In re Cannavest Corp. Sec. Litig.

Citation: 307 F. Supp. 3d 222Docket: 14 Civ. 2900 (PGG)

Court: District Court, S.D. Illinois; March 31, 2018; Federal District Court

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A federal securities law class action has been initiated on behalf of investors who acquired CannaVest common stock during the Class Period from May 20, 2013, to April 14, 2014. The Consolidated Complaint alleges violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The CannaVest Defendants, including CannaVest and its executives Michael Mona, Jr., Bart P. Mackay, Theodore R. Sobieski, and Edward A. Wilson, have filed motions to dismiss based on Fed. R. Civ. P. 12(b)(6), claiming the Plaintiffs failed to adequately plead loss causation, scienter, and control person liability. Defendant Stuart Titus has also moved to dismiss, arguing insufficient allegations regarding scienter, market manipulation, and control person liability.

The Court determined that Plaintiffs adequately alleged material misstatements and omissions but decided to dismiss claims against Mackay, Sobieski, and Titus due to a lack of allegations regarding their active management roles at CannaVest under the "group pleading doctrine." The Court also dismissed the market manipulation claim for lack of alleged market activity and ruled that Plaintiffs did not provide sufficient facts to demonstrate Sobieski's control over CannaVest or Titus as a "culpable participant," leading to the dismissal of the Section 20(a) claims against them. The motions to dismiss were denied for other claims. 

CannaVest is a publicly traded Delaware corporation focused on developing and selling industrial hemp-based consumer products, particularly cannabidiol. Michael Mona, Jr. has held various roles, including president and CEO, and previously consulted for Medical Marijuana, Inc., where he retained a 4% stake. Bart P. Mackay is the majority owner and became a director in March 2013. Stuart Titus, CEO of Medical Marijuana, Inc., sold substantial amounts of CannaVest stock during the Class Period and previously owned a 7.1% stake in the company. Edward A. Wilson and Theodore R. Sobieski joined the board in March 2013; Wilson is affiliated with an accounting firm in Las Vegas.

CannaVest, originally formed as Foreclosure Solutions, Inc. in Texas on December 9, 2010, aimed to provide information on pre-foreclosure properties but failed to secure necessary financing. On November 16, 2012, entities controlled by Mackay and Titus acquired 99.7% of Foreclosure Solutions' shares for $375,000, with Titus providing the funds through individual promissory notes. The company changed its name to CannaVest on January 29, 2013, and simultaneously purchased assets from PhytoSphere Systems, LLC for $35 million, payable in five installments at CannaVest's discretion, either in cash or stock. The payment schedule was set for various dates throughout 2013, with a pricing "collar" limiting stock issuance between $4.50 and $6.00 per share. Medical Marijuana, Inc. had previously acquired an interest in PhytoSphere for $2.5 million in April 2012 and announced the sale of PhytoSphere on March 1, 2013. CannaVest reported its acquisition in its 2013 Form 10-K, following GAAP under ASC Topic 805, which requires assets and liabilities to be recorded at fair market value, with any excess purchase price recognized as goodwill. The accounting process involves identifying the acquirer, determining acquisition date, recognizing identifiable assets and liabilities, and measuring goodwill or gains from bargain purchases.

On March 14, 2013, CannaVest's Board expanded to four members by adding directors Mackay, Sobieski, and Wilson. As of April 12, 2013, the company employed five staff members. On May 14, 2013, CannaVest replaced its independent auditor, Turner Stone Company, with Anton Chia, LLP. The company's Form 10-Q for Q1 2013, filed on May 20, reported $33,656,833 in intangible assets and $1,275,000 in revenue, with income derived mainly from raw hemp sales totaling $337,941. The Q2 2013 Form 10-Q, filed on August 13, revealed $26,998,125 in goodwill and $4,995,895 in net intangible assets, lacking related party disclosures. The Q3 2013 Form 10-Q, filed on November 14, indicated $4,466,666 in intangible assets and a goodwill impairment of $26,998,125, reducing goodwill to zero.

On April 3, 2014, CannaVest filed a Form 8-K admitting to financial misreporting in its earlier Form 10-Qs, leading to a 20% share price drop. The Amended Form 8-K filed on April 14 disclosed an overstatement of goodwill from the PhytoSphere transaction and an overvaluation of Q1 2013 revenue by $192,625. This resulted in an additional 19.5% drop in stock price. On April 24, 2014, CannaVest restated financials for Q1-Q3 2013, reporting an overstatement of intangible assets by $28,079,488 in Q1, with all revenue sourced from affiliates of Medical Marijuana, Inc. The restatement for Q2 noted an overstatement of $1,837,387 in intangible assets, while Q3 indicated overstated intangible assets by $904,666 and understated goodwill by $1,855,512, with all revenue again from Medical Marijuana, Inc. A Consolidated Complaint was filed on September 14, 2015.

To survive a motion to dismiss under Rule 12(b)(6), a complaint must present sufficient factual matter that, when accepted as true, establishes a claim for relief that is plausible on its face, as established in Ashcroft v. Iqbal and Bell Atlantic Corp. v. Twombly. The court must accept all alleged facts as true and draw all reasonable inferences in favor of the plaintiff. Complaints that contain only bare assertions without further factual enhancement are deemed inadequately pleaded. Additionally, a complaint must provide enough factual allegations to give the defendant fair notice of the claims and their grounds. Conclusory statements without supporting facts do not establish entitlement to relief. In evaluating a motion to dismiss, a district court may consider the facts in the complaint, attached exhibits, and documents referenced within the complaint.

A securities fraud complaint under Section 10(b) of the Securities Exchange Act is subject to two heightened pleading standards. First, it must comply with Federal Rule of Civil Procedure 9(b), which mandates that the complaint specify the fraudulent statements, identify their speaker, indicate when and where the statements were made, and explain their fraudulent nature. This rule is designed to provide defendants with fair notice of claims against them and to protect their reputations from baseless allegations.

Second, the complaint must adhere to the Private Securities Litigation Reform Act (PSLRA), which requires plaintiffs to detail facts that give rise to a strong inference of the defendant's fraudulent intent (scienter). This inference must be cogent and at least as compelling as any opposing inference of nonfraudulent intent. Courts evaluating the sufficiency of scienter allegations under the PSLRA must compare inferences proposed by the plaintiff against counter-inferences drawn from the same facts. A complaint will only survive this scrutiny if the inference of scienter is deemed strong by a reasonable person.

Plaintiffs assert claims under Section 10(b) of the Exchange Act (15 U.S.C. 78j(b)) and Rule 10b-5, as well as Section 20(a) (15 U.S.C. 78t(a)), alleging false and misleading statements along with deceptive and manipulative conduct. They claim violations of Rule 10b-5(b) through misstatements or omissions of material facts, and Rules 10b-5(a) and (c) through manipulative conduct. To establish a claim under Section 10(b) and Rule 10b-5, plaintiffs must demonstrate: (1) misstatements or omissions of material fact; (2) scienter; (3) connection to securities transactions; (4) reliance by the plaintiff; and (5) proximate causation of injury. For market manipulation claims, essential elements include manipulative acts, reliance on an efficient market, damage, scienter, and connection to securities transactions facilitated by the defendant. The claims of misstatements and market manipulation are interconnected, as the manipulation claim involves nondisclosure, which is critical to a manipulative scheme.

Materiality of misstatements or omissions is determined by whether the omitted fact would significantly alter the total mix of information for a reasonable investor. At the pleading stage, plaintiffs must assert a statement or omission deemed significant by a reasonable investor, and dismissal for lack of materiality is only appropriate if the allegations are clearly unimportant. Plaintiffs allege that defendants engaged in a scheme to mislead investors regarding the value of CannaVest's stock, profiting from the misrepresentation, particularly through the PhytoSphere acquisition, which they claim involved materially false statements about its value and CannaVest's financial situation.

Defendants misrepresented key financial facts regarding the PhytoSphere transaction, including (1) inflating its value and the intangible assets acquired, (2) overstating CannaVest's revenues for Q1 2013, (3) failing to disclose that all revenues in the first three quarters of 2013 were from Medical Marijuana, Inc., a related party, (4) concealing co-defendant Michael Llamas's involvement in management despite his indictment for fraud, and (5) falsely asserting compliance with GAAP in CannaVest's financial statements. The Court found that Plaintiffs sufficiently alleged material misstatements, particularly noting that CannaVest overstated the PhytoSphere assets by approximately $27 million compared to the fair market value later revealed. Supporting evidence includes CannaVest's amendments to SEC filings, such as an amended Form 10-Q for Q1 2013 which corrected previously reported intangible assets of $33,656,833 to an overstatement of $28,079,488. This amendment also adjusted the fair market value of the PhytoSphere transaction from $35 million to $8,020,000. Additional amendments for Q2 and Q3 2013 revealed further overstatements and adjustments to intangible assets and goodwill related to the PhytoSphere transaction.

Defendants claim that misstatements regarding the PhytoSphere transaction and CannaVest's financial performance were not material, citing an impairment of goodwill reported in their third-quarter Form 10-Q for 2013, which resulted in a net carrying value of $0. However, "truth-on-the-market" defenses are typically fact-specific and not suitable for dismissing a 10(b) complaint for lack of materiality. The impairment does not negate the materiality of Plaintiffs' allegations, which assert that Defendants did not believe the PhytoSphere transaction had a fair market value of $35 million and failed to disclose that this valuation was fraudulently set. The Court finds a "substantial likelihood" that revealing the true value of the transaction would significantly alter the information available to reasonable investors.

Plaintiffs also allege that CannaVest over-reported its first-quarter revenue for 2013, initially claiming $1,275,000 but later restating this to $1,082,375, a difference exceeding 15%, sufficient to establish materiality at the pleading stage. Furthermore, CannaVest misrepresented that all revenues during the first three quarters of 2013 were generated from third parties, failing to disclose that these revenues were derived from entities affiliated with Medical Marijuana, Inc., a stockholder. This misrepresentation included claims made in a June 20, 2013 press release and was later corrected in the April 24, 2014 restatement, which clarified that all reported revenues for the first three quarters of 2013 came from affiliated entities.

Lastly, Plaintiffs allege that CannaVest falsely claimed compliance with GAAP in its financial statements, identifying specific GAAP violations. This assertion parallels previous legal findings, as it highlights an untrue statement of material fact supported by factual allegations detailing the instances of non-compliance.

The Consolidated Complaint asserts that CannaVest violated Generally Accepted Accounting Principles (GAAP) by failing to disclose significant related party transactions, as mandated by the Accounting Standards Codification (ASC). Plaintiffs allege that CannaVest's 2013 Form 10-K improperly accounted for the acquisition of PhytoSphere Systems, LLC, contrary to GAAP, and that a subsequent Form 8-K disclosed that the purchase price allocation was not in compliance with accounting principles. Regarding accountability for the alleged misstatements and omissions, the court references the Supreme Court's ruling in Janus Capital Group, which states that only those with ultimate authority over a statement can be considered its "maker." CannaVest's SEC filings were signed by Mona, making both CannaVest and Mona liable for the contents. Additionally, the plaintiffs invoke the "group pleading" doctrine, which presumes that statements in group-published documents are made by all high-ranking officers involved in the company's operations. This doctrine is limited to corporate insiders with active roles and has been upheld in this district post-Janus, allowing for multiple individuals within a corporation to be considered joint makers of misstatements. Thus, those with direct involvement in CannaVest's operations are presumed to have made the statements in question.

Defendant Mackay, appointed director of CannaVest on March 14, 2013, is the majority owner and creator of the company. The group pleading doctrine may extend to outside directors with substantial ownership if they maintain a special relationship with the corporation, typically requiring involvement in the misleading statements or day-to-day operations. Plaintiffs failed to provide sufficient facts showing that Mackay was involved in preparing misleading statements or in daily management. General allegations of influence and control are inadequate. Similarly, Defendant Sobieski's status as a director does not meet the requirements for group pleading without specific involvement in the alleged misleading statements. Defendant Wilson, who served as a director from March 14, 2013, to October 31, 2013, is noted to have handled accounting functions, suggesting direct management involvement, which is sufficient for pleading purposes. Defendant Titus, CEO and controlling shareholder of Medical Marijuana, Inc., financed CannaVest's acquisition and owned 7.1% of its stock but lacked ultimate authority over SEC filings and press releases, as he was neither a director nor corporate officer. His role as a consultant and advisor, while significant, does not fulfill the criteria for applying the group pleading doctrine.

The Court determines that the Consolidated Complaint supports the liability of CannaVest, Mona, and Wilson for statements made in CannaVest's SEC filings and press releases, but not for Mackay, Sobieski, and Titus. To establish scienter under the PSLRA, plaintiffs must provide specific facts that strongly indicate that the defendant acted with the required intent. This strong inference must be compelling and at least as strong as any counter-argument of non-fraudulent intent, as established in ECA v. JP Morgan Chase Co. 

Plaintiffs can show scienter by demonstrating either the defendants' motive and opportunity to commit fraud or by presenting strong circumstantial evidence of conscious misbehavior or recklessness. Four circumstances that may indicate a strong inference of scienter include: (1) personal benefit from the alleged fraud; (2) engagement in illegal behavior; (3) knowledge of information contradicting public statements; and (4) failure to monitor necessary information. If no motive is shown, stronger circumstantial evidence is required. 

The inquiry focuses on whether the collective facts indicate a strong inference of scienter rather than assessing individual allegations in isolation. To establish motive, plaintiffs must show concrete and personal benefits from the fraudulent statements, avoiding reliance on general motives applicable to all corporate insiders. Desires for profitability or high stock prices are deemed insufficient motives. While stock ownership and sales can demonstrate motive, courts require evidence of suspicious or unusual activity related to these transactions.

Unusual or suspicious insider trading can imply scienter, but in the case reviewed, the plaintiffs did not prove that the defendants’ stock sales were unusual, as they retained over 80% of their shares. Although unusual trading during the class period can suggest bad faith, the plaintiffs failed to show that Kennedy's sales were unusual. However, for defendant Mona, sufficient allegations of motive and opportunity to commit fraud were presented. Specifically, Mona's attempt to sell 10 million shares of CannaVest stock, which were restricted and could not be publicly traded for six months, raised concerns that he anticipated a decline in stock price due to upcoming disclosures. 

The document elaborates on the standard for establishing scienter through conscious misbehavior or recklessness, which requires strong circumstantial evidence. If motive is not evident, the allegations must be particularly compelling. Recklessness is defined as conduct that significantly deviates from ordinary care standards, especially if the defendant was aware or should have been aware of the risks involved. Claims often survive motions to dismiss if they indicate the defendants knew of contradictory information to their public statements or failed to monitor relevant data. In cases of alleged improper accounting, mere misapplication of principles is insufficient; rather, the plaintiffs must demonstrate a high level of unreasonable conduct. At the pleading stage, allegations must indicate extreme negligence or an awareness of potential misrepresentations.

Recklessness cannot be established solely through violations of accounting standards. Evidence from CW-1, a financial consultant who joined CannaVest in May 2013, supports an inference of scienter regarding defendants Mona and Wilson. CW-1 immediately identified misapplications in accounting practices that necessitated restating the financial statements, particularly concerning the improper amortization of goodwill from the PhytoSphere acquisition. CW-1 worked with both CEO Mona and the Board of Directors, frequently discussing the need for a restatement, which was recognized as essential but could not be finalized until a complete audit was conducted. There were concerns within management about the implications of a restatement on the company's reputation. Additionally, the Consolidated Complaint highlights that CannaVest suffered from long-standing poor internal controls, evidenced by the outgoing auditing firm’s notification of deficiencies upon the replacement of its auditing firm. The company’s accounting management was inadequately staffed, with key functions outsourced due to a lack of necessary qualifications in SEC reporting and disclosure. This situation persisted even after changes in control and accounting management, raising further concerns about the company's financial oversight.

CannaVest disclosed material weaknesses in its internal financial reporting controls in its 2013 Form 10-Qs and 10-K, which supports an inference of scienter, as established by precedents in this District. Specifically, the company's admission of these weaknesses indicates potential intent or knowledge of wrongdoing. Defendant Wilson, a certified public accountant and director, was likely aware of the need to restate financials and received communications regarding internal control deficiencies shortly after joining the board. His role in overseeing CannaVest’s accounting practices, particularly concerning the PhytoSphere transaction, further strengthens the inference of scienter against him. The court concludes that the plaintiffs have adequately alleged scienter for both Wilson and another defendant, Mona, which allows for the imputation of scienter to CannaVest itself.

Regarding loss causation, the Supreme Court's ruling in Dura Pharmaceuticals emphasizes that plaintiffs must demonstrate a causal link between their losses and the defendants' fraudulent actions. Here, the plaintiffs sufficiently established loss causation by showing that CannaVest's April 3, 2014, Form 8-K filing, which acknowledged financial misreporting, resulted in a significant drop in the company's stock price the same day.

On April 14, 2014, CannaVest filed an amended Form 8-K detailing its restatements, resulting in a stock price drop of $4.49 per share (19.5%), closing at $18.51. Defendants argued that the alleged misstatements about the PhytoSphere transaction's value could not establish loss causation since CannaVest had previously written down the associated goodwill to zero. However, the distinction between a mistaken legitimate valuation and a fraudulent over-valuation is significant; only the latter involves fraud, which a reasonable investor would consider differently. The court determined that the impairment to goodwill did not undermine the plaintiffs' arguments regarding loss causation.

Defendants further contended that the volatility of CannaVest's stock during the corrective disclosures indicated that price declines were due to broader market forces rather than the disclosures themselves. Referencing Acticon AG v. China North East Petroleum Holdings Ltd., the court noted that such arguments are typically inappropriate for resolution at the motion to dismiss stage, as determining the reasons for stock price rebounds involves factual questions. 

Plaintiffs demonstrated that CannaVest's stock price declined following each relevant disclosure, which was sufficient to withstand a motion to dismiss. Consequently, the motions to dismiss filed by CannaVest, Mona, and Wilson were denied, while those by defendants Mackay, Sobieski, and Titus were granted.

Regarding market manipulation claims, plaintiffs must allege manipulative acts, damages resulting from reliance on an efficient market assumption, scienter, and that these occurred in connection with the purchase or sale of securities, furthered by the defendants' use of postal services or national securities exchange facilities. The Second Circuit has established specific standards for pleading such claims.

A manipulation claim does not require the same specificity as a misrepresentation claim at the early stages of litigation, particularly since facts may be within the defendant's sole knowledge. However, a complaint alleging manipulation must detail the nature, purpose, and effects of the fraudulent conduct, specifying which defendants were involved, when the acts occurred, and the impact on the market for the affected securities. General allegations lacking ties to defendants or based on speculation are inadequate. Case law requires that a manipulation claim must include actual market activities aimed at misleading investors regarding the valuation of a security; mere misrepresentations or omissions are insufficient. 

In the case of Lentell v. Merrill Lynch, the Second Circuit reiterated that market manipulation claims must be based on more than just misstatements or omissions. Plaintiffs in this case allege that the PhytoSphere transaction was part of a scheme to manipulate CannaVest's stock market and defraud investors. The transaction involved CannaVest purchasing assets from PhytoSPHERE Systems, LLC for $35 million, with payment structured in installments that could include stock issuance. The pricing of shares issued was capped at $6.00 and floored at $4.50. Plaintiffs support their claim by citing an article suggesting that the transaction artificially inflated CannaVest's stock value, as it involved the sale of PhytoSphere's assets primarily for CannaVest shares, thereby benefiting both companies at minimal actual cost.

Medical Marijuana Inc. announced the sale of its subsidiary PhytoSphere to CannaVest for $35 million in shares, which initially appeared significant. However, CannaVest had only $431 in assets at the time, raising concerns about the legitimacy of its stock valuation. Throughout 2013, Medical Marijuana Inc. reported incremental sales of PhytoSphere to CannaVest, which temporarily boosted its stock price due to misleading press releases amidst a cannabis market boom. The Consolidated Complaint alleges that defendants fraudulently inflated the transaction's value and manipulated CannaVest's stock issuance. Despite these claims, the court noted that an asset purchase alone does not typically support a market manipulation allegation. The plaintiffs failed to demonstrate that CannaVest's share issuance was manipulative or deceptive, focusing instead on the alleged overvaluation. The court distinguished between misstatements/omissions and market manipulation, asserting that without proof of manipulative market activity, claims of market manipulation cannot stand. This analysis aligns with other case law, such as TCS Capital Mgmt. LLC v. Apax Partners, where similar claims were dismissed for lacking evidence of market manipulation beyond mere misstatements.

The alleged "deception" centers on the failure to disclose the true financial benefits of a deal, suggesting that Telecom Italia received more per share than the €16.4 paid by Buyers, based on an undisclosed royalty agreement. The claim is characterized as a mere re-labeling of misrepresentations and omissions, failing to transform a disclosure claim into a market manipulation claim. Specifically, the purported fraud involves CannaVest's inflated valuation of the PhytoSphere transaction at $35 million, which is tied to the same misstatements and omissions. The court's reasoning in similar cases, such as TCS Capital and Menaldi v. Och-Ziff Capital Management Group LLC, indicates that misrepresentations or omissions in public filings do not support scheme liability claims under Rule 10b-5. In these cases, allegations of misconduct related to financial misstatements were deemed insufficient for establishing deceptive acts necessary for market manipulation claims. Consequently, the court found that the allegations regarding the PhytoSphere assets cannot form a basis for a market manipulation claim. As a result, the motions to dismiss the market manipulation claim are granted. Additionally, claims for control person liability under Section 20(a) of the Exchange Act require a primary violation of securities law, necessitating proof of such a violation by the controlled person.

Control of a primary violator, culpable participation in fraud, and the factual nature of determining a "controlling person" are essential elements of establishing control liability under Section 20(a). The court emphasizes that this determination is fact-intensive and typically inappropriate for resolution at the motion to dismiss stage. In this case, the plaintiffs have adequately alleged a Section 10(b) claim against CannaVest. Control, in this context, refers to the ability to direct management and policies, which can be established through ownership, contracts, or other means.

Mackay, as the creator, majority owner, and director of CannaVest, meets the control criteria, as does Mona, who serves as CEO, president, and director. Wilson is also implicated due to his role as a director and his firm’s likely involvement in auditing relevant transactions. The plaintiffs argue Wilson had significant influence over the company’s operations and decisions, which supports their claims of control liability.

Regarding Titus, the plaintiffs allege he had actual control over CannaVest, highlighting his CEO role at Marijuana Medical, Inc., his 7.1% stake in CannaVest, and his provision of financing for acquisition transactions. These factors contribute to the assertion that Titus could influence CannaVest's decision-making.

Conversely, the claims against Sobieski lack sufficient factual support for control liability, as mere directorship or membership on an audit committee does not alone establish actual control. The court concludes that while allegations against Mackay, Mona, Wilson, and Titus meet the necessary threshold, Sobieski does not present sufficient facts for similar claims.

To establish culpable participation in a Section 20(a) claim, a plaintiff must provide specific facts indicating that the controlling person engaged in conscious misbehavior or acted recklessly, as outlined in ATSI Communications and supported by case law such as Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd. and Lapin v. Goldman Sachs Grp. This requires demonstrating that the controlling person either knew or should have known about the fraudulent activities of the primary violator. The court emphasizes that a plaintiff must plead these elements with scienter, which can be shown through conscious misbehavior or recklessness. In this case, plaintiffs have adequately alleged primary violations against certain defendants, which correlates to a sufficient showing of culpable participation. Moreover, the court states that if facts indicate a strong inference of scienter regarding a misstatement, they also imply culpable participation. The court finds that allegations against Mackay, a Board member, are sufficient to infer his culpable participation, as he would likely have been informed about the need for financial restatement and deficiencies in internal controls, fulfilling the requirement for culpable participation.

The Consolidated Complaint fails to sufficiently allege that Titus engaged in "culpable participation" regarding CannaVest's material misstatements and omissions. While Plaintiffs assert that Titus served as a paid consultant and owned 7.1% of CannaVest's shares, they do not provide facts proving his involvement in the alleged misstatements. Plaintiffs argue that Titus, due to his position, should have been aware of the true valuation of PhytoSphere and thus acted recklessly by making statements promoting its value. However, Titus's control over Medical Marijuana, Inc.'s statements does not equate to his involvement in CannaVest's misstatements, and the evidence of his stock sales—selling only 10% of his shares—does not indicate unusual or suspicious trading behavior. Legal precedents suggest that unusual trading activity can imply scienter, but this case lacks sufficient evidence to support such an inference. Additionally, there is a split among district courts in the Second Circuit regarding whether "culpable participation" is a necessary element of a Section 20(a) claim. To establish controlling-person liability, a plaintiff must demonstrate that the controlling person was a "culpable participant" in the fraud committed by the controlled entity.

A Section 10(b) violation requires a showing of primary fraud by a controlled person and culpable participation by the defendant. Controlling-person liability is a secondary liability form, necessitating the plaintiff to demonstrate that the controlling individual was significantly involved in the fraud. The court confirms that "culpable participation" is essential for a Section 20(a) claim. Consequently, Titus's motion to dismiss the Section 20(a) claim is granted, while the CannaVest Defendants' motion is partly granted, dismissing Sobieski but not others. Plaintiffs have requested permission to amend their complaint if parts are dismissed, which the court finds appropriate, noting leave to amend should generally be allowed unless valid reasons exist to deny it. No compelling reasons were presented by the Defendants against amending. The Plaintiffs are granted leave to amend their complaint by April 15, 2018. The court concludes by granting the Defendants' motions to dismiss the Plaintiffs' market manipulation and certain misstatements or omissions claims, while denying dismissal of other claims. The Clerk of Court is instructed to terminate the motions. Additionally, the complaint mentions that the Financial Accounting Standards Board (FASB) approved the ASC as the primary source of authoritative U.S. accounting standards, noting that the Codification does not alter GAAP but provides a new, user-friendly structure.

Generally Accepted Accounting Principles (GAAP) define the conventions, rules, and procedures recognized by the accounting profession to establish accepted accounting practices at any given time. Plaintiffs' allegations of disclosure violations counter Defendants' argument invoking the Santa Fe doctrine, which limits Section 10(b) claims to issues beyond mere internal corporate mismanagement. A specific transaction disclosed in CannaVest's 10-Q for Q1 2013 involved a promissory note with Roen Ventures, a company partially owned by a relevant party. "Outside directors" are defined as those without management roles, as illustrated by a case where a board chairman, despite holding significant stock and having a consulting contract, was classified as such.

Plaintiffs argue that Rule 10b-5(a) and (c) address conduct not outlined in ATSI Communications, but the latter confirms that market activity is essential for a market manipulation claim. Plaintiffs' alternative theories under Rule 10b-5(a) and (c) fail because they do not allege conduct independent from their claims of material misstatements and omissions. Courts must critically evaluate pleadings to ensure that misrepresentation claims do not improperly fall under scheme liability.

Scheme liability relies on inherently deceptive acts distinct from misstatements, and Plaintiffs' reference to an SEC proceeding is deemed irrelevant due to its subsequent vacatur. Even after the vacatur, courts continue to require more than mere misstatements to substantiate market manipulation claims. Allegations alone are insufficient; actual manipulative acts—such as wash sales or rigged prices—are needed to demonstrate intent to mislead investors. Additionally, while some cases suggest that Rule 10b-5 encompasses a broader range of fraudulent activities, this interpretation predates crucial clarifications established in ATSI Communications.

A claim based on a "fraudulent and deceptive scheme" under Rule 10b-5(a) and (c) requires plaintiffs to establish four elements: (1) a deceptive or manipulative act by the defendant, (2) the requisite scienter, (3) an effect on the securities market or a connection to their purchase or sale, and (4) the defendant's actions caused the plaintiffs' injuries. The court emphasized that the conduct underlying these claims must be distinct from that supporting a material misstatement claim. The defendants were alleged to have engaged in fraudulent activities by pooling substandard mortgages into residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs), inflating Deutsche Bank's stock price and generating short-term profits, while knowing about the poor quality of the underlying mortgages. Specific knowledge was demonstrated by authorizing a significant short position on these securities. Despite awareness of poor lending practices, defendants reassured investors of conservative practices. Two out-of-circuit cases cited by plaintiffs were deemed unpersuasive due to their lack of relevance to the market activity requirement. Additionally, a trading transaction involving CannaVest was noted, but plaintiffs failed to demonstrate that it was manipulative. The court clarified that a lack of "ultimate authority" in making misstatements does not negate a finding of control for liability purposes. It rejected the notion that a broader theory of liability based on influence should be applied, distinguishing it from established control person liability under Section 20(a). The court disagreed with previous case interpretations that suggested culpable participation is necessary for a Section 20(a) claim, asserting that such language was not a binding precedent.