Northern District of California Dismisses Putative Securities Class Action Against Customer Service Software Provider For Failure To Allege Falsity and Scienter

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Shearman & Sterling LLPOn November 10, 2020, Judge Charles R. Breyer of the United States District Court for the Northern District of California dismissed without prejudice a putative class action against a software company (the “Company”) and several of its officers, for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. Reidinger v. Zendesk Inc. et al., No. 3:19-cv-06968 (N.D. Cal. Nov. 10, 2020). Plaintiff alleged that defendants made false and misleading statements and omissions regarding the Company’s performance and sales capabilities in Europe, the Middle East, and Africa (“EMEA”) and the Asian Pacific (“APAC”) and the strength of its data security. The Court dismissed the complaint with leave to amend because plaintiff failed to allege falsity or scienter, highlighting the formidable challenges plaintiffs face in pleading event-driven claims based on worse than expected earnings results.

The Company is a customer service software provider. In providing its services, the Company collects, stores, and transmits sensitive and personal information related to its customers, agents, and end-users. The Company’s Q2 2019 results showed slower revenue growth in EMEA and APAC. Then, in October 2019, the Company disclosed that it had discovered that a data breach from 2016 resulted in unauthorized access to customer and end-user personal identifiable information. The complaint alleged misrepresentations and omissions regarding (i) the Company’s results in EMEA and APAC; and (ii) the strength of the Company’s data security.

The Court dismissed these claims. The Court first held that plaintiff failed to allege falsity with respect to any statement about performance in EMEA and APAC, including statements regarding a “strong [global] demand” for the Company’s products, and its presence and growth in EMEA and APAC. The Court held that these statements concerned performance prior to Q2 2019, and not performance in Q2 2019. Moreover, other statements by defendants were consistent with slowing growth in the regions, including the statement “we look at our pipeline across every region . . . . And so far, we have not seen anything . . . Not that it won’t come. But today, with the data we have, we haven’t seen it.” The Court also rejected plaintiff’s contention that defendants failed to disclose that macroeconomic challenges and sale strategies and personnel issues were adversely impacting the Company’s business. The Court held that plaintiff’s vague allegations did not indicate what specific fact should have been disclosed or why the alleged failure to disclose that information was material. Finally, the Court held that the complaint failed to allege facts sufficient to give rise to a strong inference of scienter because the pleaded facts gave “rise to a different inference: that [the Company] made strategic mistakes that it later examined and began taking steps to fix.” Nothing suggested the Company’s “sales leaders (let alone [its] top executives) knew” the reasons for the decline “well before the end of Q2 2019.”

The Court also held that plaintiff failed to allege falsity or scienter in the Company’s discussion of its data security standards and risks in 2019. Although an alleged failure to disclose a security breach resulting in unauthorized access to customer and end-user information could be a material omission, plaintiff failed to allege that defendants were aware of the data breach when they made the challenged statements regarding the Company’s “highest possible standards for protecting” customer information. To the contrary, plaintiff’s allegations indicated that defendants were unaware of the breach at the time of these statements.

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