Friday, October 05, 2018

Thumb on scale caused Whole Foods price drop, not accounting issues

By Rodney F. Tonkovic, J.D.

A Fifth Circuit panel has weighed claims arising out of alleged overcharging by Whole Foods and found that they did not add up to fraud. Regulatory actions had revealed that Whole Foods had overcharged customers by including the weight of packaging in the price of some products. As a result, the complaint alleged, the company had fraudulently counted the overcharged money as revenue. The court ultimately concluded that the disappointing sales numbers and resulting stock price drop were more plausibly related to customer reaction to the company's public relations issues than its accounting practices (Employees' Retirement System of the State of Hawaii v. Whole Foods Market, Incorporated, October 3, 2018, King, C.).

Weights and measures. In the summer of 2015, the public learned that a sting operation in New York caught Whole Foods including the weight of packaging in the weight of many of its prepackaged products. According to the complaint, Whole Foods knew about these weights and measures issues since early 2013, when California authorities began looking into the issue. This investigation culminated in a lawsuit, and the company settled in June 2014, agreeing to implement procedures to ensure pricing accuracy and to pay $800,000.

In August 2014, and again in early 2015, regulators in New York fined the company for weights and measures violations. A June 2015 press release by the New York City Department of Consumer Affairs reported that 89 percent of the products it tested were mislabeled, causing customers to be overcharged from $0.80 to nearly $15. The inspectors said it was "the worst case of mislabeling they [had] seen in their careers." Whole Foods subsequently apologized and promised to implement policy changes. On July 29, 2015, Whole Foods hosted an earnings call during which the individual defendants attributed the lower-than-expected third-quarter results to the news that the company had overcharged its customers.

Weighty matters. The plaintiffs alleged that between July 31, 2013 and July 29, 2015, Whole Foods made three general categories of fraudulent statements that artificially inflated the price of its stock. First, the company asserted that it provided competitive pricing. Whole Foods also proclaimed that it held itself to high standards for transparency, quality, and corporate responsibility. Finally, the company's statements on its financial numbers were misleadingly inflated by the inclusion of revenues from fraudulently-labeled products.

Doesn't measure up. The district court dismissed the plaintiffs' fraud claims because it determined they failed to properly allege a material misrepresentation, scienter, or loss causation. The panel affirmed the district court's judgment.

The panel first found that Whole Foods' statements regarding the competitiveness of its prices were not rendered false by the weights and measures issues. The panel explained that it did not necessarily follow that the prices were not competitive even with the weight of the packaging added in, and the plaintiffs provided no way to compare. As a result, the complaint failed to plead with the required particularity that these statements were misleading. The panel also agreed with the district court that the generalized statements about Whole Foods' transparency, quality, and responsibility were the sort of self-serving puffery that a reasonable investor would not rely on.

Finally, the plaintiffs argued that Whole Foods overstated its revenues by $127.7 million during the time at issue. Specifically, the company violated GAAP by counting as revenue money that it was not entitled to—what the company fraudulently collected through overcharging customers. The panel noted that the plaintiffs did not plead with particularity how much of its revenue Whole Foods overstated in each statement that was alleged to have been misleading. Even if the falsity was alleged with particularity, however, the complaint failed to allege that the inflated revenues caused the plaintiffs' loss.

The plaintiffs alleged that their loss occurred when Whole Foods' stock price dropped by about 10 percent on the day after it released its third-quarter numbers. While the market had been aware for weeks that Whole Foods had been overcharging, the plaintiffs contended that the disappointing results revealed on July 29, 2015 was a partial disclosure that showed the financial impact of a previously-revealed fraud. The problem for the plaintiffs, the panel said, was that their claims were not based on misrepresentations to Whole Foods' customers (i.e., the weights and measures fraud) but were instead based on alleged misrepresentations to shareholders through its accounting errors. The public relations problems arguably led to slowed sales, but the alleged accounting issues did not cause the public relations problems, and the complaint did not allege that the accounting problems caused a separate loss in stock price.

The case is No. 17-50840.