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How a Sex Harassment Case Against American Apparel Could Lead to CEO's Fall

A week after it was revealed that American Apparel (APP) CEO Dov Charney is being sued by a former employee who alleges he trapped her in his apartment after she turned 18 and repeatedly sexually assaulted her the company has still not made an SEC filing disclosing the litigation.

Normally, companies disclose any unscheduled event that may have a "material" affect on their finances. In this case, plaintiff Irene Morales is demanding $250 million, or more than an entire quarter of American Apparel's sales. Morales won't get that sum, of course, but that's not the point. Charney has been repeatedly sued for sexual harassing his employees in the past. This time around, his board and creditors -- who now control the fate of the company, at least financially, according to this amended credit agreement -- may not be so sympathetic. Why should they keep a CEO who gets into trouble so often?

The fact that jettisoning Charney as CEO is an option ought to be the type of risk that might trigger an SEC disclosure. Instead, the company has come out with both guns blazing. It blasted Morales as a liar and a hypocrit:

We have been informed today that [redacted], a former employee of American Apparel who left the company without complaint and resigned with a letter of gratitude regarding her positive experience at the company, has filed a sexual harassment lawsuit in New York against the company.

Upon her resignation, [the employee] acknowledged in writing that she had no pending claims against the company and signed a severance agreement which included a full release of claims and an agreement to submit any future claims to confidential binding arbitration.

That sounds like a good argument that the case might be frivolous until you see this Today Show video, which includes a clip of Charney from a deposition in which he makes inadvisable statements such as:
I frequently drop my pants to show people my new product.

There's some of us that love sluts. It could be also an endearing term.

Even if you assume that the lawsuit is frivolous, does Charney want to sit in front of a Brooklyn, N.Y., jury
explaining to 12 good men and true the business context for guff like that? This sort of thing is the reason those creditors have been installing grown-up executives around Charney to try and bring his failing business under control.

There is a twist here of course: Charney currently owns 52 percent of APP's common stock, so he cannot be voted out by his own shareholders. Charney has bought millions of his own shares since 2009 to maintain that position.

That makes the Morales suit a three-cornered fight: Morales v. Charney, and Charney v. his creditors and shareholders. There is no overt sign that Charney has lost the patience of his board or his creditors. But it is not hard to imagine that investors, eager to unlock the value inside American Apparel by ousting Charney and bringing sanity to the company, might want to see the Morales suit as the trigger for a revolt that leads to Charney's downfall.


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