United States District Court, S.D. New York
IN RE CANNAVEST CORP. SECURITIES LITIGATION
MEMORANDUM OPINION & ORDER
G. GARDEPHE, UNITED STATES DISTRICT JUDGE.
a federal securities law class action brought on behalf of
investors who purchased the common stock of CannaVest between
May 20, 2013 and April 14, 2014 (the "Class
Period"). The Consolidated Complaint alleges violations
of Section 10(b) and 20(a) of the Securities Exchange Act of
1934 (the "Exchange Act") and Rule 10b-5.
CannaVest, Michael Mona, Jr., Bart P. Mackay, Theodore R.
Sobieski, and Edward A, Wilson (the "CannaVest
Defendants") have moved to dismiss pursuant to
Fed.R.Civ.P. 12(b)(6). (Dkt. No. 81) Defendant Stuart Titus
has likewise moved to dismiss under Rule 12(b)(6). (Dkt. No.
The CannaVest Defendants argue that Plaintiffs have not pled
facts establishing (1) loss causation; (2) a strong inference
of scienter; or (3) a claim for control person liability
against the individual Defendants. (Def. Br. (Dkt. No. 81))
Titus contends that he cannot be held responsible for any
misstatements made by CannaVest, and that Plaintiffs have not
pled facts sufficient to establish (1) scienter; (2) a market
manipulation claim; or (3) a control person liability claim.
(Titus Br. (Dkt. No. 109))
reasons stated below, the Court concludes that Plaintiffs
have adequately alleged material misstatements and omissions.
The misstatements and omissions claim against Mackay,
Sobieski, and Titus will be dismissed, however, because
Plaintiffs have not alleged -under the "group pleading
doctrine" - that these Defendants were actively involved
in the day-to-day management of CannaVest.
Plaintiffs' market manipulation claim, the Court
concludes that Plaintiffs have not alleged market activity.
Accordingly, Plaintiffs market manipulation claim will be
dismissed as to all Defendants.
as to control person liability, Plaintiffs have not pled
facts demonstrating that Sobieski controlled CannaVest, and
have likewise not pled facts demonstrating that Titus was a
"culpable participant." Accordingly,
Plaintiffs' Section 20(a) claim against Sobieski and
Titus will be dismissed.
motions to dismiss will otherwise be denied.
CannaVest is a publicly traded Delaware corporation whose
shares are listed on the over-the-counter ("OTC")
Bulletin Board under the symbol "CANV." (Consol.
Cmplt. (Dkt. No. 61) ¶ 12) CannaVest's primary
business is the development, marketing, and sale of consumer
products containing industrial hemp-based compounds,
including the hemp plant extract cannabidiol. (Id.
Michael Mona, Jr. became president, treasurer, and secretary
of CannaVest on November 26, 2012. (Id. ¶ 13.)
On January 28, 2013, Mona became the sole Board member of
CannaVest, and remained so until March 15, 2013, when three
additional directors were appointed to CannaVest's board.
(Id.) On July 25, 2013, he resigned as treasurer and
secretary and was appointed chief executive officer.
(Id.) Prior to joining CannaVest, Mona was a
consultant to Medical Marijuana, Inc., and during the Class
Period he retained a 4% stake in that company. (Id.)
Bart P. Mackay is the majority owner of CannaVest.
(Id. ¶ 14) He became a CannaVest director on
March 14, 2013. (Id. ¶ 27)
Stuart Titus is the chief executive officer of Medical
Marijuana, Inc. (Id. ¶ 17) Prior to the Class
Period, Titus owned a 7.1% stake in CannaVest. Between
January and March 2014, Titus sold CannaVest stock he had
bought for a nickel at prices ranging from $40.76 to $166, 17
a share, for a total of $7 million. Titus served as a
consultant and advisor to CannaVest, and he provided the
financing for a group of purchasers to buy 99.7% of
CannaVest's stock in November 2012, including the
interest acquired by Mackay. (Id. ¶¶ 17,
Edward A. Wilson and Theodore R. Sobieski became CannaVest
directors on March 14, 2013. (Id. ¶ 27) Wilson
is the president of Wilson & Company, a Las Vegas
accounting firm, (Id. ¶ 84)
corporate predecessor - Foreclosure Solutions, Inc. - was
incorporated on December 9, 2010 in Texas. (Id.
¶ 21) Foreclosure Solutions was in the business of
"provid[ing] information on pre-foreclosure and
forecasted residential properties to homebuyers and real
estate professionals on its website." (Id.) The
company was not able to secure financing for its business
plan, however. (Id.)
November 16, 2012, entities controlled by Mackay (Mai Dun
Limited, LLC and Mercia Holdings, LLC) and Titus (General
Hemp, LLC and Banburgh Holdings, LLC) acquired 6, 979, 000
shares of Foreclosure Solutions - 99.7% of its outstanding
stock - for $375, 000. (Id. ¶ 22) Titus loaned
the purchase price to the buying entities pursuant to the
terms of individual promissory notes. (Id. ¶
22) On January 29, 2013, the company changed its name to
CannaVest. (Id. ¶ 23)
same day, CannaVest purchased the assets of PhytoSphere
Systems, LLC, a subsidiary of Medical Marijuana, Inc. These
assets were purchased for $35 million in cash or CannaVest
stock at CannaVest's sole discretion. (Id.
¶ 3) CannaVest announced the acquisition in a February
12, 2013 press release:
On December 31, 2012, we entered into an Agreement for
Purchase and Sale of Assets (the "Purchase
Agreement") with PhytoSPHERE Systems, LLC, a Delaware
limited liability company ("PhytoSPHERE"), whereby
the Company acquired certain assets of PhytoSPHERE in
exchange for an aggregate payment of $35, 000, 000, payable
in five (5) installments of either cash or common stock of
the Company, in the sole discretion of the Company.. . .
The Purchase Agreement requires payment as follows: (a) $4,
500, 000 on or before January 31, 2013; (b) $6, 000, 000 on
or before March 30, 2013; (c) $8, 000, 000 on or before June
30, 2013; (d) $10, 000, 000 on or before September 30, 2013;
and $6, 500, 000 on or before December 31, 2013. For any
installments paid by the issuance of stock, the number of
shares of stock issuable by the Company is determined by
reference [to] the closing price of our common stock on the
day prior to issuance. The price is subject to a
"collar, " whereby in no event will the shares
issuable pursuant to the Purchase Agreement be priced at more
than $6.00 per share, and in no event will the shares be
priced at less than $4.50 per share.
(Id. ¶ 25)
Marijuana, Inc. announced the sale of PhytoSphere on March 1,
2013. (Id. ¶ 31) Medical Marijuana had acquired
an interest in PhytoSphere in April 2012 for $2.5 million.
(Id. ¶ 26) Throughout the Class Period, both
CannaVest and Medical Marijuana, Inc. issued a number of
press releases regarding PhytoSphere. (Id.
2013 Form 10-K, CannaVest reported that it had
"accounted for the acquisition of the assets of
PhytoSphere Systems, LLC in accordance with the Accounting
Standards Codification ("ASC") Topic 805, Business
Combinations ("ASC Topic 805")" (Id.
¶ 56),  as required by Generally Accepted
Accounting Principles ("GAAP").
to Plaintiffs, CannaVest "utilized the acquisition
(purchase) method [of accounting] prescribed under certain
provisions of ASC [Topic] 805." (Id. ¶ 57)
Under this approach, "the assets acquired and
liabilities assumed are initially recorded at their
respective fair market values. The excess of the purchase
price over the fair value of the net assets acquired is
recognized and reported as an asset called goodwill."
(Id.) This accounting treatment requires the
following steps: "[i]dentifying the acquirer";
"[d]etermining the acquisition date";
"[r]ecognizing and measuring the identifiable assets
acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree"; and "[r]ecognizing and
measuring goodwill or a gain from a bargain purchase."
(Id. ¶ 59) (emphasis omitted).
March 14, 2013, CannaVest's Board added three new
directors: Mackay, Sobieski, and Wilson. With these
additions, the Company's Board now had four directors.
(Id. ¶ 27) As of April 12, 2013, CannaVest had
five employees. (Id. ¶ 28)
SEC Filings and Press Releases
14, 2013, CannaVest announced that it had terminated its
relationship with its independent auditor - Turner Stone
& Company - and retained Anton Chia, LLP as its new
auditor. (Id. ¶ 79)
20, 2013, CannaVest filed its Form 10-Q for the first quarter
of 2013. (Id. ¶ 88) The Company reported
intangible assets of $33, 656, 833 and revenues of $1, 275,
000. (Id. ¶ 89)
20, 2013, CannaVest issued a press release concerning its
first quarter 2013 results. The press release states:
"The company's financial performance over the first
quarter of 2013 was driven by the sale of raw hemp product to
third parties... . [W]e are buying and selling to third
parties substantial inventories of raw hemp product, which
generated our income of $337, 941 in the first quarter of
2013, " (Id. ¶ 92)
August 13, 2013, CannaVest filed its Form 10-Q for the second
quarter of 2013. (Id. ¶ 96) The Company
reported $26, 998, 125 in goodwill and $4, 995, 895 in net
intangible assets. (Id. ¶ 97) This Form 10-Q
contained no related party disclosures. (Id. ¶
November 14, 2013, CannaVest filed its Form 10-Q for the
third quarter of 2013. (Id. ¶ 102) The Company
reported $4, 466, 666 in intangible assets and an impairment
to goodwill of $26, 998, 125. (Id. ¶ 103) This
impairment brought CannaVest's goodwill to a net carrying
value of $0. (Id. ¶ 106)
April 3, 2014, CannaVest filed a Form 8-K stating that it had
misreported its financial condition in its Form 10-Qs for the
first, second, and third quarters of 2013, and that it
intended to issue corrective disclosures for those quarters.
(Id. ¶ 116) In trading that day, shares of
CannaVest stock fell $7.30 per share, or more than 20%, to
close at $25.30 per share. (Id. ¶ 117)
April 14, 2014, CannaVest filed an Amended Form 8-K in which
it disclosed, inter alia, that it had overstated the
value of goodwill associated with the PhytoSphere
transaction, and that it had overvalued its revenues for the
first quarter of 2013 by $192, 625, or approximately 15%.
(Id. ¶ 119) CannaVest's stock fell $4.49
per share that day, or 19.5%, to close at $18.51 per share.
(Id. ¶ 120)
April 24, 2014, CannaVest filed re-stated financial
statements for the first, second, and third quarters of 2013.
As to the first quarter of 2013, CannaVest reported that it
had overstated its intangible assets in connection with the
PhytoSphere transaction by $28, 079, 488, and overstated its
revenue by $192, 625. (Id. ¶ 94) The
restatement also notes that
[t]he amount previously reported as due to PhytoSPHERE
pursuant to the Agreement as of March 31, 2013 was reported
as $30, 500, 000. This was calculated based on a Transaction
amount of $35, 000, 000 and a set per share price between
$4.50 and $6.00 under the Agreement. In reviewing the price
that the Company's common stock was trading at during the
year, subsequent to March 31, 2013, management determined
that using a per share price to value the Transaction may not
represent a true measure of the fair market value of the
Transaction and that obtaining a valuation of the assets
purchased from PhytoSPHERE would be required in order to
determine the fair market value of the business acquired.
Accordingly, management determined that the valuation of $8,
020, 000 represented a more reliable measure of the fair
value of the Transaction.
(Id.) The restatement also discloses that "100%
of the Company's revenue of $1, 082, 375 for [the first
quarter of 2013]. . . [was] from affiliates of Medical
Marijuana, Inc., a stockholder of the Company."
(Id. ¶ 95)
the second quarter of 2013, the restatement discloses that
(1) CannaVest had overstated its intangible assets in
connection with the PhytoSphere transaction by $1, 837, 387,
and (2) that 100% of the Company's $107, 683 in revenue
in the second quarter was from affiliates of Medical
Marijuana, Inc. (Id. ¶¶ 100-01)
respect to the third quarter of 2013, the restatement
discloses that CannaVest overstated the intangible assets it
acquired in connection with the PhytoSphere transaction by
$904, 666, and that Cannavest understated goodwill in
connection with this transaction by $1, 855, 512.
(Id. ¶ 106) The Company also disclosed that
100% of its $163, 662 in revenue in the third quarter was
from affiliates of Medical Marijuana, Inc. (Id.
Consolidated Complaint was filed on September 14, 2015. (Dkt.
Rule 12(b)(6) Standard
survive a motion to dismiss, a complaint must contain
sufficient factual matter, accepted as true, to 'state a
claim to relief that is plausible on its face, '"
Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)
(quoting Bell Atl. Corp. v. Twombly, 550
U.S. 544, 570 (2007)). "In considering a motion to
dismiss ... the court is to accept as true all facts alleged
in the complaint, " Kassner, 496 F.3d at 237
(citing Dougherty v. Town of N. Hempstead Bd. of Zoning
Appeals, 282 F.3d 83, 87 (2d Cir. 2002)), and must
"draw all reasonable inferences in favor of the
plaintiff." Id. (citing Fernandez v.
Chertoff, 471 F.3d 45, 51 (2d Cir. 2006)).
complaint is inadequately pleaded "if it tenders
'naked assertion[s]' devoid of 'further factual
enhancement, '" Iqbal, 556 U.S. at 678
(quoting Twombly, 550 U.S. at 557), and does not
provide factual allegations sufficient "to give the
defendant fair notice of what the claim is and the grounds
upon which it rests." Port Dock & Stone Corp. v.
Oldcastle Ne. Inc., 507 F.3d 117, 121 (2d Cir. 2007)
(citing Twombly, 550 U.S. at 555). "Threadbare
recitals of the elements of a cause of action, supported by
mere conclusory statements, do not suffice [to establish
entitlement to relief]." Iqbal, 556 U.S. at
considering a motion to dismiss for failure to state a claim
pursuant to Rule 12(b)(6), a district court may consider the
facts alleged in the complaint, documents attached to the
complaint as exhibits, and documents incorporated by
reference in the complaint, " DiFolco v. MSNBC Cable
L.L.C., 622 F.3d 104, 111 (2d Cir. 2010) (citing
Chambers v. Time Warner, Inc., 282 F.3d
147, 153 (2d Cir. 2002); Hayden v. Cty. of Nassau,
180 F.3d 42, 54 (2d Cir. 1999)).
Heightened Pleading Standard for Securities Fraud
complaint alleging securities fraud pursuant to Section 10(b)
of the Securities Exchange Act is subject to two heightened
pleading standards." In re Gen, Elec. Co. Sec.
Litig., 857 F.Supp.2d 367, 383 (S.D.N.Y. 2012). First,
the complaint must satisfy Federal Rule of Civil Procedure
9(b), which requires that the complaint "state with
particularity the circumstances constituting fraud."
Fed.R.Civ.P. 9(b). This requirement "serves to provide a
defendant with fair notice of a plaintiff s claim, safeguard
his reputation from improvident charges of wrongdoing, and
protect him against strike suits." ATSI
Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99
(2d Cir. 2007) (citing Rombach v. Chang, 355 F.3d
164, 171 (2d Cir. 2004)). Accordingly, a securities fraud
complaint based on misstatements must "(1) specify the
statements that the plaintiff contends were fraudulent, (2)
identify the speaker, (3) state where and when the statements
were made, and (4) explain why the statements were
fraudulent." Rombach, 355 F.3d at 170 (quoting
Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175
(2d Cir. 1993)).
the complaint must meet the pleading requirements of the
Private Securities Litigation Reform Act (the
"PSLRA"), 15 U.S.C. § 78u-4(b). The PSLRA
requires a plaintiff to "state with particularity facts
giving rise to a strong inference that the defendant acted
with the required state of mind." Id. §
78u-4(b)(2)(A); see Tellabs, Inc. v. Makor Issues &
Rights, Ltd., 551 U.S. 308, 313 (2007) ("The PSLRA
requires plaintiffs to state with particularity both the
facts constituting the alleged violation, and the facts
evidencing scienter, i.e., the defendant's intention
'to deceive, manipulate, or defraud.'" (quoting
Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194
& n.12 (1976))). "To qualify as 'strong'
within the intendment of [the PSLRA][, ] ... an inference of
scienter must be more than merely plausible or reasonable -
it must be cogent and at least as compelling as any opposing
inference of nonfraudulent intent." Tellabs,
551 U.S. at 314; see also Id. ("[T]o determine
whether a complaint's scienter allegations can survive
threshold inspection for sufficiency, a court governed by
[the PSLRA] must engage in a comparative evaluation; it must
consider, not only inferences urged by the plaintiff... but
also competing inferences rationally drawn from the facts
alleged."). "A complaint will survive . .. only if
a reasonable person would deem the inference of scienter
cogent and at least as compelling as any opposing inference
one could draw from the facts alleged." Id. at
Exchange Act Claims
bring claims under Section 10(b) of the Exchange Act, 15
U.S.C. § 78j(b) and Rule 10b-5, and Section 20(a), 15
U.S.C. § 78t(a). The Consolidated Complaint alleges both
false and misleading statements, and deceptive and
manipulative conduct. (See Consol. Cmplt. ¶¶
134-44; see also Pltf. Opp, (Dkt. No. 79) at 15
("Plaintiff alleges both false and misleading statements
in violation of Rule 10b-5(b) and deceptive and manipulative
conduct in violation of Rules 10b[-]5(a) and
state a material misstatement or omission claim under Section
10(b) and Rule 10b-5, a plaintiff must "allege that the
defendant (1) made misstatements or omissions of material
fact, (2) with scienter, (3) in connection with the purchase
or sale of securities, (4) upon which the plaintiff relied,
and (5) that the plaintiffs reliance was the proximate cause
of its injury." ATSI Commc'ns. Inc. v. Sharr
Fund. Ltd., 493 F.3d 87, 105 (2d Cir. 2007) (citing
Lentell v. Merrill Lynch & Co., 396 F.3d 161,
172 (2d Cir. 2005)).
state a claim for market manipulation, Plaintiff must allege
"(1) manipulative acts; (2) damage (3) caused by
reliance on an assumption of an efficient market free of
manipulation; (4) scienter; (5) in connection with the
purchase or sale of securities; (6) furthered by the
defendant's use of the mails or any facility of a
national securities exchange." Id. at 101
(citing Schnell v. Conseco, Inc., 43 F.Supp.2d 438,
448 (S.D.N.Y. 1999); Cowen & Co. v. Merriam, 745
F.Supp. 925, 929 (S.D.N.Y. 1990)).
"[t]hese two claims are interrelated [, ] . .. because
Plaintiffs market manipulation claim involve[s] a failure
to disclose, " In re Merrill Lynch Auction Rate Sec.
Litig., 851 F, Supp. 2d 512, 524 (S.D.N.Y. 2012),
aff'd sub nom. Louisiana Pac. Corp. v. Merrill Lynch
& Co., 571 Fed.App'x 8 (2d Cir. 2014),
"[a]nd 'nondisclosure is usually essential to the
success of a manipulative scheme, '" Id.
(quoting Santa Fe Indus., Inc. v. Green, 430 U.S.
MISSTATEMENTS OR OMISSIONS CLAIM
Misstatement or Omission of a Material Fact
Alleged misstatements or omissions
or omissions are material if there is a "substantial
likelihood that the disclosure of the omitted fact would have
been viewed by the reasonable investor as having
significantly altered the 'total mix' of information
made available.'" Basic Inc. v. Levinson,
485 U.S. 224, 231-32 (1988) (quoting TSC Indus.. Inc. v.
Northway, Inc., 426 U.S. 438, 448 (1976)). "At the
pleading stage, a plaintiff satisfies the material
requirement of Rule 10b-5 by alleging a statement or omission
that a reasonable investor would have considered significant
in making investment decisions." Ganino v. Citizens
Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000) (citing
Basic, 485 U.S. at 231). "[A] complaint may not
properly be dismissed pursuant to Rule 12(b)(6)... on the
ground that the alleged misstatements or omissions are not
material unless they are so obviously unimportant to a
reasonable investor that reasonable minds could not differ on
the question of their importance." Goldman v.
Belden, 754 F.2d 1059, 1067 (2d Cir. 1985).
Plaintiffs allege that Defendants engaged in a scheme to
mislead the investing public concerning the value of
CannaVest's common stock and to profit thereby. (Consol.
Cmplt. (Dkt. No. 61) ¶ 2) Defendants' fraudulent
scheme was assisted by Medical Marijuana, Inc. and its
"subsidiaries, affiliates, officers and directors and
others, all of whom profited or stood to profit from the
scheme." (Id.) Plaintiffs further allege that
the acquisition of PhytoSphere was part of the fraudulent
scheme. (Id. ¶ 3) In furtherance of the
fraudulent scheme, Defendants issued materially false or
misleading statements regarding the value of the PhytoSphere
transaction and CannaVest's financials. (Id.
¶ 4) More specifically, Defendants (1)
"misrepresented and materially overstated the value of
the PhytoSphere transaction and the amount of its intangible
assets and goodwill acquired thereby"; (2) overstated
the amount of CannaVest's revenues for the first quarter
of 2013; (3) misrepresented the source of CannaVest's
revenues for the first, second, and third quarters of 2013 by
"failing to disclose that 100% of CannaVest's
revenues during the first three quarters of 2013 were
generated from sales to [Medical Marijuana, Inc., ] a related
party"; (4) failed to disclose that co-defendant Michael
Llamas, who was under indictment for fraud, was participating
behind the scenes in the management of the Company; and (5)
misrepresented that CannaVest's financials complied with
GAAP. (Id. ¶ 4)
Court concludes that Plaintiffs have adequately alleged
misstatements of material facts with respect to the
PhytoSphere transaction. Plaintiffs have alleged that
CannaVest overstated the value of the PhytoSphere assets by
approximately $27 million (the difference between the $35
million purchase price and the fair market value of the
transaction as later disclosed). ...