Regular readers know that in recent months I have been following two securities class action litigation filing trends: first, the incidence of COVID-19-related securities suit filings, and, second, the influx of claims relating to macroeconomic factors, including, among other things, global supply chain disruption (which was itself caused at least in part by the coronavirus). In a lawsuit that includes allegations that involve both of these trends, a plaintiff shareholder has filed a securities class action lawsuit against the women’s online apparel company, Torrid Holdings, Inc. As discussed below, the complaint alleges, among other things, that in connection with the company’s July 2021 IPO, the company soft-pedaled the impact on the company from COVID-19 and from supply chain disruptions. A copy of the plaintiff’s November 16, 2022 complaint can be found here.
Torrid is a direct-to-consumer brand of women’s plus-size apparel. The company completed an IPO in July 2021. According to the subsequently filed securities lawsuit complaint, in its offering documents, the company made a number of statements about its business model, the impact of the coronavirus on the company, and the resilience of its supply chain. Among other things, the complaint alleges that in the offering documents the company “claimed to have successfully navigated the COVID-19 pandemic and that it had put in place numerous logistical advantages, such as an enhanced and flexible supply chain, to avoid or substantially mitigate future disruptions caused by the pandemic.”
Following the IPO, in its quarterly financial reports, the company announced disappointing sales, revenues, and financial results. Among other things in connection with these results, company management cited issues arising from global supply chain challenges as a result of the Delta COVID-19 variant. By the end of September 2022, the price of Torrid’s stock, according to the complaint, fell to a price over 80% below the IPO price.
On November 16, 2022, a plaintiff shareholder filed a securities class action lawsuit in the Central District of California against the company, certain of its directors and officers, its offering underwriters, and its controlling shareholder. The complaint purports to be filed on behalf of investors who purchased the company’s shares in or traceable to the company’s July 2021 IPO.
The complaint alleges that in connection with the IPO the defendants failed to disclose the following “adverse facts that existed at the time of the IPO”:
(a) that in the first half of 2021 Torrid had experienced a temporary surge in demand as a result of changed consumer behaviors in response to the COVID-19 pandemic and government stimulus and that such ephemeral demand trends had dissipated and were not internally projected to continue following the IPO;
(b) that Torrid was suffering from severe supply chain disruptions caused by the emergence of the Delta variant of COVID-19, which had first emerged in May 2021;
(c) that Torrid was running materially below historical inventory levels as a result of supply chain disruptions;
(d) that, as a result of (a)-(c) above, Torrid did not have sufficient inventory to meet expected customer demand for its fiscal third quarter of 2021;
(e) that as a result of (b)-(d) above, late inventory arrival had materially impaired the Company from effectively matching consumer buying trends, creating an undisclosed risk of increased markdowns and promotional activities necessary to sell undesirable inventory;
(f) that Torrid’s CFO, defendant Wehlitz, planned to retire shortly after the IPO; and
(g) that as a result of (a)-(f) above, the Registration Statement’s representations regarding Torrid’s historical financial and operational metrics and purported market opportunities did not accurately reflect the actual business, operations, financial results, and trajectory of the Company at the time of the IPO, and were materially false and misleading and lacked a reasonable financial basis.
The complaint alleges that the defendants violated Sections 11 and 15 of the Securities Act of 1933. The complaint seeks to recover damages on behalf of the class.
The most recent signs are that the supply chain disruption that tangled global commerce for much of the last two years has largely eased. Indeed, a front-page Wall Street Journal article on November 18, 2022 (here) noted that “the script has been flipped,” and now retailers, rather than struggling to obtain supplies are drowning in inventory. However, while the disruption to the supply chain has lessened, the impact over the last two years on companies’ operations continues to weigh on their financial results – and continues to find its way into securities class action allegations, as this case shows. There have in fact been a number of securities class action lawsuits over recent months based at least in part on allegations relating to the supply chain disruption.
Supply chain disruption is only one of several macroeconomic factors that are weighing on companies, and that are also finding their way into securities class action allegations, along with rising interest rates, surging economic inflation, labor supply disruption, and the war in Ukraine. And even if the supply chain issues are letting up, the other macroeconomic issues continue to weigh on companies, and continue to contribute to securities litigation risk. Perhaps of even greater concern, both for companies and for their securities litigation risk, there is a substantial chance of a global economic recession in 2023, which could significantly affect companies’ financial results and in turn lead to securities litigation.
This company’s supply chain woes were due at least in part to the COVID-19 disruptions, and COVID-19 allegations made their way into the plaintiff’s complaint. It is noteworthy that though we are now well into the third year of the pandemic, securities suits with coronavirus-related allegations continue to be filed.
By my count, there have been a total of 61 COVID-19-related securities class action lawsuits filed since the initial coronavirus outbreak in the U.S. in March 2020, including 18 YTD in 2022 (of which four have been filed in November 2022 alone). As I have previously noted, it seems that just as the coronavirus continues to be a significant global public health factor, it also continues to be a significant factor in securities class action lawsuit filing incidence.
As I have also previously noted, the COVID-19-related lawsuits generally fall into one of three categories. First, there are the suits against companies that experienced outbreaks in their facilities (cruise ship lines, private prison systems); Second, there are the suits against companies that claimed they would profit from the pandemic (diagnostic testing companies, vaccine development companies); and Third, there are suits against companies whose operations or finances were disrupted by the coronavirus (hospital systems, real estate developers). More recently, a fourth category emerged involving companies that prospered at the outset of the pandemic, but whose fortunes flagged as the pandemic progress (for example. Peloton).
This case seems to fall into the third category. Its operations and financial results were disrupted following the company’s IPO by ongoing problems from the pandemic. Though it is hard to know for sure, at least for now it seems likely that we will continue to see new lawsuits filed raising similar allegations.
Whatever may prove to be the case, it is certainly the case that the COVID-19 cases have been a significant factor in the securities lawsuit filings this year. The 18 COVID-19-related securities suit filings so far in 2022 represent slightly more than 10% of the approximately 174 securities class action lawsuit that have been filed YTD. Just as no one at the outset imagined that the pandemic would still be a significant phenomenon more than two and a half years later, no one (certainly not me) thought we would still be seeing these kinds of suits after such a long time interval.
And Speaking of a Possible Recession: The possibility of a global recession is clearly a cause for concern. A recent article in the Economist points out that while boom times in the stock market can “engender fraud,” bad times “like those that lie ahead reveal it.”
The November 7, 2022 article, which is entitled “A Sleuth’s Guide to the Coming Wave of Corporate Fraud” (here) lists the recent conditions that could have enabled a great deal of fraud to flourish and to avoid detection: “A decade of ultra-low borrowing costs has encouraged companies to load up on cheap debt. And debt can hide a lot of misdeeds. They are uncovered when credit dries up. The global financial crisis of 2007-09 exposed fraud and negligence in mortgage lending. The stockmarket bust of the early 2000s unmasked the deceptions of the dotcom bonanza and the book-cooking at Enron, WorldCom and Global Crossing.” The coming downturn, the article suggests, “seems likely to uncover a similar wave of corporate fraud.”
What may actually be revealed remains to be seen; but some guesses are possible: “The archetypal sin revealed by recession is accounting fraud. The big scandals play out like tragic dramas: when the plot twist arrives, it seems both surprising and inevitable. No simple formula exists to sort the number-fiddlers from the rest. But the field can be narrowed by searching within the ‘fraud triangle’ of financial pressure, opportunity and rationalisation.”