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United States Securities and Exchange Commission v. China Infrastructure Investment Corporation

United States District Court, District of Columbia

May 26, 2016

UNITED STATES SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
CHINA INFRASTRUCTURE INVESTMENT CORPORATION, et al., Defendants.

          MEMORANDUM OPINION

          BERYL A. HOWELL, Chief District Judge.

         The United States Securities and Exchange Commission ("SEC") initiated this action, under the Securities Exchange Act of 1934 ("Exchange Act"), against three defendants, China Infrastructure Investment Corporation ("CIIC"), Li Xipeng, Chief Executive Officer ("CEO") and Chairman of CIIC, and Wang Feng, Corporate Secretary of CIIC. Corrected Compl. ("Corr. Compl.") ¶¶ 11, 16-17, ECF No. 3. The Corrected Complaint alleges that over the course of six weeks, the defendants submitted three filings to the SEC, and one letter to NASDAQ, which falsely represented that a person named Li Lei was the Chief Financial Officer ("CFO") of the defendant CIIC, despite the fact that he had resigned. Id. ¶¶ 37-46. Shortly after the initiation of this action, the defendants stopped paying fees to and communicating with defense counsel, failed to respond to the SEC's discovery requests, and ignored several of this Court's Orders compelling compliance with the defendants' obligations under the Federal Rules of Civil Procedure. The SEC now seeks default judgment pursuant to Federal Rules of Civil Procedure 16(f) and 37(b)(2)(A)(vi). See Pl.'s Mot. Default J. Against Defs. CIIC, Xipeng, and Fang ("Pl.'s Mot."), ECF No. 21; Pl.'s Mem. Supp. Default J. Against Defs. CIIC, Xipeng, and Fang ("Pl.'s Mem."), ECF No. 21-1.[1] For the reasons discussed below, default judgment is granted.

         I. BACKGROUND

         Summarized below is the factual and procedural background of this case. The background is based on the allegations in the Corrected Complaint, as supplemented by the SEC's declaration and facts deemed admitted pursuant to this Court's October 27, 2015 Minute Order. See Min. Order (Oct. 27, 2015) ("Oct. 27, 2015 Min. Order"); Decl. of Stephen J. Schlegelmilch in Supp. Pl.'s Mot. for Default J. Against Defs. CIIC, Xipeng, and Fang (Nov. 23, 2015) ("Schlegelmilch Decl. Supp. Default J."), Exs. 2-4 (the "CIIC Admis., " "Xipeng Admis., " and "Feng Admis., " respectively), ECF Nos. 22-2-22-4.[2]

         A. Factual Background

         The defendant CIIC, a Nevada corporation, is headquartered in Zhengzhou, Henan Province, The People's Republic of China. Corr. Compl. ¶ 15. "Through a series of holding companies, " including Pingdingshan Pinglin Expressway Co., Ltd., CIIC "owns and operates" a "portion of the Pinglin Expressway" in China. Id. "CIIC is registered with the [SEC] under Section 12(g) of the Exchange Act, " and "CIIC stock was traded on the NASDAQ stock exchange from 2008 until it was delisted on February 17, 2012." Id. The defendant Xipeng is a fifty-one-year-old Chinese national and resident, who has served as both the CEO and Chairman of CIIC since 2008. Id. ¶ 16. Xipeng owns fifty percent of the stock of Joylink Holdings Limited, which owns eighty-five percent of the voting stock of CIIC. Id. ¶¶ 15-16. This makes Xipeng "the largest beneficial owner of CIIC stock." Id. During this period, "Xipeng had control over CIIC business decisions and influenced votes on CIIC's Board of Directors." Id. ¶ 27. The defendant Feng is a forty-one-year-old Chinese national and resident, and since 2008, he has served as the Corporate Secretary of CIIC. Id. ¶ 17. His role "included getting the signatures of CIIC officers on SEC-required filings and correspondence." Id. ¶ 27.

         "On September 9, 2010, NASDAQ notified CIIC that its common stock had failed to maintain the required $1.00 minimum bid price" and gave CIIC "180 days to regain compliance, followed by a second 180-day period." Id. ¶ 26. A year later, on September 7, 2011, NASDAQ issued a decision to delist CIIC and the company appealed. Id. ¶ 29. NASDAQ then scheduled a hearing for October 27, 2011 and requested additional information, including "the accounting treatment of certain non-performing loans in which Xipeng had a financial interest." Id. Both the defendants Xipeng and Feng "knew that NASDAQ had decided to delist CIIC for failure to maintain a minimum share price of at least $1.00, and they knew that the company was appealing the delisting decision." Id. ¶ 6.

         Prior to the NASDAQ delisting decision and appeal, Lei, who is not a party to this action, was appointed to the position of CFO of CIIC, effective June 27, 2011. Id. ¶¶ 2, 28. Lei also served as a member of CIIC's Board of Directors. Id. ¶ 28. Only three months after he was hired, on September 21, 2011, Lei resigned from all of his positions at CIIC, effective immediately, in a letter to the defendant Xipeng citing "personal reasons." Id. ¶¶ 2, 30; Schlegelmilch Decl. Supp. Default J. ¶ 12; see also CIIC Admis., No. 3; Xipeng Admis., No. 3; Feng Admis., No. 3. Lei also sent an e-mail communicating his resignation to the defendant Feng, the Independent Director on the defendant CIIC's audit committee, CIIC's outside auditor, and its legal counsel, the Crone Law Group, resigning his positions. Corr. Compl. ¶ 30; see also Schlegelmilch Decl. Supp. Default J., Ex. 6, ECF No. 22-6.

         In response to Lei's resignation, that same day, the Independent Director e-mailed Lei, copying the defendant Feng, to report that "legal counsel had advised him that CIIC needed to file a Form 8-K disclosing Lei's resignation by the following Tuesday (September 27)." Corr. Compl. ¶ 31; see also Schlegelmilch Decl. Supp. Default J., Ex. 6. Feng asked the Independent Director to tell the legal counsel not to act, stating: "We will have an internal discussion first." Corr. Compl. ¶ 32. On September 23, "the Independent Director emailed Feng with a proposed resolution of the Board of Directors appointing an interim CFO" and reminding the defendant Feng of the need to file the Form 8-K with the SEC. Id. ¶ 33. On September 26, 2011, "Feng told the Independent Director that Lei had decided to continue as CFO until the Form 10-K was filed." Id. ¶ 36; see also Feng Admis., No. 26. The next day, Feng sent an e-mail to the Independent Director, the outside auditor, and defendant CIIC's other legal counsel, Loeb & Loeb LLP ("Loeb"), writing falsely that the "CFO is on sick leave in the hospital." Corr. Compl. ¶ 36; see also Feng Admis., Nos. 27-28. That same day, CIIC terminated its relationship with the Crone Law Group. Corr. Compl. ¶ 35.

         On September 30, 2011, "CIIC sent a letter to NASDAQ responding to its request for additional information." Id. ¶ 37; Schlegelmilch Decl. Supp. Default J., Ex. 7 ("NASDAQ Letter"), ECF No. 22-7. Despite the fact that Lei had resigned the week prior, "Lei's electronic signature was on the letter." Corr. Compl. ¶ 37; NASDAQ Letter at 2. "Lei did not sign the document, nor did he authorize the use of his signature." Corr. Compl. ¶ 37; see also CIIC Admis., Nos. 29, 32.1, 31-32.2; Xipeng Admis., Nos. 29, 32.1, 31-32.2; Feng Admis., Nos. 29, 32.1, 31-32.2. On October 27, 2011, NASDAQ held the scheduled hearing, and on February 17, 2012, issued its final decision delisting the defendant CIIC. Corr. Compl. ¶ 38.

         On October 10 and November 14, 2011, CIIC sent Weinberg and Co., P.A. ("Weinberg"), the company's the principal auditor, "management representation letters in connection with the June 30, 2011 audit and the September 30, 2011 first quarter review." Id. ¶ 39; Schlegelmilch Decl. Supp. Default J., Exs. 8-9 ("Oct. 10, 2011 Letter" and "Nov. 14, 2011 Letter, " respectively), ECF Nos. 22-8-22-9. The representation letters contained the defendant Xipeng's handwritten signature and Lei's forged signature. Corr. Compl. ¶ 39; Oct. 10, 2011 Letter at 6; Nov. 14, 2011 Letter at 4. "Again, Lei did not sign the document, nor did he authorize the use of his signature." Corr. Compl. ¶ 39; see also CIIC Admis., Nos. 36-43; Xipeng Admis., Nos. 36-43; Feng Admis., Nos. 36-43. Further, these letters "contained the material misrepresentation that the signatories had no knowledge of any fraud affecting CIIC by management and that there had been no violations of laws or regulations whose effect should be considered for disclosure in the consolidated financial statements." Corr. Compl. ¶ 40; Oct. 10, 2011 Letter at 2-3; Nov. 14, 2011 Letter at 2-3.

         "Weinberg relied on the October 10, 2011 representation letter" signed by the defendant Xipeng and (purportedly) Lei in conducting the audit of "CIIC's consolidated financial statements" for the 201110-K filed on October 13, 2011. Corr. Compl. ¶ 41; Schlegelmilch Decl. Supp. Default J., Ex. 10 ("Form 10-K"), ECF No. 22-10. Additionally, Weinberg relied on CIIC's representation letter in connection with "its review of CIIC's condensed consolidated interim financial statements contained in CIIC's first quarter 2012 Form 10-Q, which was filed along with its Form 10-K/A for 2011, on November 14, 2011." Corr. Compl. ¶ 41; Schlegelmilch Decl. Supp. Default J., Exs. 11-12 ("Form 10-Q" and "Form 10-K/A, " respectively), ECF Nos. 22-11-22-12.

         The Form 10-K, Form 10-Q, and Form 10-K/A filed with the SEC contained Xipeng's signature and the forged signature of Lei. See Corr. Compl. ¶ 42;[3] Form 10-K at 70; Form 10-Q at 55; Form 10-K/A at 6; see also CIIC Admis., Nos. 12-24; Xipeng Admis., Nos. 12-24; Feng Admis., Nos. 12-24. These filings "failed to disclose that: (1) Lei had resigned as CFO at the time of the filings, (2) CIIC had no CFO at the time of the filings, and (3) Lei had not authorized the use of his signature as CFO of CIIC." Corr. Compl. ¶ 42; see, e.g., Form 10-K at 52 (listing Li Lei as the Chief Financial Officer and Director). The "omissions were material in that any reasonable investor would have considered the omitted information as significantly altering the total mix of available information about CIIC." Corr. Compl. ¶ 42.

         Further, all of these filings with the SEC contained the defendant Xipeng's signature, see Form 10-K at 70; Form 10-Q at 55; Form 10-K/A at 6, and thus "represented, falsely that: (1) CIIC had a CFO at the time of the filings, (2) Lei was the CFO at the time of the filings, (3) Lei had authorized his signature on the filings, and (4) the CFO had concluded that CIIC's internal control over financial reporting as of June 30, 2011, was effective." Corr. Compl. ¶ 43. "At the time Xipeng signed CIIC's Forms 10-K, 10-K/A, and 10-Q, Lei had not been performing any duties as a CFO or member of the Board of Directors" and "Xipeng knew, or was reckless in not knowing, that Lei had resigned as CFO and that the [f]ilings falsely portrayed CIIC as having a CFO." Id. ¶¶ 44-45; see also Xipeng Admis., Nos. 3-17, 31-32.1, 45, 47, 49. Finally, without his authorization, Lei's electronic signature was placed on the Officer's Certifications in each of these filings, as required by the Sarbanes-Oxley Act of 2002. Corr. Compl. ¶¶ 5, 46; Form 10-K at 112, 115; Form 10-Q at 58, 60; Form 10-K/A at 9, 12; see also CIIC Admis., Nos. 51-52; Xipeng Admis., Nos. 51-52; Feng Admis., Nos. 51-52.

         On November 28, 2011, Lei contacted the Independent Director for the first time since his resignation. By e-mail, Lei informed the Independent Director that he "found his name in CIIC's Yahoo! Finance company profiles as CIIC's CFO and director." Corr. Compl. ¶ 47. Further, Lei stated that, after his resignation, he had not spoken with the defendant Xipeng. Id. Lei wrote to the Independent Director, "I just wonder if you guys have officially processed my resignation. My name should not be there and should not be attached to the company." Id.

         After receiving this e-mail, the Independent Director telephoned the defendant Feng, who "admitted forging Lei's signature on the Forms 10-K and 10-Q" because "he did not want bad publicity from the CFO's resignation during the NASDAQ inquiry and annual report filing." Id. ¶ 48; see also CIIC Admis., No. 53; Xipeng Admis., No. 53; Feng Admis., No. 53. "Feng told the Independent Director that Xipeng knew of Lei's resignation but did not accept it." Corr. Compl. ¶ 48. "The Independent Director recommended to Feng that Feng resign." Id. ¶ 49.

         Next, the Independent Director called CIIC's legal counsel, Loeb, and reported Feng's admitted forgery. Id. ¶ 50. On December 16, 2011, Loeb filed a Form 8-K with the SEC on behalf of CIIC stating that "Lei resigned on September 21, 2011, and although the Company did not accept Mr. [Lei's] Resignation, Mr. [Lei] did not continue to perform his duties as [CFO].'" Id. ¶ 51 (quoting Schlegelmilch Decl. Supp. Default J., Ex. 13 ("Form 8-K"), ECF No. 22-13). The Form 8-K further represented that "the Board learned on December 15 that CIIC's Form 10-K, 10-K/A and 10-Q, all of which bear Lei's purported signature, had not been prepared, reviewed, signed or authorized by Lei." Corr. Compl. ¶ 52. CIIC was delinquent in paying Loeb's fees but nevertheless Loeb was tasked with conducting an internal investigation, which never took place. Id. ¶ 53.

         Since Loeb filed the Form 8-K on December 16, 2011, CIIC has been "delinquent in its filings, which is itself a violation of the securities laws." Id. ¶ 10; Schlegelmilch Decl. Supp. Default J. ¶ 16 (declaring that the October 13, 2011 Form 10-K and the November 14, 201110-Q were the last Form 10-K and Form 10-Q filed on behalf of defendant CIIC as of November 20, 2015).

         B. Procedural History

         On March 3, 2015, the SEC filed this lawsuit against the defendants, alleging eight counts of securities fraud, namely, that: (1) the defendants CIIC, Xipeng, and Feng violated the Exchange Act Section 10(b) and Rule 10b-5; (2) the defendant CIIC violated the Exchange Act Section 13(a) and Rules 12b-20, 13a-1 and 13a-13; (3) the defendants Xipeng and Feng aided and abetted violations of the Exchange Act Section 10(b) and Rule 10b-5; (4) the defendants Xipeng and Feng aided and abetted violations of the Exchange Act Section 13(a) and Rules 12b-20, 13a-1 and 13a-13; (5) the defendants Xipeng and Feng violated the Exchange Act Rule 13b2-2; (6) the defendant Xipeng violated the Exchange Act Rule 13a-14; (7) the defendant Feng aided and abetted violations of the Exchange Act Rule 13a-14; and (8) the defendant Xipeng is liable as a "control person" under the Exchange Act Section 20(a). Corr. Compl. ¶¶ 54-81; see also Compl., ECF No. 1.

         On March 20, 2015, pursuant to the SEC's ex parte motion, Pl.'s Mot. For Leave to Serve Defs. Xipeng and Feng by Alternative Means, ECF. No. 5, the SEC was granted leave to serve the Corrected Complaint, Summons, and Standing Order on the defendants Xipeng and Feng, both residents of China, by alternative means. Order (March 20, 2015) ("March 20, 2015 Order") at 2, ECF No. 6. Defendant CIIC was subsequently served on March 23, 2015, by serving Gateway Enterprises, Inc., CIIC's registered agent. Notice of Service on Def. CIIC, ECF No. 8. The defendants Xipeng and Feng were served, in accordance with the Court's March 20, 2015 Order, on March 26, 2015, by e-mail and by serving Gateway Enterprises, Inc. Decl. of Stephen J. Schlegelmilch in Supp. of Pl.'s Notice of Service by Alternative Means ¶¶ 2-9, ECF No. 7-1.

         On April 15, 2015, counsel entered an appearance for the defendant CIIC and filed an answer on its behalf.[4] Notice of Appearance, ECF. No. 9; Answer ("CIIC Answer"), ECF No. 10. The defendants Xipeng and Feng filed their answer on April 29, 2015. See Answer ("Xipeng and Feng Answer"), ECF No. 12. Thereafter, the parties submitted a Joint Meet and Confer Report, ECF No. 13, and on June 2, 2015, the Court entered a Scheduling Order requiring Rule 26 disclosures to be exchanged by June 16, 2015, any additional parties to be joined, and any pleadings to be amended, no later than June 16, 2015, and all discovery to be closed by June 1, 2016. Min. Order (June 2, 2015) ("June 2, 2015 Min. Order"). As required, the defendants filed their Rule 26 disclosures on June 16, 2015. Defs.' Initial Disclosures Pursuant to Rule 26(a)(1), ECF No. 15.

         From that point forward, the defendants become unresponsive. "On July 13, 2015, [the SEC] served by e-mail to the defendants' counsel requests for admission, interrogatories, and requests for production of documents." Pl.'s Mot. Compel and Deem Admitted Pl.'s Req. Admis. ("Pl.'s Mot. Compel") at 3, ECF No. 16; see also Decl. of Stephen M. Schlegelmilch in Supp. of Pl.'s Mot. Compel and to Deem Admitted Req. for Admis. ("Schlegelmilch Decl. Supp. Mot. Compel") ¶¶ 3-5, ECF No. 16-2. Included in this discovery request were fifty-three requests for admission, fewer than ten interrogatories, and seventeen requests for production of documents to each defendant. Id., Exs. 2-4 (Xipeng); id., Exs. 5-7 (Feng); id., Exs. 8-10 (CIIC). The SEC also requested that the defendants provide information regarding their availability for depositions. Id., Ex. 11. The defendants' counsel responded that "I have not heard from my clients in a while and will update you on that status when I can." Id., Ex. 12 at 1. The defendants failed to respond to any of the discovery requests or to provide deposition dates. Id. ¶¶ 7-8. As a result, on August 27, 2015, the SEC moved to compel the defendants to respond to its interrogatories and requests for production of documents, and to deem admitted each of the SEC's pending requests for admission. Pl.'s Mot. Compel, ECF No. 16.

         On this same day, the defendants' counsel moved to withdraw due to the defendants' "fail[ure] to honor their continuing obligations under a written retainer agreement."[5] Mot. to Withdraw as Att'y ¶ 2, ECF No. 17. Over a week later, on September 11, 2015, counsel for the defendants filed a response to the SEC's discovery motion, requesting a stay of consideration of the SEC's motion pending resolution of defense counsel's motion to withdraw. Defs.' Resp. to Pl.'s Mot. Compel and Deem Admitted Pl.'s Req. Admis., ECF No. 19. Counsel noted, ...


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