On March 30, 2022, the United States District Court for the Northern District of Illinois dismissed, without prejudice, an alleged class action claiming claims under the Securities Exchange Act of 1934 against a cosmetics retailer and some of its executives. Chandler v Ulta Beauty, Inc., no. 18-CV-1577, 2022 WL 952441, a * 1 (ND Ill. March 30, 2022). Plaintiffs alleged that the company made various misleading statements because they did not disclose the company’s alleged practice of reselling used returned products. The Court found that the plaintiffs had failed to identify any prosecutable misleading representations and had not adequately relied on scienter, but granted plaintiffs permission to reply.
Plaintiffs said company personnel were tasked with “touching up the returned used and dirty products and reselling them as new in order to reduce inventory losses.” ID. at 3. The plaintiffs asserted on this basis that the company made errors and omissions relating to (i) compliance with the code of business conduct, (ii) the company’s compensation program, (iii) the quality of the company’s products , (iv) the financial results of the company, and (v) the internal controls and reporting of the company. ID. at 7.
The Court found that the applicants had not explained why the contested statements were false. For example, with regard to the company’s statements on compliance with the code of business conduct, in particular that employees “must act ethically at all times” and in compliance with the code of conduct, which in turn provided that the employees “do not deliberately misrepresent customer information” – the Court concluded that such claims were “legally irrelevant” because they were “too general to induce a reasonable investor to rely on them” and constituted “irony impracticable “. ID. at 9 o’clock. Regarding the statements regarding the company’s “compensation plans, practices and policies”, the Court concluded that the plaintiffs did not explain how such statements were false and further noted that the alleged improper resale practices “were not so closely related to compensation “that disclosure is mandatory in order to avoid compensation claims being misleading. ID. at 10 am. Regarding the claims relating to product quality – in particular, that the company had a “pipeline of novelty and innovation in merchandising” – the Court found that this claim referred to new types of products and not it was reasonable to assume that the company was touting the product offering as “new” – rather than used – because such a claim would only make sense if investors believed that [the company] he was selling used products, “something that according to the complaint was hidden from the public. ID. at 11.
Furthermore, the Court found that the contested statements regarding the financial performance of the company were not adequately alleged as false or misleading, also because the applicants never stated, not even in a general sense, “such as the correct sales, income and inventory presumably were those [the company] he should have denounced ”. ID. a * 14. Similarly, the Court dismissed the plaintiffs’ claims regarding the statements regarding internal controls and whistleblowing, explaining that the applicants did not adduce facts demonstrating that those contested statements were false or misleading and did not explain “how [the company’s] internal controls should have been designed differently ”. ID. a * 21.
The Court then assessed the plaintiffs’ scienter allegations and concluded that they did not support a strong scienter inference on either the company itself or the chief executive officer or chief financial officer, who would have made the contested statements. The Court rejected the plaintiffs’ argument that the CFO’s alleged participation in committee meetings aimed at preventing “shrinkage” – losses due to customer returns of products, as well as theft and damage in-store – demonstrated knowledge of the CFO of the alleged improper resale, not least because there were no allegations that the regime was discussed at such meetings. ID. a * 23. Furthermore, with respect to the alleged approval by the CEO of bonuses related to the reduction of the “shrink”, the Court dismissed these allegations as attributed to a confidential witness of four levels of seniority lower than the CEO and there was no presumed basis for confidentiality witness knowledge of the alleged approval by the CEO of the bonuses. ID. a * 24. The Court also noted that, even if the CEO had approved these bonuses, the “shrink” issues covered a number of different issues and not just issues related to alleged resale practices. ID.
The Court also rejected the applicants’ argument that the CFO and the chief executive officer had to be aware of the alleged scheme given their roles and responsibilities. The court explained that plaintiffs did not state how many used products were resold or renegotiated, or that the resale of used products was critical to the company’s operations. ID. a * 24-26. While the court ruled that the CEO and CFO were “probably in the know [the company’s] general problem with shrinkage “, the court pointed out that” it does not follow that they should have been aware that retail stores were fighting it by selling used items “and plaintiffs failed to” quantify how significant the practice actually was “. ID. a * 25. Therefore, the Court concluded that although the alleged resale practice was widespread, it did not support a strong scienter inference about the CEO and CFO because there was “no alleged connection” between them and the alleged practice. ID. a * 26. Similarly, the court dismissed the plaintiffs’ claim that the chief executive officer and chief financial officer had access to weekly reports revealing that the stores were reselling used products, noting that none of the executives would plausibly be accused of examining. such reports and there was no allegation explaining how the reports would have revealed the alleged resale practices. ID. a * 27-28. Furthermore, the court dismissed the plaintiffs’ scienter allegations based on the sales of shares of the chief executive officer and chief financial officer. The court concluded that these sales occurred “shortly after the announcement of the quarterly results, a trend that appears benign” and were not close to any other significant events in time. ID. a * 28-29.
Finally, the Court dismissed the plaintiffs’ argument that scienter should be charged with the company on charges that employees other than the CEO and CFO were “aware of, and even encouraged, about the resale of used products.” ID. a * 30. The court explained that the alleged knowledge of those employees could not be attributed to the company because “they would have had no role in the promulgation of the alleged false declarations”. ID. The court concluded that the “most compelling explanation for [the company’s] alleged conduct is that the resale of used products was an unfortunate and unintended by-product of [the company’s] focus on reducing shrink, “rather than on something known to managers responsible for the alleged errors. ID. a * 31.