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Byrd v. Visalus, Inc.

United States District Court, E.D. Michigan, Southern Division

April 5, 2018

CAPRECE BYRD, et al., Plaintiffs,
v.
VISALUS, INC., et al., Defendants.

          OPINION AND ORDER (1) GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS (ECF #39) AND (2) ALLOWING PLAINTIFFS TO FILE A SECOND AMENDED COMPLAINT

          MATTHEW F. LEITMAN UNITED STATES DISTRICT JUDGE

         In this putative class action, Plaintiffs claim that the Defendants defrauded them into purchasing equity in Defendant ViSalus, Inc. Defendants ViSalus, Nick Sarnicola, Ashley Sarnicola, Blake Mallen, Ryan Blair, Todd Goergen, Gary Reynolds, and Michael Craig (collectively, the “ViSalus Defendants”) have now moved to dismiss Plaintiffs' First Amended Complaint. (See ECF #39.) For the reasons that follow, the motion is GRANTED IN PART and DENIED IN PART.

         I[1]

         ViSalus is a Nevada corporation that sells weight-loss shakes and other products. (See, e.g., First Am. Compl. at ¶¶ 2, 29, ECF #30 at Pg. ID 366, 378.) It is “run” by its “founders, ” Nick Sarnicola, Blair, and Mallen. (Id. at ¶2, Pg. ID 366.)

         ViSalus operates using a multi-level marketing (“MLM”) business model. Under this model, “participants pay money to the program promoter in return for which the participants obtain the right to: (1) recruit additional participants …; (2) sell goods or services; and (3) receive payment or other compensation … based upon the sales of those [individuals that the participant recruits].” F.T.C. v. Five Star Auto Club, Inc., 2000 WL 1609798, at *1 (S.D.N.Y. June 12, 2000). In other words, a company using the MLM model “markets its products not through direct sale to customers, but rather, through sales to individual distributors … who then sell to the general public” and recruit others to do the same. Virgin Enterprises Ltd. v. American Longevity, 2001 WL 34142402, at *1 (S.D.N.Y. Mar. 1, 2001); Altaria Corp. v. Woodbolt Distribution, LLC, 2014 WL 3121899, at *4 (W.D. Tex. July 7, 2014) (describing how companies using the MLM model “use[] promoters to sell directly to customers and also to enroll other promoters”).

         ViSalus' MLM sales and recruiting strategy worked - for a time. “Almost 400, 000 people in the United States, including over 200, 000 just in 2012 paid money to become a [ViSalus] distributor.” (First Am. Compl. at ¶3, ECF #30 at Pg. ID 367.) But, quickly, the market became “saturated as distributors tripp[ed] over each other in the same [areas].” (Id. at ¶4, Pg. ID 367.) “By the end of 2012, sales [of ViSalus' products] plummeted.” (Id.) And “[b]y 2014 [ViSalus] was in its second straight money-losing year with sales off by 80% from their high.” (Id. at ¶8, Pg. ID 369.)

         Desperate for cash, the ViSalus Defendants created a new way to make money that they referred to, at various times, as the “Founders Equity Incentive Plan” (the “Plan”) and the “March to Equity.” (Id. at ¶¶ 81 86, Pg. ID 403, 407.) Under the Plan, ViSalus promoters who met certain sales and recruiting benchmarks would obtain “equity” that would be “equivalent to 6% of [ViSalus].” (Id. at ¶¶ 13, 92, Pg. ID 317, 416.) This equity would entitle the promoters to receive “generations worth of dividends.” (Id. at ¶13, Pg. ID 317.) “The goal of the Plan was to raise capital to cover [ViSalus'] immediate and urgent cash needs” - by providing an incentive for promoters to buy more product from ViSalus and recruit new distributors - while “hid[ing] the fact from the investor promoters that the company was selling worthless equity.” (Id. at ¶81, Pg. ID 403.)

         ViSalus “promoted” the Plan with an “announcement on its web page, by personal and videotaped promotion by [its founders, Nick Sarnicola, Blair, and Mallen], and through Facebook and other social media.” (Id. at ¶14, Pg. ID 372.) In one such video, Nick Sarnicola told potential investors that:

. He, Blair, and Mallen had spent $105 million to “buy back” ViSalus from its previous owner.
. He, Blair, and Mallen were “immediately taking 6% of the equity that [they] just … acquire[d]” and offering investors “a chance to earn some of it.”
. Investors could earn “equity, ” become “shareholders, ” and get “dividend[s]”
. Participating in the Plan “could mean owning a piece of a multiple nine figure a year company…, ” ownership that investors could “pass on … to [their] children.”

(Id. at ¶87, Pg. ID 408-15.) In a second video promoting the Plan, Nick Sarnicola assured investors that they had an opportunity to earn “real money” and “real equity” through participation in the Plan, and that he, Blair, and Mallen had “set aside six percent of [ViSalus]” for distributors who participated in the Plan. (Id. at ¶125, Pg. ID 444.) Participants in the Plan were further promised that they would receive a specific dividend payment on April 17, 2017. (See Id. at ¶17, Pg. ID 374.)

         The ViSalus Defendants also recruited individuals to help market the Plan to potential investors and current ViSalus distributors. One of these individuals was Defendant Vincent Owens, the pastor of the Household of Faith Empowerment Temple in Aurora, Colorado.[2] (See Id. at ¶38, Pg. ID 384.) He “promoted [the Plan] to dozens or hundreds of people, ” including the Plaintiffs. (Id.) Among other things, Owens and/or his associate Deb Johnson told the Plaintiffs that ViSalus was a successful, “expanding, ” company with “2.2 billion dollar[s] [] to date in sales, ” that six-percent “of [ViSalus] would be available” in “equity” to promoters who participated in the Plan, and that participants in the Plan would receive “years” of “dividends, ” including “a large payout on April 17, 2017.” (Id. at ¶¶ 165, 169, 183, 259, Pg. ID 483-85, 492, 522.) At the urging of Owens and/or Johnson, each of the Plaintiffs became ViSalus distributors and invested tens of thousands of dollars in order to qualify for equity through participation in the Plan. (See Id. at ¶¶ 147-262, Pg. ID 477-523.) Plaintiffs believed that by participating in the Plan, they would become shareholders in ViSalus and start receiving dividend payments. (See id.) Plaintiffs now say that they did not receive either the promised equity or any dividends.

         II

          Plaintiffs filed this putative class action on August 10, 2017, against the ViSalus Defendants and Owens.[3] (See Compl., ECF #1.) They filed a First Amended Complaint on September 29, 2017. (See First Am. Compl, ECF #30.) In the First Amended Complaint, the Plaintiffs have brought the following claims:

. Violation of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rules 10b-5(a)-(c), 17 C.F.R. § 240.10b-5(a)-(c) against all Defendants;
. Violation of Sections 12(a)(1) and (a)(2) of the Exchange Act against all of the Defendants except for Reynolds and Ashley Sarnicola;
. Violation of Section 509(2) of the Michigan Uniform Securities Act (“MUSA”), Mich. Comp. Laws § 451.2509(2) against all Defendants;
. Violation of Sections 501, 502, and 509(3) of the MUSA, Mich. Comp. Laws §§ 451.2051, 2502, and 2509(3) against all Defendants;
. Violation of Sections 403(1), 509(5), 509(6), and 509(7) of the MUSA, Mich. Comp. Laws §§ 451.2502, 2403(1), 2509(5), and 2509(6) against all Defendants; and
. Statutory and common law conversion against Defendants ViSalus, Nick Sarnicola, Blair, and Mallen.

         Plaintiffs also request declaratory and injunctive relief. Among other things, Plaintiffs “seek a declaration from the Court[, ] in addition to any other monetary or equitable relief sought, that they and the Class are the immediate owners of 6% of the ViSalus common stock.” (Id. at ¶331, Pg. ID 582.)

         The ViSalus Defendants moved to dismiss Plaintiffs' claims on October 27, 2017. (See Mot. to Dismiss, ECF #39.) The Court held a hearing on the motion to dismiss on February 20, 2018. (See ECF #46.) The parties filed simultaneous supplemental briefs on March 2, 2018. (See ECF ## 49, 50.)

         III

          In the Motion, Defendants seek relief pursuant to Federal Rule of Civil Procedure 12(b)(6). Rule 12(b)(6) provides for dismissal of a complaint when a plaintiff fails to state a claim upon which relief can be granted. See Fed. R. Civ. P. 12(b)(6). “To survive a motion to dismiss” under Rule 12(b)(6), “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) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007)). A claim is facially plausible when a plaintiff pleads factual content that permits a court to reasonably infer that the defendant is liable for the alleged misconduct. See Id. (citing Twombly, 550 U.S. at 556). When assessing the sufficiency of a plaintiff's claim, a district court must accept all of a complaint's factual allegations as true. See Ziegler v. IBP Hog Mkt., Inc., 249 F.3d 509, 512 (6th Cir. 2001). “Mere conclusions, ” however, “are not entitled to the assumption of truth. While legal conclusions can provide the complaint's framework, they must be supported by factual allegations.” Iqbal, 556 U.S. at 664. A plaintiff must therefore provide “more than labels and conclusions, ” or “a formulaic recitation of the elements of a cause of action” to survive a motion to dismiss. Twombly, 550 U.S. at 556. “Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Id.

         In addition, where, as here, Plaintiffs allege fraud under Section 10(b) of the Exchange Act, they must “state with particularity the circumstances constituting fraud or mistake” under Rule 9b of the Federal Rules of Civil Procedure. Fed.R.Civ.P. 9(b). Under this rule, Plaintiffs “must (1) specify the statements that [they] contend[] were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent. At a minimum, Plaintiffs must allege the time, place and contents of the misrepresentations upon which they relied.” Frank v. Dana Corp., 547 F.3d 564, 570 (6th Cir. 2008) (internal punctuation and citations omitted). Finally, Plaintiffs must also satisfy the pleading requirements of the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4 (the “PSLRA”) with respect to their fraud claims under Section 10(b). See Id. Among other things, the PSLRA requires Plaintiffs to “specify each statement alleged to have been misleading, [and] the reason or reasons why the statement is misleading. 15 U.S.C. § 78u-4(b)(1).

         IV

         A

         In Count I of the First Amended Complaint, Plaintiffs bring multiple securities fraud claims under Section 10(b) and Rules 10b-5(a), (b), and (c) of the Exchange Act. (See First. Am. Compl. at ¶¶ 270-277, ECF #30 at Pg. ID 530-566.) The ViSalus Defendants argue that the Court should dismiss all of these claims because (1) the units in the Plan offered to Plaintiffs were not “securities, ” (2) even if the units were “securities, ” the alleged misrepresentations or omissions were not made in connection with the “purchase” or “sale” of the units, (3) Plaintiffs have not sufficiently pleaded that they relied on any misstatements or omissions, and (4) Plaintiffs have not sufficiently pleaded a scheme to defraud under Rules 10b-5(a) and (c). (See Mot. to Dismiss, ECF #39 at Pg. ID 657-74.) The Court concludes that Plaintiffs have sufficiently pleaded that units in the Plan are securities and that the alleged misstatements or omissions were made in connection with the purchase of a security. But it agrees with the ViSalus Defendants that Plaintiffs' Rule 10b-5(b) claim fails because Plaintiffs have not sufficiently alleged that they relied on a particular misrepresentation made by any of these Defendants. The Court also agrees with the ViSalus Defendants that Plaintiffs' Rule 10b-5(a) and (c) claims fail because Plaintiffs have not sufficiently alleged a scheme to defraud separate and apart from the ViSalus Defendants' alleged misrepresentations. The Court will therefore dismiss Plaintiffs' Section 10b and Rule 10b-5 claims and grant Plaintiffs leave to amend these claims in a Second Amended Complaint.

         1

         The ViSalus Defendants first assert that the Court should dismiss all of Plaintiffs' securities-fraud claims because (1) those claims “require[] that the plaintiff [has] purchased a security[, ]” (2) the “security” that Plaintiffs have identified here are units in the Plan, [4] and (3) units in the Plan are not securities. (Mot. to Dismiss, ECF #39 at Pg. ID 657-63.) The Court disagrees.

         At the hearing on Defendants' motion to dismiss, counsel for the ViSalus Defendants acknowledged that it would be proper for the Court to determine whether units in the Plan are securities by applying the framework described in United States Securities and Exchange Commission v. Zada, 787 F.3d 375, 380 (6th Cir. 2015). Under Zada, a court first determines whether the “instrument” at issue is expressly identified as a security in 15 U.S.C. § 77b(a)(1). Id. If the instrument does appear in that list, then it is “presumptively [a] securit[y].” Id. A defendant may “rebut [this] presumption” by showing that “the [instrument] bears a family resemblance to a list of instruments that are not securities.” Id. (internal quotation marks omitted). “Whether the [instrument] bears a resemblance to one of those instruments depends on four factors: first, the motivation prompting the transaction; second, the plan of distribution; third, the reasonable expectations of the investing public; and fourth whether a risk-reducing factor (for example, another regulatory scheme) makes application of the Securities Acts unnecessary.” Id.

         The Court first concludes that units in the Plan are presumptively securities under Zada. One of the “instruments” listed in 15 U.S.C. § 77b(a)(1) is “stock, ” and Plaintiffs plausibly allege that units in the Plan are stock. Indeed, as quoted extensively above, the ViSalus Defendants repeatedly referred to the instrument that Plaintiffs could acquire as “equity” and referred to the holders of that equity as “shareholders, ” words and phrases commonly-associated with stock.

         Moreover, Plaintiffs plausibly allege that the units had “the most common feature of stock” - the “right to receive dividends” United Housing Federation, Inc. v. Foreman, 421 U.S. 837, 851 (1975). Indeed, Plaintiffs allege that the ViSalus Defendants repeatedly promised in videos and other promotional materials that if Plaintiffs invested in the Plan, they would receive dividends:

. “But 6% of a billion dollars in dividends is $60 million a year. If we could get to that size, we'll be dividending $60 million per year to those promoters that go to work right now.” (First Am. ...

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