IN RE: VONAGE INITIAL PUBLIC OFFERING (IPO) SECURITIES LITIGATION

Filing 98

OPINION Signed by Judge Freda L. Wolfson on 4/2/2009. (ss, )

*NOT FOR PUBLICATION

U N I T E D STATES DISTRICT COURT D IS T R I C T OF NEW JERSEY

: IN RE VONAGE INITIAL PUBLIC OFFERING (IPO) SECURITIES : L IT IG A T IO N _______________________________: W O L F S O N , District Judge:

C iv il Action No. 07-177 (FLW) OPINION

This multi-district securities litigation arises out of claims by (i) investors w h o acquired Vonage Holdings Corporation ("Vonage") common stock pursuant to Vonage's May 24, 2006 Initial Public Offering ("IPO") and were allegedly d a m a g e d by Vonage's false and misleading statements to the public, including s ta te m e n ts in its Prospectus, which caused investors to purchase stock at artificially in f la te d prices; and (ii) investors who were Vonage customers and purchased shares o f stock through a Directed Share Program prior to the issuance of the IPO. The f irs t action was commenced in this jurisdiction on or about June 2, 2006, against V o n a g e , its directors and officers1 and various Underwriter Defendants (c o lle c tiv e ly, "Defendants").2 Currently, there are seventeen separate suits filed
1

The individual defendants include Jeffrey A. Citron, Michael Snyder, John S. Rego, Peter Barris, J. Sandford Miller, Harry Weller, Sharon A. O'Leary, Betsy S. Atkins, David Morton, Obit Gadiesh, John J. Roberts, Hugh Panero, and Thomas J. Ridge.
2

The Underwriter Defendants include Citigroup Global Markets Inc., Deutsche Bank Securities Inc., UBS Securities LLC, Bear Sterns & Co., Inc., Piper Jaffray & Co., and

under this consolidated action. The appointed lead plaintiff, the Zyssman Group (" L e a d Plaintiff"), filed an Amended Consolidated Complaint (the "Amended C o m p la in t" ) on behalf of all plaintiffs. In the instant matter, Vonage and the U n d e rw rite r Defendants move to dismiss the Amended Complaint in its entirety. For the reasons set forth herein, the motions are GRANTED in part, and DENIED in part. Specifically, Counts I - V are dismissed; however, Lead Plaintiff shall be g iv e n leave to amend the Amended Complaint with respect to its allegations re g a rd in g Vonage's fax service and intellectual property litigations consistent with th is Opinion. However, claims regarding churn rates are dismissed. Count VI is d is m is s e d and Vonage's motion with respect to Counts VII, VIII and IX is denied. BACKGROUND V o n a g e is a Delaware corporation which maintains its principal corporate h e a d q u a rte rs in Holmdel, New Jersey. It sells products and services which are d e s ig n e d to enable its customers to make and receive telephone calls over the In te rn e t. As of April 1, 2006, Vonage purported to have over 1.6 million subscriber lin e s and claimed that it was continuing to expand rapidly. On May 24, 2006, V o n a g e filed an amended registration statement on Form 10-12G/A and prospectus w ith the Securities & Exchange Commission ("SEC"). In accordance therewith, V o n a g e registered 31.25 million shares of its common stock for sale at $17.00 per

Thomas Weisel Partners LLC. -2-

share. According to the Prospectus and the Registration Statement, the offering p ric e of $17.00 was determined by negotiation with various underwriters, after c o n s id e rin g several factors, including Vonage's financial condition, the market for V o n a g e 's services and Vonage's future prospects. In this case, plaintiff investors allege that Vonage issued a series of false and m is le a d in g statements to the public. The crux of the investors' claims is that V o n a g e 's Registration Statement and Prospectus caused them to purchase stock th ro u g h the May 24, 2006 IPO at artificially inflated prices. Particularly, Vonage s o ld 31.25 million shares of its common stock and raised approximately $531 m illio n through its IPO. Immediately thereafter, shares of Vonage stock plunged, a l l e g e d ly upon revelations in the market of serious defects in the offering p ro c e d u re s as well as previously undisclosed material information. Indeed, the price o f Vonage stock plummeted on the first day of trading, closing at $14.85 per share c o m p a re d to its offering price of $17. The next day, the stock further declined, c lo s in g at approximately $13. The stock prices continued to decline, and at one p o in t before the Complaint was drafted, were as low as $3.00 per share. Due to a lle g e d ly significant losses and their allegations of Vonage's misrepresentations, in v e sto rs instituted suit against Vonage. In addition to the investors who purchased Vonage's common stock through th e IPO, a group of investors, prior to the IPO, purchased Vonage stock from

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Vonage's Directed Share Program ("DSP"). The DSP was a marketing device w h e re b y Vonage offered its phone customers shares in Vonage's IPO in advance of th e IPO's effective date of May 24, 2006. Purportedly, Vonage needed to employ th e DSP because of the lack of response to the IPO by institutional investors. Thus, V o n a g e entered into direct sales of its common stock with its phone customers, with th e guarantee that such customers would be allowed to cancel their orders and that th e y would be kept informed by way of an Internet link to Vonage's website. On or a b o u t May 23, 2006, Vonage announced that the promised link to Vonage's new s h a re h o ld e r/p h o n e customers did not work. The DSP investors allege that this a d m is s io n by Vonage, inter alia, is a violation of Section 5 of the Securities Act of 1 9 9 3 . Thus, these DSP investors also initiated suit against Vonage. The Amended Complaint S e v e n te e n related actions have currently been filed on behalf of those in v e sto rs who purchased or otherwise acquired the common stock of Vonage p u rs u a n t to Vonage's May 24, 2006 IPO. The first action was commenced in this ju ris d ic tio n on or about June 2, 2006. On January 12, 2007, the Judicial Panel on M u ltid is tric t Litigation transferred all of the related actions to this Court under 28 U .S .C . § 1407. By rulings dated February 5, 2007 and May 4, 2007, the Court d e n ie d certain plaintiffs' motions to remand their actions to state court. By Order d a te d July 27, 2007, the Court consolidated the related actions, and appointed the

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Lead Plaintiff and its counsel as lead counsel. The Amended Complaint was filed b y the Lead Plaintiff on behalf of all plaintiffs on November 19, 2007. Specifically, C o u n t I of the Amended Complaint alleges violations of Section 11 of the Securities A c t, 15 U.S.C. §§ 77(k) against Vonage; Count II alleges the same violations a g a in s t the Officer Defendants and the Director Defendants of Vonage; Count III a lle g e s the same violations against the Underwriter Defendants; Count IV alleges v io la tio n s of Section 12(a)(2) of the Securities Act, 15 U.S.C. § 77(1)(a)(2), against V o n a g e ; Count V alleges the same violations against the Underwriter Defendants; C o u n t VI alleges violations of Section 5 of the Securities Act, 15 U.S.C. § 77(e), on b e h a lf of the DSP Plaintiffs, against Vonage; Count VII alleges violations of section 1 2 (a )(1 ) of the Securities Act, 15 U.S.C. §§ 77(1)(a)(1), on behalf of the DSP P la in tif f s ; Count VIII alleges violations of Section 15 of the Securities Act, 15 U .S .C . § 77(o), against Vonage; and Count IX alleges the same violations against th e Director Defendants. Lead Plaintiff's Allegations L e a d Plaintiff asserts that Vonage's Registration Statements and Prospectus (c o lle c tiv e ly, the "Offering Documents"), through which Vonage registered and o ffered common stock, materially misrepresented Vonage's business by withholding f ro m investors, such as Lead Plaintiff, information that they would consider im p o rta n t in choosing to purchase Vonage common stock based on the IPO. First,

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Lead Plaintiff alleges that Vonage made certain misleading statements with respect to its subscriber line growth and average monthly churn rate. Lead Plaintiff asserts th a t Vonage stated that it had experienced rapid subscriber lines growth while m a in ta in in g a low average monthly churn rate (i.e., rate of customer termination). However, allegedly, Vonage's increase in subscriber lines and its low average m o n th l y churn rate were not the result of increased line sales, higher customer s a tis f a c tio n and/or low terminations, as suggested by Vonage in its Prospectus, but ra th e r resulted from a corporate practice of refusing customers' cancellation re q u e s ts . Particularly, Lead Plaintiff alleges that at the time of the IPO, numerous c u s to m e rs had communicated to Vonage that they were not satisfied with Vonage's s e rv ic e s . In response, Vonage's management allegedly instructed the retention d e p a rtm e n t to refuse cancellation requests in order to keep the average monthly c h u rn rate down. Instead, the customer was offered a "zero rate plan," which kept th e customer with Vonage but at a monthly service payment as low as $4.99 and, in s o m e instances, no monthly payment. This practice had been in effect since at least th e Fall 2005. As a result, Lead Plaintiff claims that by keeping the average m o n th ly churn rate down through deceptive corporate practices, Vonage showed an in f la te d number of subscriber lines. Second, Vonage allegedly failed to disclose the truth about technical p ro b le m s and fundamental deficiencies that were plaguing its services and products

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at the time of the IPO, especially when Vonage's Prospectus boasted that the C o m p a n y's success depended on its ability to provide reliable services. For

e x a m p le , Lead Plaintiff alleges that Vonage failed to disclose the inability of V onage's VoIP technology to properly handle facsimile transmissions, i.e., facsimile tra n s m is s io n s using Vonage's technology platform were often either aborted in m id s tre a m , transmitted in a fashion which was illegible to the recipient or simply d id not transmit . Third, Vonage allegedly failed to disclose that Vonage's business depended u p o n the misappropriation of other companies' intellectual property. In particular, L e a d Plaintiff asserts that AT&T filed a lawsuit against Vonage in Wisconsin a lle g in g that Vonage was infringing one of its patents, and that Vonage continued to use the patent without entering into any licensing agreement (the patent covered te c h n o lo g y relating to routing telephone calls over data networks like the Internet). Lead Plaintiff alleges that prior to the IPO, Vonage received notice that it was in f rin g in g on AT&T's intellectual property rights. Additionally, it is alleged that V o n a g e did not disclose in the Prospectus that it infringed on Verizon's patents. As a result, Lead Plaintiff claims that the statements in the Prospectus relating to in te lle c tu a l property and patent litigation were materially false and misleading by f a ilin g to disclose that prior to the IPO, its competitors had already advised Vonage o f their claims of patent infringement and of potential/threatened litigation.

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Finally, with respect to the DSP, Lead Plaintiff alleges that because the w e b site , wherein customers could obtain timely information regarding their c o n d itio n a l offers and withdraw their offers, was not functioning properly, many of th e participants were denied their right to withdraw. Moreover, Vonage allegedly v io la te d certain notice regulations set by the SEC. Vonage (including its officers and directors) and the Underwriter Defendants jo in in moving to dismiss the Amended Complaint in its entirety.3 Defendants' p o s itio n with respect to the allegations pertaining to the Offering Documents is that n o n e of the claims made by Lead Plaintiff are actionable because Lead Plaintiff has f a ile d to allege a single fact that would render any of the challenged statements f a ls e . Defendants contend that Plaintiff simply attacks each statement at issue by c itin g other, unrelated information that was supposedly omitted and then claiming th a t investors were misled. Defendants further contend that Plaintiff's § 11 claims f a il because the face of the Amended Complaint indicates that investor plaintiffs h a v e not suffered harm from any of the alleged misstatements. In that connection, D e f e n d a n ts insist that Lead Plaintiff cannot attribute any portion of Vonage's stock p ric e decline during the IPO to the alleged misstatements, and thus, investors have n o damages.

3

The Court held oral argument on October 10, 2008. -8-

With respect to the allegations of the DSP, Defendants maintain that Lead P la in tif f has failed to allege any illegal acts that would violate the SEC rules. Instead, the email and voicemail sent to the prospective investors of the DSP were v a lid and they conformed with all the regulation guidelines. DISCUSSION I. S ta n d a r d of Review

W h e n reviewing a motion to dismiss on the pleadings, courts "accept all f a c tu a l allegations as true, construe the complaint in the light most favorable to the p la in tif f , and determine whether, under any reasonable reading of the complaint, the p la in tif f may be entitled to relief." Phillips v. County of Allegheny, 515 F.3d 224, 2 3 3 (3d Cir. 2008) (citation and quotations omitted). In Bell Atlantic Corporation v . Twombly, 550 U.S. 544 (2007), the Supreme Court clarified the 12(b)(6) s ta n d a rd . Specifically, the Court "retired" the language contained in Conley v. G ib s o n , 355 U.S. 41, 45-46 (1957), that "a complaint should not be dismissed for f a ilu re to state a claim unless it appears beyond doubt that the plaintiff can prove no s e t of facts in support of his claim which would entitle him to relief." Id. at 1968 (q u o tin g Conley, 355 U.S. at 45-46). Instead, the factual allegations set forth in a c o m p la in t "must be enough to raise a right to relief above the speculative level." Id. a t 1965. As the Third Circuit has stated, "[t]he Supreme Court's Twombly f o rm u la tio n of the pleading standard can be summed up thus: `stating ... a claim

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requires a complaint with enough factual matter (taken as true) to suggest' the re q u ire d element. This `does not impose a probability requirement at the pleading s ta g e ,' but instead `simply calls for enough facts to raise a reasonable expectation th a t discovery will reveal evidence of' the necessary element." Phillips, 515 F.3d at 2 3 4 (quoting Twombly, 127 S.Ct. at 1965). II. C o u n ts I - V: 15 U.S.C. § 77(k) and 15 U.S.C. § 77(1)(a)(2) C la im s

" T h e primary innovation of the [Securities] Act was the creation of federal d u tie s -- for the most part, registration and disclosure obligations -- in connection w ith public offerings." Gustafson v. Alloyd Co., 513 U.S. 561, 571 (1995); see also In re Adams Golf, Inc. Secs. Litig., 381 F.3d 267, 273 (3d Cir. 2004). As relevant h e re , Section 11 concerns material misstatements or omissions in registration s ta te m e n ts , while section 12(a)(2) concerns material misrepresentations in p ro s p e c tu s e s and other solicitation materials. Adams, 381 F.3d at 273. Section 11 of the Securities Act allows purchasers of a registered security to s u e certain enumerated parties in a registered offering when false or misleading in f o rm a tio n is included in a registration statement. Herman & MacLean v.

H u d d le s to n , 459 U.S. 375, 381-82 (1983). This section was designed to assure c o m p lia n c e with the disclosure provisions of the Act by imposing a stringent s ta n d a rd of liability on the parties who play a direct role in a registered offering. Id. "If a plaintiff purchased a security issued pursuant to a registration statement, he -10-

need only show a material misstatement or omission to establish his prima facie c a s e . Liability against the issuer of a security is virtually absolute, even for innocent m is s ta te m e n ts ." Id. Defendants bear the burden of demonstrating due diligence. See 15 U. S. C. § 77k(b). Section 11 places a relatively minimal burden on a p la in tif f . Herman, 459 U.S. at 382. A similar burden exists for a plaintiff under a § 12 claim. In re Suprema S p e c ., Inc. Sec. Litig., 438 F.3d 256, 269-70 (3d Cir. 2006). Section 12(a)(2)

p ro v id e s for civil liability against anyone who offers or sells a security "by means o f a prospectus or oral communication, which includes an untrue statement of m a te ria l fact or omits to state a material fact necessary in order to make the s ta te m e n ts , in light of the circumstances under which they were made, not m is le a d in g . . . ." 15 U.S.C. § 77l(a)(2). Like Section 11, Section 12(a)(2) is a " v irtu a lly absolute" liability provision that does not require an allegation that d e f e n d a n ts possessed scienter. In re Suprema Spec., 438 F.3d at 270 (citations o m itte d ). To state a prima facie claim under Section 12(a)(2), "the plaintiff must a lle g e the purchase of securities pursuant to a materially false or misleading pro s p e c tu s or oral communication." Id. (citations omitted). For analytical purposes, c la im s arising out of Sections 11 and 12 involve the same legal scrutiny. Moreover, s in c e Lead Plaintiff alleges that both Vonage and the Underwriter Defendants " p la ye d a direct role in the IPO," the same legal analysis of the claims applies to

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those defendants. A. H e ig h te n e d Pleading Requirements of Rule 9(b)

F ra u d is not a necessary element to establish a prima facie claim under S e c tio n 11 or Section 12(a)(2). See Shapiro v. UJB Fin. Corp., 964 F.2d 272, 288 (3 d Cir. 1992). However, claims under those provisions can be, and often are, p re d ic a te d on allegations of fraud. See, e.g., Cal. Pub. Emples'. Ret. Sys. v. Chubb C o rp ., 394 F.3d 126, 160 (3d. Cir. 2004). Where the plaintiff grounds these S e c u r i t i e s Act claims in allegations of fraud -- and the claims thus "sound in f ra u d " -- the heightened pleading requirements of Rule 9(b) apply. Id. at 161-63; S h a p iro , 964 F.2d at 288-89. However, the Securities Act claims do not sound in f ra u d if ordinary negligence is expressly pled in connection with Sections 11 and 12 c la im s . In re Suprema Spec., 438 F.3d at 272. H e re , the Court finds that Lead Plaintiff must plead its Sections 11 and 12 c la im s under the heightened pleading requirements of Rule 9(b). While Lead P la in tif f did not allege a fraud claim based on §10(b) of the Securities Act, n o n e th e le s s , because its claims allege intentional, knowing or reckless conduct, th e s e claims "sound in fraud," and therefore must be pled with particularity. The lin c h p in of Lead Plaintiff's action is the allegation that Defendants knowingly and in te n tio n a ll y omitted certain information in the Offering Documents to mislead p o te n tia l investors. Nowhere in the Amended Complaint does Lead Plaintiff allege

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negligence. Nevertheless, Lead Plaintiff argues that the Amended Complaint did not p le a d a state of mind, and that the allegations do not require intent. Specifically, L e a d Plaintiff vehemently argues that because the Amended Complaint is devoid o f words such as "intentional" and "reckless," Rule 8 liberal pleading standards s h o u ld apply. In support of its contention, Lead Plaintiff cites to In re Ravisent T e c h n o lo g ie s, Inc., No. 00-1014, 2004 WL 1563024, at *13-14 (E.D. Pa. Jul. 13, 2 0 0 4 ). It contends that the court there held that the failure to include language such a s "intentional" and "reckless" weighs against applying Rule 9(b) to § 11 claims. Lead Plaintiff misconstrues the holding in In re Ravisent. The court there held that p la in tif f s had carefully drafted the complaint to plead negligence sufficient to avoid th e heightened pleading requirements. Id. at *13. In that connection, the court re a s o n e d that plaintiffs, in their complaint, expressly excluded any allegations of k n o w le d g e or scienter on the part of the defendants. Id. at *14. Likewise, Lead Plaintiff's reliance on In re WorldSpace Sec. Litig., No. 072 2 5 2 , 2008 WL 2856519 (S.D.N.Y. Jul. 21, 2008), is misplaced for similar reasons. There, the court held that the plaintiffs' allegations as to the defendants' intent were c a re f u lly couched in the language of negligence. Id. The complaint alleged that the d e f e n d a n ts owed a duty to make a reasonable and diligent investigation of the s ta te m e n ts contained in the Registration Statement and Prospectus, and the

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Registration Statement and Prospectus were "negligently prepared," resulting in m a te ria l misstatements and omissions. Id. at *5. Here, there is no such express, or inferential, language of negligence in the A m e n d e d Complaint. In fact, Lead Plaintiff's churn rate allegations brim with the typ e s of wording and imputations classically associated with fraud. For example, th e Amended Complaint states: "retention department [instructed] to refuse c a n c e lla tio n requests in order to keep the average monthly churn rate down," see C o n so lid a te d Amended Complaint ("CAC"), ¶ 106; "directed not to let customers c a n c e l their service to keep the average monthly churn rate down," Id., ¶ 109; " V o n a g e misrepresented its growth," Id., ¶ 111; "[statements about growth and c h u rn ] were materially false and misleading because they failed to disclose . . . the tru th ," Id., ¶ 112; and compellingly, the Amended Complaint alleges that the d is c o u n tin g practice was implemented for the express purpose of "misrepresenting [ V o n a g e 's ] growth." Id. Moreover, Lead Plaintiff's fax allegations are similarly pled with intentional a n d knowing conduct by asserting that Defendants "failed to disclose the truth about te c h n ic a l problems and fundamental deficiencies that were plaguing Vonage's s e rv ic e s and products at the time of the IPO." Id., ¶ 114. Lead Plaintiff's

in te lle c tu a l property allegations fare no better. The Amended Complaint asserts that " th e Prospectus failed to disclose that Vonage's business depended upon the

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misappropriation of other companies' intellectual property." Id., ¶ 118. The A m e n d e d Complaint goes on to allege that despite this knowledge, "the statements in the Prospectus relating to intellectual property and patent litigation were m a te r i a lly false and misleading by omitting to disclose, prior to the IPO, its c o m p e tito rs had already advised Vonage of their claims of patent infringement and o f potential/threatened litigation." Id. Clearly, these allegations are associated with k n o w in g and intentional conduct and, thus, the Court has no basis to infer any n e g lig e n c e . See Cal. Pub. Employees Ret. Sys., 394 F.3d at 160 -161 ("Allegations s o u n d in fraud where they are based on knowing and intentional conduct; where a p le a d in g is completely devoid of any allegations that the defendants acted n e g lig e n tly" ; and where the pleading alleges that offering documents were false and m is le a d in g or concealed key facts from the public); see Rombach v. Chang, 355 F .3 d 164, 172 (2d Cir. 2004)(applying Rule 9(b) to Section 11 claims where " w o rd in g and imputations of the complaint are classically associated with fraud: that th e Registration statement was `inaccurate and misleading;' that it contained `untrue s ta te m e n ts of material facts;' and that `materially false and misleading written s ta te m e n ts ' were issued"). Accordingly, Lead Plaintiff must plead with particularity w ith respect to Counts I - V.4

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During oral argument, Lead Plaintiff argued, unconvincingly, that the securities cases upon which Defendants rely with respect to the standard of pleading are cases that have both a section 10(b) claim, as well as a section 11 or 12 claim. Lead Plaintiff argued that because -15-

In order to satisfy Rule 9(b), Lead Plaintiff must plead: "(1) a specific false re p re s e n ta tio n of material fact; (2) knowledge by the person who made [it] of its f a l sity; (3) ignorance of its falsity by the person to whom it was made; (4) the in te n tio n that it should be acted upon; and (5) that the plaintiff acted upon it to his [ o r her] damage." Shapiro, 964 F.2d at 284; see Cal. Pub. Employees' Ret. Sys., 3 9 4 F.3d at 163 ("to plead with particularity the `who, what, when, and how' of e a c h statement" must be alleged). Candidly, Lead Plaintiff conceded that if the C o u rt were to apply the Rule 9(b) standard, it has not satisfied the pleading re q u ire m e n ts under Rule 9(b).5 In light of that concession and given that I find that R u le 9(b) pleading requirements adhere in this matter, Counts I - V are dismissed. However, the Court will nevertheless analyze each of the claims to determine w h e th e r Lead Plaintiff should be provided another opportunity to amend its A m e n d e d Complaint.

this case is solely brought under sections 11 and 12, the Court should not infer any fraud. The Court disagrees. The Court's inquiry here focuses on the language of the allegations, and not on whether a separate section 10(b) claim has been pled. Indeed, the Third Circuit has clearly held that the determination of the pleading standard pursuant to Rule 9(b) is predicated on allegations of fraud regardless of the type of the claims pled. Cal. Pub. Employees' Ret. Sys., 394 F.3d at 160; see, e.g., Ladman Partners, Inc. v. GlobalStar, Inc., No. 07-976, 2008 U.S. Dist. LEXIS 76670, at *31-34 (S.D.N.Y. Sep. 30, 2008). Accordingly, Plaintiff's argument is unavailing.
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During oral argument the Court asked Lead Plaintiff's attorney, "Would you say to me, then, if I were to find that 9(b) applies, that you have not satisfied 9(b)?" Counsel responded, "I would say, your Honor, that is correct. We have not attempted to and we have not." See Transcript dated October 10, 2008 at p. 6. -16-

B.

C h u r n Rate Allegations

Lead Plaintiff alleges that Vonage made misstatements about its historical s u b s c rib e r line growth and its customer base; those statements failed to disclose the th e n current practice of refusing customers' termination requests. According to P la i n t i f f , despite customers experiencing problems with Vonage's service and a tte m p ts to cancel service, Vonage misstated its monthly churn rate based upon the im p le m e n ta tio n of the "zero rate plan." As a result, Lead Plaintiff alleges that V o n a g e misled investors about its expected revenues. When reviewing the Prospectus or Registration Statement, the Court must re a d the entire document as a whole. In re Donald J. Trump Casino Sec. Litig. - Taj M a h a l Litig., 7 F.3d 357, 377 (3d Cir. 1993); see also In re U.S. Interactive, Inc. S e c . Litig., No. 01-522, 2002 WL 1971252, at *7 (E.D. Pa. Aug. 23, 2002) (citing E P Medsystems Inc. v. EchoCath, 235 F.3d 865 (3d Cir. 2000))("Courts must avoid e x a m in in g the alleged misstatements in isolation `because accompanying statements m a y render them immaterial as a matter of law'"). After reviewing the Offering D o c u m e n t s , I find that Lead Plaintiff fails to allege any materially misleading or o m itte d statements regarding the churn rates that would render them fraudulent. At the outset, Defendants argue that a customer receiving a discount is n o n e th e le s s still a customer, so those customers should properly be included in the c a lc u la tio n of the churn rate. To support their position, Defendants rely on In re

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Cytyc Corp. Sec. Litig., No. 02-12399, 2005 U.S. Dist. LEXIS 6166, at *65 (D. M a s s. Mar. 2, 2005) for the proposition that pull-ins or deep discounts are actual s a le s which are treated no differently than any other sale. However, the facts upon w h ic h that court based its holding involved recognition of revenues rather than the n u m b e r of customers. As such, this Court finds Defendants' argument

u n p e rs u a siv e . Rather, customers retained by Vonage, either by receiving steep d is c o u n ts or being on the "zero rate" plans, may in some instances be used to d e c re a s e the churn rate. This is especially true when the churn rate is calculated by ta k in g the average monthly customer churn for a particular period of time divided b y the number of customers that terminated their service during that period. See P ro s p e c tu s at 7. Therefore, if the number of terminated customers is low,

u n d o u b te d ly, the churn rate will remain low. To begin, Lead Plaintiff argues that Vonage's failure to specifically mention th e "zero rate" plan misled investors about its expected revenues.6 Such allegations c a n n o t sustain a Section 11 or Section 12 claim. As courts have consistently held,

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Lead Plaintiff also argues that because Vonage's historical performance was misstated due to the omission of the "zero rate" plan, this precludes Defendants from relying on cases that require accurate reports of historical performance. As discussed, infra, Lead Plaintiff's argument in that respect is insufficient to overcome materiality. The Prospectus delineated financial data, see Prospectus at 54, that reflected Vonage's historical performance. Lead Plaintiff cherry picks through the data and alleges one aspect of it is misleading without also alleging how this particular data materially affects Vonage's historical performance, especially in light of the fact that Lead Plaintiff does not dispute that the revenue per line basis accurately reflects any discounts Vonage may have provided to its customers. -18-

accurate disclosure of historical performance is simply not a basis for liability based o n the risk that future performance may deteriorate. Zucker v. Quasha, 891 F.Supp. 1 0 1 0 , 1014 (D.N.J. 1995) aff'd, 82 F.3d 408 (3d Cir. 1996)(dismissing claim that c o m p a n y should have disclosed adverse trend in customer returns because adverse tre n d in current quarter did not render historical return rate false or misleading and c o m p a n y made no projections that were false or misleading); Carney v. Cambridge T e c h . Partners, Inc., 135 F.Supp. 2d 235, 242 (D. Mass. 2001)(to the extent c h a lle n g e d statements were historical, they were accurate and not misleading; to the e x te n t they were forward looking, they included adequate cautionary language to in s u la te against the risk of misleading investors). Moreover, to the extent Lead P la in tif f alleges that the historical statements were forward looking by way of p ro je c tin g future revenues and trend, Vonage counters that it included adequate c a u tio n a ry language to insulate against the risk of misleading investors.7 Although
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The following are excerpts of warning statements from the Offering Documents: Flaws in our technology and systems could cause delays or interruptions of service, damage our reputation, cause us to lose customers and limit our growth. Although we have designed our services network to reduce the possibility of disruptions or other outages, our service may be disrupted by problems with our technology and systems, such as malfunctions in our software or other facilities and overloading of our network. Our customers have experienced interruptions in the past and may experience interruptions in the future as a result of these types of problems. Interruptions have in the past and may in the future cause us to lose customers and offer substantial customer credits, which could adversely affect our revenue and profitability. -19-

there is substantial explicit cautionary language regarding future success and re v e n u e s , the Court notes that because this is a motion to dismiss, the adequacy of th e s e cautionary statements may present a fact question. Regardless, the law is c le a r, an accurate report of past successes does not contain an implicit re p r e s e n ta tio n that the trend is going to continue, and hence does not, in and of its e lf , obligate the company to update the public as to the state of the quarter in p ro g re s s . In re Burlington Coat Factory Securities Litigation, 114 F.3d 1410, 1432 (3 d Cir. 1997) (citing Shaw v. Digital Equipment Corp., 82 F.3d 1194, 1202 (1st C ir. 1996)); Raab v. General Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993); In re C o v e rg e n t Technologies Sec. Litig., 948 F.2d 507, 513-14 (9th Cir. 1991) (rejecting p la in tif f s ' contention that accurate reporting of past results "misled investors by

Prospectus at 11-12 (emphasis added). We believe that telephony services revenue will continue to increase in 2006, as we expect an increase in the number of subscribers. However, we might not experience the same rapid growth as in prior years. Prospectus at 32. [C]ompetition or continued price decreases may require us to lower our prices to remain competitive, may result in reduced revenue, a loss of customers or a decrease in our subscriber line growth and may delay or prevent our future profitability. Prospectus at 9. Moreover, the cautionary language of the Offering Documents specifically warned investors that the "churn rate could increase in the future if customers are not satisfied with [Vonage's] service . . . . [I]f [they] are unsuccessful in retaining customers . . . [their] revenue could decrease." Prospectus at 13. -20-

implying that [the company] expected the upward first quarter trend to continue th ro u g h o u t the year"); Zucker, 891 F.Supp. at 1015. Furthermore, "[t]he fact that a company has reported accurately about past successes does not by itself burden the c o m p a n y with a duty to inform the market that the present circumstances are less p o s itiv e ." Gross v. Summa Four, Inc., 93 F.3d 987, 992 (1st Cir. 1996). Here, Lead P la in tif f only alleges that the financial information posted in the Offering D o c u m e n ts was misleading because the historical revenues tend to overestimate the e x p e c te d revenues. M o s t importantly, regardless of whether the historical performance is a c c u ra te , Lead Plaintiff fails to allege that the failure to disclose the number of c u s to m e rs being retained either by way of steep discounts or "zero rate" plan is m a te ria l. The Amended Complaint does not allege that Vonage's alleged corporate p ra c tic e had a material effect on any of the company's financial data. Likewise, the A m e n d e d Complaint does not allege that the practice had a material effect on V o n a g e 's prospects for growth. Indeed, to sufficiently allege facts that omitted in f o rm a tio n is material, a complaint must allege that there is a substantial likelihood th a t a reasonable shareholder would consider the omitted information important in m a k in g an investment decision. See Twombly, 127 S. Ct. at 1974; see also In re D o n a ld J. Trump, 7 F.3d at 369 ("For an omission to be deemed material, `there m u s t be a substantial likelihood that [its disclosure] would have been viewed by the

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reasonable investor as having significantly altered the `total mix' of information m a d e available')(citations omitted). Lead Plaintiff simply fails to allege the impact o f the alleged corporate practice on the business. Without such allegations, there is nothing to support Lead Plaintiff's conclusory assertion that omitting the in f o rm a tio n regarding "zero rate" plans or customer credits is materially misleading. See, e.g., In re Alamosa Holdings, Inc. Sec. Litig.,382 F.Supp.2d 832, 852 (N.D. T ex. 2005)(dismissing as immaterial a claim that a wireless communication provider a lle g e d ly inflated the number of subscribers it had by entering into contracts with 1 ,0 0 0 non-creditworthy subscriber); Danis v. USN Commc'n, Inc., 121 F.Supp.2d 1 1 8 3 , 1191 (N.D. Ill. 2000)(the plaintiff must show that defendant's alleged illegal c o rp o ra te practice by inflating revenue through a practice of billing former c u s to m e rs for monthly recurring charges had a material impact on the company as a whole). Indeed, there is no basis for Lead Plaintiff to aver that there is a material im p a c t on the business because of the alleged wrongdoing. Even assuming the a lle g a tio n s (i.e., failure to report customers on the "zero rate" plan distorts the n u m b e r of customers and the churn rate) are true, the Prospectus explicitly reported V o n a g e 's revenue on a per line basis, which Lead Plaintiff does not dispute. This in f o rm a tio n would identify the impact of any discounting or customer credit practice s in c e any rate reductions offered to subscribers would cause a drop in revenue and

-22-

a corresponding drop in the average revenue per line. Clearly, even if there were c u s to m e rs who paid no monthly fees, the average revenue per line would necessarily d e c re a s e . See Prospectus at 54 (identifying not only the customer churn rate, but a ls o the average monthly revenue per line on the same summary chart). Accordingly, an investor could have drawn his/her own conclusions from those f ig u re s and made an informed decision. See Prospectus at 54; Goldstein v.

Q u a n tu m Health Res., Inc., No. 95-713, 1996 WL 813245, at *5-6 (C.D. Cal. Dec. 2 3 , 1996)("when a company accurately discloses financial information, the market is expected to draw its own conclusions"). In sum, these allegations pertaining to th e churn rates are not actionable under the Securities Act. C. F a x Service Allegations

Lead Plaintiff alleges that Vonage's statements regarding its product and te c h n o lo g y platform were misleading by virtue of Vonage's omissions as to thene x is tin g facsimile problems. Specifically, Lead Plaintiff alleges that Vonage, at the tim e of the IPO, was experiencing significant and substantial problems with its c o m p a n y's VoIP technology and could not adequately handle facsimile tra n s m is s io n s. Lead Plaintiff further alleges that these technological deficiencies le d to a class action lawsuit, Bustos v. Vonage America, Inc., which was filed five d a ys before the IPO, but was not disclosed in the Offering Documents. The issue a ris in g from the allegations is whether Vonage had a duty to disclose the specific

-23-

technical deficiencies of its facsimile service despite a general disclosure of te c h n o lo g ic a l issues with the VoIP.8 F irs t, Defendants contend that Plaintiff fails to allege any facts to suggest that a n y problems with Vonage's fax services were material because nothing in the A m e n d e d Complaint indicates that fax service was an important part of Vonage's b u s in e s s model or product line. The Court is unconvinced by this argument. By re v ie w in g the Offering Documents, it is reasonable and conceivable that investors c o u ld have deemed the fax service an essential part of the service provided by V o n a g e 's VoIP.9 In the "Our Market Opportunity" section of the Prospectus, V o n a g e touts that "VoIP communications are carried as data packets and require a b ro a d b a n d Internet connection that has sufficient bandwidth to deliver the data u n in te r r u p te d . . . [C]onsumers will increasingly look to use their high-speed In te rn e t connections for more of their voice, video and data communications." Prospectus at 2. Additionally, the financial revenues reported in the Offering

8

Another issue not germane to this particular analysis is Lead Plaintiff's allegations with respect to the Bustos Litigation. During oral argument, Lead Plaintiff argued that aside from the fact that Defendants knew of the existence of the litigation, they deliberately omitted disclosure of the filing of the complaint in the Prospectus. I rejected that position at oral argument by finding that the Bustos litigation was only pled to show that Vonage had knowledge of its allegedly substantial problems with the fax service.
9

In addition to the Amended Complaint, the Court may consider any materials "integral to or explicitly relied on in the complaint," as well as matters of public record. In re Rockefeller Ctr. Props., Inc. Sec. Litig., 184 F.3d 280, 287 (3d Cir. 1999)(citation omitted). -24-

Documents presumably encompass premium service revenues, including fax n u m b e rs and services, that investors could have reasonablely relied on in making th e ir decision. See Prospectus at 1. At the very least, the current record reveals that f a x services have been prominently featured in the Prospectus. Next, Defendants contend that, as a matter of law, where a company g e n e ra lly acknowledges a technical error or limitation, it does not have to also e x p la in how that deficiency applies to a particular aspect of a product. For support, D e f e n d a n t s cite to relevant portions of the Prospectus to show that there were m u ltip le warnings regarding Vonage's VoIP technology. For example, Defendants c ite to the Prospectus which states "system disruptions or flaws in our technology" is one of the foremost risk factors associated with investing in Vonage. Prospectus a t 3. Further, the Prospectus explained that Vonage's VoIP technology worked by c o n v e rtin g voice signals into "data packets," which are then transmitted over the In te rn e t and could be "delayed or lost." Id. at 55-56. The Prospectus also declared th a t the differences between Vonage's VoIP telephone service and traditional te le p h o n e service had in the past and may in the future cause Vonage's customers to experience poorer call quality and higher dropped-call rates than customers of tra d itio n a l telephone companies. Id. at 10-12. Cumulatively, Defendants assert, the P ro s p e c tu s informed investors that Vonage's technology was not perfect and that n o reasonable investor could possibly read those "general" warnings as applying to

-25-

everything but Vonage's fax service. In that connection, Defendants claim that f e d e r a l securities laws do not require disclosures about "technical deficiencies." They cite to numerous cases for the proposition that providing a "general warning" o f technological deficiencies in the Offering Documents does not trigger a duty to a ls o explain how these flaws might affect a particular service. But those cases do n o t fully support Defendants' position. Defendants primarily rely upon Backman v. Polariod, 910 F.2d 10 (1 st Cir. 1 9 9 0 ). In that case, the First Circuit affirmed the dismissal of a claim that

d is c lo s u re s by Polariod about its Polavision instant movie camera - a product that u ltim a te ly proved to be a commercial disaster - were misleadingly incomplete. The B a c k m a n court held that "a voluntary disclosure of information that a reasonable in v e sto r would consider material must be `complete and accurate.'" Id. at 17. The c o u rt went on to say, "this . . . does not mean that by revealing one fact about a p ro d u c t, one must reveal all others." Id. However, the court cautioned that the d is c lo s u re must not be "so incomplete as to mislead." Id. (quotations omitted). Importantly, the court explained that "if management knew at the time of the report th a t Polavision was a commercial failure . . . [its failure to specifically so state] m ig h t well be found to be a material misrepresentation by half-truth and in c o m p le te n e s s ." Id. at 17-18.1 0 Here, this is the scenario, albeit not sufficiently
10

Similarly, the following two cases are factually distinguishable from this case: In re -26-

pled, that Lead Plaintiff appears to be suggesting. Lead Plaintiff alleges that the warning statements contained in the Prospectus " f a ile d to disclose the truth about technical problems and fundamental deficiencies th a t were plaguing Vonage's services and products at the time of the IPO." To s h o w the extent and knowledge of such flaws, Lead Plaintiff points to the Bustos L itig a tio n , a lawsuit challenging Vonage's fax service. At this juncture, giving L e a d Plaintiff all favorable inferences, Vonage could have known, prior to the IPO, th a t its fax technology was so flawed that it would amount to a substantial and real d is ru p tio n to its services. Moreover, although a corporation has no general duty to disclose all te c h n ic a l issues, the keystone of the inquiry of whether a statement should have b e e n included is its materiality. The Third Circuit has cautioned that "materiality is a relative concept, so that a court must appraise a misrepresentation or omission in the complete context in which the author conveys it." In re Donald J. Trump, 7 F .3 d at 369. "In other words, a particular misrepresentation or omission significant to a reasonable investor in one document or circumstance may not influence a

OPUS360 Corp. Sec. Litig., No. 01-2938, 2002 WL 31190157, at *8 (S.D.N.Y. Oct. 2, 2002)(the court found that the prospectus need not disclose that software was known to be a fatally flawed application because the investors were warned that the product was still being developed, and was still subject to further commercial testing); and In re Allscripts, Inc. Sec. Litig., No. 00-6796, 2001 WL 743411 (N.D. Ill. Jun. 29, 2001)(the court there held that plaintiffs failed to plead sufficiently that defendant company had a duty to disclose the average 50% customer return rate for a product because plaintiffs furnished no particularized statements about the technical defect of the product). -27-

reasonable investor in another." Id. Materiality is a mixed question of law and fact w h ic h the factfinder ordinarily decides. See TSC, 426 U.S. at 450; Shapiro, 964 F .2 d at 280 n.11. The alleged misrepresentations or omissions would have to be "so o b v io u s ly unimportant to an investor that reasonable minds cannot differ on the q u e s tio n of materiality . . . for the district court to rule that the allegations are in a c tio n a b le as a matter of law." Shapiro, 964 F.2d at 280 & n.11. Accordingly, the C o u rt cannot, at this juncture, determine that as a matter of law, no reasonable in v e sto r would deem the existence of a serious technical fax service issue, which u ltim a te ly led to a separate class action lawsuit in this District, to be unimportant a n d immaterial, especially when the Prospectus touted the benefits of Vonage's f a c sim ile service.1 1 The Court nevertheless dismisses this claim because Lead P la in tif f has failed to plead with particularity; however, Lead Plaintiff shall be given leave to amend its Amended Complaint on this basis.

11

Defendants argue that they had no knowledge of the filing of the Bustos litigation prior to the IPO issuing. In support of the contention, Defendants assert that the Bustos Complaint was not served on Vonage until May 31, 2006 - one week after the IPO. However, the relevant inquiry here is whether Defendants omitted facts that were known or knowable at the time of the offering. In re Tellium, Inc., 2005 WL 1677467, at *13 (D.N.J. Jun. 30, 2005). The Amended Complaint here referenced the time frame in which the Bustos litigation was filed, i.e., May 19, 2006. Such reference was then followed by the claim that the Prospectus failed to mention the existence of the lawsuit. The logical inference is that the May 19th date was five days before the IPO, and therefore, Vonage knew or should have known that the Bustos litigation existed before the Offering Documents became published; whether or not Vonage in fact had knowledge is irrelevant for a Rule 12(b)(6) analysis. -28-

D.

V o n a g e 's Intellectual Property

Lead Plaintiff challenges Vonage's statements that its "network is based o n internally developed software" and that it "also developed a number of software s ys te m s , such as a web-based system that provide [Vonage's] customers with v a lu a b le feature while simultaneously enabling [Vonage] to manage [their] business m o re efficiently" as misleading. Compl., ¶ 119. Lead Plaintiff's basis for claiming th a t these statements were misleading is the fact that Verzion, AT&T, and Klausner T e c h n o lo g ie s notified Vonage of their belief that Vonage's software infringed on th o s e companies' patents, and that there was a possibility of future patent litigation. Compl., ¶ 131. In other words, Lead Plaintiff asserts that by omitting this pertinent in f o rm a tio n , Vongage mislead its investors. The crux of Defendants' response is that such omissions, i.e., notices from V e riz o n , AT&T, and Klausner that Vonage was infringing upon their patents, are n o t material because there is no duty to disclose a "potential lawsuit" or "possible f u tu re litigation" because it is too speculative. Defendants cite to numerous cases to support their contention that Vonage had no duty to disclose the threats of litig a tio n from Verizon, AT&T and Klausner. In addition, Defendants cite to the P ro s p e c tu s to show that adequate cautionary language was placed in the Prospectus to warn investors of potential intellectual property lawsuits. Such language is as f o llo w s :

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We may be subject to damaging and disruptive intellectual property litig a tio n . We have been named as a defendant in three suits currently pending that re la te to alleged patent infringement . . . . In addition, we have been s u b je c t to other infringement claims in the past and may be subject to in f r in g e m e n t in the future. We may be unaware of filed patent a p p lic a tio n s and issued patents that could relate to our products and s e rv ic e s . Prospectus at p. 15. The Prospectus then went on to describe in detail how in te lle c tu a l property litigation could be time-consuming and expensive. See Id. Indisputably, with respect to a company's failure to disclose impending litig a tio n , there is no requirement "to make disclosures predicting such litigation a b s e n t an allegation that the litigation "was substantially certain to occur during the re le v a n t period." In re Citigroup, Inc. Sec. Litig., 330 F.Supp. 2d 367, 377-78 (S .D .N .Y . 2004); see also In re Par Pharm., 733 F.Supp. 668, 678 (S.D.N.Y. 1990); B a lla n v. Wilfred American Educ. Corp., 720 F.Supp. 241, 248 (E.D.N.Y. 1989). Indeed, Third Circuit authority establishes that while pending litigation may be m a te ria l under certain circumstances, the mere possibility of litigation is not. Gen. E le c . Co. By Levit v. Cathcart, 980 F.2d 927, 935 (3d Cir. 1992); see also, e.g., P re ttn e r v. Aston, 339 F.Supp. 273, 287 (D. Del. 1972) (any statement regarding " th e possibility of" litigation other than a pending or threatened legal proceeding " w o u ld have been wholly speculative and was not required"); City of Philadelphia v . Fleming Cos., 264 F.3d 1245, 1267 (3d Cir. 2001)("We therefore conclude that

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Defendants cannot be held responsible for the failure to consider the cumulative e f f e c t of other, similar lawsuits that had not been filed and, as far as the pleadings e s ta b lis h , were not even threatened, at the time Defendants decided not to disclose th e David's Litigation")(emphasis added); see also Bell Atlantic Corp. v. Bolger, 7 7 1 F.Supp. 686, 687 (E.D. Pa. 1991); Goldsmith v. Rawl, 755 F.Supp. 96 (S .D .N .Y . 1991); Fry v. Trump, 681 F.Supp. 252, 261 (D.N.J. 1988); Bertoglio v. T e x a s Int'l Co., 488 F.Supp. 630 (D. Del. 1980); Beatty v. Bright, 318 F.Supp. 169 (S .D . Iowa 1970) (all concerning the disclosure of pending lawsuits); Mills v. E s m a rk , Inc., 544 F.Supp. 1275, 1296 (N.D. Ill. 1982) ("Defendants cannot be held to a standard of disclosure which requires consideration of all possible c o n t i n g e n c ie s " ). But cf SEC v. Fehn, 97 F.3d 1276, 1291 (9 th Cir. 1996)(where p e n d in g litigation would be material, a defendant company could be held liable for la c k of disclosure, even where no lawsuits had yet been filed based upon those v io la tio n s, because those violations could have spawned lawsuits that would have " re p re s e n te d a potentially large financial loss" for the company). In light of these legal principals, Lead Plaintiff has not sufficiently pled facts to support its allegation of material omission with respect to these subsequent litig a tio n s. The Court approaches this analysis by first establishing the nature of the s u its in question and whether there are allegations that these litigations were s u b s ta n tia lly certain to occur. As alleged, all three companies, Verizon, AT&T and

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Klausner, repeatedly advised and warned Vonage prior to the IPO that Vonage was in f rin g i n g upon their respective patents. See Compl, ¶ 122 ("Prior to the IPO, A T & T also communicated to Vonage's counsel, in numerous meetings, letters and e m a ils , that Vonage's services and products were infringing AT&T's intellectual p ro p e rty rights"); see Id. at ¶ 123 ("Prior to the IPO, Verizon claimed that Vonage w a s infringing on seven of Verizon's patents relating to VoIP technology"); see Id. a t ¶ 127 ("Klausner Technology informed Vonage in January 2006 that Vonage was in f rin g in g one of its patents . . ."). However, nowhere in the Amended Complaint d o e s Lead Plaintiff allege that Verizon, AT&T, and Klausner were initiating, or e v e n threatened, litigation. Rather, quoting Vonage's own Prospectus, Lead

P la in tif f avers in a conclusory manner that claims of infringement or the e n f o rc e m e n t of any of the patents would have a material impact on Vonage's b u s in e s s and share price. Compl., at ¶ 130. Thus, the Amended Complaint fails to p le a d that the lawsuits were substantially certain to occur during the relevant period o f time.1 2 Simply put, Lead Plaintiff has only alleged a "possibility of litigation" ra th e r than any pending or threatened legal proceeding, which in this Circuit is not

12

Plaintiff referenced in the Amended Complaint a press release dated June 16, 2006, issued by Vonage, which announced the Verizon Lawsuit. The release explicitly stated that Vonage had "not previously been notified by Verizon regarding the seven patents identified in the lawsuit." See Press Release dated June 16, 2006. -32-

actionable under the Securities Act.13 N e v e rth e le s s , while the Court is aware that a mere infringement notice does n o t constitute a threat of litigation in a patent context, see Amsted Indus. v. Buckeye S te e l Castings Co., 24 F.3d 178, 187 (Fed. Cir. 1994), the nature of the alleged n o tic e s given to Vonage is not clear from the face of the Amended Complaint. In f a c t, the contents of the alleged emails, letters and meetings are not before the Court a n d , as such, there is no basis to definitively find that Lead Plaintiff could never p le a d this claim, especially since Vonage has, shortly after the IPO, acknowledged th e existence of a lawsuit brought by Verizon. Accordingly, Lead Plaintiff shall be g iv e n leave to amend this claim if it can allege in good faith that the events and w ritin g s before the issuance of the IPO make clear that litigation was substantially c e rta in to occur. III. A ffir m a tiv e Defense of Negative Causation

W h ile the Court has dismissed Counts I - V against Defendants, the Court

13

To the extent Plaintiff argues that the risk of infringement claims renders misleading Vonage's disclosure that it developed its software internally, the Court finds Lead Plaintiff's argument unavailing. Patent law provides an inventor with protection against persons who appropriate his/her inventions and also provides the inventor with protection against persons who develop the same invention independently. See Russell v. Trimft, Inc., 428 F.Supp. 91, 93 (E.D. Pa. 1977). Even if Vonage's software did infringe another company's patent, that fact alone does not render Vonage's statement misleading because Vonage's software can still be internally developed and yet infringe on a patent already developed. Patents only reserve to the patent holder the right to use the technology, but it does not preclude others from developing the same or similar technology. Further, there is no allegation that Vonage copied or otherwise misappropriated its technology. -33-

will nevertheless engage in the analysis of Negative Causation in the event Lead P la in tif f moves to amend its Amended Complaint. As an affirmative defense, D e f e n d a n ts argue that even if Lead Plaintiff had sufficiently alleged disclosure c la im s against them, Counts I - III should be dismissed because it is apparent from th e face of the Complaint that none of the investor plaintiffs' supposed losses stem f ro m the revelation of the information that Lead Plaintiff identifies as being omitted f ro m the Prospectus. As a legal matter, however, section 11 plaintiffs do not have to plead loss causation. In re Merk & Co., Inc. Securities Litigation, 432 F.3d 261, 2 7 4 (3d Cir. 2005). Instead, "it is an affirmative defense in section 11 cases; d e f e n d a n ts can limit damages by showing that the plaintiffs' losses were caused by s o m e th in g other than their misrepresentations." Id. (citing 15 U.S.C. § 77k(e)). In o th e r words, it is Defendants' burden to prove that negative causation exists, which w ill limit their damages. In re Adams Golf, Inc. Sec. Litigation, 381 F.3d 267 (3d C ir. 2004). The same pleading requirements exist for a § 12 claim. In re Suprema S p e c ., 438 F.3d at 269-70. Indeed, the Third Circuit has stated that loss causation, a s an affirmative defense, may not be generally used to dismiss a plaintiff's c o m p la in t under Rule 12(b)(6). Adams Golf, 381 F.3d at 277. While the Third Circuit, in other contexts, has held that a "complaint may be d is m is s e d under Rule 12(b)(6) where an unanswered affirmative defense appears o n its face," Victaulic Co. v. Tieman, 499 F.3d 227 (3d Cir. 2007), in the securities

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context, Defendants bear the burden of proving that the stock drop was caused by s o m e th in g other than the misleading registration statement. As the court in In re IP O Sec. Litig. held, although section 11(e) does provide that damages should be re d u c e d to the extent that loss is attributable to something other than a misstatement in the registration statement, that provision is an affirmative defense, with the b u rd e n of proof explicitly on the defendant. 241 F.Supp. 2d 281, 351 (S.D.N.Y. 2 0 0 3 )(c ita tio n s omitted). "Whether losses were attributable to other sources is n e c e s s a rily a fact question; plaintiffs are certainly not required to plead that the o f f e rin g price was artificially inflated in order to successfully state a Section 11 c l a i m ." Id. at 351 n. 80; see Herman & MacLean, 103 S.Ct. 683 (plaintiff "need o n ly show a material misstatement or omission to establish his prima facie case"). Furthermore, Defendants contend that Plaintiff's claims must be dismissed b e c a u s e plaintiffs in this case sold their shares prior to a corrective disclosure and th u s have "no damages." Due to the nature of the negative causation defense, s e c tio n 11 can be said to create a factual presumption that "any decline in value is ... caused by the misrepresentation in the registration statement." McMahan & Co. v . Wherehouse Entm't, Inc., 65 F.3d 1044, 1048 (2d Cir.1995) (citing Greenapple v . Detroit Edison Co., 618 F.2d 198, 203 n. 9 (2d Cir.1980) ("plaintiff need show n o causal connection between the decline in the price of the security and the m a te ria lly false misstatement or omission")). Thus, because an analysis of causation

-35-

is often fact-intensive, negative causation is generally established by a defendant on a motion for summary judgment or at trial. Levine v. AtriCure, Inc., 508 F.Supp. 2 d 268, 273 (S.D.N.Y. 2007). "To conclude otherwise places a burden of pleading lo s s causation on the plaintiffs, and removes the burden of establishing negative c a u s a tio n from the defendants, where it properly lies." In re WRT Energy Sec. L itig ., No. 96 Civ. 3610, 2005 WL 2088406, at *2 (S.D.N.Y. Aug. 30, 2005). In support of the contrary position, Defendants rely primarily upon In re M e rrill Lynch & Co. Research Reports Sec. Litig., in which Judge Pollack granted a defense motion to dismiss a § 11 claim pursuant to Rule 12(b)(6) based on the a b s e n c e of loss causation, after finding that the absence of loss causation was a p p a re n t from the face of the complaint. 272 F.Supp.2d 243, 255 (S.D.N.Y.2003). T h e court relied on a finding that the decline in plaintiff's share price was p ro p o rtio n a l to sector-wide declines and plaintiff's losses occurred before the first a lle g e d disclosure of the omission. However, the court cited no other cases in which a Rule 12(b)(6) motion to dismiss was granted based on the absence of loss c a u s a tio n in a § 11 claim. Defendants further rely on several additional cases d is m is s in g § 11 complaints pursuant to Rule 12(b)(6) where the complaint failed to a lle g e any corrective disclosures before plaintiffs sold their securities. See Davidco In v e sto rs , LLC v. Anchor Glass Container Corp., No. 04-2561, 2006 WL 547989, a t *2 4 (M.D.Fla.2006); In re Alamosa, 382 F.Supp. 2d at 866; In re McKesson

-36-

HBOC Secs. Litig., 126 F.Supp.2d 1248, 1262 (N.D.Cal.2000). However, these cases fail to recognize the possibility that declines in stock p ric e prior to broad public disclosure may be reflective of leaking of relevant in f o rm a tio n into the marketplace, which is a fact-sensitive inquiry. For example, in the present case, the Bustos litigation was filed on May 19, 2006 - prior to investors' sales of their securities. If the omission of the fax service defect is material, Plaintiff may ultimately be able to show that investors had knowledge of the Bustos action prior to the tim e they sold their shares, which may have caused the decline in the price of V o n a g e 's stock. In the Court's view, failure to recognize the possibility of material in f o rm a tio n being released to the marketplace improperly ignores the presumption o f causation, at least where declining prices prior to the sale of plaintiffs' shares are n o t shown to be consistent with sector-wide performance ­ a scenario which D e f e n d a n ts have not presented at this juncture. See In re Merrill Lynch, 272 F .S u p p .2 d at 255 (dismissing § 11 claim at Rule 12(b)(6) stage where decline in p la in tif f 's stock value prior to first alleged disclosure was consistent with s e c to r-w id e declines). Simply, at the Rule 12(b)(6) stage, Lead Plaintiff does not h a v e the burden to present evidence demonstrating loss causation. It should be n o te d in claims brought under § 10(b), that the burden of pleading and eventually p ro v in g loss causation is on the plaintiff and his or her failure to do so is proper g ro u n d s for dismissal. In contrast, plaintiffs have no obligation to plead or prove

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loss causation in § 11 or § 12 cases, rather, causation is presumed. McMahan & C o ., 65 F.3d at 1048.

V I.

V o n a g e 's Status Pursuant to the Securities Act

V o n a g e alternatively contends that Count IV fails to state a claim against it b e c a u s e Vonage did not offer or sell securities to Lead Plaintiff. Under § 12(a)(2), a person who "offers or sells" a security by means of a misleading prospectus is lia b le "to the person purchasing such security by him." 15 U.S.C. § 771(a). The T h ird Circuit has interpreted this provision to require a relationship between a buyer a n d seller of securities that is "`not unlike traditional contract privity.'" In re W e s tin g h o u s e Sec. Litig., 90 F.3d 696, 715 (3d Cir. 1996)(quoting Pinter v. Dahl, 4 8 6 U.S. 622, 642 (1988)). In so doing, the Circuit recognized only two types of s e lle rs who have such a relationship with securities purchasers: (1) "one who passes title to the buyer for value (a direct seller)" ` and (2) one who "successfully solicits th e purchase, motivated at least in part by a desire to serve his own financial in te re s ts or those of the securities owner' (a solicitor seller)." In re Westinghouse, 9 0 F.3d at 716 (quotations omitted). Plaintiff alleges that Vonage was both a direct a n d solicitor seller. However, Defendants contend that it is apparent from the face o f the Complaint that Vonage was neither. In In re Craftmatic Securities Litigation, 890 F.2d 628 (3d Cir.1989) the

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Third Circuit cautioned that "the language of § 12, which makes a participant liable to the `person purchasing such a security from him ...,' precludes actions against re m o te sellers, and focuses the inquiry on the relationship between the purchaser a n d the participant, rather than on the latter's degree of involvement in the tra n s a c tio n ." Id., 890 F.2d at 636 (citation omitted). With regard to solicitation lia b ility, "although an issuer is no longer immunized from § 12 liability, neither is a n issuer liable solely on the basis of its involvement in preparing the prospectus. T h e purchaser must demonstrate direct and active participation in the solicitation of th e immediate sale to hold the issuer liable as a § 12(2) seller." Id. (citations o m itte d ). Notably, the court in In re OPUS360 Corp. Sec. Litig., No. 01-2938, 2002 W L 31190157, at *10 (S.D.N.Y. 2002), opined