They Can’t Both Be Right

Let’s say a company provides a financial statement to a government regulator, but then provides a different (and significantly more favorable) financial statement to investors. The financial statement given to the investors has to be false, right? Not so fast.

In In re L&L Energy, Inc. Sec. Litig., 2012 WL 6012787 (W.D. Wash. Dec. 3, 2012), the court addressed a securities class action brought against a U.S. company engaged in coal mining and related operations in China. The plaintiffs alleged that L&L Energy’s revenue and income for FY2009, as disclosed in its SEC filings, was grossly overstated. The allegation was “based primarily on the fact that L&L Energy’s subsidiaries in China reported much lower revenue and income to the PRC State Administration for Industry and Commerce (‘SAIC’) over a comparable period.” Moreover, the plaintiffs asserted, it was clear that the SAIC numbers reflected L&L Energy’s true financial performance because “there are strict penalties, including the revocation of an entity’s business license, for filing false statements with the SAIC.”

The court was less sure about which numbers to believe. As a threshold matter, the court found that it was difficult to determine whether the plaintiffs were actually comparing apples to apples, given that the SAIC data appeared to “differ[] in material ways from the information provided to the SEC, and not just in amounts.” Even if one of the filings must be incorrect, however, the court held that the plaintiffs had failed to adequately plead it was the SEC numbers that were false. Willful misstatements in an SEC filing can also result in significant penalties and, therefore, the “only reasonable inference is that corporations make false statements to both the SAIC and the SEC at their peril.”

Holding: Motion to dismiss granted with leave to amend.

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