World Surveillance Group Inc v. La Jolla Cove Investors, Inc.

Filing 48

ORDER by Judge James Donato granting 39 Motion to Dismiss (lrcS, COURT STAFF) (Filed on 9/2/2014)

1
2
3
4

UNITED STATES DISTRICT COURT

5

NORTHERN DISTRICT OF CALIFORNIA

6
7

WORLD SURVEILLANCE GROUP INC.,

Case No. 13-cv-03455-JD

Plaintiff,

8

v.

9

LA JOLLA COVE INVESTORS, INC.,

10

Defendant.

ORDER GRANTING MOTION TO
DISMISS
Re: Dkt. No. 39

United States District Court
Northern District of California

11
12
INTRODUCTION

13

This case arises out of alleged breaches of investment agreements between plaintiff World

14
15

Surveillance Group Inc. (“WSGI”) and defendant La Jolla Cove Investors, Inc. (“La Jolla”). In a

16

prior round of pleadings challenges, the Court dismissed without prejudice WSGI’s claims for

17

intentional misrepresentation, fraud in the inducement, and securities fraud for failure to satisfy

18

the heightened pleading requirements of Federal Rule of Civil Procedure 9(b), and also dismissed

19

without prejudice WSGI’s claim for breach of fiduciary duty. Dkt. No. 36. WSGI amended its

20

complaint to try to save these claims but the amendments are not enough. They are now dismissed

21

with prejudice. WSGI’s claims for breach of contract, breach of the covenant of good faith and

22

fair dealing, and under the California Unfair Competition Law will go forward.
DISCUSSION

23
24
25
26
27
28

I.

Breach of Fiduciary Duty
The Court’s prior dismissal order outlines the factual background and the pertinent legal

standard, which will not be repeated here. See Dkt. No. 36.
The Court’s prior order dismissed WSGI’s breach of fiduciary duty claim because it failed
to allege facts sufficient to show that, in this arms-length business deal, La Jolla assumed the

1

mantle of a fiduciary for WSGI and intended to act primarily for WSGI’s benefit. Dkt. No. 36 at

2

4. The amended complaint again fails to plead facts indicating that the relationship between

3

WSGI and La Jolla was anything other than a garden-variety contract with no special duties or

4

obligations attendant to it.

5

The governing California state law on this issue is straightforward. A fiduciary

6

relationship is a special circumstance in which the fiduciary “assumes duties beyond those of mere

7

fairness and honesty” and “must undertake to act on behalf of the beneficiary, giving priority to

8

the best interest of the beneficiary.” Comm. On Children’s Television, Inc. v. Gen. Foods Corp.,

9

35 Cal.3d 197, 222 (1983). “A fiduciary’s power to transact business with his beneficiary is
severely limited; he must use the utmost good faith and, if he profits from the transaction, the law

11
United States District Court
Northern District of California

10

presumes the agreement was entered into by the beneficiary without sufficient consideration and

12

under undue influence.” Id. (internal quotations omitted). The obligation to put the interests of

13

the other party first is why a fiduciary relationship generally does not arise out of ordinary arms-

14

length business dealings. In a typical business contract or relationship, one party does not commit

15

to act in the other party’s best interest rather than in its own. See, e.g., Scognamillo v. Credit

16

Suisse First Boston LLC, No. C-03-2061 TEH, 2005 WL 2045807, at *4 (N.D. Cal. Aug. 25,

17

2005) (finding no fiduciary relationship because it was “highly unlikely that the CEO and CFO of

18

a company on the other side of a merger deal would seek to act in the target company’s best

19

interests”). This is why a fiduciary relationship will be found only when an individual or entity

20

has knowingly undertaken that high duty or when the law imposes the duty in special relationships

21

such as agency, partnership or joint venture. City of Hope Nat. Med. Center v. Genentech, Inc., 43

22

Cal. 4th 375, 386 (2008); Comm. On Children’s Television, 35 Cal.3d at 222. Consequently, to

23

state a claim for breach of fiduciary duty, WSGI must allege that La Jolla either knowingly agreed

24

to act on behalf and for the benefit of WSGI, or that it entered into a relationship with WSGI that

25

imposed that undertaking as a matter of law. See City of Hope, 43 Cal.4th at 386.

26

WSGI did not meet this requirement. In the wake of the prior dismissal, the amended

27

complaint added three allegations intended to show a fiduciary relationship: (1) “it was WSGI’s

28

understanding that La Jolla would, in addition to, and separate from, any financial agreement
2

1

between the parties, use its expertise as investors as well as its business knowledge to take the role

2

of fiduciaries in advising and supporting WSGI during the growth of its business, acting primarily

3

in and for WSGI’s benefit” (Dkt. No. 38 at 5); (2) La Jolla “made specific statements about how

4

La Jolla was acting, and would continue to act, in the best interest of WSGI and its shareholders”

5

(id. at 11); and (3) “[p]ursuant to the statements and assurances made by La Jolla . . . and WSGI’s

6

understanding of its relationship with La Jolla, La Jolla established, either through their explicit or

7

implicit representations, a fiduciary relationship with WSGI, which included explicit or implicit

8

fiduciary duties to WSGI to act on, and/or for the benefit of WSGI” (id. at 48).
These conclusory allegations do not come close to alleging facts sufficient to impose the

10

exceptional duties of a fiduciary on La Jolla. Taken as a whole, the transactions described in the

11
United States District Court
Northern District of California

9

amended complaint -- and in the deal documents WSGI attached to it (Dkt. No. 38, Exs. A, B, and

12

C) -- were typical arms-length business dealings between an investment house and a company

13

looking to raise money. The amended complaint offers no facts whatsoever showing that La Jolla

14

knowingly undertook the duty of putting WSGI’s interests before its own and acting as WSGI’s

15

fiduciary. The allegation that “it was WSGI’s understanding” that La Jolla was acting primarily in

16

and for its benefit may describe WSGI’s hopes and dreams but it does not demonstrate that La

17

Jolla consciously committed to assuming that role. And the amended complaint does not allege

18

any facts to support the allegation that La Jolla represented that it would “use its expertise as

19

investors as well as its business knowledge to take the role of fiduciaries in advising and

20

supporting WSGI during the growth of its business.” Dkt. No. 38 at 5. Nor does the amended

21

complaint allege anything supporting the existence of a relationship such as joint venture or

22

agency that would impose the duty as a matter of law.
Because WSGI has failed to adequately allege the fiduciary duty claim after two

23
24
25

opportunities, it is dismissed with prejudice.
II.

Intentional Misrepresentation and Fraud In the Inducement

26

As the prior dismissal order held, WSGI’s claims for intentional misrepresentation and

27

fraud in the inducement are subject to the heightened pleading requirements of Federal Rule of

28

Civil Procedure 9(b). The Court dismissed these claims for failure to state the “time, place, and
3

1

specific content of the false representations as well as the identities of the parties to the

2

misrepresentation.” Dkt. No. 36 at 4-5.

3

WSGI responded by adding 22 new allegations in the amended complaint. See Dkt. No.
38 at 4, 11-12, 20-21, 51-52, 54. But most of these additions again fail to state the time, place,

5

specific content of the representations and identities of the parties to the misrepresentation, (see,

6

e.g., Dkt. No. 38 at 4, 51-52, 54-55 (alleging only that sometime in 2011 and 2012, La Jolla made

7

“certain assurances” to WSGI through agents of the companies “including but not limited to”

8

Messrs. Estrella and Huff, and that “from the beginning of the relationship with La Jolla, La Jolla

9

fraudulently induced WSGI, through their factual omissions, to sign the Agreements”)), or they

10

are inactionable puffery, (see, e.g., Dkt. No. 38 at 11, 12, 20 (Mr. Huff’s statement that La Jolla

11
United States District Court
Northern District of California

4

was dedicated to being the “perfect [paraphrasing] financial partner,” and that he “expressed La

12

Jolla’s committed desire to support the stock price in any way it could,” and Mr. Sanberg’s

13

statements about La Jolla’s “continued support of and commitment to WSGI’s well-being,” and

14

“how excited La Jolla was to be associated with WSGI”)). See In re iPass, Inc. Sec. Litig., No. C

15

05-0228 MHP, 2006 WL 496046, at *4 (N.D. Cal. Feb. 28, 2006) (describing puffery as

16

“statements consist[ing] of forward-looking or generalized statements of optimism that are not

17

capable of objective verification, and lack a standard against which a reasonable investor could

18

expect them to be pegged.”) (internal quotations omitted).

19

The few allegations that get by the “who, what, when, where, and how” requirement of

20

Rule 9(b) fail to state fraud claims because they were made well after the parties had executed the

21

contracts. WSGI alleges that on the evening of June 28, 2012 -- approximately five months after

22

the investment agreements were executed in January 2012 -- Mr. Huff told Glenn Estrella, an

23

executive officer for WSGI, at Incanto restaurant in San Francisco that “La Jolla would continue

24

to provide WSGI with capital to fully fund the ongoing operations of WSGI while sponsoring

25

WSGI’s further research and development as well as its marketing initiatives.” Dkt. No. 38 at 11.

26

WSGI alleges similar representations at another in-person meeting between the parties in August

27

2012. Id. at 20-21.

28
4

These statements do nothing to support WSGI’s fraud claims because the ink was already

1
2

dry on the deal documents by the time they were allegedly made, and consequently WSGI could

3

not have relied upon them as a basis for entering into the contracts or relationship. See

4

Manderville v. PCG & S Group, Inc., 146 Cal.App.4th 1486, 1498, 55 Cal.Rptr.3d 59, 69 (2007)

5

(intentional misrepresentation claim requires plaintiff to allege and prove that he or she actually

6

relied upon the misrepresentations and, in the absence of the misrepresentation, would not have

7

entered into the contract); Julius Castle Restaurant Inc. v. Payne, 216 Cal.App.4th 1423, 1442,

8

157 Cal.Rptr.3d 839, 853 (2013) (fraud in the inducement claim requires reasonable reliance on

9

assurances made prior to entering into an agreement). These claims are also dismissed with
prejudice.

11
United States District Court
Northern District of California

10

III.

12

Securities Fraud
Securities fraud claims must satisfy the heightened pleading standards of both Rule 9(b)

13

and the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4. See In re

14

VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694, 701 (9th Cir. 2012). The PSLRA requires a

15

plaintiff alleging securities fraud to “plead with particularity both falsity and scienter.” Zucco

16

Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990-91 (9th Cir. 2009).

17

The Court’s prior order dismissed WSGI’s securities claim because the complaint failed to

18

allege scheme liability under § 10(b) of the Securities Exchange Act and Rule 10b-5, and also

19

failed to adequately allege scienter. See Dkt. No. 36 at 6-7, 8 n.5. Under Rule 10b-5, a defendant

20

who uses a “device, scheme, or artifice to defraud,” or who engages in “any act, practice, or course

21

of business which operates or would operate as a fraud or deceit,” may be liable for securities

22

fraud. 17 C.F.R. § 240.10b-5; WPP Luxembourg Gamma Three Sarl v. Spot Runner, Inc., 655

23

F.3d 1039, 1057 (9th Cir. 2011).

24

As an initial matter, the Court has serious doubts that La Jolla’s alleged conduct falls

25

within the scope of § 10(b) liability. In Stoneridge Inv. Partners v. Scientific-Atlanta, the Supreme

26

Court considered an allegation of scheme liability under § 10(b) where there was no duty to

27

disclose, the alleged deceptive acts were not communicated to the public, and no member of the

28

investing public had knowledge, either actual or presumed, of the alleged deceptive acts. See
5

1

Stoneridge Inv. Partners v. Scientific-Atlanta, 552 U.S. 148, 160, 128 S.Ct. 761, 169 L.Ed.2d 627

2

(2008). The Court found that alleged scheme liability failed because a private cause of action

3

under § 10(b) was not meant to be applied beyond the securities markets to cover “all commercial

4

transactions that are fraudulent and affect the price of a security in some attenuated way.” See id.

5

at 161; Sec. Exch. Comm’n. v. Zandford, 535 U.S. 813, 820, 122 S.Ct. 1899, 153 L.Ed.2d 1 (2002)

6

(“[Section 10(b)] must not be construed so broadly as to convert every common-law fraud that

7

happens to involve securities into a violation”); Marine Bank v. Weaver, 455 U.S. 551, 556, 102

8

S.Ct. 1220, 71 L.Ed.2d 409 (1982) (“Congress, in enacting the securities laws, did not intend to

9

provide a broad federal remedy for all fraud.”). WSGI has not provided the Court any authority
showing that La Jolla’s alleged conduct falls within the confines of a § 10(b) claim, and the Court

11
United States District Court
Northern District of California

10

is reluctant to extend § 10(b) liability to allegations that amount merely to a breach of contract

12

claim. See Foster v. Wilson, 504 F.3d 1046, 1051 (9th Cir. 2007) (finding that “at most” the

13

plaintiff’s claim alleged a breach of contract, and concluding that “[s]uch a breach, however, does

14

not constitute federal securities fraud under § 10(b).”).

15

Even if § 10(b) liability were proper, the additional factual allegations in the amended

16

complaint do not salvage this claim. The alleged fraudulent scheme is that La Jolla bought

17

WSGI’s shares at a deep discount and short sold those shares “to manipulate the stock prices to

18

their advantage.” Dkt. No. 38 at 57. Short selling stock, however, requires that the seller borrow

19

shares for a certain period of time and then return them. See United States v. Deeb, 175 F.3d

20

1163, 1165 n.4 (9th Cir. 1999) (explaining that in a “short sale, an investor contacts his broker and

21

borrows a particular stock from the broker and sells it on the open market. The investor receives

22

the proceeds from the sale and then has a certain amount of time within which to return the

23

borrowed stock to the broker.”) The amended complaint neither alleges that La Jolla borrowed

24

stock from WSGI and subsequently returned it, nor provides any specific details about how La

25

Jolla allegedly manipulated WSGI’s stock price, aside from the details about La Jolla’s history of

26

funding under the Agreements. Moreover, the allegations added to the amended complaint to

27

support WSGI’s claims for fraudulent inducement and intentional misrepresentation do not bolster

28
6

1

its § 10(b) claim, because they do not pertain to the alleged scheme to sell WSGI’s shares at a

2

deep discount or through short sales.

3

In addition, the amended complaint does not allege a proper inference of scienter on the

4

part of La Jolla. Post-PSLRA, a plaintiff must allege with particularity facts giving rise to a strong

5

inference that the defendant acted with the required state of mind. See 15 U.S.C. § 78u-4(b)(2).

6

At minimum, a plaintiff must plead particular facts giving rise to a strong inference of deliberate

7

or conscious recklessness. See No. 84 Employer-Teamster Joint Council Pension Trust Fund v.

8

America West Holding Corp., 320 F.3d 920, 937 (9th Cir. 2003). Even considering the complaint

9

as a whole, WSGI has failed to plead the existence of a strong inference that anyone at La Jolla
acted with deliberate or conscious recklessness in allegedly purchasing and selling WSGI’s shares.

11
United States District Court
Northern District of California

10

The Court dismisses this cause of action with prejudice, as WSGI has had two opportunities to

12

plead this claim.
CONCLUSION

13
14

WSGI’s claims for breach of fiduciary duty, intentional misrepresentation, fraud in the

15

inducement and securities fraud are dismissed with prejudice. WSGI’s other claims for breach of

16

contract, breach of covenant of good faith and fair dealing, open book account, account stated and

17

UCL violation will go forward.

18

IT IS SO ORDERED.

19
20
21

Dated: September 2, 2014
______________________________________
JAMES DONATO
United States District Judge

22
23
24
25
26
27
28
7