In re Cannavest Corp. Sec. Litig.

307 F.Supp.3d 222

IN RE: CANNAVEST CORP. SECURITIES LITIGATION

14 Civ. 2900 (PGG)

United States District Court, S.D. New York.

Signed March 31, 2018

MEMORANDUM OPINION & ORDER

PAUL G. GARDEPHE, United States District Judge:

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.

BACKGROUND

I. FACTS²

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...