Case Name: Alafi, et al. v. Cohen, et al.
Case No.: 18CV333075
According to the allegations of the first amended complaint (“FAC”), in late 2015 and early 2016, defendant Stanley N. Cohen (“Cohen”) told plaintiffs Moshe Alafi (“Moshe”) and Chris Alafi (“Chris”) that he and defendant Tzu-Hai Cheng (“Cheng”) that he had discovered a cure for Huntington’s Disease, and possibly, other nucleotide repeat diseases as well, such as amyotrophic lateral sclerosis, and muscular dystrophy. (See FAC, ¶ 14.) Cohen represented that the oral delivery of a small molecule, “NU 106” or “HD 106”, coupled with a non-invasive cell-based biomarker PBMC assay that could demonstrate the efficacy of the treatment would expedite FDA approval for the treatment. (See FAC, ¶ 14.) Cohen represented that, based on past progress, the FDA would approve the treatment for clinical trials by Q2 2016. (See FAC, ¶ 15.) Cohen stated that the company he and Cheng had formed to develop this product, Nuredis, Inc. (“Nuredis”), had one competitor, Ionis Pharmaceuticals, which was not a meaningful competitor because its product was inferior to the HD 106 molecule. (See FAC, ¶ 18.) Cohen offered to plaintiffs Moshe, Chris, Alafi Capital Company, LLC and the Christopher D. Alafi Family Trust (collectively, “Plaintiffs”), a seat on Nuredis’ Board of Directors, and a 20% interest in Nuredis, in exchange for a $20 million investment. (See FAC, ¶¶ 17, 19-20.)
However, these representations were false: Defendants had not discovered a cure for HD or other diseases; they had no valid basis for asserting that the HD 106 molecule had sufficient safety and efficacy to permit the drug compound to move into the human clinical trials stage or that the FDA would allow clinical trials to proceed without significant and time-consuming preclinical studies; Defendants had not developed an assay that could demonstrate efficacy of the treatment; and, Ionis Pharmaceuticals was, in fact, far ahead of Nuredis in its development, as well as other competitors such as WaVe Life Sciences. (See FAC, ¶¶ 22-25.) Defendants also failed to disclose that HD 106 had, in fact, been used decades earlier to treat psoriasis, and excessive toxicity problems with the molecule, including resultant fatal thromboembolic cardiac conditions, caused the molecule to be pulled from the market, and thus, the FDA would require extensive toxicity studies and a demonstration of proof of efficacy of the molecule in significantly reducing toxic protein aggregation prior to any clinical trials to be approved. (See FAC, ¶ 26.) Based on Defendants’ misrepresentations, Plaintiffs invested $20 million on July 26, 2016. (See FAC, ¶ 27.) Defendants continued to make further misrepresentations, and then, using their majority shareholder status, operated the company for their own personal benefit, causing Nuredis to pay exorbitant bonuses approve travel expenses, advisory fees, and salaries to them, despite failing to develop the product and instead concealing roadblocks of which Defendants were aware. (See FAC, ¶¶ 28-37.) Ultimately, the outcome of mice studies and PBMC studies were not successful, and after the April 17, 2018 board meeting, the HD 106 program was discontinued. (See FAC, ¶¶ 38-41.) On September 21, 2018, after Defendants had removed the instant case to the District Court, Plaintiffs filed an amended complaint with the U.S District Court, Northern District of California, asserting causes of action against Defendants for:
1) Fraudulent inducement;
2) Fraudulent concealment;
3) Securities fraud in violation of Corporations Code § 25401;
4) Unfair competition;
5) Common law unfair competition;
6) Common law fraud;
7) Breach of fiduciary duty; and,
8) Reformation of contract due to mutual mistake.
Defendants demur to each of the causes of action of the FAC.
First cause of action for fraudulent inducement and sixth cause of action for fraud
Defendants argue that the first cause of action for fraudulent inducement does not allege a misrepresentation, but rather alleges nonactionable opinions. (See Defs.’ memorandum of points and authorities in support of demurrer (“Defs.’ memo”), pp.5:23-28, 6:1-25, 7:7-21, 8:1-28, 9:1-18.) Defendants further argue that the representations are not alleged with sufficient particularity because “Plaintiffs fail to explain whether such quotes are alleged verbatim statements made by Dr. Cohen… how Cohen made these alleged statements—including whether orally or in writing, when and to whom they were made, and in what context… [and] Plaintiffs do not allege any documents to support these allegations, and fail to attach any documents to their Amended Complaint.” (Defs.’ memo, pp.6:26-28, 7:1-6.)
Defendants are correct that “fraud actions are subject to strict requirements of particularity in pleading.” (Furia v. Helm (2003) 111 Cal.App.4th 945, 956; see also Nagy v. Nagy (1989) 210 Cal.App.3d 1262, 1268 (stating same); see also Small v. Fritz Companies, Inc. (2003) 30 Cal.4th 167, 184 (stating that “[i]n California, fraud must be pled specifically; general and conclusory allegations do not suffice”).) Minimally, a fraud cause of action must “allege the names of the persons who made the allegedly fraudulent representations, their authority to speak, to whom they spoke, what they said or wrote, and when it was said or written.” (Lazar v. Super. Ct. (Rykoff-Sexton, Inc.) (1996) 12 Cal. 4th 631, 645; see also Tenet Healthsystem Desert, supra, 245 Cal.App.4th at p.838 (stating same).) “[L]ess specificity is required of a complaint when “ ‘it appears from the nature of the allegations that the defendant must necessarily possess full information concerning the facts of the controversy….” (Tenet Healthsystem Desert, supra, 245 Cal.App.4th at p.838.) If discovery would clear any confusion as to who made the representations and by what means, if the allegations of fraud are otherwise sufficiently detailed, defendant cannot persuasively complain that it misunderstands the fraud claim. (Charpentier v. Los Angeles Rams Football Co. (1999) 75 Cal.App.4th 301, 312.) Here, the FAC adequately alleges Cohen’s fraudulent representations, to whom they were made, what they said and when it was said. Defendants’ argument that the fraud causes of action are not pled with the requisite particularity is without merit.
As for Defendants’ argument that the first cause of action does not allege an actionable misrepresentation, but only a nonactionable opinion, the FAC first alleges that in late 2015 and early 2016, Cohen represented to Moshe and Chris that he and Cheng had discovered a cure for Huntington’s Disease. (See FAC, ¶ 14.) In fact, however, he had made no such discovery. (See FAC, ¶ 24.) The FAC also alleges that Cohen further represented that he had developed a non-invasive cell-based biomarker PMBC assay that could demonstrate the efficacy of his treatment. (See FAC, ¶ 14.) Again, however, in reality, he had not developed such an assay. (See FAC, ¶ 24.) The FAC also alleges that Cohen represented that Nuredis’ competitor was Ionis Pharmaceuticals, but it did not present any meaningful competition as the drug it was developing was inferior to the HD 106 molecule. (See FAC, ¶ 18.) However, Defendants knew that, in fact, Ionis had already conducted extensive, successful preclinical studies of their drug and was rapidly advancing to human clinical trials, and that he was far from conducting either such studies, and additionally, that HD 106 was previously used and resulted in fatal thromboembolic cardiac conditions that caused it to be pulled from the market, and would undoubtedly require extensive toxicity studies in addition to preclinical studies. (See FAC, ¶¶ 25-26.) Defendants are correct that “an actionable misrepresentation must be made about past or existing facts; statements regarding future events are merely deemed opinions.” (Neu-Visions Sports, Inc. v. Soren/McAdam/Bartells (2000) 86 Cal.App.4th 303, 309–310; see also Brakke v. Economic Concepts, Inc. (2013) 213 Cal.App.4th 761, 769-770 (stating that “it is inherently unreasonable for any person to rely on a prediction of future IRS enactment, enforcement, or non-enforcement of the law by someone unaffiliated with the federal government… [because] to be actionable, a misrepresentation must be of an existing fact, not an opinion or prediction of future events”); see also Borba v. Thomas (1977) 70 Cal.App.3d 144, 152 (stating that “[p]redictions as to future events, or statements as to future action by some third party, are deemed opinions, and are not actionable fraud”).) However, here, it is alleged that Cohen represented that he had discovered a cure for Huntington’s Disease and developed a non-invasive cell-based biomarker PMBC assay. These are not future events or actions by a third party; rather these are alleged representations by Cohen of past or existing facts that are not true. Accordingly, Defendants’ argument lacks merit and the demurrer to the first and sixth causes of action is OVERRULED.
Second cause of action for fraudulent concealment
The second cause of action alleges that Defendants concealed material facts from Plaintiffs regarding toxicity issues, risks presented by the treatment, Defendants’ failure to consult any thrombolytic experts or designed any risk mitigation plans despite knowing of the risks as stated above, the failure to determine whether efficacy was achievable in suppressing the SUPT4H/5H factor if administered in low doses, the exit time and related toxicity issues presented by such long exit time, the challenges presented by large doses, that development of HD106 would not be worthwhile if pre-clinical testing was going to be required by the FDA, and the state of development of competitors’ drugs, so that Defendants could entice Plaintiffs to invest $20 million in Nuredis. As Defendants state, “[a] duty to disclose can arise from the making of affirmative representations with knowledge of undisclosed facts that ‘materially qualify the facts disclosed, or … render [the disclosed facts] likely to mislead.’” (Blickman Turkus, LP v. MF Downtown Sunnyvale, LLC (2008) 162 Cal.App.4th 858, 877.) “To plead tort liability based on false or incomplete statements, the pleader must set forth at least the substance of those statements.” (Id. at p.878.) Defendants argue that “there is no duty to disclose every possibly adverse fact to investors, including negative data about drug treatments… [and that] Plaintiffs… knew of the compound’s alleged toxicity issues… [and] information about a drug being publicly pulled from the market was equally available to Plaintiffs… [and a] plaintiff cannot rely on the failure to disclose information that is publicly available and could have been obtained by its own due diligence.” (Defs.’ memo, p.9:19-25, 10:1-28, 11:1-12.)
Defendants cite to Matrixx Initiatives, Inc. v. Siracusano (2011) 563 U.S. 27, to support their assertion that they are under no duty to disclose negative data regarding drug treatments such as the alleged concealed facts. However, in Matrixx, the U.S. Supreme Court specifically refused “to adopt a bright-line rule that reports of adverse events associated with a pharmaceutical company’s products cannot be material absent a sufficient number of such reports to establish a statistically significant risk that the product is in fact causing the events.” (Id. at pp.40-45.) Instead, the Matrixx court stated that the question is “whether a reasonable investor would have viewed the nondisclosed information ‘as having significantly altered the ‘total mix’ of information made available.’” (Id. at p.44.) The court then determined that the investors adequately pleaded materiality. (Id. at p.45.) Here, a reasonable investor would have viewed the nondisclosure of toxicity issues, prior resultant fatal thromboembolic cardiac conditions from treatment associated with the drug, the exit time of the molecule, the challenges presented by large doses, Defendants’ own failure to address these roadblocks, and that development would not be worthwhile if preclinical studies were required, significantly alter the total mix of information made available to Plaintiffs. Matrixx does not support Defendants’ position.
As to Defendants’ argument that Plaintiffs were under a duty to discover certain information that was publicly available, much of the argument does not involve information that was, in fact, publicly available. For example, it is unclear how it would be public knowledge that Defendants did not consult with any thrombolytic experts or otherwise design any risk mitigation plans, or that Defendants had not determined whether efficacy had been achieved in suppressing the SUPT4H/5H factor if the drug were administered in low doses, or that Defendants knew that it was technically challenging to give large doses of HD106 for extended periods, or that Defendants were aware that it would not be worthwhile to proceed with development of HD106 at all if preclinical testing was to be required. Thus, it appears that Defendants’ argument rests on the purported publicly available 1975 toxicity studies and the state of the competitors. As to the toxicity studies, the FAC does not allege that Plaintiffs knew or should have known that the prior toxicity studies were negative or involved adverse events; rather, the FAC alleges that the studies would be presented to the FDA to allow Nuredis to “obtain approval to proceed to clinical studies in HD patients in a matter of only a few months.” (See FAC, ¶ 16.) Moreover, Defendants’ failure to address the other alleged concealed facts is also fatal to Defendants’ argument as a demurrer does not lie as to a part of a cause of action. (See Kong v. City of Hawaiian Gardens Redevelop. Agency (2003) 108 Cal.App.4th 1028, 1046.) Defendants’ demurrer to the second cause of action is OVERRULED.
Third cause of action for violation of Corporations Code § 25401
The third cause of action alleges that Defendants violated Corporations Code § 25401. Section 25401 states that “[i]t 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.” (Corp. Code § 25401.) Defendants demur to the third cause of action arguing that the third cause of action does not allege that they offered to sell, buy or offer to buy a security, and that section 25401 does not provide a private right of action.
In opposition, Plaintiffs assert that section 25501 provides a private right of action for violations of section 25401 and sections 25504 and 25504.1 permit actions against those who control the selling entity or assist in the selling of a security in violation of section 25401. While Plaintiffs are correct that they may assert a cause of action pursuant to the aforementioned statutes, “statutory causes of action must be pleaded with particularity.” (Covenant Care, Inc. v. Super. Ct. (Inclan) (2004) 32 Cal. 4th 771, 790.) Here, the third cause of action neither mentions the aforementioned code sections, and does not specifically allege that Defendants controlled the selling entity or assisted in the sale of a security in violation of 25401. Accordingly, the demurrer to the third cause of action is SUSTAINED with 10 days leave to amend.
Fourth and fifth causes of action for unfair competition
Defendants demur to the fourth and fifth causes of action for unfair competition, asserting that they fail to state facts sufficient to constitute a cause of action because section 17200 does not apply to alleged securities fraud, citing Bowen v. Ziasun Technologies, Inc. (2004) 116 Cal.App.4th 777. (See Defs.’ memo, pp.12:16-28, 13:1-8.) In Bowen, the plaintiffs alleged that they were defrauded by a pyramid scheme orchestrated by the company from which they purchased stock. After considering other states’ unfair competition laws modeled after the FTC, the Bowen court “conclude[d] that section 17200 does not apply to securities transactions.” (Id. at p.787.) However, in Overstock.com, Inc. v. Gradient Analytics, Inc. (2007) 151 Cal.App.4th 688, the First District noted that the reach of Bowen was limited: “[w]hether one agrees with Bowen or not, its holding that securities transactions are not covered under the UCL bars lawsuits based on deceptive conduct in the sale and purchase of securities, nothing more… Overstock’s claims do not arise from any stock transactions between the parties.” (Id. at p.715; see also Strigliabotti v. Franklin Resources, Inc. (N.D. Cal., Mar. 7, 2005, No. C 04-00883 SI) 2005 WL 645529, at *9 (stating that “even the broad language of the Bowen case is limited to “securities transactions,” and does not encompass all situations where securities are somehow implicated but not purchased or sold”); see also In re Charles Schwab Corp. Securities Litigation (N.D. Cal. 2009) 257 F.R.D. 534, 553 (stating same).) Here, unlike Bowen, Plaintiffs are not alleging fraud by Nuredis itself regarding the purchase of a security in Nuredis; instead, Plaintiffs are alleging fraud by Defendants that induced them to invest in Nuredis, and also continued fraud to deprive Plaintiffs of recouping their investment so that Defendants could personally enrich themselves. (See FAC, ¶¶ 31-45.) Thus, as this cause of action alleges fraudulent conduct that is unconnected with the sale and purchase of a security, the demurrer to the fourth and fifth causes of action for unfair business practices is OVERRULED.
Seventh cause of action for breach of fiduciary duty
Defendants argue that the seventh cause of action for breach of fiduciary duty fails to allege facts to constitute a cause of action because it is an improper derivative claim in disguise. (See Defs.’ memo, pp.13:9-28, 14:1-8.) However, “[f]iduciary duties arise as a matter of law ‘in certain technical, legal relationships… includ[ing] relationships between… controlling shareholders and minority shareholders….” (Oakland Raiders v. National Football League (2005) 131 Cal.App.4th 621, 632, citing Jones v. H. F. Ahmanson & Co. (1969) 1 Cal.3d 93, 108-112.) The seventh cause of action alleges that Defendants, as controlling majority shareholders of Nuredis, breached their fiduciary duties owed to minority shareholder Plaintiffs by freezing out Plaintiffs from any economic benefit from their investment, siphoning Plaintiffs’ investment monies for Defendants’ sole benefit. The seventh cause of action alleges a direct claim, and the demurrer to the seventh cause of action is OVERRULED.
Eighth cause of action for reformation
Defendants assert that the eighth cause of action fails to state facts sufficient to constitute a cause of action because reformation is a remedy and it does not allege that the parties executed a contract that fails to reflect the terms of their agreement. (See Defs.’ memo, pp.14:9-28, 15:1-9.) As to Defendants’ argument that reformation is only a remedy, the procedural device for challenging a cause of action seeking an improper remedy is a motion to strike. (See Caliber Bodyworks, Inc. v. Super. Ct. (2005) 134 Cal.App.4th 365, 385.) As to Defendants’ latter argument, the eighth cause of action does, in fact, allege that the parties executed a “contract of sale [that] should be reformed” due to a mutual mistake or fraud regarding the terms of and supporting facts for Plaintiffs’ investment. The demurrer to the eighth cause of action is OVERRULED.
Cheng’s demurrer
Cheng lastly demurs to the fraud causes of action on the ground that Plaintiffs’ fraud claims “fail to allege any specific fraudulent misrepresentations by Dr. Cheng.” (Defs.’ memo, p.12:14-15.) However, as Cheng acknowledges, the FAC alleges that “at all pertinent times, Defendant Cheng was aware of and aided and abetted the actions and omissions of Defendant Cohen.” (FAC, ¶ 11.) “Liability may … be imposed on one who aids and abets the commission of an intentional tort if the person (a) knows the other’s conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other to so act or (b) gives substantial assistance to the other in accomplishing a tortious result and the person’s own conduct, separately considered, constitutes a breach of duty to the third person. (Casey v. U.S. Bank Nat. Assn. (2005) 127 Cal.App.4th 1138, 1144.) Here, contrary to Defendants’ assertion, the FAC sufficiently alleges facts supporting the fraud causes of action with the requisite particularity. The alleged misconduct by Cohen is of an ongoing nature, and Cheng is alleged to have knowledge of all of it, and to have given substantial assistance to Cohen in accomplishing the defrauding of Plaintiffs. The allegation of knowledge is an ultimate fact. (See Johnson v. Casetta (1961) 197 Cal.App.2d 272, 276 (stating that “an allegation of knowledge of incompetency is an allegation of ultimate fact”); see also People v. Rogers (2013) 57 Cal.4th 296, 338 (stating that defendant’s knowledge or intent is an “ultimate fact”); see also People v. Foster (2010) 50 Cal.4th 1301, 1347 (same); see also People v. Medina (1995) 11 Cal.4th 694, 763 (same).) Here, the FAC adequately alleges facts as to defendant Cheng and Cheng’s demurrer to the fraud causes of action is OVERRULED.
Defendants’ request for judicial notice
Defendants, in connection with their reply brief, requested judicial notice of certain documents. However, Defendants present these documents for the first time in reply to support new arguments not raised in the demurrer. (See reply brief, pp.2:18-28, 3:1, 23-25, 5:3-10.) These documents will not be considered. Defendants’ request for judicial notice is DENIED.
The Court will prepare the Order.
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