American Apparel board had CEO trust issues

Directors moved to fire Dov Charney after learning of his response to accusations of misconduct. Shares rise more than 6% after the news emerged.

By MSN Money Partner Jun 20, 2014 9:19AM
Credit: © Michael Tran/FilmMagic/Getty Images
Caption: Dov Charney of American ApparelBy Suzanne Kapner, Ethan Smith and Joann S. Lublin, The Wall Street Journal

American Apparel's (APP) board moved to fire CEO and founder Dov Charney (pictured) after his response to existing lawsuits raised concerns about his trustworthiness, a person familiar with the decision said Thursday.

The move by the board sets off a battle at the top of a company that carved an outsize niche in popular culture thanks to its affordable fashions and sexually themed marketing, but which has since fallen on tough times.

Mr. Charney has been accused of harassment in a string of civil lawsuits brought by former employees in recent years, but it wasn't until certain facts related to how Mr. Charney responded to the accusations came to light this spring that the board decided to open an investigation, the person said.

As more details came out, five of the board's independent directors concluded they had no choice but to remove Mr. Charney as chairman and CEO, the person said. The matter came to a head Wednesday at a board meeting following the annual stockholders meeting.

According to the person familiar with the matter, the directors and Mr. Charney gathered at noon in a small conference room at the Times Square offices of Skadden, Arps, Slate, Meagher & Flom LLP in New York, the company's legal counsel, and didn't emerge for 10 hours.

Shortly afterward, the board put out a news release saying it had voted to remove Mr. Charney as chairman and had notified him of its intent to remove him from his jobs as president and CEO for cause, a decision that grew out of "an ongoing investigation into alleged misconduct."

"I wonder about the timing of this because I think Dov, my impression is, he did a pretty good job turning around the company," said Minho Roth, who runs Switzerland-based FiveT Capital, a firm that helped American Apparel meet a debt payment earlier this year by buying up much of a stock offering by the company. Mr. Roth and Mr. Charney have been in touch lately. "If they wanted to oust him why didn't they do it last year or two years ago?" Mr. Roth said.

Mr. Roth says he hasn't talked to any of the board members or had calls returned by interim chief executive, John Luttrell.

The company has previously called some of the lawsuits "fraudulent and malicious" and is currently in arbitration. Mr. Charney is the company's largest individual shareholder, with about 27 percent of American Apparel's stock, according to S&P Capital IQ. He doesn't intend to sell it, a person familiar with the matter said.

The company's efforts over the years to raise cash to support the business have left it with a number of important constituencies, including Mr. Charney, FiveT and investment firm Lion Capital.

Mr. Charney, who founded American Apparel as a wholesale T-shirt business in 1998, won some plaudits by making the unusual choice to produce the garments in America and becoming an outspoken advocate of immigration reform and better wages. But his overt sexuality -- he frankly discussed his own sex life, sometimes wandered around his factory in his underpants and staged provocative photo shoots in the basement of his mansion -- eventually left him at the center of harassment lawsuits brought by former employees.

In a recent securities filing, the company listed five arbitration cases against Mr. Charney and certain directors that allege claims of sexual harassment, assault and battery, impersonation through the Internet, defamation and other related claims. The company settled two cases, one with no monetary liability.

In 2008, American Apparel agreed to pay $1.3 million to Mary Nelson, a sales manager who claimed Mr. Charney made sexual advances and inappropriate comments to her before firing her. The settlement later got entangled in a dispute over language in the arbitration that would say Mr. Charney never made any advances toward her.

At the meeting in New York on Wednesday, lead independent director Allan Mayer kicked off discussions by outlining the board's concerns and its intention to fire Mr. Charney for cause, the person familiar with the situation said. Mr. Charney, who had little inkling of the concerns, appeared to have been taken by surprise, the person said.

Although the board had already made up its mind, they felt they owed it to Mr. Charney to hear him out, the person said. The hours ticked by as Mr. Charney calmly made his case. Directors paused only briefly to eat a light meal of salad, the person said. As the hour grew late, the directors moved to draw the meeting to a close, the person said.

One of the first calls the directors made once the news was announced was to Lion Capital, one of the company's lenders. The credit agreement allowed Lion to call in its loan in the event of a CEO change, the person familiar with the matter said. The two sides were in contact again Thursday morning with the directors reassuring Lion of the company's financial position, the person said.

American Apparel's shares rose 6 percent Thursday on the news, but at just 68 cents remain badly battered, down more than 40 percent this year and well below the $8 price of its 2005 initial public offering.

American Apparel reported a net loss of $5.5 million for the three months ended March 31, narrower than the $46.5 million loss it reported a year earlier. Comparable-store sales fell 7 percent. At the end of May, American Apparel had about 10,000 employees and operated 249 retail stores in 20 countries.

The company raised $28.6 million by selling stock in March and said in a securities filing in May that it has enough funding to meet its needs for 12 months.

American Apparel directors have broad leeway to fire Mr. Charney for cause, which would deprive the CEO of severance payments except for unpaid expenses, according to his contract. The 2012 employment agreement defines cause in several ways, among them: "any willful misconduct by the Executive that is materially injurious to the financial condition or business reputation of the Company or any of its affiliates or subsidiaries.''

It is a highly unusual move nonetheless -- especially when the chief is a founder and big shareholder. "Terminating a founder with a lot of stock is dangerous," said Charles Elson, head of the Weinberg Center for Corporate Governance at University of Delaware's business School.

Under Mr. Charney's contract, there is a 30-day period to resolve the conflict before he can be fired. On Wednesday, the board named Mr. Mayer as co-chairman along with David Danziger, who heads the board's audit committee.

Mr. Charney would have received an exit package of about $17 million if he had been terminated without cause or simply quit for good reason, estimates Mark Reilly, head of the executive compensation practice for human resources consultants Verisight Inc. The calculation by Mr. Reilly, who has never worked for American Apparel, reflects two years of salary and maximum annual bonus plus accelerated vesting of the CEO's equity awards based on the stock's closing price Wednesday.

The situation is an extreme example of the dilemma that confronts many fashion companies, which rely on creative geniuses whose impulses don't often translate well to the more staid corporate environments that prevail once their businesses get established. The risk in parting ways is that such companies could lose their creative spark.

Lululemon Athletica's (LULU) directors are battling with founder Dennis "Chip" Wilson, who voted against members of the board including its new chairman after directors sidelined him for meddling with managerial affairs. Abercrombie & Fitch (ANF) earlier this year stripped Michael Jefferies, the chief executive who created the modern face of the brand, of his chairman title in an attempt to improve governance of the retailer, which has faced pressure from activist investors amid a drop in demand for its logo T-shirts and other items. And BCBG Max Azria Group Inc.'s founder is at risk of losing control of his company to Guggenheim Partners LLC.

More from The Wall Street Journal



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