Colman et al v. Theranos, Inc. et al

Filing 63

ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS; ORDER TO SHOW CAUSE RE: JOINDER OF LUCAS VENTURE GROUP, CELADON TECHNOLOGY FUND, AND SHAREPOST. Re: Dkt. 29 . Response due 4/26/2017. Defendants may respond by 5/3/2017. Signed by Judge Nathanael Cousins. (lmh, COURT STAFF) (Filed on 4/18/2017)

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UNITED STATES DISTRICT COURT

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NORTHERN DISTRICT OF CALIFORNIA

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ROBERT COLMAN, et al.,
Plaintiffs,

United States District Court
Northern District of California

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v.

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THERANOS, INC., et al.,

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Defendants.

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Case No.16-cv-06822-NC
ORDER GRANTING IN PART AND
DENYING IN PART DEFENDANTS’
MOTION TO DISMISS; ORDER TO
SHOW CAUSE RE: JOINDER OF
LUCAS VENTURE GROUP,
CELADON TECHNOLOGY FUND,
AND SHAREPOST
Re: Dkt. No. 29

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Defendant Theranos, Inc. is a private life sciences company founded in 2003 by
defendant Elizabeth Holmes. Theranos purported to have developed proprietary
technology that would allow commercial pharmacies to run a multitude of highly accurate
blood tests from a few drops of a patient’s blood. Beginning in 2013, Theranos began an
extensive advertising campaign and concluded a contract with Walgreens to promote its
technology. From 2013 to 2015, Holmes and Theranos gave dozens of interviews and
press releases to emphasize the groundbreaking possibility of their technology. Defendant
Ramesh Balwani was the President, Chief Operating Officer, and board member of
Theranos during that time. Plaintiffs allege that the advertising campaign was for the
purpose of raising capital. Theranos is financed by private individual investors and
investment funds and has raised over $700 million.
Case No. 16-cv-06822-NC

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On October 15, 2015, the Wall Street Journal published an exposé questioning the

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existence and future viability of Theranos’ technology. The exposé prompted

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investigations by regulators, and in July 2016, the Center for Medicare and Medicaid

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Services imposed significant sanctions on Theranos. In November 2016, Walgreens sued

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Theranos for breach of contract.

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Plaintiffs Robert Colman and Hilary Taubman-Dye purchased Theranos securities

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through third-party investment funds. Colman purchased the securities in September 2013

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through a member interest in Lucas Venture Group XI. He alleges that the sole purpose of

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the venture group was to purchase Series G Theranos Shares. Taubman-Dye purchased the
securities in August 2015 from Celadon Technology Fund (through SharePost Financial

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United States District Court
Northern District of California

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Corporation). She alleges that the sole purpose of the Celadon Technology Fund was to

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acquire Series C preferred shares of Theranos.

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Needless to say, plaintiffs are now displeased that their investments have allegedly

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become worthless. Plaintiffs bring their class action complaint under California state law

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theories of securities fraud under the California Corporations Code and fraud under

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common law. They sue on behalf of all persons or entities who directly or indirectly

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purchased an interest in Theranos securities from July 29, 2013 through October 5, 2016.

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Defendants Theranos, Holmes, and Balwani move to dismiss. The question

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presented to the Court is whether plaintiffs, as indirect share purchasers, can hold Theranos

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and its officers liable for securities fraud. The Court finds that plaintiffs can proceed under

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California Corporations Code § 25400(d) because that code section seeks to protect the

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market generally from a security seller’s misrepresentations. However, the Court finds

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that California Corporations Code § 25401 is limited to a suit by the buyer against the

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seller, and plaintiffs cannot pursue their claim against these defendants. Finally, plaintiffs

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sufficiently allege a cause of action for common law fraud, which is sufficient to sustain

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their remaining claims. In addition, the Court finds that the intermediaries, Lucas Venture

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Group, Celadon Technology Fund, and SharePost are necessary parties under Federal Rule

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of Civil Procedure 19.
Case No.16-cv-06822-NC

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I.

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LEGAL STANDARD
A motion to dismiss for failure to state a claim under Rule 12(b)(6) tests the legal

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sufficiency of a complaint. Navarro v. Block, 250 F.3d 729, 732 (9th Cir. 2001). On a

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motion to dismiss, all allegations of material fact are taken as true and construed in the

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light most favorable to the non-movant. Cahill v. Liberty Mut. Ins. Co., 80 F.3d 336, 337-

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38 (9th Cir. 1996). The Court, however, need not accept as true “allegations that are

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merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” In re

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Gilead Scis. Secs. Litig., 536 F.3d 1049, 1055 (9th Cir. 2008). Although a complaint need

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not allege detailed factual allegations, it must contain sufficient factual matter, accepted as
true, to “state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly,

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United States District Court
Northern District of California

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550 U.S. 544, 570 (2007). A claim is facially plausible when it “allows the court to draw

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the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft

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v. Iqbal, 556 U.S. 662, 678 (2009).

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If a court grants a motion to dismiss, leave to amend should be granted unless the

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pleading could not possibly be cured by the allegation of other facts. Lopez v. Smith, 203

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F.3d 1122, 1127 (9th Cir. 2000).

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II.

DISCUSSION

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Defendants’ motion to dismiss surrounds the uncontroverted fact that plaintiffs did

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not purchase their securities directly from defendants Theranos, Holmes, or Balwani. The

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parties do not dispute that an intermediary was used to purchase the shares, that the shares

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were not available on the open market for sale, and that the intermediaries are not named

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defendants in this lawsuit. Thus, the Court first considers whether the causes of action

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related to securities fraud under the California Corporations Code can be asserted by these

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plaintiffs against these defendants. Second, the Court considers whether common law

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fraud can be asserted by these plaintiffs against these defendants.

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At the outset, the Court notes that the 58-page complaint is factually detailed,

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specific, and sufficiently places defendants on notice of the accused conduct. To plead

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fraud under Rule 9(b), “a party must state with particularity the circumstances constituting
Case No.16-cv-06822-NC
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fraud.” “Plaintiffs’ complaint must identify the who, what, when, where, and how of the

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misconduct charged, as well as what is false or misleading about the purportedly

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fraudulent statement, and why it is false.” Salameh v. Tarsadia Hotel, 726 F.3d 1124, 1133

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(9th Cir. 2013). Here, the complaint lists a number of articles and the specific claims made

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touting Theranos’ technology. The Court finds that the complaint states with sufficient

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particularity the circumstances constituting fraud to fulfill the Rule 9(b) standard. The

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Court separately analyzes the sufficiency of these facts in establishing a fraud claim below.

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A.

California Corporations Code §§ 25400(d), 25500

Defendants first argue that plaintiffs’ first cause of action is barred as a matter of
law because plaintiffs did not purchase their securities from Theranos. California

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United States District Court
Northern District of California

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Corporations Code § 25400(d) provides that it is unlawful for a person selling or offering

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for sale securities “to make, for the purpose of inducing the purchase or sale of such

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security by others, any statement which was, at the time and in the light of the

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circumstances under which it was made, false or misleading with respect to any material

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fact, or which omitted to state any material fact.”

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The California Corporate Securities Law can be enforced by (1) criminal

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prosecution, (2) civil action, or (3) administrative action brought by the Commissioner.

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People ex rel. DuFauchard v. O'Neal, 179 Cal. App. 4th 1494, 1501 (2009), as modified

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(Dec. 29, 2009). The civil enforcement mechanism for Section 25400(d) is Section 25500.

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Section 25500 provides a right for individuals to sue for damages in the amount of “the

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difference between the price at which such other person purchased or sold securities and

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the market value which such securities would have had at the time of his purchase or sale

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in the absence of such act or transaction, plus interest at the legal rate.” Cal. Corp. Code §

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25500. Section 25500 “extends liability to all persons affected by market manipulation

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without requiring reliance or privity. But, section 25500 is limited to intentional

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misrepresentations.” California Amplifier, Inc. v. RLI Ins. Co., 94 Cal. App. 4th 102, 109

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(2001).

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Case No.16-cv-06822-NC

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Defendants argue that the Section 25400 reference to “such security” requires the

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plaintiffs to have purchased the same security as was offered for sale, i.e., Theranos must

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have sold directly to plaintiffs. Dkt. No. 29 at 15. Defendants also note that even if

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liability attaches, it should only attach to Theranos, as the complaint does not allege that

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Holmes and Balwani themselves sold or offered to sell any security.

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In California Amplifier, the California Supreme Court considered a similar
provision in 25500 and concluded that: “section 25500 provides that the price of the

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security must be ‘affected by such act or transaction’ in order for there to be liability.

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Since only the false or misleading statement can affect the price of the security, ‘such act

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or transaction’ must be interpreted as referring to the false or misleading statement itself.”

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United States District Court
Northern District of California

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94 Cal. App. 4th 102, 111-12 (2001).

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The California Supreme Court also interpreted these sections together in assessing

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whether out-of-state plaintiffs could sue under Section 25500. In Diamond Multimedia

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Sys., Inc. v. Superior Court, 19 Cal. 4th 1036, 1048 (1999), the Court noted that Section

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25400 “regulates market manipulation, not third party transactions affected by market

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manipulation.” Id. at 1048. The Court concluded that “Section 25500 does not limit a

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violator’s liability to persons who purchase or sell stock in California. ‘Any’ person

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affected by acts of market manipulation which take place in California may recover

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damages from the violator.” Id.

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These cases caution against a narrow interpretation of the statute. The purpose of

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Section 25400(d) is prevent the manipulation of the market by fraud, and it focuses on the

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actions of the seller of the securities, not the relationship between seller and buyer.

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Notably, neither section requires plaintiffs to prove their reliance on the

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misrepresentations. California Amplifier, Inc., 94 Cal. App. 4th at 109.

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However, Sections 25400 and 25500 are not unlimited in their reach. Plaintiffs

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must still prove defendants’ intent to induce the purchase of securities through misleading

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statements, which necessarily limits the relationship between a seller and foreseeable

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buyers.
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As to defendants’ arguments that Holmes and Balwani, the statute allows for

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liability for any person who makes false or misleading statements. California Amplifier,

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94 Cal. App. 4th at 114. The complaint alleges that Holmes and Balwani made misleading

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statements on behalf of Theranos for the purpose of inducing purchases of Theranos stock.

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The Court has not found any persuasive authority limiting these sections to only the

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corporate entity that sells the stock.
In conclusion, the motion to dismiss as to plaintiffs’ first cause of action is

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DENIED.

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B.

California Corporations Code §§ 25401, 25501

Plaintiffs’ second cause of action under California Corporations Code §§ 25401,

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United States District Court
Northern District of California

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25501 similarly targets a security seller’s misrepresentations. “Sections 25501 and 25502

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extend liability to some negligent conduct, but retain the privity requirement from common

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law fraud.” California Amplifier, 94 Cal. App. 4th at 109. Thus, while Sections 25400

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and 25500, discussed above, focus on the defendants’ actions and not the relationship

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between the parties, Sections 25401 and 25501 focus on the relationship between the

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parties. As above, Section 25401 provides the description of the wrongful conduct, while

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25501 provides the civil enforcement mechanism.1 In relevant part, Section 25501

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provides that “Any person who violates Section 25401 shall be liable to the person who

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purchases a security from him or sells a security to him, who may sue either for rescission

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or for damages.”
In Apollo Capital Fund, LLC v. Roth Capital Partners, LLC, 158 Cal. App. 4th 226,

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253 (2007), the California Appellate Court analyzed whether Section 25501 permits

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liability when an intermediary purchased and resold the security. The Court reasoned:

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Cal. Corp. Code § 25401 provides: “It is unlawful for any person to offer or sell a
security in this state, or to buy or offer to buy a security in this state, by means of any
written or oral communication that includes an untrue statement of a material fact or omits
to state a material fact necessary to make the statements made, in the light of the
circumstances under which the statements were made, not misleading.”
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Case No.16-cv-06822-NC

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“Section 25501 on its face requires privity between the plaintiff and the defendant. The

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investors purchased their securities from eNucleus, not from Roth, which acted as

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eNucleus’s placement agent. Consequently, Roth cannot be civilly liable for a violation of

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section 25401.” Id. A separate court similarly noted that “the statute, by its terms, limits

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recovery to plaintiffs who purchased the security from the defendant.” People ex rel.

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O’Neal, 179 Cal. App. 4th at 1503.

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Thus, the Court finds defendants’ arguments persuasive as to these sections.

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Plaintiffs have not alleged privity, and it appears from the facts alleged and represented

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that no privity exists. The motion to dismiss this claim is GRANTED. Plaintiffs have not
made any proffer that this cause of action could be cured by amendment, so the claim

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United States District Court
Northern District of California

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against the present defendants is dismissed without leave to amend.

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C.

Elements of Fraud

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The core of plaintiffs’ pleadings is an allegation of fraud, the elements of which are

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incorporated in the code sections discussed above and in the common law causes of action.

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In the interest of efficiency, the Court will only analyze the elements of fraud, as these

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apply to most of the substantive claims in the case.

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“The elements of fraud, which give rise to the tort action for deceit, are (a)

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misrepresentation (false representation, concealment, or nondisclosure); (b) knowledge of

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falsity (or ‘scienter’); (c) intent to defraud, i.e., to induce reliance; (d) justifiable reliance;

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and (e) resulting damage.” Lazar v. Superior Court, 12 Cal. 4th 631, 638 (1996).

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Defendants challenge plaintiffs’ allegations of reliance. The Court agrees with

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plaintiffs that the complaint here is distinguishable from the complaint in People for the

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Ethical Treatment of Animals v. Whole Foods Mkt. California, Inc., No. 15-cv-04301 NC,

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2016 WL 362229, at *4 (N.D. Cal. Jan. 29, 2016). Here, plaintiffs list the specific

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newspaper articles that were part of the advertising campaign touting Theranos’

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technology. The complaint alleges that Colman’s purchase occurred after receiving the

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September 8th Wall Street Journal article and the September 9th Theranos press release

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from Lucas. As to Taubman-Dye, the complaint alleges her reliance on Theranos and
Case No.16-cv-06822-NC

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Holmes’ statements from 2013 to 2015. Finally, on a motion to dismiss, the Court must

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draw all inferences in favor of plaintiffs, and the Court can reasonably infer that such

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advertisements would induce an individual to invest in the company. The Court finds

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these allegations to be reasonably specific and plausibly state a claim for fraud.

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Thus, the Court DENIES the motion to dismiss as to all other claims in the case.
III. CONCLUSION
The Court finds that plaintiffs may not proceed against Theranos for claims under

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California Corporations Code §§ 25401, 25501 because there is no privity between the

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parties. The motion to dismiss as to this claim is GRANTED. As to all other claims, the

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motion to dismiss is DENIED. Defendants must answer the complaint within 14 days.

United States District Court
Northern District of California

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However, the Court finds defendants’ concerns about the intermediary relationship

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to be valid. The Court also notes that plaintiffs suggest that the intermediary sellers exist

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as an agent of Theranos. Federal Rule of Civil Procedure 19 requires the joinder of a party

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that “claims an interest relating to the subject of the action and is so situated that disposing

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of the action in the person’s absence may: (i) as a practical matter impair or impede the

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person’s ability to protect the interest; or (ii) leave an existing party subject to a substantial

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risk of incurring double, multiple, or otherwise inconsistent obligations because of the

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interest.” The Court finds that Lucas Venture Group, Celadon Technology Fund, and

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SharePost are entities required to be joined in this case; however, Rule 19 provides an

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exception for joinder of parties when venue would be disturbed. Thus, by April 26, 2017,

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the plaintiffs must SHOW CAUSE why Lucas Venture Group, Celadon Technology Fund,

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and SharePost should not be joined as defendants in this case. Defendants may respond by

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May 3, 2017.

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IT IS SO ORDERED.

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Dated: April 18, 2017

_____________________________________
NATHANAEL M. COUSINS
United States Magistrate Judge

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Case No.16-cv-06822-NC

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