Yesterday, Judge Badalamenti denied Target’s motion to dismiss a securities fraud claim against it arising out of its decision to run a pride campaign. The securities fraud claim was brought by America First Legal and other firms. They issued the following statements after the decision:

Statement from Reed D. Rubinstein, America First Legal Senior Vice President:

“Today’s decision is a warning to publicly traded corporations’ boards and management: Our federal securities laws mandate fair and honest disclosure of the market risk created by management when it uses shareholder resources, including consumer goodwill, to advance idiosyncratic and extreme social or political preferences. The risk of ESG mandates and DEI initiatives, such as Target’s “Pride Month” that targeted young children, cannot be whitewashed with boilerplate language or ignored,” said Reed Rubinstein.

Statement from Jonathan Berry, Managing Partner of Boyden Gray PLLC:

“Today’s ruling is an important win for our clients; we look forward to continuing to litigate this case to obtain relief for our clients and hold Target accountable for their actions,” said Jonathan Berry.

The decision certainly sends a message to corporations about what to expect. Candidly, the decision surprised me. After the initial complaint in the matter, I expected the case to get dismissed and for the court to order sanctions against them for filing the suit. I even wrote an opinion piece last year making that point.

But the Court had its own view of the pleadings. Two things surprised me about the decision. The first is that it allowed claims to go forward on the possibility that statements might be false. The other is that it found scienter by ruling that a business decision was reckless–not that a statement was recklessly made.

Possibly False Statements

Let’s start with the alleged misstatements. Target’s 2021 Annual Report contained a risk factor disclosing that it could face boycotts for things that it does. It specifically states:

It may be difficult to control negative publicity, regardless of whether it is accurate. Target’s responses to crises and our position or perceived lack of position on environmental, social, and governance (ESG) matters, such as sustainability, responsible sourcing, and diversity, equity, and inclusion (DE&I), and any perceived lack of transparency about those matters, could harm our reputation. While reputations may take decades to build, negative incidents involving us or others with whom we do business can quickly erode trust and confidence and can result in consumer boycotts, workforce unrest or walkouts, government investigations, or litigation.

To me, this and other similar disclosures appear to cover the possibility that people could boycott it if Target did something the public disliked. Consumers boycotted Target after its 2023 pride campaign. This seems like the sort of risk that the risk factor contemplates.

The plaintiffs alleged, without any evidence I can see, that “’the known risk of [] reactions was not being monitored or addressed by the Board” and because of this, “Target was thus not attempting to ‘preserve Target’s reputation’ or ‘control negative publicity’.”

The Court allowed the claim to go forward on the possibility that Target might have made a false statement. It explained that “[t]o be clear, the Court is not finding that Defendants’ 2021 disclosure is misleading because such an assertion would be premature at this stage in the proceedings.” As best I can understand it, the Court let the case go forward on the theory that the disclosure might be false if discovery can establish that Target’s board actually did not monitor or consider the risk of backlash from a pride campaign.

Later, the Court allows plaintiffs to explore whether a statement was false again. Consider this language:

These pleaded facts demonstrate that it is plausible that Target, its Board, and its GSC may have ignored social and political risks relating to the 2023 Pride Month Campaign . . .

This seems inconsistent with the way the PSLRA is supposed to work. I understood it to prohibit fishing expeditions to see whether or not some statement was false. Target ran a pride campaign. Target experienced backlash. There doesn’t appear to be any factual allegation to support the view that Target’s leadership or board did not consider the possibility that they would face backlash. Instead the plaintiffs just baldly assert that Target failed to disclose that it wasn’t considering these risks. Apparently that was enough for the Court.

It’s entirely possible that Target thought about backlash risk and just misjudged it. I would even say that is the stronger inference available from the known facts.

The Court also disagreed with Target’s argument that shareholders understood the risk that it could be boycotted for pride campaigns because it had been boycotted for pride campaigns before. It found that the prior campaigns didn’t put shareholders on notice of risks that might arise from “placing potentially controversial merchandise at the center of its stores—could be construed as a change to their ESG/DEI campaigns in prior years.”

I take it from this that if Target were to relocate adult-oriented merchandise from one location to another in the store, it might also be securities fraud? This issue isn’t limited to Target. Could Walmart face securities fraud liability under this theory if it relocates products from one area to another? Do we want retailers to really add risk factor disclosures that they could be boycotted if they do something differently than they did it in the past? How does that substantially alter the total mix of information available?

Scienter

The Court also found fraudulent intent with the following reasoning:

Plaintiffs pleaded that Defendant Cornell acted with severe recklessness because he knew that the 2023 Pride Campaign carried the risk of customer backlash. . . Severe recklessness constitutes a strong inference of scienter. . . . Severe recklessness is established by showing “highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.” . . .

Here, the Court finds that Plaintiffs have adequately pleaded severe recklessness. Specifically, Plaintiffs have pleaded that Cornell had knowledge that prior LGBT campaigns led to backlash, such as Target’s opposition to the North Carolina transgender bathroom law. . . Target’s reaction to the law caused 1.5 million people to pledge to boycott Target, and Target’s sales fell in the following three quarters following Target’s opposition. . . . Further, Plaintiffs pleaded that—not only did Cornell know about the boycott—he admitted that Target “didn’t adequately assess risk” in the matter. . . These facts demonstrate severe recklessness. It is highly unreasonable that Cornell would approve a new, more aggressive LGBT campaign in 2023 after allegedly admitting that Target didn’t adequately assess the risk of boycotts in a prior campaign. Plaintiffs have pleaded that Cornell’s decision to issue a new aggressive campaign—knowing that the preceding campaign received immense backlash—is an extreme departure from the standards of ordinary care that was so obvious that Cornell should have been aware of it. Accordingly, Plaintiffs have adequately pleaded scienter . . .

As best I can understand it, the scienter reasoning here seems entirely disconnected from the alleged possible misstatements. The reasoning seems to find, in hindsight, that the business decision to run a pride campaign was “severely reckless” because Target had faced a boycott before. That doesn’t seem like securities fraud to me.