On September 17, 2020, Judge Rachel P. Kovner of the United States District Court for the Eastern District of New York dismissed without prejudice a putative class action asserting claims under the Securities Exchange Act of 1934 against a cosmetics company and certain of its executives.  Lachman v. Revlon, Inc., No. 19-CV-2859 RPK RER, 2020 WL 5577406 (E.D.N.Y. Sept. 17, 2020).  Plaintiffs alleged that the company made misrepresentations regarding a new software system that was supposed to combine the tracking of different areas of the company's operations but allegedly led instead to production delays, lost sales, and a material weakness in the company's internal controls with respect to financial reporting.  The Court held that plaintiffs failed to identify any actionable misstatement or to plead that defendants acted with scienter.

Plaintiffs' allegations concerned a new integrated software system that the company implemented to replace a number of previously separate systems that monitored accounting, procurement, project and risk management, compliance matters, and supply-chain operations for various products.  Id. at *2.  As the company worked to implement the software, it encountered various problems that led the company to repeatedly delay full implementation, and once the software was implemented, it negatively impacted various elements of the company's production cycle, which the company disclosed in SEC filings and public statements regarding its efforts to remediate the situation.  Id.  

First, plaintiffs challenged certain statements prior to the software's launch, including arguing that statements in the company's annual report regarding risks associated with implementing the new software were false because the company failed to disclose additional risks that allegedly were known to defendants and had already materialized.  Id. at *9.  The Court concluded, however, that plaintiffs failed to plead facts supporting these allegations.  Id.  Plaintiffs also challenged a statement that certain executives were awarded bonuses attributable in part to expected synergies from the new software, but the Court explained that plaintiffs pleaded no facts to raise a doubt that the bonuses were, in fact, awarded on that basis, and that the statement was not a representation that there were, would not be “substantial transitional risks or costs.”  Id.  The Court further held that certain statements were non-actionable puffery, including an executive's statement that the company had “significant opportunities for improvements in operational excellence” in part because of the new software.  Id.

The Court then examined statements the company made after the software launch.  Plaintiffs argued that the next annual report misled investors about the severity of the company's software launch issues.  Id. at *10.  The Court rejected this argument because plaintiffs failed to identify how the company's statements about difficulties associated with the software launch were inaccurate.  Id.  The Court similarly rejected the argument that an executive's statement that the company was taking “immediate actions to address the situation” presented by the software launch, which was otherwise “on schedule,” downplayed the problems the company faced; the Court held that these statements did not suggest the company's remediation efforts had already been successful, and plaintiffs did not identify any facts suggesting the statements were false when made.  Id.  While the Court agreed that plaintiffs had plausibly identified an inaccurate statement that the software would work “flawlessly” at a particular location, the Court concluded this statement was immaterial in light of the company's other disclosures about the problems the company experienced with the software.  Id. at *11.

The Court also rejected plaintiffs' argument that the company's certifications of its internal controls over financial reporting were false because of the weaknesses in the reporting systems that were discovered in the course of the software launch.  Id. at *12.  The Court explained that these certifications were based on the certifying officer's knowledge, and plaintiffs failed to allege any facts suggesting that the certifications were knowingly false when made.  Id.

In addition, the Court held that plaintiffs failed to establish a “strong inference” of scienter for any alleged misstatement, either by alleging facts to show that defendants had motive and opportunity to commit fraud or by alleging facts constituting strong circumstantial evidence of conscious misbehavior or recklessness.  With respect to motive and opportunity, the Court explained that plaintiffs failed to allege facts indicating that any defendant received a concrete and personal benefit from any of the alleged misrepresentations.  Id. at *13.  Regarding evidence of conscious misbehavior or recklessness, the Court held that plaintiffs failed to allege that the executives who made the statements in question actually received information that contradicted their challenged statements.  Id. at *14-15.

Finally, the Court rejected plaintiffs' attempt to plead corporate scienter without reference to any specific individual, which the Court emphasized had been accepted only in “exceedingly rare instances” where the allegedly fraudulent statements are “so dramatic” that they “would have been approved by corporate officials sufficiently knowledgeable about the company to know that those statements were misleading.”  Id. at *15.  The Court concluded that the statements identified by plaintiffs fell short of that level.

Originally published by Shearman & Sterling, September 2020

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