In the current difficult business environment, many businesses face a broad array of daunting business challenges, including economic inflation, rising interest rates, supply chain and labor supply disruptions, the continuing threat of COVID-19 shutdowns, and the war in Ukraine. These various circumstances not only represent potential operational hurdles they may also involve increased litigation risk as well – as I have noted on previous posts (for example, here) these various business challenges can translate into litigation, as well. In the latest example of this phenomenon, earlier this week a plaintiff shareholder launched a securities class action lawsuit against the healthcare apparel firm FIGS, Inc. relating to the increased supply chain costs the company experienced since its June 2021 IPO. A copy of the November 1, 2022 complaint against the company can be found here.
FIGS is a direct-to-consumer healthcare apparel company, selling medical scrubs, lab coats and related products. The company completed an IPO in June 2021. In the offering documents prepared in connection with its IPO, the company stated that its direct-to-consumer model allowed it to assemble and maintain significant customer data, which in turn afforded the company significant operating efficiencies. Among other efficiencies the company claimed was its ability to “reliably predict” customer demand, which in turn allowed the company to “continually assess the supply chain and improve efficiency.”
The company also reported in its offering documents that the COVID-19 pandemic had disrupted many of its suppliers’ operations. In order to maintain its own product production, the company found that it had to rely on more costly air freight for its materials supply rather than the overseas shipping that it more typically used.
In the subsequent quarterly reporting periods following the company’s completion of its IPO, the company continued to report on its use of air freight. As characterized in the subsequently filed securities lawsuit complaint, in its earnings calls in connection with its quarterly earnings releases during 2021, the company “downplayed” its use of costly air freight shipping and continued to try to portray its use of more costly air freight as “transitory” and that its use of air freight was at its “peak.”
In its May 12, 2022 earning call in which the company reported its financial results for the first quarter of 2022, the company reported disappointing financial results that were “primarily due to a significant increase in the Company’s use of air freight to help mitigate supply chain challenges.” The company, according to the subsequent complaint, “admitted” that not only did the company continue to rely on air freight during the first quarter of the year despite its assurances that, according to the complaint, that its “dependence on air freight had ‘peaked’ in the fourth quarter of 2021,” but that “for the rest of the year we plan to significantly increase our use of airfreight to reduce our exposure to unpredictable transit times.” According to the complaint, the company’s stock price fell approximately 25% on this news.
On November 1, 2022, a plaintiff shareholder filed a securities class action lawsuit in the Central District of California. The complaint names as defendants the company itself and certain of its directors and officers. The complaint purports to be filed on behalf of two classes of investors: those who purchased the company’s securities between May 27, 2021 and May 12, 2022; and those who purchased FIGS stock pursuant to/or traceable to the Offering Documents FIGS issued in connection with its IPO.
The complaint alleges that the company’s offering documents and subsequent statements, the defendants “(i) inflated the Company’s true ability to successfully secure repeat customers; (ii) failed to disclose the Company’s increased dependence on air freight; (iii) inflated the expected net revenues, gross margin, and adjusted EBIDTA margin for 2022; and (iv) that, as a result of the foregoing, defendants’ statements about the Company’s business, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
The complaint asserts claims under both the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks to recover damages on behalf of both of the plaintiff classes.
It may be hoped that the various causes that led to such widespread supply chain disruption have started to ease. However, this case shows how the supply chain issues continue to affect company’s financial results. The case also shows how these kinds of issues can translate into securities class action litigation.
In addition to being a case representative of the way in which macroeconomic factors can contribute to securities litigation frequency, this case is also an example of another recent securities litigation phenomenon, which is the prevalence of COVID-19-related securities litigation. I have been tracking the COVID-19-related securities litigation since the initial outbreak of the coronavirus in the U.S. in March 2020. According to my tally, this lawsuit against FIGS is the 58th COVID-19-Related securities suit to be filed since March 2020. It is also the 15th COVID-related suit to be filed so far this year in 2022. While there have been a surprising number of COVID-19-related securities suits filed this year — the third year of the coronavirus outbreak — the pace of filings has slowed as the year has progressed. By my reckoning, this new lawsuit is the first COVID-related case to be filed since late August 2022.
As for the complaint’s allegations, it sure seemed to me in reading the complaint that what happened here is that earlier on the company simply underestimated how long the COVID-19-caused supply chain problems would continue to disrupt its ability to source its materials supply. The company didn’t set out to alter its supply source over to air freight from ocean freight as a long-term choice; instead, the persistent problems simply forced the company to continue to use the more costly air freight more often and for a longer time period that it thought would be the case. These circumstances seem more like an illustration of the difficulties of doing business in the pandemic disrupted world that they seem like an example of securities fraud.
I also think that when the time comes for the court to determine with respect to the plaintiff’s ’34 Act claims whether the plaintiff has adequately alleged scienter, the court is going to have to look long and hard to find any scienter allegations, much less scienter allegations sufficient to meet the PSLRA’s heightened pleading standard.