Northern District Of California Pares Claims In Putative Class Action Against Technology Company - Corporate/Commercial Law

Northern District Of California Pares Claims In Putative Class Action Against Technology Company – Corporate/Commercial Law

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On March 22, 2021, Judge Beth Labson Freeman of the United
States District Court for the Northern District of California
dismissed certain of the claims asserted in a putative class action
brought under the Securities Exchange Act of 1934 against a
technology company and certain of its
executives.  City of Sunrise Firefighters’
Pension Fund, et al. v. Oracle Corporation, et al.
, No.
18-cv-04844-BLF, slip op. (N.D. Cal. Mar. 22, 2021). 
Plaintiffs alleged that the company made misrepresentations
regarding its transition from locally installed software to
cloud-based products, which plaintiffs alleged was driven through
undisclosed “coercive sales practices.”  After the
Court dismissed an earlier iteration of the complaint without
prejudice for failure to allege any actionable misstatements,
plaintiffs filed an amended complaint.  The Court held that a
number of allegations failed to establish falsity or scienter, but
permitted some claims to go forward against certain defendants on a
limited theory of liability.

Plaintiffs alleged that the company engaged in two strategies to
use its legacy business of locally installed software to
artificially inflate its numbers for its cloud-based software
subscriptions.  First, the company allegedly installed
features in locally installed software that would cause customers
to exceed the limits of their software license, which the company
would then allegedly use as a basis to pressure the customer to
accept short-term cloud subscriptions.  Second, the company
allegedly offered significant discounts if the customer agreed to
accept a short-term cloud subscription.  Plaintiffs alleged
that these tactics resulted in deals that were not genuine
purchases—because the customers allegedly did not want or
intend to use the cloud-based software—and that the company
in this way inflated short-term results for its cloud-based
subscriptions.  Id. at 3.

The Court characterized the alleged misrepresentations as
falling into the following categories:  (1) statements related
to the revenue growth of the company’s cloud-based products;
(2) statements related to allegedly coercive sales practices; and
(3) statements regarding the “technical adequacy or
superiority of cloud products.”

The Court held that certain alleged misstatements were
non-actionable statements of corporate optimism or were protected
by the PSLRA’s safe harbor provision for forward-looking
statements accompanied by meaningful cautionary language. 
Specifically, the Court explained that statements that the
company’s cloud software had a “modern user
interface,” was “easy to use,” and could provide
“very high performance at a dramatically lower cost”
were “subjective and unverifiable” and therefore were
not actionable.  Id. at 19-20.  The
Court also noted that statements such as “we think our
customers are going to move very, very rapidly to the cloud”
and “right now you certainly have a very large [cloud]
business growing at a high rate” were non-actionable because
they were “made in response to forward-looking
questions” or were otherwise accompanied by meaningful
cautionary language.  Id. 21-22.

The Court then addressed plaintiffs’ additional
allegations, observing that plaintiffs had “dedicated
significant investigative resources in the operative
complaint.”  Although the Court found many of
plaintiffs’ purported claims legally deficient, it concluded
that, with respect to certain allegations, plaintiffs had
adequately alleged “a narrow omission-based theory of
fraud” which would be permitted to proceed and be reviewed on
a more developed factual record.  Id. at

The Court rejected plaintiffs’ argument, which they
attempted to support with an expert opinion submitted to the Court,
that the company’s financial reporting violated GAAP because
sales resulting from the alleged sales practices were
“multiple element arrangements” for which the company
was required to disclose the nature of the arrangements and
“significant deliverables” within the
arrangements.  Id. at 23.  The Court
held this theory of liability was untenable given that the
company’s Form 10-K complied with the GAAP provision and
explained the company’s method of accounting for
arrangements.”  Id. at 26.

Plaintiffs also attempted to bolster allegations regarding the
company’s allegedly improper sales tactics by adding new
allegations from confidential witnesses.  The Court observed,
however, that the company’s “concededly accurate
financial reporting and projections [were] a tough hurdle for
[plaintiffs] to overcome,” id., and that while
the new allegations were sufficient to “fortify allegations
about [the company’s] pervasive use of the Sales
Practices,” plaintiffs still had not established that the
company had an independent duty to disclose those
practices.  Id. at 30.  Nor,
determined the Court, had plaintiffs sufficiently shown the falsity
of challenged statements regarding the quality of the
company’s cloud offerings.  Id. at

However, the Court determined that the company’s alleged
statements attributing material cloud revenue growth to the
“quality and competitiveness of its cloud offering”
were potentially misleading because they allegedly failed to
disclose the impact of the alleged coercive sales practices on
those results.  Id. at 31.  The Court
also held that plaintiffs sufficiently alleged that the company
omitted information about the alleged coercive sales practices when
it attributed a decline in cloud revenue growth to customers
waiting for the next generation of the company’s cloud
product.  Id. at 34.  Thus, the Court
held that, at the pleadings stage, plaintiffs had sufficiently
alleged a “narrow omission theory” based on the fact
that the company made affirmative statements regarding the reasons
for growth and deceleration in the company’s cloud
business.  Id. at 35-36.

With respect to scienter, the Court held that plaintiffs’
“overall fraud theory” was “plausible, cogent and
compelling.”  Id. at 38.  While
the Court took a holistic approach and considered alternative
theories for alleged misstatements such as corporate optimism, the
Court explained that it was plausible to believe both that
defendants were optimistic about the eventual success of the cloud
products while nevertheless attempting to buy time to facilitate
the transition to the cloud by engaging in and concealing improper
sales practices.  Id.

Considering scienter allegations as to specific executives, the
Court held that plaintiffs’ confidential witness allegations
cured prior deficiencies with respect to the company’s
co-CEOs, who, the Court determined, were plausibly alleged to have
acted with “at least deliberate
recklessness.”  Id. at 39. 
While the Court’s prior order found that plaintiffs
established the CEOs had “approved large sales tied to [the
alleged coercive] Sales Practices” but failed to establish
when those approvals occurred or how those approvals showed the
materiality of the sales practices, plaintiffs’ new
allegations were sufficient to show the timing of the approvals,
the relative magnitude of the deals approved, and that the CEOs
received regular briefings on the alleged sales practices before
they made the challenged statements.  Id. 
at 40.  The Court also determined that scienter was adequately
alleged as to the company’s Senior Vice President of Investor
Relations, who prior to the alleged misstatements acknowledged
being aware of the sales practices and attempted to downplay them,
and the Chief Technology Officer, who allegedly received a letter
from industry participants detailing the alleged sales practices
and allegedly “spent the large majority of [his] time on
investor calls discussing the
cloud.”  Id. at 42-44.

The Court also addressed the “core operations”
doctrine, which can permit knowledge of facts critical to a
company’s core operations to be attributed to certain
individuals.  While the Court’s prior order rejected the
theory due to a lack of detail as to the revenue generated by the
alleged sales practices, the Court held that plaintiffs’ new
allegations cured that deficiency and sufficiently alleged that
certain executives were involved in day-to-day decision-making
regarding cloud products.  Id. at
50-51.  Thus, the Court explained that the core operations
allegations, while insufficient alone to raise an inference of
scienter, “add[ed] heft to the inference of scienter”
for certain executives when considered as part of a holistic review
of plaintiffs’ allegations.  Id.

The Court held, however, that scienter was not adequately
alleged as to two other executives, as the allegations respecting
those executives focused primarily on alleged product defects, not
the challenged sales practices that were central to
plaintiffs’ claims.  Id. at 53.

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