Sgarlata v. PayPal Holdings, Inc.

[3] 4 UNITED STATES DISTRICT COURT 5 NORTHERN DISTRICT OF CALIFORNIA [6] 7 RONALD SGARLATA, et al., Case No. 17-cv-06956-EMC 8 Plaintiffs, ORDER GRANTING DEFENDANTS’ 9 v. MOTION TO DISMISS SECOND AMENDED COMPLAINT 10 PAYPAL HOLDINGS, INC., et al., Docket No. 79 11 Defendants. [12] 13 Defendants PayPal Holdings, Inc., TIO Networks ULC, TIO Networks USA, Inc., Daniel 14 H. Schulman, John D. Rainey, Jr., and John Kunze (collectively, “Defendants”) move to dismiss 15 Plaintiffs Michael Eckert and Edwin Bells’ (“Plaintiffs”) second amended complaint (“SAC”). 16 Plaintiffs bring this action individually and on behalf of all others who purchased PayPal securities 17 between November 10, 2017 and December 1, 2017 (the “Class Period”). Plaintiffs claim that 18 they purchased PayPal securities at allegedly inflated prices during the Class Period. The Court 19 previously dismissed Plaintiffs’ first amended complaint (“FAC”) with leave to amend. Docket 20 No. 78. The SAC continues to allege claims for relief against Defendants under 10(b), 10b–5, and 21 20(a).1 22 Pending before the Court is Defendants’ Motion to Dismiss (“Mot.”) the SAC pursuant to 23 Federal Rules of Civil Procedure Rule 12(b)(6), Rule 9(b), and the Private Securities Litigation 24 Reform Act (“PSLRA”). Docket No. 79. [27] 1 I. BACKGROUND 2 A. Factual Background2 3 “On February 14, 2017, PayPal announced an agreement to purchase TIO Networks 4 Corporation for $233 million.” Id. ¶ 3. “TIO is a bill-pay management company that processed 5 roughly $7 billion in bill payments on behalf of fourteen (14) million customers in 2016.” Id. 6 Plaintiffs’ claims arise from press releases that they allege were materially misleading. On 7 November 10, 2017, Defendants TIO and PayPal issued press releases (the “November 8 Announcement”). The November Announcement read as follows: 9 PayPal Holdings, Inc. (Nasdaq: PYPL) announced that TIO Networks (TIO), a publicly traded company PayPal acquired in July 10 2017, has suspended operations to protect TIO’s customers. This suspension of services is a result of PayPal’s discovery of security 11 vulnerabilities on the TIO platform and issues with TIO’s data security program that do not adhere to PayPal's information security 12 standards. TIO is not integrated into PayPal’s platform. The PayPal platform is not impacted by this situation in any way and PayPal’s 13 customers’ data remains secure. 14 Upon the recent discovery of this vulnerability on the TIO platform, PayPal took action by initiating an internal investigation of TIO and 15 bringing in additional third-party cybersecurity expertise to review TIO’s bill payment platform. A focus of the investigation will also 16 include TIO’s practices and representations prior to the acquisition. 17 Concurrent with this press release in November, TIO posted the following statement on its 18 website: 19 On Friday, November 10, 2017, TIO Networks suspended our operations due to the discovery of security vulnerabilities on the 20 TIO platform and issues with TIO’s data security program. While we apologize for any inconvenience this suspension of services may 21 cause, the security of TIO’s systems and the protection of TIO’s customers are our highest priorities. We are actively investigating 22 this situation and working with appropriate authorities to safeguard TIO customers. [23] 24 TIO also sent the following message to some of its customers: 25 On November 10, PayPal announced that TIO Networks, a publicly traded company that PayPal acquired in July 2017, suspended 26 operations to protect TIO’s customers. This suspension of services is a result of PayPal’s discovery of security vulnerabilities on the [27] TIO platform and issues with TIO’s data security program that do 1 not adhere to PayPal’s information security standards. 2 FAC ¶ 40. Then, on December 1, 2017, TIO and PayPal released a statement disclosing that, in 3 fact, a breach had occurred and that the confidential information of 1.6 million users had been 4 potentially compromised. Id. ¶ 5. The press release dated December 1, 2017 (the “December 5 Announcement”), read as follows: 6 PayPal Holdings, Inc. (Nasdaq: PYPL) today announced an update on the suspension of operations of TIO Networks (TIO), a publicly 7 traded payment processor PayPal acquired in July 2017. A review of TIO’s network has identified a potential compromise of personally 8 identifiable information for approximately 1.6 million customers. The PayPal platform is not impacted in any way, as the TIO systems 9 are completely separate from the PayPal network, and PayPal’s customers’ data remains secure. [10] As announced on November 10, PayPal suspended the operations of 11 TIO to protect customer data as part of an ongoing investigation of security vulnerabilities of the TIO platform. This ongoing 12 investigation has identified evidence of unauthorized access to TIO’s network, including locations that stored personal information 13 of some of TIO’s customers and customers of TIO billers. As a result, PayPal is taking steps to protect affected customers. [14] TIO has also begun working with the companies it services to notify 15 potentially affected individuals, and PayPal is working with a consumer credit reporting agency to provide free credit monitoring 16 memberships. Individuals who are affected will be contacted directly and receive instructions to sign up for monitoring. [17] 18 Defendants’ Request for Judicial Notice, Ex. E.3 The following trading day, December 4, 2017, 19 PayPal’s share price dropped $4.33 (5.75%) and closed at $70.97. SAC ¶ 40. 20 Plaintiffs contend the November Announcement failed to fully disclose the seriousness of 21 the security breach. Id. ¶ 30. Instead, Plaintiffs assert that Defendants were aware of an alleged 22 breach of TIO’s security that exposed the personal information of TIO’s customers, bill-pay 23 clients, and employees. Id. Plaintiffs argue this omission was materially misleading. They assert 24 the drop in price following the December Announcement, which disclosed the potential [26] 3 The Court DENIES Defendants’ RJN as to Exhibits A and B as moot because these exhibits are not relevant to resolving this motion. The Court GRANTS Defendants’ RJN as to Exhibits C, D, [27] and E as incorporated by reference because Plaintiffs referenced them throughout the SAC, and 1 compromise of 1.6 million users’ data, caused the loss in stock value suffered by Plaintiffs. 2 In asserting their claims of securities fraud by Defendants, Plaintiffs rely primarily on three 3 confidential former employees’ (“FE") statements. Below are the statements from the three FEs, 4 and how their statements in the SAC were amended from the FAC: 5 1. Former Employee 1 6 FE1 was a Support Operations Manager at TIO from February 2016 to March 2018, and reported to Senior Vice-President of Operations 7 at TIO. FE1 learned of the breach on November 10, 2017 when FE1 and colleagues received an email around 3 p.m. inviting them to a 8 special meeting. They learned that TIO would be shut down and were told that someone had access to confidential information for 9 customers. FE1 was informed at the special meeting that someone had accessed the names and addresses for customers as well as 10 employees’ information, including gender, social security, numbers, and dates of birth. FE1 also recalled that they were informed at 11 that meeting that the intruder had accesses confidential customer information, and that PayPal said someone had tools and had 12 accessed confidential information, which was sitting in the TIO Networks’ servers. [13] 14 SAC ¶ 31 (emphasis added to illustrate amendment). 15 2. Former Employee 2 16 FE2 was a contract Senior Systems Administrator at TIO Networks in Vancouver from September 2017 to February 2018, reporting to 17 TIO IT Manager Mike McKenzie. FE2 stating that in early November while waiting for an all-hands TIO meeting in their 18 conference room FE2 was summoned back to a different office to hear an announcement from Kunze, telling that TIO had actually 19 been breached. FE2 states that PayPal discovered the breach during a security analysis of the TIO network, and that when they were 20 doing so, they discovered someone in the system. Immediately after Kunze informed FE2 of the breach, the network team immediately 21 severed the link between the corporate and production side of the network, the latter of which being where sensitive customer 22 information was stored, in an attempt to minimize harm to customers. FE2 understood the decision to sever ties between the 23 two halves of the network to demonstrate a serious concern that TIO’s customer information was in jeopardy or already had been 24 compromised. 25 SAC ¶ 33 (emphasis added to illustrate amendment). 26 3. Former Employee 3 27 FE3 was Senior .NET Developer for TIO from January 2010 until integrations between clients’ application programming interfaces 1 and TIO’s server. FE3 stated that employees of TIO learned of a security breach in early November when TIO announced it had 2 discovered a vulnerability. It was FE3’s understanding that this was also the time the breach was discovered. [3] 4 SAC ¶ 34 (emphasis added to illustrate amendment). Plaintiffs assert that the FE statements, as 5 amended, demonstrate that Defendants knew at the time of the November Announcement that it 6 was materially misleading. 7 B. Procedural Background 8 Plaintiffs filed this action on December 6, 2017. Docket No. 1. On March 15, 2018, the 9 Court appointed Michael Eckert and Edwin Bell as interim co-lead plaintiffs. Docket No. 31. 10 Plaintiffs filed their FAC on June 13, 2018. Docket No. 57. Thereafter, Defendants filed motions 11 to dismiss the FAC. Docket Nos. 59, 61. The Court dismissed the FAC with leave to amend. 12 Docket No. 75. Plaintiffs filed their SAC on January 14, 2019. Docket No. 76. 13 II. LEGAL STANDARDS 14 A. Rule 12(b)(6) 15 Federal Rule of Civil Procedure 8(a)(2) requires a complaint to include “a short and plain 16 statement of the claim showing that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a)(2). A 17 complaint that fails to meet this standard may be dismissed pursuant to Federal Rule of Civil 18 Procedure 12(b)(6). See Fed. R. Civ. P. 12(b)(6). To overcome a Rule 12(b)(6) motion to dismiss 19 after the Supreme Court’s decisions in Ashcroft v. Iqbal, 556 U.S. 662 (2009), and Bell Atlantic 20 Corp. v. Twombly, 550 U.S. 544 (2007), a plaintiff’s “factual allegations [in the complaint] ‘must . 21 . . suggest that the claim has at least a plausible chance of success.’” Levitt v. Yelp! Inc., 765 F.3d 22 1123, 1135 (9th Cir. 2014). The court “accept[s] factual allegations in the complaint as true and 23 construe[s] the pleadings in the light most favorable to the nonmoving party.” Manzarek v. St. 24 Paul Fire & Marine Ins. Co., 519 F.3d 1025, 1031 (9th Cir. 2008). But “allegations in a 25 complaint . . . may not simply recite the elements of a cause of action [and] must contain sufficient 26 allegations of underlying facts to give fair notice and to enable the opposing party to defend itself [27] 1 effectively.” Levitt, 765 F.3d at 1135 (internal quotation marks omitted).4 “A claim has facial 2 plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable 3 inference that the defendant is liable for the misconduct alleged.” Iqbal, 556 U.S. at 678 . “The 4 plausibility standard is not akin to a probability requirement, but it asks for more than a sheer 5 possibility that a defendant has acted unlawfully.” Id. (internal quotation marks omitted). 6 B. Rule 9(b) and the Private Securities Litigation Reform Act (“PLSRA”) 7 The PSLRA imposes additional pleading requirements. Ronconi v. Larkin, 253 F.3d 423 , 8 429 (9th Cir. 2001). “In alleging fraud or mistake, a party must state with particularity the 9 circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b). In order to “properly allege 10 falsity, a securities fraud complaint must now ‘specify each statement alleged to have been 11 misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding 12 the statement or omission is made on information and belief, . . . state with particularity all facts 13 on which that belief is formed.’” In re Rigel Pharm., Inc. Sec. Litig., 697 F.3d 869 , 876–77 (9th 14 Cir. 2012) (quoting 15 U.S.C. § 78u–4(b)(1)) (marks of omission in original). 15 Scienter must also be pled with greater particularity. For a private securities fraud 16 complaint to survive a Rule 12(b)(6) motion to dismiss, pleadings must raise a “strong inference” 17 that Defendants made misleading statements to investors knowingly or with deliberate 18 recklessness. Ronconi, 253 F.3d at 429 . In particular, a “plaintiff may recover money damages 19 only on proof that the defendant acted with a particular state of mind, the complaint shall, with 20 respect to each act or omission alleged to violate [section 10(b)], state with particularity facts 21 giving rise to a strong inference that the defendant acted with the required state of mind.” 15 22 U.S.C.A. § 78u-4. The term scienter for the purposes of section 10(b) “refers to a mental state 23 embracing intent to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185 , 24 193 n.12 (1976). A plaintiff must show that “the defendants made false or misleading statements 25 either intentionally or with deliberate recklessness.” Zucco Partners, LLC v. Digimarc Corp., 552 [27] 4 A court “need not . . . accept as true allegations that contradict matters properly subject to 1 F.3d 981, 991 (9th Cir. 2009), as amended (Feb. 10, 2009). Plaintiffs’ assertion of a strong 2 inference of scienter “must be more than merely plausible or reasonable—it must be cogent and at 3 least as compelling as any opposing inference of nonfraudulent intent.” Tellabs, Inc. v. Makor 4 Issues & Rights, Ltd. 551 U.S. 308, 314 (2007). When evaluating scienter, a court must “engage 5 in a comparative evaluation,” and must consider “not only inferences urged by the plaintiff,” but 6 the court must also consider “competing inferences rationally drawn from the facts alleged.” Id. 7 “Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful for ‘any person . 8 . . [t]o use or employ, in connection with the purchase or sale of any security registered on a 9 national securities exchange . . . any manipulative or deceptive device or contrivance in 10 contravention of such rules and regulations as the Commission may prescribe as necessary or 11 appropriate in the public interest or for the protection of investors.” Zucco Partners, LLC, 552 12 F.3d at 990 (quoting 15 U.S.C. § 78j(b)) (internal quotation marks omitted) (alterations in 13 original). 14 Rule 10b–5 states: 15 It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the 16 mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any 17 untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the 18 circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates 19 or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. [21] 17 C.F.R. § 240 .10b–5. “The SEC promulgated Rule 10b–5 pursuant to authority granted under § 22 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). Although neither Rule 10b–5 23 nor § 10(b) expressly creates a private right of action, [the Supreme] Court has held that ‘a private 24 right of action is implied under § 10(b).’” Janus Capital Grp., Inc. v. First Derivative Traders, [25] 564 U.S. 135 , 141–42 (2011) (quoting Superintendent of Ins. of N.Y. v. Bankers Life & Casualty 26 Co., 404 U.S. 6, 13, n. 9 (1971)). 27 To succeed on a claim under section 10(b) and Rule 10b–5, a plaintiff must show: “(1) a 1 misrepresentation or omission and the purchase or sale of a security; (4) reliance; (5) economic 2 loss; and (6) loss causation.” Oregon Pub. Employees Ret. Fund v. Apollo Grp. Inc., 774 F.3d 3 598, 603 (9th Cir. 2014) (citing Stoneridge Inv. Partners, LLC v. Scientific–Atlanta, Inc., 552 U.S. 4 148, 157 (2008)). A complaint asserting claims under section 10(b) and Rule 10b–5 “must satisfy 5 the dual pleading requirements of Federal Rule of Civil Procedure 9(b) and the PSLRA.” Zucco 6 Partners, LLC, 552 F.3d at 990. 7 III. DISCUSSION 8 A. A Material Misrepresentation or Omission: Falsity 9 The Court previously found that Plaintiffs’ claims satisfied the pleading requirements for 10 falsity. Docket No. 75 (the November Announcement “could plausibly have created an 11 impression that only a potential vulnerability and not an actual breach had been discovered, and 12 certainly not one which threatened the privacy of 1.6 million users.”). Defendants request the 13 Court to reconsider its previous ruling, Mot. at 17, while claiming, alternatively, that they are not 14 bound by the findings relating to an inoperative complaint. Reply at 3. Plaintiffs claim that the 15 Court need not revisit the prior finding because the falsity argument remains unchanged from the 16 FAC to the SAC. Opp. at 22. Defendants cite to Askins v. U.S. Department of Homeland 17 Security, 899 F.3d 1035, 1043 (9th Cir. 2018), which holds that the “district court may decide the 18 second motion to dismiss in the same way it decided the first, but permitting the filing of an 19 amended complaint requires a new determination.” 20 As with the FAC, the alleged false, misleading statement arises from the November 21 Announcement. SAC ¶ 39–41. Here, Defendants set forth the same arguments against falsity as 22 they did in their prior motion to dismiss. Compare Mot. at 17–18, with Docket No. 61 at 7–10. 23 Specifically, they claim that the November Announcement must be “necessarily inconsistent” with 24 the subsequent December Announcement. Reply at 2. 25 To prove falsity for the purposes of Section 10(b) and Rule 10b–5, Plaintiffs must “specify 26 each statement alleged to have been misleading, [and] the reason or reasons why the statement is 27 misleading.” 15 U.S.C. § 78u–4(b)(1). As this Court concluded in its earlier ruling, a literally true 1 Transitional Hosps. Corp., 280 F.3d 997, 1006 (9th Cir. 2002) (citing In re GlenFed Sec. Litig., 42 2 F.3d 1541, 1551 (9th Cir. 1994)). “To be actionable under the securities laws, an omission must 3 be misleading; in other words, it must affirmatively create an impression of a state of affairs that 4 differs in a material way from the one that actually exists.” Id. (citing McCormick v. The Fund 5 American Cos., 26 F.3d 869, 880 (9th Cir. 1994)). 6 Plaintiffs’ contention was, and still is, that the November Announcement was false and 7 misleading “because they disclosed only a security vulnerability, rather than an actual security 8 breach that potentially compromised all 16 million TIO customers, which PayPal and TIO did not 9 acknowledge had been detected . . . .” SAC ¶ 42 (emphasis added). Specifically, Plaintiffs allege 10 “that an unknown but unauthorized person or entity was at that time logged in to TIO’s networks 11 and had access to the financial information of 1.6 million users.” Id. ¶ 4.5 Defendants continue to 12 argue that the November Announcement was consistent with the December Announcement—i.e., 13 that the prior announcement disclosing the investigation of vulnerabilities was not inconsistent 14 with the subsequent announcement revealing an actual security breach. Mot. at 18. 15 As the Court found in its previous order, Defendants’ November Announcement purported 16 to disclose a “vulnerability” in TIO’s security, which triggered an investigation and review. This 17 disclosure could plausibly have created an impression that only a potential vulnerability and not an 18 actual breach had been discovered, and a vulnerability differs considerably from a breach that 19 actually threatens the privacy of 1.6 million users. See Berson v. Applied Signal Tech., Inc., 527 20 F.3d 982 , 987 (9th Cir. 2008) (finding that “[i]t goes without saying that investors would treat” a 21 risk and a certainty differently). Notwithstanding the December Announcement being 22 “corrective” and “not inconsistent,” the November Announcement could reasonably have created a 23 false impression that had the effect of misleading investors. 24 At the hearing, Defendants argued that plausibility is not sufficient for a finding of 25 falsity—i.e., the heightened pleading standard applies to the false and misleading statement as well 26 as the scienter. See Brody, 280 F.3d 997 (“[i]n order to survive a motion to dismiss under the [27] 1 heightened pleading standards of the [PLSRA], the plaintiffs' complaint must specify the reason or 2 reasons why the statements made by [the defendant] were misleading.”). But even so, the result is 3 the same because Plaintiffs have specifically pled, with detail, why the November Announcement 4 was misleading—e.g., because current or potential investors understood the security vulnerability 5 to be minor. See SAC ¶¶ 39–41. Accordingly, Plaintiffs have again adequately pled a misleading 6 statement. 7 B. Scienter and Loss Causation 8 To survive a motion to dismiss, however, Plaintiffs must also demonstrate with 9 particularity that the speaker (here, Mr. Kunze) made the misleading statement with a guilty state 10 of mind. Here, scienter is premised on Plaintiffs’ argument that a holistic view of the SAC 11 supports their allegation that Defendants, particularly Mr. Kunze, knew of an actual data breach 12 and compromise of the privacy of millions of customers at the time of the November 13 Announcement; Plaintiffs’ loss-causation theory relies on the fact that when the public learned 14 about the actuality of the breach and its severity (affecting 1.6 million customers), the price of 15 PayPal’s stock dropped 5.75%. 16 To succeed under the loss-causation theory alleged in the SAC, Plaintiffs must satisfy the 17 heightened pleading requirements for scienter—specifically, that Defendants knew not only of a 18 vulnerability but an actual breach which compromised the privacy of 1.6 million customers. In re 19 Gilead Scis. Sec. Litig., 536 F.3d 1049, 1055 (9th Cir. 2008) (quoting In re Daou Sys., Inc., 411 20 F.3d 1006 , 1014 (9th Cir.2005)) (recognizing that a plaintiff must “demonstrate a causal 21 connection between the deceptive acts that form the basis for the claim of securities fraud and the 22 injury suffered by the plaintiff”). 23 Plaintiffs continue to rely on three former employees of TIO to support a showing of 24 scienter. SAC ¶¶ 30–35. In addition to these employees, Plaintiffs now also rely on the 25 statements of a cybersecurity expert they engaged to “review[] PayPal’s and TIO’s public 26 statements on November 10 and December 1, confidential witness statements set forth in [the 27 SAC], and publicly available information concerning TIO’s breach.” SAC ¶ 36. 1 1. Former TIO employees 2 The Court previously dismissed the FAC when it found the FE statements failed to satisfy 3 the scienter requirement because they showed “at most [] that some of the Defendants may have 4 known that there was some breach in TIO’s platform. They do not substantiate allegations that 5 Defendants on November 10, 2017, ‘determined that an unknown but unauthorized person or 6 entity was at that time logged in to TIO’s networks and had access to the personal financial 7 information of 1.6 million users.’” Docket No. 70 (emphasis in original). 8 As such, most of the SAC’s amendments are based on the amended FE statements. 9 Confidential witness statements can create a strong inference of scienter only if the reporting 10 witness has “reliable personal knowledge of the defendants’ mental state.” Zucco Partners, LLC 11 v. Digimarc Corp., 552 F.3d 981, 998 (9th Cir. 2009), as amended (Feb. 10, 2009). The Ninth 12 Circuit has articulated a two-prong test for a plaintiff relying on confidential-witness statements to 13 prove scienter: (1) statements must be described with sufficient particularity to establish their 14 reliability and personal knowledge; and (2) the statements must themselves be indicative of 15 scienter. Id. at 994 (citing In re Daou Sys., Inc., 411 F.3d 1006 , 1015–16, 1022 (9th Cir. 2005)). 16 Therefore, for the FEs to support the necessary finding of scienter, the FEs’ statements must 17 demonstrate with reliable facts creating a “strong inference” that Mr. Kunze knew of or recklessly 18 disregarded the breach, the magnitude of which could have affected 1.6 million customers. 19 a. Former Employee 1 20 FE1 stated she learned of the breach on November 10, 2017, when she received an e-mail 21 around 3:00 p.m., inviting her to a special meeting where she and other employees “were told that 22 someone had access to confidential information for customers.” SAC ¶ 31. Plaintiffs further 23 allege that “FE1 was informed at the special meeting that someone had accessed the names and 24 addresses for customers as well as employees’ information, including gender, social security 25 numbers, and dates of birth. FE1 also recalled that they were informed at the meeting that the 26 intruder had accessed confidential customer information, and that PayPal said someone had tools 27 and had accessed confidential information, which was sitting in the TIO Networks’ servers.” Id. 1 impact all TIO customers and all TIO employees—everyone whose personal information was 2 stored on its servers.” Id. (emphasis removed). 3 Like FE1’s statements in the FAC, FE1’s recounting of the events in the SAC still fails to 4 show that Mr. Kunze knew, by the November Announcement, that someone had compromised the 5 data of 1.6 million TIO customers. No statement is attributed to Mr. Kunze or any of the other 6 individual defendants. Nor do the alleged statements made at the meeting show that the individual 7 defendants knew the breach had compromised the records of 1.6 million customers. FE1’s 8 statement is made more problematic by the fact that the amended statement is inconsistent with 9 FE1’s prior statement. Previously, FE1 is quoted as stating that “they suspected or saw” that 10 someone had access to customer data (FAC ¶ 32), which is materially different than “they were 11 informed” of the intrusion (SAC ¶ 31). There is a distinct difference in degree of certainty and, by 12 implication, the depth of the company’s knowledge regarding the breach. This discrepancy raises 13 credibility concerns about FE1. See Zucco, 552 F.3d at 995 (reliability and personal knowledge 14 must be satisfied in the first prong of the two-part test); In re Maxwell Techs., Inc. Sec. Litig., 18 15 F. Supp. 3d 1023 , 1034 (S.D. Cal. 2014) (a court must “examine the witnesses for indicia of 16 reliability and personal knowledge . . . .”). 17 In sum, FE1’s statements fail for three reasons. First, that an unknown individual informed 18 FE1 at a special meeting of a breach of confidential information, and that “PayPal said someone 19 had tools and had accessed confidential information” fails to show specifically who at PayPal 20 informed FE1 of the breach or what the individual said. In particular, the SAC fails to connect the 21 dots as to who informed her of the breach at the specially-called meeting, or why the unknown 22 individual felt obliged to report the breach to FE1 in her role as a Support Operations Manager. 23 Second, nearly all the amendments to FE1’s summary relies on hearsay (e.g., she was informed by 24 an unnamed person at PayPal and informed by an unnamed person at the meeting), which the 25 Court must weigh against reliability when considering scienter. See Zucco, 552 F.3d at 998 , n. 4 26 (hearsay statements relied upon by confidential witnesses may not be sufficiently reliable, 27 plausible, or coherent to warrant further consideration of proving the scienter requirement). 1 the SAC. Compare FAC ¶ 32 (“they suspected or saw that someone had access to customer data . 2 . . .” and that “[t]hey shut down service to complete the investigation.”); with SAC ¶ (“[we] were 3 informed at the special meeting that someone had accessed the names and addresses for customers 4 as well as employees’ information . . . and that PayPal said someone had tools and had accessed 5 confidential information . . . .”). 6 Plaintiffs argue that this Court previously credited the FEs’ statements as reliable. This is 7 not so—the Court never opined on the reliability of the FE statements. The Court’s prior decision 8 assumed arguendo that the statements “at most establish that some of the Defendants may have 9 known that that there was some breach in TIO’s platform. They do not substantiate allegations 10 that Defendants on November 10, 2017, ‘determined that an unknown but unauthorized person or 11 entity was at the time logged into TIO’s networks and had access to personal information of 1.6 12 million users.” Docket No. 75 at 11. FE1’s amended statement remain deficient. 13 In particular, the statement on its face do not show—let alone mention—that Mr. Kunze 14 had knowledge of a breach affecting 1.6 million customers and used that knowledge (or recklessly 15 disregarded it) to deceive the market. Yet, Plaintiffs must allege Mr. Kunze’s scienter because he 16 is the only alleged speaker relative to the November Agreement. See Declaration of Ludwig, 17 Exhibit A, at 15:21–22 (“That’s right, Your Honor. And let’s be specific. Scienter has to be to 18 Mr. Kunze, who’s the only alleged speaker.”). FE1’s statements are not sufficiently indicative of 19 scienter.6 [20] 6 Plaintiffs cite S. Ferry LP #2 v. Killinger, 687 F. Supp. 2d 1248, 1254 (W.D. Wash. 2009) for the [21] proposition that a complaint may rely on either direct or circumstantial evidence to plead scienter adequately. However, an expanded reading of the passage to which Plaintiffs cite reads “but even [22] the circumstantial allegations in the complaint must be strong and particular enough to withstand the PLSRA’s heighted pleading requirements. Id. (citing In re Silicon Graphics Inc. Sec. Litig., [23] 183 F.3d 970, 974 (9th Cir. 1999), as amended (Aug. 4, 1999). Plaintiffs next two cases are casespecific applications of circumstantial evidence. See In re UTStarcom, Inc. Sec. Litig., 617 F. 24 Supp. 2d 964, 975 (N.D. Cal. 2009) ($400 million in restated revenues can support an inference of scienter because revenues must be earned before it can be recognized.); In re Alstom SA, 406 F. 25 Supp. 2d 433, 504 (S.D.N.Y. 2005) (trial court finds pleadings sufficiently show a strong inference that the cost overruns were widely known). Here, Plaintiffs do not analogize the alleged [26] security breach with restated revenues, nor does the SAC allege with specificity that the breach was “widely known,” especially given that it was a “special meeting” where FE1 learned of this [27] information. Confidential statements can only create a strong inference of scienter when the 1 b. Former Employee 2 and 3 2 FE2’s amended statement reiterates the earlier assertion that Mr. Kunze announced, in a 3 closed meeting, that TIO had actually been breached. SAC ¶ 33. Like the FAC, at most, this 4 statement, if believed, may show that there was some breach in the TIO platform known to Mr. 5 Kunze. The new statement, however, goes on to state that “immediately after Kunze informed 6 FE2 of the breach, the network team immediately severed the link between the corporate and 7 production side of the network, the latter of which being where sensitive customer information 8 was stored, in an attempt to minimize harm to customers.” Id. FE2’s new statement does not 9 take the extra step of specifically pleading, as the PSLRA and Rule 9(b) require, that Mr. Kunze 10 had knowledge of the magnitude of the breach. Instead, Plaintiffs seek to infer that the subsequent 11 severing of the network is somehow an admission that Mr. Kunze had knowledge of the depth of 12 the breach (reaching 1.6 million customers); but this inference is less cogent and compelling than 13 the inference that the severing of the network was for preventative measures pending further 14 investigation. In essence, FE2’s statement remains substantively unchanged between the FAC and 15 SAC. Similarly, FE3’s statement remains substantively unchanged between the FAC and SAC. 16 Like FE1’s statement, FE3’s statement does not even mention Mr. Kunze, and simply claims that 17 it was her understanding (rather than Mr. Kunze having knowledge) that there was a breach in 18 November 2017. 19 The Ninth Circuit requires that confidential witnesses meet the two-prong test of 20 reliability. See Daou, 411 F.3d at 1014 ; Zucco, 552 F.3d at 991 (first, the statements must be 21 described with sufficient particularity to establish their reliability and personal knowledge; and 22 second, the statements must themselves be indicative of scienter). None of the FEs’ statements, 23 either individually or collectively, meet that test of reliability in demonstrating that Mr. Kunze 24 knew on November 10, 2017, of the magnitude of the breach when he made the November 25 Announcement. 26 The weakness of any inference of scienter is underscored by the lack of any obvious 27 incentive to mislead. There is no allegation of motivation – e.g., that Defendants sold stock during 1 wrongdoing. Nor is there any satisfying explanation of what benefit Defendants hoped to gain by 2 delay disclosure of the full scope of the breach by three weeks. This was not like overestimating 3 financial performance of a company with the hope and possibility that financial fortunes might 4 improve and thereby mask an otherwise misleading statement. If there were a breach causing 1.6 5 million customer files to be compromised, that fact could not be undone, mooted, or masked by 6 waiting three weeks.7 7 2. Cybersecurity Expert (Mr. Kenny Yeung) 8 To bolster their showing of scienter, Plaintiffs “engaged the services of a cybersecurity 9 expert in determining what information was likely available to TIO regarding the scope of 10 potential compromise of TIO customers’ data at the time the breach was discovered on November 11 10.” SAC ¶ 36. Defendants take issue with the use of Mr. Yeung’s conclusions because he has no 12 personal knowledge about what occurred at TIO. Mot. at 12. 13 Both parties agree that there is authority for the proposition that a plaintiff can support a 14 securities fraud claim with opinions provided by an expert. In Nursing Home Pension Fund, 15 Local 144 v. Oracle Corporation, a case alleging false reporting of revenue and 16 misrepresentations regarding sales projections by defendant Oracle, the Ninth Circuit found that 17 documents relating to the billing and payment histories of Oracle's customers, obtained by 18 plaintiffs and analyzed by their financial expert, appeared to establish improper revenue 19 adjustment. Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226 , 1232–34 20 (9th Cir. 2004). The Ninth Circuit credited the use of plaintiff's expert—a former financial 21 analyst—who (1) had reviewed the billing and payment histories of some of Oracle's customers; 22 (2) had actually spoken with Oracle employees regarding customer payments; and (3) had 23 provided specific and detailed reporting of the statements of the Oracle employees. Id. at 1233 . 24 Nursing Home concluded that the complaint had described the witnesses (including plaintiff's [26] 7 In their opposition and at the hearing, counsel for Plaintiffs argued a “soft landing” theory—i.e., that Defendants intentionally disclosed only some of the bad news before making the full [27] disclosure so as to soften the negative reaction from the public. Opp. at 16. This theory is not 1 expert) “with sufficient particularity to establish that they were in a position to know Oracle's 2 accounting practices.” Nursing Home, 380 F.3d at 1233 (citing Novak v. Kasak, 216 F.3d 300 , 3 314 (2d Cir. 2000)). The court added, however, that what was even more important was that the 4 documents in which plaintiff’s expert relied “themselves appear to establish improper revenue 5 adjustment.” Id. (emphasis added). 6 Thus, based on Nursing Home and Zucco, district courts can consider allegations from 7 experts if such factual allegations satisfy the same standard applied to confidential informants. 8 See Browning v. Amyris, Inc., 2014 WL 1285175 , at *19 (N.D. Cal. Mar. 24, 2014) (experts are 9 evaluated just as confidential informants). Therefore, Mr. Yeung must meet the two-prong test of 10 Zucco such that (1) his statements must be described with sufficient particularity to establish his 11 reliability and personal knowledge; and (2) his statements must themselves be indicative of 12 scienter. 13 According to the SAC, Mr. Yeung has twenty-three years of experience in information 14 technology (security, audit, risk assessment, and risk management) and IT operations. SAC ¶ 36. 15 He reviewed three categories of information to reach his conclusion: (1) PayPal’s and TIO’s 16 public statements on November 10 and December 1; (2) confidential statements set forth in the 17 SAC, and (3) publicly available information concerning TIO’s breach.” Id. Mr. Yeung concluded 18 that “PayPal and TIO’s conduct in response to the breach indicates that they were likely aware that 19 all customer data had been potentially compromised as of November 10th.” Id. ¶ 37 (emphasis in 20 original). He reached this conclusion because, to him, TIO’s customer’s personal and financial 21 data are its most valuable information and are what criminals who breach such servers would 22 immediately attempt to steal. Id. 23 However, Mr. Yeung’s expert opinion fails to sufficiently strengthen the inference of 24 scienter. There is also no allegation that Mr. Yeung was familiar with, much less had knowledge 25 of, the specific security architecture of Defendants’ privacy network. In fact, the SAC coins Mr. 26 Yeung’s conclusion as “the most reasonable assumption,” which appears to be merely a guess 27 about the structure of Defendants’ network. Unlike the expert in Nursing Home, Mr. Yeung did 1 themselves—demonstrate inconsistencies that were available to Mr. Kunze during the November 2 Announcement. See Nursing Home, 380 F.3d at 1230 (“[t]he most direct way to show both that a 3 statement was false when made and that the party making the statement knew that it was false is 4 via contemporaneous reports or data, available to the party, which contradict the statement.”). 5 The situation here is similar to a recent decision in this district wherein plaintiffs’ theory of 6 securities fraud relied on the opinion of a non-testifying expert. In In re OmniVision Techs., Inc. 7 Sec. Litig., 937 F. Supp. 2d 1090, 1108 (N.D. Cal. 2013, plaintiffs sued defendant for purportedly 8 concealing the fact that it (a designer and supplier of semiconductors) lost a contract with Apple to 9 Sony before the production of a new iPhone. Id. at 1094 . Apple was the defendant’s largest 10 customer. Id. Plaintiffs hired a non-testifying expert consultant to opine as to when Apple’s 11 procurement process would have begun and when Apple would have started looking for 12 alternative suppliers. Id. at 1095 . Specifically, this expert was used to establish that because this 13 iPhone had an extended product development cycle, Apple would have decided to use Sony 14 components (and not the defendant’s components) on a date prior to the start of the class period. [15] Id. at 1107 . The OmniVision court found that the complaint’s reliance on this expert was 16 “essentially an allegation made on information and belief without disclosing the actual basis” for 17 its findings—i.e., no personal knowledge. 18 Plaintiffs attempt to distinguish OmniVision by arguing that, there, the expert witness’s 19 opinions were inadequate because “they were phrased in terms of what Apple ‘would have done’ . 20 . . not facts about what Apple actually did.” Opp. at 15. But that is essentially what Mr. Yeung 21 has done here—i.e., he is inferring what likely would have happened in the event of any breach. 22 Even considered holistically with the SAC, Mr. Yeung’s conclusions do not support a 23 finding of scienter. See Nursing Home, 380 F.3d at 1234 (“Considered separately, Plaintiffs' 24 allegations may not create a strong inference of scienter. However, we must consider “whether 25 the total of plaintiffs' allegations, even though individually lacking, are sufficient to create a strong 26 inference that defendants acted with deliberate or conscious recklessness.”) (citing No. 84 27 Employer-Teamster Joint Council Pension Tr. Fund v. Am. W. Holding Corp., 320 F.3d 920 , 938 1 Accordingly, Defendants’ motion to dismiss is GRANTED with prejudice. See Salameh 2 || v. Tarsadia Hotel, 726 F.3d 1124, 1133 (9th Cir. 2013) (“A district court's discretion to deny leave 3 || to amend is ‘particularly broad’ where the plaintiff has previously amended.”’). 4 1 C. Control Liability 20(a) 5 For a Section 20(a) claim, Plaintiffs “must show that a primary violation was committed 6 || and that the defendant ‘directly or indirectly’ controlled the violator.” Paracor Fin., Inc. v. Gen. 7 || Elec. Capital Corp., 96 F.3d 1151 , 1161 (9th Cir. 1996). “Section 20(a) claims may be dismissed 8 summarily .. . if a plaintiff fails to adequately plead a primary violation of section 10(b).” Zucco 9 || Partners, LLC, 552 F.3d at 990 . Plaintiffs’ Section 20(a) claim relies on the viability of a Section 10 10(b) claim. As such, Defendants’ motion to dismiss Plaintiffs’ Section 20(a) claim is 11 GRANTED with prejudice. 12 In sum, the SAC is dismissed with prejudice. This order disposes of Docket No. 79. 13 The Clerk is instructed to enter Judgment and close the file. [14] IT IS SO ORDERED. [16] = 17 Dated: September 18, 2019 [18] <4 ED M. CHEN 20 United States District Judge