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  • Shelly Albaum

WTH Just Happened? INVESTORS GUIDE to the ChromaDex Litigation


EXTRA DISCLAIMER: Just a reminder that although I am a ChromaDex shareholder, I am a lawyer, not an investment advisor, and I am NOT recommending that anyone buy or sell the stock. My object here is simply to decode and to demystify the legal proceedings -- especially what's been going on in California in recent weeks -- so investors can make their own decisions, hopefully with a better sense of the legal pros and cons.

TL;DR: The litigation doesn't matter. Don't follow it, it's just a distraction. Don't read this article. Don't even read Right of Assembly, except for my funny and interesting non-legal posts.

So a BUNCH of unexpected things happened in California this week. We were expecting to see some summary judgment motions and evidentiary motions narrowing the scope of a trial that would begin in just two weeks. Instead, we got:

1. A whole new round of briefing on summary judgment motions that were already fully briefed

2. Rulings on fully briefed evidentiary issues were even further delayed

3. The trial was delayed for at least three months, maybe more

4. The Judge in the case says he thinks it should be a routine breach of contract case, not the much higher stakes dispute that both parties have asserted

5. The Judge doesn't understand how the Elysium's trade secret theft in particular could have caused so much harm

6. The judge doesn't want to wade through thousands of pages of exhibits, and wants it all spelled out more clearly

7. The judge doesn't see how Elysium can be asserting a patent misuse claim when it apparently could not have been damaged by the alleged behavior

That last one -- that Elysium doesn't have a leg to stand on with its bogus, fictional patent misuse claim -- wasn't unexpected at all. We have known for two years that if the Judge ever actually looked at it he'd throw it out, and we are still sure that that will occur.

But we were surprised and disappointed that the judge doesn't want to engage with the evidence in the case. It's the most interesting and most important case on his docket, I'd wager (I've looked at his docket), and if Judge Carney was every going to, on behalf of the legal system, dig in to a juicy case and pass judgment upon some egregious behavior, this would be a great opportunity.

But it's not a bad thing that he gave ChromaDex's law firm, Cooley, a roadmap for how he wants ChromaDex's case proved. Cooley's loving it. Here's what Cooley had to say about the Judge's ruling:

These questions are readily answered with evidence that ChromaDex has submitted to the Court, additional evidence it will submit, and still more evidence that it would prove at trial but will advance now in response to the Court’s order. This evidence is overwhelming, and will prove beyond doubt that Morris and Elysium’s theft of ChromaDex’s confidential information and trade secrets—framed by Morris’s pledge to “destroy” ChromaDex in order to benefit Elysium’s founders, to whom he promised “unconditional loyalty” while he was still a ChromaDex executive—materially and economically benefitted Elysium and Morris and hurt ChromaDex.

I can't wait to see the "additional evidence" and the "still more evidence" that Cooley will be appending to its brief next month.

And I'm not really worried that Judge Carney is going to conclude that Elysium gets no consequences for stealing trade secrets and then hiding its conduct. As Cooley also said on Thursday,

One does not steal information in order to destroy a company and then decide never to use the stolen information. Morris and Elysium are not bank robbers who held up the teller, took the money, got in the getaway car, and then inexplicably decided never to spend their ill-gotten proceeds. And ChromaDex will prove their misuse of the information at trial with overwhelming evidence of their strategic and calculated perfidy.

I wouldn't want to spend my time convincing Judge Carney to care about this case, but I do not doubt for a moment that Cooley is willing to try and able to succeed.

So that leaves the delay. What an annoyance! And what a disappointment! I had air fare and hotels already booked (fully refundable!), and I was all excited to blog the trial!

But setting aside my bruised expectations and disappointment, should investors care about what Judge Carney said this week?

Background

It was just a couple months ago, on August 1st, that I penned this epic summary of 2.5 years of ChromaDex-Elysium litigation, tracing the litigation back to its roots, and forecasting what might happen in each of the four major proceedings.

But it's been a wild couple months, and now we know a lot more than we did then.

So if you don't know what the fight is about or how it started, or why it's so furious, I urge you to read up here. For those who have been following the litigation along with me, let's step back and look at the big picture to see how much the recent events in California actually matter.

When I wrote the most recent summary, we hadn't seen the evidence attached to the parties' respective summary judgment and evidentiary motions -- hundreds of exhibits made up of deposition excerpts, emails, text messages, and other documents. That evidence was shocking, and certainly changed our view of how things were likely to go in the litigation.

Specifically, it seemed like, with all the smoking gun evidence -- and some of it damning in ways so sensitive that they remain redacted -- Elysium was probably feeling extraordinary pressure to settle.

And, correspondingly, ChromaDex was probably feeling really comfortable with taking its case to a jury, not particularly interested in settling.

Settlement Make So Much Sense

So it was no surprise when the parties emerged from their mandatory pretrial settlement conference in August with no agreement.

It is important to note that judges are in the business of settling cases, not trying cases. Millions of civil lawsuits are filed every year, and if even 10% of them went to trial, the judicial system would be badly overwhelmed. So the cases MUST settle almost all the time.

The judges know this. And they have learned the most effective ways to pressure parties into settlement.

The millions of cases gets whittled down first through motions to dismiss, which eliminate baseless and erroneous claims.

Next comes discovery, which takes a while, but allows the true facts of the matter to emerge. Once the parties have a good sense of the strengths and weaknesses of their position, settlement becomes much more likely.

After discovery comes Summary Judgment, which knocks out claims for which the evidence turned out to be hopelessly weak.

Other pre-trial motions, like motions to exclude evidence from trial, further clarify the strength or weakness of the parties' respective positions, which makes settlement easier.

Often what's left isn't worth fighting over, or the writing is on the wall for one party.

Trials are very, very expensive. So each side has a strong incentive to estimate its likelihood of winning or losing, and multiply that by how much is at stake, to determine a good settlement amount.

And a settlement can usually be reached, because simply avoiding the cost of the trial provides a big pool of potential wealth for both sides to split. That dividend for avoiding trial makes mutually disappointing settlement terms easier to swallow. Plus, there's less risk, and they avoid the potential cost of appeals.

That's why SO many cases settle in the days before trial, or even literally on the courthouse steps, or even during jury selection.

Except for When Settlement Doesn't Make Sense

But all of that assumes rational actors engaged in normal civil litigation who have a commercial dispute and they'd like to resolve it and get on with their business.

The dynamics for settlement change dramatically when you have irrational actors that are trying to destroy each other, and the issues involved in the litigation are just symbols of a much larger dispute.

That's what's going on in the ChromaDex-Elysium case. It's no stretch to say that Elysium was trying to destroy ChromaDex. We have the text messages that use words like "destroy," "bloodbath," and "worst nightmares." And these text messages aren't being sent to or from mailroom clerks -- these are being traded among the highest officials in the company, including the CEO and COO.

And what the parties are fighting over is not a simple breach of contract. We know from the emails that Elysium at one point contemplated just figuring out how much they owed ChromaDex and paying it, if they had to do so for another reason. This is a fight over control of an industry that MIGHT have something akin to a Fountain of Youth Pill that could be worth billions of dollars.

That's right, this case isn't about millions of dollars; it's about billions of dollars -- who lives, who dies, and who controls this emerging industry -- which maybe it WON'T ever be an industry, and maybe nobody will control it. But maybe it will be, and that's what the fight is about.

It's about something else, too, though.

How To Take Control of a Billion Dollar Industry

There are rules in the United States that govern commercial behavior, and they are analogous to the rules that govern sports like football.

In football, you can run creative plays, you can hit hard, you can try a blitz, and you can hire giants like William "Refrigerator" Perry to power the ball over the goal line.

But there are also things you may not do.

There are lines on the field that you cannot cross. You literally cannot go out of bounds, or else your play is over. You cannot grab someone's face mask; that's dangerous. You cannot hit someone from behind; that's dangerous. These things are not allowed, and they are severely punished, because if everybody did those things, the game itself would become unplayable.

So, too, in business there are permissible ways of competing, and there are impermissible ways of competing.

And if the rules of football seem exquisitely detailed, that means you've never read the rules of unfair competition and antitrust, which have been worked out over many generations as ingenious bad actors have perpetrated an endless array of dirty tricks to fool customers and destroy competitors.

It is a HUGE body of law. And the reason it exists is because unfair competition is a very bad thing. We have collectively as a society put in place a LOT of laws to prevent it, or at least to minimize it -- or, as a last resort, to punish it in the hopes that future bad actors will think twice before they cheat.

I use the phrase "unfair competition" generically. Although there are many statutes specifically devoted to that topic, the whole fabric of the law is woven through with rules to prevent wrongful commercial behavior, including rules against fraud (which is part of Commercial Law) and rules against stealing trade secrets (which is part of Intellectual Property Law).

Unfair Litigation

The greatest strength of our justice system -- a guaranty of due process -- is also its Achilles' Heel. Even the worst criminal in the world is entitled to put on the best defense they can, and they are entitled to summon evidence, and make motions, and have their claims heard by a jury. After that, they are entitled to appeals. Even when they are in prison, they still have civil rights and due process rights that are enforceable in court.

This is a great triumph of civilization, and a thing to be proud of -- although it occasionally tries the patience of jurists and others.

But that also means that a bad actor invoking its right can kick up enough mud and blow enough smoke to really slow down the adjudication process.

And if it is a well-funded bad actor, it can impose unimaginable pain and suffering on everyone sucked into their sphere of influence, including poor judges and law clerks who have to wade through endless motions trying to sort out who hit whom first and whether that matters. I think that's where Judge Carney is right now.

But that situation is very uncommon. Exceedingly uncommon. I would go so far as to say it is a very rare case in which a bad actor has access to huge amounts of money and also has an incentive to create havoc around them. Usually you can make more money just by going about your normal business, so that's what people usually do.

The Limits on ChromaDex's Potential Recovery

But we have one of those unusual cases. And it has spawned separate litigations, involving separate sets of bad behavior.

In California, ChromaDex complains of trade secret theft. In New York, ChromaDex complains of unfair competition. In Delaware, ChromaDex complains of patent infringement.

In each case, ChromaDex will likely request damages roughly equal to the value of its business and/or Elysium's business, because ChromaDex believes that it has been deprived of its legal right to exclusivity with respect to the Nicotinamide Riboside market.

Although monopolies are mostly illegal, a patent grants an exclusive right for a limited time extending just to the subject of the patent. And during that limited time, the patent holder is exclusively entitled to the fruits of the invention, in exchange for having published the details of the invention.

ChromaDex believes that it is entitled to legal exclusivity because ChromaDex is the exclusive licensee of the patent for using NR in a health supplement to raise NAD, and because ChromaDex built a business around that patent (and other patents), and developed its own patents.

In short, ChromaDex played by the book, and followed the laws, and did what you are supposed to do to develop profitable new markets, thereby guiding Adam Smith's invisible hand to make everyone a little richer. And ChromaDex believes that it is entitled to all the fruits of that legal business.

Plus exemplary damages.

Under the right circumstances, treble damages are available for Trade Secret Theft, Unfair Competition, and Patent Infringement. That means that if the harm done to ChromaDex in terms of lost sales turns out to be $25M then ChromaDex could potentially recover $75M. And that's probably true in California, New York, and Delaware.

Or, I should say, it's probably true in California, New York, OR Delaware. Because if ChromaDex gets a big win in California, the other courts will have a hard time finding any damages that haven't ALREADY been fully compensated. In other words, if ChromaDex had its leg cut off, it might be entitled to a new leg, but it can't have three new legs, even if the original leg was cut off with three knives.

So it would be nice to win $75M (or whatever would fully compensate for Elysium's wrongs, plus a penalty), but we only get that once, not three times.

I say that to explain why it doesn't greatly matter whether ChromaDex eventually finds justice in California, New York, or Delaware. Unless it is denied justice in all three courts, then the wheels of justice only ground slowly, which is all we were ever promised; they did not jam entirely.

So How Does This Relate to the California Litigation?

So if we can only win big once, and we don't really care which one, and none of them is going to trial until 2020 or 2021, then why do we care about what's going on in California?

Damages

Well, one reason is because we might be worried that if we don't win in California, we won't win ever. That seems to me silly. Once you've read the dastardly deeds depicted in the evidence that has already been shown -- and ChromaDex says there's more evidence coming: more in supplemental briefing, and more again at trial, "overwhelming" evidence that will "prove beyond doubt" that Elysium acted wrongfully and thereby harmed ChromaDex -- once you've seen that evidence, or even some of it, then you know that is exactly the kind of behavior that the unfair competition laws were designed to prevent.

Courts have to decide as a matter of law whether the harm was caused by trade secret theft or by false advertising or by patent infringement, or by all three. But it's hard to imagine a scenario where Courts say that what Elysium did was okay, and thereby give a green light to all other such actors to proceed similarly. I just think that's a ridiculously unlikely outcome. Theranos got away with much worse behavior and caused far more damages than whatever Elysium did -- bad things do happen! -- but Theranos didn't get away with it forever.

Speed

So then the second reason we might care about California is just speed. We want this to be resolved, and we want it to be resolved fast. I certainly do. In all honestly, I'm sick of blogging about this; I'd like to move on to something else. I'd like to move on to some other investment. I'd like a faster return, or any return, on my investment.

And not only is the litigation directly holding down the share price by creating doubt, it is indirectly doing so, too, by channeling as much as $10M per year into additional legal fees that COULD HAVE BEEN SPENT ON MARKETING. Is it any consolation that ChromaDex probably would have misspent those marketing dollars? NO! If they are going to mis-spend on marketing, get that over with, too! Let's get onto the show!

I feel that urgency.

And to myself I say, and to anyone else who feels such urgency I say, tough cookies.

It's not going to happen that way. It's going to be long, slow, and drawn out. There will be additional delays, there will be stupid legal rulings, there will probably be appeals.

I honestly have no idea why someone thinks it's still worthwhile to pay Elysium's legal fees. I don't.

Theranos' former CEO, Elizabeth Holmes, can't pay her attorneys, and so her law firm just asked the Court for permission to withdraw because they are not getting paid and have no prospects of getting paid. Read about it, and you'll never guess who the withdrawing law firm is -- it's OUR law firm, Cooley! I can't wait for the day when Baker Hostetler files a similar motion with the Court saying that they are not getting paid by Elysium and have no prospect of getting paid.

But as long as someone wants to feed lawyers on both sides, they will go on fighting forever. For years, anyway. And I'll keep blogging, and maybe you'll keep reading, until we both stop caring.

Let It Go!

ChromaDex has a great product, and an interesting product pipeline, and seems to have access to enough money so that it can fight indefinitely a multi-front litigation to "own the science."

And that's why I say, maybe we should just ignore the litigation.

If the litigation is a permanent part of our lives until we almost certainly win some years hence, that means there are only two ways out of our current position in which the litigation directly and indirectly drags down share price: Settlement and Profits.

Settlement

Settlement is the thing that everyone thinks they crave. I'm not so sure about it.

The problem is that it takes two to settle. Elysium has to want to, too. And so far I think they don't. I think they'd rather fight. I think they still want to destroy ChromaDex. I think they still think that they, due to their superior Silicon Valley Credentials are entitled to be Lords Of This Market Space. Obviously we do NOT want ChromaDex to accept settlement offers like, "We'll apologize, pay you $3M, take a half-interest in ChromaDex, take control of the combined entity -- with all its ADDITIONAL intellectual property -- take it private, and then squeeze out the small investors for a few dollars each."

If you think that Elysium was in fact out to destroy ChromaDex, then you negotiate with them like you negotiate with terrorists: Not at all. You set an example of them so that every crappy supplement provider in the industry doesn't immediately file copycat shakedown lawsuits to get a sweet piece of that settlement action.

Are there such things as attorneys who will file baseless lawsuits in order to extort settlements worth less than the potential cost of the litigation? Do patent trolls walk the earth? Of course!

And so setting an example for the market to deter such future litigation is a critical strategic objective for ChromaDex. That makes settlement highly unlikely, or at least unlikely on terms that would delight Elysium.

So I don't think settlement is probably going to happen, and I don't even think it should happen.

Profits

That leaves just one way out: Profits.

I don't know what to say when retail investors suggest that we need to somehow communicate to ChromaDex that ChromaDex should try to achieve profitability by improving marketing to generate more revenue and also cut costs. Executives in public corporations need to be told about quarterly pressure for results, said NO ONE EVER.

Besides, we're not investors. We are speculators in the stock. Actual investors deliver their money directly to the corporation so the business can use it to invest in growth.

Buying shares from other speculators does not directly deliver a dime to the corporation. Indirectly, maybe there is some small incremental effect on the share price, which could eventually matter if there is to be a future public or private offering. But that is speculative at best, and insignificant in any case.

However, although it is not us, there ARE real investors handing real money to the corporation -- smart, wealthy, powerful people who are capable of simultaneously supporting both legal spend and marketing spend as long as it takes to ensure that ChromaDex does in fact "own the science" while building a principled, fundamentally sound business operation focused on long-term growth.

There is nobody, anywhere, telling anyone that this stock is about to skyrocket. All we know is that (1) they have posted steady quarterly top-line growth, (2) they have set up major distribution agreements like Watsons and Nestle, (3) they are making progress on international approvals, like in the EU, (4) the science keeps looking good, except for some bioavailability questions, and (5) they have not yet cracked the secret of how to market this in the US -- although by now they at least have a fairly robust market segmentation (e.g., sports teams, fitness buffs, seniors worried about aging).

So when you look at that big picture, and you see an extra million dollars a month going to lawyers that COULD be going to marketing, that is a real pebble in our shoe. But it's just a pebble in our shoe. No more than that.

The One Really Important Issue

If there were some reason to think that ChromaDex's patents were invalid, that would be a big deal. But I don't know any reason to think they are.

Elysium totally failed to invalidate the most important patent, the '807 patent.

They couldn't even totally invalidate the '086 patent, although they keep trying.

The Natural Alternatives v. Creative Compounds case ensured that health supplements like Niagen are in fact patent-eligible. The Court held -- and this is binding authority in patent cases all over the country regarding supplements made from natural ingredients --

The supplement is not a product of nature and the use of the supplement to achieve a given result is not directed to a law of nature. We do not see, therefore, how a claim to the manufacture of a non-natural supplement would be directed to the law of nature or natural product.

So "eligibility" doesn't appear to be a problem.

We haven't heard anyone -- including Elysium -- explain or even theorize what might be wrong with ChromaDex's patents.

And it's not like Elysium has a great track record in litigation. They lost before the PTAB with the '807 patent. They lost in the Southern District of New York when they challenged ChromaDex's right to file a citizen petition with the FDA. The other litigations are ongoing, but discovery is closed in California and we've seen that the facts look very bad for Elysium. Judge Carney has cast severe doubt on the viability of Elysium's patent misuse claim. In New York we've seen that their claims are very ticky-tacky, like they complain that Dr. Brenner didn't discover NR, but only discovered NR's critical function that makes it valuable in Basis. How is Elysium ever going to show that such a distinction was material to customers? Impossible.

All those legal battles took years, but they mostly have come out right so far. We have first-rate lawyers, who totally understand the case. It's unfortunate that Judge Carney for some reason thinks or wishes that he was dealing with a simple breach of contract case instead of a much higher stakes matter. But now that he has said that, Cooley knows how to handle this situation.

How Much Is $10M In Legal Fees Worth Right Now?

So, do a thought experiment. If somebody had one year ago parachuted down to ChromaDex an extra $10M to spend on Marketing, do you think that Tru Niagen would have taken off by now? Probably not? Then legal spend isn't the problem. Because if legal spend were the only problem, we could certainly get the extra $10M.

I think that investors should figure out what are the real challenges this company faces, and figure out whether ChromaDex is likely to surmount them. Can we market better in the US? Will the bioavailability question resolve favorably? Will the results in rodent studies manifest well enough in human studies? Can we show that NR works better than NA or NAM in humans? Will NMN suddenly become inexpensively available? Do we already own the next generation of NAD precursors? Will NAD precursors stop mattering when some new technology, like Senolytics, becomes available?

Based on the answers to those questions, you might have a good idea whether to park a bet on ChromaDex for the next few years.

But whether the legal cases get delayed a few months, or a few years, might be the smallest consideration.

Afterword

I met Mark Friedman, ChromaDex's General Counsel, once, briefly back in 2018, when I attended an annual shareholders meeting. I came away favorably impressed. He has previous experience with vicious wars like our Elysium fight.

Billionaire investor William Ackman in 2012 wagered $1B that Herbalife's stock price would tumble to zero -- he wanted Herballife to be destroyed -- but six years later Herbalife's share price had gone up, not down.

Mark Friedman wasn't Herbalife's General Counsel for the entire six years, but he was GC for most of it, and he is entirely familiar with the kind of legal adversity that we are facing. If anything, Elysium Health is small fry compared to Ackman.

When I met Mark Friedman, he said to me that his job was to handle the litigation so that everyone else on the management team could focus on the business.

I liked that; that made sense -- because everyone else at ChromaDex responsible for Marketing, Business Development, Operations, and Product Development have giant challenges to deal with, challenges that require their full attention.

But as for myself, I really enjoyed following the litigation. As a lawyer, it's interesting to me. And I have a day job for which it is extremely helpful to understand what litigators have to deal with, so I get some professional benefit from doing this, too.

But as an investor, I don't think the obsession is helpful; I think it's a distraction from more important things.

Nonetheless, I am going to continue to post all the litigation documents, because I think it is important that the public -- including investors, industry analysts, and citizens rightly alarmed about the workings of our civil justice system -- have some way of getting at the truth of what's going on. Most people can't easily access PACER, and Google doesn't index what's in PACER. I can fix that.

And I will continue to provide some analysis of the documents, so those who are curious can check in to see how it all came out.

But my recommendation would be that you not read any of it. Instead, read up on the science. It's more important. This legal stuff is just lurid. Very lurid. But it is being handled well, and it doesn't need to be closely watched.

#CDXC #ChromaDex #ElysiumHealth #Litigation

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