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As if Medical Marijuana, Inc. (OTCPK:MJNA) needs more controversy, a lawsuit filed by the minority owner of its Red Dice Holdings subsidiary has shed light on many of the issues that have been weighing on the company. The allegations raised in the lawsuit are quite serious and, if true, suggest potential fraud. In light of this new information, I am more confident in my recent prediction that the price of MJNA could fall to $0.05, though the risk of a substantially worse outcome exists.

Background

I have covered the details of MJNA extensively since February, and readers can refer to a link to a catalog of my articles on the stock that I included in my most recent article, "Medical Marijuana: Definitely a Dope Opera" a few weeks ago. A lot has happened since that last article, and I shared my most recent views a few days after, when MJNA released its Q3 press release well after it had filed its OTC disclosure, suggesting the stock should be sold.

For background specific to this lawsuit, readers should be aware of the 2012 transaction that formed MJNA subsidiary Red Dice Holdings ("RDH"). Tripp Keber and Chuck Smith contributed intellectual property and certain assets as well as the "Dixie Elixirs" brand in exchange for 40% of the JV, while MJNA contributed $1.45mm to be funded with shares valued at $0.06. Keber and Smith each received options at $0.06 as well. The goal of the transaction was to extend the brand beyond Colorado and into new products.

A very quick summary of the major issues would include:

  • the formation of CannaVest (OTCQB:CANV)
  • the outrageous guidance given by MJNA in February
  • questions about the legality of increases in the authorized share count
  • suggestions by MJNA filings that RDH was having financial issues
  • the launch of rival products by CannaVest
  • a lawsuit disclosed in the November 10-Q that was filed in August by CannaVest against Dixie Holdings as well as MJNA subsidiary RDH

Litigation

The initial lawsuit was filed in San Diego County on July 18th, and I have provided a link to the original complaint. Dixie Holdings filed the lawsuit on behalf of RDH against MJNA. At present, the most recent filing dated 12/2 suggests that the two parties are in the process of beginning arbitration. Keep in mind that what is presented is just one side of the story. Keber, who has been bound by a confidentiality and non-disparagement agreement, had been awfully quiet since he left the Board in early March (not disclosed by MJNA until late April). I urge investors to read the entire complaint, but here are some major allegations:

  • MJNA never contributed 24,166,667 unrestricted common shares as required
  • Former MJNA President Michael Llamas transferred 10mm shares in November, after he had left the company in September following federal indictment and received $200K from the partial proceeds
  • "Upon information and belief, MJNA, Michelle Sides and/or Michael Llamas personally, and/or through his intermediaries, including Michelle Sides, have (1) actively disregarded MJNA's corporate structure; (2) failed to adhere to corporate formalities required by law such as holding and documenting corporate board of director meetings and votes as so required, which includes MJNA's failure to obtain board of director approval for the sale of its majority owned subsidiary, PhytoSPHERE Systems, LLC's assets to CannaVest Corp.; (3) published false and misleading financial statements to the public; (4) published false and misleading disclosure documents to the public; (5) and engaged in a pattern of behavior intended to mislead and defraud its investors, affiliates, subsidiaries, and business partners, including Red Dice and Dixie."

In a letter sent prior to the lawsuit (see page 91), Dixie attacks the corporate governance and flaws in the Articles of Incorporation:

2. Corporate Governance. As you are well aware, Vincent M. Keber, III is a principal of Dixie as well as a former director of MINA. Mr. Keber resigned from the board because of the lack of information provided by the officers and chairman of MJNA, the lack of formal board meetings, and, upon information and belief', various other improper actions by MJNA's officers and chairman. Due to the multiple instances of fraud and moral turpitude committed by MJNA, Mr. Keber, along with his affiliated entities and partners, are understandably concerned about any potential liability he might face from an MINA shareholder lawsuit. As a result, we hereby demand MJNA, HDDC, Michelle Sides, and Michael Llamas shall indemnify the parties as set forth below.

3. Articles of Incorporation. For several years, the officers of MJNA have fraudulently filed amendments to the articles of incorporation either increasing or decreasing the authorized capital of MJNA without shareholder approval. Dixie was told that proper corrective actions would be taken by May 2013. As of the date of this letter, we are unaware of any actions taken by MINA to remedy this material problem. We hereby demand MJNA calls a shareholder meeting by 5:00pmMT on June 18, 2013 to take appropriate corrective actions to amend the articles of incorporation.

The situation Keber describes regarding the Board is appalling, and it's no wonder he resigned, if true. It also helps explain several other director departures as well as the sudden resignation of Ted Caligiuri, acting CEO, earlier this year.

Implications

One of the big mysteries of late has been the SEC inquiry, which was first disclosed in the Q2 OTC disclosure statement in mid-August. The company stated then that the SEC had approached it on June 17th. Two weeks ago, I addressed this inquiry, suggesting several potential reasons, including an internal investigation that began in January, questions about the legality of changes in the authorized share-count, misrepresentations about the CannaVest deal, issues that pre-dated the 2011 reverse merger, or perhaps any number of potentially false and misleading press releases.

On June 11th, four days before the SEC inquiry began, the lawyer representing Dixie sent a letter via email to the company (as well as CannaVest backer Bart Mackay). This letter is on pages 89-92 of the original complaint. Based on the timing and the tone of that letter, I would speculate that Keber went to the SEC with his concerns. The letter included several allegations and demands, but it is this one that convinces me that Keber had no choice but to go the SEC:

Other issues of concern regarding MJNA.

1. Financial Accounting. Dixie is deeply concerned that the financial records of MJNA are inaccurate and/or misleading, even though they have been certified by you as being true and correct. It is Dixie's view that MJNA ("A") lacks proper accounting and reporting procedures, and ("B") upon information and belief, has materially misstated its financial reporting in publicly filed documents certified as being true and correct by you. For example, the financial information provided by Red Dice to MJNA for the fourth quarter of 2012 and for the first quarter of 2013 appears to be inaccurately reported by MJNA in its quarterly filings made with OTC Markets. Red Dice has repeatedly requested copies of MJNA's auditor work papers and consolidation schedule to verify the method of financial reporting implemented by MINA. These requests are continuously ignored. We hereby demand MINA provide Red Dice the auditor work papers and consolidation schedules used by MJNA's auditor to prepare the financial statements for the fourth quarter of 2012 and the first quarter of 2013 by 5:00pm MT on June 13, 2013. Failure to do so will force the management of Red Dice to publicly disclose its belief that MJNA's financial statements are incorrect and materially misleading.

It appears that when MJNA likely failed to meet the deadline, Keber went to the SEC. The issues raised are extremely alarming in and of themselves, but to have the SEC involved increases the risk of enforcement action or an intervention. The SEC has the power to halt trading for ten days for a variety of reasons, including "Questions about the accuracy of publicly available information, including in company press releases and reports, about the company's current operational status, financial condition, or business transactions;" as described here.

For the past ten months, I have described many troubling governance and transparency issues at MJNA, and the details of the lawsuit filed by Dixie against MJNA validate these concerns. The fact that MJNA has never disclosed this material issue is alarming. I stand by my recent projection that the stock could trade to $0.05, but there is considerably more downside in my opinion if the SEC were to take action.

Source: Did Dixie Narc On Medical Marijuana, Inc. To The SEC?