YVONNE GONZALEZ ROGERS, District Judge.
Lead Plaintiffs Ali Shehk and Alan Richards (collectively "Plaintiffs") bring this consolidated class action complaint against Defendants Violin Memory, Donald Basile, Dixon Doll, Cory Sindelar, Howard Bain III, Larry Lang, Jeff Newman, Mark Rosenblatt, David Walrod, (together, "Violin Memory Defendants") and J.P. Morgan, Deutsche Bank Securities Inc., Merrill Lynch, Barclays Capital Inc., Robert Baird and Co., Pacific Crest Securities LLC, and EM Securities LLC (together "Underwriter Defendants").
The Consolidated Amended Complaint ("CAC") alleges violations of the Securities Act of 1933 ("Securities Act") in connection with the initial public offering ("IPO") of Violin Memory, Inc. ("Violin Memory"), a California-based company that developed and sold flash-based memory devices. Plaintiffs assert that Violin Memory's Registration Statements
Both groups of Defendants, the Underwriter Defendants and the Violin Memory Defendants, have filed motions to dismiss the CAC on the grounds that, generally, Plaintiffs have failed to meet the pleading standard under Federal Rules of Civil Procedure 8 and 9 and have failed to state a claim under Rule 12(b)(6). (Dkt. Nos. 61, 66.) Each group of defendants has joined in the other's motion to dismiss. Defendants have also filed requests for judicial notice (Dkt. Nos. 62, 69) and the Violin Memory Defendants have filed a separate Appendix to their Motion (Dkt. No. 68.) Plaintiffs have moved to strike the Appendix and have opposed certain requests for judicial notice.
These motions came on for hearing on June 17, 2014. Having carefully considered the papers submitted and the pleadings in this action, the arguments presented at the hearing, and for the reasons set forth below, the Court hereby
The facts herein are gleaned from the CAC, documents referred to therein, and judicially noticed materials.
Violin Memory is a California-based technology company that designs and manufactures flash memory devices for servers and networks in the form of flash memory arrays and memory cards. (CAC ¶ 10.) Flash memory is a computer storage medium that can be electrically erased and reprogrammed. (Id.) It is used in memory cards, USB flash drives, solid-state drives, and similar products, for general storage and transfer of data. (Id.) Flash memory offers potential advantages compared to traditional hard disks or tape. (Id.) For example, it does not have the mechanical limitations and latencies (or slowness) of hard drives, and it has the potential to be more efficient relative to hard disks when considering speed, noise, power consumption, and reliability. (Id.)
On September 27, 2013, Violin Memory issued an IPO of 18 million shares of common stock at $9 per share. (CAC ¶ 1.) In connection with the IPO, the Company filed several offering documents, including the Registration Statement on Form S-1 filed on August 26, 2013, Amended Registration Statement on Form S-1/A filed on September 16, 2013 ("Amended Registration Statement") and a Prospectus on Form 424B4 filed on September 27, 2013 ("Prospectus"). These documents contained information regarding the Company's financial status, business and management, and products. These documents also contained risk disclosures amounting to twenty-six pages and pertaining to, among other things, the Company's number of customers, operating history, cash flow, its recent introduction of a new line of products, market acceptance of its products, and the impact of adverse economic conditions. (Prospectus, at 5, 10-36; Amended Registration Statement at 11-37.) The disclosures did not minimize the high-risk nature of the investment. For example, relative to the financial condition of the Company, the Amended Registration Statement included the following:
The Amended Registration Statement disclosed the Company's relatively limited operating history, the difficulty of estimating future growth and the unlikelihood of similar growth rates in the future:
The Amended Registration Statement also highlighted the significant market and industry risks facing the Company and their potential to impact sales and profitability:
Despite these and many other stark disclosures regarding business risks, Violin Memory's IPO was fully subscribed and Defendants allegedly raised over $145 million. Soon after the IPO, the stock price plummeted: Violin Memory's stock price closed on November 22, 2013, at $3.11 per share. (CAC ¶ 2.)
In November 2013, Plaintiffs brought this putative class action against Defendants. The operative CAC, filed on March 28, 2014, identifies alleged misrepresentations and omissions in the Registration Statement documents relating to the following topics, the disclosure of which purportedly caused the stock price to decline:
(See CAC ¶ 31.)
The two specific Violin Memory products at issue in the CAC are the 6000 Series Flash Memory Arrays ("6000 Flash Arrays"), which were introduced in September of 2011, and the Velocity Peripheral Component Interconnect Express Flash Memory Cards ("PCIe Cards"). At the time of Violin Memory's September 2013 IPO, substantially all of the Company's revenue was derived from the Flash Memory Arrays. (Dkt. No. 69-1 at 19.) For the six months ended July 31, 2012, sales of the 6000 Series Flash Memory Arrays represented approximately 84% of the Company's product revenue, and over the next year rose to 91%. (Id. at 53.) The PCIe Cards, introduced in March 2013, were intended to provide generally the same technology and benefits of the 6000 Flash Arrays, but in a different form for other segments of the market. (CAC ¶ 11.) Unlike the 6000 Flash Arrays, PCIe Cards can operate in both servers and workstations via PCIe interfaces on a computer's motherboard. (CAC ¶ 11.) At the time of the IPO, the Company had not derived significant revenue from the sale of the PCIe Cards. (Amended Registration Statement at 1-2.)
Plaintiffs claim that at the time of the IPO in September 2013, Violin Memory represented that these products had been successfully designed, developed, and well-received in the market across multiple segments, including the U.S. federal government, and that these representations were false when made. (See Opp. at 1.) Plaintiffs specifically allege that the Registration Statement failed to disclose material defects and development problems regarding the PCIe Cards, including that the PCIe Cards were not optimized or sustainable due to material technical and engineering defects. Plaintiffs further allege that the Registration Statement contained an omission or misleading statement with respect to how the PCIe Cards were programmed and developed for Toshiba, a leading provider of flash memory and one of the Company's principal stockholders. The Registration Statement represented that the Company had entered into a PCIe Card development agreement with Toshiba, pursuant to which Violin Memory was to "develop a derivative product." Plaintiffs allege that contrary to this representation, at the time of the IPO, the Company was experiencing "material difficulties building and developing the PCIe Cards in accordance with Toshiba's specifications." (CAC ¶ 37.) Plaintiffs also contend that although the Registration Statement represented that the PCIe cards had gained, or very likely would gain, market acceptance, that was not so.
Plaintiffs advance similar claims regarding the 6000 Flash Arrays, alleging that at the time of the IPO, Violin Memory was experiencing material engineering and development problems with these products as well. According to the CAC, in the months leading up to the IPO, Violin Memory experienced material negative developments and engineering defects that resulted in breakdowns, failure to protect data, and the need for costly unique IP addresses that resulted in compatibility problems for customers. (CAC ¶ 47.)
Next, Plaintiffs assert that material negative trends concerning sales to the federal government were not disclosed and that the government sequestration was negatively impacting the Company's revenue. The Registration Statement represented that "[t]he United States government can also suspend operations if Congress does not allocate sufficient funds to a particular agency or organization, and the United States government may allow our competitors to protest our successful bids. The occurrence of any of these events may negatively affect our business, operating results and financial condition." (CAC ¶ 54.) Plaintiffs contend that this statement, and other similar statements, were untrue because at the time of the IPO, sales in the Company's federal division had been declining materially over the course of the fiscal year. Plaintiffs further contend that the government sequestration negatively impacted the Company's revenues, but nowhere was that reflected in the Registration Statement.
Furthermore, Plaintiffs contend that negative information concerning the background and business experience of the Company's Chief Executive Officer ("CEO"), Donald Basile was improperly withheld and was material. Plaintiffs argue that the failure to share the fact that Mr. Basile was terminated "for cause" from his position as CEO at Fusion-io, Inc. was misleading. (CAC ¶ 75.) Plaintiffs allege that they and other members of the Class would have considered the fact that Defendant Basile was recently terminated "for cause" from his position as Chief Executive Officer with one of the Company's main competitors in their decision to invest in the Company. Plaintiffs contend that this information should have been disclosed.
Plaintiffs next allege that unusual transactions conducted by Mr. Basile artificially and materially inflated the Company's income and revenue. Before the IPO, Violin Memory sold the 6000 Flash Arrays to J.P. Morgan and BofA Merrill Lynch in exchange for being selected as underwriters for the Company's IPO. (CAC ¶ 78.) Plaintiffs argue that this transaction artificially inflated Violin Memory's revenue as reported in the Registration Statement. Plaintiffs contend that in light of the unusual means by which the transactions were negotiated and the fact that it inflated revenues, the Registration Statement should have disclosed the above information but failed to do so.
Finally, Plaintiffs contend that the Registration Statement should have disclosed the Company's non-cancelable purchase orders, which Plaintiffs argue was required by U.S. generally accepted accounting principles ("GAAP"). (CAC ¶¶ 79, 81.) Plaintiffs assert that Registration Statement reported that, as of January 31, 2013, the Company had approximately $15.9 million of outstanding purchase commitments to contract manufacturer and other vendors. The Registration Statement did not disclose the amount of outstanding purchase commitments as of July 31, 2013. The next reported outstanding purchase commitments, as of October 31, 2013, disclosed that those commitments were in excess of $85 million. Plaintiffs contend that this negative trend was material and that the figures as of July 31, 2013, should have been disclosed, and that the omitted information would have been considered by reasonable investors in making their decisions to purchase Violin Memory stock. (CAC ¶¶ 83-86.)
In general, a court cannot consider materials outside the pleadings on a motion to dismiss for failure to state a claim. See Fed. R. Civ. P. 12(b). A court may, however, consider items of which it can take judicial notice without converting the motion to dismiss to one for summary judgment. Barron v. Reich, 13 F.3d 1370, 1377 (9th Cir. 1994). A court may take judicial notice of facts "not subject to reasonable dispute" because they are either "(1) generally known within the territorial jurisdiction of the trial court or (2) capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned." Fed. R. Evid. 201. Additionally, a court may take judicial notice of "`matters of public record' without converting a motion to dismiss into a motion for summary judgment." Lee v. City of Los Angeles, 250 F.3d 668, 689 (9th Cir. 2001) (quoting MGIC Indem. Corp. v. Weisman, 803 F.2d 500, 504 (9th Cir. 1986)). Under the incorporation by reference doctrine, courts may consider documents "whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the [plaintiff's] pleading." In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 986 (9th Cir. 1999) (quoting Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994)) (alteration in original) (superseded by statute on other grounds). Where a document is referenced or incorporated by reference into a complaint, "[t]he court may treat such a document as `part of the complaint'" and the Court "may assume [their] contents are true for purposes of a motion to dismiss under Rule 12(b)(6)." Marder v. Lopez, 450 F.3d 445, 448 (9th Cir. 2006) (citations omitted).
Applying the "incorporation by reference" doctrine, the Court grants Defendants' unopposed requests for judicial notice of (i) Violin Memory's Form A-1/A, filed with the SEC on September 16, 2013; (ii) a transcript of Violin Memory's Q3 2014 Earnings Call from November 21, 2013; (iii) Violin Memory's Form 8-K, filed on November 21, 2013, and attached press release, (iv) the Prospectus filed with the SEC on September 27, 2013; (v) Form S-1 filed with the SEC on August 26, 2013; and (vi) the Sequester Order For Fiscal Year 2013 issued on March 1, 2013. (Dkt. Nos. 63-1, 63-2-63-5, 63-6; 69-1, 69-2, 69-3; see also Dkt. Nos. 74 at 7; 75 at 4.)
Plaintiffs dispute Defendants' request for judicial notice of nine documents falling into four categories: an SEC filing, analyst report, news articles, and court documents. The Court considers each category in turn.
In the first category, Plaintiffs contest judicial notice of Violin Memory's SEC filing Form 10-K for fiscal year 2014, filed on April 16, 2014.
Second, Defendants seek judicial notice of a Deutsche Bank analyst report (Dkt. No. 69-5) as relevant to their argument concerning loss causation. Defendants argue that judicial notice is appropriate, as the report relates to the relationship between disclosures made in the Earnings Call and Press Release, subsequent analyst guidance and ultimate stock price decline, and information that was provided to the market concerning the effect of the decline in sales to the federal government. Plaintiffs counter that this document is not relied upon in the complaint and the information therein is redundant of other information of which the Court has taken judicial notice insofar as it relates to what information the market reasonably knew at the time of the IPO. (Dkt. No. 74 at 7-8.) The Court agrees. Consideration of this document is not appropriate in this procedural context. Defendants' request for judicial notice is
Third, Defendants seek judicial notice of certain court documents related to Mr. Basile's termination from Fusion-io: a stipulation of dismissal, an order of dismissal, and a docket sheet. (Dkt. Nos. 63-7, 63-8, 63-9.) Federal courts may "take notice of proceedings in other courts, both within and without the federal judicial system, if those proceedings have a direct relation to the matters at issue." Del Puerto Water Dist. v. U.S. Bureau of Reclamation, 271 F.Supp.2d 1224, 1233 (E.D. Cal. 2003) (citing United States ex rel Robinson Rancheria Citizens Council v. Borneo, Inc., 971 F.2d 244, 248 (9th Cir. 1992)). Plaintiffs argue that these documents inappropriately dispute that Mr. Basile was terminated "for cause" and are therefore not appropriate for judicial notice. The Court agrees. Although documents related to judicial proceedings are generally deemed appropriate for judicial notice, here these documents are offered to dispute the factual merits of Plaintiffs' claim concerning the nature of Mr. Basile's termination. Accordingly, the Court
Finally, Defendants seek judicial notice of news articles relating to the federal government slowdown to show what information was generally known to the public during the relevant time period. Plaintiffs argue that because these articles do not pertain to Violin Memory directly, they are not properly subject to judicial notice. For that, and other fundamental reasons, the Court agrees. Patel v. Parnes, 253 F.R.D. 531, 549 (C.D. Cal. 2008) ("The numerous cases that discuss news articles as part of the `total mix' of information available to investors address only articles about the defendant's activities and performance, not articles about an industry as a whole" (listing cases)). Defendants' requests for judicial notice related to these documents is
The parties dispute whether Plaintiffs' CAC should be analyzed under the notice pleading standards of Rule 8 or the heightened pleading standards of Rule 9(b). Rule 9(b) requires that "in alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." Fed. R. Civ. P. 9(b). The Court addresses each standard in turn.
Whether the heightened standards of Rule 9(b) applies turns on the nature of the allegations, not the elements of the claim. "Rule 9(b) applies to `averments of fraud' in all civil cases in federal district court . . . in cases in which fraud is not an essential element of the claim, Rule 9(b) applies, but only to particular averments of fraud." Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103 (9th Cir. 2003). A plaintiff "may allege a unified course of fraudulent conduct and rely entirely on that course of conduct as the basis of a claim. In that event, the claim is said to be `grounded in fraud' or to `sound in fraud,' and the pleading of that claim as a whole must satisfy the particularity requirement of Rule 9(b)." Id. at 1103-04. A typical example of that situation is where a plaintiff alleges that the same course of conduct constitutes both securities fraud under Section 10 as well as a violation of Section 11. In other cases, "a plaintiff may choose . . . to allege some fraudulent and some non-fraudulent conduct. In such cases, only the allegations of fraud are subject to Rule 9(b)'s heightened pleading requirements." Id. at 1104.
Section 11 claims are not inherently fraud-based even though they do require a misrepresentation. When grounded in fraud, "the particularity requirements of Rule 9(b) appl[ies] to claims brought under Section 11." In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1404-05 (9th Cir. 1996), cert denied, 520 U.S. 1103 (1997). "Fraud can be averred by specifically alleging fraud, or by alleging facts that necessarily constitute fraud (even if the word `fraud' is not used). Vess, 317 F.3d at 1105 (citations omitted). "Under California law, the `indispensable elements of a fraud claim include a false representation, knowledge of its falsity, intent to defraud, justifiable reliance, and damages.'" Id. (citations omitted). Importantly, scienter is not required for claims under Section 11; defendants may be liable under Section 11 for negligent or even innocent misrepresentations. In re Daou Sys., Inc., 411 F.3d 1006, 1027 (9th Cir. 2005) (internal citations omitted).
In their CAC, Plaintiffs argue that they do not advance a claim that sounds in fraud or a unified course of fraudulent conduct. See In re Charles Schwab Corp. Sec. Litig., 257 F.R.D. 534, 545 (N.D. Cal. 2009) (noting that where, as here, the plaintiff has not alleged that the same course of conduct constitutes both a Section 11 violation and a violation of other laws necessarily sounding in fraud such as Rule 10b-5, the "unified course of fraudulent conduct" test is essentially circular and is therefore uninstructive). Defendants counter that although fraud is not specifically pleaded, the allegations in the CAC necessarily constitute fraud. (VM Defs.' Mot. at 8 ("At its core, the CAC alleges that the Violin Memory Defendants knew but failed to disclose material negative information concerning its business, products and customers in connection with the Company's IPO."); 10-11.) Having examined the CAC, the Court agrees with Plaintiffs and finds that with one minor exception
The CAC does not specifically allege fraud and avoids averments inherently suggestive of fraud— i.e., there is no allegation that defendants "knowingly" or "intentionally" concealed information or made misrepresentations. Although such allegations could be inferred, the allegations in the CAC can equally support the inference that Defendants committed such misrepresentations without any scienter. Plaintiffs' factual allegations preset a plausible claim that Defendants committed the misrepresentations and omissions negligently. Plaintiffs have not expressly pleaded fraud, and have pleaded non-fraud bases for liability. Thus, the Court declines to find that Plaintiff's CAC necessarily sounds in fraud. See In re Charles Schwab Corp. Sec. Litig., 257 F.R.D. at 546 (noting the paucity of Ninth Circuit published decisions finding that Rule 9(b) applies to a Section 11 claim where, as here, the underlying conduct was not also alleged to have constituted fraud).
In light of that finding, the Court will evaluate whether the Complaint states a claim for a violation of Section 11 under Federal Rule of Civil Procedure 8. Rule 8(a) requires that a plaintiff "`provide a `short and plain statement of the claim showing that [he] is entitled to relief.'" Johnson v. Riverside Healthcare Sys., LP, 534 F.3d 1116, 1122 (9th Cir. 2008) (quoting Fed. R. Civ. P. 8(a)(2)). "This is not an onerous burden. Specific facts are not necessary; the statement need only give the defendant[s] fair notice of what . . . the claim is and the grounds upon which it rests." Id. (internal quotation marks and citation omitted). Nonetheless, the complaint is properly dismissed if it fails to plead "`enough facts to state a claim to relief that is plausible on its face.'" Weber v. Dep't of Veterans Affairs, 521 F.3d 1061, 1065 (9th Cir. 2008) (quoting Bell Atlantic. Corp. v. Twombly, 550 U.S. 544 (2007)). In making this determination, a court must be mindful that
In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1057 (9th Cir. 2008) (quoting Twombly, 550 U.S. at 556). That said, the Court is "not required to accept as true conclusory allegations which are contradicted by documents referred to in the complaint." In re Stac Elecs. Sec. Litig., 89 F.3d at 1403.
Section 11 of the Securities Act "provides a cause of action to any person who buys a security issued under a materially false or misleading registration statement." In re Century Aluminum Co. Sec. Litig., 729 F.3d 1104, 1106 (9th Cir. 2013). To state a claim under Section 11, plaintiffs must adequately plead "(1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment." Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156, 1161 (9th Cir. 2009) (quoting In re Daou Sys., Inc., 411 F.3d at 1027). Section 11 is a strict liability statute that does not require fraudulent intent. In re Daou Sys., Inc., 411 F.3d at 1027. "A claim under Section 11 based on the omission of information must demonstrate that the omitted information existed at the time the registration statement became effective." Rubke, 551 F.3d at 1164. Moreover, where the adequacy of the disclosures is at issue, Defendants must make a "stringent showing" that "reasonable minds could not disagree" that the disclosures were not misleading. See Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 947 (9th Cir. 2005) (dismissal on the pleadings based on sufficient cautionary language "requires a stringent showing: There must be sufficient `cautionary language or risk disclosure [such] that reasonable minds could not disagree that the challenged statements were not misleading.'"). The "materiality" of an omission is a fact-specific determination that should ordinarily be assessed by a jury. In re Stac Elecs. Sec. Litig., 89 F.3d at 1405 (citing Fecht v. The Price Co., 70 F.3d 1078, 1080-81 (9th Cir.1995)). "[O]nly if the adequacy of the disclosure or the materiality of the statement is so obvious that reasonable minds could not differ are these issues appropriately resolved as a matter of law." Id. (citing Fecht, 70 F.3d at 1081).
The crux of Defendants' argument is that the alleged omissions that form the basis for Plaintiffs' Section 11 claim are, in fact, not actionable omissions either because they were contained in the Registration Statement or were in the public domain at the time of Violin Memory's IPO. In essence, Defendants contend that none of the statements with which Plaintiffs take issue are actionable because the CAC lacks allegations to support an inference that they were either false or misleading as a matter of law. The Court considers each category of Plaintiffs' allegations in turn, as outlined on Pages 5-6, supra.
Plaintiffs argue that there are five misrepresentations relating to PCIe Cards. (Opp. at 10-12.) The relevant excerpts from the Amended Registration Statement including the alleged misrepresentations include:
The core of Plaintiffs' argument is that problems existed at the time of the IPO and the Registration Statement's presentation of such problems as mere possibilities was inaccurate and misleading.
Defendants contend that none of Plaintiffs' identified representations qualify as material omissions or misrepresentations because the Registration Statement contained adequate risk disclosures and cautionary language regarding PCIe Cards. In particular, Defendants argue that the Registration Statement's representations concerning PCIe Cards were framed as possibilities; e.g., that there may be "undetected" errors or defects, or that "if" the PCIe Cards "do not gain acceptance" the investors stood to lose, and cannot overcome the heavy weight of the myriad disclosures in the Registration Statement.
The Court agrees. "[W]here a company's filings contain abundant and specific disclosures regarding the risks facing the company, as opposed to terse, generic statements, the investing public is on notice of these risks and cannot be heard to complain that the risks were masked as mere contingencies." Plevy v. Haggerty, 38 F.Supp.2d 816, 832 (C.D. Cal. 1998) (discussing cases). "Rather, to be actionably misleading, an omission `must affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists.'" In re Ubiquiti Networks, 2014 WL 1254149, at *10 (N.D. Cal. March 26, 2014) (quoting Brody v. Transitional Hospitals Corp., 280 F.3d 997, 1006 (9th Cir. 2002)).
Here, the Registration Statement contained numerous disclosures regarding the highly technical nature of the Flash Arrays and PCIe Cards, including explicit disclosures that the PCIe Cards may contain undetected defects, and that the PCIe Card was a new product for which the Company had derived no meaningful revenue as of the IPO, and might never generate revenue. Given these disclosures, Plaintiffs cannot be heard to complain that the disclosures were inadequate. For example, the Company disclosed:
The Company further explained that developing the PCIe Cards was a time intensive and expensive process, explaining that "our investments in research and development . . . may result in products that are more expensive than anticipated, take longer to generate revenue or generate less revenue, if at all, than we anticipate. . . . we may not receive significant revenue from these investments in the near future, if at all." (Id. at 21.) The Registration Statement warned that the PCIe Cards "may never gain broad adoption." (Id. at 19.) In fact, some of the purported omissions with which Plaintiffs take issue were specifically disclosed in the Registration Statement. For example, Plaintiffs allege that the Company omitted "software incompatibility problems" (CAC ¶ 51) when the Registration Statement disclosed that "our products must interoperate with network interfaces such as . . . software applications and hardware developed by others, and if we are unable to ensure that our products interoperate with such software and hardware, we may . . . experience reduced demand for our products." (Dkt. No. 69-1 at 20.)
Under the facts alleged in the CAC, viewed in a light most favorable to Plaintiffs, and giving due consideration to the facts provided in the Registration Statement, the Court finds that no reasonable investor could have been misled regarding the high degree of risk involved in the purchase of Violin Memory stock. The Company's myriad comprehensive and specific disclosures relating to the PCIe Cards make clear that the statements with which Plaintiffs take issue, even if construed as Plaintiffs allege, did not "alter the mix" of information such that they could reasonably be understood as misleading, much less materially misleading.
Defendants' motion as to this category of allegations is
Plaintiffs also contend that the Registration Statement failed to disclose "material difficulties building and developing the PCIe Cards in accordance with Toshiba's specifications." (CAC ¶¶ 36, 37.) Plaintiffs offer no specific factual allegations concerning what those "material difficulties" were. Regardless, the Registration Statement is sufficiently clear about the Company's relationship with Toshiba and the status of the PCIe Cards development to render Plaintiffs' bald "material difficulties" allegation immaterial.
The language in the Registration Statement that Plaintiffs contend is misleading is contained in the following excerpts:
To the extent that Plaintiffs contest any forward-looking statements ("we believe our relationship with Toshiba" or "we will develop"), the Court finds that the "bespeaks caution" doctrine "`provides a mechanism by which [it] can rule as a matter of law that defendants' forward-looking representations contained enough cautionary language or risk disclosure to protect the defendant against claims of securities fraud.'" In re Stac Elecs. Sec. Litig., 89 F.3d at 1408 (citing Fecht, 70 F.3d at 1081). By definition, the bespeaks caution doctrine applies only to affirmative, forward-looking statements. However, the Ninth Circuit has observed that the doctrine "merely represents the pragmatic application of two fundamental concepts in the law of securities fraud: materiality and reliance." In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1414 (9th Cir. 1994). Again, based on the Registration Statement's extensive and specific disclosures, the Court finds that no reasonable investor would have considered any of Plaintiffs' alleged misstatements or omissions material.
The Registration Statement discloses the early stage and hurdles of the PCIe Card development process both as a general matter (as explained above) and specifically with respect to the Toshiba deal. (Dkt. No. 69-1 at Ex. 10.23.) This agreement reflects that Toshiba had not agreed to purchase any PCIe Cards and would reject the Cards if certain milestones were not met. (Id. at Ex. 10.23 p. 4-5 (stating that if "Toshiba rejects the Developmental Samples, Toshiba shall promptly notify Violin . . .".) Violin Memory also related the attendant risks, including the obligation to pay damages in the event that it failed to satisfy Toshiba's requirements. (Id. ("If Violin has not been able to deliver the Developmental Samples for each Product by August 31, 2014, then, unless [otherwise] agreed . . . Violin shall reimburse to Toshiba the Individual Developmental Service fee for each such Product that is in delay . . . as liquidated damages . . .").) The Registration Statement informed investors that Toshiba's acceptance or purchase of any PCIe Cards was not guaranteed, and the attachment to the Registration Statement related that "any potential deliverables that might be included in [a future] Agreement are
Plaintiffs allege three misrepresentations concerning the 6000 Flash Arrays, which turn on Defendants' alleged failure to disclose material defects with this product. Relevant excerpts of the Amended Registration Statement including these alleged misrepresentation are as follows:
Plaintiffs argue that the representation that the 6000 Flash Arrays already "integrate enterprise-class hardware and software technologies" and that the Company's "four-layer hardware architecture" and "software stack" already "optimize the management of flash memory . . .," (CAC ¶ 46), was untrue because there were ongoing "material negative developments and engineering defects," (CAC ¶ 47). Second, Plaintiffs take issue with the Registration Statement's claim that the Company "must sometimes develop updated versions" of its "software so that [its] products interoperate properly," but that the Company "may not accomplish these development efforts quickly, cost-effectively or at all." (CAC ¶ 48.) Plaintiffs assert that this statement is misleading because the 6000 Flash Arrays had already been experiencing engineering defects with regard to the "controller cards," a general "inability to develop data management software," "incompatibility problems," and "delays in developing a software system enabling Company customers to utilize products without "experiencing low throughput . . . ." (CAC ¶ 51.) Third, Plaintiffs challenge the Registration Statement's claim that the Company's 6000 Flash Arrays "may contain undetected errors, defects or security vulnerabilities" and that these errors, defects, and security vulnerabilities "could result in a loss of revenue or delay in revenue recognition . . . ." (CAC ¶ 49.) Plaintiffs contend that these statements are misleading due to the already realized software operability problems described above and argue that these problems "resulted in lost sales" and Defendant Basile's admission that "additional optimizations [had] delayed [the Company's] revenue." (CAC ¶¶ 50-52.) Defendants counter that the Registration Statement contained disclosures that warned investors that problems might arise, and that if so, revenues would likely be impacted.
For the reasons stated above, the Court finds that the Company disclosed myriad comprehensive and specific information regarding the nature of these products as complex and highly technical, and that all of its products including the 6000 Flash Arrays were susceptible to defects and vulnerabilities. Indeed, the alleged misrepresentations Plaintiffs identify are embedded within certain relevant disclosures. (See Dkt. No. 69-1 at 17.) It was no mystery that the risks relative to the 6000 Flash Arrays could have a substantial effect on revenue. The Registration Statement related that at the time of the IPO, substantially all of the Company's revenue was derived from the Flash Memory Arrays. (Dkt. No. 69-1 at 19.) For the six months ended July 31, 2012, sales of the 6000 Series Flash Memory Arrays represented approximately 84% of the Company's product revenue, and over the next year rose to 91%. (Id. at 53.) To the extent that Plaintiffs contend that a defect existed at the time of the IPO, that fact, even if true, cannot overcome the great weight of the disclosures that specifically disclosed the likelihood that errors or defects would be discovered after the IPO. (See id. at 17 ("Some errors in our products may only be discovered after they have been installed and used by end-customers.").) At bottom, the risk disclosures were sufficiently comprehensive to cover defects that both preceded and post-dated the IPO, and adequately warned investors that any error could result in marked revenue decline. Accordingly, the Court finds that reasonable minds could not disagree as to the lack of materiality of Plaintiffs' alleged misrepresentations and omissions, even accepting those allegations in the light most favorable to Plaintiffs. Defendants' motion to dismiss on this ground is
Plaintiffs allege that the Registration Statement should have disclosed all information required under the SEC rules, and that this includes a "trend" relating to the decline of the Company's federal government sales and the effect of federal sequestration. Plaintiffs assert that the Registration Statement should have disclosed this material negative trend but failed to do so, and the Defendants therefore violated Item 303 of Regulation S-K. Specifically, Plaintiffs allege that in the months leading up to the IPO, the federal government sales had been declining and materially impacting revenues. (CAC ¶¶ 57-64.) The Registration Statement allegedly failed to reflect accurately this trend, instead indicating that the Company was undertaking to "increase the sales to government customers." (CAC ¶ 54.) Plaintiffs also allege facts which, when taken as true and construed in a light favorable to Plaintiffs, establish that the decline in government sales was reasonably likely to have an unfavorable impact on net sales or revenues. (See CAC ¶¶ 57-64.)
Item 303 requires disclosure of "any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations." 17 C.F.R. § 229.303(a)(3)(ii). The Ninth Circuit has held that because Section 11 imposes liability if a registrant "omits to state a material fact required to be stated" in the registration statement, "any omission of facts `required to be stated' under Item 303 will produce liability under Section 11." Steckman v. Hart Brewing, 143 F.3d 1293, 1296 (9th Cir. 1998).
Defendants counter that disclosures in the Registration Statement were sufficient and that any trends would have been publicly known. That the federal government shut down in 2011 had profound results on the markets was widely and publicly known. (See Fed. R. Evid. 201(b); see also Dkt. No. 63-6, Sequester Order for Fiscal Year 2013.) However, at this early stage, the Court is not prepared to declare that reasonable minds could not disagree that there was no "trend" as defined in Item 303 as of the date of the IPO for which disclosure was required as a matter of law.
Defendants' argument that the crux of Plaintiffs' allegations is a claim that the Registration Statement should have disclosed a future trend projection, as opposed to a then-present trend, is belied by the allegations in the CAC. Plaintiffs allege that in the months leading up to the IPO, there was a material negative trend related to federal government sales that should have been disclosed pursuant to Item 303. (CAC ¶¶ 57-64.) There remains a narrow question as to whether in the months leading up to the IPO, federal sales had declined such that there was a "trend" as required for disclosure under Item 303. Defendants' motion to dismiss on this ground is
The CAC alleges omissions relating to the business experience and background of Violin Memory's former CEO, Defendant Basile. Basile served as the CEO of Fusion-io, a competitor to Violin Memory in the flash memory industry, prior to joining Violin Memory in 2009. (CAC ¶ 12.) According to Plaintiffs, Fusion-io terminated Basile "for cause." (CAC ¶ 73.) Because Basile's employment agreement with Fusion-io lists five different grounds for a "for cause" termination, all of which relate to his job performance to varying degrees of ethical severity, Plaintiffs assume that one of those grounds formed the basis for Basile's termination. Plaintiffs further argue that no matter which ground or grounds served as the basis for Basile's termination, it should have been disclosed in the Registration Statement because each basis speaks to his background and competence and all are negative. (CAC ¶ 74.) Pursuant to Item 401 of Regulation S-K (17 C.F.R. § 229.401(e)(1)), the Registration Statement should have disclosed the omitted material information relating to Basile's "for-cause" termination because it related to his "responsibilities in prior positions, overall professional competence, experience, qualifications, attributes, and skills to serve as [a] director[] and officer[] of a start-up publicly traded company," and would have been considered by the public when deciding to invest. (CAC ¶ 75.) Plaintiffs assert that the omitted information rendered the representations concerning Mr. Basile's credentials misleading, and that such information was material to a reasonable investor's decision to purchase Violin Memory stock.
Defendants argue that the "for cause" termination was the substance of a civil lawsuit that had been made part of the public record and that had resolved in a voluntary dismissal before the case was ever decided on the merits. (Dkt. No. 61 at 16.) They thus contend that there was no duty to disclose the lawsuit or the allegations therein, and there was no way these facts could be material or "of any interest to a reasonable investor." (Id.)
The Court disagrees. The allegations in the CAC, taken as true and construed in Plaintiffs' favor, plausibly state that the reasons given for Mr. Basile's termination were material to a reasonable investor's decisionmaking with respect to purchasing Company stock. Defendants argue that Plaintiffs do not identify any applicable duty requiring disclosure of "additional details" concerning Mr. Basile's prior employment with Fusion-io, but that is not so. The regulation requires disclosure of Mr. Basile's prior work experience and competence, and his "for cause" termination was relevant. Thus, Plaintiff has alleged that there was a duty to disclose, and the Court finds that a reasonable investor could have considered the omitted information material. Moreover, Defendants' argument concerning the voluntary dismissal of the related civil action against Mr. Basile again begs the question of whether that fact is sufficient to render the alleged omission immaterial. At this early juncture, construing the facts alleged in Plaintiffs' favor, the Court cannot find that no reasonable investor could have had an interest in knowing that Mr. Basile had been terminated "for cause" from his position as CEO of Fusion-io. Defendants' motion to dismiss on this ground is
Plaintiffs allege that as of July 31, 2013, the Company failed to disclose the amount of non-cancelable purchase orders for commitments that had a remaining term in excess of one year as of the date of the latest balance sheet presented. Plaintiffs claim that this violated GAAP, specifically FASB Codification 440-10-50-2 and 440-10-50-4. (CAC ¶¶ 81, 82.) Plaintiffs further allege that in the Company's report for the quarter ended October 31, 2013, filed with the SEC on Form 10-Q, Violin Memory disclosed that purchase commitments were in excess of $85 million, including non-cancelable purchase orders, an increase from January 31, 2013, of approximately 435%.
As an initial matter, "[a]s with any alleged misrepresentation, GAAP violations should generally be more than `minor or technical in nature' and `constitute[] widespread and significant inflation'" to give rise to securities law liability. In re Countrywide Fin. Corp. Sec. Litig., 588 F.Supp.2d 1132, 1197-98 (C.D. Cal. 2008) (dismissing Section 10(b) claim against auditor despite alleged GAAP violations). Moreover, closer inspection of the Company's SEC filing appears to belie Plaintiffs' claimed 435% increase. The purchase orders disclosed as of January 2013 were approximately $60,000 and in October had increased to approximately $85,000. (Compare Dkt. No. 69-1 at 64, with Dkt. No. 77-1 at 26.)
As part of its overall analysis, district courts have dismissed Section 11 claims on the pleadings where it was apparent on the face of the complaint that the plaintiffs would be unable to establish loss causation. See, e.g., In re DNAP Sec. Litig., 2000 WL 1358619, at *3 (N.D. Cal. 2000). The federal securities laws provide a private right of action to shareholders "to protect them against those economic losses that misrepresentations actually cause," "not to provide investors with broad insurance against market losses." Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 345 (2005). Such causal losses occur when the share price falls significantly after the truth about the untrue statements or misleading omissions becomes known. Id. at 347; In re Daou Sys., 411 F.3dat 1027 (explaining that damages are recoverable under the federal securities laws when the shareholders' economic loss from the decline in their stock value was the direct result of alleged misrepresentations).
In a Section 11 securities case, plaintiffs need not allege loss causation, that is, the plaintiffs need not allege that the misrepresentations in the registration statement caused the plaintiffs' loss. Rather, the defendants may prove as an affirmative defense that the plaintiffs' loss, or some portion thereof, was not caused by the alleged misstatements or omissions. Defendants argue that this case warrants dismissal on this ground.
As courts in other circuits have explained, a plaintiff may establish loss causation by alleging simply "that the subject of the fraudulent statement or omission was the cause of the actual loss suffered;" that defendants' "misstatements and omissions concealed the price-volatility risk (or some other risk) that materialized and played some part in diminishing the market value of" the security. Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173, 177 (2d Cir. 2005) (citation omitted; emphasis in original). That is, the loss must be caused by the "materialization of the concealed risk." Thus, "in order `[t]o plead loss causation, the complainant must allege facts that support an inference that [defendants'] misstatements and omissions concealed the circumstances that bear upon the loss suffered such that plaintiffs would have been spared all or an ascertainable portion of that loss absent the fraud.'" In re Charles Schwab Corp. Sec. Litig., 257 F.R.D. at 547 (citing In re Merrill Lynch & Co. Research Reports Sec. Litig., 568 F.Supp.2d 349, 359 (D. Md. 2008) (citations omitted)).
As detailed above, all but two of Plaintiffs' claimed misstatements and omissions are undermined by disclosures in the Registration Statement and thus play no part in the instant analysis. First, with respect to the failure of the Registration Statement to include a trend pursuant to Item 103 related to the declining federal sales, the CAC alleges that Plaintiffs suffered losses when the stock price dropped following the November 21 Press Release and Earnings Call. (CAC ¶¶ 2, 62.) In the Press Release and on the Earnings Call, the Company revealed the disappointing quarter results and attributed the results to a decline in government contract revenues. (See CAC ¶¶ 2, 62; Dkt. No. 69-2 at 2, 4 and 5.) Given this link, the Court cannot say that Plaintiffs would not be able to establish loss causation. Defendants' motion to dismiss on this ground is
However, with respect to the misstatement concerning Mr. Basile's prior employment experience, Plaintiffs' CAC lacks any allegation that this misstatement is related to the loss they purportedly suffered. Accordingly, Defendants' motion to dismiss this theory of Section 11 liability is
To state a claim under Section 12(a)(2) against the Underwriters, Plaintiffs must allege that the Underwriters were "sellers" within the meaning of the statute. Under Section 12(a)(2), "any person who offers or sells a security" by means of a "prospectus or oral communication" that is materially false or misleading is liable "to the person purchasing such security from him." 15 U.S.C. § 77l(a)(2). The Supreme Court has defined "seller" as "the owner who passed title," or a "person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner" — i.e., a broker. Pinter v. Dahl, 486 U.S. 622, 642, 647; see also Moore v. Kayport Package Express, Inc., 885 F.2d 531, 537 (9th Cir. 1989) (applying Pinter's definition of seller to a Section 12(a)(2) claim and affirming dismissal for failure to allege defendants "played any role at all in soliciting the purchases"); Rosenzweig v. Azurix Corp., 332 F.3d 854, 871 (5th Cir. 2003) ("To count as a `solicitation,' the seller must, at a minimum, directly communicate with the buyer."). "Generally, issuers and underwriters are not sellers within the meaning of Section 12 unless they actively participate in the negotiations with the plaintiff/purchaser." Thomas Lee Hazen, The Law of Securities Regulation § 7.6[1] (5th ed. 2006); see also Foster v. Jesup & Lamont Sec. Co., 759 F.2d 838, 845-46 (11th Cir. 1985) (observing "[t]he fact that Congress made every underwriter liable in § 11, but not in § 12, suggests that underwriters are not to be liable under § 12 solely by virtue of their status as underwriters"; rather, there must be a showing of "active involvement in bringing about the buy-sell transaction"), abrogated on other grounds by Ryder Int'l Corp. v. First Am. Nat'l Bank, 943 F.2d 1521, 1525-28 (11th Cir. 1991). "[I]t seems quite clear that § 12 contemplates only an action by a buyer against his or her immediate seller. That is to say, in the case of the typical firm commitment underwriting, the ultimate investor can recover only from the dealer who sold to him or her." Rosenzweig, 332 F.3d at 871 n.11 (quotation omitted). Plaintiffs must "show that the defendants solicited purchase of the securities for their own financial gain." Pinter, 486 U.S. at 647; In re Daou Sys., 411 F.3d at 1029. "Mere participation" in a solicitation or sale does not suffice. Pinter, 486 U.S. at 650. A plaintiff must allege that the defendants "had some `direct' role in the solicitation of the plaintiff." Charles Schwab, 257 F.R.D. at 549 (citing In re Daou Sys., 411 F.3d at 1029) (finding 12(a)(2) liability where underwriters had signed the registration documents, allegedly participated in the distribution of the fund's shares; offered, sold, and actively solicited the sale of the fund's shares, and certain of the underwriters "participated in the written or oral communications used to market the fund" or otherwise "participated in the marketing of the fund.").
Defendants argue that the Complaint does not allege that Shehk or Richards obtained title to the securities directly from any of the Underwriters. Defendants concede that there is one allegation that Richards "bought common stock . . . directly from J.P. Morgan" (CAC ¶ 9), but argue that other than this one conclusory statement, Plaintiffs do not allege any facts to establish that Underwriters actively and directly solicited, communicated with, or negotiated with Plaintiffs in connection with their stock purchases. The Court agrees. The CAC contains no allegation that the Underwriters actively solicited any Plaintiff, either named or class members, for sales of the Violin Memory stock. Even with respect to Richards, who allegedly "bought" "directly from" an underwriter, there are no allegations concerning the nature of that sale or that purport to depict J.P Morgan — much less any of the other underwriters — as having "solicited purchase" of the securities for their own financial gain. That four of the Underwriters "served as a joint book-running manager and as a representative of the underwriters for the IPO" (CAC ¶¶ 21-24), without more, does not suffice.
Accordingly, because the Complaint fails to allege facts sufficient to make plausible their claim that that Underwriters constituted "sellers" within the meaning of Section 12(a)(2), Plaintiffs have failed to assert standing as to this claim. Defendants' motion to dismiss this claim is
Section 15 of the Securities Act of 1933 imposes joint and several liability upon every person who controls any person liable under Sections 11 or 12 of the Act. 15 U.S.C. 77o; In re Daou Sys., Inc., 411 F.3d at 1029-30. To state a control person claim, plaintiff must establish (1) a primary violation of the pertinent federal securities laws, and (2) that defendants exercised actual power or control over the primary violator. See Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). Plaintiffs' Section 15 claim is predicated on their alleged Section 11 claims. In re Harmonic, Inc. Sec. Litig., 163 F.Supp.2d 1079, 1085 (N.D. Cal. 2001).
Here, because Plaintiffs have not pleaded an underlying violation of Section 11 under most of their theories, their control person claim against the Individual Defendants as to these same theories fails and must be dismissed. In re Infonet Servs. Corp. Sec. Litig., 310 F.Supp.2d 1080, 1105 n. 24 (C.D. Cal. 2003). However, as to the remaining theory for Section 11 liability — the omission of a trend required to be disclosed pursuant to Item 303 — Plaintiffs have alleged sufficient factual allegations to permit this claim to move forward.
For the reasons stated above, the Court
This terminates Docket Numbers 61, 66, and 74.
