In re Extreme Networks, Inc.

In re EXTREME NETWORKS, INC. SECURITIES LITIGATION

Case No. 15-cv-04883-BLF

UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA SAN JOSE DIVISION

March 21, 2018

ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS THE AMENDED COMPLAINT

[Re: ECF 107]

This is a putative class action for securities fraud brought against Extreme Networks, Inc. ("Extreme") and its officers Charles W. Berger, Kenneth B. Arola, and John T. Kurtzweil ("Individual Defendants"), (collectively with Extreme, "Defendants"). Plaintiffs have filed an Amended Consolidated Class Action Complaint alleging that Defendants violated Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. See ECF 105 ("Amended Compl."). Plaintiffs also assert that the Individual Defendants are liable for violations of federal securities laws as "control persons" of Extreme, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).

Defendants have moved to dismiss the Amended Complaint, arguing that Plaintiffs have not cured the deficiencies identified by the Court in its previous order granting Defendants' motion to dismiss with leave to amend. See ECF 107 ("Mot."); ECF 102 ("Prior Order"). The Court heard oral argument on Defendants' motion to dismiss the Amended Complaint on December 14, 2017. For the reasons set forth herein, the motion to dismiss is GRANTED IN PART and DENIED IN PART.

I. BACKGROUND

Founded in 1966, Extreme is a Delaware corporation with its principal offices in San Jose, California, that develops and sells network infrastructure equipment such as wired and wireless devices for accessing the Internet, as well as relevant software. See Amended Compl. ¶¶ 2, 32.¹ The Individual Defendants were officers and directors of Extreme during the time relevant to this litigation. Defendant Charles W. Berger was the Company's President and Chief Executive Officer ("CEO") and a member of Extreme's Board of Directors from April 2013 until April 19, 2015. Id. ¶ 34. Defendant John T. Kurtzweil was Extreme's Chief Financial Officer ("CFO") and Senior Vice President from June 29, 2012 through June 1, 2014. Id. ¶ 35. From June 2, 2014 until September 30, 2014, Kurtzweil served as "Special Assistant to the CEO." Id. Defendant Kenneth B. Arola was the Company's CFO and Senior Vice President from June 2, 2014 through May 2016. Id. ¶ 36.

To summarize in relevant part, Plaintiffs bring this action against Defendants for alleged misrepresentations regarding the success of Extreme's post-acquisition integration with its former competitor, Enterasys Networks, Inc. ("Enterasys"), as well as developments in Extreme's "key partnership" with Lenovo Group Ltd. ("Lenovo"). Amended Compl. ¶¶ 1-7. Defendants' positive representations to investors about the resulting "synergies" from the Enterasys integration and benefits of the Lenovo partnership—including a commitment that cost savings from these arrangements would lead to double-digit revenue growth and a 10% operating margin by June 2015—caused Extreme's stock price to rise. Meanwhile, Extreme's stock price dropped when Extreme reported disappointing financial results at various points between February 2014 and the end of the Class Period on April 9, 2015. Id. ¶¶ 17-22.

Relying on six (6) confidential witnesses ("CWs"), Plaintiffs allege that Defendants knew or recklessly disregarded material, adverse facts regarding the lack of any integration plan for the Enterasys merger, which was not "on track" or "complete" as represented. Id. ¶ 13.² Plaintiffsalso point to accounts from CWs that the Lenovo partnership was largely unproductive, in direct contrast to Defendants' representations to the market. Id. ¶ 17. According to Plaintiffs, Defendants' false statements caused Extreme's stock to trade at artificially inflated prices during the Class Period, reaching a high of $8.14 per share on January 23, 2014. Id. ¶ 19. Plaintiffs allege that four partial corrective disclosures by Defendants announcing revenue shortfalls, guidance misses, and turnovers of Extreme executives, caused the stock price to plummet as the undisclosed risks relating to the Enterasys integration and Lenovo partnership materialized. Id. ¶ 20-22.

A. Procedural History

On September 26, 2016, Lead Plaintiff Arkansas Teacher Retirement System ("Plaintiffs") filed a Consolidated Class Action Complaint on behalf of all investors who purchased the publicly traded common stock of Extreme and/or exchange-traded options on such common stock between September 12, 2013, and April 9, 2015, (the "Class Period"). See Consolidated Complaint ¶ 1, ECF 87. The Consolidated Complaint alleged two counts: (1) violation of § 10(b) of the Exchange Act and Rule 10b-5 against all Defendants; and (2) violation of § 20(a) of the Exchange Act against the Individual Defendants for liability as control persons of Extreme.

Plaintiffs allege that Defendants made false statements that generally fall into three separate categories: (1) false statements assuring investors regarding the status of Extreme's acquisition of and integration with Enterasys; (2) misrepresentations of the potential impact of Extreme's partnership with Lenovo; and (3) false promises to investors that these business arrangements would lead Extreme to achieve double-digit revenue growth and a 10 percent profit margin by June 2015. Plaintiffs originally offered statements by seven CWs to suggest that the Individual Defendants knew of or deliberately disregarded the falsity of their statements at the time they were made.³

Defendants moved to dismiss the Consolidated Complaint, arguing that many of theallegedly false statements are immaterial and non-actionable. See Prior Order at 18-25. The Court agreed in part, finding that certain challenged statements were non-actionable statements of corporate optimism and puffery. Id. Although some of Plaintiffs' allegations regarding Defendants' statements about the Enterasys integration and the Lenovo partnership amounted to objectively verifiable matters of fact, id. at 25, the Court dismissed Plaintiffs § 10(b) and Rule 10b-5 cause of action with leave to amend because the allegations of falsity were insufficient with respect to such statements. The Court also found that Plaintiffs had not adequately alleged scienter in the Consolidated Complaint. Id. at 33. Without a primary violation of the Exchange Act, the Court dismissed with leave to amend Plaintiffs' second count against the Individual Defendants for violations of Section 20(a) of the Exchange Act. Id. at 42.

B. Factual Allegations in the Amended Complaint

Plaintiffs filed an Amended Consolidated Class Action Complaint on June 2, 2017 that contains the same two causes of action for securities violations against the same Defendants. See generally Amended Compl. Plaintiffs focus their amended factual allegations on statements that the Court indicated were actionable, and attempt to cure the previously identified deficiencies with respect to falsity and scienter.

i. The Enterasys Integration

Enterasys was a privately held company that was one of Extreme's direct competitors. Amended Compl. ¶ 3. Like Extreme, Enterasys also sold network infrastructure equipment and software, including analytics and security products. Id. Extreme announced its acquisition of Enterasys on September 12, 2013 and the transaction was completed on October 31, 2013 for $180 million in cash. Id. ¶ 4. As explained in the Court's Prior Order, Plaintiffs allege that Defendants made a number of false and misleading statements related to the Enterasys acquisition during the Class Period. See Prior Order at 5-8.

1. Timeline of Statements and Disclosures

Specifically, Plaintiffs allege that when the Enterasys acquisition was announced on September 12, 2013, CEO Charles Berger assured investors that "[t]here will be no disruption in customers' ability to grow and operate their networks. Period. None." Amended Compl. ¶¶ 4, 52,170, 400. Meanwhile, CFO John Kurtzweil stated on behalf of Extreme's management that "[w]hen we have fully integrated the two Teams, we plan to reduce product costs and operating expenses between $30 million to $40 million. We expect to realize these synergies over a 12 to 24-month period." Id. ¶¶ 5, 52, 165, 185. The market reacted favorably to these statements, made on September 12, 2013, announcing the "plan" for the Enterasys integration and Berger's assurance that there would be no disruption to customers. Id. ¶ 176. Extreme's stock price increased seven (7) percent, by $0.30 per share, from $4.03 per share at the close of trading on September 11, 2013, to $4.33 per share at the close of trading on September 12, 2013. Id.

As time went on, Defendants partially disclosed issues with the Enterasys integration. Before the market opened on February 5, 2014, Extreme issued a press release announcing its Second Quarter ("Q2") 2014 financial results and its Q3 2014 guidance. Id. ¶¶ 21, 195. Extreme reported revenues toward the low end of the guidance announced in its November 4, 2013, press release for Q2 2014, and expected reserves for Q3 2014 below the consensus estimates of $154 million. Id. ¶ 195. During a conference call with investors to discuss this announcement, Berger acknowledged that the Company had "not seen significant evidence of revenue [due] to synergies."⁴ Id. After this disclosure, Extreme's stock declined sixteen (16) percent, from $7.04 per share to $5.92 per share at the close of trading on February 5, 2014. Id. ¶ 196

Over the course of the Class Period, and in the midst of the lower guidance, Plaintiffs allege that Defendants continued to assure investors that Extreme was "on track" to realize the $30-40 million in synergies as a result of the integration with Enterasys. Id. ¶¶ 12, 53, 56, 197. For example, in the February 5, 2014 press release when the disappointing Q2 2014 financials were announced, Berger...