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Smith v. Lifevantage Corp.

United States District Court, D. Utah

December 5, 2019

BRIAN SMITH, individually, MICHAEL ILARDO, individually, Plaintiffs,
v.
LIFEVANTAGE CORPORATION, a corporation; and DARREN JENSEN, an individual, Defendants.

          MEMORANDUM DECISION AND ORDER DENYING IN PART AND GRANTING IN PART DEFENDANTS' [94] MOTION TO DISMISS

          David Nuffer United States District Judge.

         District Judge David Nuffer Defendants LifeVantage Corporation and Darren Jensen moved to dismiss (the “Motion”)[1] Plaintiffs Brian Smith and Michael Ilardo's First Amended Class Action Complaint.[2] Plaintiffs responded and requested leave to file an amended complaint if the Motion to Dismiss is granted.[3]Defendants replied in support of the Motion.[4]

         The Complaint alleges securities fraud, sale of an unregistered security, antitrust violations, and unjust enrichment. These claims stem from Plaintiffs' involvement as Distributors of LifeVantage products.[5] Defendants' Motion to Dismiss[6] argues Plaintiffs have not pleaded fraud with the exacting degree of particularity demanded by Fed. R. Civ. Pro. 9(b) and the Private Securities Litigation Reform Act (“PSLRA”).[7] Defendants also argue that Distributorship agreements are not required to be registered as securities.[8] Defendants further argue that Plaintiffs have failed to plead sufficient facts to state a claim for antitrust violations or unjust enrichment.[9]

         Under a scheme liability framework, Plaintiffs have plausibly stated a claim for violation of Rule 10b-5 of the Securities Act. However, Plaintiffs have failed to plausibly allege facts stating claims for sale of an unregistered security; violation of the Sherman and Clayton Acts; and unjust enrichment. Therefore, Defendants' Motion to Dismiss[10] is DENIED in part and GRANTED in part.

         Contents

         FACTUAL BACKGROUND ......................................................................................................... 3

         STANDARD OF REVIEW ............................................................................................................ 4

         DISCUSSION ................................................................................................................................. 5

         I. Plaintiffs Allege Sufficient Facts to State a Securities Exchange Act

         10(b) Rule 10b-5 Claim ............................................................................................................ 5

         A. A Distributorship in LifeVantage qualifies as a security. . .......................... 5

         B. Requirements to state a claim under Section 10(b) and Rule 10b-5. . ......... 6

         C. Plaintiffs sufficiently allege a 10b-5 claim under scheme liability ............. 7

         D. Plaintiffs sufficiently allege scienter. . ....................................................... 10

         II. Plaintiffs Fail to Allege Sufficient Facts to State a Claim for Sale of Unlicensed Securities ............................................................................................................... 13

         III. Plaintiffs Fail to Allege Sufficient Facts to State a Claim for Antitrust Violations ............................................................................................................................... 14

         A. Plaintiffs fail to sufficiently allege that Defendants committed a fraud on the USPTO ................................................................................................ 14

         B. Plaintiffs have failed to allege sufficient facts that satisfy the remaining elements of a Walker Process Claim ....................................................... 16

         IV. Plaintiffs Fail to Allege Sufficient Facts to State a Claim for Unjust Enrichment 17

         ORDER ......................................................................................................................................... 18

         FACTUAL BACKGROUND

         Plaintiff Brian Smith enrolled as a LifeVantage Distributor in March 2016, hoping to make an income and support his cancer charity while he was unable to work outside the home.[11]Smith spent over $1, 000 to sign up and obtain LifeVantage products to sell. Smith also signed up to purchase more products automatically.[12] Smith attempted to use social media to sell these products, but because other Distributors in his area were already using social media for this very purpose, Smith did not sell any of product he purchased.[13] Smith was also unsuccessful in enrolling any new Distributors.[14]

         Plaintiff Michael Ilardo became a LifeVantage Distributor in February 2017, hoping to create an income that would support him as he attempted to establish an evangelical ministry.[15]Ilardo spent approximately $1, 800 signing up as a LifeVantage Distributor.[16] But Ilardo found few customers.[17]

         Both Plaintiffs allege that they lost money by joining LifeVantage.[18] Plaintiffs' central allegation is that LifeVantage is an illegal pyramid scheme rather than a legitimate multi-level marketing (“MLM”) business.[19] Specifically, Plaintiffs bring the following causes of action against the Defendants: (1) Violation of Section 10(b) of the Securities Exchange Act And Rule 10b-5; (2) Violation of 15 U.S.C. § 77l(a)(1) and (2); (3) Violations of Sections 1 and 2 of the Sherman Act 15 U.S.C. §1, 2, and Sections 4 of the Clayton Act, 15 U.S.C. § 15; (4) Unjust Enrichment. Defendants request dismissal of all of the causes of action in Plaintiffs' First Amended Class Action Complaint under Rule 12(b)(6) and Rule 9(b) of the Federal Rules of Civil Procedure.[20]

         STANDARD OF REVIEW

         Dismissal is appropriate under Rule 12(b)(6) when the complaint, standing alone, is legally insufficient to state a claim upon which relief may be granted.[21] Each cause of action must be supported by enough sufficient, well-pleaded facts to be plausible on its face.[22] In reviewing a complaint on a Rule 12(b)(6) motion to dismiss, factual allegations are accepted as true and reasonable inferences are drawn in a light most favorable to the plaintiff.[23] However, “the plausibility standard . . . asks for more than a sheer possibility that a defendant has acted unlawfully.”[24] Therefore, to show an entitlement to relief, the facts must “permit the court to infer more than the mere possibility of misconduct.”[25]

         Under Rule 9(b), a party making allegations of fraud must “state with particularity the circumstances constituting fraud.”[26] When the fraud alleged is a species of securities fraud, the complaint must also satisfy the requirements of the Private Securities Litigation Reform Act (“PSLRA”). “The PSLRA requires plaintiffs to state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter, i.e., the defendant's intention to ‘deceive, manipulate, or defraud.'”[27]

         DISCUSSION

         I. Plaintiffs Allege Sufficient Facts to State a Securities Exchange Act 10(b) Rule 10b-5 Claim

         A. A Distributorship in LifeVantage qualifies as a security.

         As an initial matter, liability under Rule 10b-5 attaches only “in connection with the purchase or sale of any security.”[28] A threshold question is whether a Distributorship in LifeVantage is a security. Defendants do not argue in their motion to dismiss that a LifeVantage Distributorship is not a security. Plaintiffs allege that the combination of the Compensation Plan (“Plan”), the Policies and Procedures, and the Distributor Enrollment Form is “an offering for investment and a security under federal securities laws.”[29] Plaintiffs allege that seven out of eight ways for a Distributor to earn money as described in the Plan are “directly tied to recruiting”[30]and forming a downline of Plan participants whose sales supplement the Distributor's income.[31]

         In S.E.C. v. W.J. Howey Co., the Supreme Court defined an investment contract under Federal Securities law as “a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”[32] Courts, including the Tenth Circuit, have broadly interpreted the Howey test so that “the word ‘solely' must not be given an unduly restrictive application.”[33] Therefore, investment in the Plan, where profit comes “if not solely, at least predominantly from the efforts of others, namely of the downline members, ”[34] falls under the definition of an investment contract governed by securities laws.

         Moreover, Plaintiffs allege that the LifeVantage MLM structure constitutes a pyramid scheme. “Investment in a pyramid scheme is itself a security.[35] As is discussed below, this allegation is key to Plaintiffs' 10b-5 claim.

         B. Requirements to state a claim under Section 10(b) and Rule 10b-5.

         Plaintiffs allege that Defendants have violated Section 10(b) of the Securities Exchange Act and its associated Rule 10b-5.[36] Section 10(b) forbids the use of “any manipulative or deceptive device or contrivance” that would violate any “such rules and regulations as the Commission may prescribe.”[37]

         Rule 10b-5 operates under the authority granted by Section 10(b), and prohibits the employment of “any device, scheme, or artifice to defraud” as well as “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person” when transacting in securities.[38] To state a 10b-5 claim, Plaintiffs must allege facts showing this type of fraud or deceit, made with scienter.[39] Scienter is “a mental state embracing intent to deceive, manipulate, or defraud.”[40] The Tenth Circuit acknowledges both fraudulent intent and recklessness as satisfying the scienter requirement.[41]

         C. Plaintiffs sufficiently allege a 10b-5 claim under scheme liability.

         Defendants argue that Plaintiffs fail to allege sufficient facts to state a claim under the Securities Exchange Act.[42] Defendants contend that Plaintiffs cannot assert an “inherently fraudulent[43]” pyramid scheme and expect to survive a motion to dismiss, because Plaintiffs “fail[] to identify any specific statements.”[44] When a plaintiff alleges fraud by misleading statements or omissions, the fraudulent statements must be set forth specifically.[45] In such circumstances, the Tenth Circuit has required inclusion of “the time, place, and contents of the false representation, the identity of the party making the false statements and the consequences thereof.”[46] Specifically, to state a claim for securities fraud under Section 10(b) of the Act, Plaintiffs' complaint must include the following five allegations:

(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.[47]

         Despite its length, Plaintiff's Complaint is insufficient with regard to at least elements (1) and (3). Plaintiffs' voluminous Complaint comes near to puzzle pleading. Puzzle pleading occurs when a complaint is so voluminous and ineffectively organized as to “place the burden on the reader” to “solve the puzzle” of the plaintiff's claims.[48] Although the Tenth Circuit has expressed disapproval of puzzle pleading, [49] this district and the Tenth Circuit also recognize the “preference for deciding cases on the merits.”[50] Therefore, without deciding whether the Complaint is actually a puzzle pleading, it is clear that the Complaint goes on at length without directly setting forth statements made by Defendants. And where such statements are present in the complaint, Plaintiffs do not allege those statements clearly with respect to elements (2), (4), and (5) above.

         Plaintiffs' lengthy Amended Complaint contains no reference to specific statements where the identity of the person making the statement, the time and circumstances of the statement, and the consequences of the statement are clearly stated. Moreover, statements praising business products and prospects are employed by many businesses to express an optimistic view of themselves to investors. These statements are not considered fraudulent.[51]

         However, a claim under Rule 10b-5 can be pleaded under a theory of “scheme liability.” Plaintiffs allege that the business opportunity that they joined was actually an illegal pyramid scheme. An allegation of scheme liability “hinges on the performance of an inherently deceptive act that is distinct from an alleged misstatement.”[52] Under a scheme liability framework, Plaintiffs must show that Defendants “participated in an illegitimate, sham or inherently deceptive transaction where [their] conduct or role ha[d] the purpose and effect of creating a false appearance.”[53] This district has recognized scheme liability.[54] Therefore, the question on this 12(b)(6) motion is not whether Plaintiffs have identified specific statements, but have plausibly pleaded facts supporting an inherently fraudulent scheme.

         Plaintiffs have alleged enough plausible facts in their Complaint to state a claim for scheme liability under Rule 10b-5. Plaintiffs allege that Defendants structured their purported MLM as a pyramid scheme. As part of the scheme, recruited Distributors paid for the right to receive compensation that was dependent on the recruitment of additional participants in the scheme rather than on legitimate retail sales. Plaintiffs also allege that Defendants hired professional marketers to pose as “success stories” to convince potential recruits that they could attain great financial rewards that were, in reality, highly unlikely.

         Plaintiffs also allege that Defendants made improper health claims for an unregulated supplement and misrepresented the scope of their patents.[55] Plaintiffs' Complaint references the Koscot test[56] and alleges that Defendants' MLM was a pyramid scheme. Plaintiffs' factual allegations, taken as as true, state a claim that is facially plausible.

         D. Plaintiffs sufficiently allege scienter.

         Defendants argue that Plaintiffs' 10b-5 claim fails because it does not adequately allege scienter.[57] The U.S. Supreme Court has determined that “[u]nder the PLSRA, a plaintiff must ‘state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.'”[58] Noting that Congress has “raise[d] the bar for pleading scienter, ”[59] the Supreme Court also requires that a complaint show an “inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged” to pass muster under the PSLRA.[60] In making such determination, a court must “consider the complaint in its entirety” and “take into account plausible opposing inferences.”[61]

         Defendants argue that Plaintiffs' cannot rely on allegations that Defendants benefitted from the alleged scheme.[62] But “evidence of motive and opportunity . . . may be considered as part of the mix of information that can come together to create the ‘strong inference' of scienter required by the PSLRA.”[63] Plaintiffs may not rely on such motives exclusively, but “the court's job is not to scrutinize each allegation in isolation, but to assess all the allegations holistically.”[64]

         Moreover, Defendants' heavy reliance on City of Philadelphia v. Fleming Companies, Inc., is unconvincing. The allegations of fraud at issue in Fleming hinged upon the omission of one set of allegedly material facts, [65] which is fundamentally distinct from the encompassing allegations in this case of a fraudulent scheme carried out by Defendants.

         Defendants further argue Plaintiffs fail to sufficiently allege that Defendants knew of “any unlawful scheme.”[66] On this point, Defendants rely on Sanchez v. Crocs, an unpublished case, in asserting that scienter cannot be pleaded from “knowledge of falsity based on access to mere raw data” but that the data must all be “collected in identifiable reports demonstrating the falsity.”[67]

         However, Plaintiffs allege substantially more than “mere” access to data. Plaintiffs allege that Defendants knew that they were perpetrating a pyramid scheme or something so dangerously close that it risked being found to be a pyramid scheme.[68] This allegation that Defendants executed an illegitimate business is qualitatively different from the allegation in Sanchez that a fully legitimate business operation failed to monitor and report to its investors important information involving the value of its inventory.[69] The ruling in Sanchez speaks to the fact that not every company that makes a mistake is aware of the problem at the time, and “unseen warning signs” or conceivable negligence do not establish scienter.[70]

         Therefore, Defendants cannot rely on Sanchez. Plaintiffs allege that Defendants operate a pyramid scheme. In support of that allegation, Plaintiffs further allege, for example, that seven of the eight ways Distributors may earn commissions “are based, directly or indirectly” on recruiting.”[71] Defendants designed this method of compensation, so it is not an “unseen warning sign” of which Defendants may be negligently unaware. The financial data Plaintiffs gathered is relevant when viewed holistically with this and Plaintiffs' other allegations.

         Finally, Defendants argue that the following allegations are unavailing without “establish[ing] the falsity of any statement”: that Defendants knew about FTC regulations, that Defendants knew of lawsuits filed against two other MLM companies, and that Defendants knew of reports filed with the SEC and the Distributor spending data.[72] But again, Defendants rely on a requirement for allegations of specific false statements, when the scheme liability that Plaintiffs allege instead requires “performance of an inherently deceptive act that is distinct from an alleged misstatement.”[73] Plaintiffs allege the inherently deceptive act of presenting a pyramid scheme as a legitimate business opportunity, and the allegations that Defendants seek to discredit tend to support the inference that Defendants knew they were engaged in such a scheme, and thus should be considered.

         Accepting the facts alleged by Plaintiffs as true and taking Plaintiffs' allegations as a whole, as instructed by the United States Supreme Court[74] and the Tenth Circuit, [75] Plaintiffs allegations of scienter, while not necessarily greater than any other inference, are “at least as compelling as any opposing inference.”[76]

         Plaintiffs allege that Defendants, with a motive to turn a profit on a business that had been previously unsuccessful, operated a pyramid scheme, and that they knew or should have known that their business structure did, in fact, constitute a pyramid scheme, and that other MLM businesses with the same structure had previously been found to be pyramid schemes. Furthermore, the specific alleged fact that Defendants hired professionals to pose as successful Distributors leads to a strong inference that Defendants were aware that their ...


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