City of Sunrise Firefighters' Pension Fund v. Oracle Corp.

          ORDER GRANTING DEFENDANTS' MOTION TO DISMISS WITH LEAVE TO AMEND [RE: ECF 44]

          BETH LABSON FREEMAN, UNITED STATES DISTRICT JUDGE

         This is a putative class action for securities fraud brought against Oracle Corporation (“Oracle” or “Company”) and its officers Safra A. Catz (“Catz”), Mark Hurd (“Hurd”), Lawrence J. Ellison (“Ellison”), Thomas Kurian (“Kurian”), Ken Bond (“Bond”), and Steve Miranda (“Miranda”) (“Individual Defendants”), (collectively with Oracle, “Defendants”). Lead Plaintiff, Union Asset Management Holding AG, (“Plaintiff”) has filed a Consolidated [Amended] Class Action Complaint (the “CAC”) alleging that Defendants violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5, 17 C.F.R. § 240.10b-5. See ECF 40 (“CAC”). Plaintiff also asserts that Catz, Hurd, and Ellison are liable for violations of federal securities laws as “control persons” of Oracle, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). Id. Finally, Plaintiff claims Kurian violated Section 20A of the Exchange Act by selling Oracle common stocks. Id.

         I. BACKGROUND

         Oracle develops and markets database software and related technology. CAC ¶ 38. The Individual Defendants are six current or former Oracle executives: Safra A. Catz (co-CEO and a member of Oracle's Board of Directors); Mark Hurd (co-CEO, a member of Oracle's Board of Directors, and former co-president); Lawrence J. Ellison (co-founder, former CEO, current Chief Technology Officer, and Chair of the Board of Directors); Thomas Kurian (former President, Product Development); Ken Bond (Senior Vice President of Investor Relations); and Steve Miranda (Executive Vice President of Oracle Applications Product Development). Id. ¶¶ 30- 35.

         Oracle's business historically focused on selling licenses for its “on-premises” database software and products, which are installed locally, on a licensee's own computer and maintained on the user's own infrastructure and platforms. CAC ¶ 38. In contrast, “cloud-based” software allows licensees to store and access data over the internet. Id. ¶ 39. According to the CAC, companies such as Amazon, Google, and Microsoft introduced their cloud-based software between 2006 and 2010, while “Oracle was stubbornly refusing to acknowledge that customers were increasingly shifting towards cloud technology.” Id. ¶¶ 40-41. Oracle's revenue growth and new software license sales declined between 2013 and 2016. Id. ¶ 47. Oracle “belatedly pivoted to the cloud in high gear.” Id. ¶ 48.^[1] On a March 15, 2016 Earnings Call, Catz announced that Oracle was “making the ‘move to cloud' which would represent ‘a generational shift in technology that [wa]s the biggest and most important opportunity in [the] Company's history.'” Id.

         “As a late entrant in the cloud software market, ” Oracle had to develop (1) “a cloud product with competitive capabilities” and (2) “an effective sales and marketing strategy for its nascent cloud product.” CAC ¶ 51. To overcome these challenges, the CAC alleges that Oracle engaged in “coercive sales practices.” See Id. ¶¶ 82-149. Oracle allegedly employed “two tactics to generate artificial cloud revenue, ” which Oracle employees coined as “financially engineered deals.” Id. ¶¶ 13, 16.

         First, Oracle allegedly employed a strategy called “Audit, Bargain, Close.” CAC ¶ 14. Under this strategy, Oracle would first initiate an audit of an on-premises customer for violations of its on-premises software license. Id. If it found violations, Oracle would “threaten to impose large penalties unless the customer agreed to purchase a short-term cloud subscription.” Id. The CAC alleges that customers “neither desired nor intended to use” the Cloud products but purchased them to avoid the hefty penalties. Id.

         Second, Oracle allegedly engaged in a tactic known as “attached deal[s].” CAC ¶ 15. Oracle offered its customers “a significant discount” on its on-premises products, provided the customer also purchased a short-term cloud subscription - “even if the customer neither wanted nor intended to use the attached cloud product.” Id.

         The CAC alleges that the “Audit, Bargain, Close” and “Attached” deals (collectively, “Sales Practices”) were not “true sales” of Cloud products but Oracle nonetheless touted them as such- and by doing so, misled investors because the revenues generated by these deals were “artificial and unsustainable.” CAC ¶ 17. According to the CAC, in late 2017, many of the Cloud subscriptions generated through the Sales Practices began to expire and many customers declined to renew their Cloud subscriptions. Id. ¶ 18. Consequently, between December 14, 2017 and March 19, 2018, Oracle disclosed that its Cloud revenue growth rate had declined from 58% to 32%. Id. ¶ 19. The market reacted and Oracle's stock price fell from approximately $50 per share to approximately $46 per share, a decline of nearly 10%. Id. ¶ 21. On June 19, 2018, Oracle announced that it would no longer report financial results for its Cloud business separately. Id. ¶ 22.

         Based on these allegations, Lead Plaintiff, Union Asset Management Holding AG^[2](“Union”), brings this lawsuit on behalf of itself, and other purchasers of Oracle stock between March 15, 2017 and June 19, 2018 (the “Class Period”), alleging that Defendants misrepresented Oracle's revenue growth within its Cloud segment and the drivers of that growth. See CAC ¶¶ 2-12.

         A. Confidential Witnesses

         The CAC provides statements from nine former Oracle employees regarding the Sales Practices. CAC ¶¶ 37, 87-134.

         Confidential Witness^[3] (“CW1”) was a Regional Sales Director for Middle East and Africa from February 2009 to March 2018. CAC ¶ 37. CW1 sold Cloud and other Oracle products to customers and attended meetings at which Cloud sales were discussed. Id. CW1 stated that at least 80% of Middle East and Africa Cloud revenue was generated by “inserting cloud into compliance-based deals” and that it was “crystal clear these [sales] are fake” because “none of these deals are renewed.” Id. ¶¶ 87, 106. Further, more than 75% of CW1's team's Cloud sales in 2017 were made to customers under threat of license audits, who purchased the product simply to avoid the hefty penalties. Id. ¶ 102. In 2018, such sales accounted for 86% of CW1's team's revenue. Id.

         CW1 also reported that he (and other sales teams) discussed their “audit-driven cloud deals” with Loic Le Guisquet, who sat on the Oracle Executive Management Committee during the Class Period and reported directly to Hurd. CAC ¶ 112. CW1 explained that, he prepared weekly slides concerning “sales volume and progress” and provided them to Le Guisquet for presentation to Hurd. Id. These slides, according to CW1, “would very clearly say” that Oracle's License Management Services division was engaged in “compliance deals.” Id. In addition, CW1 attended meetings in which “executives were instructed to offer customers a 90% discount on on-premises licenses if they purchased $300, 000 worth of cloud subscriptions” and “assure the customer that they did not need to use the product, and that the purchase of cloud products was merely a necessary condition to unlocking the on-premises discount.” Id. According to CW1, sales and compliance teams coordinated to “use audits in order to sell unwanted cloud subscriptions.” Id. ¶ 89.

         Confidential Witness 2 (“CW2”) was a Vice President in North America Cloud sales from September 2015 to December 2018, who spoke with customers and sales personnel about sales of Oracle Cloud products. CAC ¶ 37. CW2 stated that “90-95% of the cloud deals [CW]2's team dealt with had no ‘use cases' attached to them.” Id. ¶ 103^[4]. CW2 learned from speaking with customers and sales personnel that “customers neither intended to use nor renew the cloud products.” Id. ¶ 104. CW2 stated, he “saw presentations that went to Hurd's directs” and “the info they were receiving about deal quality and it was absolutely something that was discussed.” Id. ¶ 180.

         Confidential Witness 3 (“CW3”) was a Senior Technology and Cloud Sales Consultant in Southern California from 2012 to March 2017, who supported all of Oracle's Southern California Cloud sales. CAC ¶ 37. CW3 described an increase in the frequency of Oracle's audits in fiscal year 2017 and characterized the audit-based sales as “an active practice”. Id. ¶ 109.

         Confidential Witness 4 (“CW4”) was Vice President of Global Sales Engineering, who served as General Manager of Sales Engineering in 2015 and reported to Miranda. CAC ¶ 37. CW4 sold the first iterations of Oracle's Cloud product. Id. CW4 also reported on the cooperation of audit and sales divisions in creating the audit-based sales. Id. ¶ 90. CW4 stated that most Cloud sales were driven by “extortion” through the audit process and that Oracle knew that customers were not planning on renewing their Cloud subscriptions and “sales leadership often expressly communicated to customers that they could “wash [their] hands” of Cloud products after the contract expired but keep the discounts for on-premises products. Id. ¶ 118.

         Confidential Witness 5 (“CW5”) was a Director of Cloud Customer Success at Oracle from 2016 to October 2018 and led the team responsible for Cloud customer success and renewal for Cloud products. CAC ¶ 37. CW5 stated that customers were forced to purchase Cloud products under threat of audits and that that these customers would be “irate” when the customer success team contacted them to ask how they could get them to “deploy and expand their Cloud footprint.” Id. ¶ 87. According to CW5, many of the Cloud contracts were called “dead on arrivals” or “DOA^[5], ” because when it came time to renew, the customers would refuse. Id. ¶ 122. CW5 explained that “Oracle's renewal rate was 15-20% for certain quarters, and that the percent of DOA customers that did not renew was 90%.” Id. ¶ 125.

         Confidential Witness 6 (“CW6”) was a Channel Sales Representative from October 2010 to January 2018 and worked with authorized resellers to engineer deals with customers in the Northeast Region. CAC ¶ 37. CW6 learned from vendor partners that Oracle customers were “made to purchase products under threats of audit” and that this was a “regular practice.” Id. ¶ 92. CW6 heard from sales representatives that Oracle “would bundle things together and push cloud subscriptions right through” and that customers did not “underst[and] what they were getting in terms of cloud.” Id. ¶ 131.

         Confidential Witness 7 (“CW7”) was a Regional Technology Sales Director at Oracle from February 2013 to October 2018 and was responsible for Oracle's Cloud business in the Czech Republic, Hungary, and Slovakia. CAC ¶ 37. CW7 stated that 65% of his teams' Cloud sales were made through engineered sales, including Attached deals. Id. ¶ 116. CW7 stated that 90% of customers with Attached deals were not using their Cloud products “throughout 2017 and 2018.” Id. ¶ 119.

         Confidential Witness 8 (“CW8”) was a Cloud Platform Sales Manager at Oracle from March 2013 to July 2018 and managed a North America Cloud sales team. CAC ¶ 37. CW8 stated that it was “extremely common to provide very steep discounts to on-premise licenses in exchange for a customer purchasing cloud subscriptions, ” estimating that more than 75% of CW8's Cloud revenue came from Attached deals. Id. ¶ 120. Less than 10% of CW8's clients renewed their Cloud subscriptions at the same level they initially signed up for. Id.

         Confidential Witness 9 (“CW9”) was a Director of Cloud Customer Success and Customer Experience at Oracle from 2016 to 2018, whose team was responsible for customer adoption and expansion of Cloud. CAC ¶ 37. CW9 also described the DOA deals and explained that customers told CW9's team that they subscribed to the Cloud product in order to get a better deal on another product. Id. ¶¶ 122-23. According to CW9, renewals for the Cloud product subscriptions would range from only 15%-25% and that 90% of the accounts that did not renew were DOA. Id. ¶ 125.

         Additionally, CW1 stated that all deals worth more than $5 million dollars had to be approved by “HQ, ” meaning either Hurd or Catz. CAC ¶ 110. CW1 further stated that “he would see Hurd's and Catz's names on approvals of ‘compliance' deals … and in approval notifications that were released once Hurd or Catz signed off on the deal.” Id. Also, according to CW3, all software discounts in excess of 50% had to be approved by Hurd's office, and “80% of [CW3's] engineered deals went to Hurd's office for approval.” CAC ¶ 134.

         B. Other Allegations Regarding Oracle's Sales Practices

         The CAC provides a few examples to corroborate allegations that Oracle engaged in the allegedly coercive Sales Practices.

         First, Plaintiff alleges, based on documents obtained by a CBS reporter, that on July 27, 2016 (prior to the Class Period), Oracle initiated an audit of one of its on-premises customers: City of Denver. CAC ¶¶ 93-101. According to the CAC, an Oracle sales manager “pressured Denver to quickly make a deal to resolve the audit, telling Denver that further delay could result in a tripling of its audit penalties from approximately $3 million to ‘in excess of $10M.'” Id. ¶ 96. On December 22, 2016, Oracle told Denver that it would need to pay an extra $2 million to “right size” its on-premises licensing, unless it purchased a one-year subscription to Oracle's Cloud. Id. ¶ 99.^[6]

         Second, CW1 reported that Oracle, at an unspecified time, “attached” $22 million dollars in “unwanted” Cloud products to a $120-million-dollars deal with Saudi Telecom Company. CAC ¶ 106. According to the CAC, local government regulations prevented Saudi Telecom Company from using Cloud data centers outside of the country and, at the time of the purchase, there were no in-country Oracle data centers. Id. ¶ 107. Saudi Telecom Company, nevertheless, purchased Oracle's Cloud products for 22 million dollars “effectively purchasing a discount on audit penalties.” Id.

         Third, on September 11, 2015 (prior to the Class Period), Chilean anti-competition regulators initiated an investigation into alleged anticompetitive conduct by Oracle. CAC ¶¶ 137-46. On March 28, 2018, the Chilean regulators issued a report finding links between audits and sale of Cloud products, which in their opinion constituted an “abuse of a dominant position.” Id. ¶ 144. Oracle did not acknowledge any wrongdoing or that it engaged in the underlying practices but nevertheless agreed to implement a series of corrective measures recommended by the Chilean regulators. Id. ¶¶ 145-46.

         Fourth, several advisory firms-specifically, UpperEdge (April 10, 2018), Gartner (May 23, 2018), and Palisade Compliance (January 2, 2019)-warned of Oracle's practice to use audits in order to sell Cloud products. CAC ¶¶ 147-49.

         Fifth, Clear Licensing Counsel, a European organization that advocates for the interests of software consumers, sent a letter on January 6, 2015 (prior to the Class Period) to Ellison and Oracle's Board of Directors, including Hurd and Catz. CAC ¶ 57. The letter (later released publicly) warned Oracle executives of “deep-rooted mistrust of [Oracle's] core customer base as a result of [Oracle's] auditing and licensing practices.” Id. ¶¶ 58-59.

         C. Allegedly False or Misleading Statements

         Plaintiff alleges that Defendants made a number of false and misleading statements within the Class Period. See CAC ¶¶ 209-74. Primarily, these statements fall into the following categories:

         1. Statements related to the cloud-based products' revenue growth

         Some of the alleged misstatements touted the rapid growth of cloud-based revenue. For example:

• “Our fourth quarter results were very strong as revenue growth and earnings per share both substantially exceeded the high end of guidance. . . . We continue to experience rapid adoption of the Oracle Cloud led by the 75% growth in our SaaS business in Q4. This cloud hyper-growth is expanding our operating margins, and we expect earnings per share growth to accelerate in fiscal 2018.” (CAC ¶ 229, statement by Catz on June 21, 2017).

• “We sold $855 million of new annually recurring cloud revenue (ARR) in Q4, putting us over our $2 billion ARR bookings goal for fiscal year 2017 . . . . We also delivered over $1 billion in quarterly SaaS revenue for the first time. Next year is going to be even better. We expect to sell a lot more than $2 billion in new cloud ARR in fiscal year 2018.” (CAC ¶ 230, statement by Hurd on June 21, 2017).

         Plaintiff alleges that these statements were materially false and misleading when made, because Defendants stated that Oracle was experiencing “rapid adoption” of its Cloud products, “hyper-growth” of its Cloud business, and emphasized its large sales figures without disclosing that: “(1) a material portion of Oracle's cloud revenue was driven by ‘financially engineered deals' that were based on Oracle's use of the coercive ‘Audit, Bargain, Close' and ‘attached' deal tactics; (2) the revenue produced through these deals was artificial because it did not result from true purchases of Oracle's cloud products, but rather resulted from clients purchasing a discount on audit penalties or on-premises products; and (3) consequently, a material portion of the reported cloud revenue and revenue growth did not consist of true cloud sales, and was not sustainable.” Id. ¶ 231.

         Another set of the alleged misstatements relate to the sustainability of Cloud revenue growth. For example:

• “The sustained hyper-growth in our multi-billion dollar cloud business continues to drive Oracle's overall revenue and earnings higher and higher . . .” (CAC ¶ 242, statement by Catz).

• “So this is absolutely not a 1-year phenomena. In fact, what you should see, as this goes on, is we will have less drag from the transition and the base will continue to grow. And so this should really accelerate. And understand that in our PaaS-IaaS business, we're not even at scale. So as we really scale that up, profitability is going to increase more quickly and revenues will be built on the base of another recurring revenue -- of the recurring revenue business.” (CAC ¶ 236. Statement by Catz, June 21, 2017)

         Plaintiff claims that it was misleading for Catz to state that Oracle's Cloud business was experiencing “sustained hyper-growth” and to emphasize the Company's Cloud growth was “absolutely not a 1-year phenomena, ” while failing to disclose that: “(1) a material portion of Oracle's cloud revenue was driven by ‘financially engineered deals' that were based on Oracle's use of the coercive ‘Audit, Bargain, Close' and ‘attached' deal tactics; (2) the revenue produced through these deals was artificial because it did not result from true purchases of Oracle's cloud products, but rather resulted from clients purchasing a discount on audit penalties or on-premises products; and (3) consequently, a material portion of the reported cloud revenue and revenue growth did not consist of true cloud sales, and was not sustainable.” Id. ¶¶ 243, 237.

         Several of the alleged misstatements relate to Oracle customers' adoption of Cloud products. For example:

• “[a]s we move to cloud, the first thing that we see is we start to address more of the customer spend. The customers are willingly making a choice, where they're forgoing their traditional multi-vendor strategy, spending money on software, then another vendor for hardware, another for labor and so on to going to a single vendor. And that product provider, in the case it's Oracle, it does mean a fairly significant uplift in revenue for Oracle.” (CAC ¶ 222, statement by Bond on May 9, 2017).

• “[w]hat do we hear from our customers as far as the reasons why they choose us over competition? First and foremost, across the board, most customers today are moving to SaaS for speed. It's all about speed of innovation, speed of reaction, speed of either disrupting others in their industry or speed to be avoided in that disruption.” (CAC ¶ 252, statement by Miranda on October 5, 2017).

         Plaintiff alleges these statements were materially false and misleading when made because Defendants stated that “customers [] willingly making a choice” to abandon a “multi-vendor strategy” to consolidate with Oracle, or that Oracle's speed was causing its customers to adopt the Cloud products without disclosing that: “(1) a material portion of Oracle's cloud revenue was driven by ‘financially engineered deals' that were based on Oracle's use of the coercive ‘Audit, Bargain, Close' and ‘attached' deal tactics; (2) the revenue produced through these deals was artificial because it did not result from true purchases of Oracle's cloud products, but rather resulted from clients purchasing a discount on audit penalties or on-premises products; and (3) consequently, a material portion of the reported cloud revenue and revenue growth did not consist of true cloud sales, and was not sustainable.” Id. ¶¶ 223, 253.

         Finally, Plaintiff alleges that Defendants made false or misleading statements about the reasons Cloud revenue growth was decelerating. For example, on December 14, 2017 Ellison responded to an analyst question about the case of Oracle's revenue slowdown by stating “a lot of customers are waiting for” Oracle's next generation cloud product, “the Autonomous Database, ” a cloud database that uses machine learning to reduce the need for periodic maintenance, “just to become available.” CAC ¶ 264. In Plaintiff's view, this statement was misleading because “in truth, the deceleration of cloud revenue was caused by the fact that Oracle was finding it increasingly difficult to use the [Sales Practices] to push its cloud products on customers who did not want them” and customers were not renewing the deals “they had previously been pushed into.” Id. ¶ 265.

         2. Statements related to the allegedly coercive Sales Practices

         On May 9, 2017, an analyst asked Bond to “give us some sort of indication as to what percentage of revenue and margin is associated with auditing practices of customers.” CAC ¶ 224. In response, Bond made the following statements:

- “This is one of those things where - gets talked about a lot. And I think this is one of those things where the story is a lot bigger than the realities.”

- “And we try to do it as best we can, in as gracious [a] way as we can.”

- “[o]n the other hand, the key, as we go to cloud, is this conversation is going to go away.”

- “[A]s we go to cloud, we don't have to worry about that anymore. Because when you're in the cloud, you basically have a number of users that you've signed up for.”

Id. Plaintiff alleges that these statements were materially false and misleading when made, because Bond “den[ied] that Oracle used audits to drive cloud sales, and that Oracle's audits were not coercive, without disclosing that a material portion of Oracle's cloud revenue was, in fact, driven by ‘financially engineered deals' that were based on Oracle's use of the coercive ‘Audit, Bargain, Close' tactic.” Id. ¶ 225.

         As another example, on May 22, 2018, in response to a report by The Information, the Company stated:

• “Oracle, like virtually every other software company, conducts software audits in limited circumstances to ensure that our products are used as licensed. We pride ourselves in providing our existing 400, 000 customers a variety of options to move to the cloud when they are ready. Oracle is grateful to its large and growing customer base and has no reason to resort to scare tactics to solicit business. We are disappointed that The Information is presenting inaccurate accounts regarding a handful of customers, based on anonymous sources or competitors who seek to enhance their own consulting services.”

CAC ¶ 273. The CAC alleges that this statement was also misleading because Oracle “den[ied] that Oracle used audits to drive cloud sales, and state that Oracle had ‘no reason to resort to scare tactics to solicit business,' without disclosing that a material portion of Oracle's cloud revenue was, in fact, driven by ‘financially engineered deals' that were based on ...