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Zhang v. Lifevantage Corp.

United States District Court, D. Utah

June 15, 2017

JUN ZHANG, Individually and On behalf of All Others Similarly Situated, Plaintiff,
v.
LIFEVANTAGE CORPORATION, DARREN JAY JENSEN and MARK R. JAGGI, Defendants.

          MEMORANDUM DECISION AND ORDER GRANTING DEFENDANTS' MOTION TO DISMISS

          Ted Stewart United States District Judge

         This matter is before the Court on Defendants' Motion to Dismiss for Failure to State a Claim. For the reasons discussed below, the Court will grant the Motion and dismiss Plaintiffs' claims without prejudice.

         I. BACKGROUND

         LifeVantage is a network marketing company incorporated in Colorado and headquartered in Utah. LifeVantage sells dietary supplements, skin care products, energy drink mixes, pet supplements, and other products. LifeVantage sells products in the United States, Japan, Hong Kong, Australia, Canada, Philippines, Mexico, and Thailand.

         Beginning in 2009, LifeVantage adopted a business model known as Multi-Level Marketing, or “MLM.” Instead of selling its products in retail stores, LifeVantage relies on “independent distributors” both to sell its products and to recruit additional distributors. MLMs are subject to regulatory constraints in most countries and are banned in others.

         LifeVantage defines an independent distributor as someone who purchases LifeVantage products at wholesale prices and either resells it at retail prices or consumes it. An independent distributor can establish a “downline” by recruiting additional distributors and may earn a commission on the product purchased by those in her downline.

         After adopting the MLM model, LifeVantage grew rapidly. The company's revenue roughly tripled annually for three consecutive years, surging from $4.14 million to $126.18 million. Revenue rose again in 2013 to $208.18 million before plateauing and beginning to decline in 2014.

         On February 4, 2015, LifeVantage's Board stated that a new CEO was necessary because LifeVantage's growth had reached a plateau, and was therefore not progressing in line with its business model. Another reason the Company gave for hiring a new CEO was to “successfully manage the complexities of international product distribution and finance.”[1] In 2015, nearly all of the Company's top management resigned, including the President and CEO, Chief Financial Officer, Chief Sales Officer, Chief Science Officer, and the General Counsel. Around the same time, LifeVantage eliminated the position of General Counsel, appointed a new Chief Marketing Officer, and changed auditors.

         LifeVantage's new CEO, Mr. Jensen, announced new initiatives to enhance the business in September, 2015. These included rewards for the recruitment of new distributors and incentives for newly enrolled distributors to purchase more product. Mr. Jensen also promoted global expansion by “targeting certain gateway markets which in turn opens up opportunities in more and more markets.”[2]

         SEC rules require management to evaluate a company's internal controls and disclose every material weakness of which they are aware.[3] A material weakness is defined as “a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant's annual or interim financial statements will not be prevented or detected on a timely basis.”[4] In a 2015 10-K and in four 10-Q Forms, Defendants represented that LifeVantage's internal controls over financial reporting did not contain any material weaknesses.[5] In various statements, Defendants touted the adequacy of the Company's international controls, distributor oversight, and LifeVantage's compliance department.

         Then, in 2016, LifeVantage employees raised concerns about LifeVantage's international policies, and an employee submitted a formal Sarbanes-Oxley complaint. An independent review led to a revelation that improper sales practices had occurred in 2015 and 2016, and that LifeVantage had material weaknesses in some of its internal controls. In connection with this investigation, revelation, and subsequent remedial efforts, the market value of LifeVantage securities fell precipitously. In this class action lawsuit against CEO Mr. Jensen, CFO Mr. Jaggi, and LifeVantage, Plaintiffs claim that Defendants' representations regarding the adequacy of LifeVantage's internal controls were false and made recklessly or with the intent to mislead investors.

         II. STANDARD OF REVIEW

         In considering a motion to dismiss for failure to state a claim upon which relief can be granted under Rule 12(b)(6), all well-pleaded factual allegations, as distinguished from conclusory allegations, are accepted as true and viewed in the light most favorable to Plaintiffs as the nonmoving party.[6] Plaintiffs must provide “enough facts to state a claim to relief that is plausible on its face, ”[7] which requires “more than an unadorned, the-defendant-unlawfully harmed-me accusation.”[8] “A pleading that offers ‘labels and conclusions' or ‘a formulaic recitation of the elements of a cause of action will not do.' Nor does a complaint suffice if it tenders ‘naked assertion[s]' devoid of ‘further factual enhancement.'”[9]

         “The court's function on a Rule 12(b)(6) motion is not to weigh potential evidence that the parties might present at trial, but to assess whether the plaintiff's complaint alone is legally sufficient to state a claim for which relief may be granted.”[10] As the Court in Iqbal stated,

only a complaint that states a plausible claim for relief survives a motion to dismiss. Determining whether a complaint states a plausible claim for relief will . . . be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense. But where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged-but it has not shown-that the pleader is entitled to relief.[11]

         Section 10(b) of the Exchange Act prohibits the “use or employ[ment], in connection with the purchase or sale of any security . . . [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe.”[12]SEC Rule 10b-5 implements Section 10(b) by making it unlawful to “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made . . . not misleading . . . in connection with the purchase or sale of any security.”[13] Section 10(b) “affords a right of action to purchasers or sellers of securities injured by its violation.”[14]

         “A plaintiff suing under [§] 10(b) . . . bears a heavy burden at the pleading stage.”[15] To properly state a claim for securities fraud, a complaint must allege facts supporting the following:

(1) the defendant made an untrue or misleading statement of material fact, or failed to state a material fact necessary to make statements not misleading; (2) the statement complained of was made in connection with the purchase or sale of securities; (3) the defendant acted with scienter, that is, with intent to defraud or recklessness; (4) the plaintiff relied on the misleading statements; and (5) the plaintiff suffered damages as a result of his reliance.[16]

         Federal securities fraud claims are subject to the pleading requirements of Federal Rule of Civil Procedure 9(b), which states that “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.”[17] The Tenth Circuit requires a plaintiff pleading fraud to “set forth the time, place and contents of the false representation, the identity of the party making the false statements and the consequences thereof.”[18]

         III. DISCUSSION

         Defendants argue that the Amended Complaint: (1) fails to specify each statement alleged to have been misleading; (2) fails to plead sufficient facts supporting the misleading nature of the statements; (3) fails to plead particularized facts giving rise to a strong inference of scienter; and (4) fails to state a claim for relief under Section 20(a). Each argument will be addressed in turn.

         A. FALSITY

         1. Specifying Challenged Statements

         First, Defendants complain that Plaintiffs failed to identify each challenged statement with specificity. The Amended Complaint lists allegedly misleading statements in lengthy block quotes; something courts have found unhelpful in pleading fraud with particularity.[19] However, Plaintiffs used bold lettering to flag specific statements, making it possible for Defendants and the Court to isolate the challenged statements as follows:

         a. Regarding distributor oversight and compliance:

         1. “Our policies and procedures, when followed, ensure that our independent distributors comply with applicable laws and regulations.”[20]

         2. “Products may be promoted only by personal contact or by collateral materials produced or approved by us.”[21]

         3. “Our independent distributors agree to abide by our strict policies and procedures designed to ensure our independent distributors will comply with legal requirements.”[22]

         b. Regarding international sales and distributor enrollment:

         4. “[O]ur policies and procedures for our independent distributors differ slightly in some countries due to the different legal requirements of each country in which we do business.”[23]

         5. “We have proactively taken steps to ensure that we are fully in compliance with this ever changing regulatory landscape. [24]

         6. Life Vantage has “positioned [itself] to enter new international markets adapted to the ever changing regulatory landscape.”[25]

         7. “[W]e believe that we are the industry leader in terms of setting a standard for compliance. ”[26]

         c. Regarding LifeVantage 's compliance department:

         8. “We have a compliance department that addresses violations of our independent distributors when they become known to us.” [27]

         9. “We monitor and systematically review alleged independent distributor misbehavior through our internal compliance department. ”[28]

         10. “Our compliance department monitors the activities of our independent distributors as part of our effort to enforce our policies and procedures.” [29]

         d. Sarbanes-Oxley Act Certifications

         11. Plaintiffs also challenge Jensen and Jaggi's certification of LifeVantage's 2015 10-K and four separate Quarterly Report 10-Qs, which stated that they had “[d]isclosed in this report any change in the registant's internal control over financial reporting . . . that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting, ” and had reported to auditors “[a]ll significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting.” [30]

         These statements are specific, and Plaintiffs include the date they were made, the identity of the speaker, and the class of people to whom they were made. The Court therefore finds that the Complaint adequately identifies the challenged statements.

         2. Facts Supporting the Misleading Nature of the Statements

         15 U.S.C. § 78u-4(b)(1) requires a plaintiff to specify the reasons why each statement is misleading. Defendants claim that Plaintiffs did not observe or have personal knowledge of facts supporting their belief of falsity, and that the allegations must therefore be treated as information-and-belief pleading. Allegations made on information and belief trigger a statutory requirement that the complaint “state with particularity all facts on which that belief is formed.”[31] Information and belief pleading regarding falsity is scrutinized under a six-factor test.[32]

         Here, however, the majority of facts alleged in support of the misleading nature of the statements are taken from Defendants' admissions in LifeVantage's 2016 10-K form. Defendants argue that Plaintiffs did not observe the creation of the 10-K form or the investigation that preceded it, and therefore, any allegations regarding the Form's contents are made upon information and belief. However, statements drawn from official Company statements need not be construed as having been made on information and belief.[33] Even if these statements are construed as being made on information and belief, Plaintiffs have satisfied their burden.

         The admissions in the 2016 10-K contradict most of the challenged statements and create a factual basis supporting allegations that the earlier statements were misleading. The Court finds that Plaintiffs have pleaded the facts upon which their belief is based with sufficient particularity to satisfy the Private Securities Litigation Reform Act (“PSLRA”), with one exception. Plaintiffs have failed to plead any facts supporting the falsity of the statement that distributors should promote products only by “personal contact or by collateral materials produced or approved by [LifeVantage].”[34] Therefore, the second statement fails to pass scrutiny under the first prong of the PSLRA.

         3. Materiality of the Statements

         Next, Defendants argue that some of the challenged statements are immaterial. For purposes of a 10(b) claim, a statement or omission is only material “if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”[35]An omitted fact must significantly alter the “total mix” of information made available.[36]

         Defendants argue that no reasonable investor would rely on the challenged statements because they were “vague statements of corporate optimism.”[37] Statements of “‘corporate optimism' or ‘mere puffing' are . . . generalized statements of optimism that are not capable of objective verification.”[38] However, “statements cannot be dismissed as mere corporate optimism” if they “could have, and should have had, some basis in objective and verifiable fact.”[39]

         Here, most of the challenged statements were or should have been based in objective and verifiable fact. The first and third statements include a factual assertion that LifeVantage's “strict” policies and procedures were capable of producing compliance with international regulations if followed. The fourth and fifth statements are based on a factual assertion that LifeVantage had country-specific policies and procedures in place that could ensure full compliance with international law. The eighth, ninth, and tenth statements are based on factual assertions that LifeVantage had a compliance department that monitored and addressed distributor violations. While Plaintiffs do not dispute the existence of a compliance department, the Amended Complaint does allege that LifeVantage had inadequate controls related to the training, monitoring and oversight of personnel who managed international business operations, and that the compliance department was therefore incapable of detecting or addressing distributor violations.[40] These statements had, or should have had, some basis in objective fact, and are therefore material. In addition, the statements regarding the adequacy of policies and procedures and the competence of the compliance department are types of facts that would assume “actual significance in the deliberations of the reasonable shareholder.”[41]

         On the other hand, the sixth and seventh statements are inactionable statements of corporate optimism. The comments that the Company had “positioned [itself] to enter new international markets adapted to the ever changing regulatory landscape” and the stated belief that LifeVantage was “the industry leader in terms of setting a standard for compliance” are precisely the type of “puffing” that is incapable of verification, and therefore immaterial. In sum, the Court finds the challenged statements material, with the exception of the sixth and seventh statements.

         B. SCIENTER

         The PSLRA requires that “the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”[42] This requirement, known as scienter, is an essential element and “consists of ‘a mental state embracing intent to deceive, manipulate, or defraud, or recklessness.'”[43]

         “Recklessness is ‘conduct that is an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.'”[44] Allegations of motive and opportunity may be important to an inference of fraudulent intent, “but are typically not sufficient in themselves to establish a ‘strong inference' of scienter.”[45] Other pleaded facts that bolster scienter may include divergence between internal reports and external statements, or disregard of the most current factual information before making statements.[46]

         The Court does not consider scienter for the statements that were not adequately supported with the particularity required by the PSLRA.[47] Therefore, the second, sixth, and seventh statements will not be considered here. For the remainder of the statements, Plaintiffs must show an inference of scienter that is “more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.”[48]

         To establish scienter, Plaintiffs rely on the following: (1) Defendants' knowledge of improper sales in the MLM industry and failure to impose stricter internal controls; (2) Defendants' motive and opportunity to conceal improper practices; (3) information from former employees; (4) LifeVantage's implementation of a recovery plan; and (5) false Sarbanes-Oxley Act ...


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