Reidinger v. Zendesk, Inc.

Background

A class of Zendesk stock purchasers, led by Local 353, I.B.E.W. Pension Fund, sued Zendesk, Inc. and three officers—Mikkel Svane, Elena Gomez, and Norman Gennaro—under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. The Pension Fund also sued the individual defendants under Section 20(a), which can impose liability on people who control a person or company responsible for securities fraud.

The claims concerned two alleged events: slower-than-expected performance in the Europe, Middle East, and Africa and Asia-Pacific regions during the second quarter of 2019, and a data breach that Zendesk discovered and disclosed in September and October 2019. The Pension Fund alleged that Zendesk’s earlier statements about demand, sales execution, regional growth, and data security misled investors and caused them to buy stock at inflated prices before later stock-price declines.

Legal Standard

Zendesk 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. Securities-fraud claims under Section 10(b) and Rule 10b-5 require allegations of a material misstatement or omission, scienter, a connection to buying or selling a security, reliance, economic loss, and loss causation. “Scienter” means the required wrongful state of mind, such as an intent to deceive or conscious recklessness about the truth.

The heightened pleading rules under the Private Securities Litigation Reform Act required the Pension Fund to identify each allegedly misleading statement and explain why it was misleading. The Pension Fund also had to allege particular facts supporting a strong inference that the defendants acted with the required intent.

Regional-Performance Claims

The court held that the Pension Fund failed to state a claim based on Zendesk’s statements about performance in the Europe, Middle East, and Africa and Asia-Pacific regions. The court found that the complaint did not adequately identify a false statement or a material omission.

The court reasoned that many challenged statements described Zendesk’s earlier 2018, fourth-quarter 2018, or first-quarter 2019 performance and were not alleged to have been false when made. Statements about strong global or regional demand were also not shown to be inconsistent with a later slowdown. The complaint did not allege that Zendesk knew in advance that deals would take longer to close or that its sales pipeline had already weakened.

The court also found that statements about adding sales representatives and enterprise leaders did not promise that regional growth would remain steady or accelerate. It concluded that statements describing Zendesk’s global footprint as an advantage or opportunity were vague expressions of optimism rather than specific factual assertions that could be proven true or false.

The alleged omissions were also insufficiently pleaded. The Pension Fund did not specify what Zendesk should have disclosed about Brexit or the trade dispute between the United States and China, or explain why those developments materially affected Zendesk’s business when the statements were made. It also did not explain why investors would have viewed the differences between sales practices in the United States and other regions as important enough to change the overall information available to them. Finally, the complaint did not identify specific, objectively verifiable facts about allegedly weak regional leadership that Zendesk knew and failed to disclose.

The court separately found that the allegations did not create a strong inference of scienter. Instead, they suggested that Zendesk may have made strategic mistakes and later took steps to address them. The court stated that the allegations did not show that Zendesk’s sales leaders or top executives knew early enough that deals would take longer to close or why they would take longer.

Data-Security Claims

The court held that the Pension Fund also failed to state a claim concerning the data breach. It did not adequately allege that Zendesk’s statements about its security program were false. The breach occurred in 2016, while the challenged statements cited by the Pension Fund were made in 2019. The allegations indicated that Zendesk’s security had improved between 2016 and 2019, making the 2019 statements potentially consistent with the earlier breach.

The court did find that the alleged failure to disclose the breach could plausibly be a material omission because a reasonable investor might consider such a breach important. But the Pension Fund did not adequately plead scienter. The allegations indicated that Zendesk was unaware of the breach until September 2019, and the complaint did not suggest that Zendesk knew earlier or was consciously reckless in failing to detect and disclose it. The court therefore found no strong inference that Zendesk intended to deceive or defraud investors.

Section 20(a) Claims

Because the Pension Fund had not adequately pleaded an underlying Section 10(b) securities-fraud claim, the court held that the Section 20(a) control-person claims also failed.

Disposition

Judge Charles R. Breyer granted Zendesk’s motion to dismiss without prejudice. The court granted the Pension Fund leave to amend because it was conceivable that additional allegations could cure the pleading deficiencies. The Pension Fund was given 60 days from the order’s date to file an amended complaint. Because the complaint failed to satisfy the first two elements of a Section 10(b) and Rule 10b-5 claim, the court did not decide whether loss causation was adequately pleaded. The court also vacated the previously scheduled oral argument.