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In re CannaVest Corp. Securities Litigation

United States District Court, S.D. New York

March 31, 2018




         This is 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.

         Defendants 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. 108)[1] 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))

         For the 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.

         As to 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.

         Finally, 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.

         Defendants' motions to dismiss will otherwise be denied.


         I. FACTS[2]

         A. Parties

         Defendant 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. ¶ 20)

         Defendant 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.)

         Defendant Bart P. Mackay is the majority owner of CannaVest. (Id. ¶ 14) He became a CannaVest director on March 14, 2013. (Id. ¶ 27)

         Defendant 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, 22)

         Defendants 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)

         B. CannaVest's Formation

         CannaVest's 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.)

         On 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)

         That 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)

         Medical 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. ¶¶ 33-41)

         In its 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), [3] as required by Generally Accepted Accounting Principles ("GAAP").[4]

         According 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).

         On 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)

         C. SEC Filings and Press Releases

         On May 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)

         On May 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)

         On June 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)

         On 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. ¶ 98)

         On 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)

         On 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)

         On 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)

         On 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)

         As to 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)

         With 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. ¶ 107)

         The Consolidated Complaint was filed on September 14, 2015. (Dkt. No. 61)



         A. Rule 12(b)(6) Standard

         "To 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)).

         A 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 678.

         "In 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)).

         B. Heightened Pleading Standard for Securities Fraud Complaints

         "A 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)).

         Second, 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 324.

         C. Exchange Act Claims

         Plaintiffs 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 (c)."))[5]

         To 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)).

         To 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)).

         Here, "[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. 462, 477(1977)).


         A. Misstatement or Omission of a Material Fact

         1. Alleged misstatements or omissions

         Misstatements 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).

         Here, 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)

         The 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). ...

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