Sanchez v. Crocs, Inc.
667 F. App'x 710
| 10th Cir. | 2016Background
- Crocs rapidly expanded its business but used primitive Excel-based inventory tracking, assigned duplicate barcodes, lacked formal procedures, and experienced both inventory surpluses of unsalable items and shortages of best-sellers.
- Crocs reported inventory at cost on its 2006 and 2007 Form 10-Ks; Deloitte issued unqualified audit opinions for both years and an unqualified opinion on Crocs’s internal controls for 2007.
- Plaintiffs (the Sanchez Group, Babbitt, and Lundberg) filed a securities-fraud class action alleging Crocs overstated inventory and Deloitte, as auditor, knowingly or recklessly issued misleading audit opinions in violation of § 10(b) and Rule 10b-5.
- The district court dismissed the complaint for failure to plead scienter as to Deloitte; plaintiffs appealed while settling claims against the Crocs defendants, leaving Deloitte as the sole defendant on appeal.
- National Roofing moved to dismiss the appeal on Morrison extraterritoriality grounds, but the court found that argument merits-based (not jurisdictional) and National Roofing’s motion moot after it dismissed its related appeal with prejudice.
- The Tenth Circuit affirmed dismissal, holding plaintiffs failed to plead particularized facts showing Deloitte knew of red flags or was recklessly blind to blatantly obvious fraud; alleged facts suggested negligence, not the required strong inference of scienter.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Morrison deprives Sanchez Group of standing to sue under § 10(b) | Sanchez Group claims CFDs losses are tied to U.S. securities and they have standing | National Roofing argued CFDs were foreign and outside § 10(b) after Morrison | Court: Morrison addresses merits/extraterritoriality, not jurisdiction; motion moot and standing adequate at pleading stage |
| Whether Deloitte’s audit statements were false or misleading | Plaintiffs: Deloitte issued unqualified opinions despite obvious red flags (inventory system flaws, inventory buildup, unsalable goods) | Deloitte: plaintiffs fail to particularize which documents/audits showed red flags; statements not shown false at pleading stage | Court: Plaintiffs adequately alleged statements but failed to plead scienter sufficiently |
| Whether plaintiffs pleaded scienter against Deloitte (knowledge or recklessness) | Plaintiffs: Deloitte had regular access to Crocs’ internal info and ignored clear warning signs—strong inference of recklessness or deliberate indifference | Deloitte: Generalized access allegations and hindsight about inventory buildups only support negligence, not recklessness; plaintiffs must identify specific documents or obvious red flags | Court: Dismissed—allegations were generalized; red flags were not so obvious as to constitute an egregious refusal to see the obvious; inference of negligence more compelling |
| Whether plaintiffs should have been granted leave to amend complaint | Plaintiffs: requested leave below (briefly) and argued additional facts (e.g., NDAs with ex-employees) might exist | Deloitte: plaintiffs failed to specify amendment contents or provide adequate notice to court/opposing parties | Court: Denial of leave to amend not an abuse of discretion—plaintiffs gave no particulars of proposed amendment |
Key Cases Cited
- Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010) (extraterritorial reach of § 10(b) is a merits question)
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) (courts must compare plaintiff's inference of scienter against competing inferences)
- Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (2011) (consider the complaint in its entirety when assessing scienter)
- Nakkhumpun v. Taylor, 782 F.3d 1142 (10th Cir. 2015) (elements of § 10(b) claim and standards for Rule 12(b)(6) review)
- Gold Res. Corp. v. 776 F.3d 1103 (10th Cir. 2015) (pleading standards for securities fraud under PSLRA)
- City of Philadelphia v. Fleming Companies, 264 F.3d 1245 (10th Cir. 2001) (definition of recklessness in securities context)
- Dronsejko v. Thornton, 632 F.3d 658 (10th Cir. 2011) (recklessness threshold is high; negligence insufficient)