District Of Maryland Dismisses Exchange Act Claims For Failure To Adequately Allege Scienter
On August 19, 2019, Judge Richard Bennett of the United States District Court for the District of Maryland dismissed 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. Aug. 19, 2019). Plaintiffs alleged that the Company misrepresented its financial health by concealing that consumer demand had declined and the Company had resorted to discounting to prop up its sales. In a prior decision, the Court had dismissed plaintiffs’ claims but permitted plaintiffs to replead the Exchange Act claims to attempt to plead scienter. The Court held, however, that plaintiffs’ further amended complaint suffered from the same defects as their prior complaint, and therefore dismissed the action with prejudice.
In its prior decision, plaintiffs had attempted to assert claims against multiple Company executives, and had made general allegations about defendants as a group, which the Court held was insufficient. Slip op. at 17. In their further amended complaint, plaintiffs asserted claims against the Company and only one of its executives and sought to add allegations supporting the reliability of the industry data cited in an analyst report regarding the Company’s sales. Id. at 18. Plaintiffs also alleged that defendants “knew, or recklessly disregarded” the Company’s declining demand, that it was “implausible to suggest that [the executive] was not monitoring the Company’s performance” using similar data, and that the executive’s alleged sales of Company stock shortly before the alleged adverse company disclosures provided a motive in support of an inference of scienter. Id. The Court held, however, that although such allegations “may be sufficient to state a facially plausible claim under a typical dismissal standard,” they did not meet the high bar to establish scienter under the Private Securities Litigation Reform Act (“PSLRA”). Id. at 22.
At the outset, the Court noted that pleading a strong inference of scienter “is no small burden.” Id. at 16. The Court further emphasized that, under the PSLRA, the complaint should be dismissed if the inference that defendants “acted innocently, or even negligently” was “more compelling than the inference that they acted with the requisite scienter.” Id. at 22. Plaintiffs sought to plead that the defendant executive acted with the requisite scienter based on allegations concerning his stock sales, his access to industry data, and his knowledge of the struggles of some of the Company’s customers. The Court found, however, that the executive’s stock sales were made pursuant to a pre-scheduled Rule 10b5-1 trading plan disclosed previously as part of a long-term strategy to increase liquidity, that he had sold substantially more Company stock on prior occasions, and that he retained 95% of his Company shares. Id. at 20-21. Against this backdrop, the Court determined that, while the executive may have been “negligent” in “not paying more attention to non-conforming and negative sales data,” there was “no strong or compelling inference of deliberately intentional misconduct or such severe recklessness that it rises to the level of fraud.” Id. at 23. Rather, the Court determined that the more compelling inference was that the executive “attributed any non-conforming data to typical retail market challenges, and assumed the Company would continue to rise above such challenges,” and that the stock sales were due to the pre-announced plan to increase liquidity. Id. at 23.
In addition, the Court found that plaintiffs failed to establish scienter on behalf of the Company itself. Plaintiffs attempted to allege that two of the Company’s non-defendant executives knew of the Company’s declining sales, declining demand, excess inventory, and margin compression, and that one of them executed an unfavorable contract with a retail customer allowing the customer to return up to 80% of the goods it ordered if they went unsold. Id. at 24. The Court found these allegations unavailing, both because plaintiffs had not alleged that the two executives actually were involved in making any misstatement and because plaintiffs had made no factual allegations to support that the Company acted with scienter. Id. Based on the dismissal of the Section 10(b) claims against the Company and the executive, the Court dismissed the Section 20(a) and 20A claims as well given that there was no predicate violation of the Exchange Act in order to proceed under those claims.
Moreover, the Court also separately addressed defendants’ motion to strike two expert declarations attached to plaintiffs’ amended complaint. While noting that district courts within the Fourth Circuit are divided on whether such declarations are permissible attachments to pleadings and that the Fourth Circuit had yet to address the issue, the Court determined that it was appropriate to evaluate both the “purpose of the declarations” and the “context of the case.” The Court initially observed that plaintiffs “may not substitute factual allegations with the speculation of their expert witness.” Slip Op. at 10. Further, because plaintiffs had stated that the expert declarations “only serve to support and help explain the allegations,” and because plaintiffs’ factual allegations were already entitled to a presumption of truth and also subject to a heightened pleading standard under the PSLRA, the Court granted defendants’ motion to strike the expert declarations. See id. at 9-11. The Court noted, however, that any factual allegations contained in the amended complaint that were derived from the expert reports shall be “accorded the consideration due to factual allegations in a dismissal context.” Id. at 11.