Court: District Court, N.D. California; February 4, 2019; Federal District Court
Lead Plaintiff Andrew Moreau, representing a class of individuals who purchased Aerohive Networks, Inc. common shares between November 1, 2017, and January 16, 2018, alleges that Defendants Aerohive, CEO David K. Flynn, and CFO John Ritchie violated federal securities laws through misrepresentations and omissions. The court grants Defendants' motion to dismiss without prejudice after reviewing the case details and relevant legal standards. Aerohive, a California-based company trading under the symbol "HIVE," offers a cloud networking platform and related products, servicing various sectors including healthcare and education, primarily through channel partners. Despite consistent revenue growth from 2013 to 2016, Aerohive has never achieved profitability and faced challenges such as dependence on the E-Rate program for nearly 40% of its revenues and delays in the launch of its new platform, HiveManager NG, which led to elongated sales cycles.
In 2017, Aerohive underwent a significant restructuring of its sales organization and strategy, which Defendants claimed would enhance revenues and profitability. Key changes included the hiring of Ron Gill as Vice President of Americas Sales, who previously worked at competitor Ruckus, and the addition of industry veteran Alan Amrod to improve organizational agility. Gill reported to Thomas J. Wilburn, the Senior Vice President of Worldwide Field Operations. The restructuring involved "unbundling" Aerohive's product and service offerings to diversify its customer base, including the introduction of a lower-priced product called "Aerohive Connect" and a subscription service named "Aerohive Select." Additionally, Defendants emphasized plans to expand business with Dell.
However, Plaintiffs allege that the sales execution strategy was flawed and concealed from investors. They argue that the restructuring led to significant issues, including high turnover among sales personnel, inadequate sales revenue forecasting systems, failures in offering the new lower-priced product and upselling the subscription service, and shortcomings in developing the partnership with Dell. Notably, the departure of key sales figures like Timothy Balistreri and David Greene, alongside layoffs favoring Gill's former colleagues from Ruckus, negatively impacted team morale, as supported by testimonies from former Aerohive employees identified as Confidential Witnesses.
CW1, a former inside sales representative, reported that layoffs executed by Gill were abrupt and poorly communicated, with the VP of Sales Operations unaware of the decision until after it occurred. CW2, a program director, confirmed that Gill's rapid layoffs of experienced E-Rate sales personnel negatively impacted the company, resulting in a loss of significant business and a decline in preferred provider status among E-Rate customers. CW3, a territory manager, noted an unprecedented attrition rate among regional sales managers, leading to a lack of product knowledge necessary for effective selling.
Additionally, Plaintiffs assert that Aerohive's inadequate sales revenue forecasting systems exacerbated employee turnover, as unrealistic quotas led to inflated sales projections and missed deal closures. CW2 indicated that sales pipelines were consistently overestimated, causing a recurring disconnect between projected and actual revenues. By mid-2017, it became apparent that Aerohive would not meet its revenue targets due to insufficient sales staff and ineffective sales strategies.
Moreover, Plaintiffs allege that Aerohive's strategy to boost revenue through lower-priced products and upselling was failing. CW4, a renewals coordinator, highlighted issues arising from the unbundling of products and services, revealing that many customers had previously received support for free and were resistant to new charges. This situation was known to company leadership, who considered cutting off services to compel payments. Ultimately, significant discounts were offered on service renewals, resulting in lower-than-expected revenue.
Plaintiffs claim that Aerohive's partnership with Dell did not meet expectations, with internal witnesses indicating that reliance on this partnership resulted in disappointment, as it did not yield the anticipated benefits and led to operational challenges. The premature termination of Aerohive's E-Rate representatives hindered support for Dell's business, causing the company to lose previously gained market share in that area. In response to stagnant revenue and turmoil within the sales organization, defendants implemented severe cost-cutting measures, including significant reductions in engineering, product management, and sales personnel, which left the sales team "stripped down" and operationally ineffective.
Additionally, plaintiffs allege that between November 1, 2017, and January 16, 2018, defendants made several false or misleading statements regarding sales personnel, sales execution, and projected revenues in various filings and communications, including the 3Q17 Form 10-Q and the 3Q17 earnings call. The court has categorized these alleged misrepresentations and provided context for specific statements made during this period. For instance, one statement claimed ongoing investment in sales capacity and partnerships, while another attributed lower-than-expected revenue to delays in funding approvals under the E-Rate program. A third statement discussed the introduction of new product offerings and the potential impacts on revenue growth, suggesting that lower pricing could lead to a revenue shortfall that would take time to adjust for.
The excerpt presents a series of statements regarding Aerohive's sales performance and strategies, highlighting challenges faced in the fourth quarter and the outlook for the first quarter of fiscal year 2017. Key points include:
1. **Product Introduction and Revenue Impact**: The introduction of the HiveManager NG product to complex customers was premature, as its features did not fully meet their needs, leading to extended sales cycles and diminished revenue, contributing to lower performance in Q4.
2. **Sales Strategy Enhancements**: Defendant Flynn outlines efforts to improve the go-to-market strategy through an OEM relationship with Dell EMC and a shift towards a channel-centric approach. This included launching the Connect-to-Select offering and recruiting 900 new resellers, transitioning to a 2-tier model, and restructuring the sales leadership.
3. **Sales Efficiency Metrics**: Defendant Ritchie reports improvements in sales efficiency, with non-GAAP sales and marketing costs at 39% of revenue in Q3, a reduction from previous quarters. This trend indicates ongoing cost reductions and improved productivity.
4. **Revenue Projections**: Expected revenue for Q4 is projected between $40 million and $42 million.
5. **Plaintiffs' Allegations**: Plaintiffs claim that statements made by the defendants were misleading for several reasons:
- Allegations of understaffing and inadequacy in the sales organization due to the replacement of experienced personnel and cost-cutting.
- Claims that the defendants' portrayal of successful sales strategy implementation was inaccurate.
- Accusations that the decline in E-Rate business was misattributed solely to the program's issues, ignoring the dismissal of specialized sales personnel.
Overall, the statements reflect a mixture of optimism about strategic adjustments and recognition of challenges contributing to revenue performance, while plaintiffs argue that the narrative presented was misleading due to underlying organizational issues.
Plaintiffs argue that Defendants made misleading statements regarding the Aerohive Connect and Aerohive Select programs, claiming that these statements suggested potential revenue reductions while failing to disclose significant setbacks in the transition to these programs that would negatively impact fourth-quarter revenues. Although sales efficiency metrics may have been accurate, Plaintiffs allege that they were misrepresented as indicators of successful sales strategy implementation, while the reality involved cost-cutting due to lower-than-expected revenues.
Additionally, Defendant Ritchie projected fourth-quarter revenues for 2017 between $40 million and $42 million without revealing negative information about Aerohive’s business and financial performance. On January 16, 2018, a press release indicated that actual revenues were expected to be around $37 million, falling short of the prior guidance. The release also noted underlying sales execution issues discovered after a change in sales leadership. Following this announcement, Aerohive's stock price dropped by 28.6%.
In terms of procedural history, three separate lawsuits by Aerohive shareholders were filed between January 19 and January 30, 2018. On February 15, 2018, the Court related the cases, and on August 9, 2018, consolidated them, appointing Andrew Moreau as lead plaintiff. A Consolidated Amended Class Action Complaint was filed on September 28, 2018, followed by Defendants' motion to dismiss on October 26, 2018, and subsequent filings from both parties.
Defendants have filed a request for judicial notice regarding five documents relevant to their motion to dismiss: (1) a transcript of Aerohive's 4Q16 earnings call (February 14, 2017), (2) a transcript of the 2Q17 earnings call (August 2, 2017), (3) Aerohive's 3Q17 quarterly report on Form 10-Q (filed November 1, 2017), (4) a transcript of the 3Q17 earnings call (November 1, 2017), and (5) a transcript of the 4Q17 earnings call (February 8, 2018). The court typically limits its review on a motion to dismiss to the complaint unless certain conditions are met: the complaint must reference the document, the document must be central to the plaintiff's claim, and the authenticity of the document must be undisputed. Defendants assert that all exhibits were referenced in the Plaintiffs' complaint, allowing for incorporation by reference. Plaintiffs have not objected to the judicial notice of these documents, which include details from the earnings calls and the quarterly report. Consequently, the court grants the request for judicial notice of Exhibits 1-5.
Regarding the legal standard for a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), the Plaintiffs' federal securities fraud claims are subject to heightened pleading standards outlined in Rule 9(b) and the Private Securities Litigation Reform Act (PSLRA). Unlike general notice pleading standards, Rule 9(b) requires specific details regarding the circumstances of the alleged fraud, including the time, place, and content of the misrepresentations. This particularity requirement applies to all elements of a securities fraud action.
The Private Securities Litigation Reform Act (PSLRA) sets forth stringent pleading standards for securities fraud complaints, requiring plaintiffs to detail the facts of the alleged violation and the evidence supporting scienter. To establish falsity, the complaint must identify specific misleading statements and articulate why they are misleading. Adequate pleading of scienter necessitates presenting facts that create a strong inference of the defendant's required state of mind. In evaluating a Rule 12(b)(6) motion, the court accepts factual allegations as true and favors the nonmoving party, but it is not obligated to accept legal conclusions posed as facts. Conclusory legal assertions and unfounded inferences are insufficient to overcome a motion to dismiss, and a plaintiff may inadvertently negate their claim through their own allegations.
Under Rule 15(a) of the Federal Rules of Civil Procedure, amendments to pleadings should be allowed freely to promote justice unless they would unduly prejudice the opposing party, cause significant delay, be futile, or arise from bad faith.
The plaintiffs assert two claims: a violation of Section 10(b) of the Exchange Act and Rule 10b-5 against all defendants, and a violation of Section 20(a) against the individual defendants. To succeed under Section 10(b) and Rule 10b-5, plaintiffs must demonstrate six elements, including a material misrepresentation or omission and scienter. The defendants challenge the complaint on grounds of insufficient personal knowledge of confidential witnesses, lack of actionable misstatements, and inadequate allegations of scienter. The court finds that the allegations from confidential witnesses do not meet the required reliability, and the plaintiffs have failed to sufficiently allege actionable misrepresentations or omissions. While addressing these deficiencies, the court also touches on the issues of scienter in anticipation of a potential amended complaint.
A complaint based on statements from confidential witnesses must meet two criteria under the PSLRA: first, the witnesses must be described in detail to establish their reliability and personal knowledge; second, their statements must indicate scienter. For the first criterion, the complaint must provide enough detail about the confidential witnesses to support the likelihood that someone in their position would have the claimed information. Courts evaluate the witnesses' knowledge based on factors such as the detail provided, corroborating evidence, coherence of allegations, number of sources, and the credibility of the sources. In this case, the defendants argue that the complaint inadequately establishes the personal knowledge of the four confidential witnesses (CWs) regarding Aerohive's 4Q17 revenue guidance, citing that none were employed at Aerohive when the guidance was issued and that their job descriptions lack necessary details. The court concurs, noting that while the complaint lists the CWs' titles, it fails to provide essential employment details, including their specific responsibilities. This lack of specificity renders the CWs unreliable, as established in precedent. Consequently, the complaint does not sufficiently demonstrate that the CWs were positioned to possess the knowledge they claim.
Confidential witnesses (CWs) must be described with sufficient detail to demonstrate their knowledge of the facts alleged. The complaint fails to establish that CW1 had the necessary insight into the partnership with Dell or that CW3, a territory manager, could ascertain the sales performance of Aerohive’s inside sales team, lacking contextual specifics. CW4, identified as a "sales operations renewals coordinator," does not have clear allegations showing personal knowledge of issues within the company, undermining the reliability of these witness statements. The complaint also does not sufficiently connect the CWs to relevant work related to Organica’s role in Medivation or clarify their positions to validate their statements about knowledge of the Dimebon pills or Amkor's forecasting process. Specifically, while CW2 reported to high-level executives, their comments pertained to a new Vice President’s management decisions, lacking direct relevance or personal insight, rendering them opinions rather than factual assertions. The Court concludes that the CWs do not possess the required personal knowledge or reliability due to insufficient details about their roles and responsibilities. Furthermore, the plaintiffs claim that between November 1, 2017, and January 16, 2018, the defendants made false or misleading statements in Aerohive's 3Q17 Form 10-Q and Earnings Call. However, defendants argue that their statements are truthful, not misleading, and protected by the PSLRA's "Safe Harbor" provision, with the Court finding that the alleged misrepresentations and omissions are not actionable.
To establish a claim under the Private Securities Litigation Reform Act (PSLRA), plaintiffs must plead falsity with particularity, detailing specific facts that demonstrate why the statements in question were false. Statements must be false at the time they were made, and merely being proven wrong in hindsight does not constitute falsity. Plaintiffs argue that the defendants' statements were misleading due to omissions of material information regarding sales personnel and strategy failures, asserting that the statements were technically true but incomplete. However, the law does not impose an obligation to disclose all material information, and silence is not misleading without a duty to disclose. For an omission to be actionable, it must materially misrepresent the actual state of affairs, significantly altering the information available to a reasonable investor.
The court specifically addresses deficiencies in the allegations concerning two statements from Aerohive's 3Q17 Form 10-Q. Statement 1 relates to Aerohive's expectation of continued investment in sales capacity and channel programs. Statement 2 refers to a slowdown in order volume due to delays in federal funding approvals. Plaintiffs claim these statements are misleading because they fail to disclose the replacement of experienced sales personnel and the firing of staff specializing in the E-Rate Program. However, the legal sufficiency of the plaintiffs' claims regarding these statements is questioned.
Plaintiffs argue that Aerohive provided incomplete statements regarding its sales personnel issues, but securities laws only prohibit misleading or untrue statements, not incomplete ones. Citing *Intuitive Surgical*, the Ninth Circuit clarified that to withstand a motion to dismiss under the PSLRA, plaintiffs must specify why statements are misleading or untrue, rather than merely incomplete. The plaintiffs' claims regarding Aerohive's statements fail because they do not adequately specify the misleading nature of the statements. Furthermore, Aerohive did disclose information about sales personnel turnover in its 3Q17 Form, contradicting the plaintiffs' assertion of omission. The plaintiffs' claims about understaffing are vague and lack quantifiable details, making it difficult to assess the impact on revenue or the specific roles of the sales personnel involved in the E-Rate program. This lack of specificity invites speculation, similar to the situation in *In re Silicon Graphics Inc. Sec. Litig.*, leading to the dismissal of the claims.
Plaintiffs' complaint lacks specific factual allegations demonstrating how identified problems resulted in declining revenues, making it impossible to assess the impact of customer order reductions on the company’s business. Without details on the timing and scope of these reductions, it cannot be determined if the defendants were aware of the issues during revenue projections. The complaint is also vague regarding what constitutes "adequate training" and "sufficient numbers" of hires, along with unclear allegations about losses in the E-Rate business. Additionally, while the complaint mentions lengthening sales cycles, it fails to define what constitutes a "substantial" lengthening or the actual duration at the time. The accounts from confidential witnesses (CWs) used to support allegations of falsity are deemed insufficient. As a result, the Court rules that the Plaintiffs have not adequately pleaded falsity as required by the Private Securities Litigation Reform Act (PSLRA), leading to the dismissal of related statements. However, the Court allows Plaintiffs to amend their complaint, as doing so would not be futile or prejudicial to the Defendants.
Furthermore, statements from the 3Q17 Form 10-Q regarding the Aerohive Connect and Select programs and the introduction of HiveManager NG are challenged by the Plaintiffs as false or misleading due to undisclosed setbacks and inadequate internal controls for revenue projections. However, the allegations concerning these statements are also found to be insufficient, primarily because the information from CWs lacks personal knowledge and reliability.
Plaintiffs have not adequately specified how statements 3 and 4 were misleading or untrue, instead of merely incomplete. Statement 3 warned investors about potential issues with the Aerohive Connect and Aerohive Select programs and noted difficulties in forecasting future operating results in the 3Q17 Form 10-Q. For an omission to be actionable under securities laws, it must materially misrepresent the actual state of affairs. The plaintiffs' factual allegations regarding failures in the Aerohive programs lack the required specificity, failing to detail the severity of the issues, the revenue impact from customers not converting to service subscriptions, or the meaning of "substantial discounts." The court referenced prior cases that affirmed dismissals due to vague allegations prompting speculation about the severity of problems. Additionally, the plaintiffs' claims about statement 4 are also vague, merely stating that sales projections were overinflated without clarification. As a result, the court dismisses the claims related to statements 3 and 4 due to insufficient pleading of falsity as mandated by the PSLRA. However, the court permits the plaintiffs to amend their complaint, as doing so would not be futile or prejudicial to the defendants.
Statement 5, made by Defendant Flynn during the 3Q17 Earnings Call, discussed Aerohive's strengthening go-to-market strategy and a leadership restructuring under a COO organization. Flynn indicated that these changes would enhance sales efficiency and address the mid-market.
Results indicate ongoing improvements in operating efficiency with a focus on growth. Plaintiffs contend that this assertion omits critical information, specifically that: 1) the Aerohive Connect and Aerohive Select programs and the partnership with Dell were underperforming; 2) the abandonment of the education sector and the E-Rate program adversely affected revenues; 3) significant cost-cutting measures were implemented to create a façade of efficiency while concealing revenue shortfalls; 4) experienced sales staff were replaced, leading to an understaffed sales organization; and 5) employee Wilburn's departure was partially attributed to dysfunction within the sales team. Despite these claims, the Court finds the allegations regarding statement 5 lack sufficient factual support, particularly concerning the sales personnel and E-Rate program issues. Additionally, allegations about Wilburn's departure are unsupported by concrete facts. The restructuring of the leadership team in February 2017 was found to be factual and not misleading. Consequently, the Court dismisses statement 5 and allows Plaintiffs the opportunity to amend their complaint without causing undue delay or prejudice to Defendants.
Regarding statement 6, made by Defendant Ritchie during the 3Q17 Earnings Call, which discussed "sales efficiency" and "sales productivity," Plaintiffs argue it is false or misleading due to claims that the sales force was inefficient and cost-cutting measures were merely used to mask revenue shortfalls. However, Plaintiffs acknowledge that the metrics cited in statement 6 were technically accurate. The Court concludes that, despite being seen as misleading, the statement is literally true and the allegations regarding Defendants' sales execution failures lack the necessary specificity to establish misleading conduct.
The court affirmed the dismissal of allegations that lacked sufficient specifics, which led to speculation regarding the severity of the problems. Consequently, Defendants' motion to dismiss statement 6 was granted, but Plaintiffs were given leave to amend the complaint, as they acted in good faith and amendment would not be futile or prejudicial to Defendants.
Statement 7, made by Defendant Ritchie during a 3Q17 Earnings Call on November 1, 2017, projected Q4 revenue between $40 million and $42 million. Plaintiffs contended this statement was misleading due to the lack of contextual performance information and because actual Q4 revenue turned out to be $37 million. Defendants argued that this statement is protected under the PSLRA's "Safe Harbor" provision, which shields forward-looking statements from liability if they are clearly identified as such and accompanied by meaningful cautionary statements regarding potential discrepancies with actual results.
The court found that the revenue forecast qualifies as a forward-looking statement under the PSLRA, as it involves a projection of revenues. The court rejected Plaintiffs' argument to treat the statement as mixed, clarifying that it is distinct from cases where predictions are supported by substantive evidence. If a forward-looking statement is properly identified and accompanied by cautionary language, it is not actionable regardless of the intent behind it. However, if not properly identified, it can be actionable only if made with actual knowledge of its misleading nature.
Statements made by the defendants indicated optimism about business opportunities, highlighting a "growing" pipeline and consistency with past reports. However, the plaintiffs challenged a specific revenue prediction without adequately linking it to other statements regarding issues like personnel turnover. The revenue prediction was accompanied by cautionary statements that referenced risks that could materially affect actual results, including variable sales timing, a slowing rate of revenue growth, and disruptions from high turnover among sales staff. Defendants had previously warned that these factors could adversely affect revenue and operating results. The plaintiffs labeled the cautionary statements as "boilerplate," but similar language had been deemed sufficient by the Ninth Circuit in past cases, where warnings about sales force effectiveness and retention were critical to understanding the risks involved. The Court found that the defendants' warnings were specific and relevant, thus rejecting the plaintiffs' claims that the statements were false or misleading, particularly as the plaintiffs' reliance on confidential witness statements was deemed unreliable due to a lack of personal knowledge.
The Court permits Plaintiffs to amend their complaint, finding no bad faith in their actions and concluding that such an amendment would not be futile, would not cause undue delay, and would not unduly prejudice Defendants. Although the Court grants Defendants' motion to dismiss based on the non-actionable nature of the statements made, it addresses the issue of scienter in anticipation of the amended complaint. To survive dismissal, Plaintiffs must establish a strong inference of scienter, requiring particularized facts demonstrating that Defendants acted with the necessary state of mind. The Ninth Circuit emphasizes that such inference must be cogent and compelling, surpassing mere plausibility.
Plaintiffs must show that Defendants made false or misleading statements either intentionally or with deliberate recklessness; mere recklessness or motive is insufficient. Specific allegations must detail contemporaneous statements or conditions that illustrate the false or misleading nature of the statements. For omissions, Plaintiffs must demonstrate an extreme departure from ordinary care that could mislead buyers or sellers, known or obvious to the defendant.
The Court must first assess whether any individual allegation suffices to create a strong inference of scienter. If not, a holistic review of all allegations is required. Plaintiffs argue they have adequately pled scienter through (1) various confidential witness statements viewed collectively, (2) inferences drawn from Defendants' company positions, and (3) implications from Wilburn's resignation. In contrast, Defendants assert that Plaintiffs' allegations lack sufficient state of mind assertions and argue that the existence of company problems, Wilburn's departure, voluntary disclosures, and the absence of motive weaken the inference of scienter.
The Court found all statements in question to be non-actionable and noted that it need not consider all arguments presented by the parties. The reliability of the confidential witness (CW) statements is lacking due to insufficient information regarding the CWs' responsibilities, requiring Plaintiffs to provide more details if their allegations of scienter rely on these statements. Additionally, the assertion that Wilburn's departure stemmed from dysfunction in the sales organization is unsupported by factual allegations about the source of this information. The Court agreed with Defendants that Plaintiffs' claims regarding what Flynn and Ritchie knew are inadequate, citing deficiencies in the CWs' statements.
Regarding Section 20(a) of the Exchange Act, the Court stated that to establish liability, Plaintiffs must prove a primary violation of federal securities law and that the defendant exercised control over the primary violator. Since Plaintiffs failed to adequately plead a primary securities law violation, their Section 20(a) claim also fails. Consequently, Defendants' motion to dismiss the claim under Section 20(a) is granted.
While the Court granted Defendants' motion to dismiss the entire complaint without prejudice, it allowed Plaintiffs the opportunity to amend their complaint within 30 days, emphasizing that failure to address the identified deficiencies will result in dismissal with prejudice. Plaintiffs are prohibited from adding new claims or parties without the Court's permission. The Court clarified references to the statements in Defendants' motion, consolidating certain statements for clarity.
