Tsai v. Basile et al
Filing
87
ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTIONS TO DISMSS by Judge Yvonne Gonzalez Rogers granting in part and denying in part 61 Motion to Dismiss; granting in part and denying in part 66 Motion to Dismiss; granting in part and denying in part 74 Motion to Strike (fs, COURT STAFF) (Filed on 10/31/2014)
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UNITED STATES DISTRICT COURT
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NORTHERN DISTRICT OF CALIFORNIA
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IN RE VIOLIN MEMORY SECURITIES
LITIGATION
Case No.: 13-CV-5486 YGR
ORDER GRANTING IN PART DEFENDANTS’
MOTIONS TO DISMISS
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United States District Court
Northern District of California
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Lead Plaintiffs Ali Shehk and Alan Richards (collectively “Plaintiffs”) bring this
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consolidated class action complaint against Defendants Violin Memory, Donald Basile, Dixon
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Doll, Cory Sindelar, Howard Bain III, Larry Lang, Jeff Newman, Mark Rosenblatt, David Walrod,
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(together, “Violin Memory Defendants”) and J.P. Morgan, Deutsche Bank Securities Inc., Merrill
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Lynch, Barclays Capital Inc., Robert Baird and Co., Pacific Crest Securities LLC, and EM
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Securities LLC (together “Underwriter Defendants”).
The Consolidated Amended Complaint (“CAC”) alleges violations of the Securities Act of
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1933 (“Securities Act”) in connection with the initial public offering (“IPO”) of Violin Memory,
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Inc. (“Violin Memory”), a California-based company that developed and sold flash-based memory
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devices. Plaintiffs assert that Violin Memory’s Registration Statements1 contained material and
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misleading omissions and misrepresentations. (CAC ¶ 3.) On behalf of themselves and all others
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Documents comprising the “Registration Statements” include: Violin Memory’s
Registration Statement filed with the SEC on Form S-1 on August 26, 2013 (Dkt. No. 63-2),
Amended Registration Statement filed with the SEC on Form S-1/A on September 16, 2013 (Dkt.
No. 69-1), and Prospectus filed with the SEC on Form 424B4 on September 27, 2013 (Dkt. No. 631; “Prospectus”). (CAC ¶ 8.)
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who purchased or otherwise acquired Violin Memory securities in connection with the IPO,
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Plaintiffs assert strict liability and negligence claims under Sections 11, 12(a), and 15 of the Act.
Both groups of Defendants, the Underwriter Defendants and the Violin Memory
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Defendants, have filed motions to dismiss the CAC on the grounds that, generally, Plaintiffs have
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failed to meet the pleading standard under Federal Rules of Civil Procedure 8 and 9 and have failed
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to state a claim under Rule 12(b)(6). (Dkt. Nos. 61, 66.) Each group of defendants has joined in
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the other’s motion to dismiss. Defendants have also filed requests for judicial notice (Dkt. Nos. 62,
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69) and the Violin Memory Defendants have filed a separate Appendix to their Motion (Dkt. No.
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68.) Plaintiffs have moved to strike the Appendix and have opposed certain requests for judicial
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notice.2 (Dkt. No. 74.)
These motions came on for hearing on June 17, 2014. Having carefully considered the
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Northern District of California
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papers submitted and the pleadings in this action, the arguments presented at the hearing, and for
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the reasons set forth below, the Court hereby GRANTS in part the Motion to Dismiss with leave to
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amend. Defendants’ Requests for Judicial Notice are GRANTED in part. Plaintiff’s Motion to
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Strike is GRANTED in part.
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I.
The facts herein are gleaned from the CAC, documents referred to therein, and judicially
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FACTUAL BACKGROUND
noticed materials.
Violin Memory is a California-based technology company that designs and manufactures
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flash memory devices for servers and networks in the form of flash memory arrays and memory
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cards. (CAC ¶ 10.) Flash memory is a computer storage medium that can be electrically erased
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Neither Violin Memory Defendants nor Plaintiffs have complied fully with the rules
governing local civil practice in this district. Violin Memory Defendants have included additional
argument in support of their Motion to Dismiss in the form of a chart itemizing the alleged
omissions in the CAC and contrasting those allegations with excerpts from the Registration
Statement. Defendants are hereby cautioned that they must seek leave of Court to file such
submissions in the future. Plaintiffs’ Motion to Strike challenges both the Violin Memory
Defendants’ Appendix and the various requests for judicial notice. A motion to strike is not the
appropriate mechanism for challenging Defendants’ requests for judicial notice. The Court has
nonetheless considered these arguments as opposition to the requests. (See Section IIA, infra.)
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and reprogrammed. (Id.) It is used in memory cards, USB flash drives, solid-state drives, and
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similar products, for general storage and transfer of data. (Id.) Flash memory offers potential
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advantages compared to traditional hard disks or tape. (Id.) For example, it does not have the
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mechanical limitations and latencies (or slowness) of hard drives, and it has the potential to be more
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efficient relative to hard disks when considering speed, noise, power consumption, and reliability.
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(Id.)
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On September 27, 2013, Violin Memory issued an IPO of 18 million shares of common
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stock at $9 per share. (CAC ¶ 1.) In connection with the IPO, the Company filed several offering
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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
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Northern District of California
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Statement”) and a Prospectus on Form 424B4 filed on September 27, 2013 (“Prospectus”). These
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documents contained information regarding the Company’s financial status, business and
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management, and products. These documents also contained risk disclosures amounting to twenty-
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six pages and pertaining to, among other things, the Company’s number of customers, operating
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history, cash flow, its recent introduction of a new line of products, market acceptance of its
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products, and the impact of adverse economic conditions. (Prospectus, at 5, 10–36; Amended
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Registration Statement at 11-37.) The disclosures did not minimize the high-risk nature of the
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investment. For example, relative to the financial condition of the Company, the Amended
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Registration Statement included the following:
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Without obtaining adequate capital funding or improving our financial
performance, we may not be able to continue as a going concern. The report
of our independent registered public accounting firm for the year ended
January 31, 2013 included herein contains an explanatory paragraph
indicating that there is substantial doubt as to our ability to continue as a going
concern as a result of recurring losses from operations and negative cash flows
. . . Our ability to continue as a going concern will be determined by our
ability to complete this offering enabling us to fund our expansion plans and
realize our business objectives. In addition, we have incurred a net loss and
negative operating cash flows in each quarter since our inception and expect
to incur losses in future periods as we continue to increase our expenses in
order to position us to grow our business. If we are unable to obtain adequate
funding from this proposed offering or in the future, or if we are unable to
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grow our revenue substantially to achieve and sustain profitability, we may
not be able to continue as a going concern. (Dkt No. 69-1 at 12 (italics and
bold in original; additional emphasis supplied).)
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We have experienced significant losses as we have continued to invest in our
product development, customer service and sales and marketing organizations
. . . We intend to increase our investments in our marketing services and sales
organization and to continue investing significantly in research and
development at the expense of near-term profitability. As a result, we
anticipate that we will incur net losses at least for the next several quarters.
(Id. at 48 (emphasis supplied).)
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:
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Northern District of California
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[W]e have limited experience from which to formulate an accurate
expectation of our product lifecycles, which could make it more difficult for
us to plan our product development timelines to meet customer and market
demands. (Id. at 11.)
Our revenue growth rate in recent periods is not likely to recur and is not
indicative of our future performance. You should not consider our revenue
growth in recent periods as indicative of our future performance. We do not
expect to achieve similar revenue growth rates in future periods. In fact, in
future periods, our total revenue could decline. For example, even though our
total revenue increased 373% in fiscal 2012 compared to fiscal 2011, our total
revenue declined 53% for the three months ended April 30, 2012 compared to
the three months ended January 31, 2012. You should not rely on our revenue
for any prior quarterly or annual periods as an indication of our future revenue
or revenue growth. If our revenue declines from our prior performance, it may
be difficult to achieve and maintain profitability. (Id. at 12-13 (emphasis in
original).)
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The Amended Registration Statement also highlighted the significant market and industry risks
facing the Company and their potential to impact sales and profitability:
The market for flash memory in storage products is rapidly evolving.
Accordingly, our future financial performance will depend in large part on
growth in this market and on our ability to adapt to trends in this market as
they develop and evolve . . . The rapidly evolving nature of the technology in
the data storage products market, as well as other factors that are beyond our
control, reduce our ability to accurately predict our future performance. Our
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products may never gain broad adoption, and changes or advances in
technologies could adversely affect the demand for our products . . . A
reduction in demand for flash-based data storage caused by lack of endcustomer acceptance, technological challenges, competing technologies and
products or otherwise would result in a lower revenue growth rate or
decreased revenue, either of which would negatively impact our business and
operating results. (Id. at 18-19.)
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Despite these and many other stark disclosures regarding business risks, Violin Memory’s
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Northern District of California
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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
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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:3
(1) Material engineering and development problems with Violin Memory’s 6000 Series
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Flash Arrays, a flash memory device;
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(2) Material technical defects with Violin Memory’s PCIe Cards, another of Violin
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Memory’s flash memory devices, and that product’s failure to gain market acceptance;
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(3) That Violin Memory was having difficulties optimizing the PCIe Cards for
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Toshiba, one of its largest customers;
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(4) Material negative trends concerning the Company’s sales to the federal
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government, a major consumer of Violin Memory’s products;
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(5) Material negative information concerning Violin Memory Chief Executive Office
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If we fail to develop and introduce new or enhanced products on a timely
basis, our ability to attract and retain customers could be impaired and our
competitive position would be harmed. (Id. at 20 (emphasis in original).)
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Despite including block quotations and purported excerpted sections of the Registration
Statement in the CAC, Plaintiffs have neglected to include any citations referencing particular
pages in the relevant documents. Plaintiffs’ failure to include citations has required that Defendants
and the Court search extensively for each citation through hundreds of pages of SEC filings.
Should Plaintiffs elect to file a proposed First Consolidated Amended Complaint, they must include
proper citations, including pincites.
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Donald Basile’s prior experience in the flash memory market and his “for cause”
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termination from Fusion-io, a competitor flash memory company;
(6) Unusual transactions in the form of sales to Underwriters J.P. Morgan and BofA
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Merrill Lynch that inflated the Company’s sales and revenue figures just prior to the
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IPO; and
(7) The amount of the Company’s non-cancelable purchase orders.
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(See CAC ¶ 31.)
The two specific Violin Memory products at issue in the CAC are the 6000 Series Flash
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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
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Northern District of California
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time of Violin Memory’s September 2013 IPO, substantially all of the Company’s revenue was
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derived from the Flash Memory Arrays. (Dkt. No. 69-1 at 19.) For the six months ended July 31,
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2012, sales of the 6000 Series Flash Memory Arrays represented approximately 84% of the
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Company’s product revenue, and over the next year rose to 91%. (Id. at 53.) The PCIe Cards,
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introduced in March 2013, were intended to provide generally the same technology and benefits of
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the 6000 Flash Arrays, but in a different form for other segments of the market. (CAC ¶ 11.)
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Unlike the 6000 Flash Arrays, PCIe Cards can operate in both servers and workstations via PCIe
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interfaces on a computer’s motherboard. (CAC ¶ 11.) At the time of the IPO, the Company had
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not derived significant revenue from the sale of the PCIe Cards. (Amended Registration Statement
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at 1-2.)
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Plaintiffs claim that at the time of the IPO in September 2013, Violin Memory represented
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that these products had been successfully designed, developed, and well-received in the market
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across multiple segments, including the U.S. federal government, and that these representations
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were false when made. (See Opp. at 1.) Plaintiffs specifically allege that the Registration
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Statement failed to disclose material defects and development problems regarding the PCIe Cards,
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including that the PCIe Cards were not optimized or sustainable due to material technical and
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engineering defects. Plaintiffs further allege that the Registration Statement contained an omission
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or misleading statement with respect to how the PCIe Cards were programmed and developed for
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Toshiba, a leading provider of flash memory and one of the Company’s principal stockholders.
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The Registration Statement represented that the Company had entered into a PCIe Card
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development agreement with Toshiba, pursuant to which Violin Memory was to “develop a
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derivative product.” Plaintiffs allege that contrary to this representation, at the time of the IPO, the
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Company was experiencing “material difficulties building and developing the PCIe Cards in
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accordance with Toshiba’s specifications.” (CAC ¶ 37.) Plaintiffs also contend that although the
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Registration Statement represented that the PCIe cards had gained, or very likely would gain,
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market acceptance, that was not so.
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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
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Northern District of California
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these products as well. According to the CAC, in the months leading up to the IPO, Violin
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Memory experienced material negative developments and engineering defects that resulted in
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breakdowns, failure to protect data, and the need for costly unique IP addresses that resulted in
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compatibility problems for customers. (CAC ¶ 47.)
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Next, Plaintiffs assert that material negative trends concerning sales to the federal
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government were not disclosed and that the government sequestration was negatively impacting the
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Company’s revenue. The Registration Statement represented that “[t]he United States government
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can also suspend operations if Congress does not allocate sufficient funds to a particular agency or
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organization, and the United States government may allow our competitors to protest our successful
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bids. The occurrence of any of these events may negatively affect our business, operating results
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and financial condition.” (CAC ¶ 54.) Plaintiffs contend that this statement, and other similar
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statements, were untrue because at the time of the IPO, sales in the Company’s federal division had
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been declining materially over the course of the fiscal year. Plaintiffs further contend that the
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government sequestration negatively impacted the Company’s revenues, but nowhere was that
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reflected in the Registration Statement.
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Furthermore, Plaintiffs contend that negative information concerning the background and
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business experience of the Company’s Chief Executive Officer (“CEO”), Donald Basile was
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improperly withheld and was material. Plaintiffs argue that the failure to share the fact that Mr.
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Basile was terminated “for cause” from his position as CEO at Fusion-io, Inc. was misleading.
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(CAC ¶ 75.) Plaintiffs allege that they and other members of the Class would have considered the
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fact that Defendant Basile was recently terminated “for cause” from his position as Chief Executive
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Officer with one of the Company’s main competitors in their decision to invest in the Company.
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Plaintiffs contend that this information should have been disclosed.
Plaintiffs next allege that unusual transactions conducted by Mr. Basile artificially and
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materially inflated the Company’s income and revenue. Before the IPO, Violin Memory sold the
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6000 Flash Arrays to J.P. Morgan and BofA Merrill Lynch in exchange for being selected as
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underwriters for the Company’s IPO. (CAC ¶ 78.) Plaintiffs argue that this transaction artificially
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inflated Violin Memory’s revenue as reported in the Registration Statement. Plaintiffs contend that
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Northern District of California
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in light of the unusual means by which the transactions were negotiated and the fact that it inflated
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revenues, the Registration Statement should have disclosed the above information but failed to do
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so.
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Finally, Plaintiffs contend that the Registration Statement should have disclosed the
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Company’s non-cancelable purchase orders, which Plaintiffs argue was required by U.S. generally
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accepted accounting principles (“GAAP”). (CAC ¶¶ 79, 81.) Plaintiffs assert that Registration
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Statement reported that, as of January 31, 2013, the Company had approximately $15.9 million of
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outstanding purchase commitments to contract manufacturer and other vendors. The Registration
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Statement did not disclose the amount of outstanding purchase commitments as of July 31, 2013.
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The next reported outstanding purchase commitments, as of October 31, 2013, disclosed that those
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commitments were in excess of $85 million. Plaintiffs contend that this negative trend was
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material and that the figures as of July 31, 2013, should have been disclosed, and that the omitted
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information would have been considered by reasonable investors in making their decisions to
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purchase Violin Memory stock. (CAC ¶¶ 83-86.)
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II.
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DISCUSSION
A.
REQUESTS FOR JUDICIAL NOTICE
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
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which it can take judicial notice without converting the motion to dismiss to one for summary
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judgment. Barron v. Reich, 13 F.3d 1370, 1377 (9th Cir. 1994). A court may take judicial notice
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of facts “not subject to reasonable dispute” because they are either “(1) generally known within the
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territorial jurisdiction of the trial court or (2) capable of accurate and ready determination by resort
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to sources whose accuracy cannot reasonably be questioned.” Fed. R. Evid. 201. Additionally, a
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court may take judicial notice of “‘matters of public record’ without converting a motion to dismiss
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into a motion for summary judgment.” Lee v. City of Los Angeles, 250 F.3d 668, 689 (9th Cir.
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2001) (quoting MGIC Indem. Corp. v. Weisman, 803 F.2d 500, 504 (9th Cir. 1986)). Under the
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incorporation by reference doctrine, courts may consider documents “whose contents are alleged in
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a complaint and whose authenticity no party questions, but which are not physically attached to the
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United States District Court
Northern District of California
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[plaintiff's] pleading.” In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 986 (9th Cir. 1999)
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(quoting Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994)) (alteration in original) (superseded
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by statute on other grounds). Where a document is referenced or incorporated by reference into a
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complaint, “[t]he court may treat such a document as ‘part of the complaint’” and the Court “may
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assume [their] contents are true for purposes of a motion to dismiss under Rule 12(b)(6).” Marder
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v. Lopez, 450 F.3d 445, 448 (9th Cir. 2006) (citations omitted).
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Applying the “incorporation by reference” doctrine, the Court grants Defendants’
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unopposed requests for judicial notice of (i) Violin Memory’s Form A-1/A, filed with the SEC on
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September 16, 2013; (ii) a transcript of Violin Memory’s Q3 2014 Earnings Call from November
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21, 2013; (iii) Violin Memory’s Form 8-K, filed on November 21, 2013, and attached press release,
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(iv) the Prospectus filed with the SEC on September 27, 2013; (v) Form S-1 filed with the SEC on
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August 26, 2013; and (vi) the Sequester Order For Fiscal Year 2013 issued on March 1, 2013.
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(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.)
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Plaintiffs dispute Defendants’ request for judicial notice of nine documents falling into four
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categories: an SEC filing, analyst report, news articles, and court documents. The Court considers
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each category in turn.
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In the first category, Plaintiffs contest judicial notice of Violin Memory’s SEC filing Form
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10-K for fiscal year 2014, filed on April 16, 2014.4 (Dkt. No. 74 at 5-7.) The Court grants judicial
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notice of this document. The April 2014 10-K, which post-dates the filing of this action, is
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nowhere referred to in the CAC, but the substance therein relates to Plaintiffs’ allegations that there
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had been financial chicanery at play both with respect to disclosure of the Company’s purchase
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order commitments and GAAP compliance. Moreover, public records, such as SEC filings, are
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properly the subject of judicial notice, and routinely considered in deciding a motion to dismiss in a
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securities case. In re Extreme Networks, Inc. S'holder Derivative Litig., 573 F. Supp. 2d 1228,
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1232 n.2 (N.D. Cal. 2008) (citing In re CNET Networks, Inc., 483 F. Supp. 2d 947, 953–54 (N.D.
Cal. 2007); In re Calpine Corp. Sec. Litig., 288 F. Supp. 2d 1054, 1076 (N.D. Cal. 2003)).
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Northern District of California
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Accordingly judicial notice is GRANTED.
Second, Defendants seek judicial notice of a Deutsche Bank analyst report (Dkt. No. 69-5)
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as relevant to their argument concerning loss causation. Defendants argue that judicial notice is
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appropriate, as the report relates to the relationship between disclosures made in the Earnings Call
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and Press Release, subsequent analyst guidance and ultimate stock price decline, and information
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that was provided to the market concerning the effect of the decline in sales to the federal
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government. Plaintiffs counter that this document is not relied upon in the complaint and the
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information therein is redundant of other information of which the Court has taken judicial notice
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insofar as it relates to what information the market reasonably knew at the time of the IPO. (Dkt.
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No. 74 at 7-8.) The Court agrees. Consideration of this document is not appropriate in this
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procedural context. Defendants’ request for judicial notice is DENIED.
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Third, Defendants seek judicial notice of certain court documents related to Mr. Basile’s
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termination from Fusion-io: a stipulation of dismissal, an order of dismissal, and a docket sheet.
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(Dkt. Nos. 63-7, 63-8, 63-9.) Federal courts may “take notice of proceedings in other courts, both
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within and without the federal judicial system, if those proceedings have a direct relation to the
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matters at issue.” Del Puerto Water Dist. v. U.S. Bureau of Reclamation, 271 F. Supp. 2d 1224,
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Plaintiffs do not contest judicial notice of the Form 10-Q, which is the subject of
Defendants’ Supplemental Request for Judicial Notice. (Dkt. No. 77-1.) The Court GRANTS
judicial notice of this document.
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1233 (E.D. Cal. 2003) (citing United States ex rel Robinson Rancheria Citizens Council v. Borneo,
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Inc., 971 F.2d 244, 248 (9th Cir. 1992)). Plaintiffs argue that these documents inappropriately
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dispute that Mr. Basile was terminated “for cause” and are therefore not appropriate for judicial
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notice. The Court agrees. Although documents related to judicial proceedings are generally
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deemed appropriate for judicial notice, here these documents are offered to dispute the factual
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merits of Plaintiffs’ claim concerning the nature of Mr. Basile’s termination. Accordingly, the
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Court DENIES judicial notice of these documents.
Finally, Defendants seek judicial notice of news articles relating to the federal government
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slowdown to show what information was generally known to the public during the relevant time
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period. Plaintiffs argue that because these articles do not pertain to Violin Memory directly, they
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Northern District of California
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are not properly subject to judicial notice. For that, and other fundamental reasons, the Court
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agrees. Patel v. Parnes, 253 F.R.D. 531, 549 (C.D. Cal . 2008) (“The numerous cases that discuss
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news articles as part of the ‘total mix’ of information available to investors address only articles
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about the defendant’s activities and performance, not articles about an industry as a whole” (listing
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cases)). Defendants’ requests for judicial notice related to these documents is DENIED.
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B.
MOTIONS TO DISMISS
1.
Legal Standard
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The parties dispute whether Plaintiffs’ CAC should be analyzed under the notice pleading
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standards of Rule 8 or the heightened pleading standards of Rule 9(b). Rule 9(b) requires that “in
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alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud
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or mistake.” Fed. R. Civ. P. 9(b). The Court addresses each standard in turn.
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Whether the heightened standards of Rule 9(b) applies turns on the nature of the allegations,
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not the elements of the claim. “Rule 9(b) applies to ‘averments of fraud’ in all civil cases in federal
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district court . . . in cases in which fraud is not an essential element of the claim, Rule 9(b) applies,
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but only to particular averments of fraud.” Vess v. Ciba–Geigy Corp. USA, 317 F.3d 1097, 1103
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(9th Cir. 2003). A plaintiff “may allege a unified course of fraudulent conduct and rely entirely on
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that course of conduct as the basis of a claim. In that event, the claim is said to be ‘grounded in
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fraud’ or to ‘sound in fraud,’ and the pleading of that claim as a whole must satisfy the particularity
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requirement of Rule 9(b).” Id. at 1103–04. A typical example of that situation is where a plaintiff
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alleges that the same course of conduct constitutes both securities fraud under Section 10 as well as
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a violation of Section 11. In other cases, “a plaintiff may choose . . . to allege some fraudulent and
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some non-fraudulent conduct. In such cases, only the allegations of fraud are subject to Rule 9(b)'s
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heightened pleading requirements.” Id. at 1104.
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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]
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to claims brought under Section 11.” In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1404–05 (9th Cir.
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1996), cert denied, 520 U.S. 1103 (1997). “Fraud can be averred by specifically alleging fraud, or
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by alleging facts that necessarily constitute fraud (even if the word ‘fraud’ is not used). Vess, 317
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Northern District of California
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F.3d at 1105 (citations omitted). “Under California law, the ‘indispensable elements of a fraud
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claim include a false representation, knowledge of its falsity, intent to defraud, justifiable reliance,
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and damages.’” Id. (citations omitted). Importantly, scienter is not required for claims under
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Section 11; defendants may be liable under Section 11 for negligent or even innocent
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misrepresentations. In re Daou Sys., Inc., 411 F.3d 1006, 1027 (9th Cir. 2005) (internal citations
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omitted).
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In their CAC, Plaintiffs argue that they do not advance a claim that sounds in fraud or a
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unified course of fraudulent conduct. See In re Charles Schwab Corp. Sec. Litig., 257 F.R.D. 534,
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545 (N.D. Cal. 2009) (noting that where, as here, the plaintiff has not alleged that the same course
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of conduct constitutes both a Section 11 violation and a violation of other laws necessarily
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sounding in fraud such as Rule 10b–5, the “unified course of fraudulent conduct” test is essentially
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circular and is therefore uninstructive). Defendants counter that although fraud is not specifically
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pleaded, the allegations in the CAC necessarily constitute fraud. (VM Defs.’ Mot. at 8 (“At its
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core, the CAC alleges that the Violin Memory Defendants knew but failed to disclose material
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negative information concerning its business, products and customers in connection with the
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Company’s IPO.”); 10-11.) Having examined the CAC, the Court agrees with Plaintiffs and finds
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that with one minor exception5, the facts alleged do not “necessarily constitute fraud (even if the
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word ‘fraud’ is not used).” Vess, 317 F.3d at 1105 (citations omitted).
The CAC does not specifically allege fraud and avoids averments inherently suggestive of
3
4
fraud— i.e., there is no allegation that defendants “knowingly” or “intentionally” concealed
5
information or made misrepresentations. Although such allegations could be inferred, the
6
allegations in the CAC can equally support the inference that Defendants committed such
7
misrepresentations without any scienter. Plaintiffs’ factual allegations preset a plausible claim that
8
Defendants committed the misrepresentations and omissions negligently. Plaintiffs have not
9
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.,
11
United States District Court
Northern District of California
10
257 F.R.D. at 546 (noting the paucity of Ninth Circuit published decisions finding that Rule 9(b)
12
applies to a Section 11 claim where, as here, the underlying conduct was not also alleged to have
13
constituted fraud).
In light of that finding, the Court will evaluate whether the Complaint states a claim for a
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
violation of Section 11 under Federal Rule of Civil Procedure 8. Rule 8(a) requires that a plaintiff
5
The only instance of a factual allegation that sounds in fraud occurs at CAC Paragraphs 7678, under the heading “The Registration Statement Failed to Disclose that Basile Artificially
Inflated Sales of Violin Memory’s 6000 Flash Arrays.” Plaintiffs assert that prior to 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. The sales to J.P. Morgan and BofA Merrill
Lynch resulted in sizable product revenue gains for the Company in the first two quarters of fiscal
2014, and therefore artificially inflated Violin Memory’s revenue. Given the unusual means by
which the transactions were negotiated, Plaintiffs allege that the Registration Statement should have
disclosed the above information but failed to do so. As further support, Plaintiffs argue that Item
303 of Regulation S-K (17 C.F.R. Part 229) required that the Registration Statement disclose
unusual or infrequent transactions that materially affected reported income, and that the
Registration Statement failed to disclose or explain how Violin Memory in material part achieved
the increase in product revenue. The Court finds Plaintiffs to have essentially pleaded that Mr.
Basile “artificially inflated” the sales and orchestrated this “unusual” transaction and the resultant
failure to disclose such transactions in the Registration Statement. These allegations sound in
fraud, but nowhere does the CAC allege with any particularity facts concerning Mr. Basile’s
orchestration of these transactions or the decision to omit these details from the Registration
Statement. Accordingly, Plaintiffs’ allegations related to Mr. Basile’s financial dealings with the
underwriters are “disregarded,” or “stripped from the claim,” for failure to satisfy Rule 9(b). Vess,
317 F.3d at 1105.
13
1
“‘provide a ‘short and plain statement of the claim showing that [he] is entitled to relief.’” Johnson
2
v. Riverside Healthcare Sys., LP, 534 F.3d 1116, 1122 (9th Cir. 2008) (quoting Fed. R. Civ. P.
3
8(a)(2)). “This is not an onerous burden. Specific facts are not necessary; the statement need only
4
give the defendant[s] fair notice of what . . . the claim is and the grounds upon which it rests.” Id.
5
(internal quotation marks and citation omitted). Nonetheless, the complaint is properly dismissed if
6
it fails to plead “‘enough facts to state a claim to relief that is plausible on its face.’” Weber v.
7
Dep't of Veterans Affairs, 521 F.3d 1061, 1065 (9th Cir. 2008) (quoting Bell Atlantic. Corp. v.
8
Twombly, 550 U.S. 544 (2007)). In making this determination, a court must be mindful that
9
a district court ruling on a motion to dismiss is not sitting as a trier of fact. It is
true that the court need not accept as true conclusory allegations, nor make
unwarranted deductions or unreasonable inferences. But so long as the plaintiff
alleges facts to support a theory that is not facially implausible, the court's
skepticism is best reserved for later stages of the proceedings when the plaintiff's
case can be rejected on evidentiary grounds. “[A] well-pleaded complaint may
proceed even if it strikes a savvy judge that actual proof of those facts is
improbable, and that a recovery is very remote and unlikely.”
10
United States District Court
Northern District of California
11
12
13
14
15
In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1057 (9th Cir. 2008) (quoting Twombly, 550 U.S. at
16
556). That said, the Court is “not required to accept as true conclusory allegations which are
17
contradicted by documents referred to in the complaint.” In re Stac Elecs. Sec. Litig., 89 F.3d at
18
1403.
19
2.
Count 1, Part 1: Section 11 Claim – Actionable Omissions
20
Section 11 of the Securities Act “provides a cause of action to any person who buys a
21
security issued under a materially false or misleading registration statement.” In re Century
22
Aluminum Co. Sec. Litig., 729 F.3d 1104, 1106 (9th Cir. 2013). To state a claim under Section 11,
23
plaintiffs must adequately plead “(1) that the registration statement contained an omission or
24
misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would
25
have misled a reasonable investor about the nature of his or her investment.” Rubke v. Capitol
26
Bancorp Ltd., 551 F.3d 1156, 1161 (9th Cir. 2009) (quoting In re Daou Sys., Inc., 411 F.3d at
27
1027). Section 11 is a strict liability statute that does not require fraudulent intent. In re Daou Sys.,
28
Inc., 411 F.3d at 1027. “A claim under Section 11 based on the omission of information must
14
1
demonstrate that the omitted information existed at the time the registration statement became
2
effective.” Rubke, 551 F.3d at 1164. Moreover, where the adequacy of the disclosures is at issue,
3
Defendants must make a “stringent showing” that “reasonable minds could not disagree” that the
4
disclosures were not misleading. See Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d
5
940, 947 (9th Cir. 2005) (dismissal on the pleadings based on sufficient cautionary language
6
“requires a stringent showing: There must be sufficient ‘cautionary language or risk disclosure
7
[such] that reasonable minds could not disagree that the challenged statements were not
8
misleading.’”). The “materiality” of an omission is a fact-specific determination that should
9
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
11
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Northern District of California
10
materiality of the statement is so obvious that reasonable minds could not differ are these issues
12
appropriately resolved as a matter of law.” Id. (citing Fecht, 70 F.3d at 1081).
13
The crux of Defendants’ argument is that the alleged omissions that form the basis for
14
Plaintiffs’ Section 11 claim are, in fact, not actionable omissions either because they were
15
contained in the Registration Statement or were in the public domain at the time of Violin
16
Memory’s IPO. In essence, Defendants contend that none of the statements with which Plaintiffs
17
take issue are actionable because the CAC lacks allegations to support an inference that they were
18
either false or misleading as a matter of law. The Court considers each category of Plaintiffs’
19
allegations in turn, as outlined on Pages 5-6, supra.
a. Statements About PCIe Cards
20
21
Plaintiffs argue that there are five misrepresentations relating to PCIe Cards. (Opp. at 10-
22
12.) The relevant excerpts from the Amended Registration Statement including the alleged
23
misrepresentations include:
24
25
26
27
28
Our Velocity Peripheral Component Interconnect Express, or PCIe, Flash
Memory Cards leverage our persistent memory-based architecture in servers
and are optimized for applications that require continuous access to large
quantities of low latency persistent memory located directly in servers. We
have demonstrated that our persistent memory-based storage solutions provide
low latency and sustainable performance with enterprise-class reliability,
availability and serviceability through product testing and customer feedback.
15
Our solutions enable customers to realize significant capital expenditure and
operational cost savings by simplifying their data center environments. (Dkt.
No. 69-1 at 78.)
1
2
3
Our Flash Memory Arrays integrate enterprise-class hardware and software
technologies to cost-effectively address the limitations of other storage
solutions. Our storage systems are based on a four-layer hardware architecture
which is tightly integrated with our Violin Memory Operating System, or
vMOS, software stack to optimize the management of flash memory at each
level of our system architecture. In March 2013, we expanded our innovation
in persistent memory technologies and proprietary techniques in flash
management from our memory arrays to our Velocity PCIe Flash Memory
Cards. Our Velocity PCIe Flash Memory Cards leverage our expertise in
persistent memory-based storage and controller design, as well as our vMOS
software stack, to offer a differentiated architecture in a widely deployable
PCIe form factor. (Dkt. No. 69-1 at 1, 78.)
Our products are highly technical and may contain undetected defects,
which could cause data unavailability, loss or corruption that might, in
turn, result in liability to our customers and harm to our reputation and
business.
Our Flash Memory Array and Velocity PCIe Flash Memory Card products
and related software are highly technical and complex and are often used to
store information critical to our end-customers’ business operations. Our
products may contain undetected errors, defects or security vulnerabilities that
could result in data unavailability, loss or corruption or other harm to our endcustomers. Some errors in our products may only be discovered after they
have been installed and used by end-customers. Any errors, defects or security
vulnerabilities discovered in our products after commercial release, or any
perception of the same in the marketplace, could result in a loss of revenue or
delay in revenue recognition, injury to our reputation, a loss of end-customers
or increased service and warranty costs, any of which could adversely affect
our business. (Dkt. No. 69-1 at 17 (emphasis in original).)
Factors that are difficult to predict and that could cause our operating results
to fluctuate include:
[. . .]
the degree to which our Velocity PCIe Flash Memory Cards gain
market
acceptance. (Dkt. No. 69-1 at 15.)
If our Velocity PCIe Flash Memory Cards do not gain market adoption or
sales of our Velocity PCIe Flash Memory Cards grow more slowly than
anticipated, we may not be able to increase our revenue sufficiently to
achieve and maintain profitability.
4
5
6
7
8
9
10
United States District Court
Northern District of California
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
16
We have devoted a significant amount of resources to developing and
marketing our Velocity PCIe Flash Memory Cards and believe our future
growth will substantially depend on the market acceptance and adoption of
this new product. Because we are strategically targeting the PCIe memory
card market and expending a considerable amount of resources in doing so, if
our Velocity PCIe Flash Memory Cards do not gain market acceptance, our
results of operations, business and prospects would be materially and
adversely affected. (Dkt. No. 69-1 at 19.)
1
2
3
4
5
6
The core of Plaintiffs’ argument is that problems existed at the time of the IPO and the
7
8
Registration Statement’s presentation of such problems as mere possibilities was inaccurate and
9
misleading.6 (CAC ¶¶ 32-35; 38-45.) Specifically, Plaintiffs allege that the Registration Statement
failed to disclose material defects and development problems regarding the PCIe Cards that had
11
United States District Court
Northern District of California
10
materialized prior to the IPO. Plaintiffs assert that although the Registration Statement represents
12
that the Company had already “optimized” its PCIe Cards and had already “demonstrated” their
13
capabilities through “product testing and customer feedback,” and that it had already expanded its
14
innovation in flash memory to the new line of PCIe Cards that “leverage” its “expertise,” when in
15
reality, the PCIe Cards were “not optimized or sustainable” because of numerous “material
16
technical and engineering defects,” including inoperable firmware, reliance on hardware instead of
17
supporting components, difficulties associated with repairing hardware, unexpected shutdowns, and
18
power disruptions. (CAC ¶¶ 34, 37.) Plaintiffs take further issue with the statement that the PCIe
19
Cards “may contain undetected errors, defects or security vulnerabilities,” (CAC ¶ 33), arguing that
20
this representation was untrue because it represents that the only material errors, defects, or security
21
vulnerabilities suffered by the PCIe Cards were undetected, i.e., there were no present material
22
errors or defects. Plaintiffs also contend that the statement that “the degree to which [its] [PCIe
23
Cards] gain market acceptance” is “difficult to predict” and could cause “operating results to
24
fluctuate” was misleading because “[t]he PCIe Cards had already been offered to and rejected by
25
the market.” (CAC ¶¶ 39, 45.) According to Plaintiffs, the Registration Statement represented that
26
the Company had “devoted a significant amount of resources to developing and marketing [its]
27
28
6
Plaintiffs expressly disclaim that their claims concerning PCIe Cards should have been
disclosed pursuant to Item 303 of Regulation S-K. (Opp. at 11 n.13.)
17
1
[PCIe Cards]”; that the Company’s “future growth will substantially depend on the market
2
acceptance and adoption of this new product”; and that “if [the PCIe Cards] do not gain market
3
acceptance, [the Company’s] results of operations, business and prospects would be materially and
4
adversely affected.” (CAC ¶ 40.) Plaintiffs contend that such representations are “untrue” because
5
they are framed as contingencies rather than actualities. In reality, Plaintiffs assert, the PCIe Cards
6
had already proven unsaleable and obsolete by the time the Registration Statement became
7
effective. (CAC ¶¶ 41-45.)
8
9
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
11
United States District Court
Northern District of California
10
Registration Statement’s representations concerning PCIe Cards were framed as possibilities; e.g.,
12
that there may be “undetected” errors or defects, or that “if” the PCIe Cards “do not gain
13
acceptance” the investors stood to lose, and cannot overcome the heavy weight of the myriad
14
disclosures in the Registration Statement.
15
The Court agrees. “[W]here a company’s filings contain abundant and specific disclosures
16
regarding the risks facing the company, as opposed to terse, generic statements, the investing public
17
is on notice of these risks and cannot be heard to complain that the risks were masked as mere
18
contingencies.” Plevy v. Haggerty, 38 F. Supp. 2d 816, 832 (C.D. Cal. 1998) (discussing cases).
19
“Rather, to be actionably misleading, an omission ‘must affirmatively create an impression of a
20
state of affairs that differs in a material way from the one that actually exists.’” In re Ubiquiti
21
Networks, 2014 WL 1254149, at *10 (N.D. Cal. March 26, 2014) (quoting Brody v. Transitional
22
Hospitals Corp., 280 F.3d 997, 1006 (9th Cir. 2002)).
23
Here, the Registration Statement contained numerous disclosures regarding the highly
24
technical nature of the Flash Arrays and PCIe Cards, including explicit disclosures that the PCIe
25
Cards may contain undetected defects, and that the PCIe Card was a new product for which the
26
Company had derived no meaningful revenue as of the IPO, and might never generate revenue.
27
Given these disclosures, Plaintiffs cannot be heard to complain that the disclosures were
28
inadequate. For example, the Company disclosed:
18
1
We only recently introduced our Velocity PCIe Memory Card solutions in
March 2013 and have not derived significant revenue from the sale of these
solutions to date. (Dkt. No. 69-1 at 1-2.)
Our Flash Memory Array and Velocity PCIe Flash memory Card products and
related software are highly technical and complex and are often used to store
information critical to our end-customers’ business operations. Our products
may contain undetected errors, defects or security vulnerabilities that could
result in data unavailability, loss or corruption or other harm to our endcustomers. Some errors in our products may only be discovered after they
have been installed and used by end customers. Any errors, defects or security
vulnerabilities discovered in our products after commercial release, or any
perception of the same in the marketplace, could result in a loss of revenue or
delay in revenue recognition, injury to our reputation, a loss of end-customers
or increased service and warranty costs, any of which could adversely affect
our business. (Id. at 17.)
If our Velocity PCIe Flash Memory Cards do not gain market adoption or
sales of our Velocity PCIe Flash Memory Cards grow more slowly than
anticipated, we may not be able to increase our revenue sufficiently to
achieve and maintain profitability. (Id. at 19 (emphasis in original).)
2
3
4
5
6
7
8
9
10
United States District Court
Northern District of California
11
12
13
14
15
The Company further explained that developing the PCIe Cards was a time intensive and
16
expensive process, explaining that “our investments in research and development . . . may result in
17
products that are more expensive than anticipated, take longer to generate revenue or generate less
18
revenue, if at all, than we anticipate. . . . we may not receive significant revenue from these
19
investments in the near future, if at all.” (Id. at 21.) The Registration Statement warned that the
20
PCIe Cards “may never gain broad adoption.” (Id. at 19.) In fact, some of the purported omissions
21
with which Plaintiffs take issue were specifically disclosed in the Registration Statement. For
22
example, Plaintiffs allege that the Company omitted “software incompatibility problems” (CAC ¶
23
51) when the Registration Statement disclosed that “our products must interoperate with network
24
interfaces such as . . . software applications and hardware developed by others, and if we are unable
25
to ensure that our products interoperate with such software and hardware, we may . . . experience
26
reduced demand for our products.” (Dkt. No. 69-1 at 20.)
27
28
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
19
1
reasonable investor could have been misled regarding the high degree of risk involved in the
2
purchase of Violin Memory stock. The Company’s myriad comprehensive and specific disclosures
3
relating to the PCIe Cards make clear that the statements with which Plaintiffs take issue, even if
4
construed as Plaintiffs allege, did not “alter the mix” of information such that they could reasonably
5
be understood as misleading, much less materially misleading.
6
Defendants’ motion as to this category of allegations is GRANTED.
b. Statements About the Company’s work with Toshiba
7
Plaintiffs also contend that the Registration Statement failed to disclose “material
9
difficulties building and developing the PCIe Cards in accordance with Toshiba’s specifications.”
10
(CAC ¶¶ 36, 37.) Plaintiffs offer no specific factual allegations concerning what those “material
11
United States District Court
Northern District of California
8
difficulties” were. Regardless, the Registration Statement is sufficiently clear about the Company’s
12
relationship with Toshiba and the status of the PCIe Cards development to render Plaintiffs’ bald
13
“material difficulties” allegation immaterial.
14
15
16
The language in the Registration Statement that Plaintiffs contend is misleading is contained
in the following excerpts:
In March 2013, we expanded our innovation in persistent memory
technologies and proprietary techniques in flash management from our
memory arrays to our Velocity PCIe Flash Memory Cards. Our Velocity PCIe
Flash Memory Cards leverage our expertise in persistent memory-based
storage and controller design, as well as our vMOS software stack, to offer a
differentiated architecture in a widely deployable PCIe form factor.
Additionally, we believe our relationship with Toshiba, a leading provider of
flash memory and one of our principal stockholders, allows us to design our
systems to unlock the inherent performance capabilities of flash technology
and enables us to develop around new generations of flash memory rapidly.
(Dkt. No. 69-1 at 1.)
In July 2013, we entered into a PCIe Card Development Agreement with
Toshiba, pursuant to which we will develop a derivative product to our
Velocity PCIe Flash Memory Card which complies with Toshiba’s
specifications and sell sample PCIe cards to Toshiba. Pursuant to this
agreement, Toshiba paid us $16 million. The $16 million payment consisted
of $8 million for our services to be performed for the development of the PCIe
cards, and $8 million for our sale of sample PCIe cards to Toshiba and related
support services. If we are not able to meet the milestones described in the
17
18
19
20
21
22
23
24
25
26
27
28
20
1
agreement, we must refund the amount attributed to undelivered goods and
services by September 15, 2014. (Dkt. No. 69-1 at 119.)
2
3
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”
5
doctrine “‘provides a mechanism by which [it] can rule as a matter of law that defendants’ forward-
6
looking representations contained enough cautionary language or risk disclosure to protect the
7
defendant against claims of securities fraud.’ ” In re Stac Elecs. Sec. Litig., 89 F.3d at 1408 (citing
8
Fecht, 70 F.3d at 1081). By definition, the bespeaks caution doctrine applies only to affirmative,
9
forward-looking statements. However, the Ninth Circuit has observed that the doctrine “merely
10
represents the pragmatic application of two fundamental concepts in the law of securities fraud:
11
United States District Court
Northern District of California
4
materiality and reliance.” In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1414 (9th Cir. 1994).
12
Again, based on the Registration Statement’s extensive and specific disclosures, the Court finds
13
that no reasonable investor would have considered any of Plaintiffs’ alleged misstatements or
14
omissions material.
15
The Registration Statement discloses the early stage and hurdles of the PCIe Card
16
development process both as a general matter (as explained above) and specifically with respect to
17
the Toshiba deal. (Dkt. No. 69-1 at Ex. 10.23.) This agreement reflects that Toshiba had not
18
agreed to purchase any PCIe Cards and would reject the Cards if certain milestones were not met.
19
(Id. at Ex. 10.23 p. 4-5 (stating that if “Toshiba rejects the Developmental Samples, Toshiba shall
20
promptly notify Violin …”.) Violin Memory also related the attendant risks, including the
21
obligation to pay damages in the event that it failed to satisfy Toshiba’s requirements. (Id. (“If
22
Violin has not been able to deliver the Developmental Samples for each Product by August 31,
23
2014, then, unless [otherwise] agreed … Violin shall reimburse to Toshiba the Individual
24
Developmental Service fee for each such Product that is in delay … as liquidated damages …”).)
25
The Registration Statement informed investors that Toshiba’s acceptance or purchase of any PCIe
26
Cards was not guaranteed, and the attachment to the Registration Statement related that “any
27
potential deliverables that might be included in [a future] Agreement are contingent deliverables
28
that are dependent upon the successful development and completion of the PCIe cards under the
21
1
current development agreement for which there is substantive uncertainty.” (Id. at F-27
2
(emphasis supplied).) Given these extensive and substantive disclosures, Plaintiffs’ contention that
3
the Registration Statement in some way misrepresented the nature of the deal with Toshiba or the
4
Company’s development of the PCIe Cards for that purpose fall short. Again, even construing
5
Plaintiffs’ alleged omission in a light most favorable to them, this cannot overcome the great
6
weight of the Registration Statement’s disclosures. Defendants’ motion as to these allegations is
7
GRANTED.
c. Statements About the 6000 Flash Arrays
8
9
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
11
United States District Court
Northern District of California
10
Amended Registration Statement including these alleged misrepresentation are as follows:
12
13
Our Flash Memory Arrays integrate enterprise-class hardware and software
technologies to cost effectively address the limitations of other storage
solutions. Our storage systems are based on a four-layer hardware architecture
which is tightly integrated with our Violin Memory Operating System, or
vMOS, software stack to optimize the management of flash memory at each
level of our system architecture. (Dkt. No. 69-1 at 1.)
Our products must interoperate with network interfaces, such as operating
systems, 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 fail to increase, or we may lose, market share and we
may experience reduced demand for our products.
Our storage products comprise only a part of a datacenter’s infrastructure.
Accordingly, our products must interoperate with our end-customers’ existing
infrastructure, specifically their networks, servers, software and operating
systems, which are typically manufactured by a wide variety of systems
vendors. When new or updated versions of these software operating systems
or applications are introduced, we must sometimes develop updated versions
of our software so that our products interoperate properly. We may not
accomplish these development efforts quickly, cost-effectively or at all. (Id.
at 20 (emphasis in original).)
Our Flash Memory Array and Velocity PCIe Flash Memory Card products
and related software are highly technical and complex and are often used to
store information critical to our end-customers’ business operations. Our
products may contain undetected errors, defects or security vulnerabilities that
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
22
1
2
could result in data unavailability, loss or corruption or other harm to our endcustomers. Some errors in our products may only be discovered after they
have been installed and used by end-customers. (Id. at 17.)
3
Plaintiffs argue that the representation that the 6000 Flash Arrays already “integrate
4
enterprise-class hardware and software technologies” and that the Company’s “four-layer hardware
5
architecture” and “software stack” already “optimize the management of flash memory . . . ,”
6
(CAC ¶ 46), was untrue because there were ongoing “material negative developments and
7
engineering defects,” (CAC ¶ 47). Second, Plaintiffs take issue with the Registration Statement’s
8
claim that the Company “must sometimes develop updated versions” of its “software so that [its]
9
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
11
United States District Court
Northern District of California
10
misleading because the 6000 Flash Arrays had already been experiencing engineering defects with
12
regard to the “controller cards,” a general “inability to develop data management software,”
13
“incompatibility problems,” and “delays in developing a software system enabling Company
14
customers to utilize products without “experiencing low throughput . . ..” (CAC ¶ 51.) Third,
15
Plaintiffs challenge the Registration Statement’s claim that the Company’s 6000 Flash Arrays “may
16
contain undetected errors, defects or security vulnerabilities” and that these errors, defects, and
17
security vulnerabilities “could result in a loss of revenue or delay in revenue recognition . . . .”
18
(CAC ¶ 49.) Plaintiffs contend that these statements are misleading due to the already realized
19
software operability problems described above and argue that these problems “resulted in lost
20
sales” and Defendant Basile’s admission that “additional optimizations [had] delayed [the
21
Company’s] revenue.” (CAC ¶¶ 50-52.) Defendants counter that the Registration Statement
22
contained disclosures that warned investors that problems might arise, and that if so, revenues
23
would likely be impacted.
24
For the reasons stated above, the Court finds that the Company disclosed myriad
25
comprehensive and specific information regarding the nature of these products as complex and
26
highly technical, and that all of its products including the 6000 Flash Arrays were susceptible to
27
defects and vulnerabilities. Indeed, the alleged misrepresentations Plaintiffs identify are embedded
28
within certain relevant disclosures. (See Dkt. No. 69-1 at 17.) It was no mystery that the risks
23
1
relative to the 6000 Flash Arrays could have a substantial effect on revenue. The Registration
2
Statement related that at the time of the IPO, substantially all of the Company’s revenue was
3
derived from the Flash Memory Arrays. (Dkt. No. 69-1 at 19.) For the six months ended July 31,
4
2012, sales of the 6000 Series Flash Memory Arrays represented approximately 84% of the
5
Company’s product revenue, and over the next year rose to 91%. (Id. at 53.) To the extent that
6
Plaintiffs contend that a defect existed at the time of the IPO, that fact, even if true, cannot
7
overcome the great weight of the disclosures that specifically disclosed the likelihood that errors or
8
defects would be discovered after the IPO. (See id. at 17 (“Some errors in our products may only
9
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
11
United States District Court
Northern District of California
10
IPO, and adequately warned investors that any error could result in marked revenue decline.
12
Accordingly, the Court finds that reasonable minds could not disagree as to the lack of materiality
13
of Plaintiffs’ alleged misrepresentations and omissions, even accepting those allegations in the light
14
most favorable to Plaintiffs. Defendants’ motion to dismiss on this ground is GRANTED.
15
16
d. Statements About the Company’s Government Contracts
Plaintiffs allege that the Registration Statement should have disclosed all information
17
required under the SEC rules, and that this includes a “trend” relating to the decline of the
18
Company’s federal government sales and the effect of federal sequestration. Plaintiffs assert that
19
the Registration Statement should have disclosed this material negative trend but failed to do so,
20
and the Defendants therefore violated Item 303 of Regulation S-K. Specifically, Plaintiffs allege
21
that in the months leading up to the IPO, the federal government sales had been declining and
22
materially impacting revenues. (CAC ¶¶ 57-64.) The Registration Statement allegedly failed to
23
reflect accurately this trend, instead indicating that the Company was undertaking to “increase the
24
sales to government customers.” (CAC ¶ 54.) Plaintiffs also allege facts which, when taken as true
25
and construed in a light favorable to Plaintiffs, establish that the decline in government sales was
26
reasonably likely to have an unfavorable impact on net sales or revenues. (See CAC ¶¶ 57-64.)
27
28
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
24
1
revenues or income from continuing operations.” 17 C.F.R. § 229.303(a)(3)(ii). The Ninth Circuit
2
has held that because Section 11 imposes liability if a registrant “omits to state a material fact
3
required to be stated” in the registration statement, “any omission of facts ‘required to be stated’
4
under Item 303 will produce liability under Section 11.” Steckman v. Hart Brewing, 143 F.3d
5
1293, 1296 (9th Cir. 1998).
6
Defendants counter that disclosures in the Registration Statement were sufficient and that
7
any trends would have been publicly known. That the federal government shut down in 2011 had
8
profound results on the markets was widely and publicly known. (See Fed. R. Evid. 201(b); see
9
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
11
United States District Court
Northern District of California
10
defined in Item 303 as of the date of the IPO for which disclosure was required as a matter of law.
12
Defendants’ argument that the crux of Plaintiffs’ allegations is a claim that the Registration
13
Statement should have disclosed a future trend projection, as opposed to a then-present trend, is
14
belied by the allegations in the CAC. Plaintiffs allege that in the months leading up to the IPO,
15
there was a material negative trend related to federal government sales that should have been
16
disclosed pursuant to Item 303. (CAC ¶¶ 57-64.) There remains a narrow question as to whether in
17
the months leading up to the IPO, federal sales had declined such that there was a “trend” as
18
required for disclosure under Item 303. Defendants’ motion to dismiss on this ground is DENIED.
19
20
e. Statements About Donald Basile’s Former Employment
The CAC alleges omissions relating to the business experience and background of
21
Violin Memory’s former CEO, Defendant Basile. Basile served as the CEO of Fusion-io, a
22
competitor to Violin Memory in the flash memory industry, prior to joining Violin Memory in
23
2009. (CAC ¶ 12.) According to Plaintiffs, Fusion-io terminated Basile “for cause.” (CAC ¶ 73.)
24
Because Basile’s employment agreement with Fusion-io lists five different grounds for a “for
25
cause” termination, all of which relate to his job performance to varying degrees of ethical severity,
26
Plaintiffs assume that one of those grounds formed the basis for Basile’s termination. Plaintiffs
27
further argue that no matter which ground or grounds served as the basis for Basile’s termination, it
28
should have been disclosed in the Registration Statement because each basis speaks to his
25
1
background and competence and all are negative. (CAC ¶ 74.) Pursuant to Item 401 of Regulation
2
S-K (17 C.F.R. § 229.401(e)(1)), the Registration Statement should have disclosed the omitted
3
material information relating to Basile’s “for-cause” termination because it related to his
4
“responsibilities in prior positions, overall professional competence, experience, qualifications,
5
attributes, and skills to serve as [a] director[] and officer[] of a start-up publicly traded company,”
6
and would have been considered by the public when deciding to invest. (CAC ¶ 75.) Plaintiffs
7
assert that the omitted information rendered the representations concerning Mr. Basile’s credentials
8
misleading, and that such information was material to a reasonable investor’s decision to purchase
9
Violin Memory stock.
10
Defendants argue that the “for cause” termination was the substance of a civil lawsuit that
United States District Court
Northern District of California
11
had been made part of the public record and that had resolved in a voluntary dismissal before the
12
case was ever decided on the merits. (Dkt. No. 61 at 16.) They thus contend that there was no duty
13
to disclose the lawsuit or the allegations therein, and there was no way these facts could be material
14
or “of any interest to a reasonable investor.” (Id.)
15
The Court disagrees. The allegations in the CAC, taken as true and construed in Plaintiffs’
16
favor, plausibly state that the reasons given for Mr. Basile’s termination were material to a
17
reasonable investor’s decisionmaking with respect to purchasing Company stock. Defendants
18
argue that Plaintiffs do not identify any applicable duty requiring disclosure of “additional details”
19
concerning Mr. Basile’s prior employment with Fusion-io, but that is not so. The regulation
20
requires disclosure of Mr. Basile’s prior work experience and competence, and his “for cause”
21
termination was relevant. Thus, Plaintiff has alleged that there was a duty to disclose, and the
22
Court finds that a reasonable investor could have considered the omitted information material.
23
Moreover, Defendants’ argument concerning the voluntary dismissal of the related civil action
24
against Mr. Basile again begs the question of whether that fact is sufficient to render the alleged
25
omission immaterial. At this early juncture, construing the facts alleged in Plaintiffs’ favor, the
26
Court cannot find that no reasonable investor could have had an interest in knowing that Mr. Basile
27
had been terminated “for cause” from his position as CEO of Fusion-io. Defendants’ motion to
28
dismiss on this ground is DENIED.
26
f. GAAP violation regarding purchase order commitments
1
Plaintiffs allege that as of July 31, 2013, the Company failed to disclose the amount of non-
2
3
cancelable purchase orders for commitments that had a remaining term in excess of one year as of
4
the date of the latest balance sheet presented. Plaintiffs claim that this violated GAAP, specifically
5
FASB Codification 440-10-50-2 and 440-10-50-4. (CAC ¶¶ 81, 82.) Plaintiffs further allege that
6
in the Company’s report for the quarter ended October 31, 2013, filed with the SEC on Form 10-Q,
7
Violin Memory disclosed that purchase commitments were in excess of $85 million, including non-
8
cancelable purchase orders, an increase from January 31, 2013, of approximately 435%.7 Plaintiffs
9
reason that this constitutes a material negative trend from January 31, 2013, through October 31,
2013, and that it is highly unlikely that the Company did not have any unconditional purchase
11
United States District Court
Northern District of California
10
obligations as of July 31, 2013. Plaintiffs conclude that the amount of outstanding purchase orders
12
leading up to the IPO would have been considered by reasonable investors in making their
13
decisions to purchase Violin Memory stock. Thus, they contend that the failure by Violin Memory
14
to disclose the amount of non-cancelable purchase commitments caused the Registration Statement
15
and, in particular the July 31, 2013, financial statements, to be misleading and in violation of
16
GAAP.
As an initial matter, “[a]s with any alleged misrepresentation, GAAP violations should
17
18
generally be more than ‘minor or technical in nature’ and ‘constitute[] widespread and significant
19
inflation’” to give rise to securities law liability. In re Countrywide Fin. Corp. Sec. Litig., 588 F.
20
Supp. 2d 1132, 1197-98 (C.D. Cal. 2008) (dismissing Section 10(b) claim against auditor despite
21
alleged GAAP violations). Moreover, closer inspection of the Company’s SEC filing appears to
22
belie Plaintiffs’ claimed 435% increase. The purchase orders disclosed as of January 2013 were
23
approximately $60,000 and in October had increased to approximately $85,000. (Compare Dkt.
24
No. 69-1 at 64, with Dkt. No. 77-1 at 26.)8 Accordingly, Plaintiffs have alleged no plausible facts,
25
26
27
28
7
The Court notes that in their Opposition brief, Plaintiffs offer no citation to the documentary
record to substantiate these figures. Rather, Plaintiffs cite to paragraphs in their CAC, which as
noted above, also contains no citation to the Registration Statement documents.
8
As noted above, Plaintiffs do not contest Defendants’ filing of a supplemental request for
judicial notice to include the SEC filing form 10-Q ending October 31, 2013. However, rather than
27
1
as opposed to mere conclusions, to show how disclosure of purchase order commitments as of July
2
31, 2013, would have materially altered the “total mix” of information available to investors. Basic
3
Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). Defendants’ motion to dismiss on this ground is
4
GRANTED.
5
6
3.
Count 1, Part 2: Section 11 Claim – Loss Causation
As part of its overall analysis, district courts have dismissed Section 11 claims on the
7
pleadings where it was apparent on the face of the complaint that the plaintiffs would be unable to
8
establish loss causation. See, e.g., In re DNAP Sec. Litig., 2000 WL 1358619, at *3 (N.D. Cal.
9
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
11
United States District Court
Northern District of California
10
with broad insurance against market losses.” Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 345
12
(2005). Such causal losses occur when the share price falls significantly after the truth about the
13
untrue statements or misleading omissions becomes known. Id. at 347; In re Daou Sys., 411 F.3dat
14
1027 (explaining that damages are recoverable under the federal securities laws when the
15
shareholders’ economic loss from the decline in their stock value was the direct result of alleged
16
misrepresentations).
17
In a Section 11 securities case, plaintiffs need not allege loss causation, that is, the plaintiffs
18
need not allege that the misrepresentations in the registration statement caused the plaintiffs’ loss.
19
Rather, the defendants may prove as an affirmative defense that the plaintiffs’ loss, or some portion
20
thereof, was not caused by the alleged misstatements or omissions. Defendants argue that this case
21
warrants dismissal on this ground.
22
23
24
25
26
27
28
filing a motion for leave to file a sur-reply to address the merits of Defendants’ reply arguments
concerning the import of this document, Plaintiffs have included substantive argument regarding
Defendants’ new arguments in their “Reply Re Motion to Strike” (which, for reasons stated above,
the Court has construed as a brief in opposition to Defendants’ Request for Judicial Notice). (Dkt.
No. 79 at 10-11.) The inclusion of such argument in a brief purporting to address only whether the
Court should take judicial notice of certain documents is improper. Accordingly, the Court has
considered arguments made therein relative to only whether judicial notice can properly be taken.
Plaintiffs’ substantive argument regarding the Form Q-10 is STRICKEN.
28
As courts in other circuits have explained, a plaintiff may establish loss causation by
2
alleging simply “that the subject of the fraudulent statement or omission was the cause of the actual
3
loss suffered;” that defendants’ “misstatements and omissions concealed the price-volatility risk (or
4
some other risk) that materialized and played some part in diminishing the market value of” the
5
security. Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173, 177 (2d Cir. 2005) (citation omitted;
6
emphasis in original). That is, the loss must be caused by the “materialization of the concealed
7
risk.” Thus, “in order ‘[t]o plead loss causation, the complainant must allege facts that support an
8
inference that [defendants’] misstatements and omissions concealed the circumstances that bear
9
upon the loss suffered such that plaintiffs would have been spared all or an ascertainable portion of
10
that loss absent the fraud.’” In re Charles Schwab Corp. Sec. Litig., 257 F.R.D. at 547 (citing In re
11
United States District Court
Northern District of California
1
Merrill Lynch & Co. Research Reports Sec. Litig., 568 F. Supp. 2d 349, 359 (D. Md. 2008)
12
(citations omitted)).
13
As detailed above, all but two of Plaintiffs’ claimed misstatements and omissions are
14
undermined by disclosures in the Registration Statement and thus play no part in the instant
15
analysis. First, with respect to the failure of the Registration Statement to include a trend pursuant
16
to Item 103 related to the declining federal sales, the CAC alleges that Plaintiffs suffered losses
17
when the stock price dropped following the November 21 Press Release and Earnings Call. (CAC
18
¶¶ 2, 62.) In the Press Release and on the Earnings Call, the Company revealed the disappointing
19
quarter results and attributed the results to a decline in government contract revenues. (See CAC ¶¶
20
2, 62; Dkt. No. 69-2 at 2, 4 and 5.) Given this link, the Court cannot say that Plaintiffs would not
21
be able to establish loss causation. Defendants’ motion to dismiss on this ground is DENIED.
22
However, with respect to the misstatement concerning Mr. Basile’s prior employment
23
experience, Plaintiffs’ CAC lacks any allegation that this misstatement is related to the loss they
24
purportedly suffered. Accordingly, Defendants’ motion to dismiss this theory of Section 11
25
liability is GRANTED, but with leave to amend.
26
27
28
4.
Section 12(a)(2) Claim Against Underwriter Defendants
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
29
1
person who offers or sells a security” by means of a “prospectus or oral communication” that is
2
materially false or misleading is liable “to the person purchasing such security from him.” 15
3
U.S.C. § 77l(a)(2). The Supreme Court has defined “seller” as “the owner who passed title,” or a
4
“person who successfully solicits the purchase, motivated at least in part by a desire to serve his
5
own financial interests or those of the securities owner” — i.e., a broker. Pinter v. Dahl, 486 U.S.
6
622, 642, 647; see also Moore v. Kayport Package Express, Inc., 885 F.2d 531, 537 (9th Cir. 1989)
7
(applying Pinter’s definition of seller to a Section 12(a)(2) claim and affirming dismissal for failure
8
to allege defendants “played any role at all in soliciting the purchases”); Rosenzweig v. Azurix
9
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
11
United States District Court
Northern District of California
10
sellers within the meaning of Section 12 unless they actively participate in the negotiations with the
12
plaintiff/purchaser.” Thomas Lee Hazen, The Law of Securities Regulation § 7.6[1] (5th ed. 2006);
13
see also Foster v. Jesup & Lamont Sec. Co., 759 F.2d 838, 845–46 (11th Cir. 1985) (observing
14
“[t]he fact that Congress made every underwriter liable in § 11, but not in § 12, suggests that
15
underwriters are not to be liable under § 12 solely by virtue of their status as underwriters”; rather,
16
there must be a showing of “active involvement in bringing about the buy-sell transaction”),
17
abrogated on other grounds by Ryder Int’l Corp. v. First Am. Nat’l Bank, 943 F.2d 1521, 1525–28
18
(11th Cir. 1991). “[I]t seems quite clear that § 12 contemplates only an action by a buyer against
19
his or her immediate seller. That is to say, in the case of the typical firm commitment
20
underwriting, the ultimate investor can recover only from the dealer who sold to him or her.”
21
Rosenzweig, 332 F.3d at 871 n.11 (quotation omitted). Plaintiffs must “show that the defendants
22
solicited purchase of the securities for their own financial gain.” Pinter, 486 U.S. at 647; In re
23
Daou Sys., 411 F.3d at 1029. “Mere participation” in a solicitation or sale does not suffice. Pinter,
24
486 U.S. at 650. A plaintiff must allege that the defendants “had some ‘direct’ role in the
25
solicitation of the plaintiff.” Charles Schwab, 257 F.R.D. at 549 (citing In re Daou Sys., 411 F.3d
26
at 1029) (finding 12(a)(2) liability where underwriters had signed the registration documents,
27
allegedly participated in the distribution of the fund’s shares; offered, sold, and actively solicited
28
the sale of the fund’s shares, and certain of the underwriters “participated in the written or oral
30
1
communications used to market the fund” or otherwise “participated in the marketing of the
2
fund.”).
Defendants argue that the Complaint does not allege that Shehk or Richards obtained title to
3
4
the securities directly from any of the Underwriters. Defendants concede that there is one
5
allegation that Richards “bought common stock . . . directly from J.P. Morgan” (CAC ¶ 9), but
6
argue that other than this one conclusory statement, Plaintiffs do not allege any facts to establish
7
that Underwriters actively and directly solicited, communicated with, or negotiated with Plaintiffs
8
in connection with their stock purchases. The Court agrees. The CAC contains no allegation that
9
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
11
United States District Court
Northern District of California
10
underwriter, there are no allegations concerning the nature of that sale or that purport to depict J.P
12
Morgan – much less any of the other underwriters – as having “solicited purchase” of the securities
13
for their own financial gain. That four of the Underwriters “served as a joint book-running manager
14
and as a representative of the underwriters for the IPO” (CAC ¶¶ 21–24), without more, does not
15
suffice.
16
Accordingly, because the Complaint fails to allege facts sufficient to make plausible their
17
claim that that Underwriters constituted “sellers” within the meaning of Section 12(a)(2), Plaintiffs
18
have failed to assert standing as to this claim. Defendants’ motion to dismiss this claim is
19
GRANTED with leave to amend.
20
21
5.
Section 15 Claim Against Individual Defendants
Section 15 of the Securities Act of 1933 imposes joint and several liability upon every
22
person who controls any person liable under Sections 11 or 12 of the Act. 15 U.S.C. 77o; In re
23
Daou Sys., Inc., 411 F.3d at 1029–30. To state a control person claim, plaintiff must establish (1) a
24
primary violation of the pertinent federal securities laws, and (2) that defendants exercised actual
25
power or control over the primary violator. See Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065
26
(9th Cir. 2000). Plaintiffs’ Section 15 claim is predicated on their alleged Section 11 claims. In re
27
Harmonic, Inc. Sec. Litig., 163 F. Supp. 2d 1079, 1085 (N.D. Cal. 2001).
28
31
Here, because Plaintiffs have not pleaded an underlying violation of Section 11 under most
1
2
of their theories, their control person claim against the Individual Defendants as to these same
3
theories fails and must be dismissed. In re Infonet Servs. Corp. Sec. Litig., 310 F. Supp. 2d 1080,
4
1105 n. 24 (C.D. Cal. 2003). However, as to the remaining theory for Section 11 liability – the
5
omission of a trend required to be disclosed pursuant to Item 303 – Plaintiffs have alleged sufficient
6
factual allegations to permit this claim to move forward.
7
III.
CONCLUSION
8
For the reasons stated above, the Court ORDERS as follows:
9
1. Defendants’ requests for judicial notice are GRANTED in part;
2. Plaintiffs’ motion to strike is GRANTED in part;
11
United States District Court
Northern District of California
10
3. Plaintiffs’ Section 11 claim based on statements about PCIe Cards is DISMISSED;
12
4. Plaintiffs’ Section 11 claim based on statements about the Company’s work with
13
14
15
16
17
Toshiba is DISMISSED;
5. Plaintiffs’ Section 11 claim based on statements about the 6000 Flash Arrays is
DISMISSED;
6. Defendants’ motion to dismiss Plaintiffs’ Section 11 claim based on statements about
the Company’s government contracts is DENIED;
18
7. Defendants’ motion to dismiss Plaintiffs’ Section 11 claim based on statements about
19
the Donald Basile’s former employment is DENIED, and Plaintiffs shall have leave to
20
amend to address loss causation;
21
8. Plaintiffs’ Section 11 claim based on alleged GAAP violations is DISMISSED;
22
9. Defendants’ motion to dismiss Plaintiffs’ Section 12(a)(2) claim is GRANTED with leave
23
to amend; and
24
10. Plaintiffs’ Section 15 claim is DISMISSED in part.
25
This terminates Docket Numbers 61, 66, and 74.
26
IT IS SO ORDERED.
27
28
Date: October 31, 2014
_______________________________________
YVONNE GONZALEZ ROGERS
UNITED STATES DISTRICT COURT JUDGE
32
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