Unpublished Disposition, 925 F.2d 1470 (9th Cir. 1987)

MEMORANDUM^* 

This case arises from the dramatic rise and fall of the trading price of the Gap's common stock during mid-to-late 1987. Between May and August 1987, the trading price of this stock rose from $50 per share to $78 per share. In September 1987, the trading price fell to $38 per share. The appellants allege that the Gap's shareholders sustained an overall market loss of over $1.4 billion.

The appellants, who represent a class of investors who purchased Gap common stock between May and September 1987, allege that the Gap knowingly misrepresented and/or omitted material facts relating to its inventory, thereby artificially inflating the market price of the stock. They further allege that Gap officers who sold some of their stock prior to the drop in price failed to disclose material adverse facts known to them and engaged in illegal insider trading.

The district court dismissed the appellants' misrepresentation/omission claims for failure to allege actionable misrepresentations and/or omissions, and for failure to allege loss causation. It dismissed the appellants' insider trading claims because they raised no separate legal or factual issues from the misrepresentation/omission claims.

We review de novo a dismissal for failure to state a claim upon which relief may be granted. West v. Greyhound Corp., 813 F.2d 951, 953 (9th Cir. 1987). A complaint should not be dismissed "unless it appears beyond doubt that plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Love v. United States, 871 F.2d 1488, 1491 (9th Cir. 1989) (quotations omitted). All allegations of material fact are taken as true and construed in the light most favorable to the nonmoving party. Id. Applying this standard of review, we affirm.

The Gap experienced record growth in the first two quarters of fiscal 1987. Statements in the first two quarters expressed the Gap's optimism about "the years ahead." In an August 13 press release--at the beginning of the third quarter--the Gap stated that, "looking ahead, we expect business to continue strong and that 1987 will be another fine performance year for the Gap."

Throughout the first and second quarters, the Gap increased its inventory. Its inventory level at the close of the second quarter represented a 33% increase over the level at the start of that quarter. This expansion is in sharp contrast to the previous two years, in which the Gap's inventory had increased by a total of only 25%. The Gap reported its inventory level on a Form 10-Q dated August 1, 1987, which it filed with the Securities Exchange Commission on August 24.

The appellants point to a Gap statement that inventory levels were carefully monitored. In its Form 10-K report for fiscal year 1986, the Gap said:

The Company follows a policy of regular review of its merchandise and broken assortments (items no longer in stock in a sufficient range of sizes). If inventory exceeds customer demand for reasons of style, seasonal adaptation, adverse weather conditions or changes in customer preference, mark downs are employed to clear the merchandise. Such mark downs may have an adverse impact on earnings, depending on their extent and amount of inventory affected.

On September 20, 1987, halfway through the third quarter, the Gap issued a press release stating that August sales had been weak and that the company would mark down its inventory. The press release stated that the mark downs would result in lower earnings than had been expected, and that third quarter earnings would be as much as 33% less than second quarter earnings. Soon after the issuance of the press release, stock prices fell by approximately 50%.

The appellants allege that the Gap encouraged a falsely optimistic view about its future while knowing that August sales and earnings were below internal forecasts and that the Gap's inventory far exceeded existing and reasonably foreseeable customer demand. Appellants state that the Gap's failure to disclose (1) that the inventory buildup was continuing, (2) that inventory levels were "excessive" such that inventory would have to be written off or substantially discounted, and (3) that the Gap was violating its own policy by not marking down inventory, constituted omissions of material fact. Further, they state that the Gap's August disclosure of its inventory level with no mention that it would be unable to sell the inventory without substantial mark downs--viewed in light of the Gap's earlier optimistic statements--constituted an affirmative misrepresentation that sales would increase sufficiently to absorb the expanded inventory. These omissions and misrepresentations, according to the appellants, amounted to violations of Sec. 10(b) of the Securities Exchange Act, violations of Rule 10b-5, common law fraud, and negligent misrepresentation. The appellants further allege that Gap officers who sold stock prior to the drop in price without disclosing the above information engaged in insider trading.

The district court correctly held that the Gap had no duty to disclose that the increase in inventory was continuing. Under 17 C.F.R. Sec. 240.10b-5, a company has a duty to disclose material information only if "the company made an affirmative statement on the same subject which would be misleading absent disclosure of the information." See Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980); see also Backman v. Polaroid Corp., 910 F.2d 10, 16-18 (1st Cir. 1990) (en banc); Hayden v. Walston & Co., Inc., 528 F.2d 901 (9th Cir. 1975); Cooper v. Hwang, [1987 Transfer Binder] Fed.Sec.L.Rep. (CCH) p 93,289 at 96,429 & n. 11 (N.D. Cal. Apr. 20, 1987). Absent misleading or false affirmative statements, the securities laws require a company only to report quarterly. See 17 C.F.R. Sec. 249.308a (quarterly reports); Roeder v. Alpha Indus., Inc., 814 F.2d 22, 26-28 (1st Cir. 1987).

Taking appellants' allegations as true, the Gap knew or should have known that it was not reasonably foreseeable that it could dispose of its inventory without a markdown; yet because of irrevocable commitments for delivery, the inventory buildup continued. The Gap disclosed that inventory increased in the second quarter of fiscal 1987 by 33%, compared with only a 25% increase over the preceding two years. The statements to which appellants refer did not suggest that the second quarter would be the only one in which inventory would be increased. No misleading or false affirmative statement required the Gap to disclose continued increase of inventory prior to its next quarterly report.

The district court also correctly held that the Gap had no duty to disclose that inventory levels were "excessive" such that inventory would have to be written off or substantially discounted. The Gap would have a duty to issue a projection only if it had earlier issued a projection that required correction. See Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980); accord Bradshaw v. Jenkins, [1983-84 Transfer Binder] Fed.Sec.L.Rep. (CCH) p 99,719 at 97,909-10 (W.D. Wash. Mar. 9, 1984); Beebe v. Pacific Realty Trust, 578 F. Supp. 1128, 1144 (D.Ore.1984). Appellants argue that the Gap made a projection about the third quarter when it said, "looking ahead, we expect business to continue strong and that 1987 will be another fine performance year for the Gap." We hold that this statement was too general to constitute a projection about third quarter sales. Therefore, we hold that the Gap had no duty to issue a corrective projection.

Appellants also argue that in light of the Gap's earlier optimistic statements, the unqualified disclosure of the Gap's high inventory levels amounted to an affirmative misrepresentation that sales and earnings would increase sufficiently to absorb the expanded inventory. We reject this argument because, if accepted, it would convert every quarterly report into a projection about future sales and would make every quarterly report subject to corrective projections. This result would nullify the rule of Vaughn, 628 F.2d 1214.

The reasons underlying dismissal of the first two claims can be simply stated. The Gap disclosed all of the relevant factual data to its shareholders. Appellants' complaint is that the Gap should have characterized the facts, projected future difficulties, and anticipated business set-backs. Assuming that the Gap knew or should have known of these potential future difficulties, it had no obligation to go beyond disclosing the underlying facts unless its prior affirmative statements would have been misleading to the shareholders given the existence of those facts. Here, the statements were not of such a nature.

The district court dismissed on grounds of loss causation appellants' claim that the Gap failed to disclose that it was violating its own policy by not marking down inventory. In a footnote, the court added that the decision to expand inventory, whether through new acquisitions or through failure to mark down inventory, was a nonactionable management decision. See Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 479-80 (1977).

We affirm the dismissal of this claim. The Gap's markdown policy contains no time limits on when markdowns must be taken. Because decisions on the timing of markdowns are left to the discretion of company management, the question of whether the markdown policy had been violated--which must be resolved before reaching the question whether the Gap failed to disclose a violation--is protected by Santa Fe Industries.

The district court dismissed the insider trading claims because it found that they raised no separate legal or factual issues from the misrepresentation/omission claims. The appellants did not challenge this determination in their opening brief, but argue in their reply brief that even if the Gap had no duty to disclose, the insiders still could not trade on the basis of the information left undisclosed. Because this issue was not raised in the appellants' opening brief, we decline to address it. See Cross v. Washington, 911 F.2d 341, 345 (9th Cir. 1990).

AFFIRMED.