Lee v. McDowell, 2020 NCBC 74.
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE SUPERIOR COURT DIVISION MECKLENBURG COUNTY 19 CVS 17741
KEITH LEE and YOUNG KWON (individually and derivatively on behalf of rFactr, Inc.),
Plaintiffs,
v.
CHRIS MCDOWELL; CHRIS LAU; and ROBERT DUNN, ORDER AND OPINION ON Defendants, DEFENDANT CHRIS MCDOWELL’S MOTION TO DISMISS PLAINTIFFS’ and VERIFIED AMENDED COMPLAINT
RFACTR, INC.,
Nominal Defendant.
CHRIS MCDOWELL,
Third-Party Plaintiff,
RICHARD BRASSER and GREG GENTNER,
Third-Party Defendants.
CHRIS LAU and ROBERT DUNN,
Third-Party Plaintiffs,
v. RICHARD BRASSER and GREG GENTNER,
1. THIS MATTER is before the Court on Defendant Chris McDowell’s
(“McDowell”) Motion to Dismiss Plaintiffs’ Verified Amended Complaint (the
“Motion”) pursuant to Rule 12(b)(6) of the North Carolina Rules of Civil Procedure
(“Rule(s)”). (ECF No. 15.)
2. This case arises from Plaintiffs Keith Lee’s and Young Kwon’s (collectively,
“Plaintiffs”) investments in, and McDowell’s alleged mismanagement of, Nominal
Defendant rFactr, Inc. (“rFactr” or the “Company”). The Company is now insolvent
but was formerly engaged in business sales technology. (Verified Am. Compl. ¶¶ 1,
9, 19 [hereinafter “Am. Compl.”], ECF No. 10.) Plaintiffs allege that McDowell failed
to disclose to Plaintiffs rFactr’s poor financial condition and correct management’s
misrepresentations to Plaintiffs about rFactr’s business while at the same time
actively and successfully soliciting their investments in the Company. (Am. Compl.
¶9.)
3. Having considered the Motion, the Verified Amended Complaint (“Amended
Complaint”), the related briefing, and the arguments of counsel at the hearing on the
Motion, the Court, for the reasons set forth below, DENIES the Motion.
Moore & Van Allen PLLC, by Christopher D. Tomlinson and William M. Butler, for Plaintiffs Keith Lee and Young Kwon.
James, McElroy & Diehl, P.A., by John R. Buric, for Nominal Defendant rFactr, Inc. Rosenwood, Rose & Litwak, PLLC, by Erik M. Rosenwood and Carl J. Burchette, for Defendant/Third-Party Plaintiff Chris McDowell.
Troutman Pepper Hamilton Sanders LLP, by Kiran H. Mehta, William J. Farley, and Mackenzie Willow-Johnson, for Defendants/Third-Party Plaintiffs Chris Lau and Robert Dunn.
Lincoln Derr PLLC, by Sara R. Lincoln and Phoebe Norton Coddington, for Third-Party Defendants Richard Brasser and Greg Gentner.
Bledsoe, Chief Judge. I.
FACTUAL BACKGROUND
4. The Court does not make findings of fact on a motion to dismiss under Rule
12(b)(6). Rather, the Court recites the allegations asserted and documents referenced
in Plaintiffs’ Amended Complaint that are relevant to the Court’s determination of
the Motion. See, e.g., Concrete Serv. Corp. v. Investors Grp., Inc., 79 N.C. App. 678,
681, 340 S.E.2d 755, 758 (1986) (noting a motion to dismiss “generally tests the legal
sufficiency of the complaint”).
5. Defendants McDowell, Chris Lau (“Lau”), and Robert Dunn (“Dunn”) are
current or former directors of rFactr. (Am. Compl. ¶ 1.) McDowell served as a
director from 2015–18, Dunn from 2015–17, and Lau since May 2017. (Am. Compl.
¶¶ 12, 14–15.) At all relevant times, Third-Party Defendant Richard Brasser
(“Brasser”) was the Chief Executive Officer and President of rFactr, and Third-Party
Defendant Greg Gentner (“Gentner”) was the Company’s Chief Operating Officer.
(Am. Compl. ¶ 3.) In addition to serving as a member of rFactr’s board of directors, McDowell was at all relevant times a shareholder of the Company, (Am. Compl. ¶
12), as well as “[Plaintiffs’] personal broker[,]” (Am. Compl. ¶ 13).
6. Plaintiffs allege that they were first introduced to rFactr and Brasser by
McDowell at a dinner party McDowell hosted in New York City in early 2014. (Am.
Compl. ¶ 20.) Plaintiffs allege that “McDowell never disclosed to [Plaintiffs] that he
was a consultant for rFactr and was being compensated by rFactr.” (Am. Compl. ¶
27.)
7. During the dinner, both Brasser and McDowell “solicited [Plaintiffs] to
purchase convertible promissory notes from rFactr.” (Am. Compl. ¶ 21.) Brasser
“stated that, due to their relationship with McDowell, [Plaintiffs] would be treated
‘like ‘friends and family.’ ” (Am. Compl. ¶ 22.) Brasser also told Plaintiffs that rFactr
was a “new company[,]” would be “cash flow positive ‘in the next six months,’ ” and
was raising money “specifically for new subscription demand created by pending large
customers.” (Am. Compl. ¶ 23.)
8. Plaintiffs allege that Brasser’s statements were false and that “McDowell
had knowledge of Brasser’s misrepresentations and omissions and aided in the sale
of convertible notes to [Plaintiffs], including by personally soliciting and
recommending their investments in rFactr, arranging and attending their meeting
with Brasser, and by communicating with the [Plaintiffs] regarding their potential
investments in rFactr[.]” (Am. Compl. ¶ 28.) According to Plaintiffs, McDowell not
only “recommended investments in rFactr[,]” but also “vouched for Brasser.” (Am.
Compl. ¶ 26.) 9. Plaintiffs allege that rFactr was merely a rebranded version of its
predecessor, Targeted Golf Solutions, Inc. (“Targeted Golf”), not a new company as
Brasser had represented. (Am. Compl. ¶¶ 46, 51.) As a continuation of Targeted
Golf, rFactr remained subject to Targeted Golf’s substantial liabilities, (Am. Compl.
¶¶ 47–53), which McDowell knew about but “did not disclose . . . to [Plaintiffs,]” (Am.
Compl. ¶ 52).
10. Plaintiffs assert that, as a result of McDowell’s acts and omissions, they each
“purchased convertible promissory notes from rFactr[,]” (Am. Compl. ¶ 29), which
they “would not have purchased . . . but for the recommendation and inducement of
McDowell[,]” (Am. Compl. ¶ 93). Kwon purchased one note in the principal amount
of $300,000 in March 2014, (Am. Compl. ¶ 31), and Lee purchased notes in the
aggregate principal amount of $300,000 in April 2014 and March 2015, (Am. Compl.
¶ 30).
11. The Company’s financial fortunes worsened after Plaintiffs made their
investments. According to Plaintiff, whether as Targeted Golf or as rFactr, the
Company failed to pay its outstanding state and federal taxes. (Am. Compl. ¶ 81.)
By mid-2016, rFactr “ceased paying service providers,” (Am. Compl. ¶ 82), and by
August 2018, rFactr could not pay its employees, had laid off all full-time employees,
was “unable to pay its outstanding debts . . . [or] support ongoing operations[,]”
“bec[a]me a shell company with no ability to do business and [with] huge debts it
[could] not pay[,]” (Am. Compl. ¶ 84), and had “ceased operations and [was] winding-
up[,]” (Am. Compl. ¶ 83). 12. Plaintiffs allege, among other things, that McDowell, as a Company director,
“fail[ed] to provide oversight of rFactr’s finances and permit[ed] Brasser and Gentner
to conceal the state of rFactr’s finances[,]” (Am. Compl. ¶ 60(a)), “approv[ed] or
permit[ed] rFactr’s officers to misuse and squander corporate funds,” (Am. Compl. ¶
60(d)), and “fail[ed] to disclose or correct known misrepresentations made to rFactr’s
creditors and shareholders[,]” (Am. Compl. ¶ 60(f)). Thus, according to Plaintiffs,
McDowell “prevented noteholders and shareholders from learning the true state of
rFactr and taking action and facilitated the decline of rFactr and the squandering of
all of rFactr’s assets.” (Am. Compl. ¶ 72.)
13. The convertible promissory notes Plaintiffs purchased became due in 2017.
Plaintiffs “notified rFactr and its [d]irectors in writing that their [n]otes had matured
and payment was due.” (Am. Compl. ¶ 78). Although “rFactr promised to pay the
respective [n]oteholder the principal amount plus accrued interest” when due, (Am.
Compl. ¶ 33), “rFactr has failed to pay [Plaintiffs] any amounts due under the
[n]otes,” (Am. Compl. ¶ 34), or “offer a plan for repayment[,]” (Am. Compl. ¶ 79).
II.
PROCEDURAL BACKGROUND
14. Plaintiffs filed the Complaint initiating this action on September 6, 2019,
(Compl., ECF No. 3), and later filed the Amended Complaint on November 26, 2019,
(ECF No. 10). Plaintiffs assert the following claims in their Amended Complaint: (i)
a derivative claim against all Defendants for breach of their fiduciary duties as
directors of rFactr, (Am. Compl.¶¶ 116–20); (ii) a separate breach of fiduciary duty claim against McDowell for his failure to disclose information regarding his role in
rFactr and rFactr’s financial troubles (Am. Compl. ¶¶ 90–100); (iii) a claim for
constructive fraud against McDowell, (Am. Compl. ¶¶ 101–06); and (iv) claims for
securities fraud against McDowell under section 78A-56 of the North Carolina
Securities Act, section 10(b) of the United States Exchange Act, and Rule 10b-5
promulgated thereunder by the Securities Exchange Commission, (Am. Compl.
¶¶107–15).
15. This case was designated a mandatory complex business court case on
October 14, 2019, (ECF No. 1), and assigned to the undersigned on the same day,
(ECF No. 2).
16. McDowell filed the Motion on December 23, 2019. (ECF No. 15.) The Motion
has been fully briefed, and a hearing on the Motion was held on June 16, 2020 by
videoconference, at which all parties were represented by counsel. The Motion is now
ripe for resolution.
III.
LEGAL STANDARD
17. When deciding whether to dismiss for failure to state a claim under Rule
12(b)(6), the Court considers “whether the allegations of the complaint, if treated as
true, are sufficient to state a claim upon which relief can be granted under some legal
theory.” Corwin v. British Am. Tobacco PLC, 371 N.C. 605, 615, 821 S.E.2d 729, 736
(2018) (quoting CommScope Credit Union v. Butler & Burke, LLP, 369 N.C. 48, 51,
790 S.E.2d 657, 659 (2016)). 18. “[D]ismissal pursuant to Rule 12(b)(6) is proper when ‘(1) the complaint on
its face reveals that no law supports the plaintiff’s claim; (2) the complaint on its face
reveals the absence of facts sufficient to make a good claim; or (3) the complaint
discloses some fact that necessarily defeats the plaintiff’s claim.’ ” Id., 821 S.E.2d at
736–37 (quoting Wood v. Guilford Cty., 355 N.C. 161, 166, 558 S.E.2d 490, 494 (2002)).
19. Although the Court construes the complaint “in the light most favorable to
the non-moving party[,]” Christenbury Eye Ctr., P.A. v. Medflow, Inc., 370 N.C. 1, 5,
802 S.E.2d 888, 891 (2017) (quoting Kirby v. N.C. DOT, 368 N.C. 847, 852, 786 S.E.2d
919, 923 (2016)), the Court need not “accept as true allegations that are merely
conclusory, unwarranted deductions of fact, or unreasonable inferences[,]” Good Hope
Hosp., Inc. v. N.C. Dep’t of Health & Human Servs., 174 N.C. App. 266, 274, 620
S.E.2d 873, 880 (2005) (citation omitted); see also McCrann v. Pinehurst, LLC, 225
N.C. App. 368, 377, 737 S.E.2d 771, 777 (2013) (“While we treat plaintiffs’ factual
allegations as true, we may ignore plaintiffs’ legal conclusions.”).
IV.
ANALYSIS
20. Plaintiffs’ individual claims are premised on McDowell’s omissions, rather
than his affirmative representations, and are based specifically on McDowell’s failure
to correct Brasser’s misrepresentations to Plaintiffs regarding rFactr’s financial
condition and future prospects leading up to Plaintiffs’ investments. (Am. Compl. ¶
9.) McDowell contends that Plaintiffs’ individual claims against him must be
dismissed because (i) Plaintiffs have not pleaded facts showing proximate cause for any claim;1 (ii) Plaintiffs did not plead their constructive fraud and securities fraud
claims with sufficient particularity; (iii) Brasser’s statements regarding rFactr’s
financial future cannot serve as the basis for Plaintiffs’ fraud-based claims;2 and (iv)
Plaintiffs have not pleaded facts showing either McDowell’s intent to benefit himself
or that McDowell “knowingly kept material information from Plaintiffs prior to their
purchases of the [n]otes” because they did not allege that “McDowell was aware or
had reason to believe any statements made by Brasser or Gentner about the Company
or its economic prospects were false.” (Br. Supp. Mot. Dismiss 5–9.) 3
21. The Court addresses each argument in turn.
A. Proximate Cause–All Claims
22. McDowell first contends that Plaintiffs have not sufficiently alleged
proximate cause to support any of their claims against him because “Plaintiffs cannot
demonstrate that they reasonably relied on McDowell’s actions or inactions when
making the decision to purchase the [n]otes[.]” (Br. Supp. Mot. Dismiss 7.)
Specifically, McDowell argues that “Plaintiffs had, at all times, direct access to
Brasser and Gentner and the financial records of rFactr, and therefore any failure by
1 This is the sole ground McDowell advances for dismissal of Plaintiffs’ derivative claim for
breach of fiduciary duty. (Def. Chris McDowell’s Br. Supp. Mot. Dismiss Pls.’ Verified Am. Compl. 7–9 [hereinafter “Br. Supp. Mot. Dismiss”], ECF No. 16.)
2 Plaintiffs’ securities fraud claims are the only fraud-based claims Plaintiffs assert against
McDowell in the Amended Complaint. (Am. Compl. ¶¶ 107–15.)
3 The Motion also sought to dismiss Plaintiffs’ Amended Complaint under Rule 12(b)(7) for
failure to join Brasser and Gentner as necessary parties. (Br. Supp. Mot. Dismiss 1–2.) McDowell confirmed at the hearing, however, that the addition of Brasser and Gentner to this action as Third-Party Defendants moots this aspect of his Motion. The Court, therefore, does not consider this aspect of McDowell’s Motion and hereby denies it as moot. McDowell to report information about the Company could not be the cause of any of
the Plaintiffs’ alleged damages.” (Br. Supp. Mot. Dismiss 7–8.)
23. “Proximate cause is defined as ‘a cause which in natural and continuous
sequence, unbroken by any new and independent cause, produced the plaintiff’s
injuries, and without which the injuries would not have occurred.’ In re Se. Eye Ctr.-
Pending Matters, 2019 NCBC LEXIS 29, at *178 (N.C. Super. Ct. May 7, 2019)
(quoting Adams v. Mills, 312 N.C. 181, 192, 322 S.E.2d 164, 172 (1984)). Proximate
cause exists only where “the risk of injury . . . is within the reasonable foresight of
the defendant.” Williams v. Carolina Power & Light Co., 296 N.C. 400, 403, 250
S.E.2d 255, 258 (1979).
24. “Questions concerning proximate cause are ordinarily best left to the jury.”
In re Se. Eye Ctr., 2019 NCBC LEXIS 29, at *178 (quoting Williams, 296 N.C. at 403,
250 S.E.2d at 258 (noting that only in “exceptional cases” should the issue of
proximate cause be resolved as a matter of law)). With these principles in mind, the
Court reviews each claim to determine whether Plaintiffs have sufficiently alleged
proximate cause.
1. Breach of Fiduciary Duty and Constructive Fraud4
25. McDowell argues that Plaintiffs’ breach of fiduciary duty and constructive
fraud claims fail for failure to allege proximate cause because “Plaintiffs
4 McDowell has not challenged Plaintiffs’ allegation that he owed Plaintiffs a fiduciary duty
at the time Plaintiffs allege he solicited their investments. Therefore, the Court will assume without deciding for purposes of the Motion that Plaintiffs have alleged facts sufficient to show that a fiduciary relationship existed between McDowell and Plaintiffs. See, e.g., Dalton v. Camp, 353 N.C. 647, 651, 548 S.E.2d 704, 707 (2001) (describing a fiduciary relationship had . . . direct access to Brasser and Gentner and the financial records of rFactr[,]”
(Br. Supp. Mot. Dismiss 7–8). Despite McDowell’s assertion, however, these
purported facts are not in the Amended Complaint, and it is the allegations of the
Amended Complaint that the Court must test under Rule 12(b)(6). See Corwin, 371
N.C. at 615, 821 S.E.2d at 736.
26. Further, Plaintiffs have alleged facts showing an unbroken chain of events
causing them injury which would not have occurred but for McDowell’s alleged
breaches of fiduciary duty. See In re Se. Eye Ctr., 2019 NCBC LEXIS 29, at *178. In
particular, Plaintiffs allege that McDowell, as their personal investment broker,
vouched for Brasser, personally arranged for Plaintiffs’ meeting with Brasser, knew
that Brasser made false representations to Plaintiffs at the New York City meeting
but failed to correct them, and solicited Plaintiffs’ purchase of rFactr notes, all of
which induced Plaintiffs to invest their funds in rFactr’s notes and thereby suffer
injury. (Am. Compl ¶¶ 20–34.) Plaintiffs further allege that they “would not have
purchased the [n]otes but for the recommendation and inducement of McDowell.”
(Am. Compl ¶ 93.) As such, the Court concludes that, when viewed in the light most
favorable to Plaintiffs, these allegations are sufficient to demonstrate that
McDowell’s alleged breach of fiduciary duty proximately caused Plaintiffs’ injury. See
Adams, 312 N.C. at 193, 322 S.E.2d at 172 (stating that “[p]roximate cause is an
as one of “special confidence” (quoting Abbitt v. Gregory, 201 N.C. 577, 598, 160 S.E. 896, 906 (1931))); Searcy v. Searcy, 215 N.C. App. 568, 573, 715 S.E.2d 853, 857 (2011) (stating that a claim of constructive fraud requires a “relation of trust and confidence” (quoting Sidden v. Mailman, 137 N.C. App. 669, 677, 529 S.E.2d 266, 272 (2000))). inference of fact to be drawn from other facts and circumstances”). McDowell’s
Motion seeking dismissal on this basis must therefore be denied.
2. Securities Fraud
27. One primary difference between claims for breach of fiduciary duty,
constructive fraud, and securities fraud is that securities fraud, whether under North
Carolina or federal law, does not require that a plaintiff’s injuries result from reliance
on a relationship of trust and confidence with the defendant. Rather, as applied here,
Plaintiffs must allege that McDowell’s omissions caused Plaintiffs to invest in rFactr
and resulted in Plaintiffs’ loss. See Bruschi v. Brown, 876 F.2d 1526, 1530 (11th Cir.
1989) (stating that causation under federal securities law requires pleading “that the
defendant’s misrepresentations caused the plaintiff to make the investment” and
“that the untruth was in some reasonably direct . . . way responsible for his loss”
(citations omitted)); Saw Plastic, LLC v. Sturrus, 2017 NCBC LEXIS 76, *26 (N.C.
Super. Ct. Aug. 25, 2017) (“An action under [G.S. § 78A-56(a)] sounds in fraud,
comparable to common law fraud and must include allegations and proof typical of
common law fraud claims.” (citation and internal quotation marks omitted)); see also
Claggett v. Wake Forest Univ.,126 N.C. App. 602, 610, 486 S.E.2d 443, 447 (1997)
(noting a plaintiff alleging common law fraud must aver that “plaintiff suffered
damage resulting from defendant’s misrepresentation or concealment”).
28. The allegations Plaintiffs advance to support their various claims for
securities fraud, including to establish proximate cause, involve the same allegations
they advance to support their breach of fiduciary duty and constructive fraud claims. (See Am. Compl. ¶¶ 21, 23, 28, 30–31, 34 (alleging McDowell’s solicitation of and
failure to inform Plaintiffs); compare 91, 93, with ¶ 113 (alleging reliance on
McDowell’s acts and omissions when deciding to invest).) All of these claims are
premised on Plaintiffs’ allegations that McDowell successfully solicited their
investments while concealing from them material information about the Company’s
finances that he had a duty to disclose—investments Plaintiffs would not have made
had McDowell disclosed the truth he knew about the Company. (Am. Compl. ¶¶ 110,
112–13.) These allegations are sufficient to show that McDowell’s fraudulent conduct
proximately caused Plaintiffs’ investment losses for purposes of Plaintiffs’ securities
fraud claims. See Williams, 296 N.C. at 403, 250 S.E.2d at 258. McDowell’s Motion
to Dismiss on this ground must therefore be denied.
3. Derivative Claim for Breach of Fiduciary Duty
29. McDowell also seeks to dismiss Plaintiffs’ derivative claim based on his
alleged breach of fiduciary duty for Plaintiffs’ failure to allege proximate cause. (Br.
Supp. Mot. Dismiss 7–9.) Like his other challenges to Plaintiffs’ pleading on this
ground, McDowell’s argument is without merit.
30. Plaintiffs allege that McDowell, as a director, “fail[ed] to provide oversight
of rFactr’s finances and permit[ed] Brasser and Gentner to conceal the state of
rFactr’s finances[,]” (Am. Compl. ¶ 60(a)), “approv[ed] or permit[ed] rFactr’s officers
to misuse and squander corporate funds,” (Am. Compl. ¶ 60(d)), and “fail[ed] to
disclose or correct known misrepresentations made to rFactr’s creditors and
shareholders[,]” (Am. Compl. ¶ 60(f)). Plaintiffs further allege that McDowell provided services to rFactr, constituting a conflict of interest[,] (Am. Compl. ¶ 73),
cancelled a deal with another company “based on [his] own self interest,” (Am. Compl.
¶ 75), and refused to effect “changes regarding the governance of rFactr” after
admitting that Brasser and Gentner’s salaries were “truly outrageous” and that they
were “destroying th[e] company[,]” (Am. Compl. ¶¶ 66–67, 69).
31. Plaintiffs also allege that McDowell’s various failures “prevented
noteholders and shareholders from learning of the true state of rFactr and taking
action and facilitated the decline of rFactr and the squandering of all of rFactr’s
assets.” (Am. Compl. ¶ 72.) According to Plaintiffs, as a “result of [McDowell’s]
breaches of fiduciary duty, rFactr has suffered and will continue to suffer” injury
because the Company “[does] not have capital to pay its employees,” cannot “service
ongoing contracts with clients” or “support the ongoing operations of the
[C]ompany[,]” and cannot pay “its outstanding debts[.]” (Am. Compl. ¶¶ 84, 119.)
32. The Court concludes that these allegations, taken as true and viewed in the
light most favorable to Plaintiffs, are sufficient to show that McDowell breached his
fiduciary duties as a director by failing to take any action to prevent rFactr’s officers
from mismanaging the Company and thereby causing rFactr to “become a shell
company with no ability to do business[,]” (Am. Compl. ¶ 84), and resulting in loss to
the Company, its shareholders, and its creditors. McDowell’s Motion to Dismiss
Plaintiffs’ derivative claim based on a failure to allege proximate cause must
therefore be denied. B. Constructive Fraud Claim—Pleading with Particularity
33. McDowell seeks dismissal of Plaintiffs’ constructive fraud claim on the
additional ground that Plaintiffs have failed to plead that claim with sufficient
particularity under Rule 9(b).5 (Br. Supp. Mot. Dismiss 4.) Our appellate courts,
however, have made clear that “[a] claim of constructive fraud does not require the
same rigorous adherence to elements as actual fraud.” Terry v. Terry, 302 N.C. 77,
83, 273 S.E.2d, 674, 677 (1981). Consequently, a claim for constructive fraud “does
not need to meet the Rule 9(b) pleading requirement.” Ironman Med. Props., LLC v.
Chodri, 836 S.E.2d 682, 691 (N.C. Ct. App. 2019). Accordingly, based on the Court’s
review of the relevant allegations in the Amended Complaint, McDowell’s Motion to
Dismiss Plaintiffs’ constructive fraud claim on this ground must be denied.
C. Constructive Fraud Claim—McDowell’s Intent to Benefit Himself
34. McDowell next claims that Plaintiffs’ constructive fraud claim is fatally
deficient because “the Amended Complaint fails to demonstrate that McDowell
sought to benefit himself in a way that took advantage of . . . Plaintiffs”—specifically
that Plaintiffs have not alleged facts showing that “McDowell was aware of or had
reason to believe that any statements made by Brasser and Gentner . . . were false.”
(Br. Supp. Mot. Dismiss 5.) McDowell’s argument is meritless.
35. While McDowell is correct that a constructive fraud plaintiff must plead that
the defendant intended to use his position of trust and confidence in order to benefit
5 Rule 9(b) specifically provides that “[i]n all averments of fraud, duress or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally.” N.C. R. Civ. P. 9(b). himself, see Piles v. Allstate Ins. Co., 187 N.C. App. 399, 406, 653 S.E.2d 181, 186
(2007) (“[A]n essential element of constructive fraud is that [D]efendant[ ] sought to
benefit [himself] in the transaction.” (citation and internal quotation marks omitted)),
disc. review denied, 362 N.C. 361, 663 S.E.2d 316 (2008), Plaintiffs have satisfied
their pleading burden here.
36. Contrary to McDowell’s contention, (Br. Supp. Mot. Dismiss 5), Plaintiffs
have alleged that “McDowell took advantage of the fiduciary relationship with the
[n]oteholders to the detriment of the [n]oteholders and to the benefit of himself.” (Am.
Compl. ¶ 103.) Plaintiffs have further alleged that, based on the knowledge McDowell
gained as a shareholder and director of rFactr and his knowledge of its predecessor,
he knew that Brasser made misrepresentations to Plaintiffs, (Am. Compl. ¶ 25), yet
not only failed to disclose that information to Plaintiffs when he had a duty to do so,
but also induced Plaintiffs to invest in rFactr, the failing company in which he was a
shareholder, thereby advancing McDowell’s pecuniary interest at Plaintiffs’ expense.
(Am. Compl. ¶ 28.) The Court concludes that these allegations are sufficient to
survive dismissal under Rule 12(b)(6). McDowell’s Motion on this basis must
therefore be denied.
D. Securities Fraud Claims—Pleading with Particularity/Future Statements
37. McDowell also seeks to dismiss Plaintiffs’ securities fraud claims for failing
to plead with requisite particularity under Rule 9(b). (Br. Supp. Mot. Dismiss 4.)
Separately, he contends that these same claims should be dismissed as impermissibly based on unfulfilled promises concerning future events. (Br. Supp. Mot. Dismiss 5.)
Neither contention has merit.
38. Plaintiffs’ securities fraud claims are omission-based and are premised on
Plaintiffs’ allegations that (i) McDowell “was involved in and materially aided
rFactr’s sale of the [n]otes[,]” (Am. Compl. ¶ 110), and (ii) “in soliciting [Plaintiffs] to
purchase the [n]otes, McDowell concealed information regarding rFactr from
[Plaintiffs], failed to disclose known misrepresentations and conflicts of interest to
[Plaintiffs], and personally benefitted from rFactr at the expense of [Plaintiffs,]” (Am.
Compl. ¶ 112). Plaintiffs further allege that they “had no knowledge of the concealed
facts” and “reasonably relied upon the false or incomplete representations in deciding
to purchase the [n]otes.” (Am. Compl. ¶ 113.)
39. As to the specific information Plaintiffs allege that McDowell concealed,
Plaintiffs allege, as noted above, that Brasser told them at a dinner party in New
York City in early 2014 that rFactr was a “new company[,]” would be “cash flow
positive ‘in the next six months,’ ” and was “raising money specifically for new
subscription demand created by pending large customers.” (Am. Compl. ¶¶ 23, 26,
28.) Plaintiffs further allege that McDowell (i) was their broker/investment advisor;
(ii) invited them to the dinner party to meet Brasser and Gentner; (iii) vouched for
Brasser; (iv) heard Brasser’s representations at the dinner party; (v) knew those
representations were false; (vi) had a duty as Plaintiffs’ broker/investment advisor to
advise Plaintiffs that Brasser’s statements were not true; and still (vii) solicited their investments in rFactr notes without disclosing that Brasser’s statements about
rFactr’s business and prospects were inaccurate. (Am. Compl. ¶¶ 20, 28–31.)
40. Turning first to Rule 9(b)’s particularity requirement, the Supreme Court of
North Carolina has long held that Rule 9(b) is “met by alleging time, place and
content of the fraudulent representation, identity of the person making the
representation and what was obtained as a result of the fraudulent acts or
representations.” Terry, 302 N.C. at 85, 273 S.E.2d at 678. However, “ ‘fraud by
omission is, by its very nature, difficult to plead with particularity’ under Rule 9(b).”
Island Beyond, LLC v. Prime Cap. Grp., LLC, 2013 NCBC LEXIS 48, at *18 (N.C.
Super. Ct. Oct. 30, 2013) (quoting Lawrence v. UMLIC-Five Corp., 2007 NCBC LEXIS
20, at *9 (N.C. Super. Ct. June 18, 2007)). This Court has therefore held that fraud
claims based on omission require a plaintiff to allege:
(1) “the relationship [between plaintiff and defendant] giving rise to the duty to speak[”;] (2) the event that triggered the duty to speak or the general time period over which the relationship arose and the fraud occurred; (3) “the general content of the information that was withheld and the reason for its materiality[”;] (4) the identity of those under a duty who failed to make such disclosures; (5) what the defendant gained from withholding the information; (6) why the plaintiff’s reliance on the omission was reasonable and detrimental; and (7) the damages the fraud caused the plaintiff.
Id., at *18–19 (quoting Lawrence, 2007 NCBC LEXIS 20, at *9); see also Breeden v.
Richmond Cmty. Coll., 171 F.R.D. 189, 195–96 (M.D.N.C. 1997) (stating the same).
Plaintiffs’ allegations meet this pleading burden here, including that McDowell had
a duty to speak on the pleaded facts. See, e.g., Matrixx Initiatives, Inc. v. Siracusano,
563 U.S. 27, 44 (2011) (requiring disclosure under securities fraud claims “only when necessary to make . . . statements made, in the light of the circumstances under
which they were made, not misleading” (citation and internal quotation marks
omitted)).
41. McDowell’s argument concerning the promissory nature of Brasser’s alleged
misrepresentations likewise misses the mark. McDowell premises his argument on
settled North Carolina law that “mere unfulfilled promises cannot be made the basis
for an action of fraud.” Williams v. Williams, 220 N.C. 806, 810, 18 S.E.2d 364, 365
(1942).6 But this case law, which addresses claims against a promisor (here Brasser),
see id. at 811, 18 S.E.2d at 367 (noting that for claims based on an unfulfilled promise,
the relevant question is “the state of the promisor’s mind”), has little application to
claims against McDowell, which are based on his failure to speak, not on his making
an unfulfilled promise, see, e.g., Lawrence, 2007 NCBC LEXIS 20, at *8 (when a claim
for fraud arises by “nondisclosure, Plaintiffs . . . must allege that . . . the Defendants
had a duty to disclose material information to them, as silence is fraudulent only
when there is a duty to speak”) (citing Griffin v. Wheeler-Leonard & Co., 290 N.C.
185, 198, 225 S.E.2d 557, 565 (1976)); see also, e.g., Skoog, 2013 NCBC LEXIS 16, at
*15 (“An omission must be tied to an affirmative statement, because there is no
general duty of disclosure imposed by either federal or North Carolina securities
laws.” (citing Chiarella v. United States, 445 U.S. 222, 230 (1980))); Matrixx
6 The Court notes, however, that North Carolina and federal law are clear that an unfulfilled
promise may be actionable in fraud where “the promisor had no intention of carrying it out at the time of the promise.” Skoog v. Harbert Priv. Equity Fund, II, LLC, 2013 NCBC LEXIS 16, at *30 (N.C. Super. Ct. Mar. 25, 2013) (quoting McKinnon v. CV Indus., Inc., 213 N.C. App. 328, 338, 713 S.E.2d 495, 503 (2011)) (explaining that the rule also applies to securities fraud claims brought under the federal statute). Initiatives, Inc., 563 U.S. at 44 (“Disclosure is required under these provisions only
when necessary to make . . . statements made, in the light of the circumstances under
which they were made, not misleading.” (citation and internal quotation marks
42. Accordingly, because Plaintiffs have alleged sufficient facts to support their
omission-based fraud claims against McDowell, McDowell’s Motion should be denied.
E. Securities Fraud Claims—Knowing Concealment of Material Information
43. Finally, McDowell contends that Plaintiffs’ securities fraud claims should be
dismissed for “fail[ure] to demonstrate that McDowell . . . knowingly kept material
information from Plaintiffs prior to their purchases of the [n]otes[.]” (Br. Supp. Mot.
Dismiss 5.) In support, McDowell relies upon Sullivan v. Mebane Packaging Group,
Inc., 158 N.C. App. 19, 34, 581 S.E.2d 452, 463 (2003), to argue that a plaintiff must
demonstrate that “(1) the defendant made an untrue statement of material fact or
omitted a material fact that would have been necessary to make the statements that
were made not misleading[,]” and “(2) the defendant cannot show that he did not
know or, with reasonable care, could not have known, of the untruth or omission.”
(Br. Supp. Mot. Dismiss 4.)
44. The Court again finds McDowell’s argument without merit. Even if the
Court were to assume Sullivan controls,7 Plaintiffs have alleged facts showing that
7 Sullivan involved N.C.G.S. § 78A-56(b), which prohibits the purchase of a security by means
of an untrue statement or omission—not the sale or offer of sale of a security by those same means, which is the conduct Plaintiffs seek redress for here and is prohibited through N.C.G.S. § 78A-56(a)(2): McDowell knew that: (i) Brasser’s representations were false, (ii) Plaintiffs did not
know that Brasser’s representations were false, (iii) Plaintiffs intended to rely on
Brasser’s misrepresentations in deciding to invest in rFactr’s notes, and (iv) despite
this knowledge, did not advise Plaintiffs that Brasser’s representations were false.
(Am. Compl. ¶¶ 25–26, 28.) As such, Plaintiffs have satisfied any pleading burden to
“demonstrate that McDowell . . . knowingly kept material information from Plaintiffs
prior to their purchases of the [n]otes[.]” (Br. Supp. Mot. Dismiss 5.) McDowell’s
Motion on this ground must therefore be denied.
CONCLUSION
80. WHEREFORE, for the foregoing reasons, the Court hereby DENIES the
Motion to Dismiss.
SO ORDERED, this the 14th day of October, 2020.
/s/ Louis A. Bledsoe, III Louis A. Bledsoe, III Chief Business Court Judge
To state a claim pursuant to § 56(a)(2) . . ., a plaintiff must at a minimum allege (1) a false or misleading statement, or a statement which, because of the circumstances under which it was made, was made false or misleading because of the omission of other facts; (2) that the statement was material; and (3) that the statement was made by one who offered or sold a security.
Skoog, 2013 NCBC LEXIS 16, at *15–16. A plaintiff suing under section (a)(2) need not prove a knowing and intentional failure to disclose material information to the plaintiff. See Piazza, 246 N.C. App. 576, 601, 785 S.E.2d 695, 711 (2016) (“[A] section 78A-56(a)(2) civil plaintiff need not prove scienter.” (emphasis omitted)).