Eastern District Of New York Grants In Part And Denies In Part Motion To Dismiss Securities Fraud Class Action Against Mattress Company
On September 30, 2022, Judge Margo K. Brodie of the Unites States District Court for the Eastern District of New York granted in part and denied in part a motion to dismiss a securities fraud class action against a bedding company (the “Company”) alleging that the Company misled investors about the Company’s strength and potential for growth in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Lematta v. Casper Sleep, Inc., et al., No. 20-CV-2744 (MKB), 2022 WL 4637795 (E.D.N.Y. Sept. 30, 2022). The Court held that (i) alleged misstatements about optimizing pricing and promotional strategies in offering materials for the Company’s initial public offering (“IPO”) were not misleading and (ii) alleged misstatements about anticipated growth were puffery or forward-looking statements accompanied by sufficient cautionary language. The Court otherwise denied the motion to dismiss.
A few months after the Company went public, the Company’s stock was trading 32% below the IPO price. Plaintiff filed a complaint alleging that the registration statement for the IPO misrepresented the strength of the Company’s business. Specifically, plaintiff alleged the registration statement misrepresented: (1) the Company’s core profitability; (2) the ability of the Company’s retail stores to generate sufficient revenue to cover the costs of new store builds over an approximately two-year period; (3) the profitability of the Company’s e-commerce operations in the lead-up to the IPO; (4) the ability of the Company’s multichannel marketing and new retail store strategy to generate complementary revenue growth; (5) the Company’s strategic initiatives designed to improve profit margins; (6) the sustainability of year-over-year revenue and margin trends; (7) the Company’s intention to expand into several new international markets; and (8) the Company’s “highly qualified supply chain and distribution network.” Relying primarily on confidential witness statements from former Company employees, plaintiff alleged all eight categories of statements were misleading because the Company failed to disclose adverse facts, including that (1) the Company’s profit margins were actually declining, rather than growing; (2) the Company was changing an important distribution partner, which impacted gross margins for 2020; (3) the Company was holding a glut of old and outdated inventory that it was selling at steeply discounted clearance prices; (4) the Company was suffering accelerating losses; and (5) the Company’s core operations were causing the Company to suffer over $40 million in negative cash flows during the first quarter of 2020 alone, doubling its quarterly net loss year over year.
With respect to the statements about the Company’s profitability, the Court held that, “[b]ased on the information [the Company] provided, a reasonable investor may have believed that [the Company] was on a path to achieve profitability and implement its growth initiatives, when according to [the] factual allegations, [the Company] was actually suffering accelerating losses, its core operations were not profitable, its revenue growth rate was not sustainable, and it had not positioned itself to achieve profitability.” In crediting plaintiff’s allegations, the Court noted that one of the confidential witnesses claimed that the Company had tried to “make the books look good for the close of the quarter before the IPO” by, for example, cutting payroll and employee hours. Another confidential witness claimed the Company already recognized that international expansion was not a viable strategy. Although the Court noted that the Company provided cautionary language in connection with its profitability statements, the Court held that the Company “chose to speak about the potential path to growth and profitability,” and it thus “had an obligation to ensure its statements were ‘both accurate and complete.’” Likewise, the Court held that plaintiff adequately alleged that the Company failed to disclose a significant change to one of its key distribution partners.
With respect to the statements about pricing and promotional strategies, however, the Court concluded that the registration statement was not misleading because it included language warning investors that “[l]aunching new products or updating existing products may. . .leave [the Company] with obsolete inventory that we may not be able to sell, or we may sell at significantly discounted prices.” As the Court noted, the inventory glut materialized only after the Company explicitly warned that it could “significantly” discount old inventory. Additionally, the Court granted the Company’s motion as to statements about growth and plans to expand its global operations, holding that these statements were forward-looking and accompanied by sufficient cautionary language “highlight[ing] the risks that could prevent [the Company] from achieving its forward-looking growth plans.” The Court added that statements about the Company’s “growth and desire to expand into international markets are corporate optimism more appropriately described as puffery.”
With respect to the statements that the Court held were actionable, the Court also found that plaintiff had adequately alleged loss causation and adequately alleged a strong inference of scienter required for plaintiff’s Section 10(b) claim.