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From Securities Regulation Daily, August 22, 2013

Court dismisses Netflix pricing plan securities fraud suit, this time with prejudice

By Rodney F. Tonkovic, J.D.

A securities fraud suit against Netflix, Inc. has been dismissed with prejudice after a district court found that the plaintiffs' amended complaint failed to plead false or misleading statements. According to the court, the plaintiffs failed to plausibly show that Netflix made any false statements about the profitability of its streaming business or that it omitted any information or warnings about the retention of its subscriber base in a way that would be misleading. The dismissal of the plaintiffs' consolidated class action complaint was covered in the February 14 Securities Regulation Daily (In re Netflix, Inc., Securities Litigation, August 20, 2013, Conti, S.).

Background. Netflix is a public company that offers subscription-based entertainment services via Internet streaming or mail-order DVDs. Initially, Netflix offered only DVD services (1999-2007), but later offered a hybrid plan for $9.99/month that combined streaming and DVDs (2007). In 2010, Netflix offered a separate streaming-only plan for $7.99/month. During this period, Netflix's subscriber count saw steady increases.

Netflix, however, again revamped subscriber choices in 2011 to offer separate streaming-only and DVD-only plans at $7.99 per month each, for a combined $15.98 per month charge versus the old hybrid plan at $9.99 per month. These plan changes offended Netflix subscribers, who allegedly left in droves (Netflix’s first net subscriber loss in many years). Netflix also had spun off its DVD business into a subsidiary and began to report separate operating results for its DVD and streaming plans.

As a result, plaintiffs alleged, Netflix experienced two major stock price drops: first when Netflix announced subscriber losses due to the cancelled hybrid plan (September 15, 2011), and again when Netflix announced new segment results showing contribution margins of 8 percent for streaming plans and 50 percent–plus for DVDs, albeit with even more lost subscribers (October 25, 2011).

Allegations. Lead plaintiffs Arkansas Teacher Retirement System and State-Boston Retirement System alleged securities fraud under the Exchange Act. According to the complaint, Netflix misled investors about the prospects of the new streaming-focused business model. Netflix's stock was thus artificially inflated, resulting in an alleged total stock price drop of 67 percent when the truth was revealed.

Specifically, the plaintiffs maintained that Netflix knew that its shift to streaming would be less profitable than its DVD offerings, but nonetheless told the public that streaming "would be a good thing for the company." Netflix countered that it was not required to disclose information about streaming's profitability before it actually did so and that it had no information that contradicted what it said publicly. Netflix also argued that it never made any affirmative statements about streaming's profitability and that it disclosed the risks of the streaming-focused plan.

Duty to disclose. The plaintiffs' argument boiled down to Netflix's duty to disclose "all manner of information about streaming's margins relative to DVDs" as soon as it began to discuss its focus on streaming. The court observed, as it did in dismissing the previous complaint, that the Supreme Court’s Matrixx and the Ninth Circuit’s Brody opinions did not create affirmative duties to disclose "any and all material information." The plaintiffs needed to show that Netflix both knew of streaming's disparate profitability as compared to DVDs and had a duty to disclose that along with its public statements. The court concluded that the plaintiffs failed to do so.

Misrepresentations and omissions. The court noted that the amended complaint was nearly identical to the original, except that it cited three new statements and expanded on several others, all concerning Netflix's alleged knowledge of the truth about streaming's profitability and effect on Netflix's margins. The complaint also repleaded claims from the first complaint, and the court found them to be implausible for the same reasons as before.

The first new statement, made during a June 2011 analyst call, allegedly suggested that Netflix would kill its DVD business in favor of streaming. The court found that this was not so, stating that it was clear in context that while Netflix was shifting its focus to streaming, DVDs would remain a part of its business plan. These statements were not plausibly false or misleading, the court concluded.

Next, statements made in a July 2011 earnings call regarding streaming's profitability were, in context, optimistic statements combined with candid statements of risk. Other statements during that call, such as a reference to the ability to measure profits and losses for the DVD component, were not false or misleading and neither gave rise to a duty to discuss the streaming component nor rendered other statements actionable. Finally, statements made during a September conference call were too general to show that Netflix knew about the disparities in contribution margins between DVDs and streaming.

The plaintiffs also expanded on several statements referenced in the original complaint that were made in December 2010. These expansions did not render the claims plausible, the court concluded, stating that, in context, the statements at issue clearly indicated that Netflix was proceeding cautiously and that its actions could result in less subscriber growth. These statements, the court concluded, were not a plausible basis for the plaintiffs' claims. Finally, new statements by a confidential witness failed to show that Netflix had actual knowledge of streaming's relative profitability at any point before they actually declared it.

In sum, the court concluded that the plaintiffs failed to state a claim under the PSLRA. According to the court, none of the new or repleaded claims showed that Netflix withheld information about streaming while touting its profitability. The plaintiffs, the court said, merely supplied "an array of vague, sometimes conclusory, statements to support a theory that requires much more by virtue of its being narrow and fact-sensitive."

The case is No. 12-00225.

Attorneys: Michael Walter Stocker (Labaton Sucharow LLP) for City of Royal Oak Retirement System, Duane Labbee, Frank J. Fish, Institutional Investors, Arkansas Teacher Retirement System and State-Boston Retirement System. Mark P. Kindall (Izard Nobel LLP) for Irina Belenkova. Lionel Z. Glancy (Glancy Binkow & Goldberg LLP) for Davin Pokoik. Keith E. Eggleton (Wilson Sonsini Goodrich & Rosati) for Netflix, Inc., Reed Hastings, David B. Wells, Theodore A. Sarandos, Leslie J. Kilgore, Neil D. Hunt and Barry McCarthy.

Companies: Arkansas Teacher Retirement System; State-Boston Retirement System; Netflix, Inc.

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