(CN) - The 2nd Circuit vacated a district court ruling that dismissed a class action lawsuit against China North East Petroleum Holdings Ltd., alleging investor losses after it was revealed that the company's oil reserves weren't as robust as first reported.
Even though the company's stocks rebounded shortly after they dropped, the three-judge panel said it's not enough to defeat "an inference of economic loss in a securities fraud suit," wrote Judge Chester Straub.
In its original complaint, Acticon AG claimed that, "NEP inflated its proven oil reserves and did not account for certain warrants - which entitle the holder to purchase stock for a fixed price until the expiry date - in accordance with Generally Accepted Accounting Principles (GAAP)." Straub also cites Acticon's claim that the company's former CEO and his mother, "transferred funds from the company's corporate coffers into their own accounts."
On February 23, 2010, NEP announced it was withdrawing its 2008 and 2009 financial statements. By April 15, the company still had not filed its 2009 annual report or its Form 10-K. The next day, it announced it was facing delisting by the New York Stock Exchange, which came to fruition May 25, 2010, just five weeks after announcing "misvaluation" of gas and oil properties on April 20, according to the ruling.
"Over the summer, defendant Robert C. Bruce, the chairman of the audit committee, announced in a letter to the board that he was resigning because he had concerns regarding whether NEP's 2009 financial statements were prepared in accordance with GAAP and whether the company had bribed foreign governmental officials," Straub wrote.
NEP resumed trading on September 9, 2010, but at a 20 percent drop in stock prices on "very high" volume, Straub said. Acticon filed suit, and Straub found that even though the company's complaint contains class allegations, "the district court has not yet considered a motion for class certification."
The District Court granted NEP's motion to dismiss after concluding that Acticon did not suffer an economic loss. Straub said part of the District Court's rationale included the fact that Acticon purchased its shares at $7.25 per share, which closed higher than that price on 12 consecutive days during October and November of 2010, after the company was relisted.
The 2nd Circuit panel, however, said the District Court has failed to consider some important facts.
"A share of stock that has regained its value after a period of time is not functionally equivalent to an inflated share that has never lost value," Straub explained. "This analysis takes two snapshots of the plaintiff's economic situation and equates them without taking into account anything that happened in between; in assumes that if there are any intervening losses, they can be offset by intervening gains. Bit it is improper to offset gains that the plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons. Such a holding would place the plaintiff in a worse position than he would have been absent the fraud."
Straub also stated that it is not known "whether the price rebounds represent the market's reactions to the disclosure of the alleged fraud or whether they represent unrelated gains. We thus do not know whether it is proper to offset the price recovery against Acticon's losses in determining Acticon's economic loss. Accordingly, the recovery does not negate the inference that the Acticon has suffered an economic loss."