Takata v. Riot Blockchain, Inc.

CREIGHTON TAKATA, individuallyand on behalf of all others similarly situated, Plaintiff, v. RIOT BLOCKCHAIN, INC. F/K/A BIOPTIX, INC.,JOHN O'ROURKE, JEFFREY G. MCGONEGAL, BARRY HONIG,CATHERINE DEFRANCESCO,MICHAEL BEEGHLEY, JOHN STETSON,MARK GROUSSMAN, ANDREW KAPLAN,MIKE DAI, JASON LES, and ERIC SO, Defendants.

Civ. Action No. 18-02293 (FLW)

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY

April 30, 2020

*NOT FOR PUBLICATION*

OPINION

WOLFSON, Chief Judge:

This is a putative class action brought by shareholders against defendants Riot Blockchain, Inc. ("Riot") and certain of Riot's officers, directors and individual investors (collectively with Riot, "Defendants"). The lead plaintiff, Dr. Stanley Golovac ("Plaintiff"), alleges that he, and other shareholders, purchased Riot's stock between April 20, 2017, and September 6, 2018 (the "Class Period"), and asserts that Defendants violated Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated under that statute, 17 C.F.R. § 240.10b-5. Plaintiff also asserts that several individual Defendants are vicariously liable under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). The thrust of Plaintiff's complaint (the "Complaint") is that Defendants, acting as members of a group, participated in a "pump-and-dump" scheme to (1) amass a controlling interest in Riot; (2) conceal their control; (3) inflate the price and trading volume of Riot's stock through manipulative trading, promotional activity, and false and misleading disclosures; (4) engage in undisclosed related-party transactions with Riot; and (5) dump their shares on unsuspecting retail investors. (See Corrected Consolidated Amended Complaint ("CCAC") ¶ 1, ECF No. 73.)

Presently before the Court are seven separate motions brought by Defendants to dismiss the Complaint pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure.¹ For the reasons set forth below, Defendants' motions to dismiss are GRANTED, and the Complaint is dismissed, without prejudice.² Plaintiff's generalized request for leave to amend is denied at this time; however, Plaintiff may file a separate motion seeking leave to amend his complaint in a manner consistent with this Opinion.

I. BACKGROUND

The following facts are drawn from the allegations in the Complaint and are accepted as true for the purposes of the present motion.³

A. Defendants, the Honig Group, and Their Modus Operandi

Riot is a publicly traded corporation on NASDAQ that supports and operates blockchain technologies. (CCAC ¶ 21.) Plaintiff has sued certain of Riot's officers and directors. Defendant Michael Beeghley was Chairman of Riot from January 2017 until November 2017; CEO of Riot from April 2017 until November 2017; and served on the Board of Directors of Riot from November 2016 until November 2017. (CCAC ¶ 25.) Defendant John O'Rourke was Chairman and CEO of Riot from November 3, 2017 until September 8, 2018. (CCAC ¶ 23.) Defendant Jeffrey McGonegal was CFO of Riot from 2003 until April 30, 2018; and subsequently served as a consultant to Riot for four months. (CCAC ¶ 30.) Defendants Andrew Kaplan, Eric So, Jason Les, and Mike Dai, are former or current members of the Board of Directors of Riot. (CCAC ¶¶ 28-29, 31-32.)

The Complaint also names as defendants several individual investors in Riot who did not serve as officers or directors. In 2016, defendant Barry Honig first acquired a position in Riot when it was a biomedical company operating under a different name. (CCAC ¶¶ 22, 47, 130.) The Complaint alleges that, as Riot transitioned from a biomedical company to a provider of blockchain technologies, Honig led a group of investors, including defendants Catherine DeFrancesco, Mark Groussman, John Stetson, and others, into acquiring stakes in Riot. (CCAC¶¶ 24, 26, 27, 57-58, 62, 71, 79, 128-153.) The Complaint alleges that these individuals—which the Complaint refers to as the "Honig Group" (CCAC ¶ 79)—then, via "manipulative trading, promotional activity, and false and misleading disclosures," inflated the price of Riot's shares. (CCAC ¶ 1.) Finally, the Complaint alleges that the Honig Group sold their holdings as the market became aware of Defendants' scheme and as Riot's stock price began to fall in early 2018. (CCAC ¶¶ 163-64, 307-309, 329.)

Plaintiff alleges that Defendants' scheme closely mirrors the same modus operandi that the Securities and Exchange Commission ("SEC") has alleged, in a pending civil action in the Southern District of New York, that members of the Honig Group perpetrated at multiple other public companies.⁴ (CCAC ¶¶ 80-153, 201-203.) Relying heavily on the allegations in the SEC's complaint, Plaintiff sets forth the prior involvement of defendants Honig, O'Rourke, Groussman, Stetson, and other members of the Honig Group in at least seven additional companies: Biozone, MGT, MabVax, PolarityTE, Pershing Gold, MUNDOmedia, and Marathon. (CCAC ¶¶ 81-102, 105-115, 119-127.) According to the Complaint in this action, in each instance, members of the Honig Group engaged in similar schemes to "pump-and-dump" the stock of those companies. (CCAC ¶ 80.) As of the time of the filing of the Complaint, several of the individuals charged by the SEC had settled those charges. (CCAC ¶¶ 14, 370-72, 394.)⁵

B. The Honig Group's Acquisition of Control of Riot

Plaintiff alleges that Riot began in the early 2000s as a biomedical company, attempting to develop a blood test for use in the diagnosis and treatment of acute appendicitis. (CCAC ¶ 128.) According to the Complaint, it never achieved success in that field and, in 2015, the FDA declared that Riot's blood test did not meet or exceed the current standard of care, leaving it with no viable product. (CCAC ¶ 129.) As Riot searched for a new business model, in September 2016, defendants Honig and DeFrancesco allegedly wrote a letter to Riot's then-CEO, Stephen Lundy, "touting their combined 16.2%" stake and expressing their dissatisfaction with Riot's direction. (CCAC ¶¶ 132, 134.) The Complaint also alleges that Honig spoke several times with members of Riot's then-existing Board of Directors. (CCAC ¶ 132.) During those phone conversations, Honig allegedly implied that he had control of 40% of Riot's shares through his stock ownership and the stock ownership of Honig's friends and relatives. (Id.)

According to the Complaint, in late 2016, Honig initiated a proxy fight, and filed a lawsuit to force a shareholder meeting. (CCAC ¶¶ 135, 137.) Three of Riot's directors resigned in early 2017 (CCAC ¶ 138), and were replaced by defendants Beeghley, O'Rourke and Dai. (CCAC ¶¶ 29, 137, 139.) In April of 2017, Lundy resigned as CEO and was replaced by Beeghley. (CCAC ¶¶ 25, 142.) The Complaint alleges that, by exercising warrants and converting notes, Honig and his associates soon obtained a controlling stake of Riot's outstanding shares. (CCAC ¶¶ 214 fn. 23, 224 fn. 25, 229 fn. 26, 234 fn. 27, 139-41, 144-153.)

C. Riot's Pivot to Blockchain and Cryptocurrency Technologies

While Riot had neither a product nor revenue following Honig's proxy fight, the Complaint alleges that it had "plenty of cash" from a $20 million stock offering in 2014. (CCAC ¶¶ 4-5, 129-30.) With no viable path forward as a biomedical company, Riot explored various strategic alternatives. On October 4, 2017, Riot announced that it would pivot its business to blockchainand cryptocurrency technologies. (CCAC ¶ 166.) Riot simultaneously announced that it was changing its name to "Riot Blockchain, Inc." (from its former name, "Bioptix, Inc.") to reflect its new business focus. (Id.) Riot stated that it would pursue its new strategy for building shareholder value and future prospects by pursuing "acquisitions of businesses serving the blockchain ecosystem." (Id.) Riot then used a portion of its cash holdings and stock to acquire or invest in companies in the blockchain space and to purchase computer equipment used to perform Bitcoin mining. (CCAC ¶¶ 166, 169, 172, 182, 186, 195, 279.)

On September 29, 2017, five days before announcing its pivot towards blockchain and cryptocurrency, Riot announced that it had made a strategic investment in Coinsquare, Ltd. ("Coinsquare"), a Canadian cryptocurrency exchange. (CCAC ¶ 166.) After changing its name to Riot Blockchain, on October 16, 2017, Riot acquired approximately fifty-two percent of Tess, Inc. ("Tess"), a Canadian company, which developed blockchain solutions for telecommunications companies. (CCAC ¶ 169.) Then, on November 3, 2017, Riot announced that it had acquired Kairos Global Technology, Inc. ("Kairos"), a Nevada cryptocurrency mining company. (CCAC ¶¶ 172, 175.)

On November 16, 2017, Riot announced that it had made a strategic investment in Verady, LLC ("Verady"), a company providing cryptocurrency accounting and audit technology services. (CCAC ¶ 279.) On December 4, 2017, Riot announced that its investment in Coinsquare had more than tripled. (CCAC ¶ 182.) Subsequently, on December 11, 2017, Riot announced that Tess had agreed to merge with Cresval Capital Corp. ("Cresval"), a Canadian mining company, and would be publicly traded on the TSX Venture Exchange. (CCAC ¶¶ 186-87.) On February 16, 2018, Riot announced that Kairos had purchased 3,800 cryptocurrency mining computers inexchange for $11 million and 1 million shares of Riot's restricted common stock from Prive Technologies LLC ("Prive"). (CCAC ¶ 195.)

D. False and Misleading Statements and Omissions and Other Deceptive Conduct

Plaintiff alleges that, during the Class Period, Riot made various materially false and misleading statements and omissions, and engaged in other deceptive conduct, in violation of Section 10(b) of the Exchange Act and Rule 10(b)(5). (CCAC ¶ 209.) According to the Complaint, these allegedly false and misleading statements and omissions, and other deceptive conduct, took the form of: (1) statements in Riot's securities...