United States District Court, N.D. California, San Jose Division
CITY OF SUNRISE FIREFIGHTERS' PENSION FUND, et al., Plaintiffs,
v.
ORACLE CORPORATION, et al., Defendants.
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
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