Gimpel v. Hain Celestial Grp., Inc. (In re Hain Celestial Grp., Inc. Sec. Litig.)

• Decision Date: 17 December 2021
• Docket Number: August Term, 2021,Docket No. 20-1517
• Parties: IN RE: The HAIN CELESTIAL GROUP, INC. SECURITIES LITIGATION Salamon Gimpel, Rosewood Funeral Home, Lead Plaintiffs-Movants-Appellants, James Spadola, Rodney Lynn, Consolidated Plaintiffs, Bradley D. Flora, Individually and on behalf of all others similarly situated, Plaintiff v. The Hain Celestial Group, Inc., Irwin D. Simon, Pasquale Conte, John Carroll, Stephen J. Smith, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

20 F.4th 131

IN RE: The HAIN CELESTIAL GROUP, INC. SECURITIES LITIGATIONSalamon Gimpel, Rosewood Funeral Home, Lead Plaintiffs-Movants-Appellants,James Spadola, Rodney Lynn, Consolidated Plaintiffs,Bradley D. Flora, Individually and on behalf of all others similarly situated, Plaintiff

v.The Hain Celestial Group, Inc., Irwin D. Simon, Pasquale Conte, John Carroll, Stephen J. Smith, Defendants-Appellees.

Docket No. 20-1517

August Term, 2021

United States Court of Appeals, Second Circuit.

Argued: September 27, 2021

Decided: December 17, 2021

David J. Goldsmith, New York, NY (Jonathan Gardner, Carol C. Villegas, Christine M. Fox, Labaton Sucharow LLP, New York, NY, on the brief), for Lead Plaintiffs-Movants-Appellants Rosewood Funeral Home and Co-Lead Counsel for the Class.

Robert V. Prongay, Los Angeles, CA (Jonathan M. Rotter, Leanne Heine Solish, Glancy Prongay & Murray LLP, Los Angeles, CA, on the brief), for Lead Plaintiffs-Movants-Appellants Salamon Gimpel and Co-Lead Counsel for the Class

John M. Hillebrecht, New York, NY (Marc A. Silverman, DLA Piper LLP, New York, NY, on the brief), for Defendants-Appellees.

Before: LEVAL, SACK, and PARK, Circuit Judges.

LEVAL, Circuit Judge:

Lead Plaintiffs, Salamon Gimpel and Rosewood Funeral Home ("Plaintiffs"), appeal from the dismissal with prejudice of their securities fraud claims brought against The Hain Celestial Group, Inc. ("Hain") and four of its present or former officers, Irwin Simon,¹ Pasquale Conte,² John Carroll,³ and Stephen Smith⁴ (the "Individual Defendants," collectively with Hain, the "Defendants"). Plaintiffs asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b–5. The Second Amended Complaint ("SAC" or the "Complaint"), which is the operative complaint for this appeal, alleged essentially that Defendants had defrauded investors by making public statements attributing Hain's growing sales levels to strong consumer demand without disclosing the true facts that demand for its products was declining due to increased competition, and that Hain achieved its level of sales through "channel stuffing," whereby valuable and unsustainable sales incentives—including price reductions and grants of an absolute right to return unsold merchandise—were given near the end of each quarter to Hain's largest distributors to induce them to buy more product than needed so that Hain would meet its quarterly sales targets and analysts' estimates. Plaintiffs also claimed that—separate from these purportedly misleading representations—Defendants' use of these practices constituted an unlawful scheme to defraud investors. Finally, the SAC included a control person liability claim against the Individual Defendants under Section 20(a) of the Exchange Act.

Defendants moved to dismiss the SAC pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state claim, advancing various arguments, including failure to sufficiently allege scienter, actionable misstatements, and a fraudulent scheme or business practice. The late District Judge Arthur Spatt, in a characteristically conscientious and fastidious opinion, granted the motion in its entirety and dismissed the action with prejudice. Plaintiffs brought this appeal.

BACKGROUND

Hain manufactures and sells health food products in the United States and several other countries. Plaintiffs are entities and individuals who acquired interests in publicly traded common stock in Hain during the period from November 5, 2013 through February 10, 2017 (the "Class Period"). We summarize below the allegations of the Complaint. For the purposes of this appeal, we are required to treat these factual allegations as true, drawing all reasonable inferences in favor of Plaintiffs to the extent that the inferences are plausibly supported by allegations of fact. We will therefore recite the substance of the allegations as if they represented true facts, with the understanding that these are not findings of the court, as we have no way of knowing at this stage what are the true facts.

i. The Alleged Scheme

The Complaint alleges that, in the early 2010s, Hain experienced growing competition in the health food market, as other brands and chain retailers began offering their own selections of natural and organic foods. As a result of this increasing competition, demand for Hain's products weakened and Hain risked failing to meet its sales projections. In order to boost its quarterly sales figures and meet its projections, Hain resorted to what the Complaint describes as fraudulent and illegal "channel stuffing" (also referred to as "loading"), whereby valuable sales concessions were offered to Hain's largest customers as incentives to buy more product than needed before the end of each financial quarter, in order to enable Hain to meet its revenue targets and Wall Street's projections. Through this practice Hain achieved unsustainably inflated quarterly sales results. In 2016, when distributors refused to buy more product despite Hain's offered incentives, Hain's sales and stock price fell.

During the Class Period, Hain's largest customer—accounting for 12% of net sales—was United Natural Foods, Inc. ("UNFI"), a product distributor. The concessions to UNFI and other large distributors were extra-contractual and were not adequately documented or reflected in Hain's books and records. The concessions included: (1) cash incentives as high as $500,000 for a single distributor in a single quarter; (2) product discounts of up to 20%; (3) extended payment terms; and, most significantly, (4) an absolute right to return unsold product. "[M]ore than 15% of Hain's quarterly sales were made in the final month of each quarter from UNFI."

Joint Appendix ("App'x") at 251:¶369 (emphasis removed).

The Individual Defendants orchestrated and concealed the channel stuffing scheme. Notwithstanding the Defendants' awareness of the scheme and its role in achieving Hain's sales results, the Defendants made repeated public statements attributing Hain's growth in sales numbers to "strong consistent consumer demand" and other "organic" factors, id. at 213:¶257, 214:¶260, 216:¶266, while failing to disclose the unsustainable channel stuffing practices and how they artificially inflated sales figures.

Carroll, the CEO of Hain North America, would review Hain's sales numbers so that he "would know of the sales shortfalls before negotiating the concessions with UNFI." Id. at 252:¶372. "Carroll then provided an incentive for UNFI to take the amount of Hain's inventory necessary for Hain to meet its quarterly sales revenue numbers." Id. On internal sales calls, Carroll acknowledged having made these concessions. Id. Simon, Hain's CEO, would negotiate sales concessions directly with UNFI's owner and could "always make [UNFI] buy more if needed." Id. at 252:¶373.

Hain's Chief Operations Officer, James Meiers (who is not a named defendant) would work with his team to "creativ[ely]" account for the sales concessions, id. at 170:¶86, including by booking credits given to distributors as accruals, i.e. , "as money that distributors owed Hain," id. at 169:¶83. The "size of the accruals" was "correlat[ed]" to "how Hain was doing in a particular quarter." Id. at 170:¶85. Smith and Conte, in their capacities as CFO, signed off on Hain's accounting statements and certified their accuracy to the public. Employees who questioned the accounting practices were told to stop asking questions, id. at 175:¶104, 177:¶113, and employees who continued asking questions were fired, id. at 176:¶108.

ii. The Alleged Scheme Comes to an End

The channel stuffing scheme continued from 2013 until 2016, and ended only when distributors refused to take additional inventory and Hain opened an internal investigation into its financial reporting.

On August 15, 2016, less than a year after hiring a new Treasurer, James Langrock, Hain announced that it was opening an internal investigation into whether it had properly accounted for the revenue associated with the sales concessions, and whether Hain had adequate internal controls over its financial reporting. Ernst & Young, Hain's outside auditor, also commenced an independent audit. As a result, Hain delayed the filing of its financial results for the 2016 financial year. Hain's stock price fell by over 26% on the news.

On February 10, 2017, the final day of the Class Period, Hain announced it had expanded the scope of its internal investigation to encompass its historical financial results, and that the Securities and Exchange Commission ("SEC") was also investigating. Hain's stock price fell a further 8%.

iii. Hain Restates Its Financials and Admits Weaknesses in Internal Controls

On June 22, 2017, Hain filed its Form 10-K for the 2016 financial year. It identified "material weaknesses in [its] internal control[s] over financial reporting" as of June 30, 2016. App'x at 186. Specifically, Hain noted that its "control environment did not sufficiently promote effective internal control over financial reporting," and that its "internal controls to identify, accumulate and assess the accounting impact of certain concessions or side agreements on whether [its] revenue recognition criteria had been met were not adequately designed or operating effectively." Id. Hain further admitted that its documentation of agreements had been inadequate. Id. Hain revised its financial results for the 2014 and 2015 financial years, as well as the first three quarters of the 2016 financial year. According to the revisions, Hain's "net sales were overstated by 2.1%, 2.9% and 1.9% in fiscal 2014, fiscal 2015 and for the 9 months ended March 31, 2016, respectively." Id. at 187:¶149. These revisions were the result of: "(i) improperly recognized revenue related to the timing of trade and promotional accruals, (ii) prematurely recognized revenue on certain sales; and (iii) improperly...