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Court Pulls Plug On Securities Suit Against Netflix, Officials

Monday, February 18, 2013

The U.S. District Court for the Northern District of California Feb. 13 dismissed a putative securities class suit alleging that Netflix Inc. (NFLX) and officials made misrepresentations about the Internet movie and television subscription company’s accounting practices, profitability, price changes, and correspondence with the SEC (In re Netflix Inc. Securities Litigation, N.D. Cal., 3:12-cv-00225-SC, 2/13/13).

Judge Samuel Conti gave the investors 30 days to file an amended complaint.

The court explained that the plaintiffs--Netflix shareholders-- brought this securities suit alleging that the defendants’ misrepresentations artificially boosted Netflix’s stock price. When the alleged falsities came to light, they claimed, the stock price dropped almost 67 percent. 

Segment Reporting, Item 303

The court dismissed the suit without prejudice after reviewing the plaintiffs’ assertions. First, the court rejected the investors’ claims that the defendants violated generally accepted accounting principles by failing to provide segment reporting before 4Q11.

“This allegation is not plausible,” the court wrote, “because there is no indication that Netflix had discrete financial information for its streaming and DVD components until 4Q11.” The defendants may have had information about the prospects of streaming generally, or the performance of its steaming-only subscription plan, “but this is not the same as having information about streaming as a discrete component of Netflix’s overall service offerings,” the court declared.

Further, the court found no merit in the investors’ argument that Netflix should have reported segments in its domestic financial reports because it did so abroad.

The court also rejected the investors’ argument that Netflix violated Securities and Exchange Commission Regulation S-K, Item 303, which requires generally that companies disclose “ 'any known trends or uncertainties’” that have had or reasonably could be expected to have “ 'a material favorable or unfavorable impact on net sales, revenues or income from continuing operations.’”

The court said that these allegations “are not plausible.” In any event, the court said that the investors’ pleadings do not show that the defendants withheld information “since Defendants repeatedly stated that success in the streaming market depended on multiple factors, especially Netflix’s ability to keep its subscriber base large and happy.” The investors also have not pled that defendants made any false or misleading statements about the profitability of the streaming business, the court said.

Meanwhile, the court tossed out the investors’ allegations regarding the “virtuous cycle,” providing that as Netflix gained subscribers, it could afford to license more streaming content, increasing its appeal, and allowing Netflix to acquire more subscribers and continue the cycle. The court said that statements the investors claim to have been false or misleading “appear to be accurate descriptions of a business model that worked exactly as Netflix said it would, until Netflix began to lose subscribers after announcing its price increases and DVD-business spinoff.” 

SEC Correspondence Public

In addition, the court rejected claims that the Netflix defendants made false or misleading statements in a series of letters exchanged with the SEC. Further, the court said that since the defendants’ correspondence with the SEC “was public, Plaintiffs’ allegations that Netflix somehow hid information from investors while simultaneously filing these letters with the SEC hold no weight.”

The court also said that a Netflix blog post about price increases was not false and misleading. In this regard, the court said that the investors do not plead specific facts showing that the real reason Netflix changed its prices had to do with decreased liquidity or other concerns related to what the investors claim is a faulty business model.


To see the opinion, go to /uploadedFiles/Content/News/Legal_and_Business/Bloomberg_Law/Legal_Reports/In-re-Netflix-Inc.-Securities-Litigation(1).pdf.

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