United States:

Northern District Of Illinois Dismisses Putative Class Action Against Cosmetics Retailer For Failure To Adequately Allege Falsity And Scienter

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On March 30, 2022, the United States District Court for the
Northern District of Illinois dismissed, without prejudice, a
putative class action asserting claims under the Securities
Exchange Act of 1934 against a cosmetics retailer and certain of
its executives. Chandler v. Ulta Beauty, Inc., No.
18-CV-1577, 2022 WL 952441, at *1 (N.D. Ill. Mar. 30, 2022). 
Plaintiffs alleged that the company made various statements that
were misleading because they failed to disclose the company’s
alleged practice of reselling used returned products.  The
Court held that plaintiffs failed to identify any actionable
misrepresentations and failed to adequately allege scienter, but
granted plaintiffs leave to replead.

Plaintiffs alleged that the company’s personnel were instructed
to “retouch used and dirty returned products and resell them
as new in order to reduce inventory
losses.”  Id.  at *3.  Plaintiffs
alleged on this basis that the company made misstatements and
omissions relating to (i) compliance with the company code of
conduct, (ii) the company’s compensation program, (iii) the
quality of the company’s products, (iv) the company’s
financial results, and (v) the company’s internal controls and
reporting.  Id. at *7.

The Court held that plaintiffs failed to explain why the challenged
statements were false.  For example, with respect to the
company’s statements about compliance with the company code of
conduct—specifically, that employees “must act ethically
at all times” and in accordance with the code of conduct,
which itself provided that employees “should not deliberately
misrepresent information to customers”—the Court
concluded that such statements were “immaterial as a matter of
law” because they were “too general to cause a reasonable
investor to rely upon them” and amounted to “inactionable
puffery.”  Id.  at *9.  With
respect to statements regarding the company’s
“compensation plans, practices and policies,” the Court
concluded that plaintiffs did not explain how those statements were
false and further observed that the alleged improper reselling
practices were “not so closely tied to compensation” that
they were required to be disclosed in order to prevent the
compensation-related statements from being
misleading.  Id. at *10.  With
respect to statements concerning product
quality—specifically, that the company had a “pipeline
of newness and innovation in merchandising”—the Court
found that this statement was referring to new types of products
and it was not reasonable to infer that the company was touting the
product offerings as “being ‘new’—as opposed to
used—because such a statement would only make sense if
investors believed that [the company] was selling used
products,” something which the complaint alleged was being
hidden from the public.  Id. at *11.

In addition, the Court held that challenged statements regarding
the company’s financial performance were not adequately alleged
to be false or misleading, including because plaintiffs never
alleged, even in a general sense, “what the correct sales,
income, and inventory figures purportedly were that [the company]
should have reported.”  Id. at
*14.  Similarly, the Court rejected plaintiffs’
allegations as to statements regarding internal controls and
reporting, explaining that plaintiffs failed to allege facts
showing how such challenged statements were false or misleading and
failed to explain “how [the company’s] internal controls
should have been designed
differently.”  Id. at *21.

The Court then evaluated plaintiffs’ allegations of scienter
and concluded that they failed to support a strong inference of
scienter as to either the company itself or to the CEO or CFO, who
were alleged to have made the challenged statements.  The
Court rejected plaintiffs’ argument that the CFO’s alleged
attendance at committee meetings designed to prevent
“shrink”—losses from customer returns of products
as well as theft and in-store damage—showed the CFO’s
knowledge of the alleged improper reselling, including because
there were no allegations that the scheme was discussed at such
meetings.  Id. at *23.  Moreover, with
respect to the CEO’s alleged approval of bonuses relating to
reduced “shrink,” the Court discounted such allegations
as they were attributed to a confidential witness who was four
levels of seniority below the CEO, and there was no alleged basis
for the confidential witness’s knowledge of the CEO’s
alleged approval of the bonuses.  Id. at
*24.  The Court also noted that even if the CEO had approved
such bonuses, issues of “shrink” involved a number of
different issues and not only issues relating to the alleged
reselling practices.  Id.

The Court further rejected plaintiffs’ argument that the CFO
and CEO must have known about the alleged scheme given their roles
and responsibilities.  The Court explained that plaintiffs did
not allege how many used products were resold or reshelved, or that
reselling used products was critical to the company’s
operations.  Id. at *24-26.  While the
Court determined that the CEO and CFO were “likely aware of
[the company’s] general problem with shrink,” the Court
emphasized that “it does not follow that they must have been
aware that retail stores were combating it by selling used
items,” and plaintiffs failed to “quantify[] how
significant the practice actually
was.”  Id.  at *25.  Thus, the
Court concluded that, even if the alleged reselling practice was
widespread, it did not support a strong inference of scienter as to
the CEO and CFO because there was “no alleged connection”
between them and the alleged
practice.  Id.  at *26.  Similarly,
the Court rejected plaintiffs’ contention that the CEO and CFO
had access to weekly reports that revealed stores were reselling
used products, noting that neither executive was plausibly alleged
to have reviewed those reports, and there was no allegation
explaining how the reports would have revealed the alleged
reselling practices.  Id. at *27-28. 
In addition, the Court rejected plaintiffs’ allegations of
scienter based on the CEO’s and CFO’s stock sales. 
The Court concluded that those sales occurred “shortly after
announcements of quarterly results, a pattern that appears benign
on its face” and were not close in time to any other
event.  Id. at *28-29.

Finally, the Court rejected plaintiffs’ argument that scienter
should be imputed to the company based on the allegation that
employees other than the CEO and CFO were “aware of, and even
encouraged, the resale of used
products.”  Id.  at *30.  The
Court explained that those employees’ alleged knowledge could
not be imputed to the company because they were “not alleged
to have had any role in promulgating the alleged
misrepresentations.”  Id.  The Court
concluded that the “most cogent explanation for [the
company’s] alleged conduct is that the resale of used product
was an unfortunate and unintentional byproduct of [the
company’s] focus on reducing shrink,” rather than
something known by the executives responsible for the alleged
misstatements.  Id. at *31.

Chandler v. Ulta Beauty, Inc.

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