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Pension Trust Fund for Operating Engineers v. Kohl'S Corp.

United States District Court, E.D. Wisconsin

July 20, 2017

PENSION TRUST FUND FOR OPERATING ENGINEERS and CITY OF STERLING HEIGHTS POLICE & FIRE RETIREMENT SYSTEM, individually and on behalf of all others similarly situated, Plaintiffs,
v.
KOHL'S CORPORATION, KEVIN MANSELL, and WESLEY S. MCDONALD, Defendants.

          ORDER

          J.P. Stadtmueller U.S. District Judge

         1. INTRODUCTION

         Nearly four years ago, various shareholders of Kohl's Corporation (“Kohl's” or “the company”) filed this securities lawsuit against Kohl's and two of its officers concerning alleged devaluation of shares after the company disclosed that its accounting for lease agreements had not complied with generally accepted accounting principles (“GAAP”). The City of Sterling Heights Police and Fire Retirement System (“Retirement System”) filed this case, and the Pension Trust Fund for Operating Engineers (“Pension Trust Fund”) was later appointed lead plaintiff and filed an amended complaint, which is the operative pleading. (Docket #1, #39, and #42). The defendants filed their first motion to dismiss the amended complaint in February 2014, and it was denied without prejudice. (Docket #43 and #58). On June 12, 2015, the defendants moved a second time to dismiss the amended complaint. (Docket #63).

         In May of this year, the case was reassigned to this branch of the court following the retirement of Judge Charles Clevert, to whom it was originally assigned. At the time the case was reassigned, the defendants' (second) motion to dismiss the amended complaint had been pending unresolved for nearly two years. To be sure, such a delay in resolution is both inexplicable and unacceptable. Thus, this Court immediately requested supplemental briefing on the pending motion to allow the parties to update the Court on relevant case law from the past two years and now, having considered all the briefing on this motion, provides the parties a long overdue decision.

         The amended complaint raises two causes of action against the defendants, first for violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5, and second for violations of Exchange Act Section 20(a). The defendants contend that the plaintiffs have not met the heightened pleading standards for securities fraud cases and ask this Court to dismiss the amended complaint. For the reasons stated herein, the Court will grant the defendants' motion and dismiss this case with prejudice.

         2. STANDARD OF REVIEW

         The defendants have moved to dismiss the plaintiffs' amended complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). This rule provides for dismissal of complaints which fail to state a viable claim for relief. Fed.R.Civ.P. 12(b)(6). To state a viable claim, a complaint must provide “a short and plain statement of the claim showing that the pleader is entitled to relief.” Fed.R.Civ.P. 8(a)(2). In other words, the complaint must give “fair notice of what the . . . claim is and the grounds upon which it rests.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (citation omitted). The allegations must “plausibly suggest that the plaintiff has a right to relief, raising that possibility above a speculative level[.]” Kubiak v. City of Chicago, 810 F.3d 476, 480 (7th Cir. 2016) (citation omitted).

         In reviewing the plaintiffs' amended complaint, the Court is required to “accept as true all of the well-pleaded facts in the complaint and draw all reasonable inferences in [their] favor[.]” Id. at 480-81. However, a complaint that offers “labels and conclusions” or “a formulaic recitation of the elements of a cause of action will not do.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S. at 555). The Court must identify allegations “that, because they are no more than conclusions, are not entitled to the assumption of truth.” Id. at 679.

         Further, Section 10(b) claims sound in fraud, and the rules of procedure require particularized pleading in fraud cases. “In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally.” Fed.R.Civ.P. 9(b).

         In addition to the burden imposed by Rule 9, the Private Securities Litigation Reform Act (“PSLRA”), enacted by Congress as a check against abusive litigation in private securities fraud actions, heightens even further the pleading standards in actions such as this one. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 320-22 (2007). In charging misrepresentations or omissions of material fact, the PSLRA requires that the complaint “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1). Further, in alleging scienter, the “complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Id. § 78u-4(b)(2). Scienter is a mental state that, for these purposes, means “knowledge of the statement's falsity or reckless disregard of a substantial risk that the statement is false.” Pugh v. Tribune Co., 521 F.3d 686, 693 (7th Cir. 2008) (internal quotation marks omitted).

         If either of the above criteria are absent-specificity in describing the alleged misrepresentations and a strong inference of scienter-the court must grant a defendant's motion to dismiss. 15 U.S.C. § 78u-4(b)(3)(A).

         3. THE AMENDED COMPLAINT[1]

         The Retirement System and the Pension Trust Fund purchased Kohl's common stock between February 26, 2009 and September 13, 2011. They sue on behalf of themselves and a class of persons who purchased the common stock of Kohl's between those dates (“Class Period”). At all relevant times, Kohl's common stock was traded publicly on the New York Stock Exchange.

         Kohl's operates department stores across the United States and a website, selling moderately-priced apparel, footwear, accessories, and home products targeted to middle-income consumers. As of January 28, 2012, Kohl's operated 1127 stores in 49 states. Approximately thirty-five percent of the stores are owned by Kohl's and sixty-five percent are leased. The company's typical lease has an initial term of twenty to twenty-five years and four to eight renewal options for consecutive five-year extension terms. Most of the leases provide for a minimum annual rent that is fixed or adjusts to set levels during the lease term, including renewals, though some leases provide for additional rent based on a percentage of sales over designated levels.

         Kevin Mansell (“Mansell”) has served as Kohl's president and as a member of the company's board of directors since February 1999, as chief executive officer since August 2008, and as chairman of the board since September 2009. Wesley McDonald (“McDonald”) has served as Kohl's chief financial officer since August 2003 and a senior executive vice president since November 2010. From August 2003 through November 2010, McDonald served as the company's executive vice president. During the Class Period, the individual defendants, as senior executive officers and directors of Kohl's, were privy to confidential and proprietary information concerning the company's operations, finances, financial condition, and present and future business prospects.

         In February 2005, Kohl's disclosed that it had reviewed its lease accounting practices and concluded that they did not conform with GAAP. The errors required Kohl's to restate its financial results from fiscal year 1998 through the first three quarters of fiscal year 2004. In a February 2005 press release, Kohl's indicated that the restatements involved (i) selling, general and administrative expenses, (ii) depreciation expenses, and (iii) net income. Kohl's also indicated that the issue concerned “the commencement date of the lease term [being] the earlier of the date when Kohl's becomes legally obligated for the rent payments or the date when the Company takes possession of the building for initial setup of fixtures and merchandise.” (Docket #42 ¶ 146). When Kohl's issued its financial results for the fourth fiscal quarter and end of 2004, the numbers reflected the adjustments.

         At the beginning of the class period, on February 26, 2009, Kohl's announced its earnings for the year ended January 31, 2009. On March 20, 2009, Kohl's filed with the Securities and Exchange Commission (“SEC”) its Form 10-K for the year ended January 31, 2009, which was signed by Mansell and McDonald. The Form 10-K represented that the company's financial statements for that year were prepared and presented in conformity with GAAP, and Mansell and McDonald certified that the company's “disclosure controls and procedures are effective at the reasonable assurance level” and “internal control over financial reporting is effective.” Id. ¶ 43-45. Mansell and McDonald certified that to their knowledge the report did not contain any untrue statement of material fact or omit a material fact necessary to make those statements not misleading. Further, they certified that, based on their knowledge, the financial statements and other financial information in the report “fairly present[ed] in all material respects the financial condition” of the company during the period. Id. ¶ 45.

         The company's representations about internal and disclosure controls, and Mansell's and McDonald's certifications about the same, were repeated in all material respects in the Forms 10-K that Kohl's filed with the SEC during the remainder of the Class Period-March 2010 and March 2011-and in certifications included in the company's Forms 10-Q filed throughout the Class Period-June, September, and December 2009; June, September, and December 2010; and June 2011. The Forms 10-Q stated that “[t]he accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information.” Id. ¶¶ 48, 53, 61, 64. Mansell's and McDonald's certifications in the Forms 10-Q and Forms 10-K contained representations regarding the company's disclosure and internal controls, including their personal evaluation of such controls, to ensure they were adequate and effective.

         On November 4, 2010, Kohl's announced that it had undertaken a detailed review of its historical accounting for leased properties, resulting in various corrections. Kohl's disclosed that these errors occurred over a number of years and primarily resulted from erroneously estimating the possession date in determining the commencement of lease terms; improperly accounting for and reporting certain asset depreciation; and improperly accounting for and reporting landlord reimbursements of construction-related costs. Kohl's reported that corrections of these errors were not material to its previously reported financial statements and so were recorded as a correction during that quarter through adjustments to depreciation, interest, and rent expense. Kohl's indicated that the correction would be up to $25 million, or $0.05 per diluted share.

         However, according to the amended complaint, the company's improper lease accounting during the Class Period caused its reported liabilities and debt to be materially understated and its reported equity to be materially overstated. The plaintiffs allege that the defendants' representations that the accounting errors were not material “was false and misleading because Defendants knew or should have known the scope of the errors and the figures that had to be restated” because “Defendants had previously engaged in a detailed review of the Company's lease accounting practices several years earlier, which also resulted in restatements.” Id. ¶ 67.

         Kohl's announced third-quarter earnings on November 10, 2010, for the quarter ended October 30, 2010. Kohl's indicated that its reported results excluded the corrections for its accounting for leased properties and that it intended to complete its review of that accounting prior to filing its third-quarter Form 10-Q. Kohl's presented its third-quarter financial information “subject to reclassification” and “before adjustments for lease accounting corrections.” Id. ¶ 70. According to the amended complaint, the defendants at that time “knew that the results could or would materially change when taking into account the lease accounting corrections they had identified” and that it was materially misleading for the defendants “to publicly disseminate financial results they knew were subject to change” because the defendants knew or should have known by then which figures would change, while investors were unaware of which figures would change or the magnitude of such changes.

         On December 2, 2010, Kohl's announced information regarding total sales for month ended November 27, 2010, reiterating therein that its review of historical accounting for leased properties required corrections to financial information but that the corrections were not material to its previously reported financial statements. However, Kohl's stated this time that it expected the final adjustment to decrease third-quarter income before taxes by approximately $50 million and dilute earnings per share by $0.10 per share. Again, the plaintiffs allege that the representation that the errors were not material to any previously reported period was false and misleading because the defendants knew or should have known by then the scope and magnitude of the errors and the figures that needed to be restated.

         On December 9, 2010, Kohl's filed its Form 10-Q for the quarter ended October 30, 2010. Like the other quarterly filings, the form represented that the company's financial statements for the quarter were prepared in accordance with GAAP and included representations about internal and disclosure controls and certifications by Mansell and McDonald about those controls. The form stated that all adjustments “considered necessary for a fair presentation have been included.” Id. ¶¶ 73, 74. According to the amended complaint, the financial statements were not, in fact, prepared in accordance with GAAP and did not include all necessary adjustments for a fair presentation. Further, because of the accounting errors, Mansell's and McDonald's certifications regarding the adequacy of controls were false and misleading.

         The December 9 Form 10-Q also, as with previous forms, disclosed the company's discovery of various errors in its accounting for leased properties, this time providing more detail. Kohl's indicated that the errors resulted from failures to properly determine the commencement of lease terms, record depreciation on certain assets consistent with the rent or lease obligation period, and classify and record landlord reimbursement of construction-related costs for leasehold improvements as prepaid rent or rent incentives. Kohl's detailed the line items of the financial statements that were impacted and assured the public that the corrections were not material to its previously reported financial statements. Kohl's did not disclose, at that time, the existence of any weaknesses in its internal controls. Kohl's stock declined approximately one percent on December 10, 2010.

         Kohl's filed its Form 10-K on March 18, 2011, for the year ended January 29, 2011, and its Form 10-Q on June 1, 2011, for the quarter ended April 30, 2011. Again, these documents represented that the financial statements were prepared in accordance with GAAP and contained certifications from Mansell and McDonald ...


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