Dec 15, 2017 By Morris & Riley

On the evening of November 28, the Police Department of Chaoyang District issued a statement regarding the latest update on RYB Education, alleging that the suspected teacher had been detained for using sewing needles to discipline children, that the hard drive cannot be fully recovered due to monitor damages, and that videos and interviews that mentioned drug feeding and sexual abuse that have gone viral on the internet were either filmed due to parents misleading or fabricated.

After the "good news", RYB Education, a Nasdaq-listed stock, rebounded on November 28 EST. The closing price on that day returned to $22.2, a 23.3% increase over the previous trading day. The rapid rise of RYB Education stock price triggered public speculation and dissatisfaction, one of which is about bulk buying of RYB Education stocks at the low price by the capitalists. The public was very upset about the capitalists' hypocritcal behavior of "accusing RYB Education in WeChat circles and recommending bulk purchasing of its stocks in WeChat groups." So, more than 11,000 kilometers away, has the New York capital market really forgiven RYB Education?

1. The dilemma of volatile stock price and securities fraud

1.1 Did the stock price of RYB Education recover?

In September, 2017, RYB Education successfully went public on NASDAQ in the United States. The IPO price was $18.5 per share, which rose to $25.9 on the opening day of September 27. In the next two months, RYB Education’s price was rather stable between $24 to $30.

On the evening of November 24 Beijing time, the first trading day following the incident, the share price of RYB Education experienced a nose-dive from $26.66 of the previous trading day to the lowest point of $15.62. At the closing time that day, RYB Education’s price plummeted by 38.41%, an nearly 40 percent decrease of its market value.

Subsequently, RYB Education convened an emergency meeting with its underwriter to inform investors on the specific circumstances of the incident and indicated that it would take out its own fund of 50 million U.S. dollars for an emergency rescue.

On the evening of November 28 Beijing time, with the disclosure of the latest development in the investigation of the incident, the share price of RYB Education rose rapidly, eventually closing at $22.2. However, troubles continued in the secondary market. On November 29, the closing price of RYB Education was $20.33, down 8.42% from the previous trading day and down 23.74% as compared with the pre-incident average.

1. 2 At least 10 law firms prepared for class action of securities fraud

From the night of November 24 when the stock price started to fall to November 29, at least nine US law firms have announced their plan to file class action lawsuits against RYB Education. Among them, a number of law firms, including Wolf Haldenstein Adler Freeman & Herz LLP, issued statements that they had filed class action lawsuits in the United States District Court for the Southern District of New York on the behalf of investors. Correspondingly, on November 27, a law firm in Beijing issued a statement that it had been entrusted by an investor of RYB Education in Beijing to file a class action against RYB Education for the investors’ damages from the alleged securities fraud.

In the statement of Wolf Haldenstein Adler Freeman & Herz LLP, the firm said that RYB Education is suspected of misrepresentation or material omission in three aspects:
1) RYB Education failed to issue any security policy to prevent sexual abuse on campus;
2) RYB Education did not take remedial action on its own system, causing damages and unreasonable risk of such damages to the children during school stay;
3) RYB Education trades at an artificially raised price, resulting in damages to the interests of shareholders

2. RYB Education's own risk of IPO

In fact, there has been discussion and questioning in the market since RYB Education's IPO.

2.1 Abnormally high price-earnings ratio

From the P/E ratio point of view, the issue price of RYB Education was $18.5, whose P/E ratio reached 56.06 according to the earnings per share of $0.33 in the past 12 months. On November 22, the trading day before the plunge in RYB Education’s share price, Simple Wallst, a stock analysis firm, wrote that RYB Education had a P/E ratio of 84.5, well above the average P/E ratio of 24.6 for similar education stocks.

2.2 Up to 36 pages of risk statements

According to the public documents of the Securities and Exchange Commission of the United States, RYB Education’s prospectus contains 36 pages of risk statements, disclosing risks that damaged reputation may affect company’s profitability, performance may decline if the company cannot maintain sufficient enrollment, and the franchise model may bring certain risks.

3. The success rate of the US class action lawsuits against RYB Education

This year has seen a resurgence of Chinese companies rushing to list in the United States. By early November, there has been 11 Chinese enterprises that successfully landed on the U.S. Securities Exchange in 2017. Most notably, among the 44 IPOs approved by the U.S. Securities Exchange in September, the proportion of Chinese companies was as high as 20%.

With the gradual increase of the number of Chinese companies listed in the United States in recent years, the number of class actions against Chinese companies has also risen in the United States. As of mid-August 2015, 10 Chinese companies listed in the United States received notice of class action lawsuits on securities fraud in 2015 alone.

At present, the main basis for disclosure of misleading information and securities fraud litigation are Section10 (b) of the Securities Exchange Act of 1934 and Article10b-5 of the Rules of U.S. Securities and Exchange Commission. The plaintiff must prove that:
(1) the defendant made false statements or omissions of material facts;
(2) intent;
(3) the relationship between the defendant’s behavior and stock purchase;
(4) the plaintiff’s reliance on such false statement or omission;
(5) Damages.

In practice, a heavy burden of proof is upon the shareholder who must prove that the conduct accused has never been disclosed and prove the causation between the conduct and the decline of the stock price. In the case of Goplen v. 51job, Inc., the court denied the plaintiff’s claim for lack of causation.

In the upcoming securities class action against RYB Education, how the plaintiff proves that RYB Education made false statements or omission of material facts in the listing materials, and how the omitted information directly caused the damages to the shareholders would be important factors affecting the final outcome of the case.

In this dispute, investors can make use of at least the following two points. First is RYB Education’s omission in its prospectus of the criminal case against it relating to child abuse in Siping, Jilin Province in 2015, as well as the child abuse case in which its teachers use needles on children in Hebei Cangzhou which reflect its poor management and other related issues.

4. Is shorting of RYB Education possible?

Apart from class action lawsuits, are there any other means to exert impact on RYB Education in the capital market? Whether shorting of RYB Education shares through capital operation is feasible has been a hot topic lately.

In fact, RYB Education’s daily turnover has not been large since listing and has stabilized at below 1 million for most of the time. Among the 7.8 million shares from its public offering, 5.7 million shares are held by 44 institutional investors, accounting for 73% of total shares. Therefore, it is unlikely for other players in the secondary market to short RYB Education. The overall trend for RYB Education shares will mainly depend on the action of institution investors.

5. Revenue challenged by the public opinion of the incident

However, even if it can temporarily appease large institutional shareholders, RYB Education is still not safe in the secondary market. According to RYB Education’s third quarterly report just released, as of September 30, 2017, the student number of its direct operating kindergarten had reached 21413, with 209 franchise kindergartens and 910 franchise parent-child playground.

RYB’s prospectus shows that as of the first half of this year, 75% of RYB Education’s total revenue consisted of tuitions from directly operated institution with costs being relatively high. Other revenues were from franchise fees, brand fees, and training service fees. Apparently, the outbreak of news of child abuse will have tremendous adverse effect on the reputation of RYB Education and as a result, their direct operating kindergartens or franchise kindergartens will both likely see their enrollment affected to a great extent, which will affect their main income.

2nd Floor, East Tower, World Financial Center, 1 Dongsanhuan Zhonglu, Chaoyang District, Beijing 100020, P. R. China
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