On December 10, a New York district court judge dismissed a securities fraud class action brought by investors in China North East Petroleum Holdings, Ltd. against former director Robert Bruce (and others) on the ground that the complaint failed to plead scienter.

According to the complaint, China North overstated the amount of its proven oil reserves and the net carrying value of its oil fields, while also operating with lax internal controls that permitted illicit fund transfers to personal accounts controlled by two individual defendants. Plaintiffs alleged that Bruce violated Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 by signing a Form 10-K that contained the financial misstatements and attested to the company’s internal controls as required by the Sarbanes-Oxley Act of 2002. 

Plaintiffs argued that the complaint pleaded scienter because (a) China North restated its financial statements that contained the proven oil reserve and net carrying value disclosures, and (b) Bruce served as a member of the company’s audit committee. The court rejected these arguments and held that plaintiffs failed to plead scienter because they did not assert any “concrete and personal benefit” to Bruce. 

According to the court, the mere fact of a restatement and a defendant’s status as an audit committee member do not establish scienter in the absence of allegations showing a personal benefit to the defendant. The court further emphasized that the proven oil reserve disclosures were labeled as estimates and were accompanied by cautionary disclosures. Finally, the court noted that the alleged facts, such as Bruce resigning after the board declined to undertake a further investigation, actually exonerated him rather than showing scienter. 

On the same day, the court separately dismissed the investors’ complaint against oil consulting firm Ralph E. Davis Associates, Inc. for failure to plead scienter. According to the complaint, Davis provided “ceiling tests” and other analyses relating to oil reserves that were incorporated into China North’s SEC filings. The court dismissed the complaint against Davis for failure to allege any motive or personal financial benefit. In addition, the court noted that there were no allegations that Davis’s calculations were unreasonable or were not calculated in accord with an ordinary standard of care.   

In re China North East Petroleum Holdings Ltd. Securities Litigation, No. 1:10-cv-04577 (S.D.N.Y. Dec. 10, 2014).