United States District Court, N.D. Illinois, Eastern Division
LAWRENCE J. WERT, RICHARD D. KINCAID, and JAMES O. MYERS, individually and derivatively on behalf of Ditto Holdings, Inc. Plaintiffs,
STUART COHN, ZVI FEINER, DAVID JONATHAN ROSENBERG, and AVI FOX, Defendants.
MEMORANDUM OPINION AND ORDER
MATTHEW F. KENNELLY, DISTRICT JUDGE
Wert, Richard Kincaid, and James Myers, all shareholders of
Ditto Holdings, have sued members of Ditto Holdings'
board of directors and its general counsel in connection with
alleged mismanagement, fraud, and concealment of the
company's finances and operations. Plaintiffs allege that
they invested additional funds and retained their initial
investments in Ditto based on defendants'
misrepresentations and omissions regarding the company's
financial condition. Plaintiffs also allege that defendants
knew or should have known that directors Joseph and Avi Fox
were engaged in practices that constituted financial
mismanagement of Ditto, breach of fiduciary duty, and
Myers has sued Cohn under sections 10(b) and 20(a) of the
Securities Exchange Act and Securities and Exchange
Commission (SEC) Rule 10b-5 for fraud in connection with
Myers's purchase of shares of Ditto stock (Count 1 of the
amended complaint). Plaintiffs have brought additional state
law claims against defendants for corporate waste (Count 2),
breach of fiduciary duty (Count 3), fraudulent
misrepresentation (Count 4), fraudulent concealment (Count
5), and negligent misrepresentation (Count 6). Lastly,
plaintiffs have sued Cohn for legal malpractice (Count 7).
Plaintiffs bring the corporate waste claim solely on a
derivative basis, the breach of fiduciary duty, negligent
misrepresentation, and legal malpractice claims both
individually and on a derivative basis, and the fraudulent
misrepresentation and concealment claims solely on an
Stuart Cohn, Zvi Feiner, David Rosenberg, and Avi Fox each
have moved to dismiss plaintiffs' amended complaint on
numerous grounds. For the reasons stated below, the Court
denies defendants' motions to dismiss, except for with
respect to the derivative claims in Counts 2, 3, 6, and 7,
which are dismissed with leave to amend.
Court takes the following factual allegations from
plaintiffs' amended complaint. Plaintiffs are
shareholders of Ditto Holdings, Inc. Ditto (later renamed
SoVesTech, Inc.) is a Delaware corporation that owns 100% of
Ditto Trade, Inc. (previously FB Securities Corp.), a
securities broker-dealer registered with the SEC.
are current or past officers or directors of Ditto. Cohn was
Ditto's general counsel from its incorporation in 2010
until at least January 2016. He also was the company's
original secretary. Avi Fox was one of the original members
of Ditto's board of directors, along with his brother
Joseph Fox, who is not named as a defendant in this lawsuit.
In addition to serving as Ditto's chief compliance
officer, Rosenberg became a member of the board in 2012. It
is unclear if he has since left the board and when. Feiner
has been a member of the board since 2013. It is also unclear
if and when Feiner has left the board.
2013, Paul Simons joined Ditto's board. Upon review of
Ditto's records in preparation for an investor meeting,
Simons became aware of a number of expenditures,
transactions, and accounting irregularities that raised
concerns about corporate mismanagement. Simons outlined his
concerns in a September 2013 letter to his fellow board
members. He enumerated the following suspect transactions
between the period of January 2012 through July 2013:
• payments of approximately $170, 000 to Joseph
Fox's son, Jorden Fox, for rent, legal expenses, and the
production of "Savaged the Movie";
• other payments to Joseph Fox and other Fox family
members with no indicated or apparent business purpose;
• charges and cash withdrawals of almost $46, 000 at
various Las Vegas resorts and casinos for which Ditto did not
have an apparent business purpose; and
• payments totaling $15, 000 to a company owned by
letter also raised concerns about Joseph Fox's 2013 sale
of his own shares of stock at prices different from the price
offered by Ditto, the company's failure to file tax
returns since its incorporation, and the lack of appropriate
internal controls or systems to record transactions.
was removed from the board shortly after he sent the letter.
Ultimately, the board of directors approved the use of
company funds to sue him for defamation. Feiner replaced
Simons on the board. Also in September 2013, the Financial
Industry Regulatory Authority (FINRA) opened an investigation
into the issues raised in Simons's letter. Ditto retained
an outside law firm, Goldberg Kohn, to investigate the
allegations in Simons's letter. Goldberg Kohn issued its
final report to Ditto in January 2014.
Fox told Goldberg Kohn during its investigation that the
payments to his family members were either advances under his
employment agreement or were draws against a line of credit
extended to him by Ditto in consideration of his personal
guaranty of investor loans and stock purchases. Goldberg Kohn
accepted this explanation for the payments. Nonetheless, the
Goldberg Kohn report concluded that Ditto had been operating
on an "ad hoc undisciplined, nontransparent basis."
Am. Compl. ¶ 70 (quoting Ex. B, at 6-8). The report
further stated, "we do not condone operating a business
in the manner in which it has been run to date, " and it
made several recommendations to help Ditto establish and
comply with good corporate practices. Id. ¶ 71
(quoting Ex. B, at 8).
February 2, 2014 email, signed by Rosenberg and Feiner and
approved by Cohn, notified shareholders of the board's
receipt of the Goldberg Kohn report. A copy of the report was
not attached to the email. The email stated that the report
"does not find any dishonest business practices, nor did
it find any misappropriation or misuse of company
funds." Id. ¶ 73 (quoting Ex. C). The
email did not mention the report's condemnation of
Ditto's lack of discipline and transparency. The email
also assured investors-falsely, plaintiffs allege-that Ditto
had already adopted many of the improvements and controls
recommended in the report. Additionally, the February 2014
email included as an attachment a cash flow statement for
2010 through 2013, which the email characterized as
containing details from Ditto's consolidated income
statement. The consolidated income statement itself was not
attached to the email. Plaintiffs allege that the omitted
consolidated income statement would have revealed information
about losses that "likely would have caused concern for
shareholders and given them significant pause before
investing further in the company." Id. ¶
Myers became interested in investing in Ditto at the end of
2014. On or about January 20, 2015, Myers met with
representatives of Ditto in their Chicago office to discuss
his potential investment. During this meeting, Myers asked
Joseph Fox and Cohn to provide him with a summary of the
concerns raised by Simons and Ditto's planned response to
those concerns. Cohn also brought up the Goldberg Kohn
report. Joseph Fox told Myers the report was not available
but said he would be happy to answer questions about it.
Myers contends that he was intentionally and falsely
"led to believe by statements of Joseph and Cohn"
that the Goldberg Kohn report provided no support for
Simons's allegations of "financial
malfeasance." Id. ¶ 105. Myers alleges
that he was further misled during the meeting on whether
Ditto had implemented any of the Goldberg Kohn report's
recommendations. Acting in reliance upon these
misrepresentations and omissions, Myers says, he purchased
$25, 000 worth of Ditto stock in February 2015. He made
additional purchases in March and April 2015.
alleges that did not begin to become aware of Ditto's
problems until he obtained and read the Goldberg Kohn report
in July 2015. At that time, Myers says, he realized that he
had been misled about Ditto's operation and its true
financial condition. When he later obtained a copy of a
2012-2014 audit of Ditto, Myers says that he came to
understand the extent to which information about Ditto's
finances had been misrepresented and concealed from him prior
to his decision to invest.
allege that Ditto's persistent recordkeeping failures,
defendants' issuance and approval of misleading emails to
shareholders, and their failure to respond to calls for
reform, among other failings, served to conceal and actively
misrepresent the state of Ditto's operations and finances
through 2015. For example, plaintiffs contend that defendants
approved another intentionally misleading email from Joseph
Fox to shareholders on September 16, 2015. Joseph Fox sent
this September 2015 email shortly after the SEC issued orders
finding that Joseph and Ditto had violated the Securities Act
by selling securities without having filed a registration
statement. According to plaintiffs, the email was misleading
in its characterization of both the seriousness and the scope
of the SEC's findings.
about Ditto's apparent misappropriation of shareholder
funds, near the end of 2015, Wert hired an attorney to review
Ditto and draft a letter detailing its ongoing problems and
demanding significant changes to its structure and business
operations. Plaintiffs allege that Ditto did nothing in
response. Less than a month later, Joseph Fox informed
shareholders that he was shutting down Ditto Trade,
Ditto's subsidiary, because it was insolvent.
present, Ditto's applications for patents on its
proprietary trading technology are the only remaining assets
of any value. Due to inaction on the defendants' part,
however, the U.S. Patent and Trademark Office has since
classified the most valuable of these patents as abandoned.
Plaintiffs allege that Ditto stock is currently
"worthless." Id. ¶ 143.
Court will begin by addressing defendants' challenges to
Count 1, the sole claim under federal law, before moving on
to the state law claims (Counts 2 through 7).
Rule 10b-5 securities fraud claim (Count 1)
seeks dismissal of Count 1, Myers's claim under SEC Rule
10b-5. Cohn argues that Count 1 fails to state a claim and
that it is time-barred.
Failure to state a claim
motion to dismiss for failure to state a claim, the Court
accepts the factual allegations in the amended complaint as
true and draws reasonable inferences in favor of the
plaintiff. Alamo v. Bliss, 864 F.3d 541, 548-49 (7th
Cir. 2017). A claim is plausible on its face and thus
survives a motion to dismiss "when the plaintiff pleads
factual content that allows the court to draw the reasonable
inference that the defendant is liable for the misconduct
alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678
(2009). Where the plaintiff alleges fraud, as in this case,
Federal Rule of Civil Procedure 9(b) requires the plaintiff
to "state with particularity the circumstances
constituting fraud." Gandhi v. Sitara Capital Mgmt.,
LLC, 721 F.3d 865, 869 (7th Cir. 2013) (quoting
Fed.R.Civ.P. 9(b)). The level of particularity required
depends on the facts of the case; typically, however, Rule
9(b) requires a description of the "who, what, when,
where, and how" of the fraud. AnchorBank, FSB v.
Hofer, 649 F.3d 610, 615 (7th Cir. 2011) (quoting
Pirelli Armstrong Tire Corp. Retiree Medical Benefits Tr.
v. Walgreen Co., 631 F.3d 436, 441-42 (7th Cir. 2011)).
In addition, the Private Securities Litigation Reform Act
(PSLRA) requires a securities fraud complaint to
"specify each statement alleged to have been misleading,
the reason or reasons 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"
and "state with particularity facts giving rise to a
strong inference that the defendant acted with the required
state of mind." ABN AMRO, Inc. v. Capital Int'l
Ltd., 595 F.Supp.2d 805, 834 (N.D. Ill. 2008) (quoting
15 U.S.C. § 78u-4(b)(1)-(2)).
10b-5 makes it unlawful, in connection with the purchase or
sale of a security, "[t]o make any untrue statement of a
material fact or to omit to state a material fact necessary
in order to make the statements made, in the light of the
circumstances under which they were made, not
misleading." 17 C.F.R. § 240.10b-5. To state a Rule
10b-5 claim, a plaintiff must allege "(1) a material
misrepresentation or omission by the defendant; (2) scienter;
(3) a connection between the misrepresentation or omission
and the purchase or sale of a security; (4) reliance upon the
misrepresentation or omission; (5) economic loss; and (6)
loss causation." Amgen Inc. v. Conn. Retirement
Plans & Tr. Funds, 568 U.S. 455, 460-61 (2013). For
mere silence to be actionable under Rule 10b-5, the defendant
must be under an affirmative duty to disclose. Chiarella
v. United States, 445 ...