On Friday, July 14, 2017, Baton Rouge law firm Walters, Papillion, Thomas, Cullens, LLC secured a jury verdict in excess of $20 Million against several defendants, but most notably John Paul DeJoria, founder of Paul Mitchell Studios and Patron Tequila and a frequent guest on the TV show “Shark Tank.” J.Cullens of the Cullens Group was lead counsel.
DeJoria became a director of Latitude Solutions, Inc. (“LSI”), a publicly traded company, in October 2011. Although worth more than $3 billion according to Forbes Magazine, DeJoria had never served on the board of a publicly traded company before LSI. DeJoira was introduced to LSI by two long-time friends and business associates, Howard Appel and Ernest Bartlett, both of whom had checkered histories of stock manipulation and fraud. Prior to LSI, Appel was convicted of securities fraud manipulation and served twenty-one months in state and federal prison in New York. Within months of being released from prison in the summer of 2010, Appel became heavily involved in LSI as an “outside consultant.” In April 2011, one month before LSI signed a major contract with an outside manufacturer, DeJoria signed a one-page loan agreement with Appel and Bartlett for $2 million, payable within 90 days at an annual rate of approximately 200%, that was secured with 3 million shares of LSI stock. At trial, DeJoria maintained that this loan was personal in nature and unrelated to LSI; plaintiff maintained that this extremely unusual loan was strong circumstantial evidence that DeJoria was a knowing participant in Appel’s ongoing fraudulent scheme involving LSI.
LSI produced water-remediation units which used electro-precipitation technology to clean waste water in the oil and gas industry. In essence, an LSI unit would be placed near an oil well or fracking site to process and clean contaminated flowback water for reuse. LSI claimed that its water-remediation technology had the potential of effectively and rapidly cleaning so much water on site that it would “revolutionize” the way the oil industry handled waste water. Although most of the work performed by LSI took place in Texas and Oklahoma, LSI was based in Boca Raton, Florida.
In May 2011, LSI signed a multi-million dollar manufacturing contract with Jabil Circuits, Inc., one of the world’s largest manufacturers with over 90 facilities worldwide and 175,000 employees. Although Jabil’s due diligence revealed that LSI’s technology had potential, LSI did not provide Jabil with access to its price model or financial data regarding its projected operational costs. Significantly, Jabil was not informed that Appel was involved with LSI in any way. At the time LSI signed the Jabil contract, it did not have a working prototype, had not produced a single unit, and did not have a signed contract with a customer in hand. According to defendants, they had faith in LSI’s product and were confident that, with Jabil’s help, LSI would produce a unit that worked, would secure customers, and ultimately, would generate significant revenue. According to plaintiff, LSI’s technology had been around for decades, no other business like LSI had succeeded using electro-precipitation in the past, and LSI’s business model was never commercially viable. Prior to filing for bankruptcy, LSI spent more than $28 million to sustain its operations, while generating less than $1 million in revenues pursuant to a single contract which lasted about three (3) months.
In June 2011, the due diligence team sent to check out LSI for DeJoria, reported to DeJoria that Appel was a “scammer of the worst order,” that he had a twenty-year history of defrauding investors, and that he might be engaged in a “pump-and-dump” at LSI. DeJoria’ due diligence team commissioned a formal investigation report that revealed Appel and Bartlett’s prior criminal and regulatory histories in great detail. Although his due diligence team testified that they gave DeJoria this formal report, at trial, DeJoria testified that he had no recollection of ever receiving it. In any event, at a meeting in late June 2011, DeJoria told his due diligence team that Appel and Bartlett were “nice guys,” and that he would proceed with his investments in LSI despite their warnings. All told, over the course of his involvement with LSI, DeJoria invested or loaned LSI more than $11 million. DeJoria owned about 11.5 million shares of LSI stock (or about 16% of the company), but never sold a share at any time. Because DeJoria lost all of his investment in LSI, he argued at trial that, to the extent Appel and Bartlett did anything wrong, that he was the biggest victim of all. Plaintiff argued that DeJoria knew exactly what he was doing by partnering with Appel, and that he was well positioned to make a significant profit if Appel’s pump-and-dump scheme was a success.
As part of his guilty plea for securities fraud, Appel agreed that he would not serve as a director or officer of a publicly traded company. Appel never had a title at LSI. Appel was never an employee of LSI and never owned a share of LSI stock in his own name. Using nominee companies associated with his friends and family, however, Appel acquired more than 5% of LSI’s outstanding stock at deeply discounted prices. And although Appel claimed to be an “outside consultant” to LSI, he never signed a written contract with LSI. Instead, Appel and his defendants claimed that because Appel had a verbal contract with FEQ Realty, LLC (an entity owned and controlled by Ernest Bartlett which had a formal consulting contract with LSI), Appel could effectively perform extensive services for LSI without publicly disclosing his role at LSI.
Appel would communicate with the CFO of LSI, Matthew Cohen, on a daily basis, and Appel had access to a significant amount of material, non-public information. Appel was also heavily involved in recruiting executive officers of LSI, negotiating the terms of certain officer’s employment agreements, would attend executive committee meetings and board meetings, and, in essence, performed the functions of a de facto officer. Appel and his co-defendants argued that his verbal consulting agreement allowed LSI to provide all of this inside information and access to Appel without public disclosure. Plaintiff maintained that Appel was an undisclosed insider whose identity and criminal history needed to be disclosed pursuant to applicable SEC regulations. When Jabil discovered Appel’s involvement, approximately a year after it started doing business with LSI and after LSI had stopped paying its invoices on a timely basis, Jabil insisted that LSI clean house and get rid of Appel and his associates. Around this same time, May 2012, an outside executive with no prior ties to Appel or Bartlett, was recruited by DeJoria and Appel to “turn LSI around.” This new CEO lasted only about a month. After taking over the helm of LSI and discovering the depth of Appel’s involvement and control of LSI, learning that current management suspected Appel and Cohen of engaging in insider trading, and being told that DeJoria was only going to put more money into LSI if Appel did, this new CEO retained outside counsel and advised LSI that it might have to self-disclose Appel’s involvement and suspected securities fraud to the SEC. Within six months of the new CEO’s abrupt resignation, LSI moved its operations from Boca Raton to Fort Worth, DeJoria resigned as a director of LSI, LSI filed a formal report with the Department of Justice accusing Appel and Cohen of insider trading and orchestrating a pump-and-dump scheme, and filed for bankruptcy in Fort Worth, Texas, on November 9, 2012.
The court-appointed Bankruptcy Trustee, Carey Ebert (“plaintiff”), hired special litigation counsel to file suit against Appel, Bartlett, Cohen, and DeJoria, alleging, inter alia, breach of fiduciary duty and aiding and abetting breach of fiduciary duty. The Trustee also sought punitive damages against defendants. At trial, defendants maintained that despite their best efforts and significant monetary support, LSI failed; that the business judgment rule shielded the directors and officers of LSI from any liability. For every Google, defendants argued, there are ten MySpaces. In contrast, plaintiff maintained that defendants’ purpose in signing the Jabil contract and sustaining LSI’s corporate life through their financial support was not legitimate; that LSI’s technology was clearly a pipe-dream, and that the real purpose behind defendants’ involvement in LSI was to create a seemingly viable start-up company through which Appel and his associates could enrich themselves through a pump-and-dump scheme--regardless of whether their scheme was ultimately successful.
The one-week jury trial proceeded in federal court in Fort Worth, Texas, and concluded on July 14, 2017. The jury ruled that DeJoria and Cohen breached their fiduciary duty to LSI, and that DeJoria, Appel, and Bartlett all aided and abetted Cohen in his breach. The jury also awarded punitive damages against DeJoria, Appel, and Cohen. The jury awarded a total of $13.4 million in compensatory damages, and a total of $8 million in punitive damages. The case is currently on appeal before the U.S. Fifth Circuit.
CITATION: Ebert v. Appel, et al., No. 4:15-cv-225-O (U.S., N.D. Tx—Fort Worth, July 14, 2017).
PLAINTIFF COUNSEL: Walters, Papillion, Thomas, Cullens, LLC, Baton Rouge. Lead Counsel: J.E. Cullens, Jr. (special litigation counsel for the Bankruptcy Trustee).
PLAINTIFF EXPERTS: Robert Manz, certified fraud examiner and damages expert, BVA Group, Plano, Texas; Professor Marc Steinberg, corporate governance / SEC regulation expert, SMU Law School, Dallas, Texas; Ethan McBroom, water-remediation services expert, Amarillo, Texas.
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