CHINACAST EDUCATION CORPORATION AND OTHERS v. CHAN TZE NGON AND OTHERS

HCA 1062/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1062 OF 2012

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JUDGMENT

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1.  The plaintiffs are a group of overseas companies in the business of the provision of post-secondary and online educational services in the PRC (“the Group”). They brought this action against the 1^st to 5^th defendants for damages for the massive financial loss resulting from the alleged breaches of their respective duties and/or other tortuous acts. The 6^th to 13^th defendants were joined in these proceedings only for the purposes of the injunctive relief obtained by the plaintiffs by reason of their holding of the assets of the 1^st to 5^th defendants.

2.  In a nutshell, the case of the Group is that in the wake of a reshuffle of the management in the Group, all of the 1^st to 4^th defendants were removed from their respective key managerial positions in late 2011 and early 2012. Thereafter, the new management allegedly discovered that there had been a number of abnormalities and irregularities in the operation of the Group, incurring heavy financial losses allegedly attributable to the misconducts of the 1^st to 5^th defendants.  More precisely, the Group, having conducted a hugely profitable business with sizable cash balances over the years, had been reduced to impecuniosity due to a massive fraud perpetuated by, among other persons, the defendants.

3.  Given the default of the respective unless orders made against the 1^st and 4^th defendants, the plaintiffs have entered final judgement against them. Furthermore, immediately before the commencement of the trial, the Group withdrew their claim against the 2^nd defendant and agreed to pay him costs in the sum of HK$230,000. Therefore, for the purposes of this trial, there are only two defendants left, namely the 3^rd and 5^th defendants.

4.  The involvement of Ms Fu, the 5^th defendant, in these proceedings is very much limited, and has hardly gone beyond the pleading stage. She has long been absent from the relevant hearings including this trial. The great majority of the Group’s allegations are targeted at the 1^st to 4^th defendants. Among them, only the 3^rd defendant, namely, Mr Jim Ma (“Mr Ma”) persists in his defence. This trial essentially is a fight between the plaintiffs and Mr Ma only.  In spite of this, I do not overlook that the Group is still required to prove their pleaded allegations against D5, despite her lack of evidence in support of her defence as well as her non-attendance.

5.  Mr Ma denies liability. The main thrust of Mr Ma’s defence is that he was also ignorant of such abnormalities and irregularities, and despite his position in the Group, he should not be held responsible for them and he also could not be expected to be able to curb them.  He contends that he was in the same plight with the Group, and if the Group was defrauded, he was as well.  

6.  Mr Ma, on the other hand, has a counterclaim for his outstanding monthly salary from November 2011 to March 2012 with credit given to a sum of RMB 25,000 already received. His monthly salary was HK$99,000 and the amount that he now claims is about HK$470,000. The Group does not contest this claim.

7.  Moreover, in his counterclaim, Mr Ma claims damages for his loss and damage arising from a Mareva injunction granted by A. Chan J against him upon the application of the Group (“the Mareva Injunction”). This is an unusual claim, and Mr Ma has not adduced any evidence to support his alleged loss and damage. In any event, if the Mareva Injunction is found to have been wrongly granted, the Group pursuant to their undertaking should compensate Mr Ma for his loss and damage and this should not be canvassed in the trial.

8.  The issues in the main trial between the Group and Mr Ma are, firstly, what exactly Mr Ma’s positions in the Group was or were and thus what his duties and obligations were. Secondly, whether there were such abnormalities and irregularities in the operation of the Group. Thirdly, whether Mr Ma was accountable for such abnormalities and irregularities in view of the findings of the first issue.

9.  I should first give an introduction of the relevant parties and an account of the background facts. For the former, I may simply adopt the neutral part of the statement of claim to which the defence of Mr Ma has no gainsay. For the latter, in addition to the uncontroversial averments in the statement of claim, I also with respect adopt the summary made in the decision of A. Chan J dated 11 November 2013 whereby the Mareva injunction, among other things, was granted against Mr Ma (“the Decision”).

Parties

10.  The 1^st plaintiff (“P1”) is a company incorporated in Delaware, the United States of America with its principal place of business in Hong Kong. It had been listed on the NASDAQ stock market from October 2007 until it was delisted on 2 May 2012.

11.  The 2^nd plaintiff (“P2”) is a BVI company and a wholly owned subsidiary of P1. P2 entered into certain service agreements with each of the 1^st to 4^th defendants as their employer.

12.  The 3^rd plaintiff (“P3”) and the 4^th plaintiff (“P4”) are wholly owned subsidiaries of P1 incorporated under the laws of the People’s Republic of China as wholly foreign owned entities (“WFOEs”) with their principal place of business located in Shanghai (“the Shanghai Office”).

13.  The 5^th plaintiff is another WFOE within the Group with its principal place of business situated in Beijing (“the Beijing Office”)

14.  Until 26 March 2012, Mr Chan, the 1^st defendant, (“D1”) had been, among many other positions in the Group, a director and the Chairman and Chief Executive Officer (“CEO”) of P1 and P2; a director, the Chairman and their Legal Representative of P3 and the General Manager, Executive Director and Legal Representative of P4.

15.  Until his resignation on 26 March 2012, Mr Antonio Sena, the 2^nd defendant, (“D2”) was the Chief Financial Officer (“CFO”) and Secretary of P1 and P2 and a director, the General Manager, and Legal Representative of P5 until his removal from such positions on 20 April 2012.

16.  Mr Ma was the Chief Accounting Officer (“CAO”) and Vice President of P1 and P2 until his removal from such positions on 11 April 2012. Whether he was also the supervisor of P5 is a live issue.

17.  Mr Jiang, the 4^th defendant, (“D4”) was the Chief Investment Officer and President of P1 and P2 and a director of P3 until his removal from such positions on 29 March 2012.

18.  Ms Fu was locally born and had accounting experience. She assisted the financial side of the Group and her exact role is in dispute.

Background facts

19.  The background facts common to all the allegations of the Group are mostly uncontroversial. Firstly, I will give a summary of such facts pleaded in the statement of claim of which I am satisfied are supported by undisputed evidence.

20.  I shall start by providing more information about the business of the Group. The Group is a profit-making, post-secondary education and e-learning surfaces provider and they have an international clientele. The major business was carried on by P1.

21.  P1’s business had been divided among two main lines of business, viz, an e-learning and training services group (“ELG”), and a traditional university group (“TUG”).

22.  The TUG business offered bachelor and diploma programs to students in the PRC, and it involved three universities in the Mainland. They are the Foreign Trade and Business College of Chongqing Normal University (“FTBC”) in Chongqing, Lijian College of Guangxi Normal University (“LC”) in Guilin, and Hubei Industrial University Business College (“HIUBC”) in Wuhan.

23.  All these educational institutions were owned by P1 through such other companies under its ultimate control. For present purposes, it is not necessary to spell out the rather complicated corporate structures. Suffice it to say that P5 is one of the WFOEs which held the holding companies of LC and HIUBC until they were wrongfully transferred out of the Group.

24.  The TUG business generated approximately US$46.4 million in revenue for 2010, as reported in the annual report of P1 by way of Form 10-K filed with NASDAQ on 24 February 2012.

25.  It is convenient at this juncture for me to now give an introduction of the document known as Form 10-K. When P1 was listed, it was subject to various obligations imposed by NASDAQ and the Securities and Exchanges Commission of the US (“SEC”). One of such obligations is that P1 was required to submit a Form 10-K, that is, an annual comprehensive summary report of a listed company’s performance, to the SEC at the end of each fiscal year. A Form 10-K is a bulky document containing all the relevant information reflecting the true financial condition of a listed company including all its subsidiaries in even more detail than an annual report. It usually contains audited financial statements. On the other hand, a Form 10-Q is a listed company’s quarterly report containing fewer details.

26.  Another document worthy of a specific mention is Form 8-K. This is a form that is filed by listed companies in the US to inform their shareholders, and the general public, of unscheduled material events that are important to shareholders.

27.  For the preparation of Forms 10-Ks and 8-Ks in fulfilment of its statutory duty, P1 had to prepare and submit quarterly consolidated group financial statements (“CFSs”). Deloitte Touche Tohmatsu CPA Ltd (“Deloitte”) was the external auditor of the Group and it audited the CFSs.

28.  P3 and P4 are Mainland companies owned by P2 and they perform the corporate treasury function holding key bank accounts for P1. P3 has a registered capital of approximately RMB220 million, and P4 approximately RMB 190 million.

29.  P2 had no business operation on its own after 2007. It merely performed the personnel function for the Group and entered into service agreements with the staff of the Group including the 1^st to 4^th defendants.

30.  In late 2011, there was a proxy contest. The shareholders of P1 were at loggerheads over the constitution of the board, leading to a contentious proxy contest in an annual general meeting held on 10 January 2012. This proxy context gave rise to a series of SEC filings and Delaware litigation in the US from December 2011 to January 2012. The protagonists were one Mr Sherwood on the one hand, and D1 on the other. Eventually Mr Sherwood prevailed and his nominees were appointed to the newly constituted board despite the objections raised by D1.  

31.  Shortly afterwards, at the request of the shareholders of P1, a firm of forensic accountants FTI Consulting (“FTI”) was engaged by the audit committee of P1 (“the Audit Committee”) in late 2011 to conduct an independent verification of P1’s bank balances and fixed deposits in the PRC as at 30 June 2011.

32.  The new management also experienced grave difficulties in gaining access to the accounting documents of the Group, most of which had already been destroyed or gone missing. To the dismay of the new management, despite the apparent profitability of the business of the Group, as a result of the investigation carried out by FTI, they found out that the Group was actually impecunious with their major businesses having already been transferred away.  Unsurprisingly, they direct their acquisitions at the 1^st to 5^th defendants.

33.  In this Judgment, I shall focus on those pleaded allegations against Mr Ma and Ms Fu. The allegations against Mr Ma could be broadly described as follows:

 (1)  obstruction of the audit process and destruction of documents;

 (2)  unauthorised borrowings;

 (3)  pledges of time deposits;

 (4)  dissipation of cash balances;

 (5)  misappropriations of the funds of the Group;

 (6)  transfer of colleges; and

 (7)  mismanagement of the ELG business.

34.  The Group complains about the large-scale destruction, and/or removal of the accounting documents of the Group allegedly under the instruction of D1 thereby seriously impeding their investigation. Mr Ma is not able to argue otherwise. Another handicap of the Group is that, as acknowledged by their former senior counsel as demonstrated in the Decision, there is no direct evidence of any involvement of Mr Ma.

35.  This is also the submission of their current counsel, Mr Wong assisted by Ms Ngai. One of the repeated statements made in the oral evidence of Mr Woodrum, the current CFO of the Group, was that he did not witness (eyeball in his language) any wrongful acts committed by Mr Ma personally but he was sure that Mr Ma must have had a hand in it by reason of his position(s) within the Group. Notwithstanding the enormous amount of documentary evidence placed before me by the Group, there is not a single document indicative of the active involvement of Mr Ma in the wrongdoings.

36.  Mr Wong pitches the case of the Group lower than Mr Woodrum. He submits that there is a reasonable inference of connivance on the part of Mr Ma at the wrongs done to the Group given the key position assumed by him, and had Mr Ma put in place efficient financial controls such wrongs could have been nipped in the bud.  Mr Wong submits that Mr Ma was in breach of his duties as CAO of the Group.

37.  As Mr Wong fairly puts it, the Group’s claim is one of inferences. There is no photograph of Mr Ma reviewing the genuine bank statements and ledges of the Group. In Mr Wong’s submission, the Group’s case is one that requires this court to make inferences on primary facts. He submits that the primary facts irresistibly show that Mr Ma must have knowledge of the fraud and wrongdoings and yet opted not to do anything to stop them.

38.  In his closing submissions, Mr Wong invites this court to reach the following factual conclusions:

(1)  the corporate governance of the Group under the management of D1 was extremely poor and such deficiencies, had been identified by the external auditors including Bossfounder and Deloitte;

(2)  the prevailing financial controls were patently lacking and Mr Ma had unjustifiably, contrary to the content of his Service Agreement, the public announcements of the Group and the representation letters signed by him, sought to shift the blame on Bossfounder and Deloitte;

(3)  notwithstanding his blanket assertions, Mr Ma did receive the accounting documents such as the authenticated bank statements, which disclosed the dubious transactions and hence Mr Ma was aware of them;

(4)  Mr Ma merely minimizes his role and distances himself from the wrongs committed against the Group and he had failed to detect a systematic fraud practised on the Group on an exemplary scale over a substantial period of time;

(5)  whatever financial controls which were put in place had (1) necessitated funds recycling to “create” a bank balance to show receipts of funds which ought to have been received by the Group and (2) allowed the systematic occurrence of transactions which were highly irregular and did not serve any commercial purpose.

39.  It was quite obvious that the corporate governance of the Group was problematic and the financial controls left much to be desired. As a result, dubious transactions took place and the Group has suffered substantial loss. But this does not necessarily follow that Mr Ma should be personally liable and accountable for such loss.

40.  It is imperative to bear in mind the exact causes of action against Mr Ma in the pleading. Although very often the emphasis of Mr Wong is on Mr Ma’s failure to install effective internal financial controls in breach of the duties under his service agreement, it must be remembered that this is not a case of professional negligence. Nor is it a case of common law negligence. The alleged breach of contract and the PRC statutory duty is premised upon the allegation of Mr Ma’s connivance at all the wrongdoings injurious to the financial interests of the Group and/or his actual involvement in certain fraudulent transactions, and not upon his alleged incompetence or negligence. Such alleged conducts of Mr Ma are arguably criminal in nature.

Relevant legal principles

41.  Before I deal with the substantive merits of the parties’ respective cases, it is apposite for me to remind myself of the legal principles germane to (a) standard of proof, (b) connivance and (c) inferences to be made on circumstantial evidence. In this regard, both Mr Wong and Mr Cooney S.C., together with Mr Oh, for Mr Ma, have very helpfully supplied the relevant authorities to this court.

42.  For the applicable standard of proof in this trial, first I should refer to the Court of Final Appeal’s decision in Solicitor (24/07) v Law Society of Hong Kong [2008] 2 HLRD 576. There, Bokhary PJ, after reviewing a number of authorities in Hong Kong as well as in other Commonwealth jurisdictions, affirmed the applicability of the renowned Re H (minor) principle and had this to say at §116,

“The more serious the act or omission alleged, the more inherently improbable must it be regarded. And the more inherently improbable it is regarded, the more compelling will be the evidence needed to prove it on a preponderance of probability.”

43.  It should be noted that there, the Court of Final Appeal was deciding on the appropriate standard of proof for disciplinary proceedings in Hong Kong. The parties here do not have quarrel over the applicability of their conclusion to civil proceedings. The standard of proof required here is still the balance of probability to be satisfied by more compelling evidence.

44.  Now I turn to the notion of connivance. Mr Cooney invites my attention to the decision of DHCJ Albert Wong (as he then was) in HKSAR v Li Fung Ching Catehrine [2012] 3 HKLRD 377. In the absence of any definition of the term “connivance” in the Employment Ordinance, the deputy judge, when considering the offence of connivance thereunder, made reference to its dictionary meanings in the following dictionaries at §§62-65:

“indulgence and non-interference of misconduct” – The New Longman Advanced Chinese Dictionary

“assistance in wrongdoing by conscious failure to prevent or condemn or tacit permission whilst the word “connive” means shutting one’s eyes to something.” – The Shorter Oxford English Dictionary

“turning a blind eye to an action one ought to oppose and tacit permission.” – The English-Chinese dictionary of Joint Publishing

45.  The deputy judge concluded that to connive at somebody’s act, whether or not one agrees or disagrees with the act is not important, what is important is that one fails to stop it from happening knowingly.

46.  For completeness, this court also derives assistance from Black ‘s Law Dictionary (10^th edn.), which defines “connivance” as the act of indulging or ignoring another’s wrongdoing, especially when action should be taken to prevent it and “connive” as knowingly overlooking another’s wrongdoing.

47.  In light of the foregoing dictionary definitions, I am of the view that one can be held to have connived at somebody’s wrongdoing only if he or she had knowledge of the wrongful act, and he or she was in a position to prevent the wrongful act from being committed or continued. Knowledge of the wrongful act is an essential element of connivance.

48.  Pausing here, I note that the Group’s pleaded case of connivance is based on the position(s) of Mr Ma within the Group.

49.  For inferences, Mr Wong very fairly draws my attention to the following dictum of Ribeiro PJ in Ming Shiu Chung & Ors. v. Ming Shiu Sum & Ors. (2006) 9 HKCFAR 334 at §§78-79 & 82:

“78. Whether, at the end of the day, the court is entitled to draw the inference sought by the plaintiffs therefore depends on the evidence as a whole, the evidence both for and against such inference…. That is a matter of inference and what I stated in Nina Kung alias Nina T H Wang v Wang Din Shin (FACV No 12 of 2004, 16 September 2005), albeit there stated in relation to drawing an inference of forgery, equally applies in the present case:

“Where ...... the court is invited to reach a conclusion of forgery as an inference to be drawn on the basis of circumstantial evidence, any such inference must be properly grounded in the primary facts found. The court guards against indulging in conjecture under the guise of drawing an inference where the primary evidence does not logically and reasonably justify the particular inference in question.” (§185)

79. As was there pointed out, Dixon CJ stressed in Jones v Dunkel (1959-1960) 101 CLR 298 at 305, that a court is not entitled to

“...... choose between guesses, where the possibilities are not unlimited, on the ground that one guess seems more likely than another or the others. The facts proved must form a reasonable basis for a definite conclusion affirmatively drawn of the truth of which the tribunal of fact may reasonably be satisfied.” (at 305)

82. The problem is not confined to a question of logic. The evidence falls far short of compelling a “lack of knowledge” conclusion. It is at best equivocal and, with respect, was not fully considered by the Court of Appeal… Other matters relied on by each side do not resolve the overall equivocality of the evidence. The plaintiffs have therefore, in my view, plainly fallen short of establishing that the father signed in a state of ignorance. I would have reached this conclusion simply applying the balance of probabilities. They certainly fail to satisfy a Re H standard of proof.”

50.  I pause again to note that the major primary fact from which an inference of culpability is urged to be drawn by the Group is that Mr Ma assumed the position of CAO within the Group and the supervisor of P5. Mr Wong submits that, given the magnitude and the duration of such wrongful acts committed against the Group, they could not have escaped the attention of an honest CAO, as observed by A Chan J in the Decision.

51.  On the other hand, Mr Cooney warns against the dangers of relying on circumstantial evidence to establish one’s case, referring to the following paragraph in Breslin v Murphy [2013] NICA 75 at §45:

“Both civil and criminal cases can depend on circumstantial evidence. In the context of a civil law tort claim circumstantial evidence involves the plaintiff relying upon evidence of various circumstances relating to the claim which taken together the plaintiff claims establish liability on the part of the defendant because the proper conclusion to be drawn on a balance of probabilities is that the defendant is liable. In the criminal law context the standard direction to the jury includes a direction to the jury that it is not necessary that each fact upon which the prosecution relies taken individually proves that the defendant is guilty. The jury must decide whether all of the evidence has proved the case. Pollock CB in the well-known case of R v Exall [1866] 4 F&F used the well-known rope analogy:

“It has been said that circumstantial evidence is to be considered as a chain, and each piece of evidence as a link in the chain, but it is not so, for then if any one link breaks, the chain would fall. It is more like the case of a rope comprised of several cords. One strand of the cord might be insufficient to sustain the weight but three strands together may be quite of sufficient strength. Thus it may be in circumstantial evidence there may be a combination of circumstances no one of which would raise a reasonable conviction or more than a mere suspicion, but the three taken together may create a conclusion of guilt with as much certainty as human affairs can require or admit of.”

The standard criminal law direction to juries in criminal cases goes on to point out that circumstantial evidence must be examined with care for a number of reasons. Such evidence can be fabricated. It must be seen whether or not there exists one or more circumstances which are not merely neutral in character but are inconsistent with any other conclusion than that the defendant is guilty. This is particularly important because of the tendency of the human mind to look for and often to slightly distort facts in order to establish a proposition, whereas a single circumstance which is inconsistent with the defendant's guilt is more important than all the others because it destroys the conclusion of guilt on the part of the defendant. The principles there stated apply equally in the context of a civil law claim subject to the modification that whereas the prosecution must prove its case beyond reasonable doubt plaintiffs in a tort claim need only prove the case on a balance of probabilities albeit bearing in mind that in a case such as the present the evidence required must be sufficiently cogent to dispel the inherent unlikelihood of individuals involving themselves in a serious terrorist outrage of this kind.”

52.  I should scrutinise the witnesses’ evidence in light of the foregoing authorities.

General observations about witnesses of the parties

53.  The Group had three witnesses whereas Mr Ma alone testified for himself.  Mr Feng was the CEO of P1 from March 2012 to August 2014. He has assumed several key positions of P5 since 20 April 2012. Due to his late involvement, he did not have much personal knowledge of the key matters in dispute and those of his evidence, consisting of hearsay evidence and opinion, is not really that helpful.

54.  Mr Woodrum, the current CEO and CFO, is also a shareholder of P1. He is responsible for overseeing the financial side of the Group. Again, he had little personal knowledge of the crucial matters. He impressed me as an honest person, but I could not totally accept and work on his allegations. His frustration with Mr Ma was very obvious, and somehow understandable. He was eager to attach liability to Mr Ma due to his strong suspicions about him, despite his admitted lack of direct evidence. Mr Ma was the remaining target at trial and Mr Woodrum left no stone unturned to pin the blame on Mr Ma. He at one stage even alleges under cross-examination that Mr Ma falsified the accounting documents of the Group, even though such allegations do not feature in the pleading and Mr Wong expressly confirms that no such claim is made against Mr Ma. This court would be careful in the assessment of his evidence and should exclude all of his opinions and surmise from consideration.

55.  Mr You was the assistant to D4 and was based in the Shanghai Office. His evidence mostly related to events taking place after the removal of Mr Ma. He allegedly went to Mr Ma’s office in Beijing in August 2012 and could only recover some old documents of the Group. He also paid a visit to the three colleges of the Group in mid 2012 on the instructions of Mr Feng and Mr Woodrum to carry out investigations. He gave me the impression that he was not very sure about his evidence and he did not appear to be a reliable witness.

56.  Mr Ma’s personal information will be given below. In the witness box, perhaps owing to his good education, Mr Ma appeared to be a deep-thinker speaking with clarity, confidence and precision. He was very intelligent and analytical. He was subject to lengthy and vigorous cross-examination and he never lost his patience and composure throughout. He paid close attention to the questions posed to him and sounded well-reasoned in his answers, though he was noticeably defensive. I was impressed with his demeanour, but I should be mindful that demeanour can be deceptive and is not always reliable.

Mr Ma’s background, position(s) and duties within the Group

57.  There is a heated debate about Mr Ma’s positions and duties within the Group and this is the first issue I have to resolve. Before dealing with this controversy, I shall outline Mr Ma’s background. The following personal information of Mr Ma contained in his witness statement is not challenged.

58.  Mr Ma was born and bred in Hong Kong and is now in his mid-40s. As a student, he excelled at mathematics and secured a full scholarship to his master degree course in finance at Cambridge University. It was no mean feat. After graduation in 1994 with a master degree in finance and another master degree in engineering, Mr Ma returned to Hong Kong in 1994 and started working for Lippo Securities Limited (“Lippo”) as an associate director providing mergers and acquisitions and initial public offering advice to its corporate clients. During his employment with Lippo, Mr Ma obtained the qualification as a chartered financial analyst in 1997 through his success in public examinations. Mr Ma makes it clear that he does not have any professional accounting training and is not a qualified accountant. To this, there is no contrary evidence.

59.  In or around 1999, Mr Ma was recruited to work for the Group by P2 when it was its infancy stage only. On 11 April 2012, Mr Ma left the Group pursuant to a written notice issued by P2.

60.  In the Form 10-K filed on 11 September 2006, the description was that Mr Ma joined the Group in 1999 as Vice President of Finance. Mr Ma was responsible for the financial reporting, cultivating/maintaining investor relationships and other corporate finance activities.

The Group’s case

61.  Mr Ma signed the service agreement with P2 dated 4 January 2010 (“the Service Agreement”) whereby he was appointed the Executive in the employment of P2. Clause 3.1 of the Service Agreement, under the heading of “Duties”, provided the following:

“3.1 The Executive shall during the Term:

3.1.1 serve the Company in his capacity as Chief Accounting Officer with such executive and management responsibilities and duties (consistent with the Executive’s position as Chief Accounting Officer of the Company) as may from time to time reasonably be assigned to the Executive by the Chief Executive Officer of the Company (“CEO”) and/or the board of directors of the Company (the “Board”), including all of the powers and duties usually incident to such position for a U.S. listed public company, and specifically including but not limited to (a) creation and maintenance of proper financial controls; (b) development and submission of financial reports in accordance with U.S. Securities and Exchange Commission requirements; (c) development of corporate governance policies and procedures; (d) managerial accounting; (e) treasury functions; (f) accounting functions, including accounts payable and receivable; (g) cost controls; (h) payroll; (i) management of legal functions; (j) support of activities to identify and enter into additional joint ventures with universities; and (k) support of activities for attracting new capital and financing.

3.1.2 devote the whole of his working time, attention and abilities during normal business hours and such additional hours as may reasonably be required to administer the duties associated with his position; and

3.1.3 use his best endeavors to promote and protect the interests of the Company and shall at all times keep the Board promptly and fully informed of all matters relating to or in connection with the performance and exercise of his duties under the Agreement.

3.2 The Executive shall work in Hong Kong or the PRC which the Board may require for the proper performance and exercise of his duties under this Agreement.

3.3 The Executive shall be required to work such hours as are reasonably necessary to fulfill his duties under this Agreement.”

11.3.2 The Executive (…) shall deliver to the Company in accordance with the directions of the Board, all keys security passes, credit cards, the Documents and other property belonging to all relating to the business or affairs of the Company or any Group Company, including all copies of all Documents containing all referring to Confidential Information which may be in his possession or under his control and shall not retain copies, extracts or notes of any of the same.”

62.  Although only Mr Ma and P2 were privy to the Service Agreement, the Group’s case is that Mr Ma owed such duties to P1 and indeed the entire Group.

63.  Subsequently, Mr Ma was appointed the CAO and Vice President of P1 after the listing on NASDAQ in 2007. The unchallenged evidence is that being the CAO, he was the head of the Group’s accounting and treasury function. Mr Ma was the one that dealt with Deloitte on behalf of the Group and he was provided with the bank statements and the accounts every quarter by the subsidiaries. Each of the subsidiaries in the Group would submit trial balances to Mr Ma on a monthly basis for his preparation of the CFSs. These CFSs comprised profit and loss accounts, balance sheets and cash flow statements on a consolidated basis. All these documents should reveal all the actual transactions undertaken by the Group.

64.  As the CAO, Mr Ma had duties and obligations under various US federal laws and regulations and Delaware corporate law for a US issuer, including the development and submission of reports in accordance with the SEC requirements. He had obligations under the US Sarbanes-Oxley Act (“SOX”) to provide certifications in respect of P1’s financials which formed part of his US securities duties.

65.  Apart from his US securities duties, the pleaded case of the Group is that Mr Ma had certain statutory duties in accordance with the PRC Company Law. I need not set the relevant provisions out here and the following should suffice.

66.  Article 148 provides that the directors, supervisors and senior managers shall comply with the PRC laws and bear the obligations of fidelity and diligence to the company.

67.  Article 149 provides that no director or senior manager may act dishonestly in dealing with the properties, both tangible and intangible, of the company.

68.  Lastly, Article 150 provides that any director, supervisor or senior manager violates any law, administrative regulation or the bylaw during the course of performance of his duties shall be liable for compensation to the company for any loss caused.

69.  The Group contends that these provisions in the PRC company law apply to Mr Ma by reason of his position as the supervisor of P5. They say that the records filed with the State Administration for Industry and Commerce, a Mainland authority overseeing business undertakings in the PRC, (“AIC Records”) relating to P5 plainly show that Mr Ma had such a title. It was an application form for a change of the registration record of P5.[1]

70.  Furthermore, in the course of cross-examining Mr Ma, Mr Wong indicated that the alleged position as the supervisor of P5 is only relevant to the Group’s allegation regarding the wrongful transfer of colleges and Mr Ma was in breach of Article 150 of the PRC Company law.

71.  Mr Ma had to ensure compliance with the relevant accounting standards and practices, designing internal control systems to avoid fraud and misappropriation. This includes ensuring that material information was communicated to him, enforcement of accounting policies, internal audits, tax, liaison with external auditors, implementation of audit report recommendations and the management of financial risk for the group including liquidity risk management, cash management, investment management and capital structure (such as share issurance and repurchase). He was at the nerve centre of the finance and treasury functions of the Group and he had to report the performance of his duties to both D1 and D2.

72.  In providing the CFSs to Deloitte for the purpose of the filing of Form 10k, on behalf of P1, D1, D2 and Mr Ma signed a representation letter (“the Representation Letter”) giving the following confirmations about their responsibilities:

a. The fair presentation in the condensed consolidated interim financial statements in conformity with generally accepted accounting principles;

b. The design and implementation of programs and controls to prevent and detect fraud;

c. Establishing and maintaining effective internal control over financial reporting.

73.  Further, in the Representation Letter, D1, D2 and Mr Ma also confirmed that they had no knowledge of any fraud or suspected fraud affecting the company involving:

a. management,

b. employees who have significant roles in the company’s internal control over financial reporting and

c. others if the fraud could have a material effect on the condensed consolidated interim financial statements.

74.  In the Form 10-K for the fiscal year ended 31 December 2010, as the independent registered public accounting firm reporting to the board, Deloitte said this (“the Deloitte Observations”):

“A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material witnesses have been identified and included in management’s assessment:

1. Lack of sufficient skilled resources in the finance team to meet the demands of rapidly expanded businesses which resulted in a delayed closing process.

2. Lack of contemporaneous documentation of certain decisions made by the Board of Directors.

3. Accounting for the prepaid surface the – during 2011, the company reinterpreted its position related to the evaluation of the contractual requirement for non-current advance referred to as the prepaid service fee. As a result of that process, the company concluded it lacked adequate and effective controls to ensure all contractual requirement as well as relevant accounting guidance were conceded in determining the appropriate accounting for the prepaid service fee. This material weakness contribute to the restatement to the previously reported consolidated financial statements for the year ended December 31, 2010, as discussed in note 27 to the consolidated financial statements under the caption second restatement.

The material weaknesses were considered in determining the nature and extent of audit as applied to our audit of the consolidated financial statements and financial statements surge as of and for the year ended December 31, 2010, of the company and this report does not affect our report on our such financial statements and financial statement schedule.

In our opinion, because of the effect of the material weaknesses identified above on the achievement of the objectives of the control criteria, the Company has not maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in internal control – integrative framework issued by the committee of sponsoring organisation of the Treadway Commission.”

Mr Ma’s case

75.  Mr Ma has a very different view on his positions in the Group as well as his duties and obligations to perform.

76.  First and foremost, Mr Ma denies that the express provisions in the Service Agreements truly reflected his actual duties by reason of an estoppel. His evidence is that prior to January 2010, he did not have any written agreement with the Group, except one he signed when he first joined P2 in 1999. In 2009, D2 approached him and asked him to sign a service agreement with P1 for the purpose of the listing of P1 in the US.

77.  When Mr Ma read the provisions relating to his duties in that service agreement, in particular clause 3.1.1 thereof, he found that the duties specified therein were inconsistent with the duties undertaken by him in that the scope was much wider.

78.  Mr Ma duly raised this concern with D2. He took particular exception to the inclusion of the following duties: managerial accounting, treasury functions, accounting functions, payroll, cost control and management of legal functions. He had neither legal nor accounting qualification and so he could not perform such functions. D2 assured Mr Ma that the service agreement was drafted by the US lawyers for the Group in fulfilment of the US regulations only and despite the express term, his duties would remain the same and all such additional duties stated in the service agreement would be undertaken by such professionals engaged by the Group. D2 represented to Mr Ma that the service agreement was merely a formality. All the foregoing assurances and representation given by D2 to Mr Ma were made orally (“D2’s Assurances”).

79.  However, due to Mr Ma’s concern about tax liability in the US, it was not executed.

80.  In January 2010, D2 requested Mr Ma to sign the Service Agreement with P2. It was identical to the unsigned service agreement with P1. Mr Ma noted that the same provisions relating to his duties and obligations were there, but simply relied on D2’s Assurances and did not repeat his concerns. Under these circumstances, Mr Ma signed the Service Agreement.

81.  In his pleadings, Mr Ma makes a plea that the Group is estopped from relying on Clause 3.1 of the Service Agreement.

82.  Mr Ma based in Hong Kong from 1999 to 2001. Since 2002, Mr Ma had worked from the office of the Group in Beijing. On his own evidence, which was not challenged, Mr Ma’s work from 2002 to 2007 included dealing with professionals engaged to conduct due diligence and prepare legal documentation and preparation and submissions of CFSs on a quarterly basis in accordance with the US regulations. From 2004 to 2007 when the holding company of P2 was listed in Singapore Stock Exchange (“SSE”), there were additional duties including dealing with the enquiries of SSD, and working with auditors on the quarterly and annual reports.

83.  It is important to note what Mr Ma said about his actual duties from 2007 onwards.

84.  In his pleading, Mr Ma makes it clear that he had no responsibilities for operation matters, business strategy or decision-making. He reported directly to D2 and acted on his instructions. Subsequently, on issues of corporate restructuring, he acted on the instruction of D1. He emphasizes that he was not a director and never a member of the board. Mr Ma further sets out his duties in the following terms:

(a)  preparing a CFS for the Group for each quarter. Mr Ma would be provided with the accounts for each of the subsidiary companies and once these had been made compliant with the relevant international accounting principles (first IFRS and subsequently from 2007 onwards, US GAAP), Mr Ma would consolidate them into a consolidated financial statement. Mr Ma played no role in the preparation of the accounts provided to him by each subsidiary company and had no power to comply their creation or provision;

(b)  providing the final quarter consolidated financial statements to the auditors, Deloitte, for use by them in performing quarterly reviews and audit. Deloitte would conduct its reviews or audit procedures on the basis of consolidated financial statements provided to them by Mr Ma. Mr Ma also provided support to Deloitte such as helping them to get the necessary information and when they were conducting field audit. Mr Ma would prepare accounting memoranda based on US GAAP accounting literature and would discuss accounting treatment with Deloitte;

(c)  working with professionals such as Deloitte on tax issues of the Group;

(d)  providing financial information explaining or underlying the CFSs to D2 (CFO) for presentation to the Audit Committee at their telephone meetings held approximately quarterly. Mr Ma also attended these meetings by telephone in case there were questions about the information provided by him;

(e)  working with the internal auditors engaged by the Group to ensure compliance of P1 with the SOX requirements since the listing of P1 on NASDAQ;

(f)  building financial models for presentation to financial analysts and potential investors in fund-raising rounds to acquire colleges in the PRC;

(g)  assisting D2 in drawing up an annual audit budget for the Group for board approval and

(h)  assisting with corporate restructuring of the Group such as advising and working with external professionals on accounting aspects of restructuring and on listing requirements. Mr Ma did not carry out the actual filing of documents with the authorities, arranging for the signing of documents or the execution of share transfers, which were undertaken by the legal team in the PRC.

85.  On his own evidence, Mr Ma was responsible for the preparation and submission of CFSs for the Group on a quarterly basis in accordance with the US regulations since about 2001. To this end, the following documents (collectively “the Received Documents”) were provided to Mr Ma:

(a) profit and loss account and balance sheet from each subsidiary (there were at least 15 of them after 2010);

(b) general ledger covering the relevant quarter from each subsidiary;

(c) monthly bank statements and bank reconciliation statements covering the quarter for all bank accounts;

(d) a closing checklist decided by the internal auditors  setting out those tasks that the financial manager of each subsidiary should have completed before closing of the accounts for the subsidiary for the quarter. This provided an additional safeguard to ensure compliance with the SOX requirements.

86.  It is equally important to note what Mr Ma expressly pleads to be outside the ambit of his duties. He denies that he was responsible for preparation of any underlying accounting data from the subsidiary companies, or any transfer or handling of any company funds of the Group. He avers that he had no power or responsibility to control these activities. He also distances himself from the auditing work of the Group. The external audit for the consolidated group accounts was undertaken by Deloitte. The Deloitte people would conduct a field audit paying visits to the offices of the PRC subsidiaries. They would directly communicate with the personnel of those PRC subsidiaries for discussion and requests for additional information if necessary. They would also perform sample checks on accounting vouchers and obtain independent bank confirmation of transactions. Mr Ma merely provided assistance to them, and did not perform any of the audit tasks himself for the subsidiaries.

87.  The PRC subsidiary companies were additionally required by PRC law to conduct an external audit in accordance with the accounting rules and principles of the PRC. A local accredited accounting firm was instructed to undertake these external audits in which Mr Ma had no involvement.Under cross-examination, Mr Ma disclosed that the external contractor was Legend House.

88.  Mr Ma was assisted by a PRC registered accountant in his work from 2007 onwards on his evidence. The identity of the professional accountant was not disclosed.

89.  I should add that the Group relies on an allegation in the defence of Ms Fu that she personally sent all such accounting vouchers, checks and remittance advice prepared by her in respect of the Group’s transactions in Hong Kong to Mr Ma to show that Mr Ma was in possession of the basic accounting information in respect of P1’s subsidiaries in Hong Kong. Since Ms Fu failed to file any evidence or testify to support this allegation, I can only disregard this in the absence of any documentary proof.

90.  With respect to internal auditing, in 2007, the Group appointed Protiviti Shanghai Co. Limited (“Protiviti”) and from 2009 to 2011, replaced Provititi with Primatrix Management Consulting Ltd. (“Primatrix”), which was later renamed to be Bossfounder (Beijing) Management Consulting Ltd. (“Bossfounder”) in 2011, to provide internal audit services for the Group. Primatrix was an independent professional firm specialising in auditing.

91.  In their respective internal audit reports, it was expressly stated that they were engaged to independently review the system of internal control as established by the management. This included its adequacy and integrity vis-a-vis the objectives served as well as to make appropriate recommendations thereof. They were to assess the scope of compliance with SOX.

92.  The Internal Audit Report of P1 dated 14 March 2011 prepared by Primatrix was available to this court. In the Primatrix Report, the conclusion made was that on the deficiencies evaluation process, Primatrix any significant deficiencies and material weaknesses in the internal controls over financial reporting.

93.  In the Internal Audit Report of P1 dated 12 March 2012[2] prepared by Bossfounder, the following limitations of internal audit were spelt out (“the Bossfounder Limitations”):

The internal audit procedures rely on mission and representations made available to the Bossfounder by the management of P1 and Hubei and price enquiries and observations and limited tests of transactions on a sample basis, covering the detailed assessment objectives. Accordingly, the internal audit procedures may not detect all fraud, defalcations and irregularities.

Our work as internal auditor does not in any way diminish the responsibility of P1’s management. The design, development, implementation and operation of internal control systems are the responsibility of individual P1 and Hubei managers. They are accountable for ensuring that adequate controls exist in the areas of their responsibility and should not rely solely on periodic visits as a means of monitoring the adequacy and integrity of controls.

94.  Mr Ma’s evidence is that his duty was to assist these internal auditors in their work who would make recommendations for internal procedures. Once their recommendations were accepted, these internal auditors would guide the implementation of the new internal procedures and conduct on-site inspection to ensure compliance.

95.  The Group cannot agree with the position of Mr Ma. They insist on the binding effect of the relevant provisions in the Service Agreement, in particular clause 3.1.1, and aver that if factually Mr Ma did not perform such duties which he now alleges not to be within his remit, he must be in breach of the Service Agreement.

96.  On the other hand, though accepting that a supervisor has statutory duties to perform in accordance with the PRC company law, Mr  Ma denies that he was ever appointed supervisor of P5. He maintained that he never signed anything to accept the position as a supervisor. Nor was he aware of this alleged appointment until he read the affirmation evidence of the Group. He also contends that a supervisor is not actually vested with any power of investigation and, generally speaking, in practice the role of a supervisor is mere window dressing in the PRC.

97.  Mr Ma accepted under cross-examination that he received the financial reports of P5, and he would review them but he did not do so qua the supervisor of P5.  

98.  Mr Ma further explained that D2 was the legal representative of P5 and he was directly accountable to D2. D2 might put his name down as the supervisor of P5 in the AIC records without actually telling him about this purported appointment. He had never come across any documents showing his designation as the supervisor of P5.

Analysis of Mr Ma’s positions and duties

99.  On the evidence, I reject Mr Ma’s defence of estoppel. I do not believe Mr Ma raised objections to his duties set out in clause 3.1.1 of the draft service agreement in 2009. I am well aware of Mr Ma’s lack of accounting qualifications. However, on his own evidence, prior to 2009 he also performed accounting functions for P2 when its holding company was listed on SSE.  He also dealt with SSE on behalf of P2’s holding company. The said duties included in clause 3.1.1 should not cause him serious concern so much so that he had the urge to discuss the provision with D2 immediately.

100.  I am unable to accept that D2’s Assurance was made by D2 as a matter of fact. I do not believe that there was such a discussion about §3.1.1 between D2 and Mr Ma. D2 undoubtedly would be in a position to assist Mr Ma to establish his estoppel defence. Even after D2 dropped out of the picture on the first day of the trial, Mr Ma should have made an effort to procure his supportive testimony but, for unknown reasons, Mr Ma did not do. The adverse inference to be drawn is that D2’s evidence in this regard could not support his case.

101.  Nor can I accept that Mr Ma could establish that D2 had the authority to make D2’s Assurance on behalf of P2 or the Group. I also accept Mr Wong’s submission that no detriment is pleaded and the plea of estoppel by representation is deficient.

102.  For completeness, I should mention that in the course of the defence case, Mr Cooney made an application to amend the defence to include a defence of estoppel by convention. Mr Wong opposed the application on the ground of unexplained lateness, though he confirmed that no further evidence was required to be adduced from the Group to deal with the proposed defence.

103.  I rejected the application on the spot. First, as a matter of principle, it was made unduly late without any valid reasons given. More importantly, I do not accept the proposed amendments could constitute a valid defence of estoppel by convention. It is now settled law that the doctrine only applies where parties to a transaction act on an assumed state of facts or law: Unruh v Seeberger (2007) 10 HKCFAR 31 per Ribeiro PJ at §141.

104.  In the proposed amendments, the alleged assumption shared by P1, P2 and Mr Ma is that, whilst Mr Ma would act as CAO of P1, Mr Ma would not be responsible for, and did not assume duties, whether towards P1 or P2, for a number of functions forming part of his contractual obligations under §3.1.1 of the Service Agreement. This means that the contractual obligations would not be enforceable against Mr Ma, or that the entire Service Agreement would not be binding on Mr Ma.

105.  I opine that the alleged assumption is unable to found a valid defence of estoppel by convention. In Scottish and Newcastle Plc v. Lancashire Mortgage Corporation Limited [2007] EWCA Civ, Mummery LJ made this very clear in the following terms:

“This form of estoppel does not apply, however, to a representation or to a promise made by one party to the other as to future conduct, which is relied on and acted on by the other to his detriment. The essence of estoppel by convention is the assistance of a factual or legal state of affairs, the truth which has been assumed or assented to by the parties and is shared by them as the basis of their relationship with each other.”

106.  If the alleged assumption means that, despite the clear wording in the Service Agreement, Mr Ma did not have to perform such duties and hence he did not assume any practical responsibility for such duties because P2 would not enforce clause 3.1.1 against him, it only relates to the future conduct of the parties or a statement of intention.

107.  If the alleged assumption means that Mr Ma did not assume any legal responsibility under the said provision at all, this would mean that it was not binding on him and P2 had nothing to forbear. This is too far-fetched and in fact unsupported by Mr Ma’s own evidence. Mr Ma did not completely deny all the obligations under the Service Agreement.  

108.  For these reasons, I was unable to accept the late application of Mr Ma. Mr Ma should pay the costs of the Group relating to this application, to be taxed if not agreed.

109.  Returning to the duties of Mr Ma within the Group at the material times, I accept his unchallenged evidence relating to the tasks that he had to perform for the Group, in particular, his dealing with the Received Documents and his preparation and submission of CFSs. Despite his lack of accounting qualifications, such tasks actually entail sound accounting experience and working knowledge of the relevant accounting regulations and principles. It is really surprising that without any formal training or accounting qualifications, Mr Ma could assume the position of CAO even with the assistance of a professional PRC accountant.

110.  Insofar as the question as to whether Mr Ma was the supervisor of P5, I accept Mr Ma’s evidence that he had never expressly agreed to assume this position. I am aware that the Group was unable to adduce any documentary evidence to prove that Mr Ma ever acted in such capacity. The AIC record relied upon per se could not evidence Mr Ma’s acceptance of this position. I accept Mr Ma’s evidence that he had never come across the AIC record, which was filed at the incorporation stage.

111.  On the other hand, Mr Ma knew that there should be such a key position in P5 and a supervisor had his specific duties though he thought that it was commonplace in the PRC that such positions were only nominal in nature.  Mr Ma accepted that he was, in practice, the person in charge of the Beijing Office of P5, and also performed similar duties on behalf of P5.  There is no reason why Mr Ma could and did not identify who the actual supervisor of P5 was. I do not believe that in the course of his provision of service to P5, he never came across the actual supervisor if another individual assumed the position. I find it more probable that Mr Ma was the supervisor of P5 even though initially he had not expressly given his consent to be appointed as such. His knowing and voluntary performance of the duties of a supervisor could be taken as his tacit approval of his appointment to be the supervisor of P5.

112.  Nevertheless, I find this issue to be only a red herring. Whether Mr Ma was formally appointed as the supervisor of P5 does not alter the fact that he could not violate any law, administrative regulations or bylaws during the course of his employment with the Group and if any loss caused to the Group, he should be liable for compensation. Under the common law, any employees of the Group would be liable to indemnify the Group against such loss.  Article 150, and hence the alleged breach of PRC statutory duties, do not give any extra mileage to the plaintiffs’ claim at all.

113.  I should make it clear that my rejection of Mr Ma’s defence of estoppel by representation does not mean that I cannot accept Mr Ma to be a truthful witness in other respects. He was merely defensive, tryingvery hard to distance himself from the questionable accounting transactions and wrongdoings committed against the Group. In doing so, he made a desperate attempt to rid himself off the obligations imposed upon him by the Service Agreement.

Obstruction of the audit process and destruction of documents

Obstruction

114.  Mr Wong in his opening submissions indicated that the Group now relies on these allegations as a backdrop only. They no longer pursue a claim for damages for the obstruction of the audit process, but they continue to pursue the declaratory and injunctive relief.

115.  In my view, by these allegations, the Group clearly intend to prejudice Mr Ma by showing his close ties with the wrongdoers, and his reluctance to assist investigation, thereby strengthening their case of connivance. In his closing submissions, Mr Wong does not actually address me on the declaratory and injunctive relief. 

116.  I should nevertheless briefly deal with these allegations. It is first alleged that after the proxy contest, D1 started to actively and wrongfully prevent the new management from investigating the affairs of the Group.

117.  The first step that D1 and his accomplices, including Mr Ma, did was allegedly their prevention of Deloitte from completing their 2011 year-end audit (“the 2011 Audit”), resulting in the delisting of P1 by NASDAQ on 2 May 2012.

118.  The original deadline for P1 to file the 2011 Audit, by way of a Form 10-K to be filed with SEC, was 15 March 2012. At the meeting of the Audit Committee on 8 February 2012, D2 already indicated that the 2011 Audit would be behind schedule. He explained that the delay was due to the public holidays and hence field work could not be carried out at the Shanghai Office.

119.  Despite the repeated requests of the board, coupled with the pressure given by Deloitte, D1, D2, D4 and Mr Ma were alleged to have failed to diligently carry out the audit process.

120.  On or about 17 February 2012 at 7:07 a.m., Mr Woodrum sent an email to the Audit Committee members and Mr Ma (“17/2 Email”). In the email, Mr Woodrum specifically asked D2 and Mr Ma to obtain supporting documentation for the FTBC RMB 80 million cash transfers (as will be elaborated below) to Deloitte, as soon as possible, as they needed to audit this item quickly.

121.  On or about the same day, Deloitte issued an audit plan stating their difficulties due to non-availability of certain financial information concerning the Group (“the Audit Plan”). In the Audit Plan, the risk of material misstatements due to fraud or error was also identified. Mr Woodrum circulated the Audit Plan to the members of the Audit Committee as an attachment to his email dated 17 February 2012 at 9:11a.m..

122.  On 29 February 2012, the Audit Committee was informed that the audit was behind schedule and the Shanghai Office’s financials were not available. Field work there had not been commenced.

123.  On or about 15 March 2012, the arranged fieldwork trip to the Shanghai Office of Deloitte was aborted due to the non-cooperation of the Shanghai Office personnel.

124.  It goes without saying that the original deadline was missed. On 16 March 2012, D1 had to file a Form 12b-25 to notify the public about the delay in filing its Form 10-K. Thereafter, the new management of P1 pressed D1, D2 and Mr Ma to complete the audit process but in vain.

125.  In view of the impasse, the board issued an open letter to the shareholder of P1 dated 2 April 2012. This letter informed them that D1 and his accomplices had refused to provide the necessary financial information so as to allow Deloitte access to the Shanghai Office in order to complete their field work and as a result P1 was unable to issue the 2011 Audit pursuant to the requirements of SEC.

126.  The most direct allegation against Mr Ma is that from 26 March 2012 when the new management managed to take over control of both the Beijing and Shanghai offices, to the termination of Mr Ma’s employment on 11 April 2012, Mr Woodrum could not reach Mr Ma by any means, and Mr Ma ignored all of Mr Woodrum’s emails and telephone messages to him concerning the progress of the audit.

127.  Mr Wong urges this court to make a factual finding that Mr Ma deliberately obstructed the 2011 Audit with a view to stalling the investigation of the problems identified in the Audit Plan, including the dubious FTBC transfer. Mr Wong submits that this finding provides grounds to infer that Mr Ma connived at the wrongdoings committed against the Group.

128.  I have considered the explanations of Mr Ma. In essence, he shifted all the blame onto the Shanghai Office, over which he claimed to have no control. He explained that the aborted field audit was due to the unavailability of D4. On his part, he did travel to the Shanghai Office in the afternoon of 15 March 2012 to assist.

129.  Despite Mr Ma’s explanations, I am of the view that he could definitely have done much better to assist the 2011 Audit. Though I accept that he was not responsible for the abortion of the field audit, he could have seriously demanded the Shanghai Office to cooperate with Deloitte. I do not accept Mr Ma’s evidence that he did not have any control over the Shanghai Office. He might not have had the managerial or supervisory role in the Shanghai Office but the accounting staff of the Shanghai Office must be accountable to him given that he was the CAO. Mr Ma must be responsible for ensuring that Deloittecould do their job properly with the cooperation of the subsidiaries within the Group. As rightly referred to me by Mr Wong, the emails of Bossfounder show that Mr Ma was the one to deal with the external professionals on behalf of the internal accounting offices within the Group.

130.  Nor do I accept Mr Ma’s explanation that he thought Mr Tseung, an independent director and a member of the Audit Committee, had taken over his task. He could not have lost sight of his position and his responsibility to ensure compliance with the NASDAQ and SEC’s filing requirements.

131.  I am unable to accept Mr Ma’s allegation that he had completed his part in the audit process by 21 March 2012. There were clearly outstanding issues as pointed out by Deloitte. As the CAO, Mr Ma should have made reasonable endeavours to ensure that the 2011 Audit could be completed in good time. Further, there is no evidence that he had complied with the request of Mr Woodrum in the 17/2 Email to start with.  

132.  However, his indifference to or his nonchalant attitude towards to the 2011 Audit cannot be equated with deliberate obstruction without further ado. There is no evidence that Mr Ma ever caused or instruct any staff of the Group to hinder the progress of the 2011 Audit by non-cooperation or otherwise. I cannot accept the hearsay evidence that Mr Ma had ever told Cheng Ying, Finance Manager of the Shanghai Office, that the 2011 Audit would be put on hold.

133.  In the proxy contest, Mr Ma already indicated his reluctance to work with the new management. His nonresponse to Mr Woodrum’s messages, which I find to be intentional, was clear evidence of his reluctance.  His vacation taken from 2 to 9 April 2012, when the Audit Committee was screaming for help speaks volume for his care about the Group, or rather the lack of it.

134.  It should be noted that the 2011 Audit was in itself fraught with difficulties: such as the non-cooperation of the Shanghai Office, D2’s apparent indifference and the non-payment of the professional fees of Deloitte and the list goes on. There is every reason for Mr Ma to be less than zealous to perform his duties to assist the Group in the completion of the 2011 Audit, under these circumstances.

135.  In my view, Mr Ma could and should have done more for the Group amidst the saga of the 2011 Audit being its CAO, but I am not concluding that he was negligent or in dereliction of any duties. This is not the pleaded issue, and I do not have the relevant evidence emanating from the relevant people, such as Deloitte and the staff in the Shanghai Office.

136.  Suffice to say, I am not satisfied that the allegation that Mr Ma obstructed the 2011 Audit is borne out by evidence.  To make a claim against Mr Ma for the loss caused by the delisting of P1, as a result of the failure to file its Form 10-K in time, is plainly unreasonable and Mr Wong, very sensibly, abandons the claim.

Destruction

137.  The evidence in support of the allegation that Mr Ma destructed the documents of the Group in both the Shanghai Office and the Beijing Office to thwart the new management’s investigation is tenuous. Again, very sensibly, Mr Wong in his closing submissions says little about this. I cannot accept this allegation.

138.  First, as accepted by Mr Woodrum, Mr Ma was stationed in Beijing and had no apparent control of the premises of the Shanghai Office. He also accepts that there is no evidence as to how and when Mr Ma ever caused the documents in the Shanghai Office to be destroyed.

139.  Regarding the alleged destruction of documents in the Beijing Office, the evidence of Mr Mr Feng and Mr Woodrum was unsatisfactory. Mr Feng could not have entered the Beijing Office in late March 2012 when Mr Ma was still in the office. He must be mistaken.

140.  Mr You allegedly paid a visit to the Beijing Office in August 2012 when there were only pre-listing documents of the Group found. Even if I accept that he went to the right premises, I am unable to accept that it was Mr Ma who destroyed the documents originally stored thereat. The visit was made only 4 months after Mr Ma had walked away and there is no evidence that Mr Ma had exclusive access to the Beijing Office. Mr Ma could not be held liable for any loss or damage to any property of the Beijing Office so long a time after the termination of his employment.

141.  Further, I am inclined to accept the evidence of Mr Ma, that Mr You had very probably gone to the wrong premises. I accept Mr Ma’s evidence that the operation office was located in Block C, Golden Tower whereas Mr You went to another office of the Group in Block B2, Golden Tower as shown in the photographs. I could not accept the allegation that it was Li Wei who accompanied Mr You during his visit, and that as Li Wei worked in the operation office, he could not be mistaken. This allegation is not supported by any evidence.

Unauthorised borrowings

142.  On or about 28 April 2012, Mr Woodrum found an envelope left by an anonymous person on his desk in the Shanghai Office. The envelope contained some ledgers showing a number of loans extended to the subsidiary companies of the Group in the PRC from 2010 to 2011.

143.  These loans added up to the total amount more than RMB780 million at rates of interest between 1.5% to 6.5% per month.

144.  The complaint of the Group is that all of these loans were unauthorised and that they were not necessary for operation purposes. P1 was supposed to be a cash rich company, which needed no loans. Furthermore, they were suspect because the lenders of such unauthorised loans included D4 and his associates. These unauthorised loans incurred interest in the total amount of about RMB 70 to 80 million per year.

145.  Mr Woodrum obtained a number of long agreements and corresponding guarantees as a result of his investigation and the legal proceedings against D1 in the PRC. The information contained in the ledgers was proved to be accurate, and the unauthorised loans were confirmed.

146.  Mr Woodrum found these loans to be suspicious. Some of the lenders were unknown individuals and P4 was the borrower. The loans were paid into the bank account of P3 with Bank of Huaxia. For present purposes, it is not necessary to set out the details of these loans.

147.  Further investigation revealed that these unauthorised loans were recorded in the trial balances, bank statements and the AIC records but were nowhere to be found in the CFSs included in Forms 10-K prepared by Mr Ma.

148.  The AIC records were prepared and submitted by the accounting staff in the Shanghai Office to the PRC government authorities and they accurately tallied with the financial records of P3 and P4. The AIC records and the same financial documents were allegedly submitted to Mr Ma for his preparation of the CFSs. There is no reason why the same true picture of the financial condition of the Group was not disclosed in the CFSs.

149.  The pleaded case of the Group, in respect of these unauthorised loans against Mr Ma, is that they were incurred with the knowledge or connivance of Mr Ma in his capacity of the CAO. It is further alleged in their Answers to Request for Further and Better Particulars of the Statement of Claim that Mr Ma should, in the course of his performance of his job duties, receive the true and accurate information including the trial balances of P3 and P4 detailing every bank transaction. Nevertheless, he failed to investigate into suspicious transactions apparent in such trial balances, thereby causing, or permitting the publication of false and misleading financial information of the Group.

150.  In the evidence of Mr Woodrum, he even went further to allege that Mr Ma must have falsified and manipulated the financial information submitted to him by the accounting staff of the Group in his preparation of the CFSs for the submission to Deloitte.

151.  Mr Woodrum came to this conclusion upon his comparison of the financial information reflected in the AIC records of P3 and P4 and those set out in the corresponding Forms 10-K. He found that there were inexplicable discrepancies. For example, in the AIC records as of 31 December 2009 of P3 and P4, the total amounts receivable of P3 and P4 were RMB 474 million, whereas in the corresponding Form 10-K, those of the Group were RMB 54 million only. In addition, the total accounts payable of P3 and P4 were recorded in the AIC records were RMB 272 million, whereas those of the Group were RMB 16 million in the corresponding Form 10-K.

152.  Mr Woodrum pointed out that P3 and P4 were the most significant subsidiaries of the Group in terms of their corporate treasury function, and the significant discrepancies between their AIC records and Forms 10-K must be due to the falsification and manipulation of the financials at the Group level by Mr Ma and D2. Mr Woodrum highlighted the unlimited access of Mr Ma to the financial books and records at all levels by virtue of his position as the CAO.

153.  Other discrepancies were also found between the trial balances, the CFSs and Forms 10-K. For example, a bank debt totalling approximately RMB190 million was recorded and described as borrowings in the trial balances of P3 as of 31December 2009. I pause to note that this debt is the subject matter of another complaint.

154.  This debt did not feature in the CFSs and the corresponding Form 10-K.  Mr Woodrum fairly pointed out that in a balance sheet included in the AIC records, the bank debt of RMB 190 million was recorded, whilst in another balance sheet covering the same period, the said bank debt was not recorded. I do not understand why there are two versions of the balance sheet in the AIC records.

155.  Similar discrepancies exist, and I need not detail them here. It is clear that the information contained in the CFSs and Forms 10-K by Mr Ma was questionable.

156.  Mr Ma did not defend the propriety of these unauthorised loans. He also agreed that it was not in the ordinary business of the Group to incur high interest for loans. His simple defence is that he was unaware of all these unauthorised loans. From the Received Documents obtained from the subsidiaries for the purpose of his preparation of CFSs, he could not detect these unauthorised loans.

157.  Mr Ma maintains that the information and documents that he provided to Deloitte were the same as those he received from the Group and its subsidiaries. He was not aware of any fraudulent conduct in the accounts of the subsidiaries, let alone participating in them. He was very much in the same position of the Group in that he might also have been misled by false information.

158.  Mr Ma further pointed out that the documents now relied upon by the Group were in fact not trial balances. They were merely bank sub-ledgers being part of the general ledger. On a quarterly basis, Mr Ma would receive a general ledger in an Excel computer file from each subsidiary. To recap, Mr Ma received from each subsidiary on a quarterly basis the Received Documents and he worked on these documents to produce translation worksheets (the PRC accounting standard to the US GAAP standard), consolidation worksheets, disclosure item worksheets and working papers. Then Mr Ma would send all of the foregoing documents to Deloitte. 

159.  Mr Ma categorically denies ever having received and seen such sub-ledgers showing the unauthorised loans. He claims that had he done so, he would have reported these matters to D2, the Audit Committee and Deloitte. Absent any good explanation, he would even have made a report to SEC.

160.  I have to adhere to the pleaded case of the Group. The pleaded complaint is the incurrence of the unauthorised loans to the knowledge of Mr Ma and his connivance. The further and better particulars given somehow altered the basis of the complaint to the failure of Mr Ma to investigate into such dubious loans. The evidence even contains allegations of actual falsification and manipulation of the financial formation of the Group by Mr Ma. I should not allow any improper extension of the pleaded case.

161.  To establish the pleaded case, it has to be proved that, in the first place Mr Ma was cognisant of the unauthorised loans. The Group relies on the allegation that some accounting documents including the alleged trial balances evidencing these unauthorised loans were submitted to Mr Ma. The Group does not rely on any other means whereby Mr Ma could gain knowledge of these unauthorised loans.

162.  However, there is simply no evidence that Mr Ma actually received such revealing documents. Mr Ma denies having read such documents, and there is simply no contrary evidence. In this regard, I cannot rely on the uncontested allegations pleaded in the Defence of Ms Fu by any evidence.

163.  I should still deliberate whether it is more probable, on a balance of probabilities, that Mr Ma actually received these documents. The unauthorised loans were dubious in the first place. They cried out for explanations. P3, P4 and/or the subsidiaries had every reason to conceal these unauthorised loans from the US authorities from their origin. To this end, they had to ensure the same concealment from all the internal and external professional auditors, unless all of them acted in concert.

164.  It should be noted that it is not the case of the Group, at least in these proceedings, that Deloitte worked in collaboration with the old management, including D1, D2, D4 and Mr Ma, to make use of false accounts to deceive SEC and NASDAQ. The Group actually rely on the documents of Deloitte, including the Audit Plan and the Deloitte Observations, to establish the failure of Mr Ma to deal with the accounting problems within the Group.    

165.  For the external audit, Deloitte had to carry out field audits. It had full access to all the accounting documents of the companies within the Group including such revealing documents for the purpose of field audits. In view of this, it would be a futile exercise for Mr Ma to submit any CFSs containing untruthful information fabricated by him alone, or any other falsified accounting documents created by him. Any dubious transactions would necessarily be revealed by field audits if the Shanghai Office and other subsidiaries had the genuine accounting documents only and not those falsified accounting documents.

166.  To avoid the disclosure of such transactions to the external people including internal and external auditors during their field audits, I believe it is more likely than not that, on such occasions, a set of innocuous accounting documents dovetailing the accounting records submitted to them by Mr Ma, including the CFSs instead of those revealing documents, were made available to them. Otherwise, independent professionals including the Deloitte auditors, were bound to discover and should have taken issues with such unusual borrowings at such high interest rates.

167.  Regardless of what Deloitte said about the internal financial controls of the Group, they never pointed out any inconsistencies between Mr Ma’s accounting reports, and such financial information obtained by them from P3, P4 and the subsidiaries. They did not discover the unauthorised loans under complaint too.

168.  By reason of the foregoing analysis, I cannot conclude that it is more probable that the accounting people in P3, P4 or other subsidiaries submitted those revealing documents to Mr Ma, expecting him to somehow falsify or manipulate the financial information and manufacture false CFSs on his own. I actually have doubt as to whether Mr Ma needed to see all such genuine accounting documents at all if he had to undertake the sinister task of fabricating false accounts independently.

169.  Thus, I prefer the evidence of Mr Ma, and I believe on a balance of probabilities that those accounting documents submitted to Mr Ma differ from those documents evidencing such unauthorised loans recovered by the Group as AIC records. I accept that Mr Ma did not have the knowledge of the unauthorised loans, meaning he could never connive at them.

170.  Before I leave this topic, I should add that I am aware of Mr Wong’s argument that Mr Ma should have checked the accuracy of the SEC filings against the AIC audits/records, and that he should be able to find out any misconducts committed against the Group. I do not think this is a relevant consideration as this court is not asked to assess the competence of Mr Ma by the pleadings.

171.  Further, on the evidence adduced by the Group, it can be seen that even for the AIC records, there are two different versions of the same document in existence. One of them showed the unauthorised loan of RMB 190 million and one did not. There is no certainty that Mr Ma would be given the correct version so as to discover the true position.

Pledges of time deposit  

172.  This complaint is very much similar to the unauthorised loans in nature. The new management discovered the following pledges of the cash deposits with the PRC banks to secure loans extended to third parties:

Date	Cash deposit pledges	Loan amount	Borrower
December 2009	P3/Shenzhen Development Bank Shanghai Hongqiao Branch	RMB 50 million	Unknown
December 2009	P4/Shenzhen Development Bank Shanghai Hongqiao Branch	RMB 50 million	Unknown
December 2010	P3/Huaxia Bank Shanghai Branch	RMB 50 million	Lianyunggang Dai Xi Industrial Co Ltd
December 2010	P4/Shenzhen Development Bank Shanghai Hongqiao Branch	RMB 95 million	Lianyunggang Nangu Industrial Co Ltd
December 2010	P4/Huaxia Bank Shanghai Branch	RMB 100 million	Lianyunggang Bai Shui Yang Metal Trading Co Ltd
December 2010	P3/Bank of Shanghai Pudong Branch	RMB 47.5 million	Lianyunggang Gaoqi Metal Materials Co Ltd
December 2010	P3/Huaxia Bank Shanghai Branch	RMB 100 million	Shanghai Jieyiojing Trading Co. Ltd
December 2010	P3/Shenzhen Development Bank Shanghai Hongqiao Branch	RMB 76 million	Shanghai Ci Qiang Industrial Co. Ltd
December 2010	P3/Shenzhen Development Bank Shanghai Hongqiao Branch	RMB 66.5 million	Shanghai Run Ze Supply Co Ltd
June 2011	P3/Huaxia Bank Shanghai Branch	RMB 100 million	Shanghai Jieyiojing Trading Co. Ltd
November 2011	P3/Huaxia Bank Shanghai Branch	RMB 100 million	Shanghai Songzi Industrial Co Ltd
November 2011	P4/Huaxia Bank Shanghai Branch	RMB 100 million	Shanghai Songzi Industrial Co Ltd

173.  Regarding these unusual pledges, the Group complains in the pleading that:

(a)  the pledges are not reflected in any published accounts of P1;

(b)  D1 signed the purported resolutions of P3 and P4 to authorize such pledges to be created and such purported resolutions bore the forged signatures of Mr Tseung.

(c)  the pledges served no commercial purpose of the Group and on the contrary exposed the Group to the financial risk of forfeiture of their cash balances pledged.

(d)  it has transpired that none of the time deposits pledged still remains with the Group.

174.  The Group alleges that it has suffered:

(a)  loss of the sums pledged by way of deposit;

(b)  interest that should or could have been earned on the monies so deposited had the pledges not been made and/or

(c)  loss of the opportunity to invest the money is or make productive use of them in the business of the Group.

175.  Against Mr Ma, it is pleaded that these pledges were made with his active participation, and or knowledge or connivance.

176.  In his defence, Mr Ma denies any knowledge of the pledges let alone any role played by him in their creation. He avers that the pledges did not appear in any of the bank confirmations provided to him and neither P3 nor P4 disclosed these pledges to him.

177.  In his evidence, Mr Ma fairly accepts that the pledges were highly unusual and that they should have been subject to disclosure according to US GAAP and SEC rules. Both Deloitte and the US lawyers of the Group would be concerned about these pledges.

178.  For the purpose of the external audit, Deloitte would directly communicate with the banks of P3 and P4 and ask for their confirmations. Such bank confirmations would disclose the existence of these pledges, and could not have escaped the attention of Deloitte.

179.  The evidence of Mr Woodrum in this regard does not support the pleaded case of the Group. His evidence does not begin to support the allegation of Mr Ma’s active participation in the creation of these pledges. There is no evidence indicative of Mr Ma’s knowledge of these pledges at all. Mr Woodrum only learnt from a bank of P3 and P4 about the existence of these pledges for the first time late March 2012. He also became aware of these pledges from the emails recovered from a former employee’s computer. There is no suggestion that Mr Ma was similarly informed. Mr Wong fails to identify the basis of the alleged knowledge of Mr Ma of these pledges save his position as the CAO. This cannot suffice.

180.  There is no evidence to the effect that Mr Ma knew that the purported resolutions bore the forged signatures of Mr Tseung. Mr Ma is not cross-examined in this respect at all.

181.  I refuse to place any weight on the hearsay evidence about what Ms Cheng allegedly told Mr Woodrum about the usual arrangement of this kind of pledges. It is only unfair to Mr Ma that her alleged explanation could not be tested by cross-examination.

182.  For completeness, I should point out that the relief claimed is not justified by any appropriate evidence and is devoid of merit.

Dissipation of cash balances

183.  The allegations of the Group under this head are helpfully summarised by Mr Cooney in his closing submissions:

(a)  In late 2011, FTI was appointed by the Audit Committee of the Group to conduct an independent verification of the Group’s bank balances and fixed deposits in the PRC as at 30 June 2011. FTI confirmed, by way of bank confirmations, RMB 830,418.201 out of RMB 858,382,486 of cash balances of the various subsidiaries of the Group as at 30 June 2011 (“the FTI Report”);

(b)  Mr Woodrum prepared spreadsheets showing the transfer out of cash of over RMB 580m from the accounts of P3 between July 2011 and April 2012 and over RMB 182m from the accounts of P4 in December 2011, supported by bank confirmations. Two sums of about RMB50.8 million each in the bank account of P4 were transferred on 27 December 2011 to Shanghai Jieying, one of D4’s trading companies;

(c)  Further, the new management discovered that bank statements of various accounts provided to Deloitte for the Group’s audit were grossly inaccurate and falsified. Mr Woodrum produced the bank statements of the #3333 Account of P3 provided to Deloitte, which show balances of RMB 51m and RMB 307m as at 31 December 2010 and 30 September 2011 (“the Falsified Statements”). This was inconsistent with the statements obtained by the new management from the bank (“the Obtained Statements”), which shows that the balance was only about RMB 77,000 and RMB 71,000 as at 31 December 2010 and 30 September 2011. Mr Wong has confirmed that the plaintiffs’ case against Mr Ma is not that Mr Ma forged or falsified the bank statements, but only that he had known the statements to be forged/falsified.

(d)  The FTI Report stated the balance in the #3333 Account as at 30 June 2011 to be almost RMB 295m but the Obtained Statements show a balance of only RMB 3.7m;

(e)  The inaccuracies in the FTI Report were allegedly caused by what the plaintiffs now frame as a two-part manoeuver: firstly, by preventing FTI from obtaining bank confirmation and physical extraction of the bank statements for the #3333 Account; secondly, by depositing RMB 307m into the #3333 Account in early November 2011, transferring it away to another account with P3 (and shortly transferred away afterwards), to create the false picture that RMB 307m was in the #3333 Account. Mr Woodrum says from FTI’s perspective, since RMB 307m was transferred out of the #3333 Account in November 2011, it must have held those funds in June 2011 as supported by a June 2011 bank confirmation;

(f)  It is alleged that the defendants tried to manipulate and control the date on which FTI would visit the Bank of Shanghai for cash confirmation purposes; and

(g)  There were many payments from P3 and P4 to entities that were not clients of P3 and P4 in the “trial balances”/bank sub-ledger produced by Mr Woodrum.

184.  It is the pleaded case of the Group that, since the effective date of FTI’s cash confirmation, at least RMB762,507,222.22 (“the Misappropriated Sum”) has been removed from P1’s subsidiaries in the PRC. It is further alleged that Mr Ma operated and controlled the bank accounts of P3 and P4. Alternatively, the depletions of the bank balances were carried out with the knowledge or connivance of Mr Ma by reason of his position. It is alleged that Mr Ma misappropriated the Misappropriated Sum and should now account to the Group for the same.

185.  Basically, Mr Ma adopts the same position vis-a-vis the allegation of unauthorised borrowings. He insists that he had no knowledge of all the alleged cash dissipation.

186.  In the first place, contrary to the allegation of the Group, the bank accounts of P3 and P4 were never controlled or operated by him and he did not have the bank chops to make any transfers out of such bank accounts. The bank chops were kept in the Shanghai Office. I accept Mr Ma’s explanation in the absence of any contrary evidence.

187.  Mr Ma highlighted to this court that Deloitte has obtained bank confirmations independently from the banks after the submission of financial information by the Shanghai Office. Deloitte detected no dubious dissipations. Nor did he. This was indeed a large-scale fraud.

188.  There is no evidence that Mr Ma took any part in this outrageous wrongdoing. There is nothing suggestive of his knowledge of such cash dissipations at all. The Group cannot identify any telling documents received by Mr Ma from P3 and P4, which could fix Mr Ma the knowledge of, or should reasonably arouse his suspicion about, these transactions. 

189.  Mr Wong, probably in view of the weak evidential basis of this allegation, submits that had Mr Ma alerted the board to those unauthorised borrowings and pledges back in 2009, stringent internal controls should have been installed and all these cash dissipations from July 2011 onwards could have been avoided.

190.  With respect, this is not the basis of the Group’s claim against Mr Ma. And this court has also found that the unauthorised borrowings and pledges were concealed from Mr Ma and that he should not be held responsible for them in any respects.

191.  For completeness, on the evidence, I am not satisfied that Mr Ma had ever impeded the investigation of the FPI.

Other misappropriations

192.  The Group further alleges four additional misappropriations of their funds in P1’s accounts totalling US$122,971,501.00. I should now deal with them in turn.

US$25 million

193.  Firstly, it is alleged that approximately US$25 million was held by Great Wall Acquisition Corporation (“GWAC”), a NASDAQ listed company and a predecessor of P1, which acquired P1 in December 2006 through share exchange. The said amount has been transferred out of the Group and now cannot be traced.

194.  This allegation is not supported by the evidence of Mr Woodrum. He accepts that some of the said amount in the range from US$2.5 to 3 million could be traced to an entity called Mozart Management Company Limited (“Mozart”). He mentioned t for the first time in the witness box.

195.  Mr Ma in his witness statement explained that said amount was spent for the following purposes:

(a)  Payment to shareholders in Chinacast Communication Holdings, a member of the Group on SSE as acquisition consideration;

(b)  Profession expenses incurred in relation to the general offering in Singapore and we were stick over by P1 in the US;

(c)  Capital injection into the PRC subsidiaries of P2 for the purpose of increasing the registered capital.

(d)   Other expenses of the offshore entities of the Group including salaries of officers.

196.  The account of GWAC, held with DBS bank in Singapore, was closed after the general offering. Deloitte reviewed the account and raised no concern.

197.  There is no contrary evidence. Mr Woodrum, not without reluctance, agreed under cross-examination that the said amount was spent in the foregoing manners except the capital injection, of which he did not have any knowledge. There is no reason why I should not accept Mr Ma’s explanation.

198.  Mr Wong criticises Mr Ma on his inability to explain the purpose of the two remittances to Mozart. I do not think this is of any materiality to the issue as to whether the said amount was misappropriated.

199.  I have perused the documents evidencing the two remittances. They were made in March 2017 by Chinacast Technology (HK) Ltd (“CCT HK”), a wholly owned subsidiary of P2 in Hong Kong, and not P1. Mr Ma’s failure to recall these remittances made so many years ago without any prior references thereto is perfectly understandable and causes me no concern.

200.  I reject this allegation of misappropriation. It is baseless.

US$64.5 million

201.  The pleaded case is that between January 2008 to December 2011, a sum of US$60.5 million in identified wire transfers was transferred from P1’s account with Signature Bank in New York to a Bank of China account in the name of CCT HK in Hong Kong from January 2008 to December 2009. The said sum was then transferred out of the Group and cannot be traced now. US$41 million out of the said sum represented proceeds of a secondary stock offering of shares in P1 in December 2009 underwritten by Roth Capital Partners LLC in December 2009.

202.  In his defence, Mr Ma explains that the said sum was transferred from P1’s account to CCT HK for payment of expenses of the offshore entities of the Group including payroll and professional fees, capital injection into the PRC subsidiaries of P2 to increase the registered capital and payment of the acquisition costs of colleges by the PRC subsidiaries. Mr Ma contends that Deloitte raised no concern about the use of the said sum.

203.  It is worthy of note that the cause of action is actual misappropriation of the said sum by Mr Ma and conversion of the said sum to his own use. Even if this court if not satisfied with the explanation of Mr Ma for the use of the said sum, it does not mean that Mr Ma misappropriated the said sum or converted the said sum to his own use. It is for the Group to adduce compelling evidence to show, on a balance of probabilities, that Mr Ma committed such a serious wrongdoing against the Group, which is arguably a criminal offence.

204.  To begin with, in respect of P1’s account, there is clear evidence that only D1 and D2 were authorized to request wire transfer as per the records of the Signature Bank. The transfer under complaint was not caused by Mr Ma.

205.  On the other hand, though Mr Ma accepts that he was one of the signatories for some of the bank accounts of the offshore subsidiaries of P1, including CCT HK, his pleaded case is that he had not signed any cheque or transfer since 2001.

206.  The Group has failed to adduce any evidence that any part of the said sum was transferred out of the account of CCT HK by Mr Ma. Nor can it be proved that Mr Ma has any relationship with any of the transferees in receipt of any part of the said sum. There is in particular no allegation and evidence that Mr Ma is in any way connected with Thriving Eagle Investments Ltd (“Thriving Eagle”), which is a BVI company apparently owned and controlled by D1.

207.  In the premises, the allegation of Mr Ma’s misappropriation or conversion of the said sum must be rejected, regardless of whether this court accepts his explanation for the use of the said sum by the Group.

US$5 million

208.  The pleaded case is that in January 2010, D1 subscribed the shares of P1 through Thriving Eagle for approximately US$5 million. The new management could not locate this subscription proceeds of US$5 million in any of the Group’s accounts.

209.  In his defence, Mr Ma avers that the said sum was received by P3 in the PRC and Deloitte was convinced.

210.  Even in his evidence, Mr Woodrum did not make any allegations against Mr Ma in respect of this sum of US$5 million. The main targets are D1 and D2. There is no evidence that any part of the sum of US$5 million has ever been in the possession of, or under the control of, Mr Ma.

211.  In the circumstances, I reject the allegation that Mr Ma has ever misappropriated or converted to his own use any part of the sum of US$5 million.

US$29.3 million

212.  The pleaded case is that US$29.3 million was raised by the allotment of 3.7 million shares of P1 to one Mr Wu in May 2010 for the acquisition of HIUBC. The said sum ought to have been deposited into a bank account of P1 but it has gone missing despite the new management’s investigation.

213.  Again, in his defence, Mr Ma avers that the said sum was received by P3 in the PRC and Deloitte was convinced.

214.  On the evidence of Mr Woodrum, two BVI companies, namely, Motivation International Investment Co Ltd (“Motivation”) and China South Investments Ltd (“China South”) were allotted the shares on 2 June 2010 upon payment of the said sum of US$29.3 million purportedly into the account of CCT HK. His allegation is that no such payment was actually made by Mr Wu, Motivation and China South.

215.  Given this allegation, I cannot understand how the Group can make an allegation of misappropriation and conversion of the said sum of US$29.3 million.  

216.  The only evidence against Mr Ma in respect of this allegation is that Mr Ma produced some paid-in slips purportedly as evidence of the payment deposits into the account of CCT HK.

217.  Mr Ma explained in court that he was asked by D2 to look for such pay-in slips, and he obtained the same from Cheng Ying of the Shanghai Office. He was not told why D2 needed them and he was not in any way involved in the transaction. I accept his explanation.

218.  I therefore conclude that the case of misappropriation and conversion of the said sum of US$29.3 million cannot be made out against Mr Ma.

Transfer of colleges

HIUBC

219.  The gravamen of the complaint under this head is that in about March 2012, MA wrongfully caused or procured the transfer of the three colleges out of the Group into the hands of a number of persons without consideration and failing and/or refusing to bring this to the attention of the board in breach of the Service Agreement.

220.  P1 held interest in HIUBC through Wujan Jiyang which in turn was held by Shanghai Rubao, one of P1’s WOFEs. In February 2011, Shanghai Rubao transferred its interest in Wuhan Jiyan to P5. The AIC records of P5 show that P5 then transferred its shares in Wuhan Jiyang to D4 (70%) and Shi Shicheng (“Shi”) (30%) at no consideration on or about 5 March 2012.

221.  At the time of the transfer, Shi was an employee at HIUBC and a close business associate of D4. On 5 April 2012, D4 and Shi transferred their shares to 3 individuals: Wei Hua (40%), Xie Ji Wu (40%) and Zhan Xiao Chun (20%).

222.  The case theory of the Group is that the transfer of the three colleges at nil consideration was to repay the unauthorised borrowings.

223.  The defence of Mr Ma is that, since the transfer of HIUBC and LC were transferred to P5 in March 2011, Deloitte had raised concern that the transfer might carry tax risk under PRC law. Deloitte, on or about 6 May 2011, in its report to the Audit Committee recommended that the management team should revisit the reorganization plan. Mr Ma was not involved in any such decision.

224.  So far as Mr Ma is aware, D1 followed Deloitte’s advice and subsequently consulted Han Kun Law Offices, its lawyers in Beijing and was advised that the transfer should be done under a VIE structure by transferring the colleges to a PRC company whose shareholders were PRC citizens. Mr Ma was not aware of the transfers made in March and April and he took no part in the transfer.

225.  In his evidence, Mr Ma explained what a VIE structure is. “VIE” stands for variable interest entity. A VIE structure is designed to mitigate against the restrictions on operating a business in the PRC, including those on foreign ownership. The structure consists of a VIE, being a PRC company owns and operates the underlying business and is in turn wholly owned by PRC citizens. The VIE enters into an agreement with a WOFE whereby it surrenders its economic benefit and control. In exchange the owners of the WOFE grant owners of the VIE shareholdings or other benefits. This is a common structure for investment into the PRC and is tolerated by the Mainland authorities.

226.  Mr Ma gave a second reason for the transfer of the colleges. He explained that the SEC in October 2011underscored to the Group the risks associated with the existing structure being perceived by the mainland authorities as contravening its regulations concerning foreign ownership of education institutes. P1 consulted its Beijing lawyers in the PRC, and was advised that they should adopt a VIE structure.

227.  Mr Ma reiterated that he took no part in the foregoing transfers in any event. He merely assisted P1 in the preparation of draft agreements for a restructuring of the ownership of the colleges. In his drafts, the three colleges were to be transferred to Shanghai Mengting enterprise Ltd but no such transfer ever materialized in the end.

228.  Mr Wong makes a powerful submission on the evidence that the transfer could not result in a VIE structure. Moreover, the Group has lost control over HIUBC after the transfer in the absence of the necessary safeguards.

229.  I am convinced that in light of the contemporaneous documents including the Deloitte report and the legal advice of Han Kun Law Offices, the transfer was made with a view to adopting a VIE structure. Whether the adoption was complete or effective does not really matter.

230.  More importantly, I accept Mr Ma’s evidence that he had no role to play in the transfer even if he was the de facto supervisor of P5. He did not take part in the decision-making process and the transfer documents were executed without his participation. His draft agreement was not used ultimately. I cannot accept that he should be held in any way liable for the transfer, even if it was wrongful.

231.  In his closing submissions, Mr Wong makes the point that had Mr Ma “blown the whistle” on D1 and D4 earlier, the Group would have removed them, or at least prevented them from further jeopardising the assets of the Group, including the three colleges.

232.  This argument is, in my view, far-fetched and not pleaded. I cannot accept the validity of this argument, particularly given my foregoing findings of Mr Ma’s ignorance of the wrongdoings committed against the Company.   

LC

233.  P5 held interest in LC through China Lianhe, which in turn was held by Shanghai Xijiu, one of P1’s WOFEs. On 15 March 2011, Shanghai Xijiu transferred China Lianhe to P5. In the same month, P5’s shares in China Lianhe were transferred to D4 (70%) and Shi (30%). The AIC records show that China Lianhe is now owned by two unauthorised persons: Zheng Qi Quan (70%) and Yao Fang Can (30%). Included in the trial bundles is a transfer agreement dated 20 March 2012, executed by D2 as the legal representative of P5 on one part, and the two transferees on the other part.

234.  Mr Ma said the same thing about the transfer of LC, of which he had no knowledge.

235.  For the same reason, I reject the pleaded allegations relating to this transfer against Mr Ma. He cannot be liable in any way.

FTBC

236.  P1 held interest in FTBC through Hai Lai Education Technology Ltd (“Hai Lai”) which in turn was held by P1 through P4 and Chongqing Chaosheng Education and Investment Co Ltd (“Chaosheng”). In the Shanghai Office,  signed but undated during the agreements for the transfer of Hai Lai and Chaosheng’s interest to D4 (70%) and Shi (30%) were found.

237.  FTBC has since been transferred out of the Group into the hands of 23 individuals in various percentages. None of these transferees (except Shi Qin Yan, the son of Shi and one of the lenders of the unauthorised borrowings) was known, and there is no record of any consideration having been paid for such transfers.

238.  Mr Ma pointed out that the transfers were made to the knowledge of P1. He did not know the full details of the transfers and detected nothing untowards about them.

239.  Again, for the reasons given above, I reject this allegation as pleaded against Mr Ma. I can find no evidence of his involvement contributing to the completion of the transfers, regardless of the righteousness of the transactions.  

Mismanagement of the ELG business

240.  I shall briefly dispose of this complaint, out of which Mr Wong indicates that no claim against Mr Ma would be made. He insists on adducing evidence relating to this complaint merely to provide the relevant factual matrix for other complaints.

241.  In his closing submission, Mr Wong only addresses this court on the allegation that Mr Ma had illegitimately overstated the revenue of the ELG business. He asks this court to reject Mr Ma’s explanation under cross-examination. However, this allegation is not properly pleaded at all. I refuse to deal with this non-issue.

242.  In any event, I do not think it is in any way relevant to the other complaints resolved above.

Conclusion and order

243.  I appreciate the difficulties of the Group, and in a way I am sympathetic with their plight. No doubt they have been victimised by a group of dishonest people. However, there is no compelling evidence to allow me to draw an inference that, on a balance of probabilities, Mr Ma is one of them.

244.  Much has been said about the alleged incompetence of Mr Ma in avoiding such wrongs done to the Group by failing to put in place effective internal controls. The Representation Letter and the Bossfounder Limitations containing the usual disclaimers indeed show that Mr Ma could not completely delegate his duties as the CAO to such professionals. However, importantly, his competence or negligence should not be the focus of these proceedings.

245.  In passing, I am unable to understand what effective internal controls could have averted this disaster. Mr Wong does not make any suggestion. Nor does the pleading.

246.  The fraud could not have succeeded without the full support of the offices of P3, P4 and all other subsidiaries. The involvement of internal auditors and external auditors having access to the primary accounting documents and being accountable to the Audit Committee makes it improbable that the fraud only began at the level of Mr Ma.

247.  On the evidence, I am not satisfied that it has been sufficiently proved that Mr Ma had any knowledge of the dubious activities taking place below, particularly in the Shanghai Office. 

248.  For the reasons given above, I come to the conclusion that none of the pleaded allegations against Mr Ma can be made out. Accordingly, I dismiss all the claims of the Group against Mr Ma. For completeness, I order that the Mareva Injunction be discharged forthwith.

249.  I also enter judgement in favour of Mr Ma in respect of his counterclaim regarding his outstanding remuneration. I cannot allow his claim for damages.

250.  There is no reason why costs should follow the event. Mr Ma should have his costs of this action including his counterclaim and all such costs previously reserved, if any, to be taxed if not agreed, with a certificate for two counsel. I make an order nisi in this term.

251.  As regards Ms Fu, in Mr Wong’s closing submission, little was said in relation to her liability. Mr Wong indicates that the Group is prepared to drop the case against her, subject to the issue of costs.

252.  In light of the limited participation of Ms Fu in these proceedings, I dismiss the claim against her and order that there should be no order as to costs as between the Group and Ms Fu.

253.  Lastly, I must thank all counsel involved for their invaluable assistance rendered to this court, in particular their excellent written submissions.