Wert ex rel. Ditto Holdings, Inc. v. Cohn
| Decision Date | 01 September 2017 |
| Docket Number | Case No. 17 C 219 |
| Parties | LAWRENCE J. WERT, RICHARD D. KINCAID, and JAMES O. MYERS, individually and derivatively on behalf of Ditto Holdings, Inc. Plaintiffs, v. STUART COHN, ZVI FEINER, DAVID JONATHAN ROSENBERG, and AVI FOX, Defendants. |
| Court | U.S. District Court — Northern District of Illinois |
Lawrence Wert, Richard Kincaid, and James Myers, all shareholders of Ditto Holdings, have sued members of Ditto Holdings' board of directors and its general counsel in connection with alleged mismanagement, fraud, and concealment of the company's finances and operations. Plaintiffs allege that they invested additional funds and retained their initial investments in Ditto based on defendants' misrepresentations and omissions regarding the company's financial condition. Plaintiffs also allege that defendants knew or should have known that directors Joseph and Avi Fox were engaged in practices that constituted financial mismanagement of Ditto, breach of fiduciary duty, and corporate waste.
Specifically, Myers has sued Cohn under sections 10(b) and 20(a) of the Securities Exchange Act and Securities and Exchange Commission (SEC) Rule 10b-5 for fraud in connection with Myers's purchase of shares of Ditto stock (Count 1 of the amended complaint). Plaintiffs have brought additional state law claims against defendants for corporate waste (Count 2), breach of fiduciary duty (Count 3), fraudulent misrepresentation (Count 4), fraudulent concealment (Count 5), and negligent misrepresentation (Count 6). Lastly, plaintiffs have sued Cohn for legal malpractice (Count 7). Plaintiffs bring the corporate waste claim solely on a derivative basis, the breach of fiduciary duty, negligent misrepresentation, and legal malpractice claims both individually and on a derivative basis, and the fraudulent misrepresentation and concealment claims solely on an individual basis.
Defendants Stuart Cohn, Zvi Feiner, David Rosenberg, and Avi Fox each have moved to dismiss plaintiffs' amended complaint on numerous grounds. For the reasons stated below, the Court denies defendants' motions to dismiss, except for with respect to the derivative claims in Counts 2, 3, 6, and 7, which are dismissed with leave to amend.
The Court takes the following factual allegations from plaintiffs' amended complaint. Plaintiffs are shareholders of Ditto Holdings, Inc. Ditto (later renamed SoVesTech, Inc.) is a Delaware corporation that owns 100% of Ditto Trade, Inc. (previously FB Securities Corp.), a securities broker-dealer registered with the SEC.
Defendants are current or past officers or directors of Ditto. Cohn was Ditto's general counsel from its incorporation in 2010 until at least January 2016. He also was the company's original secretary. Avi Fox was one of the original members of Ditto's board of directors, along with his brother Joseph Fox, who is not named as a defendantin this lawsuit. In addition to serving as Ditto's chief compliance officer, Rosenberg became a member of the board in 2012. It is unclear if he has since left the board and when. Feiner has been a member of the board since 2013. It is also unclear if and when Feiner has left the board.
In July 2013, Paul Simons joined Ditto's board. Upon review of Ditto's records in preparation for an investor meeting, Simons became aware of a number of expenditures, transactions, and accounting irregularities that raised concerns about corporate mismanagement. Simons outlined his concerns in a September 2013 letter to his fellow board members. He enumerated the following suspect transactions between the period of January 2012 through July 2013:
Simons's letter also raised concerns about Joseph Fox's 2013 sale of his own shares of stock at prices different from the price offered by Ditto, the company's failure to file tax returns since its incorporation, and the lack of appropriate internal controls or systems to record transactions.
Simons was removed from the board shortly after he sent the letter. Ultimately,the board of directors approved the use of company funds to sue him for defamation. Feiner replaced Simons on the board. Also in September 2013, the Financial Industry Regulatory Authority (FINRA) opened an investigation into the issues raised in Simons's letter. Ditto retained an outside law firm, Goldberg Kohn, to investigate the allegations in Simons's letter. Goldberg Kohn issued its final report to Ditto in January 2014.
Joseph Fox told Goldberg Kohn during its investigation that the payments to his family members were either advances under his employment agreement1 or were draws against a line of credit extended to him by Ditto in consideration of his personal guaranty of investor loans and stock purchases. Goldberg Kohn accepted this explanation for the payments. Nonetheless, the Goldberg Kohn report concluded that Ditto had been operating on an "ad hoc undisciplined, nontransparent basis." Am. Compl. ¶ 70 (quoting Ex. B, at 6-8). The report further stated, "we do not condone operating a business in the manner in which it has been run to date," and it made several recommendations to help Ditto establish and comply with good corporate practices. Id. ¶ 71 (quoting Ex. B, at 8).
A February 2, 2014 email, signed by Rosenberg and Feiner and approved by Cohn, notified shareholders of the board's receipt of the Goldberg Kohn report. A copy of the report was not attached to the email. The email stated that the report "does not find any dishonest business practices, nor did it find any misappropriation or misuse of company funds." Id. ¶ 73 (quoting Ex. C). The email did not mention the report'scondemnation of Ditto's lack of discipline and transparency. The email also assured investors—falsely, plaintiffs allege—that Ditto had already adopted many of the improvements and controls recommended in the report. Additionally, the February 2014 email included as an attachment a cash flow statement for 2010 through 2013, which the email characterized as containing details from Ditto's consolidated income statement. The consolidated income statement itself was not attached to the email. Plaintiffs allege that the omitted consolidated income statement would have revealed information about losses that "likely would have caused concern for shareholders and given them significant pause before investing further in the company." Id. ¶ 78.
Plaintiff Myers became interested in investing in Ditto at the end of 2014. On or about January 20, 2015, Myers met with representatives of Ditto in their Chicago office to discuss his potential investment. During this meeting, Myers asked Joseph Fox and Cohn to provide him with a summary of the concerns raised by Simons and Ditto's planned response to those concerns. Cohn also brought up the Goldberg Kohn report. Joseph Fox told Myers the report was not available but said he would be happy to answer questions about it. Myers contends that he was intentionally and falsely "led to believe by statements of Joseph and Cohn" that the Goldberg Kohn report provided no support for Simons's allegations of "financial malfeasance." Id. ¶ 105. Myers alleges that he was further misled during the meeting on whether Ditto had implemented any of the Goldberg Kohn report's recommendations. Acting in reliance upon these misrepresentations and omissions, Myers says, he purchased $25,000 worth of Ditto stock in February 2015. He made additional purchases in March and April 2015.
Myers alleges that did not begin to become aware of Ditto's problems until heobtained and read the Goldberg Kohn report in July 2015. At that time, Myers says, he realized that he had been misled about Ditto's operation and its true financial condition. When he later obtained a copy of a 2012-2014 audit of Ditto, Myers says that he came to understand the extent to which information about Ditto's finances had been misrepresented and concealed from him prior to his decision to invest.
Plaintiffs allege that Ditto's persistent recordkeeping failures, defendants' issuance and approval of misleading emails to shareholders, and their failure to respond to calls for reform, among other failings, served to conceal and actively misrepresent the state of Ditto's operations and finances through 2015. For example, plaintiffs contend that defendants approved another intentionally misleading email from Joseph Fox to shareholders on September 16, 2015. Joseph Fox sent this September 2015 email shortly after the SEC issued orders finding that Joseph and Ditto had violated the Securities Act by selling securities without having filed a registration statement. According to plaintiffs, the email was misleading in its characterization of both the seriousness and the scope of the SEC's findings.
Concerned about Ditto's apparent misappropriation of shareholder funds, near the end of 2015, Wert hired an attorney to review Ditto and draft a letter detailing its ongoing problems and demanding significant changes to its structure and business operations. Plaintiffs allege that Ditto did nothing in response. Less than a month later, Joseph Fox informed shareholders that he was shutting down Ditto Trade, Ditto's subsidiary, because it was insolvent.
At present, Ditto's applications for patents on its proprietary trading technology are the only remaining assets of any value. Due to inaction on the defendants' part,however, the U.S. Patent and Trademark Office has since classified the most valuable...
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