(Article from Securities Law Alert, June/July 2021)
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On May 18, 2021, the District of Maryland denied the dismissal of the complaint in a putative securities fraud class action alleging that an apparel company and its former CEO misled investors concerning the company’s revenue growth and product demand and engaged in pull forward sales[1] and other allegedly suspect sales practices. In re Under Armour Sec. Litig., 2021 WL 1985015 (D. Md. 2021) (Bennett, J.). The court held that plaintiffs adequately alleged securities law violations when their allegations were “read in light of and in combination with the allegations” in an SEC cease-and-desist order entered against the company.
Plaintiffs’ Allegations
Plaintiffs alleged that defendants misled investors by, among other things, falsely claiming that consumer demand for the company’s products was strong; leading investors to believe that the company’s 26-consecutive quarter year-over-year revenue growth streak was “safely intact” when product demand was actually in decline; and manipulating the company’s financial results with pull forward sales.
SEC Cease-And-Desist Order Is Entered Against the Company
Defendants sought to dismiss, asserting that the complaint generally failed to plead adequate factual details to support plaintiffs’ claims. While the motion to dismiss was pending, the SEC entered an order instituting cease-and-desist proceedings against the company for violations of various federal securities laws and ordering it to pay a $9 million civil penalty. The SEC order stated that in anticipation of cease-and-desist proceedings, the company submitted an offer of settlement, which was accepted. While the company consented to entry of the order, it neither admitted nor denied the SEC’s findings. Following plaintiffs’ request, the court took judicial notice of the SEC order.
The SEC Order Lends Support to Plaintiffs’ Allegations
Taking into consideration the SEC order, the court held that it was “satisfied that Plaintiffs’ allegations survive the Defendants’ Motion to Dismiss.” The court clarified that the SEC order did not supply dispositive evidence as it stated that its findings were not binding. Nevertheless, the court determined that the SEC order lent support to plaintiffs’ allegations.
The court concluded that the SEC order undermined defendants’ dismissal argument because it provided “specific factual allegations regarding the amount of the products pulled forward and concludes that because of the undisclosed pull forward tactics used, investors were left with a misleading impression of how [the company] was meeting or beating analysts’ revenue estimates.” Further, the court pointed out that the SEC found that the company’s reported financial results “did not reflect its natural revenue and revenue growth, and were not indicative of its future financial results.”
[1] Pull forward sales, sometimes called channel stuffing, occur when a company ships more goods to distributors and retailers than end-users are likely to buy in a reasonable time period, which can accelerate revenue recognition to reach short-term revenue and earnings targets but can result in lower future demand.