Heath v. Root9B et al
Filing
50
RECOMMENDATION OF UNITED STATES MAGISTRATE JUDGE by Magistrate Judge Kathleen M. Tafoya on 3/4/19 re 29 MOTION to Dismiss Third Amended Complaint filed by Eric Hipkins, 30 MOTION to Dismiss Amended Complaint or in the Alternativ e, for Summary Judgment filed by Root9B. Defendant Eric Hipkins Motion to Dismiss the Third Amended Complaint [Doc. No. 29] be GRANTED and that all claims against Defendant Eric Hipkins be dismissed. Defendant Root9Bs Motion to Dismiss [Doc. N o. 30] be GRANTED in part and DENIED in part. Root9Bs Motion should be DENIED with respect to its arguments pursuant to Fed. R. Civ. P. 12(b)(1), DENIED as unnecessary insofar as the motion requests conversion to summary judgment and GRANTED as to Cl aim One, violations of 18 U.S.C. § 1348. The court further RECOMMENDS that Plaintiff be allowed to file an amended complaint to assert claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b5 against both defendants within a specified time period consistent with this Recommendation. (nmarb, )
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLORADO
Civil Action No. 18–cv–01516–RBJ–KMT
MARY HEATH,
Plaintiff,
v.
ROOT9B, and
ERIC HIPKINS,
Defendants.
RECOMMENDATION OF UNITED STATES MAGISTRATE JUDGE
Magistrate Judge Kathleen M. Tafoya
This case comes before the court on Defendant Eric Hipkins’ Motion to Dismiss the
Third Amended Complaint [Doc. No. 29] (“Hipkins Mot.”) filed August 27, 2018, to which
Plaintiff Mary Heath, acting pro se, filed a Response [Doc. No. 32] on August 28, 2018 and to
which Defendant Hipkins filed a Reply on September 7, 2018 [Doc. No. 38].
Also before the court is Defendant Root9b’s “Motion to Dismiss Amended Complaint or,
in the Alternative, for Summary Judgment” [Doc. No. 30] (“Root9b Mot.”) filed August 27,
2018), to which Plaintiff filed a Response on August 28, 2018 [Doc. No. 33] and Defendant
Root9B filed a Reply [Doc. No. 40] on September 11, 2018.
BACKGROUND AND FACTS
Plaintiff filed her Third Amended Complaint [Doc. No. 23] (“TAC”) on August 13, 2018.
Plaintiff cites her statutory authority to bring a federal action as “Federal question pursuant to 28
U.S.C. § 1331” and “18 U.S. Code 1348 – Securities and Commodities Fraud.” (TAC at 3.)
Plaintiff brings two claims against Defendant Root9B1 and Defendant Eric Hipkins. Claim One
alleges “Root9B & Eric Hipkins have committed Securities & Commodities Fraud.” Under the
“Supporting Facts” section of the TAC Plaintiff states, “They swindled their investors out of
millions of dollars.” (Id. at 4.) Claim Two alleges the defendants “falsely advertised they are the
#1 Cybersecurity Company” and references the narrative beginning on page 6 of the TAC. (Id.
at 5.)
Plaintiff asserts she was interested in investing in technical stocks so she “googled the #1
Cybersecurity Company.” (Id. at 7.) She says she came upon articles in which Root9b2 was
represented by Eric Hipkins as being the “#1 Cybersecurity 500 for the 4th consecutive quarter.”
(Id.) Before she made any investment in Root9b, Plaintiff claims she called Root9b’s “office on
the NYSE” at 212-371-8660 and spoke to a male who answered the phone who told her, “Root9b
was reorganizing to become a company that has all its resources going to cybersecurity.” (Id. at
8.) The same male allegedly also told her Root9b was “close, if not completing a contract with
the Federal Government. This contract with the Federal Government would bring in millions of
dollars.” (Id.)
Plaintiff asserts that she “first invest[ed] in Root9b” on May 16, 2017 and “purchased
over 64,000 shares of Root9b” over “the next approximately 7 months[.]” (Id. at 7.) The TAC
1
Plaintiff states that she “use[s] the name Root9b as the Defendant name “because they have
constantly changed their name from Root9b LLC to Root9b Technology to Root9b Holdings.”
(Id. at 7.)
2
The parties spell the Defendant “Root9B” and “Root9b” and “root9B and “root9b”
interchangeably. Unless specifically quoting from a document, the court will reference the
Defendant company as Root9b simply for consistency in this Order.
2
does not state what price per share Plaintiff paid for her stock. Plaintiff claims that on July 12,
2017, she called the Root9b office in Colorado Springs to express an interest in attending a
stockholder’s meeting for Root9b and spoke to an employee.3 She was discouraged from
attending the meeting, but the employee told her “the company was growing.” (Id. at 9.) When
Plaintiff expressed concern that the stock price was dropping, the employee allegedly told
Plaintiff, “they have been speaking to investors, but this is good for stockholders. The investors
will pay off the debt & stabilize the company.” (Id.)
Plaintiff alleges that between May 19, 2017 and June 29, 2017, Quad Capital
Management (“Quad”) began purchasing RTNB stock and eventually obtained 378,697 shares of
RTNB.4 Plaintiff provides no information in the TAC about the ownership or membership or
officers of Quad. Plaintiff claims that the stock price of Root9b rose to $11.99 per share. (Id.)
During or near the same time period, Plaintiff alleges “Root9b Holdings, Inc. . . . issued a series
of secured convertible promissory notes to accredited investors.” (Id. at 10.) The TAC contains
no identification of the investors. On or about August 11, 2017, those investors demanded
“immediate repayment of all outstanding amounts due” associate with the notes, alleging
improprieties under the loan provisions. (Id.) On August 22 and 23, 2017, Quad sold all its
RTNB stock, and two days later when an unspecified “press release” was issued, the company’s
stock allegedly fell to “less than $2.00.” (Id.)
3
Plaintiff implies that she knows the name of the individual she spoke to at Root9b in Colorado
Springs, Colorado, but she does not want to state his name in the TAC because “I do not want to
get this person in trouble.” (Id. at 8.)
4
The court cannot ascertain whether RTNB is a stock ticker symbol or the name of a predecessor
company.
3
The TAC alleges that the investors foreclosed on the promissory notes issued to them. 5
(Id.) The investors took all Root9b’s assets, including full ownership of Root9b, LLC, a private
entity which was apparently a Root9b Holdings’ subsidiary. (Id.) The secured investors
therefore became the sole owners of Root9b, LLC, the private entity. (Id.at 10–11.) The
investors then sold the remaining assets of Root9b Holding, Inc. at a foreclosure sale to Tracker
Capital Management.6 (Id. at 11.) Plaintiff claims that the Asset Acquisition Agreement
between the secured creditors and Tracker Capital Management contains confidentiality
provisions that she has not been allowed to see. (Id. at 12.) Plaintiff asserts that Eric Hipkins
still has ownership of “the company.” (Id. at 13.) Plaintiff claims she and other stockholders in
the “worthless Root9b Holdings” were left holding worthless stock and concludes that “insiders”
pocketed all the money received from sales of the stock at the Quad inflated price and retained
unencumbered ownership of the cybersecurity business. (Id. at 11.)
According to Plaintiff, Root9b evolved into two companies—Root9b, LLC and Root9b
Holdings. (Id. at 12.) Plaintiff contends Root9b failed to protect the financial interests of its
investors.
While disagreeing with Plaintiff’s conclusions, Root9b does not significantly disagree
with the Plaintiff’s factual version of events and transactions set forth in the TAC with respect to
the business dealings of Root9b. (Root9b Mot. at 3–4.)
5
Plaintiff’s states also that “[t]he company that took RTNB stock to $12.00/share also foreclosed
on Root9b.” (Id. at 10.) The court deems this statement to be a conclusion, not a fact, and it
appears to be inconsistent with the facts set forth in the TAC that allege that the investors
foreclosed on promissory notes, not Quad.
6
Plaintiff alleges Tracker Capital Management purchased Root9b on September 28, 2018, and
that the company transferred to Tracker with no debt. (TAC at 12.)
4
The parties agree that Tracker Capital Management “has no connection or affiliation to
[Root9b]” and “purchased the Foreclosed Assets from the Secured Creditors for fair value
pursuant to an arms-length business transaction negotiated between sophisticated commercial
entities.” (Id.) The sole variance between the Defendants and Plaintiff regarding these facts (as
opposed to conclusions drawn therefrom) is whether Eric Hipkins retains any ownership of
Root9b, LLC.7 (Root9B Mot. at 5; Bremer Decl. at ¶ 14.)
LEGAL STANDARDS
A. Pro se Plaintiff
Plaintiff is proceeding pro se. The court, therefore, “review[s] h[er] pleadings and other
papers liberally and hold[s] them to a less stringent standard than those drafted by attorneys.”
Trackwell v. United States, 472 F.3d 1242, 1243 (10th Cir. 2007) (citations omitted). See also
Haines v. Kerner, 404 U.S. 519, 520–21 (1972) (holding allegations of a pro se complaint “to
less stringent standards than formal pleadings drafted by lawyers”). Pro se plaintiffs must
“follow the same rules of procedure that govern other litigants” and “must still allege the
necessary underlying facts to support a claim under a particular legal theory.” Thundathil v.
Sessions, 709 Fed. App’x 880, 884 (10th Cir. 2017) (citations and internal quotation mark
omitted). “[A] pro se plaintiff requires no special legal training to recount the facts surrounding
his alleged injury, and he must provide such facts if the court is to determine whether he makes
out a claim on which relief can be granted.” Hall, 935. F2d at 1110. A pro se litigant’s
7
Of course, at the motion to dismiss stage, the court will presume all of plaintiff’s factual
allegations are true in any event and will construe them in the light most favorable to the
plaintiff. Hall v. Bellmon, 935 F.2d 1106, 1109 (10th Cir. 1991).
5
“conclusory allegations without supporting factual averments are insufficient to state a claim
upon which relief can be based.” Id.
Courts “cannot take on the responsibility of serving as the litigant’s attorney in
constructing arguments” or the “role of advocate” for a pro se plaintiff. Garrett v. Selby Connor
Maddux & Janer, 425 F.3d 836, 840 (10th Cir. 2005). A court may not assume that a plaintiff
can prove facts that have not been alleged, or that a defendant has violated laws in ways that a
plaintiff has not alleged. Assoc. Gen. Contractors of Cal., Inc. v. Cal. State Council of
Carpenters, 459 U.S. 519, 526 (1983). See also Whitney v. New Mexico, 113 F.3d 1170, 1173–
74 (10th Cir. 1997) (court may not “supply additional factual allegations to round out a plaintiff's
complaint”); Drake v. City of Fort Collins, 927 F.2d 1156, 1159 (10th Cir.1991) (the court may
not “construct arguments or theories for the plaintiff in the absence of any discussion of those
issues”). The plaintiff's pro se status does not entitle her to application of different rules. See
Montoya v. Chao, 296 F.3d 952, 957 (10th Cir. 2002).
B. Subject Matter Jurisdiction
Federal Rule of Civil Procedure Rule 12(b)(1) empowers a court to dismiss a complaint
for lack of subject matter jurisdiction. Fed. R. Civ. P. 12(b)(1). Dismissal under Rule 12(b)(1) is
not a judgment on the merits of a plaintiff s case. Rather, it calls for a determination that the
court lacks authority to adjudicate the matter, attacking the existence of jurisdiction rather than
the allegations of the complaint. See Castaneda v. INS, 23 F.3d 1576, 1580 (10th Cir. 1994)
(recognizing federal courts are courts of limited jurisdiction and may only exercise jurisdiction
when specifically authorized to do so). The burden of establishing subject matter jurisdiction is
on the party asserting jurisdiction. Basso v. Utah Power & Light Co., 495 F.2d 906, 909 (10th
6
Cir. 1974). A court lacking jurisdiction “must dismiss the cause at any stage of the proceedings
in which it becomes apparent that jurisdiction is lacking.” See Basso, 495 F.2d at 909. The
dismissal is without prejudice. Brereton v. Bountiful City Corp., 434 F.3d 1213, 1218 (10th Cir.
2006); see also Frederiksen v. City of Lockport, 384 F.3d 437, 438 (7th Cir. 2004) (noting that
dismissals for lack of jurisdiction should be without prejudice because a dismissal with prejudice
is a disposition on the merits which a court lacking jurisdiction may not render).
A Rule 12(b)(1) motion to dismiss “must be determined from the allegations of fact in the
complaint, without regard to mere conclusionary allegations of jurisdiction.” Groundhog v.
Keeler, 442 F.2d 674, 677 (10th Cir. 1971). When considering a Rule 12(b)(1) motion, however,
the court may consider matters outside the pleadings without transforming the motion into one
for summary judgment. Holt v. United States, 46 F.3d 1000, 1003 (10th Cir. 1995). Where a
party challenges the facts upon which subject matter jurisdiction depends, a district court may
not presume the truthfulness of the complaint’s “factual allegations . . . [and] has wide discretion
to allow affidavits, other documents, and [may even hold] a limited evidentiary hearing to
resolve disputed jurisdictional facts under Rule 12(b)(1).” Id.
The party invoking federal jurisdiction has the burden of establishing standing. Lujan v.
Defs. of Wildlife, 504 U.S. 555, 561 (1992). In addition to asserting an injury, this requires the
party to show “her injury is ‘fairly traceable to the challenged action of the defendant, and not
the result of the independent action of some third party not before the court,’ ” and that such
injury is likely to be redressed by the relief sought. Nova Health Sys. v. Gandy, 416 F.3d 1149,
1156 (10th Cir. 2005) (quoting Lujan, 504 U.S. at 560). The law in this circuit is clear that a
plaintiff lacks standing if she “fail[s] to demonstrate the necessary causal connection between
7
[her] injury and these defendants,” including by failing to present evidence that the defendants
“have done or have threatened to do anything that presents a substantial likelihood of causing
[plaintiff] harm.” Id. at 1156–57.
C. Failure to State a Claim
Federal Rule of Civil Procedure 12(b)(6) provides that a defendant may move to dismiss
a claim for “failure to state a claim upon which relief can be granted.” Fed. R. Civ. P. 12(b)(6).
“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.” Dubbs v. Head Start, Inc., 336 F.3d
1194, 1201 (10th Cir. 2003) (quotation marks omitted).
“A court reviewing the sufficiency of a complaint presumes all of plaintiff’s factual
allegations are true and construes them in the light most favorable to the plaintiff.” Hall, 935
F.2d at 1109. “To survive a motion to dismiss, a complaint must contain sufficient factual
matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’” Ashcroft v.
Iqbal, 556 U.S. 662, 678 (2009) (citing Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570
(2007)). Plausibility, in the context of a motion to dismiss, means that the plaintiff pleaded facts
which allow “the court to draw the reasonable inference that the defendant is liable for the
misconduct alleged.” Id. The Iqbal evaluation requires two prongs of analysis. First, the court
identifies “the allegations in the complaint that are not entitled to the assumption of truth,” that
is, those allegations which are legal conclusion, bare assertions, or merely conclusory. Id. at
679–81. Second, the Court considers the factual allegations “to determine if they plausibly
8
suggest an entitlement to relief.” Id. at 681. If the allegations state a plausible claim for relief,
such claim survives the motion to dismiss. Id. at 679.
Notwithstanding, the court need not accept conclusory allegations without supporting
factual averments. S. Disposal, Inc., v. Texas Waste, 161 F.3d 1259, 1262 (10th Cir. 1998).
“[T]he tenet that a court must accept as true all of the allegations contained in a complaint is
inapplicable to legal conclusions. Threadbare recitals of the elements of a cause of action,
supported by mere conclusory statements, do not suffice.” Iqbal, 556 U.S at 678. Moreover,
“[a] pleading that offers ‘labels and conclusions’ or ‘a formulaic recitation of the elements of a
cause of action will not do.’ Nor does the complaint suffice if it tenders ‘naked assertion[s]’
devoid of ‘further factual enhancement.’ ” Id. (citation omitted). “Where a complaint pleads
facts that are ‘merely consistent with’ a defendant’s liability, it ‘stops short of the line between
possibility and plausibility of ‘entitlement to relief.’ ” Id. (citation omitted).
In evaluating a Rule 12(b)(6) motion to dismiss, courts may consider not only the
complaint itself, but also attached exhibits and documents incorporated into the complaint by
reference. Smith v. United States, 561 F.3d 1090, 1098 (10th Cir. 2009) (citations omitted).
“[T]he district court may consider documents referred to in the complaint if the documents are
central to the plaintiff’s claim and the parties do not dispute the documents’ authenticity.” Id.
(quotations omitted).
ANALYSIS
A. Standing/Subject Matter Jurisdiction.
As an irreducible constitutional minimum, a plaintiff must satisfy three criteria in order
for there to be a “case or controversy” that may be resolved by the federal courts. Lujan v.
9
Defenders of Wildlife, 504 U.S. 555, 560 (1992). First, the plaintiff must have suffered an
“injury in fact”—an invasion of a legally protected interest that is both (a) concrete and
particularized and (b) actual or imminent, not conjectural or hypothetical. Id. Second, there
must be a causal connection between that injury and the challenged action of the defendant—the
injury must be “fairly traceable” to the defendant, and not the result of the independent action of
some third party. Id. Finally, it must be likely, not merely speculative, that a favorable judgment
will redress the plaintiff’s injury. Id. at 561. See also Nova Health Sys. v. Gandy, 416 F.3d
1149, 1154 (10th Cir. 2005). The causal connection requires that the defendant’s actions caused
the harm to Plaintiff. Id. at 1156-57. Root9b, LLC argues that it is the defendant in this action
and that Root9b, LLC did not cause any harm to Plaintiff. Therefore, the Plaintiff lacks standing
to bring claims against it.
At the outset, the court notes that the law firm of Ireland Stapleton Pryor & Pascoe, PC,
has taken it upon itself without authorization to amend the caption of the instant case to show
Root9b, a Colorado limited liability company, as one of the defendants in this action. Ireland
Stapleton Pryor & Pascoe, PC purports to represent Root9b, LLC. (See Root9b Mot.) Plaintiff
filed the case against the entity Root9B. She did not include the term “a Colorado limited
liability company” in her caption on her originally filed Complaint nor on any of her Amended
Complaints. [Doc. Nos. 1, 13 (which added the phrase “including directors of the company”), 21
or 23, the operative complaint.] Nor did the Plaintiff describe the Defendant in her lawsuit in
terms of its organizational structure in the body of the documents. The official caption of this
case is Mary Heath, Plaintiff v. Root9B and Eric Hipkins, Defendants.
10
For reasons not entirely clear to the court, Ireland Stapleton Pryor & Pascoe, PC insist
that Plaintiff served Root9b, LLC and that Root9b, LLC is the Defendant entity. This, too, is
factually incorrect. The Process Receipt and Return from the U.S. Marshals Service [Doc. No.
8] shows the entity “Root9B” was served on July 12, 2018 at 102 N. Cascade Avenue, Suite 220,
Colorado Springs, CO. The Chief Operating Officer for Root9b, listed as John Harbaugh, was
the individual who accepted service on behalf of the Defendant. As a limited liability company,
it is unlikely that Root9B, LLC has either a Chief Operating Officer (or any officers at all) or
Directors, although as such companies are by definition not public entities, the members can
structure an LLC in whatever way they see fit.
According to Annual Report, Form 10–K filed by ROOT9B HOLDINGS, INC., root9b
Holdings, Inc. is located at 102 N. Cascade Avenue, Suite 220, Colorado Springs, CO 80919, the
location where service was made by the Plaintiff. (Root9b Mot., Ex. 1–A [Doc. No. 30–2] at 2;
Process Receipt [Doc. No. 8].) ROOT9B, LLC, by contrast, according to documents submitted
by Root9b, LLC, is a Limited Liability Company with its principal office mailing address at 90
S. Cascade, Ave. #830, Colorado Springs, CO 80903, and the registered agent for service of
process for ROOT9B, LLC is Eric Scott Hipkins. (Root9b Mot., Ex. 1–B [Doc. No. 30–3] at 2.)
Root9B Holdings states, in the Form 10K, [Doc. No. 30–2] that “references to “we,”
“our,” “us,” “the Company,” or “root9B” refer to root9b Holdings, Inc. (Id. at 5.) Throughout
the document, root9B Holdings, Inc. refers to itself as root9b or root9B. root9B Holdings, Inc.
represented that in 2014 it became root9B Technologies, Inc. and RTNB to distinguish itself
from root9B Holdings, Inc.’s wholly owned subsidiary, root9B, LLC. (Id. at 5.) root9b
Technologies changed its name to root9B Holdings, Inc.in December 2016. During that same
11
period the company “announced our commitment to re-focus our business to that of a pure-play
cybersecurity company based on the operations of our wholly-owned subsidiary root9B, LLC.”
(Id. at 6.) As of the Form 10–K filing, root9B Holdings, Inc. represented that “the key emphasis
today is around risk related to cybersecurity. With our cyber group, root9b,8 LLC, we take a new
approach . . . .” (Id.) Additionally, root9B Holdings, Inc. relocated its corporate headquarters
from Charlotte, NC to a co-location with root9B, LLC. (Id. at 11.) root9B Holdings, Inc. lists its
headquarters in Colorado Springs, Colorado. (Id. at 19.) On root9B Holdings, Inc.’s Form 8–K
Report to the SEC August 7, 2017 (Mot., Ex. 1–C [Doc. No. 30–4], the company lists William
Hoke as its Chief Financial Officer. During this general time, it appears that Eric Hipkins was a
director and Chief Executive Officer of root9B Holdings, Inc. (See Root9b Mot, Ex. 1–G, 8–K
Report, September 28, 2017 [Doc. No. 30–8] at 3, indicating that upon the sale of the assets of
root9B Holdings, Inc., Eric Hipkins resigned these positions.)
Further, a review of the pro se allegations of the Third Amended Complaint do not
comport with an inference that Plaintiff intended to bring claims only against the private entity,
Root9b, LLC. Plaintiff’s claims are for securities fraud and misrepresentations concerning
securities. The TAC clearly makes claims and factual assertions that would only apply to a
publicly traded stock company such as Plaintiff’s assertions that she “purchased over 64,000
shares of Root9b” (TAC at 7), and that Plaintiff talked to someone associated with Root9b’s
New York Stock Exchange office (id. at 9). Many references to Root9b’s stock are contained in
the allegations (see id. at 9–12). A limited liability company has no stock and is not controlled
8
The court is unsure whether capitalization of the alpha letter b in “root9b” verses “root9B”is
significant or simply a typographical error.
12
by or answerable to the Securities and Exchange Commission, nor would it be affiliated with the
New York Stock Exchange.
Finally, Plaintiff specifically states as to her selection of a Defendant entity, “I use the
name Root9b because they have constantly changed their name from Root9b LLC to Root9b
Technology to Root9b Holdings.” (TAC at 7.) Plaintiff alleges that the changing but similar
names used by the same essential company is “one of the methods they use to confuse their
investors.” (Id.)
For Defendant to now argue that Plaintiff’s Complaint should be dismissed because she
has sued the wrong entity and made securities fraud allegations against only a private company is
disingenuous, at best.
The court recommends that Defendant Root9b’s motion to dismiss Plaintiff’s claims for
lack of standing be denied.
B. Claim One
1. 18 U.S.C. § 1348
Both Root9b and Defendant Hipkins argue that Plaintiff’s complaint fails to state a claim
pursuant to Fed. R. Civ. P. 12(b)(6) for violation of 18 U.S.C. § 1348 because this is a criminal
statute without a private right of action. (Hipkins Mot. at 6; Root9B Mot. at n.4.)
There is no question that 18 U.S.C. § 1348 is a criminal statute without a private right of
action. Butler v. Onewest Bank, FSB, No. 10–00300HG–KSC, 2010 WL 3156047, at *3 (D.
Haw. Aug. 6, 2010) (“These are criminal provisions, and Plaintiff does not offer support to show
that a private right of action exists to pursue her allegations in a civil lawsuit.”); Chavarria v.
Wells Fargo Bank, N.A., No. CV1503403BROASX, 2015 WL 4768227, at *4 (C.D. Cal. Aug.
13
11, 2015) (“To the extent that Plaintiff attempts to criminally prosecute Defendants, he has no
authority to do so. Section[ ] . . . 1348 of Title 18 [is a] federal criminal statute[ ] that do[es] not
provide for [a] civil cause[ ] of action. Plaintiff is not authorized to bring th[is] claim[ ].”).
Therefore, the court Recommends that any claim in the Third Amended Complaint
purporting to arise under 18 U.S.C. § 1348 be dismissed.
2. Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b–5.9
Neither defendant has argued whether the Plaintiff’s Claim One could survive if brought
under an appropriate civil statute such as Section 10(b) of the Securities Exchange Act of 1934
and Rule 10b–5, although Defendant Hipkins did address Rule 12(b)(6) dismissal of Claim Two,
false statements, under that statute. The court has the discretion to dismiss an in forma pauperis
complaint sua sponte under § 1915(e)(2) “at any time if . . . the action . . . is frivolous or
malicious; [or] fails to state a claim on which relief may be granted.” While the Plaintiff in this
action proceeds pro se, she is not proceeding under § 1915. The court also may dismiss a
complaint sua sponte, however, under Fed. R. Civ. P. 12(b)(6) for failure to state a claim if “it is
‘patently obvious’ that the plaintiff could not prevail on the facts alleged, and allowing [her] an
opportunity to amend [her] complaint would be futile.” See Hall, 935 F.2d at 1110 (quoting
McKinney v. Oklahoma, Dep’t of Human Services, 925 F.2d 363, 365 (10th Cir. 1991)).
Under Rule 12(b)(6), a plaintiff with an arguable claim is ordinarily accorded notice
of a pending motion to dismiss for failure to state a claim and an opportunity to
amend the complaint before the motion is ruled upon. These procedures alert him
to the legal theory underlying the defendant’s challenge, and enable him
meaningfully to respond by opposing the motion to dismiss on legal grounds or by
9
Defendant Root9b raises arguments under Fed. R. Civ. P. 12(b)(1) and 12(b)(6). Although
Defendant Root9b’s arguments pursuant to 12(b)(6) take a different tack from those argued by
Defendant Hipkins, nevertheless since the TAC fails to state a claim against anyone under the
securities laws, the court is recommending dismissal of the case against all defendants.
14
clarifying his factual allegations so as to conform with the requirements of a valid
legal cause of action.
Neitzke v. Williams, 490 U.S. 319, 329–30 (1989).
The Securities Exchange Act of 1934, § 10(b), 15 U.S.C. § 78j(b), provides:
It shall be unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce or of the mails, or any facility of any
national securities exchange—
....
(b) To use or employ, in connection with the purchase or sale of any security
registered on a national securities exchange ... any manipulative or deceptive device
or contrivance in contravention of such rules and regulations as the Commission
may prescribe as necessary or appropriate in the public interest or for the protection
of investors.
SEC Rule 10b–5, 17 C.F.R. § 240.10b–5 (2010), promulgated under the authority of this
section, states:
It shall be unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce, or of the mails or of any facility of any
national security exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of material fact or omit to state a material fact
necessary in order to make the statements made, in light of the circumstances under
which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit on any person, in connection with the purchase or sale
of any security.
Id.
Given the finding of the court, supra, that Plaintiff has erroneously listed her
jurisdictional basis for Claim One under a criminal cause of action with no private right for her
to sue, and reading the TAC liberally as the court must at this stage, the court will analyze
whether Plaintiff’s claims should be deemed to have been brought under the securities
provisions contained in SEC Rule 10b–5 and, if deficient at this stage, whether she could
15
potentially amend her complaint in such a way as to not be futile. Otherwise, this court is
prohibited from inferring an action brought under Rule 10b-5 (a) and (c) in Claim One sua
sponte.
There are three specified ways to violate Rule 10b–5. The first method is by engaging in
a scheme to defraud in connection with the sale or purchase of a company’s stock. Closely
connected to that method is subsection (c), engaging in a course of conduct that operates as a
fraud or deceit on any person in connection with the purchase or sale of stock. The third method
as set forth in subsection (b)—and the one most obviously applicable to Plaintiff’s undesignated
Claim Two for “falsely advertis[ing] they are the #1 Cybersecurity Company”—involves making
an untrue or misleading statement in connection with the sale of stock.
A plaintiff suing under Rule 10b–5 must comply with the heightened pleading standards
of Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act of 1995 (“PSLRA”),
Pub. L. No. 104–67, 109 Stat. 737 (codified as amended in scattered sections of 15 U.S.C.).
Rule 9(b) mandates that “in alleging fraud or mistake, a party must state with particularity the
circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9; Iqbal, 556 U.S. at 686. “At a
minimum, Rule 9(b) requires that a plaintiff set forth the who, what, when, where and how of the
alleged fraud, . . .” United States ex rel. Sikkenga v. Regence Bluecross Blueshield, 472 F.3d
702, 726–27 (10th Cir. 2006) (internal quotation marks and citations omitted).
SEC Rule 10b–5(a) and (c) make it unlawful to engage, directly or indirectly, in a course
of business or employ a device in furtherance of a scheme to defraud in connection with the sale
or exchange of securities. S.E.C. v. Zandford, 535 U.S. 813, 819, 122 S.Ct. 1899, 1903, 153
L.Ed.2d 1 (2002). To prove a violation of Rule 10b–5(a) or 10b–5(c), Plaintiff must prove by a
16
preponderance of the evidence that a defendant, acting with scienter, committed a manipulative
or deceptive act in furtherance of the alleged scheme to defraud. In re Qwest Communications
International, Inc. Securities Litigation, 387 F. Supp. 2d 1130, 1143 (D. Colo. 2005); United
States S.E.C. v. St. Anselm Expl. Co., 936 F. Supp. 2d 1281, 1298–99 (D. Colo. 2013)
Scheme liability, as these two subsections are sometimes called, recognizes that
“[c]onduct itself can be deceptive.” Stoneridge Investment Partners, LLC v. Scientific–Atlanta,
552 U.S. 148, 158 (2008). Nevertheless, liability does not arise simply by virtue of repackaging
a fraudulent misrepresentation a “scheme to defraud.” Public Pension Fund Group v. KV
Pharmaceutical Co., 679 F.3d 972, 987 (8th Cir. 2012). Rather, scheme liability requires proof
of participation in an illegitimate, sham, or inherently deceptive transaction where the
defendant’s conduct or role has the purpose and effect of creating a false appearance. St. Anselm
Expl. Co., 936 F. Supp. 2d at 1299, (citing SEC v. Daifotis, 2011 WL 2183314 at *9 (N.D. Cal.
June 6, 2011), modified on other grounds, 2011 WL 3295139 (N.D. Cal. Aug. 1, 2011); SEC v.
Lucent Technologies, Inc., 610 F. Supp. 2d 342, 360 (D.N.J. 2009). The conduct must be
“inherently deceptive when performed.” SEC v. Kelly, 817 F. Supp. 2d 340, 344 (S.D.N.Y.
2011).
The TAC is entirely devoid of any factual allegations against Mr. Hipkins which would
support a claim against him under SEC 10b-5(a) and (c). While Plaintiff makes several
conclusions about Mr. Hipkins, there is not even one fact alleged that Mr. Hipkins did something
or caused something to be done that would “operate as a fraud or deceit on any person” or which
is inherently deceptive. The sole and only factual statement in the TAC mentioning Mr. Hipkins
by name, outside of the vague allegation that he had made a representation in an “article” that
17
Root9b was “the #1 Cybersecurity 500 for the 4th consecutive quarter” (TAC at 7), appears on
page 13 of the TAC. Plaintiff alleges that as to “The Asset Acquisition Agreement between the
Private Investor10 and the Secured Creditors11” (id. at 12), “I [Plaintiff] believe these documents
will show Eric Hipkins still has ownership of the Company”12 (id. at 13).
The relevant factual allegations against Root9b consist of factual allegations that a
Company whose makeup and ownership is not identified—Quad Capital Management—
purchased a large amount of Root9b stock. As Quad Capital Management bought stock, the
individual stock price went up. Near the same time period Root9b issued promissory notes to a
group of investors, also unidentified. There are no facts alleged showing whether Root9b
received any money or other consideration from the investors or any mention of a loan. At some
point the investors demanded payment in full of the Notes13 and eventually foreclosed against the
assets of the company. Within a short time of the investors demanding payment, Quad sold its
stock for an unknown price. The investors ended up owning the assets of Root9b as a result of
the foreclosure sale. Later the assets were sold by the investors to a “Private Investor”
(apparently Tracker Capital Management, although the TAC is far from clear on this issue) that
“bought all the assets for fair value pursuant to an arms-length business transaction . . . .” (TAC
at 11.) Root9b Holdings was left with no assets and no stock value. The transactions involving
10
Identity not specified.
Identities not specified.
12
Plaintiff attaches a number of documents to her Complaint without explanation of their
meaning or relevance to the case. Mr. Hipkins’ name appears in some of the documentation
attached.
13
There is nothing in the TAC explaining whether or not the company could have paid the Notes
in full.
11
18
Root9b were investigated by the SEC but Root9b did not appear at the SEC hearing. (Id.)
Root9b is in the “process of delisting the company from Nasdaq.” (Id.)
Although the Plaintiff claims “insider trading” and “swindle,” she does not identify any
people involved in any of the transactions and the court is unable to draw a conclusion that
anyone was “inside” any of the companies involved. There are no facts set forth which would
indicate that any of the companies were related, had overlapping ownership or directors or were
anything but separate entities engaging in business. There are no factual allegations that any
person actually benefitted from the transactions alleged and no allegation that Plaintiff lost any
money because of the transactions.
Even granting Plaintiff the deference owed to a pro se plaintiff, based on the facts set
forth in the TAC, if Claim One is deemed to have been brought under the federal securities laws,
specifically Rule 10b-5, Plaintiff fails to state a claim under Rule 12(b)(6) against either
defendant. But, because neither party moved to dismiss based this argument, the court may only
address this claim and dismiss sua sponte if allowing the Plaintiff an opportunity to amend her
complaint would be futile. The court finds that allowing Plaintiff to file an amended complaint
to assert a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b–5(a)
and (c), if that was her intent, would not necessarily be futile. Therefore, the court declines to
infer that securities fraud claims pursuant to Rule 10b-5(a) and (c) are being attempted in Claim
One and, instead, Recommends that Plaintiff be granted an opportunity to amend her Complaint.
C. Claim Two—False Statements
Plaintiff does not list her statutory basis for Claim Two. As with Count One, however,
she asserts facts lending themselves to an analysis under Rule 10b–5(b). Defendant Hipkins has
19
addressed Plaintiff’s Claim Two under Ruel 10b-5 and requested dismissal. However, Root9B
does not move to dismiss under this theory, and, as such, the court addresses the allegations
against Root9B in Claim Two sua sponte.
To state a Rule10b–5 claim for securities fraud under subsection (b), a plaintiff must
plead that:
(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.
Adams v. Kinder-Morgan, Inc., 340 F.3d 1083, 1095 (10th Cir. 2003).
The state of mind required to state a cause of action under Rule 10b–5(b) is scienter, that
is, an “intent to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185,
193 (1976). When alleging that a defendant acted with a particular state of mind, “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.”
15 U.S.C. § 78u–4(b)(2). Scienter can be proven by showing either knowing or intentional
misconduct or recklessness, that 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.’ ” City of Philadelphia
v. Fleming Companies, Inc., 264 F.3d 1245, 1258 (10th Cir. 2001) (quoting Anixter v. Home–
Stake Production Co., 77 F.3d 1215, 1232 (10th Cir. 1996)).
The PSLRA similarly requires that “the complaint” in a securities fraud action under
Rule 10b–5 “shall specify each statement alleged to have been misleading, the reason or reasons
20
why the statement is misleading, and, if an allegation regarding the statement or omission is
made on information and belief, the complaint shall state with particularity all facts on which
that belief is formed.” 15 U.S.C. § 78u–4(b)(1). Plaintiffs alleging securities fraud under
subsection (b) “must set forth the time, place, and contents of the false representation, [and] the
identity of the party making the false statements.” U.S. ex rel. Sikkenga v. Regence Bluecross
Blueshield of Ut., 472 F.3d 702, 726–27 (10th Cir. 2006). Thus, a plaintiff suing under Rule
10b–5 must plead with particularity the defendant's fraudulent acts and the defendant’s state of
mind. See Adams v. Kinder–Morgan, 340 F.3d 1083, 1095–96 (10th Cir. 2003).
Plaintiff alleges a maximum of three false and/or misleading statements. The first is that
in articles she claimed to have read statements made by Defendant Hipkins wherein he stated
that Root9b was “the #1 Cybersecurity 500 for the 4th consecutive quarter.” (TAC at 7.)
Plaintiff does not state when she read the articles containing the statement nor in what
publications the statements were printed. Plaintiff merely stated that “When I googled the #1
Cybersecurity Company,” Root9b came up. Plaintiff attaches several articles apparently taken
off the internet where various websites mention root9B among the “best cyber security
companies” in one form or another. Plaintiff does not allege what, if any connection exists
between Mr. Hipkins and/or root9b and the purveyor of the website advertisements.
Further, Plaintiff does not allege any connection between Defendant Hipkins’ alleged
statement and her purchase of securities other than it was her understanding that “Artificial
Intelligence was the best investment for the future.” (Id.) Also, even if a foundation for the
statement was established, Plaintiff sets forth no facts to establish that the statement was
misleading, false or material.
21
Even if Plaintiff could overcome these deficiencies by more detailed pleading, at best the
statement consists only of corporate “puffing”—a “ generalized statement[] of optimism . . . not
capable of verification”—that is “not actionable because reasonable investors do not rely on
them in making investment decisions.” Grossman v. Novell, Inc., 120 F.3d 1112, 1119 (10th Cir.
1997) (collecting cases). In re Level 3 Commc'ns, Inc. Sec. Litig., 667 F.3d 1331, 1340 (10th
Cir. 2012) (noting representation that company was “focused on insuring that the excellent
reputation that [the company] has earned over the years for customer service does not get
degraded” was mere puffery and not something upon which a reasonable investor would base a
trading decision). The statement is, therefore, not material. Lastly, even if the statement was
made by Defendant Hipkins, the Plaintiff has set forth nothing, much less anything plausible, to
establish the required scienter (intent to defraud) by Defendants Hipkins or Root9B.
The second alleged statements are those made by the unidentified “male” who answered
the phone at some “office on the NYSE”14 (hereinafter “NYSE statements” and “NYSE
speaker”). (TAC at 8). It is not entirely clear what actual entity Plaintiff was calling or the entity
to which the NYSE speaker belonged. The foundational prerequisites for the NYSE statements
are entirely lacking. There no facts set forth from which a reasonable jury could determine who
Plaintiff spoke to at the New York telephone number who told her Root9b was “close, if not
completing a contract with the Federal Government. This contract with the Federal Government
would bring in millions of dollars.” No documents attached to the TAC indicate that Root9b has
offices in New York. This allegation does not come even marginally close to being pleaded with
14
The court uses NYSE (New York Stock Exchange) because that is the factual allegation
contained in the TAC. However, all documentation submitted by the parties, including the
Plaintiff, indicate that root9b Holdings, Inc. was traded on the Nasdaq, not the NYSE.
22
the particularity demanded to support a Rule 10b–5(b) claim. Not only is the NYSE speaker
unknown, no facts have been pleaded which would indicate he had the requisite scienter while
speaking.
The other statements that the Plaintiff identifies are those made by the unidentified
“person” with whom she spoke at the company’s Colorado Springs offices (hereinafter “COS
statements” and “COS speaker”). Plaintiff implies, although very vaguely, that the statements
were made by an employee of Root9B and therefore could potentially be imputed to the
company. However, Plaintiff still does not meet the legal specificity requirements here either,
and her own allegations disabuse scienter on the part of the COS speaker, whom Plaintiff “does
not want to get in trouble.” Further, the Plaintiff has also not set forth any facts which, if proven,
would show the statements were false or misleading. In particular, the COS Speaker said, “they
have been speaking to investors” and “the investors will pay off the debt”—both statements
which appear to be true according to the remainder of the factual allegations in the TAC. While
it appears that the opinion statements from the COS speaker that “this will be good for
stockholders” and that the company would be “stabilized” appear to have been inaccurate
predictions, those statements hardly qualify as statements that would influence any reasonable
person in the purchase or sale of stock. They are simply not material. Finally, according to the
TAC, the COS statements were made to Plaintiff after she had already purchased stock in
Root9b,15 so did not influence her in the purchase of the stock.
Lastly, as to the NYSE statements and the COS statements, the court notes that these
statements are not and cannot be imputed to Defendant Hipkins. Plaintiff has alleged no facts
15
Plaintiff called the company because she wanted to attend a stockholder meeting.
23
that “plausibly infer” that Defendant Hipkins had knowledge of the statements made by the COS
speaker or the NYSE speaker. City of Philadelphia v. Fleming Companies, Inc., 264 F.3d 1245,
1263 (10th Cir. 2001).
Even granting Plaintiff the deference owed to a pro se plaintiff, she fails to state a claim
pursuant to Rule 10b–5(b). Therefore, Hipkins’ Motions to Dismiss with respect to Claim Two,
claims pursuant to SEC Rule 10b–5(b) should be granted.
Defendant Root9b did not move to dismiss Claim Two on any ground other than
standing. The Court is not empowered to dismiss Claim Two sua sponte against the non-moving
Root9b because while the factual averments in the TAC patently and obviously fail to state a
claim under Fed. R. Civ. P. 12(b)(6), this court finds that it would not necessarily be futile for the
Plaintiff to attempt to amend her Complaint to state an appropriate claim pursuant to Section
10(b) of the Securities Exchange Act of 1934 and Rule 10b–5. Therefore, Claim Two must
proceed against Root9b.
WHEREFORE, for the foregoing reasons, the court
RECOMMENDS that
Defendant Eric Hipkins’ Motion to Dismiss the Third Amended Complaint [Doc. No. 29]
be GRANTED and that all claims against Defendant Eric Hipkins be dismissed.
Defendant Root9B’s Motion to Dismiss [Doc. No. 30] be GRANTED in part and
DENIED in part. Root9B’s Motion should be DENIED with respect to its arguments pursuant
to Fed. R. Civ. P. 12(b)(1), DENIED as unnecessary insofar as the motion requests conversion to
summary judgment and GRANTED as to Claim One, violations of 18 U.S.C. § 1348.
The court further RECOMMENDS that
24
Plaintiff be allowed to file an amended complaint to assert claims under Section 10(b) of
the Securities Exchange Act of 1934 and Rule 10b–5 against both defendants within a specified
time period consistent with this Recommendation.
ADVISEMENT TO THE PARTIES
Within fourteen days after service of a copy of the Recommendation, any party may
serve and file written objections to the Magistrate Judge’s proposed findings and
recommendations with the Clerk of the United States District Court for the District of Colorado.
28 U.S.C. § 636(b)(1); Fed. R. Civ. P. 72(b); In re Griego, 64 F.3d 580, 583 (10th Cir. 1995). A
general objection that does not put the district court on notice of the basis for the objection will
not preserve the objection for de novo review. “[A] party’s objections to the magistrate judge’s
report and recommendation must be both timely and specific to preserve an issue for de novo
review by the district court or for appellate review.” United States v. One Parcel of Real Prop.
Known As 2121 East 30th Street, Tulsa, Okla., 73 F.3d 1057, 1060 (10th Cir. 1996). Failure to
make timely objections may bar de novo review by the district judge of the magistrate judge’s
proposed findings and recommendations and will result in a waiver of the right to appeal from a
judgment of the district court based on the proposed findings and recommendations of the
magistrate judge. See Vega v. Suthers, 195 F.3d 573, 579–80 (10th Cir. 1999) (stating that a
district court’s decision to review a magistrate judge’s recommendation de novo despite the lack
of an objection does not preclude application of the “firm waiver rule”); One Parcel of Real
Prop., 73 F.3d at 1059–60 (stating that a party’s objections to the magistrate judge’s report and
recommendation must be both timely and specific to preserve an issue for de novo review by the
district court or for appellate review); Int’l Surplus Lines Ins. Co. v. Wyo. Coal Ref. Sys., Inc., 52
25
F.3d 901, 904 (10th Cir. 1995) (holding that cross-claimant had waived its right to appeal those
portions of the ruling by failing to object to certain portions of the magistrate judge’s order);
Ayala v. United States, 980 F.2d 1342, 1352 (10th Cir. 1992) (holding that plaintiffs waived their
right to appeal the magistrate judge’s ruling by their failure to file objections). But see MoralesFernandez v. INS, 418 F.3d 1116, 1122 (10th Cir. 2005) (stating that firm waiver rule does not
apply when the interests of justice require review).
Dated this 4th day of March, 2019.
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