In September 2009 Puda Coal Inc.’s chairman, Ming Zhao, and his brother, Yao Zhao, arranged to transfer Puda’s entire 90-percent interest in Shanxi Puda Coal Group Co., Ltd. to M. Zhao personally. This transfer left Puda as a shell company, lacking any operations or other source of revenue.
Moore Stephens Hong Kong (MSHK) audited Puda throughout this period without discovering the transfer. Puda made periodic filings with the Securities and Exchange Commission (SEC), which incorporated audit opinions on its financial statements. Puda also discussed its financial statements in press releases.
In April 2011, a research report disclosed the Zhao brothers’ transfer. Puda’s shares declined 34%; one trading day later, the SEC halted trading of Puda’s shares entirely. Numerous lawsuits were filed alleging violations of securities laws against a variety of defendants, including the MSHK auditors.
The auditors moved for summary judgment and to exclude plaintiffs’ expert testimony from Anita C.M. Hou. The plaintiffs moved to exclude the auditors’ three proposed experts: Alexander H. Mackintosh, Peter S. Nurczynski and Wang Weimin.
Hou is an expert in Hong Kong and/or PRC generally accepted auditing standards. She opined on behalf of the plaintiffs regarding the professional standards that the auditors should have met and the reasonableness of the steps the auditors took.
She concluded that the auditors committed securities fraud through their reckless conduct, which was a departure from the standards of ordinary care.
Admissibility of Keyword Expert Witness:
U.S. District Judge Katherine B. Forrest for the U.S. District Court for the Southern District of New York found Hou lacked the necessary expertise to offer any opinions on the only relevant standard of care applicable to the auditors: the standard of care applicable to auditors conducting an audit of a U.S. registered company pursuant to Public Company Accounting Oversight Board (PCAOB) standards. She has never conducted such an audit, she does not have the requisite training, and she even conceded that she lacks qualifications to opine in this area.
Even under the relatively liberal standards governing expert qualifications in the Second Circuit, Hou’s qualifications are inadequate under Daubert v. Merrell Dow Pharms., Inc. (509 U.S. 579, 597, 113 S.Ct. 2786, 125 L.Ed.2d 469 ), the judge said.
“It is not a matter of ‘not enough’ expertise on PCAOB standards; rather, it is that she has none,” the judge said. “Hou’s opinions regarding auditing standards applicable to Hong Kong and PRC audits are simply not relevant to any issue requiring determination in this case.”
Simply because Shanxi Coal is a PRC-based company does not mean the auditors’ conduct must be assessed against PRC- or Hong Kong-based standards, the judge said. Hou’s opinions run the very real risk of misleading the jury as to the applicable standard of care, the judge said.
Regarding summary judgment, the court said it is clear that the plaintiffs presented no admissible evidence as to what PCAOB standards the auditors failed to comply with; nor did they offer any admissible evidence that their conduct not only failed but egregiously failed to meet those standards, the judge said.
In contrast, the auditors proffered testimony from their experts — which the judge deemed admissible — regarding how the auditors met PCAOB standards.