District Of New Jersey Dismisses Putative Class Action Against Women’s Clothing Retailer For Failure To Allege Material Misstatement And Scienter
On June 28, 2022, Judge Kevin McNulty of the United States District Court for the District of New Jersey granted a motion to dismiss a putative class action against a retail clothing brand (the “Company”) and two of its executives (“Individual Defendants”) alleging violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. In re Ascena Retail Grp., Inc. Sec. Litig., No. CV1913529KMJBC, 2022 WL 2314890 (D.N.J. June 28, 2022). Plaintiffs alleged that the Company knowingly or recklessly overstated the value and business prospects of the Company and its subsidiaries in public statements and SEC filings. The Court dismissed plaintiffs’ complaint for failure to plead an actionable misrepresentation or allegations sufficient to support a strong inference of scienter.
According to plaintiffs, the Company, a publicly traded retailer of clothing and apparel, engaged in an “expansion-driven strategy” of acquiring other women’s clothing companies during the period from December 2015 to May 2017. The Company reported in SEC filings that the value of the Company’s goodwill and tradenames were generally stable, and that the value of its goodwill ranged from $1.268 billion to $1.29 billion while the value of its other intangible assets, such as tradenames, ranged from $1.263 billion to $1.283 billion. Plaintiffs alleged that, during the same period, “key metrics underlying the value of [the Company’s] goodwill and other intangible assets” eroded due to factors such as declining sales and store traffic, a shift in consumer spending, a significantly altered competitive environment, and a steady decline in the Company’s stock price and market capitalization. The Company allegedly acknowledged the impact of these key metrics on the value of the Company’s goodwill and tradenames in June 2017 when the Company reported an impairment charge of over $1.3 billion. Plaintiffs alleged, however, that the Company knew that these metrics demonstrated the need for an impairment analysis and a concomitant impairment charge much sooner under Generally Accepted Accounting Principles (“GAAP”).
The Court first considered whether the alleged misstatements were actionable, noting that the challenged statements regarding the value of the Company’s goodwill and tradenames were opinion statements that were properly analyzed under the Supreme Court’s holding in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 575 U.S. 175 (2015). According to the Court, although the Company’s statements about goodwill and tradenames “rest on the accounting procedures outlined by GAAP for evaluating and testing these assets,” it “require[s] the exercise of subjective judgment.” Applying Omnicare, the Court held that the challenged statements about the Company’s valuation were not false or misleading because, even though the Company allegedly knew of its challenging business environment (and said so publicly), GAAP leaves it to the Company’s judgment when to reevaluate the value of its intangible assets. And even though the size of the impairment when taken “suggests that Defendants’ valuations were overly optimistic and that the impairment could or even should have been recorded earlier,” the impairment charge appears better explained as a result of Defendants’ mistakes, bad luck, or poor performance, not a longstanding effort by Defendants to dupe investors. Accordingly, plaintiffs failed to show that Defendants “disbelieved their own statements; conveyed false statements of fact; or omitted material facts going to the basis of their opinions.”
The Court also held that plaintiffs failed to plead allegations sufficient to support a strong inference of scienter. The Court rejected plaintiffs’ argument that Individual Defendants’ statements “in press releases and investor conference calls . . . showed [the Company’s] goodwill and tradenames [were] overvalued and demonstrated the need for an impairment analysis.” Instead, the Court held that plaintiffs’ “allegations more plausibly yield the inference that Defendants’ valuations of [the Company’s] goodwill and tradenames were judgment calls—reasonable at the times they were made, even if ultimately shown to be overly optimistic.” According to the Court, although the Company’s “rosy assessments” “may bespeak mistakes in [the Company’s] management . . . they . . . do not constitute culpable conduct demonstrating the necessary scienter for securities fraud.”
Finally, the Court granted plaintiffs’ request for leave to amend their complaint to incorporate new allegations from confidential witnesses that plaintiffs had recently identified.