On October 3, 2018, the United States Court of Appeals for the Fifth Circuit affirmed the dismissal of a putative securities class action against Whole Foods Market, Inc. and certain of its executives under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Emps.’ Ret. Sys. of the State of Haw. v. Whole Foods Mkt., Inc., —F.3d—, 2018 WL 4770729 (5th Cir. Oct. 3, 2018). In connection with various regulatory investigations, Whole Foods admitted to mislabeling prepackaged foods such that it charged consumers for more food than the packages actually contained. Plaintiffs alleged that, by virtue of those “weights and measures” violations, the company had made three categories of misstatements to investors: (1) statements touting the company’s price competitiveness or efforts to increase its price competitiveness; (2) statements about the company’s commitment to transparency, quality, and corporate responsibility; and (3) statements announcing the company’s revenues, which plaintiffs alleged were artificially inflated as a result of the mislabeled packaging. The Court held that the first two categories of allegations did not constitute material representations, and the third did not cause plaintiffs’ alleged loss.

With respect to the first category, the Court held that plaintiffs failed to allege that statements about the competitiveness of Whole Foods prices were false. Specifically, the Court emphasized that the fact that Whole Foods prices should have been higher if its products were properly labeled does not mean that Whole Foods’ statements about general efforts to reduce prices were false, and plaintiffs made no allegation comparing prices at the time of the alleged misrepresentations with prior prices. Id. at *6. Allegations challenging statements about the competitiveness of Whole Foods prices suffered from a similar defect; even if Whole Foods prices were not “as competitive as advertised, it [did] not follow that they were not competitive.” Id. at *7. Again, the Court found plaintiffs’ allegations insufficient because they failed to provide a point of comparison between Whole Foods prices and its competitors’ prices.

With respect to statements regarding Whole Foods’ commitment to transparency, quality, and corporate responsibility, the Court held that these were non-actionable puffery. Rejecting plaintiffs’ argument that such statements with respect to Whole Foods should be actionable because the company’s brand was built on holding itself to higher ethical standards than its competitors, the Court emphasized that this did not change the fact a reasonable investor would not judge the company’s value “based on its own generalized and self-serving statements.” Id. at *7. Thus, investors would “not simply take Whole Foods’ word for it,” but would “rely on facts.” Id.

Finally, plaintiffs argued that statements regarding the company’s revenues were presumptively misleading because the company’s financial statements reflected unearned revenue, in violation of GAAP. The Court held the allegations were insufficient to establish falsity because they failed to plead with particularity the extent to which revenue was overstated in each statement. Id. at *8. Moreover, even if falsity were sufficiently alleged, the Court held that plaintiffs failed to allege that the inflated revenues caused their claimed loss. Id. at *8-9. While plaintiffs alleged that the company’s stock price dropped by approximately ten percent the day after a slowdown in sales growth was disclosed, those disclosures did not contain any new information on the ongoing weights-and-measures scandal. The Court emphasized that the fraud allegedly actionable in this case — the overstated revenues — was not alleged to have caused the disappointing sales; rather, it was the weights-and-measures scandal itself which caused the disappointing sales and resulting decline in stock price. Id. at *9-10.

This decision illustrates that operational problems do not necessarily give rise to securities fraud claims. The specific language of alleged misstatements will be scrutinized, and any alleged misstatement must be causally connected to a claimed investment loss.

Emps.’ Ret. Sys. of the State of Haw. v. Whole Foods Mkt., Inc.