307 F. Supp. 3d 222
S.D. Ill.2018Background
- CannaVest, an OTC-traded company, acquired PhytoSphere in a transaction announced as $35 million payable in installments of cash or CannaVest stock; later restatements reduced the transaction fair value to about $8.02 million and disclosed large overstatements of intangible assets and revenues for 2013 quarters.
- Plaintiffs filed a §10(b)/Rule 10b-5 and §20(a) class action for purchases of CannaVest stock from May 20, 2013 to April 14, 2014, alleging misstatements/omissions about the PhytoSphere valuation, related-party revenues (100% from affiliates of Medical Marijuana, Inc.), and GAAP noncompliance.
- Relevant defendants: CannaVest; CEO/officer Michael Mona, Jr.; majority owner/director Bart P. Mackay; directors Theodore Sobieski and Edward Wilson (CPA); and Stuart Titus (CEO of Medical Marijuana, Inc., investor/consultant to CannaVest).
- A confidential witness (CW-1), a financial consultant at CannaVest May 2013–spring 2014, alleged immediate recognition of incorrect goodwill accounting and reported discussions with Mona and the board about restatement needs; prior auditor flagged material weaknesses and deficient internal controls.
- After corrective disclosures (April 3 and April 14, 2014), CannaVest stock dropped ~20% and ~19.5% respectively; Plaintiffs amended SEC filings and restated quarterly results.
- On motions to dismiss, the court sustained §10(b)/Rule 10b-5 claims as to CannaVest, Mona, and Wilson but dismissed them as to Mackay, Sobieski, and Titus under group-pleading/statement-maker and scienter analyses; market-manipulation claims were dismissed against all; §20(a) control claims were dismissed as to Sobieski and Titus but survived as to Mona, Mackay, and Wilson.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Material misstatements/omissions re: PhytoSphere valuation, revenues, related-party disclosures | CannaVest misstated goodwill and revenues and failed to disclose that revenues were from related parties, violating GAAP and misleading investors | Disclosures (e.g., Q3 goodwill impairment) and volatility undercut materiality; some statements were not "made" by individual Ds | Court: Plausible material misstatements/omissions alleged; CannaVest, Mona, and Wilson may be liable; Mackay, Sobieski, Titus not makers under group-pleading/Janus |
| Scienter for §10(b) claims | Allegations of motive (attempted suspicious stock sale), CW-1's firsthand statements, auditing warnings, and weak internal controls show recklessness/knowledge | Defendants argue lack of cogent strong inference and that allegations are insufficient or common to insiders | Court: Strong inference of scienter for Mona and Wilson (motive, CW-1, CPA role, internal-control problems); scienter imputed to CannaVest; insufficient as to Mackay, Sobieski, Titus |
| Market-manipulation (Rule 10b-5(a),(c)) | PhytoSphere deal and issuance of CannaVest stock were part of a scheme to inflate stock value | Transaction/value allegations are misstatements/omissions, not manipulative market activity (no wash sales, matched orders, rigged prices) | Court: Dismissed market-manipulation claim for all defendants—plaintiffs alleged misrepresentations but not required market activity |
| Control-person liability (§20(a)) | Titus, Mackay, Mona, Wilson, Sobieski controlled CannaVest and are culpable participants | Some lacked actual control or culpable participation; mere ownership/consulting insufficient | Court: §20(a) survives as to Mona, Mackay, Wilson (alleged control and culpable participation); dismissed as to Sobieski and Titus (no culpable participation shown for Titus; Sobieski too thin) |
Key Cases Cited
- Ashcroft v. Iqbal, 556 U.S. 662 (pleading standard; plausibility)
- Bell Atl. Corp. v. Twombly, 550 U.S. 544 (pleading standard; plausibility)
- Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (maker of a statement has ultimate authority over content and communication)
- Basic Inc. v. Levinson, 485 U.S. 224 (materiality: omitted facts that would have altered the total mix)
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (PSLRA: strong-inference standard for scienter)
- Dura Pharm., Inc. v. Broudo, 544 U.S. 336 (loss causation requirement)
- Ganino v. Citizens Utils. Co., 228 F.3d 154 (materiality and corrective disclosure analysis)
- Novak v. Kasaks, 216 F.3d 300 (motive-opportunity and circumstantial scienter tests)
- Santa Fe Indus., Inc. v. Green, 430 U.S. 462 (market-manipulation requires market activity; limits on §10(b) for internal mismanagement)
- ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (market-manipulation elements and need for market activity)
- Lentell v. Merrill Lynch & Co., 396 F.3d 161 (Rule 10b-5(a),(c) claims cannot rest solely on misrepresentations/omissions)
- Acticon AG v. China N. E. Petroleum Holdings Ltd., 692 F.3d 34 (loss causation: market rebound not dispositive at pleading stage)