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Law360 (June 12, 2020, 6:07 PM EDT) -- An investor has launched derivative claims on behalf of Zoom Video Communications Inc. over its rise to prominence and subsequent scrutiny in the face of the coronavirus pandemic, accusing the company's top brass of pulling in $172.9 million via insider trading.
The action filed in Delaware federal court on June 11 accuses all but one of Zoom's nine board members, as well as its chief financial officer, of giving the investing public a "false impression of the company's business, operations and its cybersecurity" that was allegedly laid bare when the pandemic-fueled surge in Zoom use led many to question its data privacy and security measures.
Similar accusations have been made in a putative securities class action playing out on the West Coast, which, like the derivative suit, connects drops in Zoom's otherwise booming stock price to alleged revelations about security and privacy issues. The derivative suit specifically contends that Zoom's board, along with its CEO and CFO, are to blame.
"The company has been substantially damaged as a result of the individual defendants' knowing or highly reckless breaches of fiduciary duty and other misconduct," the derivative suit alleges.
Unlike the securities suit, the action in Delaware further alleges that six of the defendants, including Zoom's CEO, netted nearly $173 million in proceeds in the 12 months after Zoom's April 2019 IPO from "lucrative insider sales" based on nonpublic information.
When the Zoom IPO closed on April 23 of last year, the company had sold nearly 10 million shares at $36 apiece and continued to tout the reliability of its technology and infrastructure, saying, among other things, that end-to-end encryption could be enabled on its video communications service, according to the suit launched on June 11.
But in reality, the derivative action alleges, Zoom's platform and primary application "were riddled with security deficiencies that exposed its network, including users' webcams, to unauthorized intruders." The company was also allegedly providing unnecessary personal data to third parties like Facebook without users' consent, and did not actually offer end-to-end encryption as previously represented, the suit says.
Zoom's security vulnerabilities were first reported as early as July 2019, when a research article first detailed a flaw that allowed hackers to overtake Zoom users' webcams, leading a public interest group to file a complaint with the U.S. Federal Trade Commission and causing a stock price decline, the suit claims.
Still, Zoom's price remained artificially inflated until the "true extent of vulnerabilities inflicting the company's privacy and security" were revealed this past March and April, the derivative suit alleges. A number of articles published at the end of March revealed Zoom didn't support end-to-end encryption, and on April 1, it was reported that one of the company's largest customers had banned employees from using Zoom, ultimately leading to stock drops, the suit claims.
More reporting about suspicious stock sales by Zoom's CEO came in the following days, as did news of a state attorney general's investigation into the company, and then news on April 6 that the New York City Department of Education would no longer be using Zoom for remote learning, causing the company's share price to drop from $128.20 to $122.94. The investor suit was filed the next day.
The derivative action — including Zoom CEO Eric S. Yuan and asserted against all of Zoom's directors except former national security adviser H.R. McMaster, who joined the board in May — alleges that those directors and Zoom's CFO either caused or allowed misrepresentations to be made about Zoom's data privacy and security controls.
"Despite the company's own claims, Zoom's video communications software was not equipped with end-to-end encryption," the suit alleges. "Consequently, Zoom users faced certain risks, including a heightened risk that their personal information would be improperly retrieved by unapproved parties, such as Facebook."
While the defendants breached their fiduciary duties to correct these misrepresentations, six of them were selling their artificially inflated shares, including Yuan, who reaped $59.4 million in proceeds from sales between April 2019 and March, the suit alleges.
"His insider sales, made with knowledge of material non-public information before the material misstatements and omissions were exposed, demonstrate his motive in facilitating and participating in the scheme," according to the complaint.
Zoom and counsel for the suing investor did not immediately respond to requests for comment Friday.
The investor is represented Michael J. Farnan and Brian E. Farnan of Farnan LLP and Timothy Brown of The Brown Law Firm PC.
Counsel information for Zoom is not available.
The case is Gervat v. Yuan et al., case number 1:20-cv-00797, in the U.S. District Court for the District of Delaware.
--Editing by Alanna Weissman.
For a reprint of this article, please contact reprints@law360.com.
