In my year-end wrap up of the top D&O stories of 2022, I noted the possibilities that various macroeconomic factors could contribute to securities class action lawsuit filings in the months ahead. One of the specific factors I identified was economic inflation. In subsequent conversations, I have been asked how an economy-wide phenomenon such as inflation could lead to a securities suit against any one individual company. A lawsuit filed earlier this week provides an illustration of how the inflationary impacts can translate into securities litigation. A copy of the March 1, 2023 complaint in the lawsuit, filed against coffee retailer and franchisor Dutch Bros Inc., can be found here.
Dutch Bros operates and franchises drive-through coffee shops. It also sells and distributes coffee and coffee-related products. In various public statements in early 2022, the company’s executives, the subsequent securities class action complaint alleges, “reassured investors that the Company’s first quarter 2022 results would be positive and in particular that the Company’s margins were healthy.” The Company’s CFO allegedly told investors that “we’re just not feeling compression in margins.”
However, on May 11, 2022, the company reported disappointing financial results. The company reported a net loss of $16.3 million for the first quarter of 2022. In a conference call to discuss the results, the company’s CEO acknowledged that “margin pressure” had caused the poor financial performance, citing “faster inflation and cost of goods, especially in dairy,” as well as “the pull forward of deferred expenses related to the maintenance of shops; and normal new store inefficiency.” In the same call, the CEO said further that “we did not perceive the speed and the magnitude of cost escalation within the quarter. Dairy, for example, which makes up 28% of our commodity basket, rose almost 25% in Q1.” The complaint alleges that the company’s share price fell 26.9% on the news.
On March 1, 2023, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against the company, its CEO, and its CFO. The complaint purports to be filed on behalf of investors who purchased the company’s securities between March 1, 2022, and May 11, 2022.
The complaint alleges that during the class period the defendants made misleading statements or failed to disclose: “(1) that the Company was experiencing increased costs and expenses, including on dairy; (2) that, as a result, the Company was experiencing increased margin pressure and decreased profitability in the first quarter of 2022; and (3) that, as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the plaintiff class.
This lawsuit was filed after the company’s share price declined following its release of disappointing quarterly financial results. The reason for the company’s poor financial performance was the impact of economic inflation on the price of the company’s goods. The connection between the impact of inflation and the filing of the lawsuit is a straight line.
It is interesting to me that the company experienced inflation significant enough to undercut its financial performance in the first quarter of 2022, now more than 12 months ago. Inflation has continued to surge since that time and has affected many if not most companies during that time. Obviously not all companies have been sued; indeed, most have not. The difference may be what this company said about the impact of inflation. The gist of the lawsuit here is that the company, at least in the version of events recited in the complaint, downplayed or soft-pedaled the impact on its margins from inflationary pressure. The lesson may be not that inflation itself leads to litigation but that what the company says about the impact of inflation that could translate into a lawsuit.
Merely because the lawsuit has been filed does not mean that it is meritorious. Indeed, this lawsuit has only just been filed and it remains to be seen how it will fare. In that regards, I note that when the time comes for the court to consider the sufficiency of the plaintiff’s allegations, the court will have to look very long and hard to find anything to support allegations that the defendants acted with scienter in making the supposedly misleading statements.
In any event, because inflation remains a important part of the current economic environment, the possibility remains that its impact on company performance could lead to further securities litigation. At the same time, other macroeconomic factors I identified in my year-end wrap up of top D&O stories may prove to be less of a factor this year than they were in 2022. For example, the financial press is now reporting (for example, here) that the supply chain woes that interfered with business operations and in some instances in 2022 lead to securities litigation have recently eased significantly. Thus, while inflation continues to be a concern, and could continue to be a factor in securities litigation filings in 2023, supply chain issues, which were such a factor in 2022, likely will not be as significant this year and seem less likely to lead to securities suits.