Second Circuit Affirms Dismissal of Securities Fraud Complaint

When does a company’s failure to disclose that a warned-of risk has materialized cross the line into securities fraud? In Smith v. The Gap, Inc., No. 25-1130, 2026 U.S. App. LEXIS 15173 (2d Cir. May 28, 2026), the United States Court of Appeals for the Second Circuit drew a clear line: repeating generic risk warnings without flagging that the risk has come to pass is not fraud unless the company affirmatively told investors the risk was merely hypothetical. By clearly distinguishing prior decisions on the relevant facts alleged, Smith provides helpful guidance for practitioners going forward.

In August 2021, The Gap launched BODEQUALITY, requiring every Old Navy store to carry every women’s item in every size — including extended plus-sizes. Stores ran short of medium sizes almost immediately and had to discount surplus plus-size inventory at steep markdowns. By early 2022, The Gap pulled the in-store initiative; in May, it disclosed that first-quarter results suffered from “execution missteps” related to BODEQUALITY.

Investors who bought The Gap stock during the class period sued the company and two senior executives for violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, alleging that public statements about BODEQUALITY were false or misleading. The United States District Court for the Eastern District of New York dismissed the complaint (see Diaz v. Gap, Inc., No. 22-cv-07371, 2025 WL 1293308 (E.D.N.Y. Mar. 31, 2025)), and the Second Circuit affirmed on every ground: no actionable misstatement and no scienter.

The decision’s core holding addresses risk-factor disclosures. The Gap’s annual reports warned generically that it might misjudge demand and need to discount excess inventory. Plaintiffs argued that repeating those warnings without disclosing BODEQUALITY’s problems was misleading. The Court rejected a blanket rule that a risk disclosure becomes actionable whenever the risk materializes. It distinguished two prior cases: in Set Capital LLC v. Credit Suisse Group AG, 996 F.3d 64 (2d Cir. 2021), the defendants assured investors they had “no reason to believe” a known, virtually certain risk would materialize; in City of Hialeah Employees’ Retirement System v. Peloton Interactive, Inc., 153 F.4th 288 (2d Cir. 2025), the defendants framed inevitable inventory write-downs as hypothetical and cast deep discounts as an offensive strategy. The Gap did neither. Its warnings described risks common to every clothing retailer, acknowledged that those risks had occurred before and never suggested they were hypothetical. No reasonable investor, the Court held, would have read The Gap’s boilerplate to mean the company was not currently discounting excess inventory.

Three takeaways for practitioners:

First, generic, industry-wide risk disclosures concerning “ubiquitous risks in the industry, as opposed to more discrete, context-dependent, or event-driven risks” will not support a fraud claim even if the risk is materializing at the time. Reasonable investors read boilerplate as boilerplate.

Second, a company that acknowledges a risk has occurred before — and does not assure investors it is merely hypothetical — does not mislead by omitting news that the risk is recurring. The line is crossed only when the company affirmatively frames a known, materialized risk as merely possible.

Third, it is not enough for plaintiffs to show that an omission was material because Section 10(b) and Rule 10b-5 do not create an affirmative duty to disclose any and all material information. Discussing one headwind — supply-chain delays, for example — does not require a company to catalog every other factor affecting results. To prevail on a “materialized risk” theory, plaintiffs must show the company’s disclosures affirmatively conveyed that the risk remained hypothetical.

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