Second Circuit Affirms Dismissal of Securities Fraud Claims Against The Gap

On May 28 2026, the Second Circuit affirmed the dismissal of securities fraud claims in Smith v. The Gap, Inc.[1] This action was brought after The Gap reported that it overestimated demand for its BODEQUALITY line of plus-size clothing options, which resulted in surplus inventory that it had to sell at a steep discount.

In its decision, the court addressed five issues relating to falsity and scienter that frequently arise in securities fraud cases, making it a helpful precedent for defendants in future cases:

• The court clarified when a company’s risk factors are actionable, “reject[ing] Plaintiffs’ proposed rule that a risk disclosure is actionable whenever a company fails to disclose that the risk already materialized in some way.”[2] Instead, the analysis “depends on context.”[3] Here, the warning that “[t]o the extent we misjudge the market for our merchandise … the markdowns required to move the resulting excess inventory will adversely affect our operating results” would “not have misled a reasonable investor about the nature of the risks disclosed” because it (i) “concerned ubiquitous risks in the industry, as opposed to [a] more discrete” risk about “BODEQUALITY in particular,” and (ii) did not present the risks as “merely hypothetical,” but warned that the risks “had materialized in the past and would reoccur.”[4]
• The court held that the company’s “characterization of demand as ‘strong’ and [the] optimistic prediction that customers are ‘craving trend choice’ [are] unactionable puffery.”[5]
• The court rejected the argument that a disclosure “attributing inventory problems to supply-chain issues resulting from COVID-19” was misleading for failure “to disclose that sales were down in part due to [other] problems.”[6] “A company’s decision to speak about one aspect of sales does not necessarily require it to address other issues. Plaintiffs’ theory that if a registrant discloses sales or inventory, then it must disclose all circumstances that are materially impacting sales and inventory, is untenably overbroad and foreclosed by precedent.”[7]
• With respect to scienter, the court held that anecdotal accounts from confidential witnesses reporting problems at two stores “might support the inference that Defendants knew that certain stores were having inventory problems, but not that BODEQUALITY was faltering nationwide.”[8]
• The court declined to infer scienter on the ground that inventory management “constitute[s] Gap’s ‘core operations.’ ”[9] The court once again stated that it has “not ‘clearly affirmed the validity of the core-operations doctrine,’ ” and that there was no basis to adopt it in this case because plaintiffs “never attempt to quantify the importance of BODEQUALITY to those operations.”[10] This ruling is notable because the Ninth Circuit recently accepted that kind of argument, reasoning that “it would be absurd for [a toy company’s] CEO or CFO not to have closely monitored the company’s management of its inventory” at a warehouse, because “inventory management” was a core operation of a retailer.[11]

In sum, the court in Gap rejected numerous arguments that the plaintiffs’ bar favors and have been putting forward in various courts. Defendants facing securities fraud claims should consider whether the Gap decision supports dismissal of the claims against them.