In Re Netflix, Inc., Securities Litigation

Filing 102

Order by Hon. Samuel Conti granting 91 Motion to Dismiss(sclc2, COURT STAFF) (Filed on 2/13/2013)

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IN THE UNITED STATES DISTRICT COURT

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FOR THE NORTHERN DISTRICT OF CALIFORNIA

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United States District Court

For the Northern District of California

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) Case No. 12-00225 SC
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In re NETFLIX, INC., SECURITIES ) ORDER GRANTING MOTION TO
LITIGATION
) DISMISS
)

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I.

INTRODUCTION
Plaintiffs Arkansas Teacher Retirement System and State-Boston

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Retirement System ("Plaintiffs") bring this putative securities

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class action against Netflix, Inc. ("Netflix"); Netflix Co-Founder,

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Chairman of the Board, and CEO Reed Hastings ("Hastings"); current

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Netflix CFO David Wells ("Wells"); and Barry McCarthy ("McCarthy"),

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Netflix's CFO until December 10, 2010 (collectively "Defendants").

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Now before the Court is Defendants' Motion to Dismiss Plaintiffs'

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Consolidated Class Action Complaint ("CCAC").

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The motion is fully briefed,

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and is suitable for determination without oral argument, Civ. L.R.

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7-1(b).

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Defendants' Motion to Dismiss and DISMISSES the CCAC with leave to

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amend.

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///

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///

ECF No. 91 ("MTD").

ECF Nos. 94 ("Opp'n"), 97 ("Reply"),

For the reasons set forth below, the Court GRANTS

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II.

BACKGROUND

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Netflix is a public corporation that purports to be the

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leading Internet subscription service for viewing movies and

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television shows (collectively "movies").

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Netflix currently allows consumers to watch movies either by

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streaming them over the Internet directly to their televisions,

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computers, or mobile devices, or by receiving DVDs sent to their

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homes.

ECF No. 89 (CCAC) ¶ 20.

Id.

Netflix provided no streaming services -- only DVDs by mail --

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United States District Court

For the Northern District of California

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from 1999 to 2007.

Id. ¶¶ 38-49.

In 2007 Netflix began to allow

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its subscribers to stream movies via the "hybrid plan," the only

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plan it offered at the time, which allowed subscribers both to

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stream movies and to receive DVDs.

Id.

In November 2010, as part of its plan to develop its streaming

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services further, Netflix decided to offer its subscribers a

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standalone streaming plan in addition to the hybrid plan.

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76.

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only plan cost $7.99 per month.

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change, in October 2010, Defendants explained the "virtuous cycle"

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that would drive Netflix's transition to a streaming-focused

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company: "[A]s Netflix gained subscribers, it could afford to

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license more streaming content, which would increase its appeal,

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and therefore, allow [Netflix] to acquire more subscribers, and the

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cycle would thus continue."

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because Netflix's library of streaming content, unlike Netflix's

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DVD library, demanded continuous licensing negotiations and would

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require Netflix to continually increase its subscriber base in

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order to acquire and maintain streaming content.

Id. ¶

The hybrid plan cost $9.99 per month, and the new streamingSee id.

Id. ¶ 65.

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Shortly before this

The cycle was important

See id. ¶¶ 50-65.

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Netflix planned to offset some of the increasing content costs by

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decreasing DVD-related expenditures.

See id.

From June 2010 to July 2011, Netflix's subscriber count

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steadily increased each quarter.

Id. ¶ 91.

Its stock price

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followed suit, rising from a closing price of $153.15 on October

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20, 2010 to a high of $298.73 on July 13, 2011.

Id. ¶¶ 70, 73-74.

On July 12, 2011, however, Netflix announced that effective

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September 1, 2011 for existing subscribers and immediately for new

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ones, it would no longer offer its hybrid plan.

Id. ¶ 351.

United States District Court

For the Northern District of California

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Instead, it would offer separate DVD-only and streaming-only plans,

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both for $7.99 per month.

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previously had access to both DVD and streaming services for $9.99

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per month under the hybrid plan would now have to pay $15.98 to

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subscribe to the new, separate plans.

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Netflix's subscribers were unhappy, and Netflix experienced a net

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loss in customers for the first time in years.

Id. ¶¶ 351, 407.

Subscribers who

See id. ¶¶ 350-51.

Id. ¶¶ 377-78.

Netflix's fortunes fell further in September 2011.

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First, on

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September 2, the cable channel Starz announced that it would not

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renew its streaming contract with Netflix effective February 28,

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2012.

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Id. ¶ 372.
Second, on September 15, Netflix reported that it expected to

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lose one million subscribers during the third quarter of 2011 --

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the first quarter in years that would close with a net loss in

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subscribers.

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by $39.46 to close at $169.25.

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that "the investing public understood that the subscriber drop-off

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was due, in large part, to the price increases in July 2011."

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¶ 378.

After the announcement, Netflix's stock price dropped
Id. ¶¶ 376-79.

Plaintiffs state

Id.

Nevertheless, Netflix stood behind its decision as "the

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right choice."

Id. ¶ 380.

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Third, on September 19, 2011, Netflix announced that it

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planned to spin off its DVD services into a new subsidiary called

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"Qwikster."

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streaming services via its own subscription plans and website,

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separately from the Qwikster subsidiary.

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again recoiled from this change, and Netflix lost still more

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subscribers.

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3, at 15.1

Id. ¶ 152.

Netflix planned to continue to provide

Id.

Netflix's customers

ECF No. 93 (Request for Judicial Notice) ("RJN") Ex.

Netflix soon abandoned the Qwikster idea, but continued

United States District Court

For the Northern District of California

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its planned separation of the DVD-only and streaming-only plans,

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thereby doing away with the hybrid plan altogether.

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149, 154.

CCAC ¶¶ 148,

Shortly thereafter, on October 24, 2011 in documents related

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to the fourth quarter of 2011 ("4Q11"), Netflix began to report

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segmented financial information for the now-entirely-separate DVD-

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only and streaming-only plans -- information that had previously

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been unavailable.

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financial results under the single "Domestic" segment, which

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included customers on the hybrid plan and those on the newer

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streaming-only plan, but did not provide segmented financial

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information for the then-intertwined DVD and streaming services.

Id. ¶ 225.

Before 4Q11, Netflix reported its

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When ruling on a motion to dismiss, a court may consider documents
whose contents are incorporated by reference in a complaint or upon
which a complaint necessarily relies when authenticity is not
contested, and matters subject to judicial notice. Metzler Inv.
GMBH v. Corinthian Colls., Inc., 540 F.3d 1049, 1061 (9th Cir.
2008) (citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551
U.S. 308, 322 (2007)). The Court takes judicial notice of the
exhibits attached to the RJN because Plaintiffs refer to the
documents included in those exhibits, thereby incorporating them by
reference, and Plaintiffs did not object to the RJN.
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See id. ¶¶ 149, 151, 407; RJN Ex. 4 at 71.
In its 4Q11 reports, Netflix announced that its "contribution

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margin for domestic streaming [would] be low in 4Q11 at around 8%

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. . . due to [its] increasing content spend," whereas Netflix's DVD

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business had a contribution profit of 50-52%.

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Netflix continued to stand by its decision to offer the DVD and

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streaming subscription plans as separate services with separate

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prices, but admitted that it had made the change too quickly,

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compounding the problem "with [a] lack of explanation about the

Id. ¶¶ 382-85.

United States District Court

For the Northern District of California

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rising cost of the expansion of streaming content, and steady DVD

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costs."

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members canceled their subscriptions in response to the pricing

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changes than expected, thereby making Netflix's 4Q11 profits and

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revenues lower than predicted, though Netflix would remain

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profitable overall.

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stock price fell $41.47 per share to close at $77.37 per share on

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October 25, 2011.

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Id. ¶ 389.

Netflix stated further that more long-term

Id. ¶ 390.

After this announcement, Netflix's

Id.

Plaintiffs, Netflix shareholders, now sue Defendants for

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alleged violations of the federal securities laws.

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are all based on the theory that, between October 20, 2010 and

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October 24, 2011, inclusive (the "Class Period"), Defendants misled

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investors about the prospects of the new streaming-focused model,

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thereby artificially inflating Netflix's stock price and leading to

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a stock drop of almost 67 percent after the alleged falsity of

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those statements was revealed.

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Their claims

See id.

Plaintiffs allege that all Defendants violated Section 10(b)

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of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and

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Securities Exchange Commission ("SEC") Rule 10b-5; that the

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individual Defendants violated Section 20(a) of the Act; and that

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Hastings violated Section 20A of the Act.

Id. ¶¶ 418-23.

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III. LEGAL STANDARD

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A.

Motion to Dismiss

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A motion to dismiss under Federal Rule of Civil Procedure

Block, 250 F.3d 729, 732 (9th Cir. 2001).

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on the lack of a cognizable legal theory or the absence of

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United States District Court

12(b)(6) "tests the legal sufficiency of a claim."

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For the Northern District of California

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Navarro v.

sufficient facts alleged under a cognizable legal theory."

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Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir.

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1988).

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should assume their veracity and then determine whether they

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plausibly give rise to an entitlement to relief."

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Iqbal, 556 U.S. 662, 679 (2009).

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must accept as true all of the allegations contained in a complaint

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is inapplicable to legal conclusions.

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elements of a cause of action, supported by mere conclusory

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statements, do not suffice."

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Twombly, 550 U.S. 544, 555 (2007)).

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"limited to the complaint, materials incorporated into the

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complaint by reference, and matters of which the court may take

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judicial notice."

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U.S. at 322).

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B.

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Section 10(b) of the Exchange Act makes it unlawful "[t]o use

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or employ, in connection with the purchase or sale of any security

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registered on a national securities exchange . . . any manipulative

"Dismissal can be based

"When there are well-pleaded factual allegations, a court

Ashcroft v.

However, "the tenet that a court

Threadbare recitals of the

Id. (citing Bell Atl. Corp. v.
A court's review is generally

Metzler, 540 F.3d at 1061 (citing Tellabs, 551

Section 10(b)

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or deceptive device or contrivance in contravention of such rules

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and regulations as the [Securities and Exchange] Commission may

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prescribe . . . ."

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by the Commission is Rule 10b–5, which states that "[i]t shall be

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unlawful for any person . . . [t]o engage in any act, practice, or

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course of business which operates or would operate as a fraud or

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deceit upon any person, in connection with the purchase or sale of

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any security."

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five elements to establish a violation of Rule 10b–5: "(1) a

15 U.S.C. § 78j(b).

One such rule prescribed

17 C.F.R. § 240.10b–5(c).

Plaintiffs must plead

United States District Court

For the Northern District of California

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material misrepresentation or omission of fact, (2) scienter, (3) a

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connection with the purchase or sale of a security, (4) transaction

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and loss causation, and (5) economic loss."

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F.3d 1006, 1014 (9th Cir. 2005).

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In re Daou Sys., 411

Plaintiffs must also meet the heightened pleading standards of

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Federal Rule of Civil Procedure 9(b) and the Private Securities

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Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4.

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PSLRA requires plaintiffs to "specify each statement alleged to

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have been misleading [and] the reason or reasons why the statement

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is misleading."

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complaint must "state with particularity facts giving rise to a

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strong inference that the defendant acted with the required state

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of mind."

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establishing securities fraud is the knowing, intentional, or

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deliberately reckless disclosure of false or misleading statements.

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See Daou, 411 F.3d at 1014–15.

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scienter naturally results in a stricter standard for pleading

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falsity, because falsity and scienter in private securities fraud

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cases are generally strongly inferred from the same set of facts,

15 U.S.C. § 78u-4(b)(1).

Id. § 78u-4(b)(2).

The

Additionally, the

The "required state of mind" for

"The stricter standard for pleading

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and the two requirements may be combined into a unitary inquiry

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under the PSLRA."

Id. at 1015 (internal quotation marks omitted).

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IV.

DISCUSSION

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A.

Plaintiffs' Section 10(b) Claim

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Plaintiffs allege that Defendants made materially false and

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misleading statements about (1) Netflix's accounting practices, (2)

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the virtuous cycle, (3) streaming's profitability relative to that

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of the DVD business, (4) Netflix's statements about its price

United States District Court

For the Northern District of California

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changes, and (5) Defendants' statements to the SEC.

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argue that Plaintiffs have failed to adequately plead falsity or

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scienter.

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that Defendants' statements were materially false or misleading,

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and accordingly need not address the issue of scienter.

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Defendants

The Court agrees that Plaintiffs have failed to show

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Defendants' Alleged Accounting Fraud

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Plaintiffs allege that Defendants materially misstated

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Netflix's financial statements in violation of Generally Accepted

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Accounting Principles ("GAAP") and SEC disclosure rules.

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e.g., CCAC ¶¶ 41-56, 283, 331, 360.

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were not required to implement segment reporting until 4Q11, when

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they began to do so.

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a.

See,

Defendants argue that they

MTD at 8.
GAAP

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Plaintiffs state that the GAAP rule governing segment

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reporting, Accounting Standards Codification § 280 ("ASC 280"),

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requires a business component to be considered a separate operating

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segment for financial reporting purposes if:

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"(a) it engages in business activities from
which it may generate revenues and incur
expenses . . . (b) its operating results are
regularly reviewed by the Company's upper
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management . . . in order to assess the
segment's performance and make decisions about
resources to be allocated to the segment . . .
and (c) its discrete financial information is
available."

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4
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Id. ¶ 191.
Plaintiffs allege that Defendants violate GAAP by failing to

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provide segment reporting before 4Q11.

See id. ¶¶ 193-221.

This

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allegation is not plausible because there is no indication that

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Netflix had discrete financial information for its streaming and

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DVD components until 4Q11.

Plaintiffs claim that streaming

United States District Court

For the Northern District of California

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generated "its own revenues and incurred its own expenses separate

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and apart from those of the DVD business," but in doing so

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Plaintiffs massage the fact that the "DVD business" at that time

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was financially inseparable from the streaming component of the

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hybrid plan -- therefore this information was not "discrete."

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CCAC ¶¶ 194-195.

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prospects of streaming generally, or the performance of the

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streaming-only subscription plan, but this is not the same as

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having information about streaming as a discrete component of

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Netflix's overall service offerings.

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See

Defendants may have had information about the

Confronting this fact, Plaintiffs "formulate approximations"

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of their own devising of how the DVD and streaming components of

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the hybrid plan could have been financially separated, which

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Plaintiffs say "strongly suggest[s]" that discrete financial

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information was available to satisfy ASC 280.

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Plaintiffs' allocation is premised on their estimation that

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Netflix's streaming revenue must have been $7.99, because that was

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the price of the streaming-only plan after Netflix split its plans.

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See id. ¶ 211-212 & nn. 6, 7.

See id. ¶¶ 212-14.

This kind of hypothesized allocation

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does not plausibly show that Defendants actually had discrete

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financial information available to them, because Plaintiffs do not

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show that such an allocation was required or even possible given

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the hybrid plan's unity of services and Netflix's statement that

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until 4Q11, "revenues were generated and marketing expenses were

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incurred in connection with the subscription offerings as a whole."

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RJN Ex. 4 at 71.

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Plaintiffs' argument that Netflix should have reported
segments in its domestic financial reports because it did so abroad

United States District Court

For the Northern District of California

10

is also unavailing.

Plaintiffs' pleadings do not explain what

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kinds of plans Netflix offered abroad, which is a critical fact in

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determining whether Netflix's domestic accounting practices were

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inappropriate relative to what it did elsewhere.

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agree that Netflix erred in not reporting its United States and

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international financial data in the same way without evidence that

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the facts were the same in the United States and abroad.

The Court cannot

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The Court finds that Plaintiffs have not pled any false or

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misleading statements related to Defendants' accounting under GAAP.

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b.

SEC Regulation S-K Item 303

Plaintiffs also argue that Netflix violated SEC Regulation S-K

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Item 303, which requires companies to "describe any other

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significant components of revenues or expenses that . . . should be

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described in order to understand the registrant's results of

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operations."

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(ii)).

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uncertainties that have had or that the registrant reasonably

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expects will have a material favorable or unfavorable impact on net

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sales or revenues or income from continuing operations."

CCAC ¶ 222 (citing 17 C.F.R. § 229.303(a)(3)(i)-

These disclosures include "any known trends or

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Id.

Plaintiffs' allegations on this point are not plausible.

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"It

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is well established that violation of an exchange rule will not

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support a [Section 10(b) or Rule 10b–5] claim."

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Holdings, Inc. Secs. Litig., 11 F.3d 865, 870 (9th Cir. 1993).

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any event, Plaintiffs' pleadings do not actually show that

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Defendants withheld information about a known trend or uncertainty

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in the streaming market, since Defendants repeatedly stated that

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success in the streaming market depended on multiple factors,

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especially Netflix's ability to keep its subscriber base large and

In re VeriFone
In

United States District Court

For the Northern District of California

10

happy.

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Plaintiffs' allegations regarding Item 303 are therefore

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insufficient to state a claim for a violation of Section 10(b) or

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Rule 10b-5.

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See, e.g., RJN Ex 1 at 16; Ex. 5 at 27; Ex. 16 at 24.

2.

The Virtuous Cycle

According to Defendant Hastings: "[By way of the virtuous

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cycle, Netflix would] acquire more streaming content, which helps

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grow [Netflix's] subscriber base and lessen[s] [Netflix's] DVD-by-

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mail expense, which in turn provides [Netflix] with greater

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financial resources to acquire more streaming content, improve the

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user interface, and continue to grow the subscriber base."

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64.

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CCAC ¶

In December 2010, defendants Hastings and McCarthy stated
further:
[Defendant Hastings:] [W]e are on that
virtuous cycle of more subscribers . . . .
It means that we can write bigger checks and
get more content, and that, in turn,
attracts more subscribers. And we are going
round and round that loop as we go . . . .
[Defendant
McCarthy]:
And
so
to
be
explicitly clear, the benefit of paying less
on DVD is not higher profit margins. In the
alternative, it creates an opportunity for
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us to re-task that money with our studio
partners
in
the
licensing
of
streamed
content, which
accelerates the virtuous
cycles that we had already spoke about.

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4

Id.

¶¶ 293-94.

On other occasions, Netflix made similar

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statements affirming its reliance on the virtuous cycle to drive

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its business growth, so long as Netflix's subscriber base continued

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to grow and decreases in DVD-related expenditures allowed Netflix

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to offset some of the increases in streaming-related costs.

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e.g., id. at ¶¶ 293-94, 303-05, 325-26.

See,

Indeed, the virtuous cycle

United States District Court

For the Northern District of California

10

seemed to work as Netflix had planned until, for the first time in

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years, Netflix posted a loss in subscribers after its announcement

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that it would increase prices.

See id. ¶¶ 163, 377-78.

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Plaintiffs allege that Defendants touted Netflix's turn toward

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a streaming focus as a positive development, even though Defendants

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allegedly knew that shifting to a streaming-focused model would be

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unprofitable and unsustainable, thereby rendering Defendants'

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explanations of and statements about the virtuous cycle false or

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misleading.

19

Plaintiffs' allegations do not prove that any statement about the

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virtuous cycle was false or misleading.

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See, e.g., id. ¶¶ 277, 279.

The Court agrees with Defendants.

Defendants argue that

See MTD at 17.
The statements that

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Plaintiffs allege to have been false or misleading appear to be

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accurate descriptions of a business model that worked exactly as

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Netflix said it would, until Netflix began to lose subscribers

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after announcing its price increases and DVD-business spinoff.

26

CCAC ¶ 377-78.

27

Defendants made public statements about the virtuous cycle, any of

28

the Defendants knew that the virtuous cycle was unsustainable but

See

Plaintiffs do not show, for example, that when

12

1

pursued it as a strategy anyway; that any of Defendants' other

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actions negatively impacted the virtuous cycle's operation; that

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Defendants misrepresented the strength of the virtuous cycle at any

4

point; or that any of these statements did anything but confirm

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Netflix's reliance on a model that worked as Defendants described

6

and failed due to circumstances Netflix had warned investors about

7

in earlier disclosures.

8

warned its investors of the virtuous cycle's reliance on subscriber

9

growth: "We must continually add new subscribers . . . If too many

For example, on February 18, 2011, Netflix

United States District Court

For the Northern District of California

10

of our subscribers cancel our service, or if we are unable to

11

attract new subscribers in numbers sufficient to grow our business,

12

our operating results will be adversely affected."

13

This statement and others like it showed that Netflix warned

14

investors about the virtuous cycle's reliance on subscriber growth.

RJN Ex. 5 at 4.

Accordingly, the Court finds that Plaintiffs have failed to

15
16

plead that any of Defendants' statements about the virtuous cycle

17

were materially false or misleading.2

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3.

Profitability

Plaintiffs also allege that Defendants' statements about the

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20

prospects of the streaming business were materially false or

21

misleading because Defendants hid facts about streaming's

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disparately low profitability relative to Netflix's DVD component,

23

and because Defendants misrepresented the prospects of streaming

24

for the future of Netflix's business.
Defendants made several statements in SEC filings and

25
26
27
28

2

Defendants also argue that their statements were non-actionable
statements of optimism or forward-looking statements. Since the
Court finds the challenged statements are not false, it need not
and does not address this argument.
13

1

conference calls indicating that Netflix would shift its business

2

focus to streaming.

3

example, Netflix stated in a press release on October 20, 2010 that

4

it had become "by every measure . . . primarily a streaming company

5

that also offers DVD by mail."

6

earnings call on that same day, defendant Hastings said that

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"[Netflix's] evolution to a streaming company has just been

8

phenomenal," based on year-over-year subscriber growth of 52

9

percent and rising, more content, more device partnerships, and

United States District Court

For the Northern District of California

10
11

See, e.g., CCAC ¶¶ 62, 267, 277, 279.

Netflix's entry into Canada.

Id. ¶ 62.

For

Further, during an

Id. ¶ 66.

Hastings also told investors that increasing costs associated

12

with acquiring streaming content would be offset by the declining

13

costs of the DVD business (e.g., postage for DVDs), and that

14

"[Netflix] would like to keep [the long-term margin structure]

15

between 30% and 35% gross margin."

16

this principle, stating that the target margins could be sustained

17

by new content deals replacing postage.

18

characterize these statements as being part of a discussion about

19

"relative profitability" of DVD and streaming segments.

20

278-79.

21

to speculate about comparative long-term margins without more

22

knowledge of future market competitiveness.

23

Id. ¶ 278.

McCarthy confirmed

Id. ¶ 279.

Plaintiffs

See id. ¶¶

However, as Defendants note, Hastings specifically refused

RJN Ex. 7 at 8.

Plaintiffs' main contention as to these statements and others

24

like them is that Defendants misled investors as to the

25

profitability of its streaming component, because after Netflix

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began segment reporting for the separate streaming and DVD plans in

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4Q11, it revealed that the separate streaming plan had a

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contribution profit of only about 8 percent compared to the DVD

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plan's 50-52 percent.

2

that Defendants knew the streaming business would be less

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profitable than Netflix's DVD component, but concealed this from

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their investors, and, further, that Defendants had an obligation to

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reveal such discrete data once they had emphasized streaming's

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importance to Netflix's future business goals.

7

315, 328, 356.

Plaintiffs allege

See id. ¶¶ 281,

Defendants argue that Plaintiffs fail to plead a false or

8
9

CCAC ¶¶ 275-370, 384-385.

misleading statement regarding the streaming service's

United States District Court

For the Northern District of California

10

profitability, because "Plaintiffs do not allege facts reflecting

11

that Netflix ever made an affirmative public statement regarding

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streaming's profitability," and because Plaintiffs do not plead

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"any facts reflecting that the allegedly-omitted information was

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known to Defendants at the time of the challenged statements."

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at 14-16.

16

reference the streaming segment's profitability [in its SEC

17

disclosures and other statements about its shift to streaming] is

18

beside the point."

19

Initiatives, Inc. v. Siricusano, 131 S. Ct. 1309, 1321-22 (2011),

20

and Brody v. Transitional Hospitals Corp., 280 F.3d 997, 1006 (9th

21

Cir. 2002), for the proposition that disclosure is required where

22

failure to disclose would render statements misleading in light of

23

the circumstances in which they were made.

24

11.

25

hold that a defendant's statement is misleading merely because it

26

is complete or because a defendant could have said more.

27

Matrixx, 131 S. Ct. at 1321-22; Brody, 280 F.3d at 1006.

28

MTD

Plaintiffs respond: "That Defendants did not explicitly

Opp'n at 10.

Plaintiffs cite to Matrixx

See Opp'n at 1-2, 10-

Contrary to Plaintiffs' suggestions, Matrixx and Brody do not

In the instant matter, Plaintiffs have not shown that

See

15

1

Defendants possessed information at odds with the state of affairs

2

they presented to investors, such that restatement or additional

3

disclosure was required.

4

profitability to have been misleading, Defendants must have

5

actually known specific information about the allegedly disparate

6

profit margins of separate DVD and streaming segments.

7

not until 4Q11, because streaming was never wholly separate from

8

the DVD component until that point.

9

allegation that Defendants touted the profitability of the

For Defendants' statements about

They did

Further, Plaintiffs'

United States District Court

For the Northern District of California

10

streaming business is not convincing: the statements quoted by

11

Plaintiffs do not actually refer to the profitability of streaming,

12

but rather the interrelationship of the streaming and DVD

13

businesses contributing to one overall margin.

14

See CCAC ¶¶ 278-79.

Further, Defendants made clear throughout the Class Period

15

that the success of a streaming-focused business model was

16

contingent on other factors, primarily the growth and retention of

17

Netflix's subscriber base, suggesting that Defendants did not omit

18

any information or warnings in a way that would be misleading under

19

Rule 10b-5.

20

at 24; Ex. 5 at 27.

See, e.g., RJN Decl. Ex 1 at 16; Ex. 5 at 27; Ex. 16

21

None of what Plaintiffs plead therefore shows that Defendants

22

made any false or misleading statements about the profitability of

23

the streaming business.

24

4.

25

Defendants' Communications with the SEC

Plaintiffs further argue that Defendants made false or

26

misleading statements in a series of letters exchanged between

27

Defendants and the SEC.

28

See CCAC ¶¶ 341-47.

Plaintiffs point first to July 2009 correspondence between

16

1

Netflix and the SEC in which the SEC urged Netflix to discuss the

2

"types of plans that [it offers], the price per plan, the cost per

3

plan, [and] the total revenues by plan type."

4

did not supply that information in its response or subsequent

5

filings.

6

Id. ¶ 116.

Netflix

Id.

Later, on April 28, 2011, the SEC asked Netflix to provide

7

more information about its changing business, "such as the number

8

of subscription streaming-only plans, streaming and DVD by mail

9

plans, and DVD by mail only plans," so that investors could observe

United States District Court

For the Northern District of California

10

and analyze that data.

11

consider adding "any other operating statistics that [it believed]

12

would be useful to investors, which may include rates of churn or

13

any other statistics that would better enable investors to

14

understand [Netflix's] business."

15

May 20, 2011, that though it did not think some of this information

16

would help, it would add more disclosures, giving the following

17

paragraph as an example:

18
19
20
21
22
23
24
25
26
27
28

Id.

The SEC also requested that Netflix

Id. ¶ 343.

Netflix responded on

We believe that the DVD portion of our
service will be a fading differentiator
given the rapid growth of streaming, and
that in order to prosper in streaming we
must concentrate on having the best possible
streaming service. As a result, we are
beginning to treat them separately in many
ways. Nonetheless, we believe that the
evolution of our business model in this
manner does not change, except as otherwise
disclosed in this MD&A, our expectations in
terms of impact or trend to our operating
results.
As
we
continue
to
focus
on
streaming, we expect to continue to grow our
number of subscribers, revenues, operating
income and free cash flows. Specifically in
fiscal
2011,
we
expect
our
domestic
operating margin to increase as compared to
fiscal 2010.

17

1

Id. ¶ 346.

2

the portion of that paragraph beginning "Nonetheless . . . ."

3

¶ 347.

4

cease to provide certain operating metrics in 2012, namely gross

5

subscriber additions, subscriber acquisition costs, and churn (a

6

measurement of customer cancellations).

7

2011, the SEC again wrote to Netflix asking it to reconsider its

8

decision not to provide these metrics, but Netflix did not do so.

9

Id. ¶ 118.

United States District Court

For the Northern District of California

10
11

However, in its subsequent SEC filing, Netflix omitted
Id.

In that same letter, Netflix also stated that it would

Id. ¶¶ 117, 344.

In June

In none of these letters did the SEC specifically ask

for segmented financial information.

Id. ¶¶ 117-18, 344.

Plaintiffs allege that Netflix's choice not to include some

12

requested information in its public filings, as well as the

13

information that it did disclose in response to the SEC, prove that

14

these statements were misleading.

15

respond that Netflix's choice not to include certain information is

16

irrelevant because the exchanges between the SEC and Netflix are

17

public.

18

soon as the letters were published regardless of whether Netflix

19

repeated their contents in subsequent statements.

20

Defendants also point out that the SEC's 2009 correspondence with

21

Netflix could not possibly have concerned a streaming-only plan, as

22

none existed at that time.

23

Id. ¶¶ 341-49.

Defendants

Defendants reason that they put the public on notice as

MTD at 18-19.

Id. at 9 (citing CCAC ¶ 76).

The Court agrees with Defendants that the exchange between

24

Netflix and the SEC in 2009 does not show that Defendants'

25

statements about streaming were false or misleading.

26

about metrics like subscriber information for Netflix's different

27

plans and other operating statistics, not about specific segmented

28

financial information for DVDs and streaming segments.

18

The SEC asked

See CCAC ¶¶

1

341-45.

Moreover, Netflix did not offer standalone streaming plans

2

when the SEC sent its 2009 letters.

3

therefore irrelevant to Plaintiffs' claims and appears to serve

4

only as innuendo relating to Defendants' dealings with the SEC.

5

Further, since Defendants' correspondence with the SEC was

6

public, Plaintiffs' allegation that Netflix somehow hid information

7

from investors while simultaneously filing these letters with the

8

SEC hold no weight.

9

statements it made to the SEC in subsequent filings does not

The 2009 correspondence is

Netflix's decision not to reiterate the same

United States District Court

For the Northern District of California

10

indicate that Defendants misled investors.

Plaintiffs do not

11

otherwise allege that Netflix misled the SEC.
The Court finds that Netflix's statements to the SEC do not

12
13

support a 10b-5 claim.

14

5.

Defendants' Statements About Price Increases

In July 2011, Netflix posted on its official blog that it

15
16

would begin to offer a DVD-only plan in addition to its streaming-

17

only plan, but would phase out the hybrid plan.

18

new plans, the streaming-only and DVD-only plans, would be $7.99

19

per month -- $15.98 for both -- effective immediately for new

20

subscribers and September 1, 2011 for current ones.

21

407.

22

the long life we think DVDs by mail will have, treating DVDs as a

23

$2 add-on to our unlimited streaming plan neither makes great

24

financial sense nor satisfies people who just want DVDs.

25

an unlimited DVDs by mail plan (no streaming) at our lowest price

26

ever, $7.99, does make sense and will ensure a long life for our

27

DVDs by mail offering."

28

CCAC ¶ 351.

Both

Id. ¶¶ 350-51,

Netflix explained the reasoning behind these changes: "Given

Creating

Id. ¶ 351.

Plaintiffs argue that Netflix's announcement about price

19

1

changes was false and misleading because "it failed to disclose

2

and/or misrepresented the reason that Netflix increased its prices,

3

namely, that Netflix was suffering from decreased liquidity and was

4

unable to afford the growing costs associated with its businesses."

5

Id. ¶ 352.

6

allegation about decreased liquidity is unfounded because Netflix

7

had more than $375 million in liquid assets as of June 2011.

8

Plaintiffs did not respond to these arguments in their opposition.

9

Defendants' primary response is that Plaintiffs'

The Court finds that the blog post about price increases was

United States District Court

For the Northern District of California

10

not false or misleading.

11

indicating that the real reason Netflix changed its prices had to

12

do with decreased liquidity or other concerns related to what

13

Plaintiffs claim is a faulty business model.

14

conclusory allegation that Netflix lied about its reason for

15

changing its pricing structures and subscription plans.

16

same documents on which Plaintiffs rely in their CCAC, Netflix

17

disclosed its cash, cash equivalents, and short-term investments as

18

of June 30, 2011.

19

or other disclosures as indications of Netflix's lack of liquidity.

20

See RJN Decl. Ex. 1 at 4.

21
22

B.

Plaintiffs do not plead specific facts

They state only a

In the

Plaintiffs do not point to any of those numbers

Plaintiffs' Remaining Claims
Absent an underlying violation of the Exchange Act, there

23

can be no control person liability under Section 20(a).

Paracor

24

Fin., Inc. v. Gen. Elec. Capital Corp., 96 F.3d 1151, 1161 (9th

25

Cir. 1996).

26

Section 10(b), their control person claim is also DISMISSED.

27

Shurkin v. Golden State Vinters, Inc., 471 F. Supp. 2d 998, 1027

28

(N.D. Cal. 2006).

Because Plaintiffs have not pled a violation of

Likewise, there can be no insider trading

20

See

1

liability under Section 20A without an underlying violation of

2

Section 10(b).

3

Section 20A claim is therefore DISMISSED.

See In re VeriFone, 11 F.3d at 872.

Plaintiffs'

4
5

V.

CONCLUSION
For the foregoing reasons, the Court GRANTS Defendants Reed

6
7

Hastings, David Wells, Barry McCarthy, and Netflix, Inc.'s Motion

8

to Dismiss.

9

State-Boston Retirement System's Consolidated Class Action

Plaintiffs Arkansas Teacher Retirement System and

United States District Court

For the Northern District of California

10

Complaint is DISMISSED WITH LEAVE TO AMEND.

Plaintiffs may file an

11

amended complaint within thirty (30) days of this Order's signature

12

date.

13

with prejudice.

Failure to do so will result in dismissal of this action

14
15

IT IS SO ORDERED.

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17

13
Dated: February ___, 2013

18

UNITED STATES DISTRICT JUDGE

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