gridsum's offering of 6.7 million American Depositary Receipts at a price of $13.00 per share. Id., ¶ 73.

The Offering Materials contained Gridsum's Consolidated Statements of Operations for 2013, 2014, and 2015. See Declaration of William J. Foley (“Foley Decl.”), Ex. A at 9. Because the IPO occurred in September 2016, it was not possible to include full-year audited financials for 2016, and instead the Offering Materials contained unaudited pro forma financial statements for “the six months ended June 30, 2016.” See id. According to these pro forma statements, Gridsum recorded net losses in 2013, 2014, 2015. As a result of these net losses, the Company has no income tax expenses for each of these periods, including the first half of 2016. Id.

B. Gridsum's Subsequent Financial and Operational Disclosures

On March 15, 2017, Gridsum issued a press release containing the unaudited full-year 2016 financial results. TAC ¶ 92. The release reported that the income tax expense for the year ended December 31, 2016 was RMB 28,387,000 (¶ 86); however, that figure was subsequently revised down to RMB 14,801,000 in January 2019, when Gridsum published revisions to its previously issued financial statements for the years ended December 31, 2015, and 2016 (¶ 87) (a downward revision of tax liability from approximately $4 million to $2 million).

During a March 15, 2017 earnings conference call, Gridsum's then-CFO Michael Peng Zhang explained the basis for the one time post-IPO income tax expense: “the tax comes from a sub-optimal structure we had in place to move the offshore capital to on shore entities post-IPO,” i.e., post-September 23, 2016. TAC ¶ 92. Mr. Zhang also indicated that Gridsum had “since put in place a more efficient structure” and did “not see this tax liability as a recurring dynamic.” Id. In its 2017 Annual Report, Gridsum reminded investors that “[i]n October 2016, we officially launched our social listening solution,” which “is a cloud-based service that enables an enterprise customer to monitor and analyze web and social media posts regarding the brand, products, customer service of the customer and its competitors. It also provides sentiment analysis and generates alerts from those posts.” Foley Decl., Ex. B at 53.

III. PROCEDURAL BACKGROUND

A. The Second Amended Complaint

The first complaint in this action was filed on April 25, 2018, but it alleged only claims

under the Exchange Act and did not assert Securities Act claims. Dkt. No. 1. The first complaint alleging Securities Act claims was filed on June 25, 2018. See related case Peifa Xu v. Gridsum Holding Inc., 2018 WL 4462363 (S.D.N.Y. Sept. 17, 2018). Following the Court's appointment of Lead Plaintiffs, a First Amended Complaint was filed in this consolidated action on November 30, 2018, and the SAC was filed on March 1, 2019, alleging claims under Sections 11 and 15 of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act against Gridsum, Mr. Melcher, and numerous other defendants. Dkt. No. 104. The SAC alleged violations of the federal securities laws in connection with alleged misstatements in the Company's Offering Materials and subsequent financial disclosures, arguing that Gridsum's January 2019 revision of previously published financial data rendered its prior statements materially misleading. Id.

B. The Dismissal Order

The Court issued the Dismissal Order on March 30, 2020, dismissing the Securities Act claims against each of the moving defendants. Dkt. No. 201. The Court held that the alleged misstatements were immaterial because plaintiffs had “not provided the Court with any reason why the [alleged misstatements in the Offering Materials] 'would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.'” Dismissal Order at 16 (quoting Hutchison v. Deutsche Bank Sec. Inc., 647 F.3d 479, 485 (2d Cir. 2011)). The Court dismissed the Section 11 claims, concluding that “even when drawing all inferences in the plaintiffs' favor, the Court cannot find that the [alleged] misstatements are material.” Id. The Dismissal Order specifically noted that plaintiffs failed to articulate how the alleged “misstated” line items in Gridsum's financial statements altered the total mix of information available to investors: “What is the implication of a shift in the mix of how customer prepayments are allocated between deferred revenue and customer advances? To what extent is a large change in income tax, even when a small part of the overall picture, indicative of this company's success to investors?” Id.Because no answers were offered to those questions, the Court dismissed the Securities Act claims. Also dismissed was the Section 15 “control person” claim against Mr. Melcher because plaintiffs had not sufficiently pled a primary violation under Section 11, and the Section 10 claim against him was dismissed because he was not alleged to be a “maker” of any statements in question under Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135, 141 (2011). Id. at 23.

C. The Third Amended Complaint

The TAC was filed on May 7, 2020, and contains two new claims that were not previously asserted in any of plaintiffs' prior complaints:

(1) The Offering Materials contained a “material understatement of the tax expense reported in Gridsum's Statement of Operations for the six months ended June 30, 2016”, and failed to disclose “the existence of a 'sub-optimal' offshore capital structure,” and “plans to bring the sub-optimal offshore capital structure to the Company's anchor entities after the IPO” that were the reason for the understatement; and

(2) Defendants failed to disclose in the Offering Materials “Gridsum's plan to launch a new sentiment tracking services product within weeks, if not days, of the IPO, and that Gridsum planned to recognize revenue thereon when the services were transferred to sub-distributors (sales agents) on a consignment basis.”

See TAC ¶ 7. The TAC otherwise re-pleads virtually the same substantive allegations with little more than cosmetic changes from the SAC.³

IV. LEGAL STANDARD

“To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). “[T]he Court is not required to credit 'mere conclusory statements' or '[t]hreadbare recitals of the elements of a cause of action.'” Fries v. N. Oil & Gas, Inc., 354 F. Supp. 3d 384, 388 (S.D.N.Y. 2018) (Ramos, J.). Nor must the Court credit claims that are contradicted by documents incorporated in the complaint or publicly filed with the SEC. See Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1092 (2d Cir. 1995); In re Optionable Sec. Litig., 577 F. Supp. 2d 681, 692 (S.D.N.Y. 2008) (“If . . . [plaintiffs'] allegations . . . conflict with the plain language of the publicly filed disclosure documents, the disclosure documents control, and the court need not accept the allegations as true.”).

To state a claim under Section 11 of the Securities Act, “a plaintiff must allege that a defendant issued or signed a securities registration statement that 'contained an untrue statement of a material fact or omitted to state a material fact . . . necessary to make the statements therein not misleading.'” Dismissal Order at 12 (quoting 15 U.S.C. §77k). “Reverse-engineered” allegations “craftily drafted to imply that what only became clear due to subsequent events was somehow known to [defendants] far earlier in time” are insufficient. Panther Partners, Inc. v. Ikanos Commc'ns, Inc., 538 F. Supp. 2d 662, 669-70 (S.D.N.Y. 2008), aff'd, 347 Fed. App'x 617 (2d Cir. 2009).

V. DISCUSSION

Rather than address the deficiencies set forth by the Dismissal Order, the TAC makes no meaningful changes to the claims plaintiffs previously asserted arising from Gridsum's January 2019 revision of certain previously published financial statements, essentially conceding they have nothing more to add regarding those dismissed claims. Instead, the TAC resorts to offering two time-barred claims about a tax expense line item in Gridsum's unaudited pro forma financial statements for the first half of 2016 and the Company's business plans — claims that were noticeably absent from any of plaintiffs' earlier complaints even though they are premised on disclosures that have been in the public domain for years. These new claims are insufficient as a matter of law under the Securities Act and should be dismissed with prejudice.

A. The Newly Alleged Claims Are Time-Barred

Section 13 of the Securities Act mandates two important timeliness requirements: a three-year statute of repose and a one-year statute of limitations that requires any claims must be asserted (1) “within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence,” and (2) “[i]n no event . . . more than three years after the security was bona fide offered to the public.” 15 U.S.C. §77m; accord Ernst & Ernst v. Hochfelder, 425 U.S. 185, 210 (1976) (the one- and three-year statutory periods in Section 13 are “applicable to actions brought under [Sections] 11, 12(2), or 15.”). The TAC's new Securities Act allegations are clearly untimely under both requirements.

1. Plaintiffs' New Claims Are Barred By The Statute of Repose

Each of the newly alleged Securities Act claims are barred by the three-year statute of repose. “[S]tatutes of repose effect a legislative judgment that a defendant should be free from liability after the legislatively determined period of time.” California Pub. Emps.' Ret. Sys. v. ANZ Sec., Inc., 137 S. Ct. 2042, 2045 (2017) (internal quotation marks omitted). “[A] statute of repose begins to run without interruption once the necessary triggering event has occurred, even if equitable considerations would warrant tolling or even if the plaintiff has not yet, or could not yet have, discovered that she has a cause of action.” P. Stolz Family P'ship L.P. v. Daum, 355 F.3d 92, 102-03 (2d Cir. 2004). “In the case of §11 liability, the repose period is triggered by the effective date of the (allegedly false) registration statement for the offer — i.e., the beginning of the offer.” Id. at 104. Thus, “the three year statute of repose set forth in Section 13 provides an 'absolute' limit” to Section 11 claims raised more than three years after the publication of an IPO registration statement. In re Lehman Bros. Sec. & ERISA Litig., 903 F. Supp. 2d 152, 171 (S.D.N.Y. 2012). This applies equally to claims raised for the first time in an amended pleading — like the ones here — as it does to claims made in an initial pleading. See, e.g., Fed. Deposit Ins. Corp. for Colonial Bank v. First Horizon Asset Sec. Inc., 291 F. Supp. 3d 364, 372 (S.D.N.Y. 2018) (rejecting argument that Section 13's statute of repose “only bars commencing a new action” rather than claims “brought as an amendment to a complaint”).⁴

There is no dispute that the Registration Statement “became effective on September 22, 2016” (TAC ¶ 4), which is more than three years and seven months before plaintiffs raised these new claims for the first time on May 7, 2020. See First Horizon, 291 F. Supp. 3d at 373 (“[T]he repose provision in . . . the Securities Act 'is therefore equivalent to “a cutoff,” in essence an “absolute bar” on a defendant's temporal liability.'”) (quoting CTS Corp. v. Waldburger, 134 S. Ct. 2175, 2183 (2014)).

Nor can plaintiffs' amendment be salvaged by the “relation back” doctrine because it is well-established that “the Rule 15(c) relation back doctrine does not apply to statutes of repose.” In re Lehman Bros. Sec. & Erisa Litig., 800 F. Supp. 2d 477, 483 (S.D.N.Y. 2011) (collecting cases).⁵ The three-year repose period is not tolled by the filing and pendency of a securities class action and cannot be tolled for equitable considerations. ANZ Sec., Inc., 137 S. Ct. at 2051 (“The purpose and effect of a statute of repose . . . is to override customary tolling rules arising from the equitable powers of courts. . . . For this reason, the Court repeatedly has stated in broad terms that statutes of repose are not subject to equitable tolling.”).

2. Plaintiffs' Newly Alleged Tax Expense Claims Are Also Barred By The Statute Of Limitations

Plaintiffs' new claims regarding tax expense and capital structure are also plainly barred by the Securities Act's one-year statute of limitations. ANZ Sec., 137 S. Ct. at 2049 (“In addition to the 3–year time bar, §13 contains a 1-year statute of limitations.”); 15 U.S.C. §77m. “Statutes of limitations are designed to ensure fairness to defendants and to prevent surprises brought about by the attempt to breathe life into causes that have lain dormant.” Aslanidis v. U.S. Lines, Inc., 7 F.3d 1067, 1074 (2d Cir. 1993). This one-year period “begin[s] to run when the claim accrued or upon discovery of the facts constituting the alleged [violation].Discovery, however, includes constructive and inquiry notice as well as actual notice.” Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993).Thus, “[a] plaintiff in a federal securities case will be deemed to have discovered [the violation] for purposes of triggering the statute of limitations when a reasonable investor of ordinary intelligence would have discovered [its] existence.” Id. ⁶

By the plaintiffs' own admission, the facts underlying these new claims were all publicly known no later than March 15, 2017, and therefore were already barred by the statute of limitations at the time they filed their first complaint on April 25, 2018. According to the TAC, on March 15, 2017 — approximately six months after the Offering Materials reported zero income tax expense for the first six months of 2016 — Gridsum issued its press release that “included an income tax expense of RMB 28,387,000 for the year ended December 31, 2016.”TAC ¶ 92.At that point, any purported “discrepancy” between the figures for the first six months and the final full year was publicly announced and known.The TAC even asserts that “[t]he reporting of the income tax expense as zero violated GAAP resulting in a material understatement of the Company's reported net losses by 47.78%” (TAC ¶ 86), a “change [that] did not go unnoticed by analysts when it was reported.” Id. (emphasis added). The TAC also describes an earnings call occurring on the same day as the press release that discussed the reasons for this post-IPO expense.⁷

On that same date, March 15, 2017, Gridsum also disclosed during its earnings call each of the new facts related to the Company's “sub-optimal” capital structure and restructuring plans. TAC ¶ 92 (“[T]he tax comes from a sub-optimal structure. . . . We have since put in place a more efficient structure.”). According to the TAC, not a single fact underlying this newly alleged claim was disclosed after March 15, 2017. Thus, the TAC itself concedes that the March 15, 2017 press release and earnings call placed investors on notice of these supposed claims due to the announcement and public discussion of the information. That alone satisfies the requirement that “a reasonable investor of ordinary intelligence would have discovered” this information. Dodds, 12 F.3d at 350.This is not the case of a buried disclosure that was unnoticed by the market: indeed, the TAC admits that the tax expense “did not go unnoticed by analysts when it was reported” (TAC ¶ 86) and it quotes at length from an analyst question concerning the expense during the earnings call that same day. TAC ¶ 92. Plaintiffs cannot contest allegations from their own pleading, nor can they escape the fact that the statutory one-year period during which they could have raised a claim based on the supposed discrepancy between the tax expense figures or the capital structure closed on March 15, 2018.

Moreover, because these new claims were already time-barred at the time the first complaint was filed, they cannot “relate back” to any original claims: “It is well established that if the claim sought to be asserted in an amended complaint was time-barred at the time the original complaint was filed, the relation back doctrine will not save it.” Rosen ex rel. Egghead.Com, Inc. v. Brookhaven Capital Mgmt., Co., 179 F. Supp. 2d330, 339 (S.D.N.Y. 2002)(citing Mackensworth v. S.S. Am. Merch., 28 F.3d 246, 251-52 (2d Cir. 1994)).⁸ As the Second Circuit has held, “the relation back rule was not designed to provide a means either to circumvent or to expand the limitations period.” In re Allbrand Appliance & Television Co., 875 F.2d 1021, 1025 (2d Cir. 1989).

B. The Newly Alleged Claims Are Not Actionable Under The Securities Act

Aside from their untimeliness, the new claims should also be dismissed for the separate reasons that (i) they do not allege any actionable misstatements, and even if they did, (ii) they would not be material under the Court's materiality analysis articulated in the Dismissal Order.

1. The New Claims Sound In Fraud And Are Subject To Rule 9(b)

We recognize and are respectful of the Court's holding that plaintiffs' Securities Act allegations in the SAC did not sufficiently “sound in fraud” so as to require that the allegations be held to the strict pleading particularity requirements under Rule 9(b). Dismissal Order at 13. But the new allegations in the TAC undoubtedly do sound in fraud. See, e.g., Rombach v. Chang, 355 F.3d 164, 171 (2d Cir. 2004) (“[T]he heightened pleading standard of Rule 9(b) applies to Section 11 . . . claims insofar as the claims are premised on allegations of fraud.”). This is because plaintiffs have done something new: they repeat their new Securities Act allegations word-for-word in order to plead their Securities Act claims and to plead purported fraudulent conduct in a section titled “Additional Allegations of Scienter” in support of their Exchange Act claims. TAC ¶ 226. As demonstrated in the chart below, each of the new Securities Act allegations is also used to plead scienter and as an illustration of an alleged “fraudulent scheme . . . to ensure the success of the Company's entry into the United States public equity markets.” Id.

New Securities Act Allegations (TAC ¶ 7)	New Exchange Act Allegations (TAC ¶ 226)
“The Offering Materials were inaccurate and misleading . . . and omitted to state . . .”	“The disclosures . . . in the Registration Statement omitted to inform investors of . . .”
“the existence of a 'sub-optimal' offshore capital structure.”	“the existence of a 'sub-optimal' offshore capital structure.”
“Gridsum's plans to bring the sub-optimal offshore capital structure to the Company's anchor entities after the IPO.”	“Gridsum's plans to bring the sub-optimal offshore capital structure to the Company's anchor entities after the IPO.”
“the materially adverse tax consequences of bringing the sub-optimal offshore capital structure to the Company's anchor entities.”	“the materially adverse tax consequences of bringing the suboptimal offshore capital structure to the Company's anchor entities.”
“the material understatement of the tax expense reported in Gridsum's Statement of Operations for the six months ended June 30, 2016.”	“the material understatement of the tax expense reported in Gridsum's Statement of Operations for the six months ended June 30, 2016.”
“Gridsum's plan to launch a new sentiment tracking services product within weeks, if not days, of the IPO, and that Gridsum planned to recognize revenue thereon when the services were transferred to sub-distributors.”	“Gridsum's plans to launch a new sentiment tracking services product within weeks, if not days, of the IPO, and that Gridsum planned to recognize revenue thereon when the services were transferred to sub-distributors.”

It is well-established that where a Securities Act “claim is based on the same alleged misstatements and omissions as those with respect to Plaintiffs' explicit fraud claims . . . [the] claim sounds in fraud, and the pleading requirements of Rule 9(b) apply.” Manela v. Gottlieb, 784 F. Supp. 84, 88 n.5 (S.D.N.Y. 1992).⁹ Plaintiffs repeat these new allegations verbatim in support of their claim that defendants supposedly intended to “constitute a fraud upon Plaintiffs and the Class” under Section 10(b). Similarly, the new allegation that it is “inconceivable” that the income tax expense could have been zero at the time of the pro forma statements, for all of its faults, clearly suggests that the purported misstatement was made with scienter. TAC ¶¶ 86, 88. The new claims can only be understood as an accusation that defendants knew Gridsum would incur tax liability in 2016 and should have allocated a portion of that liability to the financial statements for the first half of 2016, but decided not to do so. This is undoubtedly an allegation of intentional misconduct that sounds in fraud and should be held to Rule 9(b)'s heightened pleading standard. See, e.g., In re AmTrust Fin. Servs. Sec. Litig., 2019 WL 4257110 (S.D.N.Y. Sept. 9, 2019) (“When the same course of conduct supports both a claim of fraud under the Exchange Act and a claim under Section 11 . . . of the Securities Act, the latter claim must meet satisfy the requirements of Rule 9(b). . . . Mere disavowal of any allegations that would make 9(b) applicable will not suffice.”); Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., 33 F. Supp. 2d 401, 440-41 (S.D.N.Y. 2014) (Ramos, J.) (analyzing Securities Act cases and applying heightened pleading standard to claim that “sounds in fraud”).

2. The New Claims Are Not Actionable Misstatements

Regardless of whether the strict requirements of Rule 9(b) are applied, plaintiffs' newly alleged violations of Section 11 should be dismissed because they were not false or misleading.

a. The TAC does not allege any misstatement concerning Gridsum's half-year income tax expense.

The TAC's principal new claim is that the pro forma statements for the first six months of 2016 “materially understated” the half-year 2016 income tax expense. The entire basis for the allegation that the pro forma was false is that “[i]t is inconceivable that the income tax expense could have been zero as of June 30, 2016, even with the lower restated amount of RMB 14,801,000 as of December 31, 2016.” TAC ¶¶ 88, 86 (similar). In other words, this allegation is based on nothing more than conjecture, unsupported by a single alleged fact or accounting rule, that because the year-end financials recorded a tax expense, the mid-year pro forma financials recording no tax expense must have been false. Id., ¶¶ 7-9. It is nothing more than an unsubstantiated “guess” that Gridsum's mid-year pro formas were not accurate.

But the TAC itself provides the explanation for why Gridsum did not, in fact, report any tax expense for the first half of 2016: the tax expense that year did not accrue until “post-IPO” — in other words, after the IPO was completed in late September 2016 — and thus could not have been reflected in the mid-year pro formas.TAC ¶ 92.Indeed, the TAC quotes Mr. Zhang's statement from the earnings call that “the tax comes from a sub-optimal structure we initially had in place to move . . . offshore capital to onshore entities post-IPO.” Id. (emphasis added); ¶ 93 (alleging Gridsum “move[d] the offshore capital to Gridsum anchor entities after the IPO”) (emphasis added). The TAC does not allege — nor could it — that any defendant was aware of the prospective capital restructuring or its potential tax consequences at the time of the IPO in September 2016, much less as of June 30, 2016.¹⁰

Plaintiffs include a conclusory allegation that that Mr. Zhang supposedly “admitted during the March 15, 2017 earnings conference call that the action triggering the 2016 full year tax expense of RMB 28,387,000 was projected at the time of the IPO” (TAC ¶ 96), but that allegation is fabricated out of thin air, and it is a judicially noticeable fact that no such thing was said at that earnings call. Foley Decl., Ex. D (transcript from March 15, 2017 earnings call). This blatantly inaccurate mischaracterization is contradicted by the earnings call transcript, which the Court may consider because it is relied upon by the TAC and therefore subject to the incorporation by reference doctrine. See Fed. R. Evid. 201 (“The court may judicially notice a fact that is not subject to reasonable dispute because it . . . can be accurately and readily determined from sources whose accuracy cannot reasonably be questioned.”); Int'l Audiotext Network, Inc. v. Am. Tel. & Tel. Co., 62 F.3d 69, 72 (2d Cir. 1995) (“[A] complaint is deemed to include any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference.”); In re Optionable, 577 F. Supp. 2d at 692 (“If . . . allegations . . . conflict with the plain language of the publicly filed disclosure documents, the disclosure documents control, and the court need not accept the allegations as true.”).

b. Gridsum had no duty to disclose information regarding its prospective business or operational plans.

Plaintiffs relatedly allege the Offering Materials did not disclose the “'sub-optimal' offshore capital structure” and the “plans” to restructure capital after the IPO that were the reason for the post-IPO expense. This of course, puts the cart before the horse, as there is no allegation that any defendant supposedly knew that the capital structure was “sub-par” prior to the IPO or that the Company would eventually be required to engage in a restructuring of its capital. This alleges nothing more than the claim that once Gridsum was a public company, it determined there was a better way to organize its capital structure and did so, but that the result was a one-time tax charge. Plaintiffs have pled nothing suggesting that any defendant viewed Gridsum's capital structure as “sub-par” at the time of the IPO based on the laws and conditions then in existence.

Even more fundamentally, the TAC does not adequately allege that defendants were obligated to disclose this information, if they did have such a view: “It is well established that there is no [Section 11] liability in the absence of a duty to disclose, even if the information would have been material.” In re Morgan Stanley Tech. Fund Sec. Litig., 643 F. Supp. 2d 366, 375 (S.D.N.Y. 2009); Resnik v. Swartz, 303 F.3d 147, 154 (2d Cir. 2002) (“Disclosure of an item of information is not required . . . simply because it may be relevant or of interest to a reasonable investor.”). The duty to disclose arises only “when additional information is needed to make another statement . . . not misleading.” In re Morgan Stanley Tech., 643 F. Supp. 2d at 375.

Further, it is “well established that a company has no . . . duty to disclose changes to its business plans — unless the company 'had “hyped” a specific plan, thereby inducing investors to believe that alternative[ ] [plans] were excluded.'” Friedman, 2018 WL 446189, at *6 (quoting San Leandro Emergency Med. Grp. Profit Sharing Plan, 75 F.3d at 810) (emphasis added).To qualify for this “hyped” exception, plaintiffs must plead facts plausibly establishing that Gridsum had “stated its intention to adhere exclusively to” a particular strategy and then changed its strategy without informing investors. Pehlivanian v. China Gerui Advanced Materials Grp., Ltd., 153 F. Supp. 3d 628, 651 (S.D.N.Y. 2015) (Ramos, J.).¹¹

The TAC does not contain any allegation suggesting that defendants had a duty to disclose Gridsum's prospective capital restructuring plans (even if they knew about them at the time of the IPO, which is not adequately alleged). There is no allegation that disclosures of those plans were required to make “another statement not misleading” — indeed, the mid-year pro formas clearly stated that they were made “For the Six Months Ended June 30, 2016.” Foley Decl., Ex. A at 9. Information regarding a potential tax liability arising after June 30 (and the TAC admits that the liability arose “post-IPO”) would have no effect on what was disclosed for the first half of the year. Nor is there any allegation that Gridsum had previously “hyped” an alternative capital restructuring plan such that a duty to disclose the “new plan” arose.

Likewise, plaintiffs' conclusory allegations that defendants failed to disclose the “plan to launch a new sentiment tracking services product” are similarly deficient and should be dismissed for the same reasons. The TAC does not allege that failure to disclose these plans (if they were even known at the time) made “another statement” misleading, and there is no allegation that Gridsum had previously “hyped” a different plan. See In re Travelzoo Inc. Sec. Litig., 2013 WL 1287342, at *6 (S.D.N.Y. Mar. 29, 2013) (company “had no duty to disclose a potentially adverse effect that the launch of one of its products could have on the overall growth and revenue of its other core business” because plaintiffs failed to plead that the products affected the company's performance “in a way that rendered Defendants' statements about the financial condition of the company misleading at the time they were made”).

3. The Alleged Understatement Of The Income Tax Expense Was Not Material

The TAC's new tax expense allegation should also be dismissed for the separate reason that it is plainly not a material misstatement under the materiality analysis applicable to this case as set forth in the Dismissal Order. In that Order, the Court questioned why the alleged misstatements in the SAC “would have been viewed by the reasonable investor as having significantly altered the total mix of information made available” (Dismissal Order at 16) and gave plaintiffs a checklist of key questions that would need to be addressed by any amended Securities Act claim. These important questions included:

What is the implication of a shift in the mix of how customer prepayments are allocated between deferred revenue and customer advances? To what extent is a large change in income tax, even when a small part of the overall picture, indicative of this company's success to investors?

Id. (emphasis added). Because the SAC did “not hint[ ] at the answer to any of these or similar questions for other line items in the corrected 2015 financials . . . even when drawing all inferences in the plaintiffs' favor, the Court [could not] find that the [alleged] misstatements are material.” Id.

The TAC does not even attempt to address these questions. Instead, plaintiffs concoct a new allegation that suffers from precisely the same lack of materiality. The TAC misleadingly alleges that the supposed mid-year 2016 tax expense understatement caused “Gridsum's net loss as of June 30, 2016” to be “materially understated by 24.9%.” TAC ¶ 9.¹² But that number suffers from two important flaws: (i) it is based on a misunderstanding of how tax liabilities accrue, and (ii) even under that mistaken assumption, such an alleged “understatement” is not material for the same reasons articulated in the Dismissal Order.

First, the allegation that net losses changed by 24.9% as a result of the tax expense is premised on the flawed assumption that tax liabilities necessarily accrue evenly over a year. TAC ¶ 88. According to the TAC, Gridsum was required to “us[e] one-half of [the full year tax expense] as the necessary accrual” for the mid-year pro forma. See id. But the TAC itself concedes that the restructuring did not occur until well “after the IPO” — i.e., after September 22, 2016. Id., ¶ 93. It is a judicially noticeable fact that there is no accounting rule that requires a company to allocate a tax expense arising at the end of the year into the first and second halves of that year. Nor is there any accounting mechanism for a company to retroactively accomplish such a feat.¹³ IPOs are often delayed, tax laws are often changed, and companies often reorganize. Plaintiffs give no reason why this Court should be the first one to hold that a company's tax expense is misstated unless it can predict the timing and impact of all these potential events and allocate them across the calendar year.

Second, even if one accepts the erroneous argument that the post-IPO expense should been allocated evenly over the first and second halves of the year, the alleged understatement of the expense is not remotely material under the analysis set forth in the Dismissal Order. When properly viewed against Gridsum's total operations, the supposed “understatement” of RMB 7,400,500 (one half of the RMB 14,801,000 income tax expense) is only 2.03% of Gridsum's net revenues (RMB 363,823,000) for 2016. Foley Decl., Ex. B at 4. As the Court held in the Dismissal Order, materiality is determined “in the context of the company's 'total operations.'” Dismissal Order at 16 (quoting Tabak v. Canadian Solar Inc., 549 Fed. App'x 24, 27 (2d Cir. 2013)). In the context of a change in “income tax,” the Court held that the alleged misstatement was to be compared to “net revenues,” rejected plaintiffs' “attempts to create a presumption that investors would find . . . a change material based on the change in the line item alone,” and held that a change in income tax amounting to 4.5% of net revenues was immaterial. Id. at 15.

C. The Control Person Claims Against Mr. Melcher Are Insufficiently Pled

The Court dismissed the Section 15 “control person” claim against Mr. Melcher on the ground that the SAC had not properly alleged a “primary violation.” Dismissal Order at 17 (citing ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 108 (2d Cir. 2007)). Because plaintiffs' new claims do not plead a primary violation of Section 11, the same result is warranted.

D. The Section 10(b) Claim Against Mr. Melcher Should Be Dismissed With Prejudice

The Court also dismissed the Section 10 claim against Mr. Melcher because “the plaintiffs never alleged that Melcher signed or otherwise 'made' the [alleged misstatements].” Dismissal Order at 23 (citing Janus Capital Grp., 564 U.S. at 141). It is not clear whether plaintiffs were given leave to amend their Section 10 claim against Mr. Melcher (and, in fact, the Dismissal Order appears to contemplate only a “Third Amended Complaint [to] realleg[e] the Securities Act claims” (Dismissal Order at 28)) but plaintiffs have realleged exactly the same claims against Mr. Melcher with virtually no modification. The TAC contains no new substantive claims against him, nor does it address the Court's holding that he is not alleged to have made the misstatements. The Section 10 claim should again be dismissed against him, this time with prejudice.

IV. CONCLUSION

For these reasons, the TAC's claims against Gridsum and Mr. Melcher under the Securities Act should be dismissed with prejudice. Additionally, as the TAC does not contain any new allegations against Mr. Melcher or address the Court's dismissal of the Section 10(b) claims against Mr. Melcher, the Court should dismiss that claim against him with prejudice.

Dated: June 8, 2020

Respectfully submitted,

ORRICK, HERRINGTON & SUTCLIFFE LLP

By: Michael C. Tu (admitted pro hac vice)
mtu@orrick.com
777 South Figueroa Street, Suite 3200
Los Angeles, California 90017
Telephone: (213) 612-2433

William J. Foley
wfoley@orrick.com
51 West 52nd Street
New York, New York 10019
Telephone: (212) 506-5000

Attorneys for Defendants
Gridsum Holding Inc. and Thomas Melcher