Lamartina v. VMware, Inc.

Background

William Lamartina originally filed this proposed class action against VMware, Inc., Patrick P. Gelsinger, and Zane Rowe. The court later appointed Northeast Carpenters Pension Fund as lead plaintiff. The lead plaintiff brought claims under Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, on behalf of people who purchased or acquired VMware securities during the alleged class period from August 24, 2018, through February 27, 2020.

The lead plaintiff alleged that the defendants made misleading statements in VMware’s Securities and Exchange Commission filings and investor earnings calls. According to the allegations, VMware improperly delayed processing secured contracts and left them in its backlog so that revenue could be recognized in later periods. The lead plaintiff alleged that this practice made VMware’s revenue and future outlook appear stronger than they were. It also alleged that Gelsinger, Rowe, and other executives sold VMware stock during the class period, and that later disclosures about declining backlog, company performance, and an Securities and Exchange Commission investigation were followed by declines in VMware’s stock price.

Motion-to-dismiss standard

The defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which permits dismissal when a complaint does not state a legally sufficient claim. They also argued that the allegations did not meet the heightened detail requirements for fraud claims under Rule 9(b) and the Private Securities Litigation Reform Act. At this stage, the court accepted well-pleaded factual allegations as true and viewed them in the light most favorable to the lead plaintiff, but it did not accept unsupported legal conclusions as facts.

The court also granted the defendants’ request for judicial notice of publicly available Securities and Exchange Commission filings, earnings-call transcripts incorporated into the complaint, and insider-trading filings. Judicial notice allows a court to consider certain facts from reliable public records without treating the motion as one for summary judgment; it does not require the court to accept disputed factual assertions in those records as true.

Section 10(b) and Rule 10b-5 claim

The court held that the lead plaintiff had not pleaded a material misstatement or omission with sufficient particularity. Although the theory that VMware’s backlog reporting could be misleading might be legally viable, the complaint provided too few facts about the alleged scheme. In particular, it did not identify who in management directed employees to withhold secured contracts, or when, where, how, and to whom those directions were given.

The court also concluded that some of the challenged statements were forward-looking statements covered at least partly by the Private Securities Litigation Reform Act’s safe-harbor rules, while other statements were not forward-looking. The court treated generalized statements of optimism as nonactionable puffery, but distinguished factual statements about specific revenue and backlog amounts and certain statements about projected revenue or past and present revenue.

The court found the allegations about scienter—meaning an intent to deceive or deliberate recklessness—insufficient. The allegations about Gelsinger’s and Rowe’s stock sales, including the increased amount and frequency of their sales and their timing before later disclosures, supported some inference of scienter. But the court could not determine when their automatic trading plans were adopted, and it found the allegations about management oversight, alleged accounting violations, the chief accounting officer’s resignation, and the timing of later disclosures insufficient to create a strong enough inference when considered together. The court also found that the allegations about sales by other executives did not support scienter as currently pleaded.

The court did find that the lead plaintiff adequately pleaded loss causation, meaning a plausible connection between the alleged misconduct and the claimed financial loss. The allegations that VMware’s stock price declined after disclosures about shrinking backlog and the Securities and Exchange Commission investigation were enough at the pleading stage to support a plausible inference that the disclosures were at least partly responsible for the losses.

Because the lead plaintiff adequately pleaded loss causation but not a material misstatement or omission or scienter, the court dismissed the Section 10(b) and Rule 10b-5 claim with leave to amend.

Section 20(a) claim

Section 20(a) provides potential controlling-person liability when an individual controlled a person that violated the securities laws. The court held that the lead plaintiff had not adequately pleaded the required underlying Section 10(b) violation. It therefore found that the lead plaintiff did not state a Section 20(a) claim against Gelsinger or Rowe.

Section 20A claim

Section 20A provides a private claim for contemporaneous insider trading. The court held that the lead plaintiff had not adequately pleaded the required underlying securities-law violation or otherwise established the necessary predicate for the Section 20A claim against Gelsinger. The court therefore found that the lead plaintiff did not state that claim.

Disposition

Judge Edward J. Davila granted in part and denied in part the defendants’ motion to dismiss with leave to amend. The court allowed the lead plaintiff to add facts supporting its claims under Sections 10(b), 20(a), and 20A and Rule 10b-5. The lead plaintiff was ordered to file a second amended consolidated complaint by September 24, 2021.