Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca9-12-57232/USCOURTS-ca9-12-57232-0/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 

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FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

IN RE CHINACAST EDUCATION

CORPORATION SECURITIES

LITIGATION,

COSTA BRAVA PARTNERSHIP III LP,

individually and on behalf of all

other persons similarly situated,

Plaintiff-Appellant,

v.

CHINACAST EDUCATION

CORPORATION; NED SHERWOOD;

STEPHEN MARKSCHEID; DEREK

FENG; DANIEL TSEUNG,

Defendants-Appellees.

No. 12-57232

D.C. No.

2:12-cv-04621-

JFW-PLA

OPINION

Appeal from the United States District Court

for the Central District of California

John F. Walter, District Judge, Presiding

Argued and Submitted

April 7, 2015—Pasadena, California

Filed October 23, 2015

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2 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

Before: Stephen Reinhardt, M. Margaret McKeown,

and Milan D. Smith, Jr., Circuit Judges.

Opinion by Judge McKeown

SUMMARY*

Securities Fraud

Reversing the dismissal of a securities fraud claim, the

panel held that a CEO’s fraud could be imputed to his

corporate employer, even though his alleged embezzlement

and misleading of investors through omissions and false

statements were adverse to the company’s interests.

Taking the allegations in the complaint as true, the panel

agreed with the Third Circuit and concluded that the CEO’s

fraudulent misrepresentations ̄and, more specifically, his

scienter or intent to defraud ̄could be imputed to the

company because the CEO acted with apparent authority on

behalf of the company, which placed him in a position of trust

and confidence and controlled the level of oversight of his

handling of the business.

* This summary constitutes no part of the opinion of the court. It has

been prepared by court staff for the convenience of the reader.

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 3

COUNSEL

Jeremy A. Lieberman (argued), Marc I Gross, and Emma

Gilmore, Pomerantz Grossman Hufford Dahlstrom & Gross,

LLP, New York, New York; Patrick V. Dahlstrom,

Pomerantz Grossman Hufford Dahlstrom & Gross, LLP,

Chicago, Illinois; Laurence M. Rosen, The Rosen Law Firm,

P.A., Los Angeles, California; Philip Kim, The Rosen Law

Firm, P.A., New York, New York, for Plaintiff-Appellant.

William G. McGuinness (argued),Israel David, and Adam M.

Harris, Fried, Frank, Harris, Shriver & Jacobson LLP, New

York, New York, for Defendants-Appellees.

OPINION

McKEOWN, Circuit Judge:

Under Rule 10b-5 of the Securities Exchange Act of

1934, “it is unlawful for ‘any person, directly or indirectly,

. . . [t]o make any untrue statement of a material fact’ in

connection with the purchase or sale of securities.” Janus

Capital Grp., Inc. v. First Derivative Traders, 131 S. Ct.

2296, 2301 (2011) (alteration in original) (quoting 17 CFR

§ 240.10b-5(b)). Both parties agree such deception occurred

in this case: ChinaCast founder and CEO Ron Chan

embezzledmillions from his corporation and misled investors

through omissions and false statements—textbook securities

fraud. The sole question on appeal is a purely legal one and

an issue of first impression in this circuit: Can Chan’s fraud

be imputed to ChinaCast, his corporate employer, even

though Chan’s looting of the corporate coffers was adverse to

ChinaCast’s interests? Taking the allegations in the

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4 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

complaint as true, we conclude that Chan’s fraudulent

misrepresentations—and, more specifically, his scienter or

intent to defraud—can be imputed to ChinaCast. 

Significantly, imputation is proper because Chan acted with

apparent authority on behalf of the corporation, which placed

him in a position of trust and confidence and controlled the

level of oversight of his handling of the business. We reverse

the district court order dismissing the complaint under

Federal Rule of Civil Procedure 12(b)(6).

BACKGROUND

The facts are drawn from Costa Brava’s complaint, which

we accept as true for purposes of the Rule 12(b)(6) motion to

dismiss. Daniels-Hall v. Nat’l Educ. Ass’n, 629 F.3d 992,

998 (9th Cir. 2010). ChinaCast, founded in 1999, is a forprofit postsecondary education and e-learning services

provider that sells distance learning and “multimedia

education content” over the Internet and from three campuses

in China. Before its abrupt downfall, ChinaCast boasted a

market capitalization topping $200 million and was listed on

the NASDAQ Global Select Market. ChinaCast’s stock

offerings in the United States in 2008 and 2009 generated $48

million in net proceeds.

In its March 2011 Form 10-K filing with the Securities

and Exchange Commission (“SEC”), ChinaCast disclosed

that its outside accounting firm Deloitte Tohmatsu CPA Ltd.

(an affiliate of Deloitte & Touche LLP) (“Deloitte”) had

identified “serious internal control weaknesses” with respect

to its financial oversight. The complaint alleged that, despite

this “clear warning from Deloitte” regarding its lax financial

oversight, the company and its board “turned a blind eye” to

the problem.

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 5

Soon after, the complaint alleges, ChinaCast’s founder

and CEO, Ron Chan Tze Ngon (“Chan”), looted the

company’s coffers, including proceeds from the U.S. stock

offerings. From June 2011 through April 2012, Chan

“transferred” $120 million of corporate assets to outside

accounts that were controlled by him and his allies. In

addition, Chan permitted a company vice president to move

$5.6 million in company funds to his son; “unlawfully

transferred control” of two of ChinaCast’s private colleges

outside the company; and pledged $37 million in company

assets to secure third-party loans unrelated to ChinaCast’s

business. These actions brought ChinaCast to financial ruin. 

The company cannot even afford its legal bills, according to

its lawyers, who submitted a bare-bones brief on appeal and

stated that “ChinaCast now unfortunately lacks the funds

necessary to mount with full vigor the defense of this appeal.”

In the midst of this fraud on multiple fronts, Chan and

ChinaCast Chief Financial Officer Antonio Sena participated

in a series of earnings calls and other communication with

investors. During these calls, neither official disclosed the

fraudulent activities taking place; instead, Chan emphasized

the company’s financial health and stability. For example, in

a press release and conference call in fall 2011, Chan

reassured investors that “no questions or concern[s] have ever

been raised by the company’s auditors or audit committee

about our cash balances.” Throughout 2011, Chan signed

SEC filings on behalf of ChinaCast and never disclosed the

$120 million in transfers and other fraudulent activities afoot.

In early 2012, ChinaCast’s board discovered that Chan

had attempted to interfere with an annual audit. The board

removed him as chairman and CEO on March 26, 2012, and

Sena resigned the next day. Beginning in April 2012,

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6 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

ChinaCast disclosed in a series of SEC forms that it had

“uncovered questionable activities” and illegal conduct on the

part of its senior officers.

In September 2012, a group of ChinaCast shareholders

who bought stock between February 2011 and April 2012

(“the shareholders”) brought this federal securities lawsuit,

alleging that ChinaCast, Chan, Sena, and the company’s

independent directors violated Rule 10b-5 of the Securities

Exchange Act of 1934.

The district court dismissed the complaint with prejudice

under Rule 12(b)(6).1 With respect to the claim against

ChinaCast, the court concluded that the shareholders failed to

plead scienter—a bedrock requirement of Rule 10b-5. 

Although the actions of corporate agents usually are imputed

to the corporate entity, the district court noted that under the

“adverse interest exception,” courts “refus[e] to impute

scienter from the fraud of a rogue agent.” In this case, “there

is no allegation that Chan or his accomplices acted out of

anything other than their own self-interest, or that their

conduct in any way benefitted ChinaCast.” Because Chan

acted adversely to ChinaCast’s interests, the district court

concluded that Chan’s scienter or intent to defraud could not

be imputed to the corporation. The shareholders therefore

failed to allege scienter as against the corporation.

1 The shareholders only appeal their claim against ChinaCast. Chan and

Sena reside outside the United States and, according to the shareholders,

have evaded service of process. The district court dismissed the claims

against ChinaCast’s independent directors because of a lack of scienter. 

The shareholders do not challenge that aspect of the ruling.

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 7

ANALYSIS

Federal securities law, embodied in the Securities Act of

1933 and the Securities Exchange Act of 1934, “create[s] an

extensive scheme of civil liability,” which encompasses not

only SEC enforcement actions but a private right of action

implied by the terms of § 10(b) of the 1934 Act. Central

Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,

511 U.S. 164, 171 (1994). These private suits serve the

“animating purpose of the Exchange Act: to insure honest

securities markets and thereby promote investor confidence.” 

United States v. O’Hagan, 521 U.S. 642, 658 (1997); see also

Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 345 (2005) (“The

securities statutes seek to maintain public confidence in the

marketplace. They do so by deterring fraud, in part, through

the availability of private securities fraud actions.” (internal

citation omitted)). Such suits, however, are a double-edged

sword, because they also can breed abusive litigation and

“impose substantial costs on companies and individuals

whose conduct conforms to the law.” Tellabs, Inc. v. Makor

Issues & Rights, Ltd., 551 U.S. 308, 313 (2007). To balance

these competing forces, and “[a]s a check against abusive

litigation by private parties, Congress enacted the Private

Securities Litigation Reform Act of 1995,” or PSLRA. Id.

The PSLRA, among other things, imposes “[e]xacting

pleading requirements” that require “plaintiffs to state with

particularity both the facts constituting the alleged violation,

and the facts evidencing scienter, i.e., the defendant’s

intention ‘to deceive, manipulate, or defraud.’” Id. (quoting

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 & n.12

(1976)). Plaintiffs must show a “strong inference” of scienter

to survive a motion to dismiss. 15 U.S.C. § 78u-4(b)(2)(A).

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8 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

The scienter requirement is at the center of this appeal.2

To be sure, CEO Chan possessed the requisite scienter, or

intent to defraud. ChinaCast itself describes Chan’s dealings

as a “massive scheme . . . to loot the Company of its most

valuable assets,” which wrought “catastrophic” damage.

3 The

question is whether Chan’s scienter can be imputed to his

corporate employer, ChinaCast. We review de novo this

legal question that underlies the Rule 12(b)(6) dismissal. N.

Cnty. Cmty. Alliance, Inc. v. Salazar, 573 F.3d 738, 741 (9th

Cir. 2009).

Section 10(b) and Rule 10b-5 can be violated by any

“person,” natural or legal, including corporations. See

15 U.S.C. § 78c(a)(9) (defining person under the Securities

Exchange Act to include corporations); see also Cent. Bank

of Denver, N.A., 511 U.S. at 191 (“Any person or

entity...may be liable as a primary violator under 10b-5.”).

Of course a corporation “can only act through its employees

and agents” and can likewise only have scienter through

them. See Suez Equity Investors, L.P. v. Toronto-Dominion

2

“The elements of a private action under Rule 10b–5 are ‘(1) a material

misrepresentation or omission by the defendant; (2) scienter; (3) a

connection between the misrepresentation or omission and the purchase

or sale of a security; (4) reliance upon the misrepresentation or omission;

(5) economic loss; and (6) loss causation.’” Janus, 131 S. Ct. at 2301 n.3

(quoting Stoneridge Inv. Part., LLC v. Scientific-Atlanta, Inc., 552 U.S.

148, 157 (2008)).

3 Chan is a Chinese national who resides in China. In 2013, the SEC

brought civil charges against Chan in the United States District Court for

the Southern District of New York. Final judgment was entered against

Chan, barring him from the securities industry and requiring him to pay

$41.4 million in disgorgement, $6.65 million in interest, and a $750,000

civil penalty. SEC v. Chan Tze Ngon, No. 13-civ-6828 TPG, Dkt. No. 29

(S.D.N.Y. Jan. 16, 2015).

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 9

Bank, 250 F.3d 87, 101 (2d Cir. 2001). Because the Securities

Exchange Act and accompanying regulations do not contain

any explicit instructions on when an employee’s acts and

intent are to be imputed as those of the company, courts have

looked to agency principles for guidance.4See Hollinger v.

Titan Capital Corp., 914 F.2d 1564, 1577 (9th Cir. 1990) (en

banc) (noting that the Exchange Act’s explicit provision for

4 There is, of course, no federal common law of agency that governs

claims brought under state law in federal court. See O’Melveny & Myers

v. F.D.I.C., 512 U.S. 79, 83 (1994). We are called on here, however, to

decide if ChinaCast is (alleged to be) a primary violator of § 10(b). That

is we must define “the scope of conduct prohibited by § 10(b), [and thus]

the text of the statute controls our decision.” Cent. Bank of Denver, N.A.,

511 U.S. at 173. Accordingly this is a question of federal securities law,

albeit one guided by (common law) agency principles. In fact, scienter

itself, though an element of state common law fraud, is required only

because of the way the Supreme Court read § 10(b). See Ernst & Ernst,

425 U.S. at 196–97.

Similarly, inAmerican Society ofMechanicalEngineers,the Supreme

Court treated the issue we deal with here ̄imputation ̄as a question of

interpreting the Sherman Act with guidance from agency principles, not

a question of agency law in the state (New York) where the Society of

Mechanical Engineers was incorporated. See Am. Soc. of Mech. Eng’rs,

Inc. v. Hydrolevel Corp., 456 U.S. 556, 565–66 (1982); see also Dark v.

United States, 641 F.2d 805 (9th Cir. 1981) (interpreting federal income

tax law using agency principles); but see Belmont v. MB Inv. Partners,

Inc., 708 F.3d 470, 494 (3d Cir. 2013) (concluding imputation under the

Exchange Act is a question of state law).

We also note that there does not appear to be a substantive difference

between the general common law of agency on this question and that

applied in Delaware, where ChinaCast was incorporated and whose law

would presumably govern if state law applied. The parties have likewise

addressed their briefing to general agency law rather than that of a

particular state. We conclude that our analysis would not be any different

if state law controlled.

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10 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

secondary liability, §20(a), “was not intended to supplant the

application of agency principles in securities cases”) (internal

quotation omitted).

Under the rule of imputation, it is “fundamental that an

employer is liable for the torts of his employee committed

while acting in the scope of his employment.” Fields v.

Synthetic Ropes, Inc., 215 A.2d 427, 432 (Del. 1965); see

also Belmont, 708 F.3d at 494 (“[T]he imputation doctrine

recognizes that principals generally are responsible for the

acts of agents committed within the scope of their authority.”)

(internal citation omitted) (alteration in original). The rule

exists for good reason: “Imputation creates incentives for a

principal to choose agents carefully and to use care in

delegating functions to them.” Restatement (Third) of

Agency § 5.03 cmt. b (2006).

In the context of Rule 10b-5, we have adopted the general

rule of imputation and held that a corporation is responsible

for a corporate officer’s fraud committed “within the scope of

his employment” or “for a misleading statement made by an

employee or other agent who has actual or apparent

authority.” Hollinger, 914 F.2d at 1577 n.28. Other courts

follow the same principles, even after the advent of the

PSLRA and its strict focus on scienter: “The scienter of the

senior controlling officers of a corporation may be attributed

to the corporation itself to establish liability as a primary

violator of § 10(b) and Rule 10b–5 when those senior

officials were acting within the scope of their apparent

authority.” Adams v. Kinder-Morgan, Inc., 340 F.3d 1083,

1106–07 (10th Cir. 2003) (collecting cases); see also Makor

Issues & Rights Ltd. v. Tellabs Inc., 513 F.3d 702, 708 (7th

Cir. 2008) (“The doctrines of respondeat superior and

apparent authority remain applicable to suits for securities

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 11

fraud.”); Snowstorm Acquisition Corp. v. Tecumseh Prod.

Co., 739 F. Supp. 2d 686, 706 (D. Del. 2010) (same with

respect to Delaware corporation).

In the face of these well-established parameters,

ChinaCast does not dispute that Chan acted within the scope

of his apparent authority. Nevertheless, the corporation

argues that the ordinary rule of imputation is inapposite

because of the common law’s so-called “adverse interest

exception.” Under that exception, a rogue agent’s actions or

knowledge are “not imputed to the principal if the agent acts

adversely to the principal in a transaction or matter, intending

to act solely for the agent’s own purposes or those of another

person.” Restatement (Third) of Agency § 5.04 (2006);

Hecksher v. Fairwinds Baptist Church, Inc., 115 A.3d 1187,

1205 (Del. 2015) (“[T]he adverse interest doctrine may

prevent a court from imputing knowledge of wrongdoing to

an employer when the employee has totally abandoned the

employer’s interests, such as by stealing from it or defrauding

it.”).

So far, so good for ChinaCast—unquestionably Chan

lined his own pockets at the expense of ChinaCast’s interests. 

But herein lies the rub: ChinaCast’s formulation ignores that

the adverse interest rule doesn’t apply in every instance

where there is a faithless fraudster within the corporate ranks. 

Specifically, the very same Restatement provision that sets

out the adverse interest exception also provides:

“Nevertheless, notice is imputed . . . when necessary to

protect the rights of a third party who dealt with the principal

in good faith.” Restatement (Third) of Agency § 504 (2006);

see also Jensen v. IHC Hosps., Inc., 82 P.3d 1076, 1091 n.13

(Utah 2003) (“Although typically an agent’s knowledge will

not be imputed to its principal when an agent is involved in

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12 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

fraud or other adverse dealings, an exception exists for

innocent third parties.”); In re Am. Int’l Grp., Inc., Consol.

Derivative Litig., 976 A.2d 872, 891 (Del. Ch. 2009) aff’d

sub. nom. Teacher’s Ret. Sys. of Louisiana v. Gen. Re Corp.,

11 A.3d 228 (Del. 2010) (even when the adverse interest

exception applies, “the corporation...[remains]responsible to

innocent third parties and the polity for any offense to

them”); cf. Restatement (Second) of Agency § 262 & cmt. a

(1958) (explaining how apparent authority protects thirdparty reliance). In other words, there is an exception to the

exception: the adverse interest rule collapses in the face of an

innocent third party who relies on the agent’s apparent

authority.

The interplaybetween these principles has been explained

as follows:

The starting point is that all information

known by the agent, at least when received

within the scope of authority, is deemed

known by the principal. But this is not so if

the agent is acting contrary to the principal’s

interests—the so-called “adverse interest”

exception. In turn, the adverse interest

exception itself has an exception: the principal

is charged with even the faithless agent’s

knowledgewhen an innocent third-partyrelies

on representations made with apparent

authority.

Donald C. Langevoort, Agency Law Inside the Corporation:

Problems of Candor and Knowledge, 71 U. Cin. L. Rev.

1187, 1214 (2003).

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 13

In short, parsing the common law in context—looking to

both the adverse interest exception and its imbedded caveats

that are essential to cabining its scope—compels the

conclusion that Chan’s scienter can be imputed to the

corporation in these circumstances. Restatement (Third) of

Agency § 5.04 cmt. b (2006) (noting that adverse interest rule

and its exceptions work together “as a whole” so that the

“doctrine reflects a balance among factors that, if pressed in

isolation to their respective extremes, would lead to divergent

outcomes”). The complaint alleges that third-party

shareholders understandablyrelied on Chan’s representations,

which were made with the imprimatur of the corporation that

selected him to speak on its behalf and sign SEC filings.

Although a question of first impression in this circuit,

case law from other courts confirms that imputation is proper

even in the face of Chan’s double dealing. The Third Circuit

recently confronted the same issue in the case of an

investment adviser who perpetrated a Ponzi scheme, diverting

$20 million of client funds to finance his lavish lifestyle. 

Belmont, 708 F.3d at 479. Defrauded clients sued the

corporate employer, MB Investment Partners, Inc., for fraud

under Rule 10b-5. Id. at 494. Just like ChinaCast, the

corporation invoked the adverse interest exception. The

Third Circuit rejected that argument and held that imputation

is appropriate when an employee acts within his actual or

apparent authority. Significantly, the court held that “a

swindler may still act with apparent authority, even if he is

acting for his own benefit.” Id. at 496 (citation omitted). The

court noted that the “underlying purpose of imputation” is

“fair risk-allocation, including the affordance of appropriate

protection to those who transact business with corporations.” 

Id. Hence, when a corporate officer commits wrongdoing,

the “principal who has placed the agent in the position of trust

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14 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

and confidence should suffer, rather than an innocent

stranger.” Id. at 494–95 (internal citation omitted); see id. at

497.

In the same vein, in the federal antitrust context, the

Supreme Court endorsed the identical principle of imputation: 

“[A] principal is liable for an agent’s fraud though the agent

acts solely to benefit himself, if the agents acts with apparent

authority.” Mech. Eng’rs, 456 U.S. at 566. According to the

Court, imputation and the corresponding threat of civil

liability give an employer greater incentive to “see to it that

[its] agents abide by the law” and “take systematic steps” to

prevent misconduct. Id. at 572–73 (internal citation omitted)

(alteration in original). Although Mechanical Engineersis an

antitrust case, its reasoning is not limited to that context. The

Supreme Court explained that the “[a]pparent authority

theory has long been the settled rule in the federal system”

and cited Gleason v. Seaboard Air Line Ry. Co., 278 U.S. 349

(1929), a railroad tort case. Mech. Eng’rs, 456 U.S. at

567–68. Significantly, the Supreme Court cited two Rule

10b-5 securities cases, among others, in noting that “[i]n a

wide variety of areas, the federal courts, like this court in

Gleason, have imposed liability upon principals for the

misdeeds of agents acting with apparent authority.” Id. at

568.

ChinaCast and the district court cite to several district

court decisions that invoke the adverse interest exception. 

See In re Rent-Way Sec. Lit., 209 F. Supp. 2d 493, 522 (W.D.

Penn. 2002); In re Cendant Corp. Sec. Litig., 109 F. Supp. 2d

225, 232–34 (D. N.J. 2000). These cases are hardly

illuminating, however, because they do not address the

relationship between the adverse interest exception and thirdparty reliance and apparent authority. In contrast, other

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 15

district courts have invoked apparent authority to override the

adverse intent exception, including a Rule 10b-5 case

involving Dennis Kozlowski’s infamous looting of Tyco. In

re Tyco Int’l, Ltd., 2004 WL 2348315, No. MDL 02-1335-B,

02-266-B, at *6 (D. N.H. Oct. 14, 2004) (holding that the

“adverse interest exception is inapplicable when a corporate

officer or director makes a material misstatement or omission

to an innocent third party while acting with the apparent

authority of the corporation for whom he works”); see also

Puskala v. Koss Corp., 799 F. Supp. 2d 941, 944, 947 (E.D.

Wis. 2011) (holding corporation liable for its vice president’s

embezzlement of more than $30 million from the company to

purchase designer clothing, jewelry, furs, and other items

even though she “committ[ed] fraud against the company

rather than on behalf of it” because she acted with apparent

authority by signing the corporation’s SEC filings).

In the circumstances of this case, imputation also

comports with the public policy goals of both securities and

agency law—namely, fair risk allocation and ensuring close

and careful oversight of high-ranking corporate officials to

deter securities fraud. See Belmont, 703 F.3d at 494–95

(noting that the “principal who has placed the agent in the

position of trust and confidence should suffer, rather than an

innocent stranger” (internal citation omitted)); see also

Broudo, 544 U.S. at 345; State Farm Fire and Cas. Co. v.

Sevier, 537 P.2d 88, 96 (Or. 1975) (“[O]ne who selects an

agent and delegates authority to him should incur the risks of

the agent’s infidelity or want of diligence rather than innocent

third persons.”).

According to the complaint, which governs our analysis

at this early procedural stage, ChinaCast received an audit

from Deloitte in 2011 detailing “material internal control

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16 IN RE CHINACAST EDUC. CORP. SEC. LITIG.

weaknesses.” Yet the corporation and its board “turned a

blind eye” and failed to take significant action or heighten

oversight. Had they done so, they may have prevented much

of the decimation of ChinaCast’s bottom line and share value. 

Indeed, the $120 million in illicit withdrawals began several

months after the Deloitte report was issued. What’s more,

Chan was hardly a random corporate bureaucrat or mid-level

manager. He was ChinaCast’s founder and CEO, the one

person on whom the board undoubtedly should have kept

close tabs. See In re Fin. Mgmt., 784 F.3d 29, 31–32 (1st Cir.

1986) (noting courts have applied apparent authority rule

against corporations “particularly when the person making

the misrepresentation is an important corporate official”). 

Permitting imputation under these circumstances encourages

appropriate corporate oversight.

According to the complaint, both Chan and Sena

knowingly misrepresented ChinaCast’s financial condition. 

Because we conclude that their scienter can be imputed to

ChinaCast for those material misrepresentation or omissions

made within the scope of their apparent authority, the

shareholders pled sufficient allegations to support imputation

and survive the pleading requirements of the PSLRA. Of

course, whether these allegations will materialize as

admissible facts remains to be seen.

In closing, we note that at the pleading stage, a key

inquiry in § 10(b) and Rule 10b-5 cases is whether the

complaint sufficiently alleges scienter attributable to the

corporation. A threshold question is whether the pleadings

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IN RE CHINACAST EDUC. CORP. SEC. LITIG. 17

support application of the adverse interest rule at all.5

Assuming a well-pled complaint, we recognize that, as a

practical matter, having a clean hands plaintiff eliminates the

adverse interest exception in fraud on the market suits

because a bona fide plaintiff will always be an innocent third

party. The gymnastic exercise of imposing a general rule of

imputation followed by analyzing the applicability of the

exception to the exception becomes unnecessary. Of course,

as the litigation proceeds, whether the plaintiff is an innocent

third party and whether the presumption of reliance is

rebutted6

remain open questions. This approach, which takes

an appropriately narrow view of the adverse interest

exception, is consistent with the purpose of the securities laws

to deter fraud and promote confidence in the securities

markets.

The district court’s order dismissing this case with

prejudice under Rule 12(b)(6) is REVERSED.

5

In re Petrobras Sec. Litig., No. 14-CV-9662 JSR, 2015 WL 4557364,

at *12 (S.D.N.Y. July 30, 2015) (rejecting the adverse interest exception

defense because “the allegations...do not conclusively establish that the

company received no benefit from the Corrupt Executives’ actions”).

6 Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2408

(2014) (reaffirming in a fraud on the market suit “the rebuttable

presumption of reliance, rather than providing direct reliance on a

misrepresentation”).

 Case: 12-57232, 10/23/2015, ID: 9729819, DktEntry: 42-1, Page 17 of 17