Bailey v. Zendesk, Inc.

Background

Lead plaintiffs Brian Bailey and Scott Franklin brought a securities class action for themselves and similarly situated former public stockholders of Zendesk, Inc. They sued Zendesk and former members of Zendesk’s Board of Directors. The dispute arose from Zendesk’s 2022 sale to private equity companies Hellman & Friedman LLC and Permira Advisers LLC, referred to collectively as the Consortium.

Zendesk had proposed acquiring Momentive Global, Inc. in 2021 and released revenue projections valuing Zendesk at $130 to $197 per share. After Zendesk shareholders rejected that transaction, JANA Partners LLC allegedly pressured the board either to sell Zendesk or face a proxy contest. Zendesk later received bids from the Consortium, including a final bid of $75.50 per share. Zendesk shareholders approved the sale on September 19, 2022.

Before the sale, Zendesk’s stock price and bookings metrics declined. The company’s stock price fell from more than $120 per share in April 2022 to below $60 per share by June 13, 2022. The company also reported year-over-year declines in bookings for April and May 2022. Management then issued lower June 2022 revenue projections, and the board approved the proposed sale.

Claims and Motion

The plaintiffs alleged that an August 8, 2022 proxy statement contained materially false or misleading statements. Specifically, they challenged statements that the June 2022 revenue projections were reasonably prepared using management’s best available estimates and judgments, and that the June 2022 value-per-share figures were reasonably determined using accurate valuations and objective fairness opinions from Qatalyst Partners and Goldman Sachs.

The plaintiffs asserted a claim under Section 14(a) of the Securities Exchange Act and Securities and Exchange Commission Rule 14a-9 against all defendants. They also asserted a Section 20(a) controlling-person claim against the individual board-member defendants. The plaintiffs sought damages, costs, attorneys’ fees, and class certification.

Defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), arguing that the proxy statement was not false or misleading because it reflected declining bookings and market prices. They also argued that the $75.50 sale price represented a premium over Zendesk’s market price when the deal was signed.

Analysis

The court explained that the Private Securities Litigation Reform Act requires securities-fraud plaintiffs to plead falsity, the defendants’ required state of mind, and loss causation with particularity. Because the challenged statements were opinions, the plaintiffs had to plead both objective falsity—that the opinions were objectively untrue—and subjective falsity—that the speakers did not actually hold the beliefs they expressed.

Objective and subjective falsity. The court held that the plaintiffs did not adequately plead objective falsity. The plaintiffs relied mainly on Zendesk’s higher October 2021 and March 2022 projections to challenge the lower June 2022 projections. The court found that those earlier projections did not establish that the June projections were false, particularly because the company’s bookings and stock price had deteriorated after the March projections.

The plaintiffs also alleged that JANA’s pressure and threatened proxy contest caused the board to approve artificially low projections. The court held that the plaintiffs did not provide evidence directly contradicting the June projections or showing that JANA’s pressure caused the board to approve false information. The court found a reasonable alternative explanation: Zendesk had experienced declining bookings and a continuously falling stock price before the sale.

The court separately held that the plaintiffs failed to plead subjective falsity. The allegations, considered individually and together, did not create a reasonable inference that the board members knew the projections were false but approved them anyway.

Required state of mind. The court also held that the plaintiffs failed to plead the required state of mind, commonly called scienter, with the particularity required by the securities laws. The court reasoned that the same allegations that failed to support subjective falsity also failed to create the stronger inference required for scienter.

Loss causation. The court held that the plaintiffs did not adequately allege loss causation, meaning a sufficiently specific connection between the alleged false statements and the claimed financial losses. The plaintiffs relied partly on Light Street Capital Management, LLC’s proposal to purchase half of Zendesk’s outstanding shares for $82.50 per share. The court found that proposal speculative because it covered only half the shares and the plaintiffs did not provide sufficient evidence that Light Street had the capital to complete it. The court also noted that the proposal lacked committed financing and that Institutional Shareholder Services had described it as not credible.

The plaintiffs separately argued that Zendesk was sold below its true value because the June projections were too low. The court rejected that theory at the pleading stage because the plaintiffs had not adequately shown that Zendesk’s true value exceeded those projections. The court noted the intervening decline in bookings and market price, the sale price’s premium over the market price, and the Consortium’s reduction of its bid from $120 to $96 and then to $75.50 per share.

Section 20(a) claim

The court held that the Section 20(a) claim also failed because it depended on an underlying Section 14(a) violation. Since the plaintiffs had not adequately pleaded the Section 14(a) claim, they could not establish the required underlying violation for the Section 20(a) claim.

Disposition

The court granted defendants’ motion to dismiss the complaint with leave to amend. The court directed that, if the plaintiffs chose to amend, they must submit an amended complaint within 21 days of the order.