New Oriental Education & Technology Group Inc. (EDU), China’s largest private-education provider, was sued by investors in its U.S.-registered shares after the Securities and Exchange Commission began investigating the company.
The American depositary receipts fell 57 percent over two days after New Oriental said July 17 that the SEC was probing the consolidation of its units’ financial statements. The plunge capped nine consecutive trading days of declines, the ADRs’ longest losing streak since the Beijing-based company’s initial public offering in 2006.
Investors in New Oriental ADRs, led by Kin Shing Wong, are seeking compensatory damages for the stock losses and class action, or group status for the lawsuit filed yesterday in Los Angeles federal court. In their complaint, the investors cited a July 18 research report alleging New Oriental inflated cash balances to obtain approval from its auditor, using franchises and other fees.
“As a result, the company’s financial statements and financial results were materially false and misleading,” investors claimed in the lawsuit.
Sisi Zhao, a Beijing-based spokeswoman for New Oriental, didn’t immediately respond to a call seeking comment made after regular business hours. The company has said three independent directors would review the report, by Muddy Waters LLC. Announcing the SEC probe, the company, known as EDU, said investigators might be focusing on “whether there is a sufficient basis for the consolidation.”
EDU owns about 664 schools and learning centers, not counting 21 third-party operated “cooperation facilities” and their students, it has said. The company aims “to provide the highest level of transparency to its shareholders,” according to a July 20 statement.
New Oriental, currently trading at around $12.30 a share in New York, was as high as $33.70 on Sept. 14 for investors in the would-be group suit, they said.
The 180 Chinese firms that started trading in New York, Hong Kong and on other global exchanges since the start of 2010 were trading earlier this year at one-fifth below their offer prices, according to data compiled by Bloomberg. Chinese companies have had disputes with auditors and research firms scrutinizing their accounting.
The Muddy Waters report cited in the lawsuit against New Oriental also questioned whether the company could consolidate its operations, because the Chinese schools conducting lessons are ultimately state-owned, the research firm said.
Toronto-listed Sino-Forest Corp., another stock targeted by Muddy Waters, dropped 74 percent before the company filed for bankruptcy. Shares of Spreadtrum Communications Inc., a Shanghai-based chipmaker, have risen since Muddy Waters in June 2011 recommended shorting the stock, or selling shares with the aim of buying them later at a lower price.
In the New Oriental lawsuit, investors alleged some of EDU’s statements in U.S. filings were false or misleading because they didn’t disclose that EDU’s network includes “numerous” franchisees, and that upfront fees inflated the company’s cash balances.
The complaint cited Muddy Waters’s accusation that EDU allegedly “tells investors that its entire store network is company owned, but this is a lie.”
“It is virtually certain that EDU uses the upfront franchise and other fees to inflate its cash balances in order to receive unqualified audit opinions from its auditor,” Muddy Waters claimed in the report, cited in the complaint filed in federal court.
The case is Wong v. New Oriental Education & Technology Group Inc., 12-cv-06316, U.S. District Court, Central District of California.
To contact the reporter on this story: Linda Sandler in New York at firstname.lastname@example.org