In another entry in the large field of securities fraud suits involving Chinese companies traded on U.S. exchanges, the Second Circuit affirmed in an unpublished memorandum the dismissal of investors’ claims against an auditor for failing to detect and disclose that a company’s CEO was pilfering the company’s coffers for personal gain.

In Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., __ Fed. App’x __, 2016 WL 1392280, at *1 (2d Cir. Apr. 8, 2016), a group of investors sought relief after ChinaCast, the company in which they had invested, disclosed that its CEO and other executives had engaged in fraud by embezzling funds. The suit accused Deloitte, ChinaCast’s independent auditor, of several violations, including a claim under Section 10(b) of the Exchange Act for giving ChinaCast a clean bill of health in audit opinions from 2007 to 2010 in connection with Deloitte’s review of ChinaCast’s SEC filings, and a claim under Section 18 of the Exchange Act for Deloitte’s filing its allegedly misleading audit opinions with the SEC. Id. The Second Circuit concluded that the Section 10(b) claim did not adequately allege Deloitte’s scienter, and—applying the Supreme Court’s landmark decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015)—that the plaintiffs did not adequately allege that Deloitte’s opinions were false or misleading.

The court held that to satisfy the scienter requirement for a non-fiduciary accountant like Deloitte, the plaintiffs had to allege facts showing “such recklessness [as to be] an extreme departure from the standards of ordinary care” and in fact come close to “an actual intent to aid in the fraud being perpetrated by the company.” Id. (quoting Rothman v. Gregor, 220 F.3d 81, 98 (2d Cir. 2000)). Applying this high standard, the court ruled that the alleged “red flags” Deloitte recklessly disregarded were inadequate to show scienter. These red flags included large transactions and assets on ChinaCast’s books that the plaintiffs contended Deloitte would have discovered with a more thorough audit, and certain transactions between ChinaCast subsidiaries and third parties that the plaintiffs alleged were suspicious. Id. at *2. But the court decided that these records were red flags only in hindsight, because there was no allegation that Deloitte was required to perform the investigation that the plaintiffs claim would have revealed the suspicious transactions, and the records that Deloitte had access to at the time of its audits suggested that the subsidiary transactions were not unusual. Id.

Deloitte’s audit opinions were also protected under Omnicare. The plaintiffs did not allege facts that would show either that Deloitte held a subjective belief inconsistent with the opinions, or else that any of the challenged statements of opinion omitted “material facts about the issuer’s inquiry into or knowledge concerning [the] statement of opinion . . . [which would] conflict with what a reasonable investor would take from the statement [of opinion] itself.” Id. at *3 (quoting Omnicare, 135 S. Ct. at 1329) (first alteration added). The court also affirmed the dismissal of other claims based on the underlying Section 10(b) and Section 18 claims. Id.