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—Chief Executive Officer Mikkel Svane, Chief Financial Officer Elena Gomez, and Senior Vice President of Worldwide Sales Norman Gennaro. The pension fund asserted claims under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, which prohibit securities fraud, and under Section 20(a), which concerns control-person liability.

The proposed class covered purchasers of Zendesk common stock between February 6, 2019 and October 1, 2019. The pension fund’s allegations focused on two events: weaker-than-expected performance in Zendesk’s Europe, Middle East, and Africa (EMEA) and Asia Pacific (APAC) regions during the second quarter of 2019, and Zendesk’s September 2019 disclosure of a data breach that had allegedly continued undetected for approximately three years.

Legal standard

Zendesk moved to dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim. The court was required at this stage to accept well-pleaded factual allegations as true and draw reasonable inferences for the pension fund. Securities-fraud claims also had to satisfy heightened pleading requirements under the Private Securities Litigation Reform Act. The complaint had to identify each allegedly misleading statement and explain why it was misleading, and it had to plead particular facts creating a strong inference of scienter—meaning an intent to deceive, manipulate, or defraud, or the conscious recklessness recognized by the Ninth Circuit.

EMEA and APAC allegations

The court held that the pension fund did not adequately plead a material misstatement or omission concerning Zendesk’s EMEA and APAC performance. Statements describing earlier performance, demand, sales efforts, and regional strategies were not shown to be false when made. The court also found that the allegations did not establish that Zendesk knew in advance that deals would take longer to close or that its regional strategies and leadership were materially deficient in a way that had to be disclosed.

The court further concluded that some statements were vague expressions of optimism rather than objectively verifiable facts. It found that the pension fund had not adequately explained why the alleged omissions about Brexit, the United States-China trade war, the use of U.S. sales practices, or regional leadership would have significantly changed the total mix of information available to a reasonable investor.

The same allegations also failed to create the required strong inference of scienter. In the court’s view, they were more consistent with Zendesk having made strategic mistakes and later taking steps to correct them than with Zendesk or its officers intending to deceive investors.

Data-security allegations

The court held that the pension fund plausibly alleged that Zendesk’s failure to disclose the data breach could have been a material omission. However, the complaint did not adequately allege scienter. The allegations indicated that Zendesk was unaware of the breach until September 2019, when it identified the incident and later disclosed it. The court found no sufficient allegation that Zendesk knew of the breach earlier or was consciously reckless in failing to detect and disclose it.

Section 20(a) allegations

Because the pension fund did not adequately plead an underlying securities-fraud claim under Section 10(b), its Section 20(a) control-person claims also failed.

Disposition

The court granted Zendesk’s motion to dismiss without prejudice. It granted the pension fund leave to amend because it found that additional allegations could potentially cure the pleading deficiencies. The pension fund was given 60 days from the date of the order to file an amended complaint. The court also vacated the previously scheduled oral argument.