District Of Maryland Denies Motion To Dismiss Securities Fraud Claims Against Sports Apparel Company, Finding Plaintiffs Adequately Pled Material Misstatements And Scienter In Light Of SEC Order In Parallel Proceeding
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  • District Of Maryland Denies Motion To Dismiss Securities Fraud Claims Against Sports Apparel Company, Finding Plaintiffs Adequately Pled Material Misstatements And Scienter In Light Of SEC Order In Parallel Proceeding
     

    05/26/2021
    On May 19, 2021, the United States District Court for the District of Maryland denied a motion to dismiss a putative securities class action involving claims brought under Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934 (the “Exchange Act”) against a sports apparel company (the “Company”) and one of its executives.  In re Under Armour Securities Litigation, No. 17-cv-00388 (D. Md. May 19, 2021).  Plaintiffs alleged that defendants misrepresented the Company’s financial health and the demand for its products by engaging in “channel stuffing”—the practice of pulling forward sales from a future quarter, thereby shifting earnings into earlier quarters—relying in part on a settlement between the Company and the SEC and the $9 million civil penalty paid in connection with the settlement to resolve similar allegations.

    As discussed in our prior post, the Court previously dismissed plaintiffs’ consolidated amended complaint with prejudice, which, in addition to the Exchange Act claims, included claims under Sections 11 and 15 of the Securities Act of 1933 (the “Securities Act”), but permitted plaintiffs to replead the Exchange Act claims to attempt to address deficiencies related to their allegation concerning scienter.  In August 2019, the Court determined that plaintiffs’ consolidated second amended complaint suffered from the same defects and dismissed the action with prejudice.  Plaintiffs filed a notice of appeal in the Fourth Circuit on September 17, 2019.  Shortly thereafter, the Wall Street Journal reported that the Company was the subject of an SEC investigation.  Plaintiffs moved in the district court for an indicative ruling to grant plaintiffs’ motion for relief, pursuant to the Federal Rules of Procedure 60(b) on the basis of newly-discovered evidence if the case was remanded from the Fourth Circuit.  The Fourth Circuit remanded, and the Court granted plaintiffs’ request in January 2020.  In October 2020, plaintiffs filed their consolidated third amended complaint alleging that defendants “manipulated the [C]ompany’s financial results by pulling sales forward from future quarters and engaged in other allegedly suspect sales practices.”

    Defendants moved to dismiss, arguing that plaintiffs’ new allegations failed to cure the deficiencies from the second amended complaint.  Specifically, defendants argued that plaintiffs failed to plead “corroborating details” to properly allege scienter and that allegations of channel stuffing are, standing alone, “insufficient to sustain the state of mind requirement in a securities fraud claim because ‘there may be a number of legitimate reasons for attempting to achieve sales earlier’ than in the normal course.”  Defendants further argued that the allegations against the officer defendant repeated factual allegations from the previously dismissed second amended complaint, and the “new pieces of ‘evidence’ provided” were emails allegedly showing the defendant’s awareness of the allegedly manipulative financial practices, which, defendants argued, was insufficient.  Finally, defendants contended that plaintiffs failed to adequately plead falsity as required by the PSLRA because the third amended complaint merely rehashed the same insufficient allegations from the second amended complaint, and that, certain allegedly forward-looking statements were protected by the PSLRA’s “safe harbor.”

    On May 3, 2021—after defendants’ motion to dismiss the third amended complaint was fully briefed but had not yet been argued—the SEC and the Company entered into a settlement and the SEC imposed a cease-and-desist order (“SEC Order”) for violations of Sections 17(a)(2) and (3) of the Securities Act, Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, 13a-13, 12b-20 thereunder, and Item 303(a)(3)(ii) of Regulation S-K.  The SEC Order imposed a $9 million civil penalty.  As part of the settlement, defendants did not admit or deny any findings.  Plaintiffs requested the Court take judicial notice of the SEC Order, which the Court granted.

    The Court held that, “[t]aking into consideration the facts alleged in the SEC Order,” plaintiffs’ allegations were sufficient to survive defendants’ motion to dismiss.  The Court noted that, while the SEC Order “does not supply dispositive evidence,” it nevertheless “lends support to the allegations . . . [and] provides specific factual allegations regarding [the alleged channel stuffing practices and] concludes that because of the undisclosed pull-forward tactics used, investors ‘were left with a misleading impression of how [the Company] was meeting or beating analysts’ revenue estimates.’”  The Court further observed that the SEC found the Company’s reported financial results “did not reflect its natural revenue and revenue growth and were not indicative of its future financial results.” 

    While recognizing that the SEC was not required to plead scienter in the parallel proceeding, the Court found that the SEC’s decision “does not impede the Plaintiffs’ ability to plead a strong inference of scienter in this case,” and that “[d]espite containing no finding on the issue of scienter, the SEC’s Order includes specific allegations that the company and its top officials, including [the executive defendant], were aware of the potential misleading nature of the undisclosed pull-forward sales practices.”  The Court—citing a decision from the Eastern District of Pennsylvania in which the district court held a “recently-issued SEC Order, of which the Court [had] taken judicial notice, provide[d] additional factual information” to support plaintiffs’ allegations of scienter—held that plaintiffs adequately alleged facts supporting a strong inference of scienter after “assessing all of [plaintiffs’] allegations ‘holistically’” through its review of the third amended complaint, briefs, and the SEC Order.

    The Court similarly held that the SEC Order’s specific allegations of the Company’s materially misleading statements concerning its revenue growth “without disclosing the significant impact on revenue from its use of pull forwards,” provides support for plaintiffs’ allegations with respect to falsity.  The Court observed that the SEC Order “specifically notes that by the third quarter of 2015, [the Company] was aware that its full-year internal projections for revenue were much lower than the late-2014 forecast had predicted,” including a “$120 million decline in sales projections for its largest market category,” and that the Company nevertheless “continued to report its financial results without disclosing its use of pull-forward sales and their effect on future revenue and growth.”  The Court further noted that the SEC “did not suggest that any of the [C]ompany’s statements were protected by the PSLRA safe harbor.”  As such, the Court held that the allegations contained in the SEC Order combined with the allegations in the third amended complaint were sufficient to state a plausible claim that defendants omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading.

    The Court similarly held that plaintiffs stated plausible claims for relief under Section 20(a) and Section 20A, having found that plaintiffs adequately alleged their predicate claims under Section 10(b) and Rule 10b-5 of the Exchange Act.
    CATEGORIES: Exchange ActFalsityPSLRAScienter

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