Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—N.D. Cal.: Fraud action against Aerohive dismissed for inadequate pleading, (Feb 6, 2019)

By Rebecca Kahn, J.D.

Statements about company's sales restructuring neither false nor misleading.

A California district court dismissed shareholders’ fraud action against a cloud platform company for failing to adequately plead actionable misrepresentations or omissions. Statements concerning the company’s restructuring were neither false nor misleading and revenue projections were protected by the PSLRA safe harbor. Confidential witnesses supporting the shareholders’ claims lacked personal knowledge and reliability because the complaint failed to specify their responsibilities as employees within the company. Shareholders were granted leave to amend (McGovney v. Aerohive Networks, Inc., February 5, 2019, Koh, L.).

Aerohive. Aerohive Networks, Inc. designs and develops a cloud networking platform servicing healthcare, education, and retail industries worldwide. Aerohive reaches most of its end-user customer base through reseller and distributor "channel partners" supported by the Aerohive’s sales organization. In 2017, the company announced a major overhaul of Aerohive’s sales organization and strategy in order to improve profits. In addition to installing new sales leadership, Aerohive sought to "unbundle" its product and service offerings and grow its business with its strategic partner, Dell.

Projected earnings. Aerohive CFO John Ritchie had gone on record projecting fourth quarter revenues in 2017 from $40 million to $42 million. The plaintiffs contended this was misleading because the company failed to disclose adverse facts about Aerohive’s business, operational and financial results. On January 16, 2018, Aerohive put out a press release expecting Q417 net revenue to be approximately $37 million. Aerohive’s share price fell $1.63, or 28.6 percent, to close at $4.07 on January 17, 2018.

Alleged violations. Investors sued Aerohive and certain officers, including CEO David K. Flynn and Ritchie, for Exchange Act Sections 10(b) and 20(a) violations between November 1, 2017 and January 16, 2018. The complaint alleged that the sales execution strategy was flawed and those flaws had been hidden from investors. In addition, the plaintiffs alleged that, between November 1, 2017 and January 16, 2018, Aerohive made false or misleading statements or omissions regarding sales personnel issues, sales execution, and projected revenues in its 3Q17 Form 10-Q and 3Q17 earnings call.

The plaintiffs alleged that "while sales efficiency and productivity metrics" presented by Aerohive "were technically accurate," they were touted as evidence of the company’s successful implementation of their new sales strategy, while concealing the fact that the company had "resorted to cost-cutting measures to compensate for lower than expected revenues."

Consolidated action. Aerohive shareholders filed three separate suits against the company, alleging violations of Sections 10(b) and 20(a) of the Exchange Act. The actions were consolidated and filed in September 2018. Defendants moved to dismiss.

Confidential witnesses. The plaintiffs alleged that the shakeup of its sales personnel "hurt morale" and relied on information from former Aerohive employees, identified as "Confidential Witnesses" ("CWs"). But the defendants pointed out that the CWs could not have had personal knowledge of Aerohive’s 4Q17 external revenue guidance or performance, as none of them had been employed by Aerohive when its 4Q17 revenue guidance was issued. The defendants further argued that the complaint failed to allege what the CWs did or how they know what they know.

The court ruled that the plaintiffs failed to allege that the CWs had personal knowledge because the complaint stated their job titles and dates of employment, but did not include job descriptions and duties. The Ninth Circuit requires that confidential witnesses be described with a "large degree of specificity," including not just the witnesses’ job description, but also his or her responsibilities. As currently alleged, the court ruled, the CWs lacked personal knowledge and reliability because the complaint failed to include these details.

Nonactionable. The court ruled that certain statements at issue were nonactionable because they were true (and therefore not misleading) and, in any case, not accompanied by sufficient allegations. Projected revenues were forward-looking, protected by the PSLRA’s safe harbor.

Incomplete information. The plaintiffs challenged the statements as false or misleading, alleging that the defendants knew but omitted material information concerning sales personnel issues and sales strategy failures. They did not contest that the defendants’ statements were technically true, but rather argued that they were incomplete. But, the court noted, Sections 10(b) and Rule 10b-5(b) do not create an affirmative duty to disclose any and all material information.

Securities laws prohibit only misleading and untrue statements, not statements that are incomplete, and the plaintiffs failed to specify why the statements were misleading or untrue. For example, the plaintiffs alleged that Aerohive was understaffed but only vaguely discussed how some staff had been fired, some left, and new employees were brought in. The plaintiffs failed to provide allegations to quantify the actual staffing problems, which made it difficult for the court to determine the severity of the problem or whether it actually had an impact on revenue. Without this information, it is difficult to assess the falsity of the defendants’ statements, the court wrote.

Because the plaintiffs failed to plead a primary securities law violation under Section 10(b), their Section 20(a) claim was also dismissed.

The case is No. 18-cv-00435-LHK.

Attorneys: Laurence Matthew Rosen (The Rosen Law Firm P.A.) for Jacob McGovney. Jennifer Pafiti (Pomerantz LLP) for Andre Moreau. John Charles Roberts, Jr. (Wilson Sonsini Goodrich & Rosati) for Aerohive Networks, Inc.

Companies: Aerohive Networks, Inc.

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