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From Securities Regulation Daily, April 11, 2014

Derivative suit against yoga apparel maker tossed

By Mark S. Nelson, J.D.

Twin shareholders’ derivative suits had to be dismissed because they lacked particularized allegations showing that demand on lululemon athletica, inc.’s (lululemon) board should be excused, said the federal court in Manhattan. The court dismissed the operative complaint without prejudice, so the plaintiffs can refile after making a demand on lululemon’s board. Motions by two pension funds to intervene in the suit were held to be moot (Canty v. Day, et al., April 9, 2014, Forrest, K.).

Background. Vancouver, B.C.-based sports apparel maker lululemon had a growth spurt during much of the tenure of its prior CEO, Christine McCormick Day, from July 2008 to January 2014. Dennis J. Wilson is the company’s founder, chair, and largest individual shareholder. The company had achieved high growth by employing a business model focused on selling premium yoga apparel to upscale consumers.

Despite this success, lululemon’s business began to falter in the wake of several publicized flops, including woes from health claims about one of its products, the distribution of shopping bags that contained leaded ink, and a highly publicized recall of its signature black yoga pants due to bleeding colors, “pilling,” and sheerness. As a result, the company had to cut its revenue guidance, and its share price suffered.

During one short period between June 4 and June 7 of 2013, Wilson allegedly made $81 million selling his lululemon shares near their peak price, including his largest-ever one-day sale of over 607,000 shares for almost $50 million on June 7, 2013, the same day the company’s board learned that CEO Day would resign. During the relevant six-month period, Wilson’s stock sales totaled $184 million, while Day’s sales totaled $14 million.

Several large stock drops followed the June 10, 2013, public announcement of Day’s impending departure. Day stayed at the company until this past January, when her replacement started. Wilson has announced that he plans to step-down as chair by mid-2014.

Demand not excused. Plaintiffs Thomas Canty and Tammy M. Federman filed similarly themed derivative suits against lululemon’s directors. These suits alleged federal proxy statement violations and numerous state laws claims, including breach of fiduciary duty. The plaintiffs focused on what they saw as suspicious stock trades by company insiders and on red flags they believed the company’s board failed to address.

The plaintiffs argued that demand on lululemon’s board was excused because some directors failed to act on Wilson’s trading in company stock, and the company’s directors faced a substantial likelihood of personal liability.

With respect to allegations of the board’s inaction, the plaintiffs had claimed that the board disregarded Wilson’s trades because he dominated the board, thus making demand futile. The court, however, said these allegations lacked particularized details. Specifically, there were insufficient allegations the board knew of Wilson’s trading in the relevant time frame, and the plaintiffs did not adequately allege that the trades were outside the scope of Wilson’s Rule 10b5-1 plan.

The plaintiffs also failed to allege particularized facts that any directors were substantially likely to be held personally liable for a myriad of related claims. For one, there were not enough details to allege that proxy statements bore material misrepresentations or omissions under Exchange Act Sec. 14(a) and Rule 14a-9 when they were made. The disputed statements dealt with representations about Day’s experience and Wilson’s special position as the company’s founder. The plaintiffs also failed to allege that the directors knew Day would abruptly resign. Vague references to “internal turmoil” at the company likewise were insufficient to allege that the company’s directors could face personal liability.

Moreover, while allegations of poor internal controls based on red flags regarding some of its products, including its flagship yoga pants, may have alleged quality control issues at the company, they failed to allege anything about how the company’s directors responded to these issues. In a footnote, the court also said a director’s exculpatory provision in lululemon’s certificate of incorporation would bar excusing demand, even if the plaintiffs had embedded duty of care claims within their complaints (the plaintiffs had disclaimed any duty of care claims).

Lastly, state law disclosure violation claims failed to allege the directors had a direct role in preparing the challenged lululemon financial reports. Other claims for unjust enrichment, abuse of control, and gross mismanagement bore similar pleading defects.

The case is No. 13 Civ. 5629 (KBF).

Attorneys: Brett D. Stecker (Harwood Feffer LLP) for Thomas Canty. Gustavo Fabian Bruckner (Pomerantz LLP) for Hallandale Beach Police Officers And Firefighters' Personnel Retirement Fund. Joseph S. Allerhand (Weil, Gotshal & Manges LLP) for Christine McCormick Day

Companies: lululemon athletica, inc.; Laborers' District Council Construction Industry Pension Fund; Hallandale Beach Police Officers and Firefighters' Personnel Retirement Fund

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