Alkhoury v. Lululemon Athletica Inc. et al
OPINION & ORDER re: 47 MOTION to Dismiss the Consolidated Amended Class Action Complaint filed by Christine McCormick Day, Lululemon Athletica Inc., 50 MOTION to Dismiss the Consolidated Amended Class Action Complaint filed by Denni s J. Wilson. For the reasons set forth above, defendants' motions to dismiss are GRANTED and the CAC is DISMISSED. The Clerk of Court is directed to close the motions at ECF Nos. 47 and 50, and to close this action. (Signed by Judge Katherine B. Forrest on 4/18/2014) (tro)
DOC#: - - - - - - - - DATE FILED: April 18, 2014
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
13 Civ. 4596 (KBF)
IN RE LULULEMON SECURITIES
OPINION & ORDER
KA.THERINE B. FORREST, District Judge:
This putative securities class action was commenced on July 2, 2013.
Following the appointment of lead plaintiff and lead plaintiffs counsel on October 1,
2013, and the filing of a Consolidated Complaint on November 1, 2013, lead plaintiff
filed a Consolidated Amended Complaint ("CAC") on January 15, 2014 with leave of
the Court. In the CAC, lead plaintiff alleges violations of Section 10Cb) of the
Securities Exchange Act and Rule 10b-5 thereunder by defendants lululemon
athletica inc. ("lululemon," or the "company"), lululemon founder and director
Dennis J. Wilson, and former chief executive officer ("CEO") Christine McCormick
Day (Wilson and Day are hereinafter referred to as the "Individual Defendants").
(CAC '1'1153-57, ECF No. 28.) Lead plaintiff also alleges violations of Section 20(a)
of the Securities Exchange Act against the Individual Defendants. (Id.
Lead plaintiff alleges that stock declines related to the events at issue resulted in
investor losses of approximately $2 billion. (Id.
Boiled down to a summary version, lead plaintiff alleges that if only
lululemon had someone tryon its black luon yoga pants before they shipped, it
would have realized they were sheer; similarly, if lululemon had only had someone
exercise in certain athletic wear (enough to produce sweat), it would have realized
that the colors bled. As a result, lead plaintiff alleges that defendants' various
statements referencing, inter alia, the high quality of lululemon's products and the
steps the company took to fix the quality issues were materially false or misleading.
This narrative requires the Court to stretch allegations of, at most, corporate
mismanagement into actionable federal securities fraud. This is not the law. See,
Santa Fe Indm3.. Inc. v. Green, 430 U.S. 462, 477-79 (1977).
On February 18, 2014, defendants moved to dismiss the CAC in its entirety
pursuant to Federal Rule of Civil Procedure 12(b)(6) on the grounds that it fails to
adequately allege the key elements of a cause of action under Section 10(b) and Rule
10b-5: falsity, scienter, and loss causation. The motions became fully briefed on
March 24,2014, and the Court held argument on the motions on April 4,2014.
For the reasons set forth below, defendants' motions to dismiss are
GRANTED, and the CAC is DISMISSED in its entirety. 1
ALLEGATIONS IN THE CAC
Lead plaintiff, the Louisiana Sheriffs' Pension & Relief Fund, has brought
this action on behalf of itself and those who purchased or acquired lululemon stock
during the period from September 7, 2012 through January 10, 2014 (the "Class
Period"). (CAC at 1.) Lululemon designs and makes athletic apparel. (Id.
1 Though lead plaintiff previously requested leave to amend in the event the Court was inclined to
dismiss the CAC (see Opp. at 40 n.37, ECF No. 63), at the beginning of the April 4, 2014 oral
argument, lead plaintiffs counsel stated that they were they were no longer "planning" to amend.
(4/4114 Tr. at 5, ECF No. 72.) Accordingly, the Court does not address the issue ofleave to amend
under Rule 15(a)(2).
Among its most popular products are fitness pants made from a proprietary
material known as "luon"-an amalgamation of 86% nylon and 14% lycra. (Id.
21.) Before the Class Period, luon athletic pants accounted for at least 17% of the
company's sales of women's bottoms and 6% of the company's total sales (or $80
million during 2012). (Id.)
Lululemon does not manufacture luon or its products-it outsources those
functions to third parties on a contract basis. (Id.
22.) For the past ten years, the
company's luon garments have been produced by Taiwan-based Eclat Textile Co.
("Eclat"). (Id.) The company's robust sales of its apparelled to significant growth.
The price of its stock also rose significantly. (Id.
Defendant Wilson founded lululemon in 1998 and has served as the
Chairman of the Board of Directors since that time. (Id.'; 17.) Wilson opened the
company's first store in 2000, and the company went public in 2007. (Id.,r 20.)
Wilson signed the company's Form 10-K for fiscal year 2012 filed with the SEC
during the Class Period. (Id. ' I[ 17.)
Defendant Day joined the company in 2008 and was promoted to CEO in July
of that yeal'; her resignation as CEO was publicly announced on June 10, 2013. (Id.
18, 72.) Day signed all of the company's Form 10-K's and Form 10-Q's filed with
the SEC during the Class Period. (Id.'; 18.)
In basic outline, the CAC tells the following story: lululemon sold its clothing
products at price points higher than the competition based on quality as a
differentiating factor. (rd.
3.) Prior to the Class Period, the company had
experienced certain quality issues, and it continued to experience quality issues
during the Class Period. 2 The CAC alleges that, throughout the Class Period,
lululemon had grossly deficient quality controls-primarily the absence of live
model testing-which resulted in a recall of its signature product, black luon yoga
pants, in March 2013 (the "Black Luon Recall," or the "Recall"). (ld.
L) The CAC
also alleges that the company made a number of statements touting the high
quality of its products during the Class Period. (Id.
The CAC alleges that the Black Luon Recall resulted in a diminution in sales
revenue in the range of $40-45 million for the first and second quarters of 2013. (Id.
L) These and other quality control issues during the Class Period are alleged to
have "halted the Company's rocketing growth, tarnished the Company's brand, and
opened the door for its many competitors to seize market share." (Id.) The CAC
alleges that the company "failed to institute the most basic quality control
processes, expend resources necessary to ensure its products were of high quality,
and exercise appropriate oversight over its manufacturing process"-the primm'y
2 The CAC alleges information regarding the company's quality controls from eleven confidential
witnesses, hereinafter referred to as a HCW" followed by the numbers listed in the CAC. For
instance, CW 1, a former Assistant Manager for Specializing and Operations between September
2010 and February 2013, stated that because of the company's high price point, customers found
quality issues unacceptable. Q.!:L" 30.) CW 2, a Vice President of Product Operational Solutions at
lululemon's headquarters from September 2011 through December 2012, stated that the company
failed to make quality control a priority because it was focused instead on growing its stores and
expanding reach; CW 2 described quality controls generally as a "catch as catch can" system. Wl ~
34.) CW 3, a Sourcing Manager between August 2012 and July 2013, responsible for certain non·
yoga lines of apparel, stated that the company did not put in place structures needed for quality
procedures. Wl) CW 4 was also a Sourcing Manager from ,July 2007 through July 2012, who was
responsible for managing part ofthe company's supply chain, for sourcing finished products, and
managing factory relationships; CW 4 stated that the company's team was strained due to fast
growth and that this negatively impacted quality on certain occasions. Wl) CW 5, the company's
Lead Raw Material Developer from July 2011 through January 2013, who found and tested fabrics,
also stated that the company's growth had impacted quality, and that the company's quality controls
were "very generic," "ineffective," and "ad hoc." Wl
example to which lead plaintiff points is that the company failed to have a person
try on its products prior to shipment. (ld.
2.) The CAC alleges that maintaining
high product quality was essential to the company's ability to maintain the value
and reputation of its brand. (Id.
Alleged Quality Issues in 2007-2012
Beginning in 2007, prior to the Black Luon Recall, lululemon had suffered
from a series of quality failures. (Id.
36.) In 2007, the company claimed its
"Vitasea" apparel contained and released "marine amino acids" that could reduce
stress and provide other health benefits to wearers. (Id.'1 37.) Third party testing
reported in The New York Times disputed these assertions, and Wilson later
admitted that the company had not itself tested the Vitasea products but had
instead trusted the claims of its suppliers. (Id.
In December 2010, the company had a second high-profile quality issue. (Id.
Shopping bags utilized by the company were printed using ink that
contained high lead content. (ld.) The bags had been made by a supplier in China.
(ld.) In response to this issue, Day told customers and investors that such product
quality issues would not occur in the future. (Id.)
On June 10,2011, Day told investors that the company's "Luon has been the
same for over 7 years" and that the company was "maniacal about protecting that
26.) Day also stated to investors that the company "monitor[s] the
quality and feedback on [its Luon] items in particular." (Id.)
In 2011 and 2012, however, the company's quality problems persisted. (Id.'1
41.) In late 2011 and early 2012, numerous customers complained that the color
dye from the company's garments bled during exercise ("color fastness issues") and
that the leaching dye stained skin and hair and caused health concerns. 3 (Id.
42.) These problems affected several different fabrics, including luon, and resulted
in the company placing warnings on defective items, pulling the items from store
shelves, and accepting returns for affected items. (Id.
Two other quality issues occurred prior to the Class Period: one in the spring
of 2012 relating to swimwear that had both color fastness and sheerness issues, and
another in June 2012 concerning elasticity in the waistband of men's athletic
shorts. 4 (Id.'1 44.)
The CAC alleges that the company's executives-and the Individual
Defendants-were informed about each of these quality control breakdowns.
Specifically, CW 2, a Vice President of Product Operational Solutions at the
company's headquarters from September 2011 to December 2012, stated that once
the severity of the quality issues became clear, Day received regular reports about
34, 46.) According to CW 2, Day was "well aware" of the color
.l CW 1, a former Assistant Manager for Specializing and Operations between September 2010 and
February 2013, stated that "color fastness was a huge issue for a long time," and impacted "all
[Lululemon's] colored pants." W:L'; 41.) CW 7, a Women's Designer at headquarters from June 2011
through May 2012 (prior to the Class Period), stated that the dye bleeding issue was a significant
problem for the company that affected a large amount of product. W;L) CW 8, the company's
Technical Operator of its ecommerce website from 2011 through March 2013, stated that the
company did not know about the color fastness issues until weeks after the products had been on
store shelves and they had received customer complaints (including a complaint from one woman
who reported that the color dye in her lululemon clothing had bled onto her and her baby). W:L ~ 42.)
4 CW 9, a merchant in the company's Men's Division from January 2012 through September 2012
(prior to the Class Period), stated that the company did not catch the elasticity issue before the
shorts were shipped to stores; the CAC alleges that as with the luon yoga pants, live model testing
would have revealed this problem. W:L,r 45.)
fastness issues by late 2011. (Id.,r 43.) According to CW 1, a former Assistant
Manager for Specializing and Operations between September 2010 and February
2013, Day "made a commitment" to resolve the color fastness issues. (Id.) CW 10, a
Quality Control Manager in the company's Hong Kong office from September 2009
through July 2013, stated that when a quality control issue impacted numerous
items or required product not to ship or be removed from shelves, it would be
elevated to Day. (Id.
46, 53.) CW 5, the company's Lead Raw Material
Developer from July 2011 through January 2013, stated that Day had access to all
company and partner reports regarding the quality oflululemon's products prior to
\Vith respect to defendant Wilson, according to press reports and as stated by
CW 2, Wilson would "dipD in and out of daily affairs" at the company, and "his
fingerprints are all over the company's policies and principles." (ld.,r 46.) CW 5
stated that 'Nilson "still ha[d] his hands in the pot," and that Wilson's aim was to
"dominate" and not to do so "through design but not good business sense." (Id.
The CAC alleges that, after the color fastness issue became public, the
company apologized for these problems in a July 2012 letter from Chief Product
Officer Sheree \Vaterson that was posted on the company's Facebook page. (ld.'1
47.) The letter stated that quality is the company's hallmark, that the company had
put "stringent testing procedures in place" to rectify the problem, and that all of the
company's products now met the company's performance requirements. (Id.) The
letter also stated that it had "brought in the leading fabric and dye expert, along
with additional on-site quality inspection at every stage to identify potential causes"
of its color fastness issues. @,) The CAC does not allege that the company did not
take any of the steps described in this July 2012 letter.
On the first day of the Class Period, September 7, 2012, Day told investors
that "[i]n the end, quality is our key differentiating factor. It is what [lululemon]
stands for and what [lululemon] will always stand behind." (Id.
25.) She also
stated that the company may have "pushed" the color limit too far, the company's
products were created with the "highest quality suppliers and manufacturers," and
that the company "stood behind" the quality of its products. (Id.
47, 96.) She
further stated that the company was investing in additional people and equipment
and was focused on its capability to deliver quality products every step of the way,
and that she was "very comfortable now" with the product and the ability to
maintain quality. (ld.'1 48.) On September 7, 2012, the company also filed with the
SEC its Form 10-Q for the second quarter of 2012. @,
98.) In that document, the
company stated that it was the "leader in technical fabrics and quality
During the Class Period, the CAC also alleges that the company's website
contained statements concerning the importance of quality to the company, that its
quality was the "highest in the industry," and that "[q]uality is at the heart of
everything we do." @'-
On December 6,2012, the company issued its earnings for the third quarter
of 2012 and reported a 37% net increase in revenue. (ld.
101.) During a
conference call with investors to discuss those results, Day stated that the company
was not pursuing "growth at any cost."5 (ld.) Lululemon also reported its quarterly
financial results to the SEC that day on Form 10-Q. (Id.
102.) The December 6,
2012 Form 10-Q again stated that the company was the "leader in technical fabrics
and quality construction." (Id.)
According to CW 6, a Quality Assurance Manager in IT at headquarters from
September 2008 through August 2013, in the winter of 2012-2013, Day stated to
employees that the company's growth had led to a sacrifice in quality. (ld.
2013 Qualitv Issues and the Black Luon Recall
Quality issues persisted. In February and March 2013, customers began to
complain that certain brightly colored luon yoga pants would become see-through or
sheer when worn (the "sheerness issue"). (ld.
50.) Lululemon discounted the
price of the product and recommended that customers try them on prior to
In a March 18, 2013 press release issued after the close of trading that day,
the company announced the Black Luon Recall due to the sheerness issue. (ld.
51.) In the press release, Day referred to the Recall as an "inconvenience," stated
that "[i]t is always our first priority to protect the quality of our fabrics that keep
our guest [sic] so loyal to our products," and stated that "[w]e will accept nothing
5 The text of Day's full statement indicates that this comment was made in response to a question
about international sales growth. (See Allerhand Decl. Ex. 28 at 12, ECF No. 49.)
less than the very highest quality that we are known for." (Id.,j 107.) The same
day, the company posted an FAQ on its website, which stated that "the quality of
our products are paramount" and "we are committed to providing the highest
quality products to our guests." . (Id.)
In the press release, the company stated that it had not been aware of the
widespread product defects in its black luon bottoms until March 11, 2013. (Id.)
The CAC alleges that this statement was false and misleading because of two
statements attributed to CWs. First, according to CW 5, the company's Lead Raw
Material Developer from July 2011 through January 2013, the black luon sheerness
issue had "definitely" been "percolating" for a while, and the company's luon pants
were "see through before it came out [publically]." (Id.
54.) Second, according to
C\V 1, a former Assistant Manager for Specializing and Operations between
September 2010 and February 2013, in October 2012, Day "acknowledged"
internally that the company had a "sheer luon" issue that she attributed to excess
demand "not being able to keep up." (Id.)6
Following the announcement of the Recall, the company reduced its expected
revenue guidance for the first quarter of 2013 by from $350-$355 million to $333
$343 million. (Id.,r 51.) Three days later, the company announced that it expected
to lose $57 -$67 million in revenue and $0.25-$0.27 in earnings per share ("EPS")
during the 2013 fiscal year, a negative 12% impact on its 2013 EPS guidance. (Id.)
Additionally, CW 11, who worked in a store for the company from October 2009 through August
2013, alleges that, in the winter of 2012-2013, corporate managers informed store managers about
widespread sheerness issues. (ill., 'If 54.)
On March 21, 2013, the company filed its Form 10-K for fiscal year 2012 with
the SEC. (Id.'1 109.) In that document, the company stated that it worked with a
"leading independent inspection, verification, testing and certification company" to
"conductD a battery oftests before each season on our fabrics."
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