The Lawsuits That Could Unravel American Apparel

American Apparel
American Apparel

American Apparel (APP) has always played by its own rules. But like many renegades, it has run into forces that threaten to throttle it -- and in this case, possibly destroy it. The notoriously independent and flamboyant clothing maker and retailer now faces high-drama legal problems worthy of daytime soap operas: sexual harassment suits, a wage-and-hour suit, immigration problems and three shareholder suits.

And perhaps most problematic of all for American Apparel are Department of Justice and Securities and Exchange investigations into its accounting that were triggered after the company's auditors resigned and said that based on new information, the accuracy of its books might be in question. Although the investigations alone don't mean wrongdoing occurred, if any has, it's hard to see how American Apparel survives.

The most titillating suits are the sexual harassment claims brought on by CEO Dov Charney's penchant for walking around in his underwear, calling female employees sluts and other "endearments," and otherwise creating a sexualized work environment. The publicly sexual nature of Charney and American Apparel's workplace aren't in doubt. Charney is a man who repeatedly masturbated (with permission) in front of a reporter doing a profile of him for Jane magazine.

One Big Suit Is Almost Settled

The most recent suggestive revelation is the claim that potential employees must submit head-to-toe photos if they want to be considered for jobs. The suits do not allege that Charney pressured anyone for sex -- he does have many consensual workplace romances. Instead, the suits charge that his actions and the rest of the culture resulted in hostile work environment.

According to the Los Angeles Times, by January 2008, one sexual harassment suit had been dismissed, two combined and settled, and one was ongoing. One of the longest-running harassment suits was filed by Mary Nelson in 2005. That case was nearly settled for $1.3 million, but the deal involved a potentially illegal arbitration agreement that would have resulted in a total exoneration of Charney and American Apparel.

According to company spokesman Peter Schey, that case is currently undergoing a different arbitration. American Apparel is also facing a broad-based investigation by the Equal Employment Opportunity Commission that began in response to employee Sylvia Hsu's complaint in 2006. Says Schey: "The company is engaged in discussions with the EEOC regarding this claim [and] intends to resolve this case in a manner fully consistent with Hsu's rights and the company's strong commitment to policies and practices prohibiting sexual harassment in the workplace."

Striking at the Brand's Heart

More surprising for American Apparel, given its public image, is the wage-and-hour class action filed in November 2009 by Guillermo Ruiz. The American Apparel brand isn't just about sex; it's also about being pro-worker and anti-sweatshop. Indeed, the company markets itself on paying good wages with good benefits. But this lawsuit claims, among other things, "the Company failed to pay certain wages due for hours worked, to provide meal and rest periods or compensation in lieu thereof and to pay wages due upon termination to certain employees."

Perhaps because the lawsuit's allegations strike at the heart of the brand (rather than arguably supporting it as the sexual harassment claims do), American Apparel's description of the case in its most recent SEC quarterly report includes this warning:

Should the matter be decided against the Company, the Company could not only incur substantial liability but also experience an increase in similar suits and suffer reputational harm. ...No assurance can be made that this matter either individually or together with the potential for similar suits and reputational harm, will not result in a material financial exposure, which could have a material adverse effect upon the Company's financial condition and results of operations.

This case went into mediation in December, 2009, which apparently failed because Schey says this case is now in arbitration. He adds: "The company fully intends to resolve this case in a manner consistent with the rights of its employees."

Sponsored Links

In addition to pitching itself as anti-sweatshop, American Apparel has publicly promoted immigration reform that enables the legalization of undocumented workers, and it proudly hires immigrants. Its hiring practices have hurt the company, however, as an immigration investigation and enforcement action early this year resulted in the loss of over 1,500 undocumented employees. The resulting disruption to production was so great, Charney claims, that the immigration action explains the company's current financial woes. Given all of American Apparel's other bad business decisions, pegging immigration enforcement as the whole or even primary cause of its problems doesn't pass the straight-face test.

American Apparel is subject of one shareholder class action and two "derivative suits," both of which make similar allegations as the class action but represent groups whose interests the class action doesn't cover, such as long-term investors in the stock. The lawsuits allege that American Apparel lied to investors about its hiring practices (citing the immigration action) and about its accounting problems, and through the accounting problems, about the company's financial health.

In July, American Apparel was forced to make an unusual announcement. Its auditors, Deloitte & Touche, told the company:

"that certain information has come to Deloitte's attention, that if further investigated may materially impact the reliability of either its previously issued audit report or the underlying consolidated financial statements for the year ended December 31, 2009."

Deloitte asked for additional information to evaluate the impact of the mysterious "certain information." Effective July 22, Deloitte quit as American Apparel's auditors, but it hasn't disavowed its prior audit of the company. American Apparel hired back its previous auditors, Marcum, shortly thereafter.

Says American Apparel's Schey: "I believe all of the information [Deloitte has] requested to date has been provided. I think it is noteworthy that Deloitte has not withdrawn its audit despite the passage of several months since it resigned."

Seeking Clarity

A month after publicly acknowledging Deloitte's statements, American Apparel was subpoenaed by the U.S. Attorney's office for the Southern District of New York seeking documents relating to the change in the company's auditors. The SEC had asked for similar information. Deloitte's mysterious statement and the government investigations prompt the question: Has American Apparel been cooking its books?

Schey suggests that the investigations, which the company is cooperating with, won't find any wrongdoing:

"The DOJ subpoena has been placed on hold while we respond to the SEC subpoena because there was a large degree of overlap between the two. We have already provided most of the documents requested in the SEC subpoena. Also note that the SEC subpoena specifically states that the issuance of the subpoena does not mean that the SEC believes there has been any wrongdoing on anyone's part. ...We believe that the SEC and DOJ investigations will be resolved positively in the next few months. We have no reason to believe that anyone in the company engaged in any wrongdoing of any kind."

More clarity will come when American Apparel finally files its quarterly report for the period ending June 30, which will be no later than Nov. 15, if the company hopes to avoid being delisted from the American Stock Exchange.

Schey's comments to DailyFinance also try to reassure American Apparel investors and customers:

"We are focusing on several tasks going forward including building revenues, improving efficiency in production, motivating and training retail sales staff, building Internet sales, etc.

American Apparel will not abandon the principles on which it was built, including domestic production, a vertically integrated business model, fair wages and healthy working conditions, a strong commitment to diversity, involvement in and support of the local communities in which it operates, etc."

Will the company successfully pull out of the tailspin that nearly caused it to crash into bankruptcy? It's hard to see how, with all these problems weighing it down. From the legal perspective, the two key things to watch are the accounting investigations and the Ruiz lost-wages case.

If either of those goes against American Apparel in a big way, there won't be any Hollywood-style near-miss ending, with pilot Dov Charney pulling out of the dive mere feet above the ground. Instead, we'll see a spectacular impact and a company going up in flames.