Oracle and its senior management suffered a significant loss in federal court yesterday involving Oracle's Audit, Bargain, Close (“ABC”) predatory sales and audit tactics. In a sweeping 54 page opinion, Judge Freeman of the Northern District of California has granted in part and denied in part Oracle's motion to dismiss a class action securities fraud lawsuit, which alleged that Oracle used predatory software audits to drive sales of its cloud products, and then omitted to tell the public about all the potential reasons for Oracle's increasing and later decreasing cloud sales. The Plaintiff will be allowed to pursue only its omission based securities fraud claims against Oracle and senior management Larry Ellison, Mark Hurd, Safra Catz, and Ken Bond. All other securities fraud theories alleged in the SAC were dismissed. Defendants Thomas Kurian and Steve Miranda were dismissed from the lawsuit with prejudice. The remaining Defendants have 30 days to file an Answer to the Second Amended Complaint (“SAC”).
Background Facts
Judge Freeman's Order sets out the background facts alleged in the SAC.
“Oracle allegedly employed a strategy called “Audit, Bargain, Close,” also referred to as “ABC.” SAC ¶¶ 16, 95-128. Under this strategy, Oracle would install its software on on-premise client ecosystems “with a variety of preferences automatically enabled that, unbeknownst to the customer, caused the customer to arguably—and unknowingly—exceed the limits of its license.” Id. ¶ 16. The company would then initiate an audit of an on-premises customer for violations of its on-premises software license. Id. When it found violations, Oracle would “threaten to impose extremely large penalties” that it would abate only if “the customer agreed to accept a short-term cloud subscription.” Id. The SAC alleges that customers “neither desired nor intended to use” the cloud products but purchased them to avoid the hefty penalties. Id. ¶¶ 16, 151-198. Second, Oracle allegedly engaged in a tactic known as “attached deal[s].” Id. ¶¶ 17, 129-150. Oracle offered its customers “a significant discount” on its on-premises products, provided the customer also agreed to receive a short-term cloud subscription – “even though the customer neither wanted nor intended to use the attached cloud product.” Id. ¶ 17. The SAC alleges that the attached deals thus served to disguise legacy on-premise revenue as cloud revenue. Id. ¶¶ 129-150.
Starting in 2014, “market participants voiced early concerns that Oracle and its auditing department should not attempt to extract ‘cloud' revenues through their audits of its licensees' ‘on- premises' software licenses.” SAC ¶¶ 51, 54-60, 62, 64. Oracle executives, however, denied that the company was misusing its audit process to gin up purported cloud sales, id. ¶¶ 61, 63, 64, instead tracing sales successes to Oracle's superior cloud products and business practices, id. ¶¶ 66-71. Oracle's stock price rose almost 24% between 2017 and 2018 as investors and analysts celebrated the strength of Oracle's cloud business. Id. ¶¶ 72-73. The representations of Oracle executives stood in stark contrast to reality according to the SAC, id. ¶¶ 74-94, as Oracle's cloud products were “deeply flawed,” limiting customer' ability to use the products effectively and forcing the company to lean on financially engineered deals, id. ¶ 74, 95.”
Oracle customers reading this description may recognize this familiar pattern, as many customers around the world have complained in the business press and otherwise that they have been subjected to these predatory ABC audits and forced to buy Oracle cloud software to resolve the audit.
Only the Omission Based Securities Fraud Theory Survived Oracle's Motion to Dismiss
Although Judge Freeman found that in many instances Plaintiff failed to set forth facts that would support many of its securities claims, the Court focused on Oracle's representations to investors about the reasons for its increasing and later decreasing cloud sales. Unlike the First Amended Complaint (“FAC”), the Court found that Plaintiff had plausibly pleaded facts in the SAC establishing an omission based fraud theory under Section 10 of the Securities Act. According to the Court:
“Plaintiff also contends that Defendants misleadingly attributed Oracle's cloud revenue growth to the quality and competitiveness of its cloud offering, while failing to disclose that engineered deals were a material driver of those results. See SAC ¶ 267, 358, 361, 418, 424; see also Opp. at 10-11. As the Court explained in its prior order: [O]nce Defendants made statements about the drivers of Cloud revenue growth, the investors would have been interested to know that “a material driver” of Cloud Sales was Oracle's Sales Practices. MTD Order at 25. However, the Court ultimately found that Plaintiff failed to establish the materiality of Oracle's Sales Practices. Id.
The SAC has overcome this hurdle. Plaintiff has provided additional allegations from the CWs (“Confidential Witnesses”) along with new allegations from industry members that establish the materiality of revenue generated through Sales Practices. See Order at 27-30 ( “CW Allegations” and “Industry Member Allegations”). Oracle does not have an independent duty to disclose its sales tactics; nevertheless, once Defendants made statements about the drivers of cloud revenue growth, investors would have been interested to know that Oracle's allegedly coercive sales practices were “a material driver” of cloud sales.”
In other words, the Court is saying that Oracle was touting its growing sales of cloud products in the marketplace as being due to customers' finding that the Oracle software was a quality product, which could go toe to toe with AWS and other competitors. Once Oracle started making statements to the public as to why sales of Oracle cloud were increasing, they owed investors a duty to disclose that Oracle's use of hard ball audit tactics may also have been a material driver of increased cloud sales. By omitting to do so, Plaintiff has stated a plausible securities fraud claim that Oracle may have violated the securities laws by omission.
Once Oracle's sales of Oracle cloud began to decrease, Oracle also had a duty to disclose other reasons why those sales were slowing, including the decreasing success of their predatory audit tactics. According to the Court:
“The Court, again, emphasizes that Oracle does not have a stand-alone duty to disclose its sales practices. However, as with Defendants' statements about drivers of cloud growth, once Defendants made statements about the reasons underpinning cloud growth deceleration, investors would have been interested to know that the dwindling efficacy of Oracle's sales practices had a material impact on this decline. (citation omitted) At this stage, the allegations relating to cloud growth deceleration are adequate to state an omission-based claim under Section 10.
Plaintiff has successfully pled a narrow omission theory of securities fraud. This theory centers on Defendants' statements about Oracle's cloud growth deceleration and the drivers of cloud growth. Statements at FAC ¶¶ 363, 367, 390, 404, 416, 418, 422, 424, 433, 434, 443, 446, and 453 support this theory. The Court emphasizes that this theory is not based on a stand-alone duty to disclose allegedly coercive sales tactics; rather, Oracle's affirmative representations about cloud growth deceleration and drivers of cloud growth “affirmatively create[d] an impression of a state of affairs that differs in a material way from the one that actually exist[ed].” Brody, 280 F.3d at 1006. This is particularly true during a Class Period where the nascent cloud market exploded and Oracle competitors enjoyed robust growth. With the exception of this theory and associated statements, the Court DISMISSES the SAC.”
Scienter
Importantly the Court rejected Oracle's arguments that Plaintiff had not pled facts sufficient to state a claim that Oracle and its top management had the requisite scienter needed to hold them liable under the securities laws. According to the Court, “[a] defendant is liable for making false statements under Section 10(b) and Rule 10b-5 when he acts with scienter, a “mental state that not only covers intent to deceive, manipulate, or defraud, but also deliberate recklessness. (citation omitted) [D]eliberate recklessness is ‘an extreme departure from the standards of ordinary care ... which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.'” (citation omitted). As such, “[f]acts showing mere recklessness or a motive to commit fraud and opportunity to do so provide some reasonable inference of intent, but are not sufficient to establish a strong inference of deliberate recklessness.” In other words, this is a very hard pleading standard to meet. Judge Freeman recognized that the Plaintiffs “must “plead with particularity facts that give rise to a ‘strong'—i.e., a powerful or cogent—inference.” Id. at 323. In evaluating whether a complaint satisfies the “strong inference” requirement, courts must consider the allegations and other relevant material holistically, not “scrutinized in isolation.”
Applying this law to the facts, the Court found that the facts alleged in the SAC “give rise to a strong inference of scienter with regard to Hurd, Catz, Ellison, Bond, and Oracle”, but that Plaintiff's allegations against Kurian and Miranda, fell short of meeting this standard. According to the Court:
“Plaintiff's core claim is that Oracle knowingly foisted inferior cloud products on unwilling customers by threatening license audits that could produce penalties in excess of the price of the cloud products. While Oracle earned real revenue from these sales, unused and non-renewed one year cloud subscriptions dwindled over time as Oracle exhausted the list of customers it was able to strong-arm. When questioned why Oracle's cloud sales rates skyrocketed at first and later slowed, Defendants affirmatively and falsely attributed Oracle's success and subsequent slowed sales rates to false reasons, masking the material impact of engineered sales on cloud growth.”
In the end Judge Freeman found Plaintiff's “overall fraud theory alleged in the SAC plausible, cogent and compelling.”
The Court went on to examine the statements and other allegations concerning the scienter of Ellison, Hurd, Catz and Bond. The Court analyzed each of these allegations and then stood back and looked at them holistically. Here's what she had to say:
“As the Court detailed above, multiple kinds of evidence individually support a finding of, at the very least, deliberate recklessness as to Hurd, Catz, Ellison, and Bond. (citation omitted) A holistic review of the evidence confirms this conclusion. Although not every kind of evidence individually supports a finding of scienter, Plaintiff's factual and CW allegations against Hurd, Catz, Ellison, and Bond are highly compelling. And while the core operations doctrine rarely succeeds, here it adds modestly to support the evidence supplied by the CWs given the centrality of engineered sales to Oracle's bottom line and allegations of Hurd, Catz, Ellison, and Bond's roles in the company and involvement in cloud sales. When viewed holistically, even Plaintiff's compensation structure and stock sales allegations have some teeth to them. In sum, the inference that Hurd, Catz, Ellison, and Bond were deliberately reckless as to the truth of their public statements is “at least as compelling as any opposing inference.”
As our readers will see, it was a bad day in Court for Oracle and the top echelons of Oracle's management. It will be very interesting to see if the case settles now that Sunrise Firefighter's have survived the motion to dismiss. Often these type of securities class action cases do settle quickly, when they are not dismissed at the pleading stage. If the case does continue, Tactical Law will bring you periodic updates about anything we find interesting in the public filings.
Oracle customers who have experienced a predatory ABC audit by Oracle may have remedies if they were forced by Oracle to purchase cloud software to resolve an audit. We would be happy to discuss your potential legal options and possible remedies.
The case is City of Sunrise Firefighters Pension Fund v. Oracle, et. al., Northern District of California, (Case No. 18-cv-04844-BLF)
Originally Published by Tactical Law Group, March 2021
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