Investors Oppose Dismissal of Suit 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, PRICEWATERHOUSECOOPERS 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

PLAINTIFFS' OMNIBUS MEMORANDUM OF LAW IN OPPOSITION TO DEFENDANTS' MOTIONS TO DISMISS THE THIRD AMENDED CLASS ACTION COMPLAINT

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TABLE OF CONTENTS

I. PRELIMINARY STATEMENT

II. STATEMENT OF FACTS

III. ARGUMENT

D. The TAC Adequately Alleges Exchange Act Claims Against Gridsum, Melcher, and Chui Based on the Amended Allegations Relating to the Offering Materials26

E. The TAC Adequately Alleges Claims Under the Exchange Act Against PwC

IV. CONCLUSION

TABLE OF AUTHORITIES

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Helicopteros Nacionales de Colombia, S.A. v. Hall, 466 U.S. 408 (1984)

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Statutes

15 U.S.C. § 77k(a)

15 U.S.C. § 78aa

17 C.F.R. § 240.10b-5(b)

Rules

ASC 740

AU § 560

AU § 711

AS No. 9

AS No. 13

Regulations

Restatement (Second) of Conflict of Laws § 37 (1988)

SAB 99, 64 Fed. Reg. 45151 (1999)

SAB 99, 64 Fed.Reg. 45150 (1999)

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Lead Plaintiff William Barth and named plaintiff Xuechen Li (“Li” and together, “Plaintiffs”) respectfully submit this omnibus memorandum of law in opposition to: (1) Gridsum Holding Inc. (“Gridsum” or the “Company”) and Thomas Melcher's (“Melcher”) Motion to Dismiss the Third Amended Class Action Complaint (“TAC”) (ECF No. 210); (2) Perry Chui's (“Chui”) Motion to Dismiss the TAC (ECF No. 213); (3) PricewaterhouseCoopers Zhong Tian LLP's (“PwC”) Motion to Dismiss the TAC (ECF No. 216); and (4) the Underwriter Defendants' Joinder in Gridsum and Melcher's Motion to Dismiss the TAC (ECF No. 218, “UB”).¹

I. PRELIMINARY STATEMENT²

On March 30, 2020, this Court denied Gridsum's motion to dismiss the Exchange Act claims in Plaintiffs' Second Amended Class Action Complaint (the “SAC”), finding the alleged false and misleading statements made in the Company's 2016 Form 20-F (the “2016 financials”) and the April 23, 2018 press release (the “April 2018 Press Release”) to be “properly plead” and finding scienter adequately pled as to Gridsum.³ ECF No. 201 at 17-23 (the “Order”). The Court granted Gridsum and Melcher's motion to dismiss the Securities Act claims but allowed Plaintiffs to file the TAC. Order at 27-28. The Court did not reach PwC's substantive motion arguments, instead dismissing the claims against PwC for lack of personal jurisdiction.⁴ Order at 23.

On May 7, 2020, Plaintiffs filed the TAC, alleging that Gridsum's Offering Materials were materially false and misleading and contained untrue statements of material fact or omitted to state material facts because, inter alia, the June 30, 2016 financial statements included in the Registration Statement materially understated Gridsum's expected tax liability and loss for the six month period then ended, failed to disclose material facts regarding Gridsum's plan to launch a new sentiment tracking services product, and that Gridsum planned to recognize revenue thereon when the services were transferred to sub-distributors (sales agents) on a consignment basis, which method of revenue recognition was improper.

Defendants take issue with the purported “new” claims alleged in the TAC, first claiming that they are time-barred, but ignoring that one of the first complaints filed in this action by current named plaintiff Li, which was consolidated, contained allegations based on Gridsum's interim consolidated financial statements and thus the claims are not “new” or time-barred by the statute of repose. Similarly, the claims are not barred by the statute of limitations. Not only was inquiry notice as to the falsity of the interim consolidated financial statements not triggered until the Company announced that the 2016 financials should no longer be relied upon, there is no limitations argument as to the alleged “plans” to launch the new sentiment tracking services product within weeks of the IPO with improper recognition of revenue that would lead to material restatements of the 2016 financials.

Defendants ignore the TAC's well-pleaded facts and insert their own counter-narrative. The TAC plainly pleads that the Registration Statement was materially false and misleading because Gridsum planned to move offshore capital to Gridsum entities at the time of IPO and therefore, in accordance with GAAP, was required to include the proportionate income tax expense triggered by such a plan in its interim consolidated financial statements. Had Gridsum done so, the Company's net losses would have been almost 47.78% higher than stated in the Registration Statement. This plan and the plan to launch the sentiment tracking services product with improper revenue recognition were material omissions that the Securities Act Defendants had a duty to disclose as both “would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available.” Basic Inc. v. Levinson, 485 U.S. 224, 232 (1988).

PwC argues that it should escape liability because Plaintiffs have not alleged that PwC disbelieved its audit opinion. PwC audited Gridsum's financial statements in the Offering Materials, and therefore, as an auditing expert, PwC “expertised” Gridsum's financial statements. Under Section 11, PwC is strictly liable for any misrepresentation or omission of fact in Gridsum's financial statements. Thus, it is not PwC's audit certification that is to be judged on this motion to dismiss — rather it is Gridsum's financial statements that PwC expertised pursuant to Section 11. Plaintiffs do not have to plead PwC's subjective falsity because in the context of a public offering, PwC did not provide an audit opinion; rather, it provided an audit certification. Finally, even if portions of PwC's audit reports are deemed an opinion, PwC is still liable because the opinion contains embedded statements of historical fact (the financial statements themselves) that are untrue.

II. STATEMENT OF FACTS

A. Gridsum's False and Misleading Registration Statement

Gridsum is a web analytics holding company founded by defendants Qi and Yu. ¶ 2. The Company designs and develops data analysis software for online marketing and digital intelligence for commercial and governmental entities. ¶¶ 2, 47. Between 2013 and 2016, Gridsum grew at a rapid pace, increasing its customer base from 141 to 395 and its employees from 268 to 929. ¶¶ 54-55, 228.

On September 23, 2016, Gridsum filed with the SEC a Prospectus pursuant to Rule 424(b)(4), commencing the public offering of 6.7 million ADSs at a price of $13.00 per share. Gridsum's IPO was successful, and with the Underwriter Defendants' exercise in full of their over-allotments, the Company issued and sold 7,705,000 ADSs for net proceeds of approximately $87.1 million. The Company's closing share price on September 23, 2016 was $15.75, exceeding the offering price by over 21%.

Unbeknownst to investors, the Offering Materials contained materially false and misleading statements and omitted material information. Specifically, the Registration Statement contained a Consolidated Statement of Operations which, for the six months ended June 30, 2016, reflected a loss before income tax of RMB 29.7 million, an income tax expense of zero, and therefore a net loss of RMB 29.7 million. ¶ 85. And yet, when the Company subsequently reported its year ended December 31, 2016 earnings, an RMB 28,387,00 income tax expense was included, with net losses totaling RMB 67.7 million. ¶¶ 86, 94. During a conference call discussing the Company's 2016 full year results, on March 15, 2017, defendant Zhang admitted that Gridsum had planned to move offshore capital to Gridsum entities after the IPO and that this move triggered the tax liability. ¶¶ 92-93. Defendant Zhang refused to give further details publicly and offered to discuss the tax liability with the analyst offline. Id. Then, on April 23, 2018, the Company shocked the market in announcing that PwC had notified Gridsum that the “audit reported for the Company's financial statements for the year ended December 31, 2016 should no longer be relied upon.” ¶¶ 99-100.

Pursuant to GAAP (ASC 740), Gridsum was required to make its best estimate of the Company's annual tax for the full year and apply it in determining the proportionate six month tax expense as of June 30, 2016. ¶ 95. As the triggering tax liability action was known prior to the IPO, Gridsum violated GAAP in reporting a zero tax liability instead of an accrued tax expense of RMB 14,193,500 (one half of RMB 28.4 million). ¶ 96. If the Securities Act Defendants had reported the accrued tax expense of RMB 14.1 million, the Company would have reported net losses 47.78% higher than what was reported as of June 30, 2016, making the Company far less appealing to investors and hampering the Company's IPO. Id.

Furthermore, the Securities Act Defendants failed to disclose that the Company planned 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, which method of revenue recognition was improper and would ultimately result in a material restatement of the Company's 2016 financials. ¶¶ 91, 127-31. More specifically, Gridsum would book millions of RMBs of revenues on “sales” to sub-distributors which were not true sales, but consignment transactions wherein Gridsum did not receive payment until the sub-distributor sold the services product to a third-party. ¶¶ 15, 134-44. As a result, among other things, the 2016 Form 20-F overstated Gridsum's 2016 revenues by 9.2%, overstated gross profit by 11.1%, understated loss from operations by 118.1%, understated the net loss by 45.6%, understated accounts payable by 307.9%, overstated deferred revenue by 57.9%, and overstated accounts receivable by 13.7%. ¶ 206.

In addition, the Registration Statement contained materially false and misleading statements and omissions relating to the Company's internal controls. ¶¶ 90-91. While the Registration Statement did reveal that Gridsum had a material weakness relating to the Company's “lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reported requirements,” there were additional material weaknesses that the Securities Act Defendants failed to disclose, as well as the fact that the reported material weakness had already caused the Company to issue materially false and misleading statements. Id.

B. PwC and the Underwriter Defendants

PwC was Gridsum's independent auditor from at least 2015 through June 2018. ¶ 35. In March 2016, PwC issued its audit report, which stated that Gridsum's consolidated financial statements for the years ended December 31, 2013, 2014, and 2015 fairly represented Gridsum's financial position and results of operations and conformed with GAAP (the “2015 Audit Report”). ¶¶64-67, 89. PwC consented to Gridsum using the 2015 Audit Report in its Registration Statement filed in connection with Gridsum's IPO. ¶ 35. PwC performed additional audit procedures through August 19, 2016, and was required to update any “subsequent events.” ¶¶ 89, 159. To conduct its audit, PwC had full access to Gridsum's corporate information, including confidential information concerning Gridsum's contracts and sales and “evidence supporting the amounts and disclosures in the financial statements.” ¶ 66. PwC personnel were frequently present at Gridsum's corporate headquarters and had access to Company personnel. ¶ 67.

When an auditor's report is included in a registration statement, the nature and extent of responsibility assumed by the auditor is specified in some detail in applicable statutes and in the related rules and regulations. ¶ 160. For example, Section 11(a) of the Securities Act imposes responsibility for false or misleading statements in an effective registration statement, or for omissions that render statements made in such a document misleading, on every accountant or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, report, or valuation, which purports to have been prepared or certified by him. Id. Section 11(b) of the Securities Act requires a “reasonable investigation” on behalf of an expert. ¶ 161.

To sustain the burden of proof that PwC made a “reasonable investigation” as required under the Securities Act, PwC was required to have performed an audit in conformity with GAAS and to extend its procedures with respect to subsequent events from the date of the audit report up to the effective date or as close thereto as is reasonable and practicable in the circumstances. ¶163. See AU § 711. Thus, under AU § 711, PwC was required to be kept advised of the progress of the IPO registration proceedings so that PwC's review of subsequent evets could be completed by the effective date. ¶ 164. PwC was, at a minimum, negligent in not knowing that as of, or at least shortly prior to, the IPO, Gridsum's Consolidated Statement of Operations for the six months ended June 30, 2016 omitted a material tax liability (see ¶¶ 85-88, 92-98) and that the notes to Gridsum's financial statements as of and for the year ended December 31, 2015 and the six months ended June 30, 2016 contained material omissions. ¶ 166.

Similarly, the Underwriter Defendants were required to conduct a due diligence investigation to participate in the IPO. ¶ 167. The Underwriter Defendants were at a minimum negligent in not knowing all of the foregoing based upon their performance of the typical IPO due diligence review of, among other things, the most recent unaudited statements, with comparable statements to the prior year; projections, capital budgets, and strategic plans; and, federal, state, local, and foreign income tax returns for last three years. Id.

On April 27, 2017, Gridsum filed the 2016 Form 20-F for the year ended December 31, 2016. ¶ 193. With PwC's consent, Gridsum included PwC's audit report dated April 27, 2017 (the “2016 Audit Report”) in the 2016 Form 20-F. ¶ 199. Again, to conduct its audit, PwC had full access to Gridsum's corporate information and PwC personnel were frequently present at Gridsum's corporate headquarters and had access to Company personnel. ¶¶ 66-67.

PwC's 2016 Audit Report was materially false and misleading and/or failed to disclose that: (i) the financial statements did not present fairly, in all material respects, the financial position of the Company in conformity with GAAP; (ii) PwC failed to conduct its audits of the 2015 and 2016 financial statements in accordance with PCAOB; (iii) PwC did not plan and perform its audits to obtain reasonable assurance that the financial statements were accurate; (iv) PwC did not adequately examine supporting evidence, assess the accounting principles used, or evaluate the overall financial statement presentation; (v) PwC's audits did not provide a reasonable basis for PwC's opinion; and (vi) Gridsum's 2015 and 2016 financial statements were not presented in accordance with GAAP and were not audited in accordance with GAAS. ¶¶ 122-66, 211, 246-52.

III. ARGUMENT

A. Relevant Legal Standards

On a Rule 12(b)(6) motion to dismiss, a court must “accept all factual allegations in the complaint as true,” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007), and “draw[ ] all reasonable inferences in the plaintiff's favor.” Steginsky v. Xcelera Inc., 741 F.3d 365, 368 (2d Cir. 2014). 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), but the “alleged fraud . . . need not be more likely than other possibilities.” Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, 797 F.3d 160, 174 (2d Cir. 2015). This determination is “a context-specific task that requires the reviewing court to draw on its judicial experience and common sense,” Ashcroft, 556 U.S. at 679, and “[a]t this stage, dismissal is appropriate only where [plaintiffs] can prove no set of facts consistent with the complaint that would entitle them to relief,” Meyer v. JinkoSolar Holdings Co., 761 F.3d 245, 249 (2d Cir. 2014). The TAC satisfies all requisite standards.

B. The TAC's Purportedly “New” Claims Are not Time-Barred⁵

A suit alleging that a defendant violated either Section 11 or Section 12(a)(2) must be filed (a) within one year of the date that the plaintiff discovered the violation, or (b) within three years of the date that the security was offered to the public, whichever is earlier. Courts sometimes refer to the former period as a “statute of limitations” and the latter period as a “statute of repose.” See P. Stoltz Family P'ship L.P. v. Daum, 355 F.3d 92, 102 (2d Cir. 2004). Neither of these time limits bar Plaintiffs' TAC or the tax expense claims alleged therein and are certainly not applicable to the sentiment tacking services product and its related improper revenue recognition which was not revealed until January 7, 2019.

1. Plaintiffs' Claims Are not Barred by the Statute of Repose

Defendants argue that “[e]ach of the newly alleged Securities Act claims are barred by the three-year statute of repose.” See GB at 8. This argument is misplaced as these are not “new” Securities Act claims. Unlike a number of cases cited to by Gridsum and Melcher (GB at 9-10 & n.5),⁶ the TAC did not add any new counts, just like the SAC there are allegations of violations of Sections 11 and 15 of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act. Cf. SAC ¶¶ 133-53, 230-47 with TAC ¶¶ 168-88, 265-82. In fact, as further discussed below, Section 11 claims were first alleged regarding Gridsum's Offering Materials and the financial statements therein as of June 25, 2018 and have continued to be alleged in every complaint amendment since. In re Direxion Shares ETF Tr., No. 09 Civ. 8011 (KBF), 2012 U.S. Dist. LEXIS 29709, at *18-19 (S.D.N.Y. Mar. 6, 2012) (rejecting statute of repose argument as to do so “treats the TAC as if it were the original complaint-rather than the amended complaint-filed by any of the ERY plaintiffs, effectively erasing more than two year of litigation”).

Here, the Company's Registration Statement became effective on September 22, 2016 (¶ 4); therefore, the initial complaint needed to be filed on or before September 22, 2019 to be within the three year statute of repose. The complaint captioned Li v. Gridsum Holding Inc., et al., Case 1:18-cv-05749 (S.D.N.Y.) (“Li Complaint”) was filed on June 25, 2018 by plaintiff Li, who is also a named plaintiff in the SAC and TAC, well within the three year time period. The Li Complaint alleged that Gridsum's unaudited interim consolidated financial statements (which omitted the adverse tax consequences) were prepared on the same basis as the Company's audited consolidated financial statements:

On September 21, 2016, the Company filed with the SEC a Form F-1 Registration Statement which offered 6,521,740 American depositary shares of Gridsum American Depositary Shares. The Form F-1 provided Gridsum shareholders with summary consolidated statements of operations data for the six months ended June 30, 2015 and 2016, and summary consolidated balance sheet data as of June 30, 2016, which was derived from the Company's unaudited interim consolidated financial statements. The unaudited interim consolidated financial statements were prepared on the same basis as the Company's audited consolidated financial statements and include all adjustments, consisting of normal and recurring adjustments, that the Company consider necessary for a fair statement of our financial position and operating results for the periods presented.

See Li Complaint at ¶ 19 [ECF No. 1].

Plaintiff Li alleged in his complaint that the Company's summary consolidated statements of operations data for the six months ended June 30, 2015 and 2016, and summary consolidated balance sheet data as of June 30, 2016, which were incorporated into the Registration Statement, were false and misleading. See Li Complaint ¶¶ 19-20, 22, 31. Thus the allegations regarding the Company's unaudited interim consolidated financial statements are not a “new” allegation in the TAC as these allegations were pled in the Li Complaint. Plaintiffs' TAC only seeks to provide more specificity as to why these unaudited interim consolidated financial statements (compare TAC ¶¶ 64, 76, 92, 167, 192 with Li Complaint ¶¶ 19, 24, 28-30) are false and misleading. Thus, Defendants' arguments regarding tolling and relation back are of no consequence, and these claims are timely.

2. Plaintiffs' Claims Are not Barred by the Statute of Limitations

A statute of limitations period for securities violations does not begin to run until a reasonable investor would have discovered wrongdoing. In re Initial Pub. Offering Sec. Litig., No. 21 MC 92 (SAS), 01 Civ. 9741, 2004 U.S. Dist. LEXIS 26000, at *7 (S.D.N.Y. Dec. 27, 2004). It is only once there are facts, or “storm warnings,” available to an investor suggesting “the probability that she has been” the subject of wrongdoing that “a duty of inquiry arises.” Id. Here, contrary to Defendants' assertions otherwise (GB at 11-12), no such duty arose as of the date of the March 15, 2017 conference call where defendant Zhang stated that Gridsum had planned the capital structure move which triggered the tax expense (¶ 92).

a. The Standard for Inquiry Notice

Defendants argue that all of Plaintiffs' claims are time barred under Section 13 of the Securities Act because Plaintiffs had been on inquiry notice of the causes of action no later than March 15, 2017 – more than one year prior to the first filed complaint. See GB at 10-12. To demonstrate that Plaintiffs had inquiry or constructive notice, Defendants are required to present evidence of so called “storm warnings.” Staehr v. The Hartford Fin. Servs. Grp., Inc., 547 F.3d 406, 427 (2d Cir. 2008). These storm warnings must be directly related to the legal claims such that they would apprise a person of reasonable intelligence of probable wrongdoing and legal claims. Shah v. Meeker, 435 F.3d 244, 249 (2d Cir. 2006) abrogated on narrower grounds by Merck & Co. v. Reynolds, 559 U.S. 633, 653, 130 S. Ct. 1784, 176 L. Ed. 2d 582 (2010 (storm warnings exist only when the available information makes wrongdoing “probable, not merely possible”).

For courts to accept that inquiry notice exists as a matter of law at the motion to dismiss stage, a defendant must present uncontroverted evidence that the plaintiff should have discovered the wrongdoing and legal claims. See In re Initial Pub. Offering Sec. Litig., 341 F. Supp. 2d 328, 347 (S.D.N.Y. 2004) (“Unless Defendants can produce 'uncontroverted evidence [that] irrefutably demonstrates when plaintiff discovered or should have discovered the fraudulent scheme,' they cannot satisfy the heavy burden of establishing inquiry notice as a matter of law.'”).⁷

Where defendants offer reasonable words of comfort or otherwise controvert the basis for any claim, the storm warnings become “controverted” and inquiry notice is not present. In re Moody's Corp. Sec. Litig., 599 F. Supp. 2d 493, 506 (S.D.N.Y. 2009) (plaintiffs are not put on inquiry notice when they “reasonably rely” on “reliable words of comfort from management”); see also Lapin v. Goldman Sachs Grp., Inc., 506 F. Supp. 2d 221, 234 (S.D.N.Y. 2006) (“A plaintiff may not be considered to have been placed on inquiry notice, 'despite the presence of some ominous indicators,' when 'the warning signs are accompanied by reliable words of comfort from management.'”) (quoting In re Alstom SA Sec. Litig., 406 F. Supp. 2d 402, 421 (S.D.N.Y. 2005)).

It is because issues of inquiry notice are so fact intensive that they are typically not decided as a matter of law on a motion to dismiss absent extreme circumstances.⁸ For example, in In re Moody's Corp. Sec. Litig., 599 F. Supp. 2d at 506-07, Judge Kram examined an extensive record of public statements concerning potential conflicts of interest in the credit-ratings industry and held that plaintiffs were not put on inquiry notice. There, the statements cited by defendants either referred to the credit ratings industry in general without specific reference to Moody's, or else only identified “possible mismanagement of conflicts of interest,” which Judge Kram held to be insufficient to create the probability of fraud necessary to find as a matter of law that inquiry notice existed at that time. Id. at 506.

b. Defendants do not Establish Inquiry Notice

Defendants argue that “[b]y 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.” GB at 11. First, as discussed in Section III.B.1. above, these are not “new claims.” Second, any notion that unaudited interim consolidated financial statements were publicly known to be false and misleading on March 15, 2017 is absurd, as it was not until April 23, 2018 that the Company announced — and the market negatively reacted to this announcement — that the “audit report for the Company's financial statements for the year ended December 31, 2016 should no longer be relied upon.” ¶ 99. In addition, although defendant Zhang did briefly discuss the income tax expense, he then purposefully sidestepped the issue, telling the analyst that they could discuss further “offline.” ¶ 92. Therefore, Defendants have failed to “irrefutably” demonstrate that as of March 15, 2017, Plaintiffs should have been on notice. Accordingly, the claim is timely.

C. The TAC Adequately Alleges Securities Act Violations

Section 11 of the Securities Act “prohibits materially misleading statements or omissions in registration statements filed with the SEC.” In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 358 (2d Cir. 2010). If a plaintiff establishes a material misrepresentation or omission, then “Section 11 imposes strict liability on issuers and signatories, and negligence liability on underwriters.” Panther Partners Inc. v. Ikanos Commc'ns, Inc., 681 F.3d 114, 120 (2d Cir. 2012) (citing 15 U.S.C. § 77k(a)). Section 11 “places a relatively minimal burden on a plaintiff” which is met if “plaintiffs plausibly allege that [an issuer] omitted material information that it was required to disclose or made material misstatements in its offering documents.” Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 716, 718 (2d Cir. 2011).

1. The TAC's “New” Allegations do not Support Disturbing this Court's Ruling on the Inapplicability of Rule 9(b) to the Securities Act Claims

As Defendants recognize, this Court found that the SAC's Securities Act allegations did not “sound in fraud” and therefore were not held to the heightened pleading requirements of Rule 9(b). GB at 13; Order at 13. Nothing has changed with the TAC as to the clear division of the Section 11 and Section 10(b) claims to make Rule 9(b) applicable now. See Order at 14 (citing In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 632 (S.D.N.Y. 2007) (finding careful division of Section 11 and Section 10 claims and allegations only of failing to make a reasonable investigation and failing to possess reasonable belief prevents Rule 9(b) and PSLRA requirements from applying)); see also In re OSG Sec. Litig., 971 F. Supp. 2d 387, 406 & n.143 (S.D.N.Y. 2013) (“[T]he fact that the alleged misstatements supporting the Section 11 and Section 12(a)(2) claims are the same as those in the Section 10(b) claims is not dispositive. . . . To hold otherwise would discourage plaintiffs from bringing Section 10(b) and Section 11 claims in the same lawsuit”); Citiline Holdings, Inc. v. iStar Fin. Inc., 701 F. Supp. 2d 506, 513 (S.D.N.Y. 2010) (applying Rule 8(a) to the allegations against the underwriters, stating “[w]hile the CAC is replete with allegations of fraud against the iStar defendants, . . . it does not levy such charges at the underwriters”).

Defendants contend that because the “new” Section 11 claims are “repeated” in the Section 10(b) section of the TAC this is “something new.” GB at 13. It is not. The SAC incorporated the materially false and misleading statements and omissions from the Offering Materials just as the TAC does. Cf. SAC ¶ 156 and TAC ¶ 191 (“The materially false and misleading statements and omissions as described in Section V. above and the reasons for those statements falsity and materiality are expressly incorporated and re-alleged as if fully set forth herein.”). Similarly, the SAC included under its “Additional Allegations of Scienter” a section regarding the Company's IPO. Cf. SAC ¶¶ 191-92 and TAC ¶¶ 226-27. The fact that the TAC explicitly lists out why the Offering Materials were materially false and misleading (TAC ¶ 226) compared to the summary given in the SAC (SAC ¶ 191) does not change the pleading to make Rule 9(b) suddenly applicable. See GB at 13-14.

The law is clear that Plaintiffs “may plead Section 10(b) fraud and Section 11 negligence claims as alternatives, as long as the complaint is organized in a way that allows the court to determine which allegations support which claim.” In re Jumei Int'l Holding Ltd. Sec. Litig., No. 14cv9826, 2017 U.S. Dist. LEXIS 3206, at *10 (S.D.N.Y. Jan. 10, 2017); Fresno Cty. Emps.' Ret. Ass'n v. comScore, Inc., 268 F. Supp. 3d 526, 558 (S.D.N.Y. 2017) (similar). Here, the TAC, just like the SAC, plainly “demarcate[s] the § 11 claims as 'in effect a separate complaint'” and “sufficiently compartmentalized the claims into two discrete theories” (see ¶¶ 60-188, Securities Act Section and ¶¶ 189-282, Exchange Act Section). Jumei, 2017 U.S. Dist. LEXIS 3206, at *10-11; comScore, 268 F. Supp. 3d at 558 (finding Section 11 claims did not sound in fraud because plaintiffs included a disclaimer and separated the complaint into two distinct parts).⁹

Last, the use of “inconceivable” in describing the possibility that the tax expense was zero at the time of the IPO does not alter the nature of the Securities Act allegations. GB at 14-15. Section 11 requires “an untrue statement of material fact or omi[ssion].” 15 U.S.C. § 77k(a). The “inconceivable” language describes why the zero tax expense was materially false and misleading, not the Securities Act Defendants' state of mind.¹⁰

2. The TAC Pleads Actionable Misstatements and Omissions

“The federal securities laws impose an obligation on speakers to be both accurate and complete.” In re Lehman Bros. Sec. & ERISA Litig., 799 F. Supp. 2d 258, 282 (S.D.N.Y. 2011). Corporations have an obligation to disclose when “secret information renders prior public statements materially misleading.” Id. at 283. Further, “once a company speaks on an issue or topic, there is a duty to tell the whole truth,” Meyer, 761 F.3d at 250 (citing Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir. 2002)), and disclosure is required “when necessary 'to make . . . statements made, in light of the circumstances under which they are made, not misleading.'” Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 44 (2011) (quoting 17 C.F.R. §240.10b-5(b)). When such disclosure is required, a plaintiff “need only demonstrate the materiality of the omitted facts and need[s] not separately address the misleading nature of the statements that were actually made.” City of Providence v. Aeropostale, Inc., No. 11 Civ. 7132 (CM) (THK), 2013 U.S. Dist. LEXIS 44948, at *28 (S.D.N.Y. Mar. 25, 2013) (citing In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267-68 (2d Cir. 1993)). Undisclosed information “is material if there is 'a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information available.'” Time Warner, 9 F.3d at 267-68 (quotingTSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).

The Securities Act Defendants' omission of the plans triggering the tax expense and misstatement that it was zero are actionable. The TAC clearly alleges that the Offering Materials stated that Gridsum's financial statements were “prepared in accordance with U.S. GAAP” (¶¶ 76, 81) and that “reporting of the income tax expense as zero violated GAAP” (¶ 86). Specifically, pursuant to ASC 740, the Company was required to make its best estimate of the Company's annual tax for the full year and apply a proportionate amount to the six months ended June 30, 2016. ¶ 95. If the Company had done so, net losses would have been RMB 43.9 million instead of RMB 29.7 million. ¶¶ 86, 96. Not only are net losses recognized by courts as material to investors in making investment decisions, the difference here is well above the oft-cited 5% materiality mark. See In re Veeco Instruments, Inc., Sec. Litig., 235 F.R.D. 220, 234 (S.D.N.Y. 2006) (“Financial reports stating profits and losses of a company are, of course, of great interest to investors, and are ordinarily material to the decision of a shareholder to buy or sell a share.”); SAB 99, 64 Fed.Reg. 45150, 45151 (1999). In addition, the tax expense omission violated SEC guidance regarding required disclosures in the MD&A section of the Offering Materials. ¶¶ 153-58. The materiality of the tax liability and expense is corroborated by the exchange during Gridsum's March 2017 earnings conference call, where a Citigroup analyst questioned the sharp increase in the income tax expense:

<Q — Alicia Yap>: Hi. Thank you. Good morning, Guosheng, Michael and [ph] Ravi (23:51). Thanks for taking my questions and also congrats on the solid results and guidance. I have a few questions.

* * *

My second question is related to the income tax expense. I thought that previously we were guided that we probably don't need to pay the income tax until couple of years later. So, can you give us what's the change for this? Thank you.

<A — Guosheng Qi>: We'll just try to answer the question, one second, guys.

<A — Michael Peng Zhang>: Thank you, Alicia. This is Michael. Let me take the first shot. And for the full-year guidance visibility, as always, we have the better visibility for the full year as our customers, their budget is set for [ph] annual (26:03) that of a quarter. So, the visibility is as good as we previously had.

And your second question was — relate to the growth profile into different segments. Given, the relatively smaller pace for our e-Government and other segment, we expect the stronger growth profile in this segment versus our Enterprise revenue.

And relate to the tax, the tax comes from a sub-optimal structure we initially had in place to move the offshore capital to onshore entities post-IPO.

We have since put in place a more efficient structure. So, do not see this tax liability as a recurring dynamic. We can have a more detailed offline discussion about this if you want. Thank you.

Similarly, the Offering Materials' omission of the plans to launch the new sentiment tracking services product within weeks of the IPO and that Gridsum planned to recognize revenue thereon when the services were transferred to sub-distributors on a consignment basis (an improper revenue recognition method) is actionable. ¶¶ 91, 127-31, 153-58. This omission resulted in material financial restatements in the future, ¶¶ 204-12, and this Court has already found that the restatement of the 2016 financials was material (Order at 22-23), thus the omission of these “plans” was a material omission as of the IPO in September of 2016.

The TAC also adequately pleads actionable misstatements and omissions relating to the Offering Materials' inadequate disclosure of material weaknesses over internal controls. This Court found the SAC's allegations lacking because of a failure to allege “what the other material weakness were or could have been.” Order at 17. In addition to the material weaknesses already causing the issuance of the materially false and misleading income tax expense and net losses as of June 30, 2016 (see immediately above), the TAC now includes relevant revelations from the Company in its restatement explaining that there were additional material weaknesses relating to the “the lack of written policies and procedures sufficiently to timely record revenues and expenses in our financial statements” (¶ 117) and control deficiencies with, inter alia, “verification of certain revenue items” and “documentation supporting certain transactions” (¶ 121).

3. The Defendants' Arguments Are Unavailing

a. Gridsum, Melcher, Chui, and the Underwriter Defendants' Arguments Against the Sufficiency of the Claims Under the Securities Act All Fail

Gridsum and Melcher's arguments against the sufficiency of the Securities Act allegations present nothing more than an improper and unavailing counter-narrative, and ignore that the Court must consider Plaintiffs' well-plead facts as true and “draw[ ] all reasonable inferences in favor of the [P]laintiff[s].” Meyer, 761 F.3d at 249. First, Gridsum and Melcher incorrectly state that the income tax expense allegation is unsupported by any accounting rules. GB at 15. This blatantly ignores the TAC's allegations that the failure to include a proportionate amount of the income tax expense violated ASC 740 and SEC regulations regarding disclosures in the MD&A section. ¶¶ 95, 153-58.

Second, Gridsum and Melcher ask this Court to interpret defendant Zhang's statements in a manner wholly inconsistent with the allegations in the TAC. GB at 15-16. Not only is this “battle of competing inferences” inappropriate, these defendants' self-serving interpretation is not reasonable and inserts inconsistent facts. Iowa Pub. Emps. Ret. Sys. v. Merrill Lynch, Pierce, Fenner & Smith Inc., 340 F. Supp. 3d 285, 313 (S.D.N.Y. 2018) (“The parties' dispute on this issue amounts to a battle of competing inferences. . . . [but] [o]n a motion to dismiss, the Court must draw 'all reasonable inferences in the plaintiff's favor[.]'”) (quoting Doe v. Columbia Univ., 831 F.3d 46, 48 (2d Cir. 2016)); In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281, 332-33 (S.D.N.Y. 2003) (rejecting defendants' attempts to “rewrite[e] the [c]omplaints in a way that they believe favors dismissal”; “[d]efendants must take the [c]omplaints as they are written”).

Similarly, while under a narrow exception, the Court may consider a document integral to the TAC (GB at 16-17; see also Mangiafico v. Blumenthal, 471 F.3d 391, 398 (2d Cir. 2006)), Gridsum and Melcher go far beyond what is appropriate, asking the Court to consider the March 15, 2017 earnings conference call transcript to “prove the truth of the contents.” Roth v. Jennings, 489 F.3d 499, 509 (2d Cir. 2007) (holding that in a securities fraud action the court could consider SEC filings referenced in the complaint on a Rule 12(b)(6) motion, but not for the truth of the matters asserted therein). Gridsum and Melcher are attempting to do exactly what the Ninth Circuit recently warned is unacceptable: “If defendants are permitted to present their own version of the facts at the pleadings stage — and district courts accept those facts as uncontroverted and true — it becomes near impossible for even the most aggrieved plaintiff to demonstrate a sufficiently 'plausible' claim for relief. Such undermining of the usual pleading burdens is not the purpose of judicial notice or the incorporation-by-reference doctrine.” Khoja v. Orexigen Therapeutics, Inc., 899 F.3d 988, 999 (9th Cir. 2018).

As alleged, defendant Zhang stated that “the tax comes from a sub-optimal structure we initially had in place to move the offshore capital to onshore entities post-IPO.” While defendants may wish to interpret the statement differently to avoid liability, a plain reading and reasonable inference is that the structure change was planned prior to the IPO, to be instituted post-IPO. ¶¶ 92-93.¹¹ In addition, Gridsum and Melcher conveniently avoid the additional allegation supporting this reasonable inference – that Zhang did not want to publicly elaborate on the details giving rise to the tax liability and offered to discuss it offline. ¶¶ 92-93. As plainly alleged, the tax expense accrued pre-IPO, but Gridsum failed to correctly account for it pursuant to GAAP until “post-IPO.” ¶¶ 92-98.¹²

Relatedly, and contrary to Gridsum and Melcher's argument otherwise (GB at 17-19), there was a duty to disclose the “plans” to restructure capital. As Gridsum and Melcher note, a duty to disclose arises “when additional information is needed to make another statement . . . not misleading.” GB at 17-18 (quoting In re Morgan Stanley Tech. Fund Sec. Litig., 643 F. Supp. 2d 366, 375 (S.D.N.Y. 2009)). Here, the omission of the “plans” made the reported income tax expense and, more importantly, the net losses misleading, understating the net losses by 47.78%. ¶¶ 96, 158. Contrary to the claim that the potential tax liability “would have no effect on what was disclosed for the first half of the year” (GB at 18), the TAC plainly states that in accordance with ASC 740, it in fact would have had an effect. ¶¶ 95-96. The same can be said for the allegations relating to the Company's “plan to launch a new sentiment tracking services product” (GB at 18-19). The omission of the sentiment tracking services product and its improper revenue recognition methods resulted in material restatements of the 2016 financials. ¶¶ 204-12. This is exactly a case where the TAC pleads that the “launch of one its products” affected the Company's performance “in a way that rendered Defendants' statements about the financial condition of the [C]ompany misleading at the time they were made” (i.e., the improper revenue recognition which would necessitate a financial restatement). GB at 19 (quoting In re Travelzoo Inc. Sec. Litig., No. 11 Civ. 5531 (GBD), 2013 U.S. Dist. LEXIS 46437, at *19 (S.D.N.Y. Mar. 29, 2013)).

Additionally, in arguing against a “duty to disclose,” Gridsum and Melcher fail to address that the TAC pleads that the SEC regulations require disclosure of “known trends or known demands, commitments, events or uncertainties” that are reasonably likely to cause previously reported financial information not to be indicative of future operating results such as the “plans” to change the structure and to launch the sentiment tracking services product while improperly recognizing revenue on it. ¶¶ 153-58.¹³

Third, Gridsum and Melcher's materiality argument fails. GB at 19-21. Notably, Gridsum and Melcher only argue materiality as to the income tax expense misstatement. To make the argument, these defendants again ignore and misconstrue the TAC's allegations, claiming that there is no accounting rule that required the reporting of the income tax expense as it did not occur until after the IPO. GB at 20. As stated above, it is plainly alleged and reasonable to infer that defendant Zhang's statement during the March 15, 2017 conference call was an admission that the Company planned the move of the offshore capital prior to the IPO (¶¶ 92-93) and that ASC 740 requires companies to make estimates of annual tax expenses and apply the estimate proportionately to the interim financials (¶¶ 95-96).

Gridsum and Melcher's second attempt at discounting the materiality of the income tax misstatement and omission by relying on the fact that the 2017 restatement reduces it basically claims that “two wrongs make a right.” The fact that the restatement led to a lower overstatement does not mean that the omission of any tax liability was not material. If Gridsum had accounted for income tax expense based on the financials they released at the time of the IPO, the net losses would have been materially higher.¹⁴ ¶ 96; Veeco Instruments, 235 F.R.D. at 234 (“Financial reports stating profits and losses of a company are, of course, of great interest to investors, and are ordinarily material to the decision of a shareholder to buy or sell a share.”); In re Electrobras Sec. Litig., 245 F. Supp. 3d 450, 465 (S.D.N.Y. 2017) (“In other words, prior annual reports understated expenses and overstated earnings, thereby implicating whether such misstatements in the previous annual reports 'mask[ed] a change in earnings or other trends' or 'change[d] a loss into income or vice versa.'”). Even as restated, there was a material understatement of net losses by 24.9% (¶ 88), and the Company gave no justification for the restated decrease (¶ 94 n.3). EP Medsystems, Inc. v. Echocath, Inc., 235 F.3d 865, 882 (3d Cir. 2000) (“necessary information . . . lies in the defendant's hands” and “without having been given the opportunity to conduct any discovery” the “allegations are sufficient”). The large misstatement of net losses, whether initially or as of the restatement, is clearly material and “in the context of the company's 'total operations.'” GB at 21; Order at 16 (quoting Taback v. Canadian Solar Inc., 549 F. App'x 24, 27 (2d Cir. 2013)). And, the fact that an analyst questioned the Company about the tax expense further adds to its materiality. Electrobras, 245 F. Supp. 3d at 464 (“the Second Circuit Court of Appeals has explained that courts must fully analyze 'all relevant considerations' when assessing materiality” and “[u]nder the holistic analysis endorsed by the Court of Appeals, sufficiently strong qualitative evidence of materiality can establish materiality as a matter of law”).

b. PwC's Arguments Against the Sufficiency of the Claims Under the Securities Act All Fail

PwC claims that the TAC fails to identify a false or misleading statement or omission attributable to it because the income tax expense occurred in 2016 and should have been included on the Company's unaudited interim financial statements which PwC did not issue a report on. PB at 8-9. As the TAC alleges, PwC's 2015 Audit Report is actionable because PwC did not complete its audit until March 9, 2016, and then performed additional audit procedures through August 19, 2016, well into 2016 when the income tax expense had been planned. ¶¶ 92-98, 159. Further, PwC was under an obligation pursuant to AU § 711 to be kept advised of the IPO registration progress and update “subsequent events” at or near the effective date. ¶ 164. In addition, PwC was required by AU § 560 to read the latest available interim financial statements and inquire whether they had been prepared on the same basis as those under the audit, and inquire about numerous other financial and accounting matters. ¶ 165. Gridsum's notes to the financial statements as of and for the year ended December 31, 2015 (and the six months ended June 30, 2016) contained the material omissions as described above at Section III.C.2., and therefore, PwC's 2015 Audit Report was materially false and misleading as well.

The 2015 Audit Report was a statement of fact, not opinion. See also Section III.E. And, even if viewed as an opinion, the 2015 Audit Report (and the financial statements it was based on) omitted information making the purported opinion misleading to a reasonable person. Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318, 1327, 1332 (2015). An opinion statement is actionable if “it is formed on the basis of an omitted fact, not disclosed by the speaker, that would likely conflict with a reasonable investor's own understanding” of the underlying situation. In re BioScrip, Inc. Sec. Litig., 95 F. Supp. 3d 711, 728-29 (S.D.N.Y. 2015) (citing Omnicare, 135 S. Ct. at 1328-29). PwC did not include the “subsequent events,” the planned capital move of offshore capital triggering the income tax expense¹⁵ (¶¶ 85-88, 92-96, 131, 163, 166) or the imminent launch of the new sentiment tracking services product (¶¶ 91, 131, 143, 163, 166). These omissions conflicted with a reasonable investor's understanding of Gridsum's then-current financial condition and prospective financial condition.

4. The Control Person Claims are Sufficiently Pled

The TAC clearly pleads a primary violation of Section 11, and thus Melcher and Chui's arguments that the Section 15 claims fail for the lack of primary violation are inapposite. GB at 21; CB at 5-6. The TAC pleads the necessary elements of a Section 15 claim (¶¶ 182-88) and neither Melcher nor Chui deny that they signed or authorized the signing of the Registration Statement.

D. The TAC Adequately Alleges Exchange Act Claims Against Gridsum, Melcher, and Chui Based on the Amended Allegations Relating to the Offering Materials

The Exchange Act claims explicitly incorporate the false and misleading statements made in the Registration Statement and state that Gridsum, Melcher, and Chui are makers of those misstatements:

Gridsum, the Individual Defendants (with the exception of Sarathy), and PwC are makers of the statements contained in the Offering Materials. Gridsum is the issuer of the statements, each of the Individual Defendants (with the exception of Sarathy) signed his name to those statements, indicating that he was a maker thereof, and PwC as the auditor of Gridsum's financial statements consented to the inclusion of its expert report and opinion. The materially false and misleading statements and omissions as described in Section V. above and the reasons for those statements falsity and materiality are expressly incorporated and re-alleged as if fully set forth herein.

¶ 191; see also ¶¶ 267-68; Refco, 503 F. Supp. 2d at 632 (even if defendants “were engaged in a massive fraud[, t]his fact . . . does not take away plaintiffs' right to plead in the alternative that defendants violated provisions requiring only negligence”).

As discussed above at Section III.C., the Registration Statement was materially false and misleading due to, inter alia, omissions regarding Gridsum's income tax expense and sentiment tracking services product. As signatories to those statements, Melcher¹⁶ and Chui “made” the misstatements and are liable under Section 10(b) of the Exchange Act. See also Pl. Opp. to MTD SAC at 16-24 (discussing the adequate pleading of a strong inference of scienter) and Order at 19-22 (finding scienter adequately pled).

1. The Court has Personal Jurisdiction Over Chui

On a Rule 12(b)(2) motion to dismiss for lack of personal jurisdiction, “the plaintiff bears the burden of showing that the court has jurisdiction over the defendant.” Metropolitan Life Ins. Co. v. Robertson-Ceco Corp., 84 F.3d 560, 566 (2d Cir. 1996). Plaintiffs can satisfy this burden by alleging personal jurisdiction generally, without asserting a particular basis for the court's personal jurisdiction over a defendant. Merial Ltd. v. Cipla Ltd., 681 F.3d 1283, 1296 (Fed. Cir. 2012) (complaint asserting jurisdiction “by virtue of [defendants] actions . . . within this State and judicial district, or his systematic and continuous contact with this State and judicial district” was sufficient to allow the court to determine whether the forum's jurisdictional requirements were met). The Court should “construe the pleadings and affidavits in the light most favorable to plaintiffs, resolving all doubts in their favor.” Dorchester Fin. Sec., Inc. v. Banco BRJ, S.A., 722 F.3d 81, 85 (2d Cir. 2013).

Chui ignores that the Exchange Act “permits the exercise of personal jurisdiction to the limit of the Due Process Clause. . . .” SEC v. Unifund SAL, 910 F.2d 1028, 1033 (2d Cir. 1990); Alstom, 406 F. Supp. 2d at 398; In re Poseidon Concepts Sec. Litig., No. 13cv1213 (DLC), 2016 U.S. Dist. LEXIS 68127, at *19 (S.D.N.Y. May 24, 2016) (holding the Canadian auditor of a Canadian company with U.S. operations was subject to personal jurisdiction under the Exchange Act); see also 15 U.S.C. § 78aa. This broad standard permits the exercise of jurisdiction over a defendant whose “conduct and connection with the [United States] are such that he should reasonably anticipate being haled into court there.” Unifund SAL, 910 F.2d at 1034 (quoting World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286, 297 (1980)); see also Szulik v. Tag V.I., Inc., 858 F. Supp. 2d 532, 540 (E.D.N.C. 2012) (“Section 78aa confers on federal district courts personal jurisdiction over any defendant that has minimum contacts with the United States”); SEC v. Mgmt. Dynamics, Inc., 515 F.2d 801, 812 (2d Cir. 1975) (Section 20(a) of the Exchange Act has been read liberally and its “provisions were enacted to expand, rather than restrict, the scope of liability under the securities laws”).¹⁷

The due process jurisdictional inquiry has two parts — the “minimum contacts” inquiry and the  “reasonableness” inquiry. See Metropolitan Life, 84 F.3d at 567. Under the minimum contacts analysis, “[s]pecific jurisdiction exists when 'a State exercises personal jurisdiction over a defendant in a suit arising out of or related to the defendant's contacts with the forum.'” Id. at 567-68 (citing Helicopteros Nacionales de Colombia, S.A. v. Hall, 466 U.S. 408, 414-16 & n. 8-9 (1984)); see also In re Parmalat Sec. Litig., 376 F. Supp. 2d 449, 454-55, 457 (S.D.N.Y. 2005) (jurisdiction favored by “the interest of the United States in securing relief . . . for U.S. citizens injured here in consequence of any violations of the federal securities laws by officials of a foreign company”); Alstom, 406 F. Supp. 2d at 399 (“A state has power to exercise judicial jurisdiction over an individual who causes effects in the state by an act done elsewhere with respect to any claim arising from these effects”); Restatement (Second) of Conflict of Laws § 37 (1988).

a. The Minimum Contacts Inquiry is Satisfied by Chui's Active Involvement in Gridsum's Corporate Affairs and the Alleged Wrongdoing

Where, as here, a controlling shareholder or director is alleged to be so entrenched in a company's fraudulent behavior that had an effect on the Company's securities, courts have held that the controlling shareholder or director has established the necessary minimum contacts. San Mateo Cty. Transit Dist. v. Dearman, Fitzgerald, & Roberts, Inc., 979 F.2d 1356, 1358 (9th Cir. 1992) (finding jurisdiction over non-domiciliary defendant under the Exchange Act who is alleged to have controlled a person liable for securities fraud). Additionally, “[i]f the suit is to enforce a liability created by the Securities Act, the court has jurisdiction of the defendant wherever he may be found.” Id.; Derensis v. Coopers & Lybrand Chartered Accountants, 930 F. Supp. 1003, 1014 (D.N.J. 1996); McNamara v. Bre-X Minerals, Ltd., 46 F. Supp. 2d 628, 636 (E.D. Tex. 1999) (“the Court has personal jurisdiction over any Defendant as to which the Plaintiffs make a prima facie showing of control person liability”); Landry v. Price Waterhouse Chartered Accountants, 715 F. Supp. 98, 102 (S.D.N.Y. 1989) (plaintiff has made “the requisite prima facie showing that he was a “control person” of Calgroup and thus amenable to suit in this forum) (emphasis in original); Unifund SAL, 910 F.2d at 1033 (minimum contact satisfied where non-domiciliary's actions had a “rather direct and an unmistakably foreseeable effect within the United States”).

Chui's argument that he personally did not participate in Gridsum's misstatements after he left the Company is irrelevant. CB at 7-8, 10. The TAC does not allege liability against Chui for the 2016 financial statements or the April 2018 Press Release. ¶ 269. Chui, however, did sign Gridsum's Registration Statement which is expressly incorporated into the Exchange Act claims as discussed further above, and which permitted the Company access to the U.S. equity markets and investors. ¶¶ 6, 29, 191. Even a single act may be enough to establish jurisdiction if it demonstrates that the defendant “availed itself of the privilege of doing business in the forum and could foresee being haled into court there.” In re Poseidon, 2016 U.S. Dist. LEXIS 68127, at *21 (finding jurisdiction over a Canadian auditor that engaged in an audit of a Canadian company with U.S. operations) (quoting Eades v. Kennedy, PC Law Offices, 799 F.3d 161, 169 (2d Cir. 2015) (upholding jurisdiction over a non-domiciled defendant in New York based on just three contacts with the State). Thus, Chui is strictly liable for the material omissions of fact and materially untrue and misleading statements incorporated into the Registration Statement under the Securities Act and is also liable under the Exchange Act.¹⁸ ¶ 63.

b. Exercise of the Court's Jurisdiction Over Chui Is Reasonable

“Where the plaintiff has made a prima facie showing of minimum contacts under the first prong, the exercise of personal jurisdiction is favored unless the defendant makes a showing that an exercise of jurisdiction is unreasonable.” Alstom, 406 F. Supp. 2d at 398 (citing Metropolitan Life, 84 F.3d at 568) (emphasis in original). In this phase, the burden “shifts to the defendant to show that the exercise of jurisdiction would nonetheless be so unreasonable as to “offend 'traditional notions of fair play and substantial justice.'” In re LIBOR-Based Fin. Instruments Antitrust Litig., No. 11 MDL 2262 (NRB), 2015 U.S. Dist. LEXIS 147561, at *158-60 (S.D.N.Y. Oct. 19, 2015) (quoting Asahi Metal Indus. Co. v. Super. Court of Cal., 480 U.S. 102, 113 (1987)). “[A] defendant must present a compelling case that the presence of some other considerations would render jurisdiction unreasonable. Parmalat, 376 F. Supp. 2d at 457. In evaluating the reasonableness of exercising personal jurisdiction over a defendant, a court may weigh five factors: (1) the burden that the exercise of jurisdiction will impose on the defendant; (2) the interests of the forum state in adjudicating the case; (3) the plaintiff's interest in obtaining convenient and effective relief; (4) the interstate judicial system's interest in obtaining the most efficient resolution of the controversy; and (5) the shared interest of the states in furthering substantive social policies.¹⁹ Id. However, “once minimum contacts are established, the interests of the forum and the plaintiff justify even large burdens on the defendant.” Wien Air Alaska, Inc. v. Brandt, 195 F.3d 208, 215 (5th Cir. 1999). “Jurisdiction is favored where the plaintiff has made a threshold showing of minimum contacts at the first stage of the inquiry.” Oneida Sav. Bank v. Uni-Ter Underwriting Mgmt. Corp., No. 5:13-CV-746 (MAD/ATB), 2014 U.S. Dist. LEXIS 130677, at *56 (N.D.N.Y. Sept. 18, 2014); Asahi, 480 U.S. at 116 (Brennan, J., concurring) (finding that only in “rare cases” will inconvenience defeat the reasonableness of jurisdiction).

First, Chui's assertion that it would be a “tremendous burden” simply because he lives in China (CB at 10) has been summarily dismissed by courts. See, e.g., In re Banco Bradesco, 277 F. Supp. 3d at 645 (denying argument that it would be a burden because of the “inconvenience of litigating in a foreign forum” and stating that “[i]n the absence of some particular argument by [the defendant] about the inconvenience this litigation would pose, the Court cannot conclude that this is the 'rare case' in which inconvenience is 'so substantial as to achieve constitutional magnitude.'”). The fact of the current pandemic does not support Chui's burden argument. CB at 10. Indeed, in light of the pandemic, attorneys and courts have begun using telephonic or video mechanisms far more than before, making Chui's need to travel less likely. On the second and third factors, “the United States has a strong interest in enforcing its own securities laws and protecting U.S. markets, and the plaintiffs have a strong interest in pursuing their claims in a United States court.” Poseidon, 2016 U.S. Dist. LEXIS 68127, at *22-23; Parmalat, 376 F. Supp. 2d at 457 (“most notably the interest of the United States in securing relief, if it ultimately is appropriate, for U.S. citizens injured here in consequence of any violations of the federal securities laws by officials of a foreign company that accessed our capital markets” supports the conclusion that jurisdiction is reasonable) Without this Court's jurisdiction, Company stockholders would be left without recourse against Chui for his participation in the alleged wrongdoing.

2. Chui Is a Control Person Under Section 20(a)

As stated above, because the TAC plainly pleads that the Registration Statement's materially false and misleading statements and omissions are incorporated into the Exchange Act claims and Chui does not deny that he signed the Registration Statement (nor can he), making him a “maker” of those statements, he can be held liable under both Sections 10(b) and 20(a) the Exchange Act. City of Roseville Emps.' Ret. Sys. v. EnergySolutions, Inc., 814 F. Supp. 2d 395, 417 (S.D.N.Y. 2011) (“Individual Defendants who signed the Registration Statements 'made' the statements under Janus.”); see also In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 392, 415-16 (S.D.N.Y. 2003) (“A short, plain statement that gives the defendant fair notice of the claim that the defendant was a control person and the ground on which it rests its assertion that a defendant was a control person is all that is required.”); Katz v. Image Innovations Holdings, Inc., 542 F. Supp. 2d 269, 276 (S.D.N.Y. 2008) (control sufficiently pled where defendants were directors who signed 10-K with false statements, one was on the audit committee, and noting that such analysis is fact-intensive and should not be resolved on a motion to dismiss).

E. The TAC Adequately Alleges Claims Under the Exchange Act Against PwC

1. The TAC Alleges Actionable Misstatements and Omissions

In its Order, the Court found that the SAC “properly pleads scienter and materiality” as to the 2016 financials and the April 2018 Press Release. Order at 18-23. PwC's substantive Exchange Act arguments were not discussed, as the Court granted PwC's motion based on lack of jurisdiction. Id. at 23.

a. PwC's Audit Reports²⁰ Were Materially False and Misleading

Plaintiffs adequately alleged that the 2016 financial audit omitted material facts that make its purported opinion “misleading to a reasonable person reading the statement fairly and in context.” In re Lehman Bros. Sec. Litig., 131 F. Supp. 3d 241, 254 (S.D.N.Y. 2015); In re Petrobras Sec. Litig., 14-cv-9662, 2016 U.S. Dist. LEXIS 21036, at *15-16 (S.D.N.Y. Feb. 18, 2016). PwC wholly ignores the well-plead allegations discussed above in arguing that the TAC fails to “call into question the issuer's basis for offering the opinion.” PB at 18. This is exactly what the TAC does. The nature of premature revenue recognition indisputably shows that auditing procedures were not performed, calling into question the basis for PwC's opinion.

Plaintiffs allege, inter alia, that PwC's audit report for the 2016 financials failed to disclose that the consolidated balance sheet and the related consolidated statements of operations and comprehensive loss, of shareholders' deficit and of cash flows did not present fairly, in all material respects, the financial position of the Company at December 31, 2015 and 2016, and the results of operations and cash flow for each the two years in the period ended December 31, 2016 in conformity with GAAP; PwC failed to conduct its audits of the 2015 and 2016 financial statements in accordance with the standards of PCAOB; PwC did not plan and perform its audit to obtain reasonable assurance about whether the financial statements were free from material misstatements; PwC did not adequately examine evidence supporting the amounts and disclosures in the financial statements, assess the accounting principles used, or evaluate the overall financial statement presentation, and PwC's audits did not provide a reasonable basis for PwC's opinion; and Gridsum's 2015 and 2016 financial statements were not presented fairly in accordance with GAAP and were not audited in accordance with GAAS. ¶ 211. See, e.g., In re Am. Realty Capital Props., 15 mc 40, 2019 U.S. Dist. LEXIS 79563, at *33-34 (S.D.N.Y. May 10, 2019) (allegations that auditor knew of potential accounting issues and failed to address them as required by applicable standards, coupled with auditor's statement that it complied with applicable standards, was sufficient to allege Section 11 claim). In addition, contrary to PwC's statement otherwise, PB at 9, 15, while PwC did not withdraw its 2015 Audit Report, Gridsum's new auditor did issue a new opinion on the 2015 financials.

Further, although PwC and Gridsum disclosed that Gridsum lacked sufficient financial reporting and accounting personnel with appropriate knowledge of GAAP and SEC reporting requirements, PwC failed to disclose that it did not alter its accounting methodology to address this shortcoming. A reasonable investor would assume that an auditor, with knowledge that the issuer had a material weakness in its financial reporting and accounting departments, would either perform an audit designed to address those weakness (as required by applicable accounting standards)²¹ or refuse to issue a clean audit opinion.

b. PwC's Audit Reports Were Statements of Fact, Not Opinion

PwC conflates the issues by focusing on the truth of its audit report (although the truth as to PwC's compliance with PCAOB and GAAS was false), as opposed to Gridsum's underlying false financial statements. The false statements at issue are Gridsum's financial statements themselves. See, e.g., OSG, 971 F. Supp. 2d at 399; Yang v. Tibet Pharm., Inc., No. 14-3538 (FSH), 2015 U.S. Dist. LEXIS 20463, at *7 (D.N.J. Feb. 20, 2015). If the financials reported in the financial statements are not opinions, then the auditor is liable if the certification of the financials is inaccurate. Indeed, there is no conceivable basis under which one might consider Gridsum's income statement amounts for revenue, equity, net loss, etc. as statements of opinion.

Nevertheless, just as it did in OSG, PwC argues that its audit of Gridsum is an opinion “because it contains the word 'opinion,' and prefaces its conclusions with the phrase 'in our opinion.'” OSG, 971 F. Supp. 2d at 399; see PB at 12-13. The OSG court correctly rejected this argument because “it would render Section 11 meaningless to find that an accountant's liability turns on this semantic choice. Auditors may not shield themselves from liability under Section 11 merely by using the word 'opinion' as a disclaimer.” Id. This Court should reject the argument as well.

In Omnicare, the Supreme Court rejected an issuer's attempt to avoid the strict liability imposed under Section 11 by arguing that its allegedly false statements were pure opinions requiring plaintiffs to plead with particularity that the issuer did not actually believe the opinions it professed. Omnicare, 135 S. Ct. at 1328-29. Addressing Section 11's omission clause, the Court held that plaintiffs could show that an opinion was false without allegations about the speaker's subjective belief, because “a reasonable investor may, depending on the circumstances, understand an opinion statement to convey facts about how the speaker has formed the opinion — or, otherwise put, about the speaker's basis for holding that view. And if the real facts are otherwise, but not provided, the opinion statement will mislead its audience.” Id. at 1328. That is especially so when opinions incorporate financial statements, like PwC's audits, where “investors do not, and are right not to, expect opinions contained in those statements to reflect baseless, off-the-cuff judgments” and “where — as in a registration statement — a speaker 'holds himself out or is understood as having special knowledge of the matter which is not available to plaintiff.'” Id. at 1330.

PwC also argues that its statements of compliance with PCAOB and GAAS standards are likewise opinions. PB at 14-15. But as the court in Miller Inv. Tr. v. Morgan Stanley & Co., LLC, 308 F. Supp. 3d 411, 429-31 (D. Mass. 2018) noted, “[s]everal other courts have implied that they would be open to considering a statement of PCAOB/GAAS compliance to be a statement of fact.” Id. at 430 (citingDeephaven Private Placement Trading, Ltd. v. Grant Thornton & Co., 454 F.3d 1168, 1175-76 (10th Cir. 2006); Edward J. Goodman Life Income Tr. v. Jabil Circuit, Inc., 595 F. Supp. 2d 1253, 1282 (M.D. Fla. 2009), aff'd, 594 F.3d 783 (11th Cir. 2010); see also MHC Mut. Conversion Fund, L.P. v. Sandler O'Neill & Partners, L.P., 761 F.3d 1109, 1117 n.6 (10th Cir. 2014)). Under the Miller Court's analysis, “[i]n the wake of Omnicare, . . . statements by auditors of their own compliance with the PCAOB standards or GAAS are statements of fact” because “[t]here is no reason that an auditor cannot state with certainty that it followed the PCAOB standards and the GAAS therein as it understood them, including that it exercised the independent judgment that is required by those standards.” Miller, 308 F. Supp. 3d at 430. The Miller Court concluded that “[b]ecause a statement of compliance with the PCAOB standards is one of fact, [the plaintiff] need only show, through well-pleaded allegations satisfying the heightened standards of the PSLRA and Rule 9(b), that [the auditor] failed to perform its audits in compliance with the PCAOB standards.” Id. at 431; see also In re Wash. Mut., Inc. Sec., Derivative & ERISA Litig., 694 F. Supp. 2d 1192, 1224 (W.D. Wash. 2009) (“Whether or not [auditor] employed the PCAOB standards is a verifiable factual statement that is material to those relying on its certification of [plaintiff's] internal controls”); Tibet Pharm., 2015 U.S. Dist. LEXIS 20463, at *12-13 (“Plaintiffs have also alleged that ACSB's audit report stated that it was “conducted . . . in accordance with the standards of the Public Company Accounting Oversight Board" and that this statement was materially and objectively false: the complaint alleges that ACSB failed to exercise such appropriate professional care and judgment — for example, that ACSB did not verify basic information within the financial statement against Tibet's bank statements, lenders, regulatory filings, or public records.”). Plaintiffs have done so here.

As detailed in Plaintiff's October 4, 2019 Letter Response (ECF No. 173) to PwC's September 20, 2019 Letter Regarding Supplemental Authority in Support of PwC's Motion to Dismiss the SAC (ECF No. 171), In re AmTrust Fin. Servs., Inc. Sec. Litig., No. 17-cv-1545 (LAK), 2019 U.S. Dist. LEXIS 153297 (S.D.N.Y. Sept. 9, 2019) is readily distinguishable. Under AmTrust, even if a statement of compliance with PCAOB standards is viewed as a statement of opinion, that statement will still be actionable if the plaintiff has alleged it was a misstatement of opinion by demonstrating that “it is plausible that [the auditor] disbelieved the statement that the audit was conducted in accordance with the relevant PCAOB standards,” and that the misstatement is material. Id. at *94-*95. Here, the Court has already held that the SAC properly pleads materiality as to the 2016 financials, and the TAC does allege “facts relevant to the way or ways in which [the auditor's] failure to supervise, review, document, and perform in good faith the [ ] audit would have been significant to a reasonable investor.” Id. at *34. The TAC states that if PwC had reviewed the purported sales agreements as it was required to do under the PCAOB they could not have avoided learning of the fictious sales (¶¶ 141, 246) and that PwC failed to perform basic auditing procedures which resulted, for example, in accounts payable being understated by RMB 37.41 million for 2016, an undeniably material understatement of 307.9% (¶ 206).

c. Even if PwC's Audit Reports Are Opinions, They Still Contain Embedded Facts that are Untrue

In Omnicare, the Supreme Court held that a defendant can be held liable for an opinion, even if the defendant honestly believed in the opinion, if the opinion contains “embedded statements of facts” that are untrue. Omnicare, 135 S. Ct. at 1326-1330. Plaintiffs adequately alleged that PwC's 2016 Audit Report was false and misleading because the report embedded the false and misleading facts contained in Gridsum's financial statements and omissions. See, e.g., Petrobras, 2016 U.S. Dist. LEXIS 21036, at *14-15 (“the facts of the financial statements were embedded in PwC's audit opinions”); Lehman Bros., 131 F. Supp. 3d at 260 (“Accountants may be found liable under Section 11 for portions of registration statements that they audited.”); Special Situations Fund III QP, L.P. v. Marrone Bio Innovations, Inc., 243 F. Supp. 3d 1109, 1124 (E.D. Cal. 2017) (complaint states Section 11 claim against auditor for certifying false financial statements in registration statement).

In Petrobas, the court explained:

PwC's audit opinions that “the accompanying consolidated [financial] statement[s] . . . present fairly, in all material respects, the financial position of [the issuer]” rested on the underlying facts contained in the financial statements. Similarly, PwC stated that its audit opinions were based on “examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.” Id. The facts of the financial statements were embedded in PwC's audit opinions.

2016 U.S. Dist. LEXIS 21036, at *14. PwC's audit opinion here contains the identical embedded facts, stating, “the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive loss, of shareholders' equity/(deficit) and of cash flows present fairly, in all material respects, the financial position of Gridsum Holding Inc.” ¶ 199. In addition, PwC states that the audit opinions were based on “examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.” Id.

In Lehman Bros., the court noted that Section 11 expressly provides a cause of action against any “accountant” who, with his consent, certifies any part of the registration statement. 131 F. Supp. 3d at 259. “It is difficult to imagine what Congress might have meant by an accountant's certification if not auditor's opinions such as those at issue in this case.” Id. at 259-60 (finding that an auditor may be liable under Section 11 for “its own audit opinions and 'for the false and materially misleading statements made by [the issuer] in its financial statements'”); OSG, 971 F. Supp. 2d at 399 (same). As stated in Petrobras, “audit opinions would be of no use to anyone if [the auditor] announced, without any basis in the content of the financial statements or other evidence, that a company's presentation of its financial health was sound.” 2016 U.S. Dist. LEXIS 21036, at *15; see also Marrone Bio, 243 F. Supp. 3d at 1116, 1118 n.6 (stating that “audit opinions are not of the same substance as those discussed in Omnicare” and “no amount of couching an audit report as an opinion obviates the certification effect of those reports when made part of a registration statement” and expressly disagreeing with Johnson v. CBD Energy, Ltd., C.A. H-15-1668, 2016 U.S. Dist. LEXIS 8714 (S.D. Tex. July 6, 2016) relied upon by PwC at PB at 13 n.3). Importantly, the false statements in the financial statements are verifiable facts, not opinions, making PwC's argument under Omnicare entirely beside the point.

This Court's decision in Special Situations, 33 F. Supp. 3d 401, is not in conflict. See PB at 13. Neither the trial court in Special Situations, decided before Omnicare, nor the appellate court addressed whether the audit opinion in question “embedded” the facts of the financial statement, instead noting that plaintiff failed to adequately allege that the auditor was aware of facts contradicting its opinion. Special Situations, 33 F. Supp. 3d 401, aff'd 645 F. Appx'x 72. See also In re Puda Coal Sec., Inc., 30 F. Supp. 230, 259-60 (S.D.N.Y. 2014);Querub v. Moore Stephens Hong Kong, 649 F. App'x 55 (2d Cir. 2016) (each failing to address the “embedded facts” factor).

2. The TAC Adequately Alleges a Strong Inference of PwC's Scienter

Plaintiffs can allege auditor scienter “by alleging facts to show either (1) that defendants had the motive and opportunity to commit fraud, or (2) strong circumstantial evidence of conscious misbehavior of recklessness.” Ret. Bd. of the Policemen's Annuity & Benefit Fund of Chi. v. FXCM Inc., 767 F. App'x 139, 141 (2d Cir. 2019) (citingECA, Local 134 IBEW Joint Pension Tr. of Chi. v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009)).²² As the Second Circuit explained, “[a]n egregious refusal to see the obvious, or to investigate the doubtful, may in some cases give rise to an inference of . . . recklessness.” Chill v. GE, 101 F.3d 263, 269 (2d Cir. 1996). Under this standard, sufficient evidence of recklessness exists where factual allegations demonstrate that auditor defendants either (i) possessed knowledge of facts or access to information contradicting their public statements; or (ii) failed to review or check information that they had a duty to monitor or ignored obvious signs of fraud. See Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir 2000); Varghese v. China Shenghuo Pharm. Holdings, 672 F. Supp. 2d 596, 605 (S.D.N.Y. 2009). With respect to claims against an auditor, a plaintiff must allege facts suggesting that the audit amounted to no audit at all or that the auditor disregarded signs of fraud so obvious that the auditor must have been aware of them. Advanced Battery Techs., Inc. v. Bagell, 781 F.3d 638, 644 (2d Cir. 2015); In re Refco, Inc., 503 F. Supp. 2d at 657-60 (scienter adequately alleged when “[t]he accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts”). In other words, courts will infer fraudulent intent “where there is evidence that the defendant remained willfully blind to the truth.” AUSA Life Ins. Co. v. Dwyer, 928 F. Supp. 1239, 1256 (S.D.N.Y. 1996).

Plaintiffs may satisfy this burden by alleging “that the auditor disregarded specific 'red flags,' which are facts that 'would place a reasonable auditor on notice that the audited company was engaged in wrongdoing to the detriment of its investors.'” Special Situations, 33 F. Supp. 3d at 427 (citing In re Longtop Fin. Techs. Ltd. Sec. Litig., 910 F. Supp. 2d 561, 574-75 (S.D.N.Y. 2012)); In re Bear Stearns Cos., Inc. Sec., Derivative, & ERISA Litig., 763 F. Supp. 2d 423, 510-18 (S.D.N.Y. 2011) (“[A]llegations of 'red flags', when coupled with allegations of GAAP and GAAS violations, are sufficient to support a strong inference of scienter”). Plaintiffs can allege that the auditor had actual knowledge of the red flags or that the auditor had access to information and a duty to review or check the information. Athale v. SinoTech Energy Ltd., 11 Civ. 05821 (ANJ), 2014 U.S. Dist. LEXIS 22996, at *25 (S.D.N.Y. Feb. 21, 2014). In addition, the magnitude of an alleged fraud is sufficient on its own to establish scienter. Special Situations, 33 F. Supp. 3d at 428.

a. The TAC Alleges that PwC Either Failed to Perform any Audit for 2015 and 2016 or that it Deliberately Concealed Gridsum's Fraud

The TAC alleges claims against PwC for violations of Section 10(b) arising out of false and misleading statements and omissions in Gridsum's Registration Statement and its 2016 Form 20-F. Plaintiffs have alleged a litany of facts (¶¶ 246-262) which, viewed collectively, raise a strong inference that PwC's 2015 and 2016 audits were so deficient as to effectively have been “no audit at all.”

PwC was obligated to form an opinion as to whether the financial statements reflected the underlying transactions and events in a reasonable manner. ¶ 125. PwC was also obligated to modify its audit strategy to address risks of material misstatement or discovery of a previously unidentified risk. ¶ 253. PwC was obligated to consider the substance of a transaction, rather than the form ascribed by the Company. ¶¶ 125, 140. PwC represented that it examined, on a test basis, evidence supporting the figures in Gridsum's financial statements. ¶ 199. PCAOB AS No. 3 provides that the audit documentation should “demonstrate that the underlying accounting records agreed or reconciled with the financial statements.” ¶ 260. PCAOB AS No. 13 obligates auditors to “exercise professional skepticism,” meaning that the auditor should use a “questioning mind and a critical assessment of the appropriateness and sufficiency of the audit evidence.” ¶ 257. To accomplish this task, PwC had unrestricted access to Gridsum's personnel and corporate information. ¶ 262.

PwC knew that Gridsum had material weaknesses and lacked personnel with knowledge of GAAP and SEC reporting requirements to properly address complex accounting issues and prepare the Company's financial statements. ¶ 254. Varghese, 672 F. Supp. 2d at 608 (knowledge of “weak internal controls” supports a strong inference of scienter). PwC had identified that Gridsum was not properly recording expenses. ¶ 254. However, PwC failed to modify its audit plan accordingly. Although PwC was obligated to test the underlying documentation against management's financial statements, it failed to examine billing statements from vendors or to compare vendor assertions regarding outstanding (unpaid) invoices with the Company's records. ¶ 258. PwC also failed to examine Gridsum's method for identifying and accruing expenses in connection with services received from others. ¶ 259. PwC failed to determine whether the audit documentation comported with the Company's reported financial statements. ¶ 152.

b. PwC Fails to Rebut the Strong Inference of Scienter

PwC improperly asks the Court to review the allegations of scienter individually and in a vacuum. Further, PwC mischaracterizes Plaintiffs' position in stating that “the mere fact that Gridsum's financials were restated must mean that PwC China's opinions” were fraudulent and the “corresponding audits were so deficient as to amount to no audit at all.” PB at 22. This oversimplified characterization ignores the TAC's allegations of violations of PCAOB, GAAS, and GAAP standards, accounting irregularities, and that an adequate audit would have learned the truth. When viewed together, as mandated by the Supreme Court, it is clear that these errors infected all aspects of PwC's work to such an extent that a strong inference of fraud arises. See Lehman Bros., 131 F. Supp. 3d at 258; In re Longwei Petroleum Inv. Holding Ltd. Sec. Litig., 13 Civ. 214, 2014 U.S. Dist. LEXIS 9689, at *17 (S.D.N.Y. Jan. 27, 2014); Varghese, 672 F. Supp. 2d 610 (collecting cases).

The main premise of PwC's argument against scienter is that Plaintiffs merely allege that PwC “would” have uncovered the fraud if they had performed appropriate due diligence but the “red flags” were concealed. PB at 24. Courts have repeatedly found such excuses wanting. Where red flags “would be clearly evident to any auditor performing its duties it is reasonable to infer that the auditor must have noticed the red flags, but deliberately chose to ignore them.” Longwei, 2014 U.S. Dist. LEXIS 9689, at *17. As clearly detailed in the TAC and above, the improper revenue recognition practices and basic cost accrual and expense errors could easily have been spotted if a correct audit was done. E.g., ¶ 246.

PwC also asks the Court to engage in fact-finding. PwC asserts that the applicable standards it violated were “couched in rather general and in some cases inherently subjective terms” and that reasonable auditors could disagree as to how such standards should be applied. PB at 23. However, the question of whether PwC complied with the auditing standards is one of fact, and whether PwC applied the standards “reasonably” is for a jury to decide after discovery. See CILP Assocs., L.P. v. Pricewaterhouse Coopers LLP, 735 F.3d 114, 127 (2d Cir. 2013) (refusing to grant summary judgment in favor of auditor because jury should determine whether auditor knowingly or recklessly failed to check information it had an obligation to monitor or ignored obvious signs of fraud); Gould v. Winstar Commc'ns, Inc., 692 F. 3d 148, 159 (2d Cir. 2012) (reversing summary judgment in favor of auditor because “some evidence” supported the contention that auditor “consciously ignored” fraud, and, after discovery, noted evidence that the auditor failed to identify improper recognition of revenue “for the sale of equipment or services without sufficient indicia of delivery;” “recognition of all revenue associated with the incomplete sale of telecommunications systems;” and recognition of revenue for sales to financially unstable companies).

PwC also makes the “boilerplate” objection that Plaintiffs allegations are conclusory. PB at 23-24. This is belied by the extensive factual detail in the TAC. E.g., ¶¶ 246-62. Plaintiffs' allegations that PwC failed to apply audit cutoff procedures is not “conclusory;” PwC admitted that Gridsum had to restate its financials due to “expense cutoff procedures.” ¶ 150. Plaintiffs did not merely “assume” that PwC “failed to reconcile the records made available to it by the Company.” PB at 23. PwC subsequently admitted that Gridsum's financial statements had to be restated, including significant restatement of its costs, expenses, and accounts payable. If PwC had confirmed these figures with the underlying documentation, it would have uncovered the massive inaccuracies. Indeed, the inference of PwC's malfeasance is even stronger in light of PwC's awareness that Gridsum lacked personnel with sufficient knowledge of GAAP accounting. ¶ 252.

Finally, the fact that in 2018 PwC changed course and finally disclosed Gridsum's fraud in 2015 and 2016 does not negate the strong inference of scienter. PB at 20-21. The alleged facts suggest that PwC had a change of heart concerning whether to disclose the accounting irregularities it was already aware of. There is nothing to suggest that PwC's decision to come forward in 2018 was anything other than a change in strategy for dealing with a difficult client. It is clear that when performing the 2017 audit, PwC's audit team finally carried out the review of underlying documentation that it failed to do with respect to the 2015 and 2016 audits and, having done so, could no longer ignore the “red flag” warnings. Indeed, the explanation could be as simple as a change in the members of PwC's audit team. The strong inference of PwC's scienter is, therefore, cogent and as compelling as any alternative PwC offers.

CONCLUSION

For the foregoing reasons, Defendants' motions should be denied.

GAINEY McKENNA & EGLESTON

Gregory M. Egleston
Thomas J. McKenna
501 Fifth Avenue, 19th Floor
New York, NY 10017
Telephone: (212) 983-1300
Facsimile: (212) 983-0383
Email: gegleston@gme-law.com
tjmckenna@gme-law.com

Attorneys for Named Plaintiff Xuechen Li