The difference between "style" and "fashion" drove a Fifth Circuit panel's conclusion that a retailer did not deliberately conceal inventory.
The fact that a fashion retailer had high inventory did not necessarily lead to the conclusion that it intentionally concealed that fact or the risk of significant markdowns, a Fifth Circuit panel concluded. The complaint alleged that Pier 1 Imports, Inc. knew that it had a large inventory of trendy merchandise that would have to be significantly reduced in price when consumer tastes changed. The court found that the merchandise was not so trend-driven and that it was equally plausible that Pier 1 reasonably believed that the existing inventory could gradually be sold at market prices (Municipal Employees' Retirement System of Michigan v. Pier 1 Imports, August 19, 2019, Elrod, J.).
In 2012, Pier 1 launched an online shopping initiative in response to consumer demand, in. The initiative did not fare well, however, and Pier 1's stock had plummeted almost 75 percent by late 2015. Disappointed investors then brought suit, asserting that Pier 1, and its CEO and CFO, his and misrepresented information that caused the stock drop when disclosed.
The investors alleged that Pier 1 failed to tell them about the risk that the company would have so much inventory that the only way to sell it would be at dramatically lower prices. This significant markdown risk was exacerbated by seasonal and specialty products affected by changing consumer tastes, the complaint said. And, to keep up with a flood of excess inventory, Pier 1 made nondiscretionary capital-improvement expenditures many times higher than the yearly average for the ten previous years.
According to the complaint, Pier 1 made a series of partial corrective disclosures in 2015 telling of unplanned expenses and "inventory related inefficiencies." During the same period, however, the company also said that there was no significant immediate markdown risk. Finally, in late December 2105, the company announced that it would take over eighteen months before inventory levels would be in line with actual demand. After this announcement, Pier 1's shares dropped by 20 percent in one day.
District court dismisses. A complaint filed in the Northern District of Texas alleged that Pier 1 fraudulently failed to disclose a significant markdown risk. The court dismissed the complaint for failing to adequately plead scienter. An amended complaint met the same fate, and the court dismissed the action with prejudice, stating that despite substantial changes, the amended complaint failed to cure the deficiencies of earlier pleading.
Panel finds no scienter. The appellate panel agreed with the district court that the investors failed to plead a strong inference of scienter. The investors' scienter theory relied on three categories of allegations: motive; knowledge of high inventory; and knowledge of significant markdown risk. Addressing the motive allegations first, the court found no support in the CEO or CFO's desire to protect their careers. The possibility of cash bonuses based on Pier 1's earnings was also insufficient to show motive in this case because Pier 1's earnings were low enough that the chance of receiving such a bonus was quite small.
Turning to the executives' alleged knowledge that Pier 1's inventory was high, the court noted that the allegation was framed as misrepresentations about the ability to offload the excess inventory without significant markdowns. The court said that knowledge of high inventory does not necessarily equal knowledge of significant markdown risk, it was equally plausible that the executives believed that the excess inventory problem could be fixed without markdowns. The court noted other defects with this set of allegations, including, for example, statements from confidential witnesses who did not interact with either the CEO or CFO.
Finally, the investors maintained that the executives knew that they could not sell the inventory without marking it down significantly. Pier 1 pointed out here that it kept ordering new inventory, which would be unreasonable if it knew that existing inventory could not be sold. The investors' argument hinged on the assertion that once fashion changes, Pier 1 is forced to mark down out-of-style inventory in order to sell it. The court was persuaded, however, by the company's argument that much of its inventory was part of "long-standing collections," adding that the general allegation that Pier 1 is a "trend-based fashion retailer" was conclusory.
The court accordingly affirmed the district court's judgment, noting that rather than conceal its problem, the company repeatedly warned investors that its high inventory would affect its output. Moreover, continuing to order inventory would be counterproductive if Pier 1 were attempting to conceal a significant markdown risk, the court said.
The case is No. 18-10998.
Attorneys: Richard Phillip Ieyoub (Ieyoub & Wyble, L.L.C.) for Municipal Employees' Retirement System of Michigan. Stephen Burton Crain (Bracewell LLP) for Pier 1 Imports, Inc.
Companies: Municipal Employees' Retirement System of Michigan; Pier 1 Imports, Inc.
MainStory: TopStory FraudManipulation PublicCompanyReportingDisclosure SarbanesOxleyAct LouisianaNews MississippiNews TexasNews
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