Sundaram v. Freshworks Inc

Opinion

1 2 3 4 5 IN THE UNITED STATES DISTRICT COURT 6 FOR THE NORTHERN DISTRICT OF CALIFORNIA 7 8 MOHAN R. SUNDARAM, et al., Case No. 22-cv-06750-CRB

9 Plaintiffs,

ORDER GRANTING IN PART WITH 10 v. LEAVE TO AMEND AND DENYING IN PART MOTION TO DISMISS 11 FRESHWORKS INC, et al., 12 Defendants.

13 This securities class action alleges violations of Sections 11 and 15 of the Securities 14 Act of 1933 (“Securities Act”) against Freshworks Inc. (“Freshworks”) and its executives, 15 directors, and IPO underwriters (collectively, “Defendants”). Lead Plaintiff Mohan R. 16 Sundaram (“Plaintiff”), on behalf of himself and all others situated, argues that he is 17 entitled to damages caused by Freshworks’ alleged failure to disclose adverse trends and 18 risks regarding its financial and business condition prior to its public offering. Pending 19 before this Court is Defendants’ motion to dismiss Plaintiff’s consolidated amended class 20 action complaint. For the reasons explained below, the Court GRANTS in part and 21 DENIES in part Defendants’ motion to dismiss. 22 I. BACKGROUND 23 Plaintiff purchased shares of Freshworks’ Class A common stock pursuant to or 24 traceable to the company’s Prospectus and Registration Statements (collectively, the 25 “Offering Documents”) filed with the Securities and Exchange Commission on August 27, 26 2021 and September 22, 2021, respectively. Compl. (dkt. 1) ¶ 1; Am. Compl. (dkt. 70) ¶ 27 1. Plaintiff alleges that the Offering Documents were materially misleading because they 1 Public Offering (“IPO”). Am. Compl. ¶¶ 4–6. 2 A. The Defendants 3 Freshworks is a Delaware corporation based in San Mateo, California. Compl. ¶ 4 14. Founded in 2010, Freshworks is a software-as-a-service company that provides 5 customer support software and tools for small- and medium-sized businesses. Am. Compl. 6 ¶ 18; Mot. (dkt. 72) at 1. 7 Members of Freshworks’ Board of Directors are named as Individual Defendants. 8 These individuals are: (1) Rathna Girish Mathrubootham, the Chief Executive Officer and 9 Chairman of the Board; (2) Tyler Sloat, the Chief Financial Officer; (3) Roxanne S. 10 Austin, a director; (4) Johanna Flower, a director; (5) Sameer Gandhi, a director; (6) 11 Randy Gottfried, a director; (7) Zachary Nelson, a director; (8) Barry Padgett, a director; 12 and (9) Jennifer Taylor, a director. Am. Compl. ¶¶ 19–28. 13 Freshworks’ IPO Underwriters (“Underwriter Defendants”) are also named as 14 Defendants. They are: Morgan Stanley & Co., LLC, J.P. Morgan Securities LLC, BofA 15 Securities, Inc., Jefferies LLC, Barclays Capital Inc., Robert W. Baird & Co. Incorporated, 16 Canaccord Genuity LLC, JMP Securities LLC, Needham & Company, LLC, Nomura 17 Securities International, Inc., Oppenheimer & Co. Inc., Piper Sandler & Co., Raymond 18 James & Associates, Inc., Amerivet Securities, Inc., CastleOak Securities, L.P., Samuel A. 19 Ramirez & Company, Inc., and R. Seelaus & Co., LLC. Id. ¶¶ 30–47. 20 B. Factual Background 21 Defendants commenced Freshworks’ IPO on September 22, 2021. Am. Compl. ¶ 22 58. That day, Freshworks issued 28,500,000 shares of Incorporated Class A common 23 stock, which was sold to the investing public at $36.00 per share. Id. ¶ 58. After the close 24 of markets on November 2, 2021, Freshworks issued a press release that announced its 25 third quarter financial results, which had ended on September 30, 2021—six business days 26 after the IPO. Id. ¶ 78. The press release reported a decline in Freshworks’ financial 27 metrics between the second quarter of 2021 and the third quarter of 2021. Id. ¶ 79. 1 Defendants’ failure to disclose Freshworks’ declining third quarter (“Q3 2021”)1 financial 2 metrics before the IPO is the subject of this class action. 3 1. Metrics Announced Prior to the IPO 4 In the lead up to the IPO, Defendants touted Freshworks’ “strong and accelerating” 5 growth to convince prospective investors of the company’s vitality. Id. ¶4. The Offering 6 Documents provided financial data that Freshworks had “grown rapidly,” had a “healthy 7 dollar retention rate,” and was “generating a healthy mix of revenue.” Id. ¶¶ 61, 63, 67. 8 Plaintiff alleges that the Offering Documents indicated to investors that Freshworks was 9 experiencing strong and significant growth prior to the IPO, and that it was highly 10 favorable that this growth would be sustained. Id. ¶¶ 62, 66, 67. 11 Defendants assessed Freshworks’ growth through three metrics: (1) the year-over- 12 year revenue growth rate, (2) the calculated billings growth rate, and (3) the net dollar 13 retention rate. Id. ¶¶ 4–5. According to the Offering Documents, Freshworks’ year-over- 14 year revenue growth rate steadily increased in the three quarters prior to the IPO, from 15 44% in 4Q 2020, to 49% in 1Q 2021, and 56% in 2Q 2021. Id. ¶¶ 62. The calculated 16 billings metric, which calculated non-generally accepted accounting principles revenue and 17 the dollar value of new contracts signed, similarly grew in the quarters preceding 18 Freshworks’ IPO, from 31% in 2Q 2020 to 47%, 53%, 54%, and 61% for 3Q 2020, 4Q 19 2020, 1Q 2021, and 2Q 2021, respectively.2 Id. ¶¶ 4, 10, 66. The net dollar retention rate 20 also increased in the five quarters leading up to the IPO, starting at 107% in 2Q 2020 and 21 ending at 118% for 2Q 2021. Id. ¶ 75. The figures for the year-over-year revenue growth 22 rate, the calculated billings growth rate, and the net dollar retention rate from 2Q 2020 to 23 3Q 2021, as provided in the Complaint, are included in the chart below. 24 25 1 Hereinafter, the Court references quarterly financial figures by the quarter and year (e.g., 26 3Q 2021). 2 Defendants contend that they are unable to replicate the Plaintiff’s alleged calculated 27 billings figures using the Offering Documents. Mot. at 1 n.4; Reply at 2 n.3. Because this Freshworks’ Growth Rate Financial Data as provided in the Offering Documents.3 1 2Q 2020 3Q 2020 4Q 2020 1Q 2021 2Q 2021 2 (ended June. (ended Sept. (ended Dec. (ended Mar. (ended June 30, 2020) 30, 2020) 31, 2020) 31, 2021) 30, 2021) 3 Revenue 44% 49% 56% 4 Year over Year Growth 5 Calculated 31% 47% 53% 54% 61% Billings Growth 6 Net Dollar 107% 109% 111% 112% 118% 7 Retention Rate 8 2. Metrics Announced After the IPO 9 Freshworks announced its “highly disappointing” 3Q 2021 financial results on 10 November 2, 2021. Id. ¶¶ 78, 79. It reported that the 3Q 2021 revenue year-over-year 11 growth rate decreased to 46%, compared to 56% in 2Q 2021. Id. ¶ 79. The press release 12 also stated that the net dollar retention rate declined to 117%, compared to 118% for 2Q 13 2021. Id. ¶ 81. In an earnings call later that day, Chief Financial Officer Tyler Sloat 14 disclosed that the calculated billings rate also decreased to 41% for 3Q 2021 from 61% for 15 2Q 2021. Id. ¶¶ 20, 80. These figures marked the first decline for the year-over-year 16 revenue growth rate, the calculated billings growth rate, and the net dollar retention rate 17 metrics after three to five quarters of consistent growth. The next day, on November 3, 18 2021, Freshworks’ stock dropped 14%. Id. ¶ 82. 19 On February 10, 2022, Freshworks announced its Q4 2021 earnings and reported 20 similar levels of growth deceleration as Q3 2021. Id. ¶ 84. The revenue year-over-year 21 growth rate declined to 44%, and the net dollar retention rate declined to 114%. Id. ¶¶ 84, 22 85. However, the calculated billings growth rate increased to 45%. Id. ¶ 86. The day after 23 this announcement, Freshworks’ stock dropped 18%, to $18.41 per share. Id. The figures 24 for these three metrics from 2Q 2020 to 4Q 2021, as well as Freshworks’ revenue in raw 25 dollars, are included in the chart below. 26 27 1 Freshworks’ Growth Rate Financial Data as provided in the Offering Documents.4 2Q 2020 3Q 2020 4Q 2020 1Q 2021 2Q 2021 3Q 2021 4Q 2021 2 (ended (ended (ended (ended (ended (ended (ended 3 June. 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, 2020) 2020) 2020) 2021) 2021) 2021) 2021) 4 5 Revenue $73.00 $80.59 $88.34 $96.61 $105.5 6 ($ in millions) 7 Revenue 44% 49% 56% 46% 44% Year over 8 Year 9 Growth Calculated 31% 47% 53% 54% 61% 41% 45% 10 Billings 11 Growth Net Dollar 107% 109% 111% 112% 118% 117% 114% 12 Retention 13 Rate 14 15 C. Procedural History 16 On November 1, 2022, Plaintiff filed an initial class action complaint, alleging that 17 Defendants included materially incorrect or misleading statements and/or omitted material 18 information in the Offering Documents in violation of Sections 11, 12(a), and 15 of the 19 Securities Act. Compl. ¶ 1. The court appointed the lead plaintiff and lead counsel on 20 February 8, 2023. Order Appointing Lead Pl. and Lead Counsel (dkt. 62). Plaintiff filed a 21 consolidated amended complaint on April 14, 2023 with the same allegations. Am. Compl 22 at 30. Defendants filed the present motion to dismiss all the claims on June 14, 2023. 23 Mot. Plaintiff filed an opposition on July 31, 2023. Opp’n (dkt. 77). Defendants filed a 24 reply on September 7, 2023. Reply. 25 II. LEGAL STANDARD 26 To survive a motion to dismiss, a complaint must contain sufficient factual matter to 27 1 state a claim that is facially plausible. Fed. R. Civ. P. 12(b)(6); Ashcroft v. Iqbal, 556 U.S. 2 662, 678 (2009). A claim is facially plausible when “the plaintiff pleads factual content 3 that allows the court to draw the reasonable inference that the defendant is liable for the 4 misconduct alleged.” Ashcroft, 556 U.S. at 678. The court “must take all of the factual 5 allegations in the complaint as true,” but it is “not bound to accept as true a legal 6 conclusion couched as a factual allegation.” Id. The plausibility standard does not impose 7 a “probability requirement, but it asks for more than a sheer possibility that a defendant 8 acted unlawfully.” Id. 9 The Court should freely give leave to amend “when justice so requires” should it 10 dismiss a complaint for failure to state a claim. Fed. R. Civ. P. 15(a)(2); see Sonoma Cty. 11 Ass’n of Retired Emps. v. Sonoma Cty., 708 F.3d 1109, 1117 (9th Cir. 2013). The Court 12 has discretion to deny leave to amend due to “undue delay, bad faith or dilatory motive on 13 the part of the movant, repeated failure to cure deficiencies by amendments previously 14 allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, 15 [and] futility of amendment.” Leadsinger, Inc. v. BMG Music Pub., 512 F.3d 522, 532 16 (9th Cir. 2008) (citing Foman v. Davis, 371 U.S. 178, 182 (1962)). 17 III. DISCUSSION 18 Plaintiff asserts claims under Sections 11 and 15 of the Securities Act.5 Plaintiff 19 alleges that Defendants violated Section 11 by (1) failing to disclose the Q3 2021 20 decelerating growth rates prior to the IPO, materially misleading investors; (2) including 21 statements in the Offering Documents that created an impression of a state of affairs that 22 materially differed from the one that actually existed; (3) failing to disclose known, 23 adverse trends in violation of Item 303 of SEC Regulation S-K; and (4) failing to disclose 24 material adverse information in the Offering Documents in violation of Item 105 of SEC 25 5 Plaintiff also alleged a claim under Section 12(a) of the Securities Act, arguing that the 26 Prospectus contained materially misleading statements of fact. Compl. ¶ 119. Defendants argued that Plaintiff lacked standing to bring the Section 12(a) claim because he purchased 27 the shares after market. Mot. at 13–14. In his reply, Plaintiff conceded that he does not 1 Regulation S-K. Plaintiff also asserts that the Individual Defendants were controlling 2 persons of Freshworks and are thus subject to Section 15 liability. Plaintiff’s Item 303 3 claim has merit, but his other Section 11 arguments fail. Since Plaintiff has plausibly 4 alleged an underlying Securities Act violation through his Item 303 claim, his Section 15 5 claim can proceed too. 6 A. Section 11 Claims 7 Under Section 11(a) of the Securities Act, a stock purchaser must plausibly allege 8 that the registration statement “contained an untrue statement of material fact” or “omitted 9 to state a material fact . . . necessary to make the statements therein not misleading.” 15 10 U.S.C. § 77k(a). A misrepresentation or omission is material where it “would have misled 11 a reasonable investor about the nature of his or her investment.” In re Daou Sys., Inc., 411 12 F.3d 1006, 1027 (9th Cir. 2005). An omission “must affirmatively create an impression of 13 a state of affairs that differs in a material way from the one that actually exists” to be 14 actionable. Brody v. Transitional Hospitals Corp., 280 F.3d 997, 1006 (9th Cir. 2002). A 15 statement must be both false and material to investors to be actionable. See In re Rigel 16 Pharm., Inc. Sec. Lit., 697 F.3d 869, 880 n.8 (9th Cir. 2012). 17 Claims brought under Section 11 “place[] a relatively minimal burden on a 18 plaintiff.” Herman & MacLean v. Huddleston, 459 U.S. 375, 382 (1983). Unlike fraud- 19 based claims, Section 11 liability does not require a showing of scienter, and Defendants 20 will be held liable for unintentional or negligent material misrepresentations or omissions. 21 In re Stac Electroncs Sec. Litig., 89 F.3d 1399, 1404 (9th Cir. 1996). Board directors of 22 the issuer company, professionals who participated in the preparation of the registration 23 statement, and underwriters of the security may be held liable under Section 11(a). 15 24 U.S.C. § 77k(a); see In re Software Toolworks Inc., 50 F.3d 615, 621 (9th Cir. 1994). 25 1. Duty to Disclose/Omissions 26 Plaintiff alleges that he sustained damages to the value of his purchased shares due 27 to the omission of material facts in the Offering Materials. Am. Compl. ¶ 107. 1 IPO, Freshworks’ revenue growth rate and billing growth rate were decelerating, and its 2 net dollar retention rate was declining. Id. ¶¶ 68, 72. Instead, the Offering Documents 3 only contained financial data from the ten quarters preceding the IPO from which “it could 4 be readily determined that Freshworks’ year-over-year revenue had experienced strong and 5 accelerating growth.” Id. ¶ 62. Given the temporal proximity between the IPO on 6 September 21, 2021, and the close of 3Q 2021 on September 30, 2021, Plaintiff alleges 7 that the Defendants knew or should have known of this deceleration, that information 8 about the decelerating rates was material to investors, and this information should have 9 been disclosed in the Offering Documents. Id. ¶¶ 71, 76. Plaintiff also alleges that the 10 Offering Documents were misleading, in violation of Defendants’ duty to be complete and 11 truthful, because Defendants affirmatively disclosed the growth rates and risk factors in the 12 Offering Documents. Id. ¶ 97. 13 Defendants respond that (1) the historical financial data was neither false nor 14 misleading; and (2) Freshworks had no duty to disclose intraquarter results. Mot. at 4–5. 15 Defendants’ arguments are correct. 16 a. Financial Data Disclosed in the Offering Documents 17 Companies cannot be held liable under Section 11 for simply reporting historical 18 financial data, particularly when a plaintiff makes no allegation that the data is inaccurate. 19 See Golubowski v. Robinhood Markets, Inc., 2023 WL 1927616, at *5 (N.D. Cal. Feb. 10, 20 2023) (“A company's statements are ‘inactionable’ if they ‘merely restate accurately 21 reported historical information.’”). 22 Plaintiff argues that the Offering Documents presented data from which it could be 23 inferred that Freshworks was “riding a then-current and ongoing period of accelerating 24 growth while failing to disclose that this was in fact no longer the case.” Opp’n at 7. 25 Plaintiff does not allege, however, that the Offering Documents contain inaccurate figures 26 with respect to the year-over-year revenue growth rate, the calculated billings growth rate, 27 or the net dollar retention rate. Even if Plaintiff alleges that the Offering Documents 1 “projections” by Freshworks were accompanied by accurate figures. See In re Gupta 2 Corp. Sec. Litig., 900 F. Supp. 1217, 1234 (N.D. Cal. 1994) (“[A]llegedly misleading 3 statements, including projections, that accompany the release of accurate historical data are 4 not actionable under federal securities laws.”). 5 The Court finds that Plaintiff fails to state a Section 11 claim based on the 6 “inferences” that could have been made from the historical financial figures stated in the 7 Offering Documents. 8 b. Failure to Disclose Ongoing 3Q 2021 Figures 9 Companies generally have no duty to disclose intraquarter results, and “courts have 10 been reluctant to impose liability based upon a failure to disclose financial data for a fiscal 11 quarter in progress.” In re Lyft Inc. Sec. Litig., 484 F. Supp. 3d 758, 773 (N.D. Cal. 2020) 12 (citation omitted); see In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1419 (9th Cir. 13 1994) (holding that a company had no duty to disclose performance figures for a quarter 14 that ended a month after its Debenture Offering in its prospectus). However, a company’s 15 failure to disclose such data can be actionable when the individual defendants have 16 information “indicating that the quarter in progress at the time of the public offering will 17 be an extreme departure from the range of results which could be anticipated based on 18 currently available information.” In re Novatel Wireless Sec. Litig., 830 F. Supp. 2d 996, 19 1023 n.31 (S.D. Cal. 2011) (quoting Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1210 (1st 20 Cir. 1996)). The question is therefore whether the information Freshworks had access to at 21 the time of the IPO was an “extreme departure” from anticipated results. Id. 22 A recent case in this Court addressed the same issue. In Golubowski, the company 23 conducted its IPO during Q3 2021 and did not disclose financial performance indicator 24 declines that occurred during Q3 2021 and prior to the IPO. 2023 WL 1927616, at *2. 25 The company saw a 35% decline in revenue between June 2021 and September 2021, a 26 19% decline in monthly active users between June 2021 and July 2021, and a 53% decline 27 in average revenues per user between March 2021 and September 2021. Id. The court 1 were insufficient to demonstrate “misleading representations by omission” in violation of 2 Section 11. Id. at *5. The plaintiff failed to plausibly state a Section 11 claim because he 3 did not allege “historical data” prior to the alleged timeframe to demonstrate that the 4 declines in any of the reported figures were “exceptional and out of line with past 5 fluctuations” as to require intraquarter disclosure. Id. 6 Plaintiff asserts that decline in Freshwork’s financial performance between 2Q 2021 7 and 3Q 2021 is an “‘extreme’ deviation from past performance” that should have been 8 disclosed in the Offering Documents. Opp’n at 8. He points to an 18% decline in the 9 revenue year-over-year growth rate (from 56% in 2Q 2021 to 46% in 3Q 2021) and a 33% 10 decline in the calculated billings metric (from 61% in 2Q 2021 to 41% in 3Q 2021). 11 Opp’n at 8–9. He also notes that this was the first instance of decelerating growth—of 12 any financial performance metric— after four consecutive quarters of growth. Am. 13 Compl. ¶ 66. Given the temporal proximity between the IPO and close of 3Q 2021, 14 Plaintiff alleges that Defendants knew or should have known of the deteriorating growth 15 rates and had a duty to disclose the figures. Id. ¶ 71. 16 The Court disagrees. Freshworks’ 3Q 2021 figures are not an extreme departure 17 from Freshworks’ historical results. Cf. Golubowski, 2023 WL 1927616, at *2. Rather, 18 these figures are exactly in line with Freshworks’ financial metrics from the preceding five 19 quarters. The revenue year-over-year growth rate for 3Q 2021, at 46%, was higher than it 20 was for 4Q 2020, at 44%. Id. ¶ 79. Similarly, the calculated billings growth rate for 3Q 21 2021 was higher than it was for 2Q 2020 (41% compared to 31%), and it even rose 22 between 3Q 2021 and 4Q 2021. Id. ¶¶ 80, 86. Moreover, the 3Q 2021 net dollar retention 23 rate, at 117%, was well within the range established in the preceding four quarters (109% - 24 118%). Id. ¶ 75. In addition, the deceleration rates between 2Q 2021 and 3Q 2021 were 25 lower than the fluctuating rates in Golubowski, which this Court found was not 26 “exceptional” to require intraquarter disclosure. Id. ¶¶ 75, 79, 80; Golubowski, 2023 WL 27 1927616, at *2. 1 disclose intraquarter figures because its 3Q 2021 financial performance metrics are not an 2 “extreme departure” from the range of results that could have been anticipated from past 3 performance. In re Novatel Wireless Sec. Litig., 830 F. Supp. 2d at 1023 n.31. 4 2. Misleading Risk Factor Language 5 Plaintiff alleges that the Offering Documents misled investors because the 6 documents presented the risk of negative financial and operational trends as “future, 7 contingent possibilities,” rather than events that already materialized. Am. Compl. ¶ 76. 8 Plaintiff points to statements in the Offering Documents such as: 9 “[E]ven if our revenue continues to increase, we expect that our revenue growth rate 10 may decline in the future;” 11 “[O]ur recent growth rates may not be indicative of our future growth;” 12 “[O]ur quarterly results of operations, including the levels of our revenue . . . may 13 vary significantly in the future.” 14 Id. ¶ 77. 15 He alleges that the declining growth figures announced in the November press 16 release demonstrate that the decline had already occurred when the Offering Documents 17 were issued. Id. 18 Plaintiff also alleges that the Offering Documents contained misleading statements 19 about Freshfield’s revenue, overall generation of business, and growth rate, which 20 contributed to the impression that Freshworks’ financial affairs “materially differed from 21 the one that actually existed.” Opp’n at 12 n.7; see, e.g., Am. Compl. ¶ 67 (“[T]he 22 Offering Documents also touted how the Company had ‘grown rapidly’ while 23 simultaneously maintaining a ‘healthy net dollar retention rate’ . . . These statements, 24 together with the reporting of historical revenue growth . . . painted a highly rosy picture of 25 continuing and accelerating growth trends as of the IPO.”); Am. Compl. ¶ 63 (“[n]ow we 26 generate a healthy mix of revenue from companies of all sizes”).6 27 1 Defendants argue that the risk disclosures were not false or misleading because (1) 2 they were sufficiently specific to the inherent market or business-related risk; and (2) no 3 relevant risk had materialized such that an Individual Defendant could have even known 4 that Freshworks’ financial affairs was materially different than the one that actually 5 existed. Reply at 7–9. 6 The Court finds that Defendants’ risk disclosures were not misleading. First, the 7 Offering Documents clearly disclosed that Freshworks had already experienced “a 8 reduction in renewal rates and increased churn rates . . . that could materially impact [its] 9 business, results of operations, and financial condition in future periods.” French Decl. Ex. 10 1 (dkt. 72-2) at 22. This is not a risk disclosure that “speaks entirely of as-yet-unrealized 11 risks and contingencies” that does not “alert the reader that some of these risks may 12 already have come to fruition.” In re Alphabet, Inc. Sec. Litig., 1 F.4th 687, 703 (9th Cir. 13 2021), cert. denied sub. nom. Alphabet Inc. v. Rhode Island, 142 S. Ct. 1227 (2022) 14 (quoting Berson v. Applied Signal Tech., Inc., 527 F.3d 982, 985-87 (9th Cir. 2008)). 15 Second, as explained above, Freshworks’ accurate reporting of historical financial 16 performance data did not misleadingly “create an impression of a state of affairs that 17 differ[ed] in a material way from one that actually exist[ed],” during 3Q 2021. See supra 18 at 8–9; Brody, 280 F.3d at 1006. Freshworks accurately reported its historical financial 19 performance metrics in the Offering Documents, and the 3Q figures were within the 20 established range. See supra at 9. Third, Defendants’ statements that Freshworks had 21 “grown rapidly,” maintained a “healthy net dollar retention rate,” and had a “healthy mix 22 of revenue” are simply statements of corporate optimism, which are inactionable and do 23 not create an impression that Freshworks’ financial condition was materially different from 24 what was detailed in the Offering Documents. See In re Cutera Sec. Litig., 610 F.3d 1103, 25 1111 (9th Cir. 2010) (collecting cases). 26

27 10. Plaintiff concedes that they are not independently actionable. Opp’n at 12 n.7. 1 The Court finds that the risk disclosure statements in the Offering Documents are 2 not misleading, and thus do not state a claim for a Section 11 violation. 3 3. SEC Regulation S-K 4 Items 303 and 105 of Regulation S-K impose independent and affirmative 5 disclosure duties for companies undergoing the IPO process. 17 C.F.R. §§ 229.105, 6 229.502(a), 229.503, § 229.303(b)(2)(ii); Steckman v. Hart Brewing, Inc., 143 F.3d 1293, 7 1296 (9th Cir. 1998). Item 303 requires disclosure of trends or uncertainties known to 8 have a material effect on a company’s revenue or income, and Item 105 requires a 9 discussion of material risk factors. 17 C.F.R. §§ 229.105, 229.502(a), 229.503, 10 229.303(b)(2)(ii). In Steckman, the Ninth Circuit held that an Item 303 violation 11 automatically states a claim for a Section 11 violation. 143 F.3d at 1296–97. Since both 12 Items 303 and 105 address a company’s disclosure requirements in their IPO documents, 13 courts treat a violation of Items 303 and 105 as a violation of Section 11. See, e.g., Pirani 14 v. Slack Techs., Inc., 445 F. Supp. 3d 367, 385 (N.D. Cal. 2020). 15 a. Item 303 Claim 16 Under Item 303, companies must “[d]escribe any known trends or uncertainties that 17 have had or that are reasonably likely to have a material favorable or unfavorable impact 18 on net sales or revenues or income from continuing operations.” 17 C.F.R. § 19 229.303(b)(2)(ii). To state a Section 11 claim for failing to adhere to Item 303, Plaintiffs 20 must plausibly allege: (1) the existence of a trend or uncertainty; (2) known to 21 management; (3) that is reasonably likely to have a material effect on the registrant’s 22 financial condition or results of operation. Steckman, 143 F.3d at 1296–97. 23 Plaintiff argues that Defendants violated Item 303 of Regulation S-K because the 24 Offering Documents did not disclose known revenue and calculated billing growth 25 deceleration. Am. Compl. ¶ 94. Defendants argue that (1) one quarter of financial 26 deceleration is insufficient to establish a trend; and (2) Plaintiffs did not allege sufficient 27 facts pertaining to Defendants’ knowledge of an adverse trend. Reply at 9–10. The Court i. Knowledge of a Trend or Uncertainty 1 2 The parties dispute whether a quarter constitutes a “trend” that must be reported. 3 Mot. at 11–12; Opp’n at 12–13. “A trend under Item 303 requires an ‘observed pattern 4 that accurately reflects persistent conditions of the particular registrant’s business 5 environment.’” In re Restoration Robotics, Inc. Sec. Litig., 417 F. Supp. 3d 1242, 1263 6 (N.D. Cal. 2019) (quoting Oxford Asset Mgmt., Ltd. v. Jaharis, 297 F.3d 1182, 1191 (11th 7 Cir. 2002)). “[T]he case law is far from settled regarding the length of time necessary to 8 constitute a “trend” for the purpose of Item 303.” Franchi v. SmileDirectClub, Inc., 633 F. 9 Supp. 3d 1046, 1066 (M.D. Tenn. 2022). Some district courts have held that a period 10 shorter than two months or a single quarter decline of 9% in operating income is 11 insufficient to establish a trend under Item 303. Mallen v. Alphatec Holdings, Inc., 861 F. 12 Supp. 2d 1111, 1128 (S.D. Cal. 2012) (collecting cases about what establishes a trend 13 under Item 303). But this is not a settled rule, and a trend may be a “factual inquiry” that 14 is resolved at a later stage of a case. In re Lyft Inc. Sec. Litig., 484 F. Supp. 3d 758, 776 15 n.7 (N.D. Cal. 2020) (finding that the plaintiff plausibly pled a violation of Item 303 16 because they alleged that the company knew of defects that would have a material 17 financial impact prior to the IPO). More facts are needed here to determine whether 18 Freshworks’ decelerating growth rates actually constitute a trend. Because it is plausible 19 that Freshworks’ Q3 2021 financial deceleration indicates an “observed business pattern 20 that accurately reflects persistent conditions” of Freshworks’ business environment, the 21 Court finds that Plaintiff sufficiently alleges this element at this stage in the proceedings. 22 Given that Plaintiff sufficiently pleads that Freshworks’ decelerating growth rates 23 are a trend, the Court finds that Plaintiff sufficiently alleges that Defendants had 24 knowledge of an adverse trend. Plaintiff points to the Offering Documents, which state 25 that Freshworks already experienced “a reduction in renewal rates and increased churn 26 rates . . . that could materially impact [its] business, results of operations, and financial 27 condition in future periods.” French Decl. Ex. 1 at 22. Plaintiff also argues that the 1 in the future” is indicative of the Defendants’ belief of financial deceleration—that it was a 2 warning. Opp’n at 14. Plaintiff asserts that these statements, taken together, demonstrate 3 that Defendants had knowledge of Freshworks’ Q3 2021 decelerating growth rates at the 4 time of the IPO. Id. Under the liberal pleading standards under Rule 12(b)(6), Plaintiff 5 plausibly alleges that Defendants knew of Freshworks’ financial deceleration prior to the 6 IPO. 7 ii. Material Impact 8 Plaintiff alleges that the growth deceleration Freshworks experienced during Q3 9 2021 had a material impact on the company’s financial condition. Plaintiff references 10 Franchi, where the court found that the plaintiffs stated a plausible Item 303 violation 11 based on “sharp and sudden decline in three different financial metrics related to [the 12 defendants’] operations” and argues that these declines mirror Freshworks’ Q3 growth 13 deceleration rates. Opp’n at 13–14; 633 F. Supp. 3d at 1067. In Franchi, the plaintiffs 14 alleged that at the time of the IPO, the defendant knew and failed to disclose that its 15 financial metrics would decrease as a result of increased marketing expenses and expenses 16 related to pending litigation and investigations. Id. at 1058. At this stage of the 17 proceedings, Plaintiff sufficiently alleges that the Q3 2021 decelerating growth rates in 18 three different financial metrics were reasonably likely to have a material impact on 19 Freshworks’ financial condition, particularly given that it was a company at the IPO stage. 20 Opp’n at 13–14. 21 The Court finds that Plaintiff adequately states a violation of Item 303 because he 22 alleges that Defendants knew that the Q3 2021 decelerating growth rates were “reasonably 23 likely” to impact Freshworks’ IPO. 17 C.F.R. § 229.303(b)(2)(ii). 24 b. Item 105 of SEC Regulation S-K 25 Item 105 requires “a discussion of the most significant factors that make an 26 investment in the registrant or offering speculative or risky,” and failure to satisfy this 27 requirement amounts to a Section 11 violation. 17 C.F.R. §§ 229.105(a), 229.502(a), 1 specific disclosures regarding the risks facing the company, as opposed to terse, generic 2 statements, the investing public is on notice of these risks and cannot be heard to complain 3 that the risks were masked as mere contingencies.” Plevy v. Haggerty, 38 F.Supp. 2d 816, 4 832 (C.D. Cal. 1998). 5 This Court recently held that a company’s risk disclosures were misleading in 6 violation of Item 105 because the “risk factors” reported in its Registration Statement had 7 already materialized at the time of its IPO. Bos. Ret. Sys. v. Uber Techs., Inc., 2020 WL 8 4569846, at *6 (N.D. Cal. Aug. 7, 2020). There, the plaintiff plausibly alleged that the 9 company’s financial affairs were materially different than what was represented in its 10 Registration Statement by pointing to the company’s corporate structure. Id. The plaintiff 11 alleged that the company intentionally delayed layoffs and restructuring “it knew were 12 inevitable” to mislead the markets in anticipation of its IPO, and indeed the company 13 dissolved director-level positions weeks after the IPO. Id. The Court found that plaintiffs 14 plausibly alleged that the risk factors had “already ‘come to fruition’” and the Registration 15 Statement was “misleading” in violation of Item 105. Id. at *6–*7. 16 Plaintiff alleges that the Offering Documents’ discussion of risk factors was 17 misleading in violation of Item 105 of SEC Regulation S-K because the Offering 18 Documents “failed to make any mention of slowing revenue growth as required by SEC 19 rules and regulations.” Am. Compl. ¶ 96. Defendants respond that the Offering 20 Documents contained robust risk disclosures that satisfied Item 105 requirements. Reply 21 at 11. The Court agrees with Defendants. 22 Freshworks’ risk disclosures adequately warned that the company may experience 23 deterioration in its revenue growth and other financial performance metrics. See, e.g., 24 French Decl. Ex. 1 at 16 (“We have experienced rapid growth in recent periods. Even if 25 our revenue continues to increase, we expect that our revenue growth rate may decline in 26 the future as a result of a variety of factors.”); French Decl. Ex. 1 at 18 (“Our quarterly 27 results may fluctuate significantly and may not meet our expectations or those of investors 1 revenue, deferred revenue, working capital, and cash flows, may vary significantly in the 2 future, such that period-to-period comparisons of our results of operations may not be 3 meaningful.”). The Offering Documents specified the following factors as potential risks: 4 the COVID-19 pandemic; the level of product demand; errors in forecasting product 5 demand; and a reduction in customer renewal rates. French Decl. Ex. 1 at 18, 19, 22. 6 These are not “terse, generic statements” that fail to comply with Item 105’s requirement 7 for a discussion about significant risk factors. Plevy, 38 F.Supp. 2d at 832. 8 Even if these statements are generic, Plaintiff has not alleged facts that plausibly 9 demonstrate that Freshworks’ financial affairs were materially different than what was 10 represented in the Offering Documents to amount to a violation under Rule 105. Plaintiff 11 alleges that the discussion of risk factors in the Offering Documents was “materially 12 misleading” because the Offering Documents “failed to make any mention of slowing 13 revenue growth.” Am. Compl. ¶ 96. However, unlike in Bos. Ret. Sys., where the 14 plaintiffs alleged that the company delayed “inevitable” layoffs and restructuring until 15 after the IPO, Freshworks reported in the Offering Documents that it had already 16 experienced “a reduction in renewal rates and increased churn rates . . . that could 17 materially impact [its] business, results of operations, and financial condition in future 18 periods.” 2020 WL 4569846, at *6; French Decl. Ex. 1 at 22. Plus, the alleged “slowing 19 revenue growth” was in line with historical figures. See supra at 9. 20 Given these risk disclosures, Plaintiff has not plausibly alleged that Defendants 21 violated Item 105 for failing to discuss “potential future adverse impacts.” Am. Compl. ¶ 22 96. 23 B. Section 15 Claim 24 Section 15 of the Securities Act imposes secondary liability on every person who 25 controls any person liable under Section 11. In re Rigel Pharms., Inc. Sec. Litig., 697 F.3d 26 at 886. Determining whether an individual is a control person is a fact intensive matter. 27 Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). An individual is a 1 the management and policies of a person, whether through the ownership of voting 2 securities, by contract, or otherwise.” 17 C.F.R. § 230.405. “Traditional indicia” of a 3 controlling person of a company include “a prior lending relationship with the accused 4 company, ownership of its stock, and a seat on its Board.” Pirani, 445 F. Supp. 3d at 391. 5 Plaintiff alleges that Individual Defendants were “controlling persons” of 6 Freshworks “[b]y reason of their ownership in, senior management positions at, and/or 7 directorships held.” Am. Compl. ¶ 124. Defendants allege that Plaintiff lacks standing to 8 bring a Section 15 claim because Plaintiff did not allege an underlying violation of the 9 Securities Act. Mot. at 14. 10 The Court finds that Plaintiff adequately alleges a Section 15 claim. Plaintiff 11 plausibly alleges a violation of Item 303, as discussed supra, which is a violation of 12 Section 11. See supra at 14–16; Steckman, 143 F.3d at 1296–97. He also sufficiently 13 alleges that the Individual Defendants were control persons by nature of their positions at 14 Freshworks, which Defendants have not contested. 15 C. Leave to Amend 16 Should the Court dismiss a complaint for failure to state a claim, it should freely 17 give leave to amend “when justice so requires.” Fed. R. Civ. P. 15(a)(2). The Ninth 18 Circuit has instructed that the policy favoring amendment “should be applied with 19 ‘extreme liberality.’” United States v. Webb, 655 F.2d 977, 979 (9th Cir. 1981) (quoting 20 Rosenberg Brothers & Co. v. Arnold, 283 F.2d 406, 406 (9th Cir. 1960) (per curiam)). 21 However, leave to amend “is not to be granted automatically.” In re W. States Wholesale 22 Nat. Gas Antitrust Litig., 715 F.3d 716, 738 (9th Cir. 2013) (quoting Jackson v. Bank of 23 Haw., 902 F.2d 1385, 1387 (9th Cir. 1990)). A court considers five factors to assess 24 whether to grant leave to amend: “[1] undue delay, [2] bad faith or dilatory motive on the 25 part of the movant, [3] repeated failure to cure deficiencies by amendment previously 26 allowed, [4] undue prejudice to the opposing party by virtue of allowance of the 27 amendment, [and] [5] futility of amendment.” Leadsinger, Inc. v. BMG Music Publ’g, 512 1 Defendants argue that all Plaintiff's claims should be dismissed with prejudice 2 || because leave to amend would be futile. Reply at 12. According to Defendants, Plaintiff 3 || has not explained what he would do differently in a third pleading, and he cannot change 4 || Freshworks’ Q3 2021 financial performance metrics. Id. Defendants do not discuss the 5 || other four factors and do not assert that (1) leave to amend will cause undue delay; (2) 6 || Plaintiff acted in bad faith; (3) Plaintiff has repeatedly failed to cure deficiencies in the 7 || complaint; or (4) leave to amend will result in undue prejudice. 8 Leave to amend will not be futile here. For example, plaintiff could amend the 9 || complaint to include facts that the Q3 2021 growth deceleration rates were exceptional and 10 || out of line with historical figures as to require intraquarter disclosure. Given that it would 11 || not be futile, and because Defendants do not assert that any of the other four factors weigh 12 || against granting leave to amend, the Court GRANTS Plaintiff leave to amend his Section 13 || 11 and Item 105 claims. 14 || IV. CONCLUSION 2 15 For the foregoing reasons, the Court DENIES Defendants’ motion to dismiss 16 || Plaintiff's Item 303 claim and Section 15 claim. The Court GRANTS Defendants’ motion 5 17 || to dismiss Plaintiff's 12(a) claim with prejudice. The Court GRANTS with leave to amend 18 || Defendants’ motion to dismiss the Item 105 claim and the Section 11 claims that 19 || Defendants (1) failed to disclose the Q3 2021 decelerating growth rates prior to the IPO; 20 || and (2) included statements in the Offering Documents that created an impression of a 21 || state of affairs that materially differed from the one that actually existed. 22 IT IS SO ORDERED. Spa 23 Dated: September 28, 2023 Lo. 24 United States District Judge 25 26 27 28