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In re Ultra Salon

March 19, 2009

IN RE ULTA SALON, COSMETICS & FRAGRANCE, INC. SECURITIES LITIGATION


The opinion of the court was delivered by: Robert W. Gettleman United States District Judge

Judge Robert W. Gettleman

MEMORANDUM OPINION AND ORDER

Lead plaintiffs Mark Mirsky, Nedra Fisher and Stephanie Carroll have brought a five count amended putative class action complaint against defendants Ultra Salon, Cosmetics & Fragrance, Inc.; its President and Chief Executive Officer ("CEO") Lynelle Kirby; and its Chief Financial Officer ("CFO") Gregg Bodnar, alleging violations of § 11, 12(a)(2), and 15 of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§ 77k and 77o, and § 10(b) and 20(a) of the Securities Exchange Act ("Exchange Act"), 15 U.S.C. §§ 78j(b) and 78t(a), and Securities Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. 24.10b-5. All of plaintiffs' complaints stem from Ulta's initial public offering ("IPO") of common stock on October 25, 2007. Plaintiffs allege that in the Registration Statement and Prospectus defendants made certain false and misleading statements that violated § 11 of the Securities Act and § 10b of the Exchange Act. Defendants have moved to dismiss for failure to state a claim under Fed. R. Civ. P. 12(b)(6). For the reasons explained below, that motion is denied.

BACKGROUND

Ulta was founded in 1990 and promotes itself as the largest beauty supply retailer offering one-stop shopping for prestige, mass, salon-quality products and salon services in the United States. At the time of the IPO Ulta operated approximately 232 retail stores located in 30 states. The Registration Statement, Prospectus and SEC forms were signed on October 24, 2007, and filed that day. In the IPO 7,666,667 shares of Ulta common stock were sold at $18 per share. The proceeds were to be used to pay $93 million of accumulated dividends in arrears on its preferred stock, the approximate $4.8 million redemption price of Series 3 preferred stock, and to reduce the company borrowing. Certain selling shareholders also sold 1.3 million shares in the IPO. At the close of the first day of trading on October 25, 2007, Ulta's stock was selling at $29.82 per share.

Ulta's third quarter of fiscal year 2007 ended on November 3, 2007, nine days after the IPO. The Prospectus, Registration Statements and SEC forms included financial information through August 4, 2007, the end of the fiscal second quarter. None of these documents included financial information for the third quarter even though it was to end nine days later. According to plaintiffs, had third quarter financial information been provided, it would have revealed that:

(1) Ulta's selling, general and administrative expenses ("SG&A expenses") in the third quarter had risen markedly, were contrary to the historical trends discussed in the Prospectus, and were 36% higher than the prior year's fiscal third quarter; and (2) Ulta's merchandise inventory levels had risen sharply in the third quarter, were contrary to the historical trends discussed in the Prospectus, and were 40% higher than the prior year's fiscal third quarter.

DISCUSSION

Defendants have moved to dismiss all counts under Fed. R. Civ. P. 12(b)(6). When ruling on a motion to dismiss for failure to state a claim, the court accepts the well-pleaded factual allegations as true and draws all reasonable inferences in plaintiffs' favor. Sprint Spectrum L.P. v. City of Carmel, Indiana, 361 F.3d 998, 1001 (7th Cir. 2004). The complaint must describe the claim in sufficient detail to give defendant fair notice of what the claim is and the grounds on which the claims rest. The allegations must plausibly suggest that the plaintiff has a right to relief, raising the possibility above the "speculative level." Bell Atlantic Corp.v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 1964-73 (2007). Additionally, allegations of fraud must meet the particularity requirements of Fed. R. Civ. P. 9(b). In a securities fraud case, Rule 9(b) "requires the essential elements of scienter be pled with a sufficient level of factual support; the complaint "must afford a basis for believing that plaintiffs could prove scienter." In re HealthCare Compare Corp. Securities Litigation, 75 F.3d 276, 281 (7th Cir. 1996).

Counts I and II

Counts I and II allege violations of § 11 and 12(a)(2) of the Securities Act against all defendants. Section 11 imposes liability when a Registration Statement contains a material misrepresentation or omission. 15 U.S.C. § 77k(a). Section 12 creates similar liability for misrepresentation or omissions in a Prospectus. 15 U.S.C. § 77l(a)(2). These acts impose "a stringent standard of liability on the parties who play a direct role in a registered offering. In re Nationsmart Corporations Securities Litigation, 130 F.3d 309, 314-15 (8th Cir. 1997) (quoting Herman & MacLean v. Huddleston, 459 U.S. 375, 381-82 (1983)). To establish a claim, plaintiffs need only show that they purchased the security and that there was a material misrepresentation or omission. Scienter is not required. Liability of the issuer of a materially misleading registration statement is "virtually absolute," even for innocent misstatements. Id.

Defendants first argue that plaintiffs' §§ 11 and 12 claims do not satisfy the particularity requirements of Rule 9(b). There is a split of authority on this issue. Some circuits have held that §§ 11 and 12 claims that "sound in fraud" are subject to Rule 9(b)'s heightened pleading standards. See ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 69 (1st Cir. 2008). Others have held that Rule 9(b) does not apply to §§ 11 and 12 claims because proof of fraud or mistake is not a prerequisite to liability. See In re Nationsmart Corp., 130 F.3d 309, 315 (8th Cir. 1997). Defendants argue that in Sears v. Likens, 912 F.2d 889, 892 (7th Cir. 1990), the Seventh Circuit has "indicated" that §§ 11 and 12 claims sounding in fraud are subject to Rule 9(b), but no district court within this circuit has read Sears as so holding. See In re First Merchants Acceptance Corp. Securities Litigation, 1998 WL 781118 at *11-12 (N.D. Ill. 1998) (Coar, J.); Friedman v. Rayovac Corp., 295 F. Supp.2d 957, 978-79 (W.D. Wis. 2003) (Crabb, J.).

This court agrees that the Sears court was not asked to and did not determine that Rule 9(b) applies to §§ 11 and 12 claims even if those claims "sound in fraud." Like the First Merchant and Friedman courts, this court questions the soundness of any decision requiring a plaintiff to plead fraud and scienter with particularity when neither is an element of the claim. "It is illogical to require plaintiffs to plead more than they would have to prove to succeed on a § 11 claim standing alone." First Merchants, 1998 WL 781118 at * 11 n.6. Such "a pleading standard which requires a party to plead particular facts to support a cause of action that does not include fraud or mistake as an element comports neither with Supreme Court precedent nor with the liberal system of 'notice pleading' embodied in the Federal Rules of Civil Procedure." In re Nationsmart, 130 F.3d at 315.

The instant amended complaint alleges that the Prospectus and Registration Statements omitted information that was necessary to make the disclosed information not misleading. Specifically, the materials omitted to disclose that SG&A expenses and inventory were increased dramatically for the fiscal third quarter, which would end just nine days after the IPO. These omissions care material because they could be viewed by a reasonable ...


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