China Shenghuo Pharmaceutical Holdings, Inc.
Practice Area: Securities Fraud
Cohen Milstein has been appointed Lead Counsel in ongoing securities litigation in the Southern District of New York on behalf of a proposed class of all persons who purchased the common stock of China Shenghuo Pharmaceutical Holdings, Inc. (“CSP” or the “Company”) (AMEX: KUN) during the period between July 23, 2007 and August 20, 2008, inclusive (the “Class Period”). The case is pending before Judge Victor Marrero.
Lead Plaintiff filed a Consolidated Amended Class Action Complaint (the “Complaint”) on February 9, 2009. Plaintiffs allege that the Company’s fraud arose from its failure to take adequate steps to ensure that its financial reporting comported with U.S. Generally Accepted Accounting Principles (“GAAP”). As a result, the Company was required to restate what were otherwise materially false and misleading financials.
Plaintiffs allege that after the fraud was publicly disclosed, CSP’s Audit Committee conducted an internal investigation of the Company’s accounting errors. Although that investigation was clearly designed to minimize the significance of the improprieties that had occurred, in the aftermath two senior finance department supervisors and the Chief Financial Officer (“CFO”) were terminated and a board member who had spent years consulting with Chinese companies about the requirements for financial reporting in accordance with U.S. standards left in protest, writing that Defendants were “uneducated and seemingly unwilling to be educated on what is necessary to be a good member of AMEX or any other credible market.”
The market swiftly reacted to the Company’s disclosure that it would need to restate its financial results. Although the Company’s stock price closed at $2.33 per share on August 19, 2008, the stock suffered a 19% drop the following day and AMEX completely halted its trading a day later.
Ultimately, the accounting fraud at CSP required the Company to restate its financial results for its full fiscal year 2007 ending December 31, 2007 (“FY 2007”) and first quarter 2008 (“1Q 2008”). For FY 2007, the Company overstated its net income by approximately 133%. When restated, net income dropped from $4,016,640 to $1,720,387 – a reduction of nearly $2.3 million. In addition, the Company materially misstated its earnings per share in FY 2007 by approximately 175%. When restated, earning per share dropped from $0.21 to $0.09 per share.
CSP later revealed that the accounting fraud occurred because of “errors in the accounting for certain sales representative commission advances and trade receivables, the Company’s internal controls, the Company’s personnel involved and related matters.” The term “trade receivables” refers to the amounts owed to a business following the sale of goods or services to another company. A subcategory of accounts receivable, trade receivables are considered a current asset on a company’s balance sheet, as they can be readily converted into cash. Plaintiffs allege that the Company reserved inadequate allowances for goods that were purportedly sold where the amounts owed were uncollectible, in violation of GAAP.
Plaintiffs further allege that the Company’s CEO and CFO were aware of these matters. Indeed, throughout the Class Period, the Company specifically stated that write offs for uncollectable accounts (including sales commission advances) were taken when, “in management’s judgment[,] … collection appears doubtful.” Plaintiffs allege that Defendants knew or recklessly disregarded the fact that CSP’s internal controls were a complete failure and that Defendants’ accounting for certain sales commissions and trade receivables was in violation of GAAP.
Plaintiffs have also named as a defendant the Company’s auditor, Hansen, Barnett & Maxwell, P.C. (“HB&M”). Plaintiffs allege that HB&M acted with scienter in violating the most fundamental principles of generally accepted auditing standards (“GAAS”) in issuing its materially false and misleading unqualified audit opinion regarding CSP’s FY 2007 financial statements. Plaintiffs allege that HB&M was reckless in either failing to modify its audit procedures in light of CSP’s known internal control deficiencies or, if it did make such modification, it recklessly disregarded the audit evidence which existed at the time of the audit. Significantly, in 2008, the Public Company Accounting Oversight Board (“PCAOB”) criticized HB&M for failing to adequately audit reserves for another entity.
On May 29, 2009, Defendants moved to dismiss the Complaint. On December 9, 2009, Judge Marrero denied Defendants’ motions to dismiss in their entirety. The Court found that “statements regarding the progress of internal control improvements and the financial statements constitute sufficient bases for a Rule 10b-5 claim. Misreported financial information clearly amounts to a false statement of fact.” Citing the resignation of CSP’s former board member, the Court further found that “Plaintiffs put forth sufficient allegations to support a claim that CSP was not engaged in the improvement efforts described in its public statements” and that the Company was aware that its public statements were false and misleading when made. The Court similarly found that with regard to HB&M, “Plaintiffs allege more than negligence; Plaintiffs allege that HB&M was aware, through CSP’s own disclosures, that CSP had serious internal control problems, especially as a company unfamiliar with U.S. GAAP standards.” The case now proceeds to the discovery phase.