On February 16, 2022, Judge James Donato of the Northern
District of California granted in part and denied in part a motion
to dismiss a putative class action asserting claims under the
Securities Exchange Act of 1934 against a videoconferencing company
and certain of its executives. In re Zoom Sec.
Litig., No. 20-cv-02353-JD (N.D. Cal. Feb. 16, 2022).
Plaintiff alleged that the company made misrepresentations
concerning the level of encryption on its primary videoconferencing
product. The Court held that plaintiff sufficiently alleged
falsity, scienter, and loss causation as to the CEO's
challenged statements regarding encryption, but it dismissed claims
as to certain other alleged misstatements, and all claims against
one executive, for failure to sufficiently allege scienter, while
granting leave to amend.
The Court first held that plaintiff adequately alleged that the
company misrepresented that its primary videoconferencing product
offered "end-to-end encryption," which plaintiff claimed
was inaccurate because the company retained the ability to
centrally decrypt and access the communications of its end
users. Slip op. at 4. The Court rejected the
company's argument that "end-to-end encryption" can
have different meanings, emphasizing that defendants'
statements as alleged in the complaint showed otherwise.
Id. at 4-5. In particular, the Court pointed to an
alleged statement by the company's CEO apologizing for
"incorrectly suggesting" that its product offered
"end-to-end encryption" and recognizing that there was a
"discrepancy between the commonly accepted definition ... and
how we were using it." Id. at 5.
Regarding scienter, the Court determined that plaintiff adequately
alleged scienter with respect to the company's CEO, and thus
with respect to the company. Id. at 5-6. The
Court rejected defendants' argument that the CEO's apology
for the company's prior "incorrect" use of the term
failed to show that he had the same understanding at the time he
made the allegedly false statement one year prior.
Id. at 5-6. The Court emphasized that, given the
CEO's technical background—including an advanced
engineering degree, founding a prior videoconferencing platform,
and being named on several encryption-related patents—there
was "no factual basis" to believe that the CEO's
understanding of the term in question changed in a relevant way
between the time he made the statement and the time he issued the
apology. Id. at 6.
The Court also held that loss causation was sufficiently alleged
based on alleged corrective disclosures. Id. at
6. The Court noted that stock price declines when a news
article allegedly revealed the truth about the company's
encryption technology and again following the CEO's apology
gave the Court "some assurance that the theory has a basis in
fact." Id. at 6-7. The Court rejected
defendants' argument that the truth of the company's
encryption technology had already been previously reported,
determining that this was a factual argument that could not be
resolved on the pleadings. Id. 7.
However, the Court dismissed plaintiff's additional
allegations of alleged misstatements, noting that plaintiff
admitted that the CEO did not make those statements, and further
holding that there were no allegations showing that the individuals
responsible for the statements acted with scienter or that the
statements were "so important and so dramatically false"
that scienter should be imputed to the company. Id.
at 7-8. The Court also dismissed all claims against the
company's CFO, noting that plaintiff had merely alleged that
the CFO "signed or authorized" SEC filings, "had the
power to authorize or approve" public statements, and spoke on
earnings calls and at investor conferences, which the Court held
amounted to "little more than a generic job description"
that "comes nowhere close" to sufficiently alleging
scienter. Id. at 3.
Finally, having held that plaintiff could pursue a Section 10(b)
claim against the CEO as the maker of the one statement found
actionable, the Court noted that it was "duplicative and
nonsensical" to impose secondary control person liability
against the CEO for that same statement, and dismissed the Section
20(a) claim against the CEO on that basis.
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