District of Massachusetts Dismisses Purported Class Action Against Online Home Goods Retailer
On July 8, 2020, United States District Judge Douglas P. Woodlock of the United States District Court for the District of Massachusetts dismissed a putative securities fraud class action asserting violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 against a large online home goods retailer (the “Company”) and its three most senior executives (collectively, “Defendants”). In re Wayfair, Inc. Sec. Litig., Civ. No. 19-10062-DPW (D. Mass. July 8, 2020). Plaintiffs alleged that defendants falsely implied that the Company was profitable and that it was experiencing positive advertising-revenue leverage—meaning that the Company was becoming more effective at generating revenue for every advertising dollar spent. The Court granted defendants’ motion to dismiss because plaintiffs failed to adequately allege any material misstatements or omissions, scienter, or loss causation. Notably, the Court repeatedly called attention to the absence of factual support for the allegations and described the complaint as “precisely the kind of pleading the Private Securities Litigation Reform Act was designed to prevent.”
Over the past several years, as competition in the online home goods retail market intensified, the Company decided to increase its advertising spending. In 2014, the Company spent $191 million in advertising. By 2018, the Company was spending $774 million. As a result of the magnitude of the advertising spending, one of the important indicators of the Company’s financial performance was its “advertising-revenue leverage.” The Company calculated the advertising-revenue leverage quarterly as a percentage of the total cost of advertising to the total net revenue. An increase in this percentage when compared to the previous year’s quarter would mean that the Company had negative advertising-revenue leverage—meaning that the Company had become less successful at generating revenue from its advertising dollars. On November 1, 2018, the Company announced in a press release that its advertising revenue had “deleveraged” from 11.8% in the third quarter of 2017 to 11.9% in the third quarter of 2018. Later that day, the Company’s stock price fell by 12.8%, with a further 3.3% drop occurring the next day.
Plaintiffs alleged that (1) in the three months preceding the announcement, the Company’s executives made a series of false and misleading statements or omissions suggesting that the Company’s advertising-revenue leverage was positive; (2) the executives knew, by virtue of their deep involvement in the Company’s finances and operations, that the advertising-revenue leverage was negative; and (3) that they failed to disclose the Company’s worsening financial performance so that they could personally offload $69 million in the Company’s stock.
First, the Court held that plaintiffs had not alleged any actionable misstatement or omission. The Court held that the executives’ statements expressing confidence in the Company’s performance were mere puffery. The Court held that another set of alleged misstatements forecasting positive advertising-revenue leverage were forward-looking statements protected by the Private Securities Litigation Reform Act’s (“PSLRA”) safe harbor. The Court held that the remaining alleged misstatements and omissions were insufficiently particularized to meet the PSLRA’s standards.
Second, the Court held that plaintiffs had not adequately alleged scienter. According to the Court, plaintiffs’ primary scienter argument was, in essence, “because Defendants said they paid close attention to their financial position and their financial position ended up being different than Defendants said it was, Defendants must have been lying and/or recklessly indifferent about [the Company’s] financial position.” The Court was unconvinced. The Court explained that plaintiffs’ argument “is akin to saying that anytime a company’s financial projection is wrong, the speaker has engaged in securities fraud,” which “is not the law.”
The Court was equally unmoved by plaintiffs’ argument that the executives had a motive to mislead investors. Plaintiffs alleged that the executives, by misleading the investors about the Company’s advertising-revenue leverage, artificially boosted the value of the stock, enabling them to profit off the sale of $69 million of personally-held Company stock. The Court rejected this argument because: (1) plaintiffs had not alleged that this trading was a departure from the executives’ customary trading pattern; (2) the sales were non-discretionary because they were executed pursuant to a pre-existing trading plan or to cover tax withholding obligations; and (3) two of the executives sold just 2% of their company holdings during the class period while the third executive actually increased his shares by 22%. The Court concluded by noting that it was difficult to find plausible the allegation that the Company’s executives would “intentionally make a revenue projection in [one month] that they knew was likely wrong, with the almost certain prospect of having to publicly correct the projection just a little over a month later.”
Finally, the Court held that plaintiffs had not adequately alleged loss causation because, although plaintiffs adequately alleged that their losses were connected to the disclosure in the November 1 press release, they did not adequately allege that the press release was a “corrective disclosure” made after a prior false or misleading statement by defendants.