case 1:12-cv-05724-jgk document 23 filed 12/10/12 page 1...

Case 1:12-cv-05724-JGK Document 23 Filed 12/10/12 of 63

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

Civil Action No. 1

D)

O/

/ IN RE NEW ORIENTAL EDUCATION & TECHNOLOGY GROUP SECURITIES

JURY TRIAL DEMANDED

LITIGATION ECF CASE

CONSOLIDATED AMENDED CLASS ACTION COMPLAINT


Table of Contents

Page

1. INTRODUCTION ..............................................................................................................1

IT. JURISDICTION AND VENUE.........................................................................................5

III. PARTIES ............................................................................................................................ 5

A. Plaintiff ............................................................................................................................... 5

B. Company Defendant...........................................................................................................6

C. Individual Defendants.........................................................................................................6

IV. SUBSTANTIVE ALLEGATIONS ....................................................................................7

A. New Oriental ADSs Would Not Be A Viable Investment Absent A VIE Structure..........7

B. New Oriental's VIE Arrangements.....................................................................................9

C. New Oriental Inappropriately Consolidates New Oriental China ....................................12

1. New Oriental's VIE Arrangements For The Fiscal Years Ending May 31, 2009 and May3l,2010 .... ........................ ........................................................................................ . ... 12

2. New Oriental's VIE Arrangements For The Fiscal Year Ending May 31,2011 .......... 19

D. Defendants Fail To Disclose A Program To Franchise The 'New Oriental" Brand........25

E. In July 2012, An SEC Investigation And Analyst Report Reveal The Falsity Of

Defendants' Public Statements .................................................................................................28

F. Post-Class Period Developments......................................................................................31

V. DEFENDANTS' FALSE AND MISLEADING STATEMENTS ...................................32

A. False and Misleading Statements Regarding The Company's Consolidation Of And

Control Over New Oriental China ................................................................. ........................... 32

1. Fiscal Year 2009 ...........................................................................................................32

2. Fiscal Year 2OlO ...........................................................................................................35

3. Fiscal Year 2011 ...........................................................................................................35

B. Defendants' False And Misleading Statements Regarding Financial Results..................36

1. Fiscal Year 2009 ...........................................................................................................36

2. Fiscal Year 20l0 ...........................................................................................................36


3. Fiscal Year 2011 ...........................................................................................................38

4. Fiscal Year 2012...........................................................................................................40

C. Defendants' U.S. GAAP Violations ................................................................................41

D. False and Misleading Statements Regarding the Company's Ownership And Operation

Of Its Schools And Learning Centers.......................................................................................42

VI. ADDITIONAL SCIENTER ALLEGATIONS.................................................................45

VII. LOSS CAUSATION.........................................................................................................48

VIII. GROUP PLEADING .......................................... ... ........................................................... 49

IX. INAPPLICABILITY OF STATUTORY SAFE HARBOR.............................................50

X. PRESUMPTION OF RELIANCE....................................................................................50

XI. CLASS ALLEGATIONS APPLICABLE TO ALL CLAIMS.........................................51

XII. CAUSES OF ACTION.....................................................................................................53

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I. INTRODUCTION

1. Lead Plaintiff Mineworkers' Pension Scheme ("MPS") on behalf of itself and all

others similarly situated, bring this action ("the Action") as a class action individually and on

behalf of all other persons and entities who purchased American Depositary Shares ("ADSs") of

New Oriental Education and Technology Group, Inc. ("New Oriental" or the "Company") on the

New York Stock Exchange ("NYSE") during the period October 19, 2009 through and including

July 17, 2012 (the "Class Period"), and who were damaged thereby (the "Class")

2. MPS alleges the following based upon personal knowledge as to itself and its own

acts and upon information and belief as to all other matters. MPS ' s information and belief is

based upon, inter alia, the investigation of Court-appointed Lead Counsel Grant & Eisenhofer

P.A. The investigation included, but was not limited to, interviews and consultations with

former employees of New Oriental and its subsidiaries and related entities, as well as review and

analysis of (i) New Oriental's public filings with the U.S. Securities and Exchange Commission

("SEC"); (ii) research reports by securities and financial analysts; (iii) transcripts of investor

conference calls; (iv) press releases and media reports; (v) economic analyses of securities

movement and pricing data; and (vi) consultation with various relevant experts.

3. This is a securities class action brought under Sections 10(b) and 20(a) of the

Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. §§ 78j(b) and 78t(a), and Rule

lOb-5 promulgated thereunder, 17 C.F.R. § 240.1Ob-5.

4. New Oriental is a Cayman Islands corporation, with its principal place of business

located at No. 6 Hai Dian Zhong Street, Haidian District, Beijing 10080, China.

5. Throughout the Class Period, New Oriental held itself out as the largest provider

of private education services in the People's Republic of China ("China"). The Company offers

foreign language training; test preparation courses for admissions and assessment tests in the

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United States, China, and Commonwealth countries; primary and secondary school education;

development and distribution of educational content; software and other technology; and online

classes.

6. Under Chinese law, foreign investors face severe restrictions when investing in

certain sectors, including internet and educational businesses. This is because China forbids

foreign investment in these government-controlled areas. However, Chinese companies and

their investors have developed a structure designed to avoid these regulatory burdens. To

operate in a restricted sector, an entity incorporated outside of China will create wholly-owned

subsidiaries in China. These subsidiaries are referred to as Wholly Foreign Owned Enterprises

("WFOEs"), and they own and operate the parts of the business that are open to foreign

ownership. The parts of the business that may not be owned by a foreign company are operated

through a Chinese company owned by Chinese citizens. The Chinese-owned component of the

business is referred to as a Variable Interest Entity ("VIE"). Through a series of legal

agreements, the WFOE takes on substantially all of the economic benefits of the VIE, as well as

the obligation to absorb all of its losses. This then permits the foreign parent corporation to

consolidate the VIE into its own financial reporting. According to the Forensic Asia research

firm, as of September 18, 2012, 48% of the 225 Chinese companies listed on the NYSE and

NASDAQ used the VIE structure.

7. The U.S. Generally Accepted Accounting Principles ("U.S. GAAP") that govern

VIEs provide that in order to consolidate a VIE, the parent company must have the power to

direct the most significant activities of the entity, must have the obligation to absorb the entity's

losses, and must have the right to receive the entity's residual returns.

2


8. The vast majority of New Oriental's reported revenues and assets are obtained by

or held in New Oriental's VIE, Beijing New Oriental Education & Technology (Group) Co., Ltd.

and its subsidiaries ("New Oriental China"). New Oriental China itself is indirectly owned by

Defendant Michael Minhong Yu and his mother. In its public filings, New Oriental has admitted

that, "We have been and are expected to continue to be dependent on New Oriental China and its

subsidiaries to operate our education business[.]" From at least its Initial Public Offering

("IPO"), in 2006, onwards, New Oriental has consolidated the financial results of its VIE, New

Oriental China, on the purported basis that (1) New Oriental has the power to direct the activities

of its VIE, and (2) New Oriental has the obligation to absorb the losses of its VIE. In fact, New

Oriental did not have the power to direct the activities of New Oriental China. Nor did New

Oriental have the obligation to absorb the losses of New Oriental China.

9. New Oriental achieved two important goals by inappropriately consolidating New

Oriental China. First, New Oriental could not have accessed U.S. capital markets without

audited financial statements, and could not have obtained audited financial statements without

consolidating the operations of New Oriental China. New Oriental's September 2006 IPO raised

approximately $112.5 million through sales of ADSs, and the Company conducted a second

offering in February 2007.

10. Second, because New Oriental China is 100% owned by a Chinese company that

is controlled by Defendant Yu, and because the contractual agreements that supposedly maintain

New Oriental's control over New Oriental China are ineffective and toothless, consolidation

allows Yu to enjoy the fruits of a public offering while still maintaining individual control over

almost all of New Oriental's supposed assets.

3


11. On May 21, 2012, Tigerstep Developments, Ltd., a Chinese company owned by

Defendant Yu's mother, sold off 1,600,000 New Oriental ADSs for approximately $41 million.

It is highly unlikely that such profits would have been achievable had Defendants been confined

to the Chinese capital markets. More importantly, by selling New Oriental ADSs, Defendant Yu

(and those persons under Yu's control) can raise money while still maintaining an undiminished

interest in New Oriental China, the company that owns virtually all of New Oriental's supposed

assets and collects virtually all of New Oriental's supposed revenues

12. On July 17, 2012, the Company disclosed that the SEC had issued a formal order

of investigation as to "whether there is a sufficient basis for the consolidation of Beijing New

Oriental Education & Technology (Group) Co., Ltd, a variable interest entity of the Company,

and its wholly-owned subsidiaries, into the Company's consolidated financial statements."

13. On this news, New Oriental's ADSs plummeted $7.64 per ADS, or more than 34

percent, to close at $14.62 per ADS on July 17, 2012.

14. On July 18, 2012, Muddy Waters, LLC ("Muddy Waters") issued an analyst

report with a strong sell rating, further describing the Company's lack of a basis to consolidate

its VIE. In particular, Muddy Waters alleged that New Oriental's VIE deviates widely from VIE

best practices and lacked many standard VIE investor protections. Muddy Waters also alleged

that New Oriental China does not own and operate many of its schools, but rather, has franchised

them.

15. On this news, New Oriental's ADSs declined an additional $5.12 per ADS, or

more than 35 percent, to close at $9.50 per ADS on July 18, 2012.

16. Throughout the Class Period, Defendants made false and/or misleading

statements, as well as failed to disclose material adverse facts about the Company's business,

4


operations, and prospects. Specifically, Defendants made false and/or misleading statements

and/or failed to disclose that: (i) the Company improperly consolidated into its financial

statements the assets and earnings of New Oriental China and its wholly-owned subsidiaries; (ii)

that a significant number of the Company's schools and learning centers were not company-

owned, but were rather operated by numerous franchisees; and (iii) as a result of the foregoing,

New Oriental's financial statements were materially false and misleading at all relevant times.

17. As a result of Defendants' wrongful acts and omissions, and the precipitous

decline in the market value of the Company's ADSs, Lead Plaintiff and the Class members have

suffered significant losses and damages.

II. JURISDICTION AND VENUE

18. This court has jurisdiction over the subject matter of this action pursuant to

Section 27 of the Exchange Act, 15 U.S.C. § 78aa and 28 U.S.C. § 1331.

19. Venue is proper in this District pursuant to Section 27 of the Exchange Act, 15

U.S.C. § 78aa, and 28 U.S.C. § 1391. At all relevant times, New Oriental's stock traded as

ADSs on the NYSE in this District under the symbol "EDU."

20. In connection with the wrongful acts and conduct alleged herein, Defendants

directly and indirectly used the means and instrumentalities of interstate commerce, including the

United States mail and the facilities of a national securities market.

III. PARTIES

A. PLAINTIFF

21. Lead Plaintiff MPS is a pension fund based in the United Kingdom with

approximately £10.9 billion in assets under management, serving employees of the former

British Coal Corporation. MPS purchased or acquired New Oriental ADSs during the Class

Period in the amounts set forth in the certification MPS filed with the Court on September 21,

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2012. On October 25, 2012, MPS was appointed by Order of the Court to serve as Lead Plaintiff

in this Action.

B. COMPANY DEFENDANT

22, Defendant New Oriental is a corporation incorporated under the laws of the

Cayman Islands, with its principal offices located at No. 6 Hai Dian Zhong Street, Haidian

District, Beijing 10080, China.

23. During the Class Period, New Oriental's ADSs were traded on the NYSE and the

Company filed annual reports on Form 20-F ("Forms 20-F") with the SEC. As of May 31, 2012,

there were over 158 million shares of New Oriental issued and outstanding. New Oriental

operates on a fiscal year that ends on May 31.

C. INDIVIDUAL DEFENDANTS

24. Defendant Michael Minhong Yu ("Yu") has served as the chairman and Chief

Executive Officer ("CEO") of New Oriental since its inception in 2001. Yu is a resident of

Beijing, China,

25, Defendant Louis T. Hsieh ("Hsieh") has served as New Oriental's Chief Financial

Officer ("CFO") since December 2005, Director since March 2007, and President since May

2009. Hsieh is a resident of Beijing, China.

26. Defendants Yu and Hsieh are referred to together herein as the "Individual

Defendants." Defendants New Oriental, Yu and Hsieh are referred to collectively herein as

"Defendants."


IV. SUBSTANTIVE ALLEGATIONS

A. NEW ORIENTAL ADSs WOULD NOT BE A VIABLE INVESTMENT ABSENT A VIE STRUCTURE

27. The Chinese government restricts or prohibits foreign entities from investing in

certain sectors, including education and e-commerce. Foreign ownership of primary and middle

schools for students in grades one to nine is forbidden, and foreign ownership of high schools for

students in grades ten and twelve is restricted. The VIE structure is designed to circumvent these

restrictions, thereby allowing Chinese businesses operating in regulated sectors to attract

investors and access capital from abroad.

28. To utilize the VIE structure, typically, one or more foreign investors, together

with a Chinese citizen or entity, will form a foreign listed entity (often a Cayman Islands

corporation) that wholly owns a Chinese company called a WFOE. Because the WFOE is

foreign-owned, it will not be eligible for the permits and licenses needed to conduct business in

restricted sectors of the economy. Instead, the business is conducted through one or more VIEs,

entities that are wholly owned by Chinese nationals. The WFOE will then enter into various

contracts with the VIE and/or its owners, granting the WFOE control over the management of

the VIE. Some typical contracts that may be involved in establishing control over a VIE include

a loan agreement, an equity pledge agreement, a proxy agreement, a call option agreement, a

technical service agreement, and/or a power of attorney.

29. The WFOE must have contractual control over the foreign listed entity in order

for its listed parent company to consolidate the VIE's financial statements with its own under

U.S. GAAP. Financial Accounting Standards Board ("FASB") Interpretation No, 46:

Consolidation of Variable Interest Entities (FIN 46) contains the accounting rules for VIEs. It

has been amended as FIN 46R, and is presently included in the FASB Codification of

7


Accounting Standards at Section 810. At present, the rules require a VIE to be consolidated

when the parent company (1) has the power to direct the activities of the entity which most

significantly impact economic performance; (2) has the obligation to absorb the expected losses

of the entity; and (3) has the right to receive the expected residual returns of the entity.

30. The diagram below describes the corporate structure of a typical VIE.

ri

- •

F'-

- V . -

L I ICi

Source: Accounting Matters: Variable Interest Entities in China.

31. While the VIE structure has never been clearly prohibited by the Chinese

government (the "PRC"), it has not received an express endorsement, either. There are

significant legal and regulatory risks associated with it. Chinese regulators could decide that the

structure violates the prohibitions on foreign investment and impose fines, require a

restructuring, or even revoke the VIE' s business and operating licenses. Alternately, if a dispute

arises between the WFOE and the VIE or its owners, the WFOE may be unable to enforce its

contracts in a Chinese court. For this reason, it is considered best practices for the WFOE itself

to own and operate the company's business to the greatest extent practicable, and to utilize the

VIE only for those functions where foreign ownership is prohibited.


32, Because New Oriental is a non-Chinese company that operates in the restricted

education sector, it would not be able to function effectively without utilizing the VIE structure.

The Company has repeatedly acknowledged this fact in its public filings. For example, New

Oriental's Form 20-F report for the fiscal year ending May 31, 2012, filed on October 12, 2012

(the "2012 Form 20-F") states that:

PRC laws and regulations currently require any foreign entity that invests in the education business in China to be an educational institution with relevant experience in providing educational services outside China. The Company's offshore holding companies are not educational institutions and do not provide educational services outside China. In addition, in the PRC, foreign ownership of high schools for students in grades ten to twelve is restricted and foreign ownership of primary and middle schools for students in grades one to nine is prohibited. Accordingly, the Company's offshore holding companies are not allowed to directly own and operate schools in China. The Company conducts substantially all of its education business in China through contractual arrangements with its VIE. New Oriental China's schools hold the requisite licenses and permits necessary to conduct the Company's education business and operate the Company's schools and learning centers.

B. NEW ORIENTAL'S VIE ARRANGEMENTS

33. Defendant Yu opened his first school in Beijing in 1993. New Oriental China

was established in 2001 to own schools and learning centers that had been established under the

"New Oriental" brand. In 2004, Yu created New Oriental as an offshore holding company in

order to access foreign capital.

34. In September 2006, New Oriental completed its bid to obtain foreign capital by

holding an initial public offering ("IPO") of 8,625,000 ADSs. In February 2007 the Company

returned to the markets to raise an additional round of capital, selling 7,300,000 ADSs in a

secondary public offering.

35. At the time of its IPO and thereafter, New Oriental did business in China through

its WFOEs, Beijing Hewstone Technology Co., Ltd. and Beijing Decision Education and


Consulting Co., Ltd. New Oriental used these WFOEs to maintain the contractual arrangements

with New Oriental China, and maintained its own contractual agreements with New Oriental

China's shareholders but, significantly, owned no equity stake in New Oriental China itself

36. Instead, prior to January 2012, Beijing Century Friendship Education Investment

Co., Ltd. ("Century Friendship") held 53% of the equity interest in New Oriental China. Century

Friendship is a Chinese domestic corporation controlled by Defendant Yu. Defendant Yu owns

80% of the equity in Century Friendship, while his mother, Ms. Bamei Li, owns the remaining

20%.

37. The following diagram illustrates the corporate structure of New Oriental, its

WFOEs, New Oriental China, and the place of incorporation of each named entity as of May 31,

2006.

10


{ [T

Qrw

I: 41

4j -j1 14. t ,0

k I I lLj Li

V

. u. E L4

PAIL'•

I

Idiikk'

4 . ' I ' ' . •'. i' i '

ty

14 . 1 ', . .; -;. - •'-I• : 1 ir'.1',1rrt 4' 54'

Source: New Oriental Form F-i Registration Form, filed August 22, 2006.

38. The vast majority of New Oriental's business is conducted through New Oriental

China. In the fiscal years ending May 31, 2010, 2011 and 2012, New Oriental China and its

schools and subsidiaries contributed in aggregate 98.9%, 97.2%, and 97.2%, respectively, of

New Oriental's total net revenues.

39. In January 2012, New Oriental China's remaining shareholders transferred all of

their equity interests in New Oriental China to Century Friendship without consideration.

According to New Oriental's 2012 Form 20-F, "The purpose of the transfers was to further

11


strengthen our corporate structure by simplifying the shareholding structure of New Oriental

China." Thus, Defendant Yu is the defacto 100% owner of New Oriental China.

C. NEw ORIENTAL INAPPROPRIATELY CONSOLIDATES NEW ORIENTAL CHINA

40. New Oriental has filed consolidated financial statements with its WFOEs and its

VIE, New Oriental China, since at least its IPO in 2006 through May 31, 2012. As discussed in

greater detail below, the contractual agreements between New Oriental, its WFOEs, and New

Oriental China, which were listed in New Oriental's Form 20-17s, provided the basis for

consolidation and are summarized below. These contractual agreements demonstrate that neither

the Company nor its WFOEs had a controlling financial interest in New Oriental China during

the Class Period.

1. New Oriental's VIE Arrangements For The Fiscal Years Ending May 31, 2009 and May 31, 2010

41. In accordance with the U. S. GAAP Codification Sub-Section ASC 810

(previously FASB Financial interpretation No. 46R) on consolidation, the reporting entity that

consolidates a VIE is referred to as the primary beneficiary of that VIE. New Oriental, by

consolidating the financial results of New Oriental China, made the determination that it was

New Oriental China's primary beneficiary. In order to be deemed a primary beneficiary, U.S.

GAAP requires a reporting entity with a variable interest in a VIE to assess whether it has a

controlling financial interest in the entity and, if so, conclude whether or not it is the primary

beneficiary, If the reporting entity is determined to be the primary beneficiary of the VIE then it

is required under U.S. GAAP to consolidate the VIE's financial results with its own.

42. In the Company's annual report on Form 20-F for the year ended May 31, 2009,

filed October 19, 2009 (the "2009 Form 20-F") and its annual report on Fonn 20-F for the year

ended May 31, 2010, filed on October 14, 2010 (the "2010 Form 20-F"), it disclosed that it had

12


entered into contractual relationships with New Oriental China, its subsidiaries and shareholders,

enabling the Company to:

Exercise effective control over New Oriental China and its subsidiaries;

Receive a substantial portion of the economic benefits from New Oriental China and its subsidiaries in consideration for the services provided by our wholly owned subsidiaries in China; and

. Have an exclusive option to purchase all or part of the equity interests in New Oriental China, in each case when and to the extent permitted by PRC law.

43. Many of New Oriental's contractual relationships consist of various service

agreements that were entered into between two of its WFOEs and New Oriental China and its

schools and subsidiaries. The two WFOEs that are wholly owned by the Company and are

parties to the contractual agreements disclosed in the 2009 Form 20-F and 2010 Form 20-F are

(1) Beijing Hewstone Technology Co., Ltd. and (2) Beijing Decision Education & Consulting

Co., Ltd.

44. The categories of agreements that make up the contractual relationships are

disclosed in the 2009 Form 20-F and 2010 Form 20-F as follows:

Trademark License Agreements Pursuant to (1) the trademark license agreement dated May 13, 2006 between us as the licensor and New Oriental China as the licensee and (2) the trademark license agreement dated May 13, 2006 between us as the licensor and Beijing Hewstone as the licensee, we have licensed our trademarks to New Oriental China and Beijing Hewstone for their use in China. We have also allowed Hewstone to enter into a sub—license agreement with each subsidiary of New Oriental China and each New Oriental school pursuant to which each of these subsidiaries and schools may use our trademarks in China by paying certain licensing fees. Beijing Hewstone is authorized to collect the licensing fees from each sub—licensee and handle other related matters. The term of each of these license and sublicense agreements is ten years from its signing date.

Website Development and Use Agreements Pursuant to the website development and use agreements dated as of April 25, 2005 and their respective supplements entered into on January 1, 2006 between Beijing Decision and certain New Oriental schools and subsidiaries of New

13


Oriental China, Beijing Decision agreed to provide website development and regular system maintenance services to each of these New Oriental schools and each of these subsidiaries for an annual fee calculated based upon the annual revenues of the school and the subsidiary, respectively, subject to quarterly adjustments. Beijing Decision agreed to design and create a web platform based upon the request of the school and the subsidiary, as the case may be, each of which has the exclusive right to use, benefit from or otherwise dispose of the web platform. Each of these agreements and corresponding supplements has a term of five years from the signing date of the supplement.

Teaching Support Agreements Pursuant to the teaching support agreements dated as of April 25, 2005 and their respective supplements entered into on January 1, 2006 between Beijing Decision and certain New Oriental schools, Beijing Decision agreed to provide exclusive teaching support services to each of these New Oriental schools for an annual fee based on the school's revenues, subject to quarterly adjustments. The teaching support services include developing a curriculum for the school. Each of these agreements and their corresponding supplements has a term of five years from the signing date of the supplement.

New Enrollment System Development Service Agreements Pursuant to the new enrollment system development service agreements dated as of April 25, 2005 and their respective supplements entered into on January 1, 2006 between Beijing Decision and certain New Oriental schools, Beijing Decision agreed to provide new enrollment system development and regular maintenance services to each of these New Oriental schools for a fee calculated based upon the number of new enrollments each month, subject to quarterly adjustments. The new enrollment system in these agreements refers to the new enrollment system designed and created by Beijing Decision. Each of these agreements and corresponding supplements has a term of five years from the signing of the supplement.

Sale of Educational Software Agreements Since 2005, Beijing Hewstone has been selling various self—developed educational software to various New Oriental Schools, which are in turn included as part of the course materials for students enrolling in relevant courses. The sales are conducted at mutually agreed uponprices without any written agreement between the parties.

45. New Oriental attached a form version of each of these agreements (except for the

Educational Software Agreements, which were conducted without written agreements) to its

Form F-I registration statement, filed with the SEC on August 22, 2006 (the "2006 Form F-I")

However, these form agreements did not disclose the actual fees that New Oriental and/or its

14


WFOEs were entitled to receive from New Oriental and its subsidiaries. For example, the

"license fee" section of the disclosed form Trademark License Agreement stated only that:

The Licensor shall pay a license fee of [*%] of the Licensee's quarterly revenue (the "License Fee") to the Licensee for Trademark License herein. The Parties may through mutual negotiation adjust the License Fee Standard in accordance with the Licensee's actual revenue and profit at the end of every quarter. If no adjustment is made, the Parties shall use the percentage applied in the closest preceding quarter.

46. Thus, while investors could examine the terms of the various service agreements

that served as the basis for New Oriental's consolidation of New Oriental China, they could not

determine what percentage of New Oriental China's revenues New Oriental was entitled to under

those agreements.

47. According to U.S. GAAP, a VIE refers to the legal entity that is subject to

consolidation according to the various provisions of the variable interest subsections of ASC

Subtopic 810-10 (formerly FIN 46R). New Oriental represented to investors that New Oriental

China meets the definition of a VIE.

48. In order to be deemed a primary beneficiary of a VIE, the reporting entity must

first have a variable interest in the VIE. A "variable interest" is an accounting term used to

describe an entity's relationship with a VIE that causes the entity to share in the VIE's risks and

rewards. A variable interest can take many forms including an investment in the VIE, financing

to the VIE, or service contracts to the VIE. Variable interests are defined as, "contractual,

ownership, or other pecuniary interests in a VIE that change with changes in the fair value of the

entity's net assets exclusive of variable interests." ASC 810-10-20, FIN 46R, par. 2.C.

49. The FASB Codification describes what is involved in identifying variable

interests:

The identification of variable interests involves determining which assets, liabilities, or contracts create the legal entity's variability and which assets,

15


liabilities, equity, and other contracts absorb or receive that variability. The latter are the legal entity's variable interests.

ASC 810-10-55-19; FIN 46R, Appendix B, par. 4.

50. Some of the contractual arrangements and service agreements (including the

Equity Pledge and Equity Option Agreements) between New Oriental's WFOEs and New

Oriental China and its schools or subsidiaries may contain a variable interest component. For

example, agreements that are linked to an entity's performance, such as revenue or net income,

typically absorb variability in the entity and would, therefore, be considered variable interests.

Since some of the contracts and agreements that New Oriental has disclosed are based on a

percentage of revenue, they represent variable interests in New Oriental China,

51. As previously discussed, if the reporting entity is deemed to be the primary

beneficiary of a VIE then consolidation is required under U.S. GAAP. In order to be the primary

beneficiary of a VIE the reporting entity must be deemed to hold variable interests that will

absorb the majority of the VIE's profits and losses. Paragraph 14 of FIN 46R states:

An enterprise shall consolidate a variable interest entity if that enterprise has a variable interest (or combination of variable interests) that will absorb a majority of the entity's expected losses [i.e., greater than 50 percent], receive a majority of the entity's expected residual returns, or both.

FIN 46R, par. 14.

52. Because the form service agreements disclosed in the 2006 Form F-1 did not state

the revenue percentages that New Oriental was entitled to, it was reasonable for investors to

assume, based upon New Oriental's other disclosures regarding consolidation, that those service

agreements collectively allowed New Oriental to receive a majority of New Oriental China's

revenues. However, after the end of the Class Period, on October 12, 2012, the Company filed

its 2012 Form 20-F containing additional disclosures on the service agreements and the fees that

New Oriental was entitled to therein. These additional disclosures show that the contracts and

16


service agreements between New Oriental, its WFOEs and New Oriental China and its schools

and subsidiaries do not contain a sufficiently large variable interest to cause New Oriental to be a

primary beneficiary of New Oriental China. Thus, consolidation was not appropriate.

53. The revenue percentages disclosed in the 2012 Form 20-F specify the fee that

New Oriental China pays to the Company for services that the Company and its WFOEs provide.

While the fee percentages represent a variable interest, they do not create a situation whereby

New Oriental receives a majority of New Oriental China's expected residual returns.

54. in the 2012 Form 20-F, New Oriental disclosed that:

(a) New Oriental China subsidiary Beijing New Oriental Vision Overseas Consultancy Co., Ltd. was paying a license fee of only 5% of its monthly revenues pursuant to the Trademark License Agreement.

(b) New Oriental China was paying a per-student enrollment fee of up to RMB60 (approximately $9.63) pursuant to the New Enrollment System Development Service Agreement. These fee arrangements have nothing to do with a direct interest in the residual profits of the VIE. To be sure, the profits of the VIE are affected by the amount of fees that New Oriental collects, but that is different from claiming that it controls the residual profits that remain.

(c) The prices of the educational software that New Oriental's WFOEs sell to New Oriental China are determined by the WFOEs. Again, these fee arrangements have nothing to do with a direct interest in the residual profits of the VIE.

(d) The fees under New Oriental's other operating service agreements with its VIE's schools and subsidiaries represented only 2% to 6% of those schools and subsidiaries' monthly revenues.

55. On information and belief, the fees that New Oriental was entitled to under the

service agreements were set at approximately these levels throughout the Class Period.

56. In light of the disclosures in the 2012 Form 20-F, the service agreements listed in

the 2009 Form 20-F and 2010 Form 20-F demonstrate that neither the Company nor its WFOEs

are the primary beneficiary of New Oriental China. The contractual service agreements do not

require the Company to absorb a majority (over 50%) of the VIE's expected losses, nor do they

17


give the Company the right to receive the majority of VIE's expected residual returns. Indeed,

while New Oriental China had $382,189,000 in net revenues in 2010, New Oriental received

only approximately $59.4 million in service fees. The service agreements do not demonstrate

that New Oriental or its WFOEs have the ability to exercise effective control over New Oriental

China and its schools and subsidiaries. Furthermore, there is nothing in New Oriental's public

filings that provide any evidence either by a qualitative analysis or quantitative analysis that the

Company is the primary beneficiary of New Oriental China.

57. The Company also disclosed in its public filings that it has both an Equity Pledge

Agreement and Exclusive Option Agreements. While each of these agreements likely meets the

definition of a variable interest in accordance with GAAP because they absorb potential

variability related to the VIE's operations, assets and liabilities, they do not create a situation

whereby New Oriental will absorb a majority of New Oriental China's expected losses or its

expected residual returns. Regarding the Equity Pledge Agreement, the Company disclosed that:

Equity Pledge Agreement Pursuant to the equity pledge agreements dated as of May 25, 2006 among New Oriental China, the shareholders of New Oriental China, Beijing Hewstone and Beijing Decision, each shareholder agreed to pledge his or its equity interests in New Oriental China to Beijing Hewstone and Beijing Decision to secure the performance of New Oriental China's or its subsidiaries' obligations under the relevant principal agreements, including certain teaching support agreements, new enrollment system development service agreements, website development and use agreements, and trademark license agreements, and each of them has agreed not to transfer, sell, pledge, dispose of or otherwise create any encumbrance on his or its equity interest in New Oriental China without the prior written consent of Beijing Decision.

58. The Equity Pledge Agreement would only be exercised if and when New Oriental

China fails to perform its obligations under the existing service agreements. This is a substantive

contingency and therefore does not create a situation where the Company would be considered a

primary beneficiary of New Oriental China.


59. Additionally, Chinese law regards equity pledge agreements as a form of security

interest that must be recorded with the State Administration for Industry and Commerce in order

to be effective. Muddy Waters has reported that New Oriental's Equity Pledge Agreement was

not recorded until May 2012. Thus, the Equity Pledge Agreement was unenforceable for the vast

majority of the Class Period due to the Company's failure to record it.

60. Regarding its Exclusive Option Agreements, the Company disclosed that:

Exclusive Option Agreements Pursuant to the exclusive option agreements entered into on various dates, as amended on May 25, 2006, among our company, New Oriental China and the shareholders of New Oriental China, the shareholders of New Oriental China are obligated to sell to us, and we have an exclusive, irrevocable and unconditional right to purchase, or cause our designated party to purchase, from such shareholders, in our sole discretion, part or of all of these shareholders' equity interests in New Oriental China when and to the extent that applicable PRC law permits us to own part or all of such equity interests in New Oriental China. The purchase price to be paid by us will be the minimum amount of consideration permitted by applicable PRC law at the time when such share transfer occurs.

61. While the right to purchase shares is a variable interest in New Oriental China, it

does not create variable interests that could absorb a majority of New Oriental China's expected

losses or receive a majority of the expected residual returns until the right is exercised.

Therefore the Exclusive Option Agreements remain a contingency until they are actually

exercised.

2. New Oriental's VIE Arrangements For The Fiscal Year Ending May 31, 2011

62. New Oriental's VIE arrangements for the fiscal year ending May 31, 2011 were

similar to their VIE arrangements for the 2009 and 2010 fiscal years. Again, the Company

represented to investors that it had entered into contractual arrangements with New Oriental

China and its subsidiaries sufficient to justify consolidation, when the Company actually lacked a

basis to do so. In December 2009, the FASB revised the U.S. GAAP rules applicable to

19


financial reporting by enterprises involved with VIEs, such that the standards applicable to the

Company's fiscal year 2011 reporting were somewhat different from the previously applicable

standards. Nonetheless, the Company's fiscal year 2011 reporting did not meet the revised

standards.

63. In accordance with the U.S. GAAP Codification Sub-Section ASC 810

(previously FASB Financial Interpretation No. 46R and Statement of Financial Accounting

Standards No. 167) on consolidation, the reporting entity that consolidates a VIE is referred to as

the primary beneficiary of that VIE. New Oriental, by consolidating the financial results of the

VIE, again made the determination that it was the primary beneficiary of New Oriental China. In

order to be deemed a primary beneficiary, ASC 810 requires a reporting entity with a variable

interest in a VIE to assess whether it has a controlling financial interest in the entity and, if so,

conclude whether or not it is the primary beneficiary. If the reporting entity is determined to be

the primary beneficiary of the VIE then it is required under U.S. GAAP to consolidate the VIE's

financial results with its own.

64. The Company disclosed in its Form 20-F annual report for the year ended May

31, 2011, filed on October 14, 2011 (the "2011 Form 20-1 7") that it had entered into "contractual

relationships with New Oriental China and its subsidiaries, pursuant to which we, through our

wholly owned subsidiaries in China, provide exclusive teaching support, new enrollment system

support and other services to New Oriental China and its subsidiaries in exchange for payments

from them. In addition, we have entered into agreements with New Oriental China and each of

the shareholders of New Oriental China, which provide us with a substantial ability to control

New Oriental China and its existing and future subsidiaries." The categories of service

co


agreements that make up the contractual relationships were disclosed in the 2011 Form 20-F as

follows:

Trademark License Agreement Pursuant to the trademark license agreement dated May 13, 2006 between us as the licensor and New Oriental China as the licensee, we have licensed our trademarks to New Oriental China for their use in China. We have also allowed New Oriental China to enter into a sub-license agreement with each subsidiary of New Oriental China and each New Oriental China school pursuant to which each of these subsidiaries and schools may use our trademarks in China by paying certain licensing fees. New Oriental China is authorized to collect the licensing fees from each sub-licensee and handle other related matters. The term of each of these license and sublicense agreements is five to ten years from its signing date.

New Enrollment System Development Service Agreements Pursuant to the new enrollment system development service agreements dated as of April 25, 2005 and their respective supplements entered into on January 1, 2006 between Beijing Decision and certain New Oriental schools, Beijing Decision agreed to provide new enrollment system development and regular maintenance services to each of these New Oriental schools for a fee calculated based upon the number of new enrollments each month, subject to quarterly adjustments. The new enrollment system in these agreements refers to the new enrollment system designed and created by Beijing Decision.

Sale of Educational Software Since 2005, Beijing Hewstone, Beijing Pioneer and Shanghai Smart Words have been selling various self—developed educational software to various New Oriental Schools, which are in turn included as part of the course materials for students enrolling in relevant courses.

65. According to U.S. GAAP, a VIE refers to the legal entity that is subject to

consolidation according to the various provisions of the variable interest subsections of ASC

Subtopic 810-10. New Oriental concluded that New Oriental China met the definition of a VIE.

66. In order to be deemed a primary beneficiary of a VIE, the reporting entity must

first have a variable interest in the VIE. Under the revised U.S. GAAP standards applicable to

the Company's fiscal year 2011 reporting, a variable interest is defined as follows:

The investments or other interests that will absorb portions of a variable interest entity's (VIE's) expected losses or receive portions of the entity's expected residual returns. Variable interests in a VIE are contractual, ownership, or other

21


pecuniary interests in a VIE that change with changes in the fair value of the entity's net assets exclusive of variable interests. ASC 810-10-20

67. The FASB Codification describes what is involved in identifying variable

interests:

The identification of variable interests involves determining which assets, liabilities, or contracts create the legal entity's variability and which assets, liabilities, equity, and other contracts absorb or receive that variability. The latter are the entity's variable interests. ASC 810-10-55-19

68. As previously discussed, if the reporting entity is deemed to be the primary

beneficiary of a VIE then consolidation is required under U.S. GAAP. In order to be the primary

beneficiary of a VIE the reporting entity must be deemed to contain variable interests and have a

controlling financial interest in a VIE. A reporting entity will be deemed to have a controlling

financial interest in a VIE when both of the following characteristics exist:

a. The power to direct the activities of a VIE that most significantly impact the VIE's economic performance, and

b. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE...

ASC 810-10-25-38A

A reporting entity must identify which activities most significantly impact the VIE' s economic performance and determine whether it has the power to direct those activities. A reporting entity's ability to direct the activities of an entity when circumstances arise or events happen constitutes power if that ability relates to the activities that most significantly impact the economic performance of the VIE. A reporting entity does have to exercise its power in order to have power to direct the activities of a VIE.

ASC 810-10-25-38B

69. Although New Oriental and its WFOEs could contract with New Oriental China

and its schools and subsidiaries to exercise power to significantly influence the economic

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performance activities of New Oriental China, the service contracts between the WFOEs and

New Oriental China do not do so. The fees paid to the Company by themselves do not amount to

meaningful impact on the economic performance of New Oriental China. Moreover, New

Oriental's WFOEs had little, or no, control over New Oriental China and its schools and

subsidiaries. For example, as described in the Muddy Waters report, there are examples of non-

financial controls that would exhibit characteristics of control, but were weak or are completely

lacking at New Oriental's WFOEs:

• Requiring the operating company to appoint directors the WFOE designates;

• The WFOE receives the right to appoint the operating company's senior executives;

• The operating company is prohibited from making material business decisions without the WFOE's approval;

• Have the WFOE own the key software codes and web domains. The WFOE should license the code and domains to the operating company;

• Allow the operating company shareholders to allow the WFOE to vote for them on all matters.

• Irrevocable Power of Attorney. Affects the proxy agreement by specifying the individuals who will vote on behalf of the operating company shareholders.

70. The Company again disclosed in its public filings that it has both an Equity

Pledge Agreement and an Exclusive Option Agreement. While each of these agreements likely

meets the definition of a variable interest in accordance with GAAP, because they absorb

potential variability related to the VIE's operations, assets and liabilities, they do not amount to a

controlling financial interest required by U. S. GAAP Codification ASC 810-25-38. The Equity

Pledge Agreement would only be exercised if and when New Oriental China fails to perform its

obligations under the existing service agreements. This is a substantive contingency and

therefore should not be considered a form of control that the Company has over the activities of

New Oriental China. And again, the Equity Pledge Agreement was not recorded until 2012.

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71. Furthermore, the majority of the service agreements referred to in the Equity

Pledge Agreement expired as of January 1, 2011, and were not renewed. According to Muddy

Waters, New Oriental failed to renew three of the four agreements that the Equity Pledge

Agreement secured, yet New Oriental did not enforce the pledge agreement by foreclosing on the

pledged security. Even if the Equity Pledge Agreement was written to allow the agreements to

terminate without triggering the pledge, the security is substantively nonexistent.

72. The pledge agreement defines the main contracts that provide the security as the:

• Trademark License Agreement. EDU has two trademark license agreements, but this presumably refers to the one between WFOE Hewstone and the various schools. This agreement expired on January 1, 2011 and was not renewed.

• Website Development Agreement and Use Agreement. This agreement also expired on January 1, 2011 and was not renewed.

• Teaching Support Agreement. This agreement expired on January 1, 2011 and was not renewed.

• New Enrollment System Development Agreement that was likely still in effect.

73. Since three of the four contracts expired on January 1, 2011 and were not

renewed, there was only contract left that could trigger the exercise of the Equity Pledge

Agreement.

74. Regarding the Exclusive Option Agreement, the Company stated that:

Exclusive Option Agreement Pursuant to the exclusive option agreements entered into on various dates, as amended on May 25, 2006, among our company, New Oriental China and the shareholders of New Oriental China, the shareholders of New Oriental China are obligated to sell to us, and we have an exclusive, irrevocable and unconditional right to purchase, or cause our designated party to purchase, from such shareholders, in our sole discretion, part or of all of these shareholders' equity interests in New Oriental China when and to the extent that applicable PRC law permits us to own part or all of such equity interests in New Oriental China. The purchase price to be paid by us will be the minimum amount of consideration permitted by applicable PRC law at the time when such share transfer occurs.

24


75. Despite the fact that the right to purchase shares is a variable interest in New

Oriental China, it does not give the Company any control over the VIE until the right is

exercised. Therefore the Exclusive Option Agreement remains a contingency until the option is

actually exercised. It is also unclear whether the PRC government will make it legal for the

listed companies to own New Orientals operating businesses anytime soon. As a result, the

Exclusive Option Agreement may not be enforceable in China. This is a potential barrier to

exercise of the option which could limit or prevent the ability of the holder to exercise the option

agreement. Therefore, the Exclusive Option Agreement does not lead to a conclusion that the

holder has the control over the VIE in accordance with the two criteria stated in ASC 810-25-

9 MM

76. On a conference call with analysts on July 17, 2012, Defendant Hsieh described

New Oriental's VIE structure as a "mess" and discussed some of the problems that can be caused

when a VIE is not under the control of a WFOE, stating that:

What happened was when New Oriental set up its original VIE in 2002 and then 2006, there was a lot of founders. Remember, New Oriental had a lot of old founders in the Company. There's like 11 of them who were the shareholders of the VIE. In the last six years since the IPO, 10 of those people have left the Company, so they no longer have any shares or minimal shares in the Company and they're not involved at all in management or anything related to the Company.

So last year, after all the scrutiny on VIEs and on - and the frauds that were coming out of those, we took it on ourselves to say, well, let's clean up our mess now; let's get rid of the other 10 shareholders so we can consolidate the VIE into Michael Yu, our CEO. He had control before anyway, at 53%, but make it 100%, because those other guys have nothing to do with the Company. There have been cases in other Chinese companies where the VIE shareholders who were disgruntled refused to sign, even though under contract they have to. So we wanted to avoid future problems by cleaning up our VIE now.

D. DEFENDANTS FAIL To DISCLOSE A PROGRAM To FRANCHISE THE "NEW ORIENTAL" BRAND

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77. New Oriental has repeatedly stressed that its brand, and its ability to offer a

consistent experience to students at each of its schools and learning centers, are critically

important to its business. For example, in the 2010 20F, it stated, "We consider our trademarks

and trade name invaluable to our ability to continue to develop and enhance our brand

recognition. We have spent over a decade building our 'New Oriental' brand by emphasizing

quality and consistency and building trust among students and parents." Accordingly, "[o]ur

business depends on our "New Oriental" brand, and if we are not able to maintain and enhance

our brand, our business and operating results may be harmed."

75. New Oriental has also acknowledged that the continued expansion of its school

network presents challenges to its brand, stating in the 2010 20-F that, "[olur planned expansion

will also place significant demands on us to maintain the consistency of our teaching quality and

our culture to ensure that our brand does not suffer as a result of any decreases, whether actual or

perceived, in our teaching quality."

79. Throughout the Class Period, New Oriental represented to investors that New

Oriental China owned and operated all of the Company's schools, learning centers and

bookstores. See Section V.D, below. These representations regarding ownership were material

to investors, because if New Oriental China engaged in franchising or other such third-party

licensing arrangements, its ability to ensure the quality and consistency of its brand would be

compromised. On an August 31, 2007 analyst conference call regarding New Oriental's first

quarter 2007 financial results, Defendant Rsieh expressly denied that New Oriental had any

plans to franchise its schools for exactly these reasons.

Analyst: Okay. I know one of your biggest competitors Global TELTS is actively implementing its franchised schools plan. So do you have any plan in the near future about implementing the franchise schools?

26


Hsieh: We've never franchised in the big cities and we did that on purpose, because one of our core competitive strengths is our brand and the ability to have a similar experience across different cities. When you franchise you lose control of the quality of teachers and teachers are key to student's educational experience. So, we believe that if you lose that control you can't really manage your brand. This is not like the McDonalds or Starbucks where everything looks exactly alike, and the key to teaching is the content, the brand and the teachers. And we believe when you franchise you lose control of the teachers and also you lose control to some degree of the look and feel of the school. Our New Oriental Schools, many of them look very similar. They have the same high quality and we believe that franchising is not optimal model if you want to build a very strong brand name.

80. However, unbeknownst to investors, no later than January 2010, New Oriental

began to permit third parties in certain cities to offer its "Pop Kids" English program and "New

Oriental Star" kindergarten program under a "brand name cooperation model." New Oriental

China exerts considerably less control over these franchised schools than the schools it directly

owns and operates. According to a recording of a phone call between New Oriental China and a

potential franchisee obtained by the research firm Muddy Waters, New Oriental China "won't

get overly involved in the daily operations and personnel management," and does not make

hiring decisions at franchise schools. As the New Oriental China employee describing the

franchise relationship stated, "A franchise school has different conditions and space for

development. They're not things that we have control over on our part, do you understand?"

Furthermore, franchisees are penalized RMB100,000 (approximately $16,000) if they do not

open one new facility per year, creating a further danger that growth will occur at the expense of

quality and consistency.

81. As of May 31, 2012, there were a total of 21 franchise schools. By way of

comparison, New Oriental China directly owned and operated 55 schools (as well as 609

"learning centers.") Thus, approximately a third of the schools operating under New Oriental's

brand were not actually owned or operated by New Oriental China. In the 2010, 2011 and 2012

27


fiscal years, New Oriental recognized revenues that these franchise schools generated through

license and training fees. However, it did not publicly disclose the existence of the franchise

program to investors until after Muddy Waters exposed it.

E. IN JULY 2012, AN SEC !INVESTIGATION AND ANALYST REPORT REVEAL THE FALSITY OF DEFENDANTS' PUBLIC STATEMENTS

82, On July 17, 2012, the Company issued a press release announcing unaudited

financial results for the fiscal quarter and fiscal year ending May 31, 2012. The press release

also contained the following disclosures regarding an SEC investigation of the Company's

financial reporting.

On July 13, 2012, the Company was informed that the U.S. Securities & Exchange Commission (the "SEC") had issued a formal order of investigation captioned "In the Matter of New Oriental Education & Technology Group Inc." The Company believes that the investigation concerns whether there is a sufficient basis for the consolidation of Beijing New Oriental Education & Technology (Group) Co., Ltd., a variable interest entity of the Company, and its wholly-owned subsidiaries, into the Company's consolidated financial statements. The Company intends to fully cooperate with the SEC in its investigation.

83. The price of the Company's ADSs declined materially upon announcement of

this order on July 17, 2012, falling 34.32% from $22.26 to close at $14.62 per share on unusually

heavy trading volume.

84. The following day, on July 18, 2012, the research firm Muddy Waters released a

report demonstrating how New Oriental's financial reports were inaccurate and too good to be

true. In the past, Muddy Waters has accurately identified several accounting and financial

irregularities and frauds with other market participants from China. The New Oriental report

was based upon sources including recordings of conversations with New Oriental employees,

New Oriental franchising documents, reviews of New Oriental's filings with American and

Chinese regulators, and consultations with Chinese legal and tax experts. Muddy Waters

identified the following inaccuracies in New Oriental's financial reporting, amongst others.

28


(a) "EDU has reported 392% revenue growth since going public. The revenue growth has been built on store growth of 338% during this time. EDU tells investors that its entire store network is company-owned, but this is a lie. As recently as last month, EDU president and CPU Louis Hsieh adamantly denied that EDU has any franchisees. This report shows Hsieh's statements are patently false EDU has numerous franchisees. However, these franchisees are not a hidden bonus for investors. Rather, they are part of a substantial fraud in EDU's accounts." (footnotes omitted)

(b) "[New Oriental] is lying to shareholders about its store growth and financial performance. As is typical of many of the frauds we have witnessed in China, how EDU actually conducts its business differs materially from what it tells investors. Inside China, EDU has an extensive and long-standing franchising operation. We know this because we have listened to discussions between EDU and a potential franchisee. Outside China, EDU's president / CFO Louis Hsieh vehemently denies the existence of any franchising or financial sharing arrangements whatsoever.

We have evidence that EDU's franchising operation covers dozens of cities, including its original Tier 1 markets, and that the franchising includes both POP Kids and traditional format stores. However, EDU has never disclosed any information related to franchising."

(c) "EDU's VIE structure deviates widely from best practices and is among the most troubling we have seen. Among other problems, EDU took over five years to register the share pledge of its VIE, and only did so this May likely in order to preempt a critical report from Muddy Waters. . . . Even worse, EDU evidently should have foreclosed on the pledged equity 17 months ago, yet did not. The pledge is therefore cosmetic only. Unlike best practices VIEs, such as Baidu, Inc. ("BIDU") which attempt to place as much economic substance within the shareholders' company as possible, EDU's structure leaves most economic value in the hands of chairman Michael Yu."

85. Muddy Waters noted that because there was little business conducted within New

Oriental's WFOEs, Defendant Yu could relatively easily walk away from the public company

shareholders while maintaining control over the operating business (and the operating business's

profits). It reported that New Oriental's WPOEs did not have management control over New

Oriental China, that New Oriental's WFOEs did not own any key assets, that New Oriental's

WFOEs lacked a proxy agreement giving them voting rights for New Oriental China or a power

of attorney for New Oriental China, and that New Oriental's equity pledge was substantively


meaningless because most of the referenced contracts had been permitted to expire (and because

the pledge itself had only recently been recorded, meaning that it was unenforceable for most of

the Class Period).

86. Muddy Waters used the VIE structure of the Internet firm Baidu, Inc. ("Baidu")

as its reference point to provide examples of the contractual agreements and shareholder

protections that a VIE should have. Baidu's co-founder and CEO, Mr. Robin Yanhong Li, has

been on the Board of New Oriental since its initial public offering, and currently sits on its Audit

Committee and Nominating and Corporate Governance Committee. Thus, Defendants knew or

should have known that more robust VIE agreements providing additional security to public

shareholders were available, but deliberately chose to utilize weaker agreements.

87. Muddy Waters also noted that New Oriental's 2011 audit fees were lower than

those of its smaller peers, and indeed, were lower than in 2007 (despite a purported 195%

increase in store base between 2007 and 2011), giving rise to an inference that the audit did not

reach the level of thoroughness that a firm of New Oriental's size and complexity demands.

After the end of the Class Period, on December 3, 2012, the SEC initiated formal administrative

proceedings against New Oriental's auditor, Deloitte Touche Tohmatsu Certified Public

Accountants Ltd. ("Deloitte China"), based on Deloitte China's willful refusal to provide the

SEC with audit workpapers and other materials prepared on behalf of another U.S. issuer with

principal operations in China.

88. In the wake of Muddy Waters' report, the Company's ADSs tumbled still further.

On July 18, 2012, the price of the Company's ADRs fell another 35.02%, or $5.12 per share,

from $14.62 to $9.50 on unusually heavy trading volume.

30


F. POST-CLASS PERIOD DEVELOPMENTS

89. In a press release issued on October 12, 2012, announcing the filing of the

Company's 2012 Form 20-F, New Oriental stated that,

Prior to the filing of the 2012 Form 20-F, New Oriental was informed by the staff of the SEC's Division of Corporation Finance that, based on the Company's representations made in response to the SEC's inquiries, the staff has no objection to the Company's consolidation of its variable interest entity, Beijing New Oriental Education & Technology (Group) Co., Ltd. ("New Oriental China"), into the Company's consolidated financial statements, and also has no objection to the Company's consolidation of its schools into New Oriental China or into the Company's wholly-owned subsidiaries in China. The SEC staff has indicated that it will continue to review New Oriental's disclosure documents, including the 2012 Form 20-F.

90, However, New Oriental's 2012 Form 20-F stated something quite different.

On July 13, 2012, we were informed that the SEC had issued a formal order of investigation captioned "In the Matter of New Oriental Education & Technology Group Inc." In that investigation the SEC's enforcement staff has requested documents and information concerning the basis for the consolidation of New Oriental China, a variable interest entity of our company, and its schools and subsidiaries, into our consolidated financial statements and other issues related to certain allegations about us contained in a reported issued on July 18, 2012 by Muddy Waters LLC. We are cooperating fully with the SEC in its investigation. We cannot predict the timing, outcome or consequences of the SEC investigation. (emphasis added)

91. Thus, contrary to New Oriental's October 12, 2012 press release, it appears that

the SEC investigation into the consolidation of New Oriental China is still ongoing.

Additionally, the phrase, "the SEC's enforcement staff," typically refers to employees of the

SEC's Division of Enforcement (the division that investigates potential violations of securities

laws) as opposed to the SEC Division of Corporate Finance (the division that provides comments

and interpretative guidance on disclosures). Thus, even if the Division of Corporate Finance has

stated that it has no objection to consolidation, it seems that the Division of Enforcement

continues to probe the matter.

31


92. Additionally, in the 2012 Form 20-F, New Oriental for the first time disclosed

that for more than two years it had, in fact, engaged in a franchising program, and that it did not

own all of the schools operating under the New Oriental brand. This was something that the

Company had flatly denied to investors previously. The Company's 2012 20-F admitted that,

"In January 2010, we established a small pilot program whereby we permit third parties in

certain small cities to offer our "Pop Kids" English program and "New Oriental Star"

kindergarten programs under a brand name cooperation model."

V. DEFENDANTS' FALSE AND MISLEADING STATEMENTS

93. During the Class Period, Defendants made materially false and misleading

statements about (1) New Oriental's consolidation of and control over New Oriental China; (2)

New Oriental's financial results; (3) New Oriental's compliance with U.S. GAAP; and (4) New

Oriental China's ownership of all of its schools and learning centers.

A. FALSE AND MISLEADING STATEMENTS REGARDING THE COMPANY'S

CONSOLIDATION OF AND CONTROL OVER NEW ORIENTAL CHINA

94. Throughout the Class Period, Defendants made false statements about the

Company's VIE structure and consolidation, consistently representing that New Oriental had the

substantial ability to control New Oriental China, such that consolidation of New Oriental China

into New Oriental's financial reporting was appropriate. Defendants did not disclose that New

Oriental lacked the power to direct the activities of New Oriental China, or the obligation to

absorb the losses of New Oriental China,

1. Fiscal Year 2009

95. On October 19, 2009, New Oriental filed the 2009 Form 20-F with the SEC. The

2009 Form 20-F was signed by Defendant Yu, and contained Sarbanes-Oxley certifications

signed by Yu and Hsieh.

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96, The 2009 Form 20-F made the following representations about New Oriental's

control over and consolidation of New Oriental China:

(a) PRC laws and regulations currently require any foreign entity that invests in the education business in China to be an educational institution with relevant experience in providing educational services outside China. Our Cayman Islands holding company is not an educational institution and does not provide educational services. In addition, foreign ownership of primary and middle schools for students in grades one to nine is prohibited in the PRC. Accordingly, our wholly owned subsidiaries in China, which are considered foreign invested enterprises, are currently ineligible to apply for the required education licenses and permits in China. We conduct our education business in China through contractual arrangements with New Oriental China and its subsidiaries and shareholders. New Oriental China is our consolidated affiliated entity directly owned by our founders and/or their respective affiliates. New Oriental China's subsidiaries hold the requisite licenses and permits necessary to conduct our education business and operate our schools, learning centers and bookstores in China. We have been and are expected to continue to be dependent on New Oriental China and its subsidiaries to operate our education business until we quality for direct ownership of educational businesses in China. We have entered into contractual arrangements with New Oriental China and its subsidiaries, pursuant to which we, through our wholly owned subsidiaries in China, provide exclusive teaching support, new enrollment system support and other services to New Oriental China and its subsidiaries in exchange for payments from them. In addition, we have entered into agreements with New Oriental China and each of the shareholders of New Oriental China, which provide us with a substantial ability to control New Oriental China and its existing and future subsidiaries. (emphasis added)

(b) New Oriental China's subsidiaries hold the requisite licenses and permits necessary to conduct our education business and operate our schools, learning centers, bookstores, as well as online education businesses in China. We have been and are expected to continue to be dependent on New Oriental China and its subsidiaries to operate our education business until we qualify for direct ownership of an education business in China under PRC laws and regulations and acquire New Oriental China and its subsidiaries as direct, wholly owned subsidiaries. We have entered into contractual arrangements with New Oriental China and its subsidiaries and shareholders, which enable us to:

• exercise effective control over New Oriental China and its subsidiaries;

• receive a substantial portion of the economic benefits from New Oriental China and its subsidiaries in consideration for the services provided by our wholly owned subsidiaries in China; and

33


have an exclusive option to purchase all or part of the equity interests in New Oriental China in each case when and to the extent permitted by PRC law.

(c) To comply with the PRC laws and regulations, the Company provides a significant portion of its services in China through its variable interest entity, New Oriental China, for which the Company is the primary beneficiary. The Company, through its wholly owned subsidiaries in China, has entered into exclusive technical and other services agreements with New Oriental China in April 2005, under which the Company provides technical and other services (the "Service Agreements") to New Oriental China and its subsidiaries in exchange for significantly all of the net income of New Oriental China and its subsidiaries. As collateral to ensure New Oriental China and its subsidiaries' payments under the Service Agreements, the shareholders of New Oriental China and its subsidiaries, through an equity pledge agreement dated April 2005, pledged all of their rights and interests in New Oriental China and its subsidiaries, including voting rights and dividend rights, to the Company. In addition, the shareholders of New Oriental China, through an exclusive option agreement, granted to the Company an exclusive, irrevocable and unconditional right to purchase part or all of the equity interests in New Oriental China and its subsidiaries when the purchase becomes permissible under the relevant PRC Law.

Through the contractual agreements described above, New Oriental China is a variable interest entity in accordance with Financial Accounting Standard Board ("FASB") Interpretation No. 46 (revised) "Consolidation of Variable Interest Entities—an Interpretation of ARB No. 51" ("FIN 46R") because the equity owners (1) lack the right to receive the expected residual returns of New Oriental China and its subsidiaries, (2) lack the ability to make decisions about New Oriental China and its subsidiaries' activities that have a significant effect on their success, and (3) substantially all of New Oriental China and its subsidiaries' businesses are conducted on behalf of the Company. The Company is the primary beneficiary of New Oriental China because it holds all the variable interests in New Oriental China. As a result, the accounts and operations of New Oriental China and its subsidiaries are included in the accompanying consolidated financial statements effective as of the date of the above agreements. Because the Company and New Oriental China are under common control by the same shareholder group, New Oriental China and its subsidiaries are accounted for as common control transfer and are consolidated on a carryover basis.

97. Each of these statements were false and misleading for the reasons presented in

Section IV.C. 1, above. In fact, the Company lacked the substantial ability to control New

Oriental China and had no basis to consolidate it under U.S. GAAP.

34


2. Fiscal Year 2010

98, On October 14, 2010, New Oriental filed its 2010 Form 20-F with the SEC. The

2010 Form 20-F was signed by Defendant Yu, and contained Sarbanes-Oxley certifications

signed by Yu and Hsieh. The 2010 Form 20-F contained misrepresentations regarding the

consolidation of New Oriental China substantially identical to those listed above in ¶96.

3. Fiscal Year 2011

99. On October 14, 2011, New Oriental filed 2011 Form 20-F with the SEC. The

2011 Form 20-F was signed by Defendant Yu, and contained Sarbanes-Oxley certificated signed

by Yu and Hsieh. The 2011 Form 20-F contained misrepresentations regarding the consolidation

of New Oriental China substantially identical to those listed above in ¶96(a) - (b). In addition,

the 2011 20-F stated that:

In June 2009, the FASB issued an authoritative pronouncement to amend the accounting rules for VIE. The amendments effectively replace the quantitative—based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a VIE with an approach focused on identifying which reporting entity has (1) the power to direct the activities of a VIE that most significantly affect the entity's economic performance and (2) the obligation to absorb losses of or the right to receive benefits from the entity. Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has the power to direct the activities of the VIE that most significantly impact the entity's economic performance. The new guidance also requires additional disclosures about a reporting entity's involvement with VIE and about any significant changes in risk exposure as a result of that involvement.

The Group adopted the new guidance on June 1, 2010 and the disclosure requirements of the new guidance were retrospectively applied for all the periods presented in the financial statements.

As discussed above, the Company had consolidated VIE, under the authoritative literature prior to the amendment discussed above because it was the primary beneficiary of those entities. Because the Company, through its WFOEs, has (1) the power to direct the activities of the VIE that most significantly affect the entity's economic performance and (2) the right to receive benefits from the VIE, it continues to consolidate the VIE upon the adoption of the new guidance

35


which therefore, other than for additional disclosures, will have no accounting impact. (emphasis added)

100. This statement was false and misleading because the Company did not actually

possess the powers to direct the activities of the VIE that most significantly affect the entity's

economic performance, did not have the right to receive benefits from the VIE, and did not have

a basis to consolidate the VIE under U.S. GAAP. See Section IV.C.2, above.

B. DEFENDANTS' FALSE AND MISLEADING STATEMENTS REGARDING FINANCIAL

RESULTS

101. Because the vast majority of the revenues, assets and operations that supposedly

make up New Oriental's business are actually revenues, assets and operations of New Oriental

China, and should not be reported by New Oriental, New Oriental's financial reporting

throughout the Class Period has been almost entirely false and misleading.

1. Fiscal Year 2009

102. On information and belief:, in the 2009 fiscal year, New Oriental China

contributed approximately 97% of New Oriental's total net revenues. Thus, the 2009 Form 20-F

filed by Defendants on the first day of the Class Period overstated New Oriental's revenues by

approximately 97% by inappropriately consolidating New Oriental China. Furthermore, the

2009 Form 20-F presented consolidated statement of operations and condensed consolidated

balance sheet data, representing that New Oriental had total assets of $469,402,000. The total

assets of New Oriental China included in the consolidated financial statement for 2009 were

approximately $307 million. By improperly consolidating New Oriental China's assets, New

Oriental overstated its own total assets by approximately 65%.

2. Fiscal Year 2010

103. In the 2010 fiscal year, New Oriental China and its schools and subsidiaries

contributed in aggregate 98.9% of New Oriental's total net revenues. Thus, the 2010 Form 20-F,

36


as well as New Oriental's October 20, 2009, January 19, 2010, April 20, 2010 and July 19, 2010

press releases discussing quarterly earnings, each overstated New Oriental's revenues by

approximately 98.9% by inappropriately consolidating New Oriental China. Furthermore, the

2010 Form 20-F presented a consolidated statement of operations and condensed consolidated





104. In addition, on April 20, 2010 and June 19, 2010, Defendant Hsieh participated in

analyst conference calls regarding New Oriental's financial results for the third and fourth

quarters of the 2010 fiscal year. At these conference calls, Hsieh made statements regarding

New Oriental's revenues, growth and operations that were materially false and misleading due to

the inappropriate consolidation of New Oriental China.

105. For example, on the April 20, 2010 conference call regarding New Oriental's

performance in the third quarter of the 2010 fiscal year, Hsieh stated that:

(a) "For the third fiscal quarter 2010 New Oriental reported net revenues of $89.2m, representing a 36.2% increase year over year. Net revenues from Educational Programs and Services for the third fiscal quarter was $86.2m, representing a 37.6% increase year over year."

(b) "Total student enrollments in language training and test preparation courses for the nine months ended February 28, 2010 increased by 15.2% to approximately 1.370m, from approximately 1.1 89m in the same period of the prior fiscal year."

106. On the June 19, 2010 conference call regarding New Oriental's performance in

the fourth quarter of the 2010 fiscal year, Hsieh stated that:

(a) "Total student enrollments for the year increased 19% to approximately 1.8 million, driving top line growth of 32% to $386 million, exceeding our 25% to 30% revenue growth target for fiscal year 2010."

37


(b) "For the fourth fiscal quarter of 2010, New Oriental reported net revenue of $86.6 million, representing a 45.7% increase year-over-year. Net revenues in educational programs and services for the fourth fiscal quarter were $74.3 million, representing a 44.7% increase year-over-year. Total student enrollments in language training and test preparation courses in the fourth quarter of fiscal year 2010 increased by 32.4% year-over-year to 437,200 from approximately 330,200 in the same period of the prior fiscal year."

3. Fiscal Year 2011


contributed in aggregate 97.2% of New Oriental's total net revenues. Thus, the 2011 Form 20-F,

as well as New Oriental's October 18, 2010, January 18, 2011, April 27, 2011, and July 18, 2011

press releases discussing quarterly earnings, each overstated New Oriental's revenues by

approximately 97.2% by inappropriately consolidating New Oriental China. Furthermore, the

2011 Form 20-F presented a consolidated statement of operations and condensed consolidated





108. In addition, on October 18, 2010 January 18, 2011, April 27, 2011 and July 18,

2011, Defendant Hsieh participated in analyst conference calls regarding New Oriental's

financial results for the first, second, third and fourth quarters of the 2011 fiscal year. At these

conference calls, Hsieh made statements regarding New Oriental's revenues, growth and

operations that were materially false and misleading due to the inappropriate consolidation of

New Oriental China,

109. For example, on the October 18, 2010 conference call regarding New Oriental's

performance in the first quarter of the 2011 fiscal year, Hsieh stated that:

38


(a) "For the first quarter of fiscal year 2011, New Oriental reported that revenues of a $192.3 million representing 28.8% increase year-over-year. Net revenues of educational programs and services of the first fiscal quarter was $180.9 million, representing 27% increase year-over-year."

110. Defendant Yu also participated in the October 18, 2010 conference call, and also

made false statements regarding revenue, growth and operations. Yu stated that:

(a) "[O]ur K to 12 all-subjects after-school children is the clear number one market share leader in China in terms of both revenues which totaled approximately USD$ 139 million and the enrollments which totaled approximately 860,000 over the last 12 months."

(b) "[D]uring the first fiscal quarter, we achieved net revenues of USD$192.3 million, representing 28.8% growth year-over-year, well within oui guidance range. Enrollments grew 8.8% and the planned ASP grew approximately 20%."

111. On the January 18, 2011 conference call regarding New Oriental's performance in

the second quarter of the 2011 fiscal year, Hsieh stated that:

(a) "As you know, in Qi 2011 our business was affected by a slow down in enrollments due to disruption caused by the Shanghai World Expo and as we expected there has been a strong bounce back since the event finished, which helped drive year over year revenue growth of 56.3% to $95.7 million and an earnings increase of 65.9% to $1.8 million in the second quarter."

(b) "[W]e saw very strong year over year growth in our key business segments of K to 12 all subject after school tutoring, overseas test prep and English language training, which grew revenues by 80%, 75% and 40% respectively. Enrollments were also strong, growing by 32.2% to about 405,800 during the second fiscal quarter of2011[.]"

112. On the April 27, 2011 conference call regarding New Oriental's performance in

the third quarter of the 2011 fiscal year, Hsieh stated that:

(a) We had approximately 490,200 enrollments in Q3 2011 compared with approximately 416,000 in the same period last year. In particular I would like to highlight that we recorded over 1.6 million enrollments in the first three quarters of 2011 fiscal year and are poised to exceed 2 million enrollments for the full fiscal year, a significant milestone for the company."

39


(b) "Net revenues from educational programs and services for the third fiscal quarter were $122.6m, representing a 48.6% increase year-over-year."

113. On the July 18, 2011 conference call regarding New Oriental's performance in the

fourth quarter of the 2011 fiscal year, Hsieh stated that:

(a) "In the fourth quarter our revenues grew by 58.7%, while profits grew by 147.8% year over year."

(b) "[F]or the 12 months ended May 31, 2011 net revenues from educational programs and services for the fiscal year ended May 31, 2011 was $508.4m, representing a 44.1% increase year over year. Total student enrollments in academic subjects, Tutoring and Test Preparation courses for the fiscal year ending May 31, 2011 increased by 15.6% year over year to approximately 2,089,600, from approximately 1,807,700 in the fiscal year ending May 31, 2010."

4. Fiscal Year 2012


contributed in aggregate 97.2% of New Oriental's total net revenues. Thus, New Oriental's

August 31, 2011, January 17, 2012, April 17, 2012, and July 17, 2012 press releases discussing

quarterly earnings, each overstated New Oriental's revenues by approximately 97.2% by

inappropriately consolidating New Oriental China,

115. On October 18, 2011, January 17, 2012, April 17, 2012, and July 17, 2012

Defendant Hsieh participated in analyst conference calls regarding New Oriental's financial

results for the first, second, third and fourth quarters of the 2012 fiscal year. At these conference

calls, Hsieh made statements regarding New Oriental's revenues, growth and operations that

were materially false and misleading due to the inappropriate consolidation of New Oriental

China.

116. For example, on the October 18, 2011 conference call regarding New Oriental's

performance in the first quarter of the 2012 fiscal year, Hsieh stated that:

40


(a) "New Oriental continues to grow at a stellar rate, with revenues increasing by 41.4% year over year to $272m. Combined with this, our efforts to control spending continue to bear fruit, enabling us to increase net income

to $90.7m.

(b) "Net revenue from education programs and services for the fiscal first quarter were $251 .9m, representing a 39.3% increase year over year. Total student enrollments in academic subjects, tutoring and test preparation courses in the first quarter of fiscal year 2012 increased by 14.6% year over year to approximately 807,700 from approximately 704,500 in the same period of the prior fiscal year."

117. On the January 17, 2012 conference call regarding New Oriental's performance in

the second quarter of the 2012 fiscal year, Hsieh stated that:

(a) "Total student enrollments grew by 16.2%, revenue grew by 38% and profit rose by 80.5%."

(b) "Net revenues from education programs and services for the second fiscal quarter was $120.1 million, which is 42.1% year-over-year."

118. On the April 17, 2012 conference call regarding New Oriental's performance in

the third quarter of the 2012 fiscal year, Hsieh stated that:

(a) "For the first nine months of fiscal year 2012, New Oriental reported net revenues of $578.4m representing a 37.6% increase year over year. Total student enrollments in academic subjects tutoring and test preparation courses in the first nine months of fiscal year 2012 increased by 17.2% to 1.875m from approximately 1.6m in the same period of prior fiscal year."

119. On the July 17, 2012 conference call regarding New Oriental's performance in the

fourth quarter of the 2012 fiscal year, Hsieh stated that:

(a) "Our results for the first - fiscal year speak to its success. Student enrollments hit 2.4m, up 15% year over year. Revenue grew 38.3% year over year to $771.7m."

C. DEFENDANTS' U.S. GAAP VIOLATIONS

120. In each of the 2009 Form 20-F, 2010 Form 20-F, and 2011 Form 20-F,

Defendants represented that, "Our audited consolidated financial statements are prepared and

presented in accordance with generally accepted accounting principles in the United States, or

41


U.S. GAAP." These representations were materially false and misleading because, as discussed

in Section IV, above, each of the 2009 Form 20-F, 2010 Form 20-F and 2011 Form 20-F did not

comply with U.S. GAAP due to the Company's inappropriate consolidation of New Oriental

China into its own financial reporting.

D. FALSE AND MISLEADING STATEMENTS REGARDING THE Coripy's OWNERSIIIP AND OPERATION OF ITS ScHooLs AND LEARNING CENTERS

121. Throughout the Class Period, Defendants made false statements about the

Company's operations, consistently representing that New Oriental China owned and operated

all of its schools and learning centers, when in fact New Oriental China had begun to open new

facilities through franchise agreements that did not give it the same degree of control as outright

ownership. Defendants did not disclose this franchising program until October 12, 2012.

122. The 2009 Form 20-F contained the following representations regarding New

Oriental China's ownership of its schools and learning centers:

(a) "We established New Oriental China in 2001 to own all of our schools and learning centers."

(b) "We deliver our educational programs, services and products to students through an extensive physical network of 48 schools, 222 learning centers and 24 bookstores operated by us, over 5,000 third-party bookstores and approximately 5,200 teachers in 42 cities as of May 31, 2009, as well as through our virtual online network, which has approximately 4.5 million registered users. . . . In addition, as we have had over 7.3 million cumulative student enrollments since our inception, we have an extensive network of students and alumni."

(c) "Due to certain restrictions and qualification requirements under PRC law that apply to foreign investment in China's education industry, our education business is currently conducted through contractual arrangements among us, our wholly owned subsidiaries in China, and our consolidated affiliated entities in China, which consist of New Oriental China and its wholly owned subsidiaries. New Oriental China's subsidiaries hold the licenses and permits necessary to conduct our educational services business in China and directly operate its schools, learning centers and bookstores, develop and distribute educational content, software and other technologies, and operate our online education business. We intend to own and operate schools and learning centers when PRC law permits us to do so."

42


123. Additionally, the 2009 Form 20-F contained the operating chart reproduced

below, representing that New Oriental China owned a 100% equity interest in each of its schools

and subsidiaries.

- H

H 41

-'P..--..

4 4

I I

I I

1 4 I I

I

- L:f 1

-

All - ..

I I-

I -

II

III I 1 II

43


124. Misrepresentations substantially similar to the above were also included in the

2010 Form 20-F and 2011 Form 20-F.

125. Additionally, in June 2012, Hsieh was confronted by two investors who were

concerned with New Oriental's ownership and control of the stores, leading to the following

conversation in which Hsieh repeated his pre-Class Period denials that the Company engaged in

franchising (see ¶79, above).

Q: Do you franchise any of your stores?

Hsieh: No. No. Our biggest asset, the reason our moat is so large is cause of our brand name. We will protect that. [inaudible] We own everything.

Q: So the four hundred and thirty learning centers...

Hsieh: We own all of them.

Q: How many? I'm sorry.

Hsieh: It's six hundred and fifty.

Q: Learning centers and schools? It's a mix?

Hsieh: Yeah. Over six hundred. About six hundred and fifty. We own everything.

Q: A hundred percent fully-owned?

Hsieh: Yes.

Q: I see. And do you have any arrangements, in terms of, you know, capital, capex, or cost sharing, or profit sharing, or any type of cooperation?

Hsieh: No.

Q: With others?

Hsieh: Nope. All ours. We've grown completely organically. We owe nobody.

Q: Purely organic, a hundred percent owned by New Oriental?

Hsieh: Correct. Absolutely correct. That's how we control the quality.

44


126. A recording and transcript of this conversation was made public by Muddy

Waters at the end of the Class Period, on July 18, 2012. Only after Muddy Waters' reporting

was released did New Oriental disclose its franchising operation to investors.

VI. ADDITIONAL SCIENTER ALLEGATIONS

127. The Individual Defendants, as directors and/or the most senior officers of New

Oriental during the Class Period are liable as direct participants in all of the wrongs complained

of herein. Through their positions of control and authority, as well as their stock and ADS

ownership, the Individual Defendants were in a position to control all of the Company's false

and misleading statements and omissions, including the contents of the Forms 20-F and press

releases, as set forth above.

128. Furthermore, because of their positions within New Oriental, the Individual

Defendants possessed the power and authority to control the contents of New Oriental's reports

to the SEC, press releases, and presentations to securities analysts, money and portfolio

managers, and institutional investors, i.e., the market. The Individual Defendants were provided

with copies of the Company's reports and press releases alleged herein to be materially false and

misleading prior to, or shortly after, their issuance and had the ability and opportunity to prevent

their issuance or cause them to be corrected.

129. Defendants had a strong motive to misrepresent the consolidation of New Oriental

China because by doing so, they were able to access the U.S. capital markets and obtain more

than a hundred million dollars in funding, without actually relinquishing control or ownership of

New Oriental China's business and assets to the public shareholders. Because the agreements

that are supposed to provide New Oriental with control over New Oriental China are weak, of

uncertain legality, or have been allowed to lapse, Defendant Yu has the capability to run off and

leave the public shareholders with nothing more than a worthless holding company.

45


130. By misrepresenting the consolidation of New Oriental China, Defendant Yu has

also made it possible for him (or people under his control) to profit from selling interests in New

Oriental without selling any underlying interest in New Oriental China. For example, on May

21, 2012, shortly before the allegations regarding New Oriental's VIE structure became public,

Tigerstep Developments, Ltd., a Chinese company owned by Ms. Bamei Li, Defendant Yu's

mother, sold 1,600,000 New Oriental ADSs for approximately $41 million. However, because

Ms. Li continues to own a stake in the holding company that is 100% owner of New Oriental

China, she could theoretically sell that interest as well, thereby profiting twice from the sale of

the same assets. Tigerstep Developments, Ltd. also sold 110,000 New Oriental ADSs in April

2010 and 500,000 ADSs in June 2011, raising an additional $72.9 million in these two

transactions. Similarly, during the Class Period, Defendant Hsieh sold 130,000 New Oriental

ADS s for approximately $13.8 million.

131. Because of their positions and access to material non-public information, the

Individual Defendants knew and/or recklessly disregarded that the adverse facts specified herein

had not been disclosed to, and were being concealed from, the public, and that the positive

representations which were being made were then materially false and/or misleading.

132. On October 19, 2009, New Oriental filed its 2009 Form 20-F with the SEC. The

20-F was signed by Defendant Yu, and reaffirmed New Oriental's financial results. The 20-F

also contained the certifications required by Sarbanes-Oxley, signed by Yu and Hsieh, who

certified:

1. I have reviewed this annual report on Form 20-F of New Oriental Education & Technology Group Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the


circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash Rows of the company as of, and for, the periods present in this report;

4. The company's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13-a-1 5(f) and 15d-15(f)) for the company and have:

a) Designed such disclosure controls and procedures, or caused such disclosure and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

C) Evaluated the effectiveness of the company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the company's internal control over financial reporting that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting; and

5. The company's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over

47


financial reporting, to the company's auditors and the audit committee of the company's board of directors (or persons performing the equivalent function):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company's ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal control over financial reporting.

133. Each of the 2010 Form 20-F and 2011 Form 20-F contained substantially identical

Sarbanes-Oxley certifications signed by Yu and Hsieh.

VII. LOSS CAUSATION

134. Defendants' unlawful conduct alleged herein directly caused the losses incurred

by Lead Plaintiff and the Class. Throughout the Class Period, the price of New Oriental's ADSs

was artificially inflated as a direct result of Defendants' materially false and misleading

statements and omissions.

135. The true facts became known by investors and the market through New Oriental's

July 17, 2012 disclosure of the SEC's investigation, and the subsequent July 18, 2012

publication of the Muddy Waters report. As the true facts became known, the price of New

Oriental ADSs declined as the artificial inflation was removed from the market price of the

ADSs, causing substantial damage to Lead Plaintiff and the members of the Class.

136. The decline in the price of New Oriental ADSs and the resulting losses are

directly attributable to the disclosure of information and materialization of risks that were

previously misrepresented or concealed by the Defendants. Had Lead Plaintiff and other

members of the Class known of the material adverse information not disclosed by Defendants or


been aware of the truth behind their material misstatements, they would not have purchased New

Oriental ADSs at artificially inflated prices.

VIII. GROUP PLEADPG

137. It is appropriate to treat the Individual Defendants as a group for pleading

purposes and to presume that the false, misleading, and incomplete information conveyed in the

Company's public filings, press releases, and other publications as alleged herein are the

collective actions of the narrowly-defined group of the Individual Defendants. Each of the

Individual Defendants, by virtues of their high-level positions with the Company, directly

participated in the management of the Company, was directly involved in the day-to-day

operations of the Company at the highest levels and was privy to confidential proprietary

information concerning the Company and its businesses, operations, growth, financial

statements, and financial condition, as alleged herein. The Individual Defendants were involved

in drafting, producing, reviewing, and/or disseminating the false and misleading statements and

information alleged herein; were aware, or recklessly disregarded, that the materially false and

misleading statements were being issued regarding the Company; and approved or ratified these

statements in violation of the federal securities laws.

138. The Individual Defendants acted with scienter in that each knew that the public

documents and statements issued or disseminated in the name of the Company were materially

false and misleading; knew that such statements or documents would be issued or disseminated

to the investing public; and knowingly and substantially participated or acquiesced in the

issuance or dissemination of such statements or documents as primary violations of the federal

securities laws. As set forth elsewhere herein in detail, Individual Defendants, by virtue of their

receipt of information reflecting the true facts regarding New Oriental, their control over, and/or

receipt and/or modification of New Oriental's allegedly materially misleading misstatements


and/or their associations with the Company which made them privy to confidential proprietary

information concerning New Oriental, participated in the fraudulent scheme alleged herein.

IX. INAPPLICABILITY OF STATUTORY SAFE HARBOR

139. The federal statutory safe harbor provided for forward-looking statements under

certain circumstances does not apply to any of the allegedly false statements pleaded in this

Complaint. The specific statements pleaded herein were not "forward looking statements" when

made. To the extent there were any forward-looking statements, there was no meaningful

cautionary statement identifying important factors that could cause actual results to differ

materially from those in the purportedly forward-looking statements. Alternatively, to the extent

that the statutory safe harbor does apply to any forward-looking statements pleaded herein, New

Oriental and the Individual Defendants are liable for those false forward-looking statements

because at the time each of those forward-looking statements was made, the particular speaker

knew that the forward-looking statement was false, and/or the forward-looking statement was

authorized and/or approved by an executive officer of New Oriental who knew that those

statements were false when made. Moreover, to the extent that New Oriental and the Individual

Defendants issued any disclosures designed to "warn" or "caution" investors of certain "risks,"

those disclosures were also false and misleading because they did not disclose that New Oriental

and the Individual Defendants were actually engaging in the very actions about which they

purportedly warned and/or had actual knowledge of undisclosed material adverse facts that

rendered such "cautionary" disclosures false and misleading.

X. PRESUMPTION OF RELIANCE

140. At all relevant times, the market for New Oriental's publicly traded securities was

an efficient market for the following reasons, among others:

50


(a) New Oriental ADSs met the requirements for listing, and were listed and actively traded on the NYSE, a highly efficient and automated market;

(b) As a regulated issuer, New Oriental filed periodic public reports with the SEC;

(c) New Oriental regularly communicated with public investors via established market communication mechanisms, including through the regular disseminations of press releases on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press and other similar reporting services; and

(d) New Oriental was followed by numerous securities analysts employed by major brokerage firms throughout the Class Period who wrote reports that were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace.

141. As a result, the market for New Oriental's publicly-traded ADSs promptly

digested current information regarding New Oriental from all publicly-available sources and

reflected such information in New Oriental's ADS prices. Under these circumstances, all

purchasers of New Oriental's ADSs during the Class Period suffered similar injury through their

purchase of New Oriental's ADSs at artificially inflated prices, and a presumption of reliance

applies.

XL CLASS ALLEGATIONS APPLICABLE TO ALL CLAIMS

142. Lead Plaintiff brings this Action as a class action pursuant to Federal Rules of

Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all persons and entities who

purchased or otherwise acquired New Oriental ADSs on the NYSE between October 19, 2009

and July 17, 2012, inclusive, and who were damaged thereby. Excluded from the Class are

Defendants, the officers and directors of the Company, members of their immediate families and

their legal representatives, heirs, successors, or assigns and any entity in which Defendants have

or had a controlling interest.

51


143. The members of the Class are so numerous that joinder of all members is

impracticable. Throughout the Class Period, New Oriental's ADSs were actively traded on the

NYSE. While the exact number of Class members is unknown to Lead Plaintiff and can only be

ascertained through appropriate discovery, Lead Plaintiff believes that there are hundreds or

thousands of members in the proposed Class. Millions of New Oriental ADSs were traded

publicly during the Class Period on the NYSE and as of May 31, 2012, there were over 158

million shares of New Oriental ADSs issued and outstanding. Record owners and other

members of the Class may be identified from records maintained by New Oriental and/or its

transfer agent and may be notified of the pendency of this Action by mail, using the form of

notice similar to that customarily used in securities class actions.

144. Lead Plaintiffs claims are typical of the claims of the members of the Class as all

members of the Class are similarly affected by Defendants' wrongful conduct in violation of the

federal laws that is complained of herein.

145. Lead Plaintiff will fairly and adequately protect the interests of the members of

the Class and have retained counsel competent and experienced in class and securities litigation.

146. Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class. Among the

questions of law and fact common to the Class are:

(a) Whether the federal securities laws were violated by Defendants' acts as alleged herein;

(b) Whether statements made by New Oriental and the Individual Defendants to the investing public during the Class Period omitted and/or misrepresented material facts about the business, operations, and prospects of New Oriental; and

(c) To what extent the members of the Class have sustained damages and the proper measure of damages.

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147. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable. Furthermore, as

the damages suffered by individual Class members may be relatively small, the expense and

burden of individual litigation makes it impossible for members of the Class to individually

redress the wrongs done to them. There will be no difficulty in the management of this Action as

a class action.

148. The prosecution of separate actions by individual Class members would create the

risk of inconsistent or varying adjudications with respect to the individual Class members, which

would establish incompatible standards of conduct for Defendants, or adjudications with respect

to individual Class members that would, as a practical matter, be dispositive of the interests of

the other members not parties to the adjudications or substantially impair their ability to protect

their interests.

149. Defendants have acted on grounds generally applicable to the Class with respect

to the matters complained of herein, thereby making appropriate the relief sought herein with

respect to the Class as a whole.

XII. CAUSES OF ACTION

COUNT I

Violation of Section 10(b) of the Exchange Act and Rule 10b-5 Promulgated Thereunder Against New Oriental and the Individual Defendants

150. Lead Plaintiff repeats and realleges each and every allegation contained above as

if fully set forth herein. This Count is being brought pursuant to Section 10(b) of the Exchange

Act, 15 U.S.C. § 78j(b), and Rule lOb-S promulgated thereunder, 17 C.F.R. § 240.10b-5, on

behalf of Lead Plaintiff and all members of the Class against New Oriental and the Individual

Defendants.

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151. Throughout the Class Period, New Oriental and the Individual Defendants carried

out a plan, scheme, and course of conduct that: (i) deceived the investing public, including Lead

Plaintiff and other Class members, as alleged herein; and (ii) caused Lead Plaintiff and other

members of the Class to purchase New Oriental's ADSs at artificially inflated prices. In

furtherance of this unlawful scheme, plan, and course of conduct, New Oriental and each of the

Individual Defendants took the actions set forth herein.

152. New Oriental and the Individual Defendants: (i) employed devices, schemes, and

artifices to defraud; (ii) made untrue statements of material fact and/or omitted to state material

facts necessary to make the statements not misleading; and (iii) engaged in acts, practices, and a

course of business which operated as a fraud and deceit upon the purchasers of the Company's

ADSs in an effort to maintain artificially high market prices for New Oriental's ADSs in

violation of Section 10(b) of the Exchange Act and Rule lob-S.

153. New Oriental and the Individual Defendants, individually and in concert, directly

and indirectly, by the use, means, or instrumentalities of interstate commerce and/or of the

United States mail, engaged and participated in a continuous course of conduct to conceal

adverse material information about New Oriental's financial well-being and prospects, as

specified herein.

154. New Oriental and the Individual Defendants employed devices, schemes, and

artifices to defraud, while in possession of material adverse non-public information and engaged

in acts, practices, and a course of conduct as alleged herein in an effort to assure investors of

New Oriental's value and performance and continued substantial growth, which included the

making of, or the participation in the making of, untrue statements of material facts and/or

omitting to state material facts necessary in order to make the statements made about New

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Oriental and its business operations and future prospects in light of the circumstances under

which they were made, not misleading, as set forth more particularly herein, and engaged in

transactions, practices, and a course of business which operated as a fraud and deceit upon the

purchasers of the Company's securities during the Class Period.

155. Each of the Individual Defendant's primary liability, and controlling person

liability, arises from the following facts: (i) the Individual Defendants were high-level executives

and/or directors at the Company during the Class Period and members of the Company's

management team or had control thereof; (ii) each of these Defendants, by virtue of his

responsibilities and activities as a senior officer and/or director of the Company, was privy to and

participated in the creation, development, and reporting of the Company's internal budgets,

plans, projections, and/or reports; (iii) each of these Defendants enjoyed significant personal

contact and familiarity with the other Defendants and was advised of, and had access to, other

members of the Company's management team, internal reports, and other data and information

about the Company's finances, operations, and sales at all relevant times; and (iv) each of these

Defendants was aware of the Company's dissemination of information to the investing public

which they knew and/or recklessly disregarded was materially false and misleading.

156. The Individual Defendants had actual knowledge of the misrepresentations and/or

omissions of material facts set forth herein, or acted with reckless disregard for the truth in that

they failed to ascertain and to disclose such facts, even though such facts were available to them.

Such Defendants' material misrepresentations and/or omissions were issued knowingly or

recklessly and for the purpose and effect of concealing New Oriental's financial well-being and

prospects from the investing public and supporting the artificially inflated price of its securities.

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157. As a result of the dissemination of the materially false and/or misleading

information and/or failure to disclose material facts, as set forth above, the market price of New

Oriental's ADSs was artificially inflated throughout the Class Period. In ignorance of the fact

that market prices of the Company's ADSs were artificially inflated, and relying directly or

indirectly on the false and misleading statements made by New Oriental and the Individual

Defendants, or upon the integrity of the market in which the securities traded, and/or in the

absence of material adverse information that was known to or recklessly disregarded by New

Oriental and the Individual Defendants, Lead Plaintiff and the other members of the Class

acquired New Oriental's ADSs during the Class Period at artificially inflated prices and were

damaged thereby.

158. At the time of the misrepresentations and/or omissions, Lead Plaintiff and other

members of the Class were ignorant of their falsity, and believed them to be true. Had Lead

Plaintiff and the other members of the Class known the truth regarding New Oriental's financial

condition and business practices, Lead Plaintiff and other members of the Class would not have

purchased or otherwise acquired New Oriental ADSs, or, if they had acquired such ADSs during

the Class Period, they would not have done so at the artificially inflated prices that they paid.

159. By virtue of the foregoing, New Oriental and the Individual Defendants have

violated Section 10(b) of the Exchange Act and Rule lOb-S promulgated thereunder and are

liable to Lead Plaintiff and the members of the Class, each of whom has been damaged as a

result of such violations.

COUNT II

Violation of Section 20(a) of the Exchange Act Against the Individual Defendants

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160. Lead Plaintiff repeats and realleges each and every allegation contained above as

if fully set forth herein. This Count is brought pursuant to Section 20(a) of the Exchange Act, 15

U.S.C. § 78t(a), on behalf of Lead Plaintiff and all members of the Class against the Individual

Defendants,

161. By reason of their positions of control and authority as officers of New Oriental,

the Individual Defendants had the power and authority to cause New Oriental to engage in the

wrongful conduct complained of herein. The. Individual Defendants were able to and did control,

directly and indirectly, the content of the public statements made by New Oriental during the

Class Period, thereby causing the dissemination of the false and misleading statements and

omissions of material facts as alleged herein.

162. As set forth above, New Oriental violated Section 10(b) of the Exchange Act by

its acts and omissions as alleged in this Complaint. By virtue of their positions as controlling

persons of New Oriental and, as a result of their own aforementioned conduct, the Individual

Defendants are liable pursuant to Section 20(a) of the Exchange Act, jointly and severally with,

and to the same extent as New Oriental is liable under Section 10(b) of the Exchange Act and

Rule I Ob-5 promulgated thereunder, to Lead Plaintiff and other members of the Class who

purchased or otherwise acquired New Oriental ADSs during the Class Period. Moreover, as

detailed above, during the Class Period during which the Individual Defendants served as

officers of New Oriental, each of the Individual Defendants is responsible for the material

misstatements and omissions made by New Oriental.

163. As a direct and proximate result of the Individual Defendants' wrongful conduct,

Lead Plaintiff and other members of the Class suffered damages in connection with their

purchases of the Company's ADSs during the Class Period.

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PRAYER FOR RELIEF

WHEREFORE, Lead Plaintiff prays for relief and judgment, as follows:

(1) Determining that this action is a proper class action under Rules

23(a) and (b)(3) of the Federal Rules of Civil Procedure on behalf

of the Class defined herein;

(ii) Awarding compensatory damages in favor of Lead Plaintiff and

the other Class members against all Defendants, jointly and

severally, for all damages sustained as a result of Defendants'

wrongdoing, in an amount to be proven at trial, including interest

thereon;

(iii) Awarding Lead Plaintiff and the Class their reasonable costs and

expenses incurred in this action, including counsel fees and expert

fees; and

(iv) Such other relief as the Court may deem just and proper.

JURY TRIAL DEMANDED

Plaintiff hereby demands a trial by jury.


Dated: December 10, 2012

485 Lexington Avenue 29th Floor New York, NY 10017 (646) 722-8500 (646) 722-8501 (Fax)

JEFF A. ALMEIDA DAVID M. HAENDLER KYLE J. MCGEE 123 Justison Street Wilmington, DE 19801 (302) 622-7503 (3 02) 622-7100 (Fax)

Lead Counsel on Beha if ofLead Plaintiff and the Class

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CERTIFICATE OF SERVICE

I, Daniel L. Berger, hereby certify that on December 10, 2012, I caused a true and correct

copy of the Consolidated Class Action Complaint to be hand-filed with the Court, and copies of

the same were served via Electronic Mail to the parties listed below:

Scott D. Musoff, Esquire SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP

Four Times Square, 421w Floor New York, NY 10036 smusoff(2skadden. corn

(Counsel for Defendants)

Dated: December 10, 2012 Respectfully submitted,

GRAN1YEISENIIOF

By: Daniel L. Berger 485 Lexington Ave e, 29th u Floor New York, NY 10017 Telephone: (646) 722-8500 Fax: (646) 722-8501 E mail: dberger(gelaw.com

case 1:12-cv-05724-jgk document 23 filed 12/10/12 page 1...

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