The U.S. District Court for the Southern District of New York denied defendants’ motion to dismiss in a consolidated securities class action lawsuit, where defendant corporation had to restate its financials after making a series of disclosures regarding poor accounting controls.

Plaintiffs alleged that defendant corporation acknowledged its accounting problems through a series of press releases but that it nevertheless continued to file audited financials, certifying accordance with generally accepted accounting principles (GAAP). When the defendant corporation ultimately made a corrective disclosure, stating that its financials would have to be restated, its share price dropped immediately.

In the ensuing litigation, the defendant corporation argued that GAAP violations, standing alone, could not provide the basis for an inference of scienter. While the court agreed with this general principle, it ruled that GAAP violations combined with a pattern of disclosures about deficient controls demonstrated that the defendant knew it had accounting problems that were reflected in its certified financials. Further, the court relied upon an email from a member of defendant corporation’s audit committee who had resigned, in which the departing director complained about the corporation’s poor corporate governance and substandard accounting practices in finding that plaintiffs had adequately alleged that the defendant corporation knowingly misled investors about its internal controls. (Varghese v. China Shenghuo Pharm. Holdings, Inc., No. 08 Civ. 7422, 2009 WL 4668579 (S.D.N.Y. Dec. 9 2009))