In re Wet Seal, Inc. Securities Litigation

• Decision Date: 29 August 2007
• Docket Number: No. CV 04-7159 GAF (CTx).,CV 04-7159 GAF (CTx).
• Citation: 518 F.Supp.2d 1148
• Court: U.S. District Court — Central District of California
• Parties: In re WET SEAL, INC. SECURITIES LITIGATION.

518 F.Supp.2d 1148

In re WET SEAL, INC. SECURITIES LITIGATION.

No. CV 04-7159 GAF (CTx).

United States District Court, C.D. California.

August 29, 2007.

William J. Doyle II of Coughlin Stoia Geller Rudman & Robins, LLP, San Diego, CA, and Stephen R. Basser of Barrack, Rodos & Bacine, San Diego, CA, for Plaintiffs.

Seth Aronson, Amy J. Longo, and Kristina M. Hersey of O'Melveny & Meyers, LLP, Los Angeles, CA, for La Senza Corporation, Irving Teitelbaum and Stephen Gross.

Charles Avrith of Hughes, Hubbard & Reed, LLP, Los Angeles, CA, for Wet Seal, Inc., Douglas Felderman, Walter Parks, Joseph Deckop, and Allan Haims.

Lawrence H. Nagler and David F. Barry of Nagler & Associates, Los Angeles, CA, for Peter Whitford.

ORDER REGARDING DEFENDANTS' MOTIONS TO DISMISS AND PLAINTIFFS' MOTION TO STRIKE EXHIBITS AND POTIONS OF DEFENDANTS' MOTIONS

GARY ALLEN FEESS, District Judge.

I. INTRODUCTION

Wet Seal, Inc. ("Wet Seal") is a specialty retailer that sells clothing to young women, specifically teenagers. For some period of time, Wet Seal managed successfully to navigate the choppy seas of this marketplace. By mid-2002, however, it started losing money, and by early 2003 its overall same store sales were declining. Indeed, Wet Seal's stock price dropped by almost 75% by the beginning date of the class period in this case. The continuing declines, the potential risks associated with those declines and with the fundamentals of its business, and the vagaries of its marketplace were regularly disclosed in its 10-Q and 10-K filings with the SEC from mid-2002 through late 2004. The record before this Court clearly describes a company that, by late 2003, could best be described as a "turn around" candidate and that would properly have been characterized as a speculative investment.

In 2003, as its difficulties mounted, Wet Seal made changes in its management and hired a new designer and, in the second half of the year, implemented new initiatives to turn itself around. A key element of the turnaround was the development of a line of clothing for the 2004 back-to-school season, one of two periods (the other being the Christmas season) that were critical to its overall profitability. While undergoing these turn around efforts, Wet Seal made a number of statements regarding its current performance and its hopes of returning to profitability after its new line was delivered to its retail stores. In the end, however, the 2004 back-to-school line did not succeed, and the company took a $75 million charge against revenues when it became clear that its cash flow would not be sufficient to support the value of its long-lived and tax assets. At about the same time that it took the charge, Wet Seal announced that its new designer had left the company. These announcements caused Wet Seal's stock price, which had already suffered huge declines over the prior two years, to suffer sizeable further declines.

Shortly after the announcement of the charge, the first of several cases in this putative class action were filed in this Court, bringing securities-fraud claims against Wet Seal and certain of its current and former officers and directors, as well as against former Wet Seal shareholder La Senza Corporation ("La Senza") and two of its officers, who were also Wet Seal directors during the Class Period. The complaints were later consolidated, and in September 2005, the Court granted all Defendants' motions to dismiss the Consolidated Amended Complaint ("CAC") with leave to amend. The Court found that the CAC failed to satisfy the particularity requirements of the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b) ("PSLRA"), for claims under the Securities Exchange Act of 1934 ("the 1934 Act"), 15 U.S.C. §§ 78j(b), 78t(a), 78t-1(a), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. The Court noted that the CACC failed to plead a sustainable theory as it essentially attacked the inability of Defendants accurately to predict the failure of the 2004 back-to-school clothing line. (Hearing Tr. at 7.)

The theory, and the support for it, have not been strengthened adequately in Lead Plaintiffs'"First Amended Class Action Amended Complaint" ("FACC"). The problem with the FACC, like the CAC, is that it is premised largely on the idea that management and members of the board knew the new line would fail, which in turn meant that they knew that Wet Seal would fail to recapture its customer base and to generate sufficient cash flows to support its balance sheet. But Plaintiff's fail to plead the concrete facts that support their premise — they do not explain the precise information, known to Defendants but not the investing public, that indicated the 2004 line would fail. The omission of such facts from the FACC is fatal, because Defendants repeatedly warned that, if the 2004 back-to-school line were not successful, they might face charges to earnings or insolvency. These disclosures mean Defendants' conduct was more consistent with their understanding of the difficult financial condition of the company and their honest hope that their turn-around efforts would succeed and thereby return Wet Seal to profitability.

Viewed in context, then, each aspect of the FACC is inadequate. To the extent that the FACC asserts that Defendants committed fraud by violating Generally Accepted Accounting Principles ("GAAP") as a result of alleged delays in writing off the value of certain assets, Plaintiff's have not pled facts to show why the charge was untimely, and therefore cannot show that financial statements submitted prior to the charge were false or misleading. The decision to take the charge turned largely on the question of whether the "long-lived assets" and the "tax assets" of the company could be supported by future cash flows, which Defendants hoped would increase with the introduction of the 2004 back-to-school line. The FACC, like the CAC, leads largely to the inference that management believed in its turnaround strategy until actual sales figures indicated the 2004 back-to-school line would not catch on, at which point Wet Seal properly took the charge against assets. Moreover, to the extent Plaintiff's point to other statements of optimism, they fail to allege facts showing that these statements were in fact false and known to be so, and they ignore contemporaneous cautionary statements contained in press releases and quarterly filings with the SEC. Instead, Plaintiffs present conclusory allegations of intra-corporate strife, many of which fail to include adequate corroborating details to satisfy the heightened pleading standard of the PSLRA, and many of which focus on facts that were disclosed to the public. Similarly, the lack of corroborating details defeats the claims that certain Defendants traded on material non-public information-in short, Plaintiff's fail to explain just what that information was.

To summarize, the FACC does not meet the heightened pleading requirements of the PSLRA. It fails to plead, with the requisite particularity, that the named Defendants made knowingly false statements about any material matter either directly or by violating GAAP (Section 10(b) and Rule 10b-5), that they controlled someone who violated these provisions (Section 20(a)), or that the La Senza Defendants traded on material nonpublic information (Section 20A). Accordingly, Defendants' motions to dismiss the FACC are GRANTED WITHOUT LEAVE TO AMEND as to all claims.

II. STATEMENT OF FACTS

A. OVERVIEW

This is a federal securities case purportedly brought on behalf of all persons who purchased publicly traded securities of Wet Seal between November 20, 2003 and August 19, 2004 (the "Class Period"). (FACC ¶ 1.) Wet Seal, certain of its officers and directors, and, La Senza, a major shareholder, allegedly issued false and misleading financial reports and statements during the Class Period. (Id. ¶ 2.) The FACC sets forth three categories of allegedly false statements: (1) press releases announcing financial results, including monthly and quarterly sales and revenue information, and SEC filings, which allegedly contained financial information that violated GAAP; (2) statements of optimism that Wet Seal's consistently diminishing sales trends would be reversed if its 2004 back-to-school line were successful, and that Defendants were confident about Wet Seal and the turnaround; and (3) allegedly false statements by La Senza officers reassuring the public that it did not sell its Wet Seal stock because of any material non-public information.

B. THE TURNAROUND PLAN AND ALLEGED MOTIVE FOR FRAUD

After enjoying considerable success through mid-2002, Wet Seal's business had declined dramatically by the beginning of the Class Period. (Id. ¶¶ 25-31.) Wet Seal's stock price fell from $37 per share in early 2002 to $10 per share in November 2003. (Historical Prices for Wet Seal (Ex. 28).) Additionally, Plaintiff's contend that by February 2003, eight months prior to the start of the Class Period, Wet Seal needed to close at least 50 under performing stores and to record, under GAAP, a loss for tens of millions of dollars in impaired store assets. Defendant Irving Teitelbaum, then the CEO of Wet Seal and Chairman and CEO of La Senza, was allegedly informed of the need to close these stores by a "director level" employee in Wet Seal's real estate department, which monitored store profitability. In addition, by November 2003 Wet Seal had experienced over 20 consecutive months and five consecutive quarters of losses and still needed to close at least 50 stores. (FACC ¶ 2.) Moreover, given a cash shortage and a new credit line that was set to expire, Defendants needed to extend Wet Seal's credit line and obtain additional cash. (Id.)

In the second half of 2003, though, Wet Seal began to implement a turnaround program intended to return the company to profitability. (2003 Form 10-K at 3-5, 11-12 (Ex. 2).) As part of its turnaround strategy,...