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Cai v. Switch, Inc.

United States District Court, D. Nevada

July 12, 2019

MINGBO CAI, Individually and On Behalf of All Others Similarly Situated, Plaintiffs,
SWITCH, INC., et al., Defendants.



         Presently before the court is Magistrate Judge Cam Ferenbach's report and recommendation. (ECF No. 88). Plaintiff Oscar Farach filed an objection (ECF No. 89), to which defendants Switch, Inc. (“Switch”); Rob Roy, Gabriel Nacht, Zareh Sarrafian, Donald Snyder, Tom Thomas, and Bryan Wolf (collectively “defendants”) responded (ECF No. 90).

         Also before the court is defendants' motion to strike. (ECF No. 63). Farach filed a response (ECF No. 79), to which defendants replied (ECF No. 85).

         Also before the court is defendants' motion to dismiss. (ECF No. 60). Farach filed a response (ECF No. 78), to which defendants replied (ECF No. 84).

         I. Facts

         Farach has brought forth this putative securities class action challenging Switch's failure to include certain information in the registration statement and prospectus that Switch issued in connection with its initial public offering (“IPO”). (ECF No. 58). The amended complaint contains the following allegations:

         Switch is a Nevada corporation that hosts data centers and provides to its customers colocation, telecommunications, cloud, and content ecosystems services. Id. Most of Switch's revenue comes from colocation services, which amounted to 81.4% of total revenue in fiscal year 2016. Id. Colocation services are rental agreements where customers lease information technology infrastructure, such as servers and storage hardware, to avoid the cost of establishing and maintaining their own facilities. Id.

         Roy was at all relevant times to this lawsuit Switch's chief executive officer (“CEO”) and chairman of the board of directors. Id. In 2000, Roy founded Switch and began building a data center in Las Vegas near another data center that Enron Corporation (“Enron”) was constructing. Id. In 2002, Enron declared bankruptcy a week before it planned to open its data center. Id. Roy subsequently acquired the state-of-the-art facility at a steep discount, which allowed Switch to transfer massive amounts of data at below market rates. Id.

         Although Switch established other data centers over the years, the Las Vegas data center remained as the company's primary source of revenue. Id. Several market advantages, in addition to Roy's shrewd acquisition of the facility, are responsible for this success. Id. The Las Vegas data center is part of a fiber optic network that connects to Switch's Tahoe/Reno data center, San Francisco, and Los Angeles. Id. Switch also purchases power in Nevada at low costs because it is authorized to directly deal with the national power market. Id. Lastly, Nevada does not impose a corporate income tax and is adjacent to California, which has a large demand for information technology services. Id.

         In 2017, Switch began changing its sales strategy to focus on selling hybrid cloud solutions, which would allow customers to move larger technology operations to Switch's data centers. Id. This new strategy presented a significant risk of lengthening sales timelines because it involved new complications and required engineering. Id. Switch did not disclose this shift in strategy and that it would likely have an adverse effect on revenue. Id.

         On June 13, 2017, Switch registered as a corporation so that it can issue class A common stock in an IPO. Id. On September 8, 2017, Switch filed the registration statement for its IPO with the Securities and Exchange Commission (“SEC”) and, on September 25, 2017, Switch amended the registration statement and the prospectus therein. Id. The registration statement included Switch's offer to sell 31, 250, 000 shares, with an option for the underwriters to purchase an additional 4, 687, 400 shares, at $17.00 per share. Id.

         Switch discussed in the registration statement its growth strategy, which involved developing new facilities in Grand Rapids, Michigan and Atlanta, Georgia. Id. However, the registration statement did not disclose facts explaining that these new facilities lacked the unique market advantages that made the Las Vegas data center successful. Id. The registration statement also failed to disclose that Switch had changed its sales strategy to focus on hybrid cloud solutions. Id. Lastly, the registration statement reported that Switch's recurring revenue for the first six months of 2017 was $177, 213, 000.00. Id. This figure included $9, 400, 000.00 for colocation services that eBay would use in 2018. Id. Had Switch not including this amount in the recurring revenue, Switch's revenue growth would have been 13% rather than 20%. Id.

         On October 6, 2017, shares in Switch began trading on the New York Stock Exchange. Id. Six days later, Switch announced the closing of its IPO and that the underwriters executed their option to purchase an additional 4, 687, 400 shares. Id. In total, Switch sold 35, 937, 500 shares of class A common stock and received $577, 300, 000.00 in proceeds. Id. Switch also incurred $4, 100, 000.00 in offering expenses. Id.

         On August 13, 2018, Switch issued a press release in which the company lowered its revenue guidance for the rest of the year. Id. Switch attributed this decrease in expected revenue to its shift in sales strategy towards selling hybrid cloud solutions. Id. Switch's chief financial officer (“CFO”) and president, Nacht and Thomas Morton respectively, also stated that Switch had been working on hybrid cloud solutions for a while and that the company was not actually changing its sales approach. Id. Analysts critiqued the sales strategy for not being as presented in the IPO materials and that the deviation in sales figures was unexpected. Id. The next day, Switch's stock dropped 22.3%-from $13.98 per share to $10.85 per share. Id.

         In sum, the alleged misleading statements and omissions in the registration statement allowed Switch to sell its class A common stock at $17.00 per share. Id. Since the IPO, Switch's stock price has decreased to approximately $9 per share, over a 47% drop. Id. Farach alleges that, had Switch filed a registration statement with adequate disclosures, the purported class would not have incurred substantial losses in the form of decreased stock prices. Id.

         II. Procedural History

         On June 11, 2018, plaintiff Mingbo Cai initiated this action. (ECF No. 1). In the amended complaint, lead plaintiff Farach alleges two causes of action: (1) violation of section 11 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77k, and (2) section 15 of the Securities Act, 15 U.S.C. § 77o. (ECF No. 58).

         Now, defendants move to dismiss the amended complaint under Federal Rule of Civil Procedure 12(b)(6) and strike paragraphs 45, 46, 56, and 65, and footnotes 4 and 7, from the amended complaint. (ECF Nos. 60, 63). Magistrate Judge Ferenbach recommends striking paragraphs 45 and 46, and footnotes 3, 4, and 7. (ECF No. 88).

         III. ...

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