Northern District Of California Declines To Dismiss Putative Class Action Against Enterprise Software Company
On April 28, 2020, Judge Susan Illston of the United States District Court for the Northern District of California denied a motion to dismiss a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against an enterprise software company and certain of its executives. Roberts v. Zuora, Inc., No. 19-cv-03422-SI, slip op. (N.D. Cal. Apr. 28, 2020), ECF No. 75. Plaintiff alleged that, prior to its initial public offering, the company misstated that its two flagship products could be integrated together and that such integration was a key part of its business strategy, when in fact the product integration was not functional. The Court held that plaintiff adequately alleged that such statements were false or misleading and made with the requisite scienter.
Plaintiff alleged that the company made a series of statements marketing its platform and applications as a functioning, combined solution, when in fact they could only function as separate standalone products. Id. at 15. For example, the company’s Twitter account stated “[t]hank goodness for [our products’] integration for a seamless order-to-revenue process,” and its website stated that the company provides a “single platform for your order-to-revenue process” and “easily connects the various applications in your order-to-revenue ecosystem.” Id. at 15–16. Moreover, plaintiff alleged that the company in SEC filings and earnings calls falsely indicated that “cross-selling” or “upselling” of its products was a key element of its growth strategy. Id. at 17. Plaintiff further alleged, relying on confidential witness statements, that the company had attempted, unsuccessfully, several internal high-priority projects to integrate its products, that the company’s executives were kept informed about those projects on a regular basis, and that customers had complained about the lack of integration and some had withheld payment as a result. Id. at 6–7.
The Court rejected the company’s argument that the alleged misstatements were not actionable because they were merely general statements of corporate optimism or forward-looking statements protected under the PSLRA’s “safe harbor” or the bespeaks caution doctrine. Rather, the Court emphasized that projections and general expressions of optimism may be actionable if they are not genuinely believed, there was no reasonable basis for the belief, or the speaker is aware of undisclosed facts seriously undermining the accuracy of the statement. Id. at 17. The Court concluded that plaintiff sufficiently alleged that the company’s executives did not have a reasonable basis to believe that the products were integrated or would work “seamlessly” or “easily” with each other because, according to the confidential witness allegations, the executives were kept informed regarding unsuccessful integration projects and related issues with key customers. Id. at 17.
The Court further held that plaintiff had adequately alleged facts giving rise to a strong inference that the alleged misstatements were made intentionally or with deliberate recklessness. The Court emphasized that scienter allegations relying on confidential witness statements must be described with sufficient particularity to demonstrate the reliability and personal knowledge of the confidential witnesses and, further, the confidential witness statements must themselves be indicative of scienter. Id. at 18 (citing Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 995 (9th Cir. 2009)).
The Court rejected the company’s arguments that the confidential witness allegations should not be credited because they were not employed for the entirety of the purported class period, they lacked personal knowledge or direct contact with company executives, and they did not indicate scienter with sufficient particularity. Id. at 18–19. Instead, the Court concluded that there was no requirement that each confidential witness be employed during the entire class period, and that this did not justify disregarding their allegations. Moreover, the confidential witnesses were alleged to have had personal knowledge as a result of their positions at the company, and were responsible for integration projects and for developing customer accounts. The Court also held that, taken together, the numerous detailed confidential witness allegations—including details from specific high-level meetings regarding integration projects and regarding customer difficulties—contributed to a strong inference of scienter.