A class-action lawsuit was filed July 2 by Robbins, Geller, Rudman & Dowd, LLP, on behalf of individual investor Houssam Alkhoury, alleging violations of the federal securities laws by Lululemon (Nasdaq:LULU) and certain of its officers and/or directors. Specifically, the complaint alleges that between March and June of this year the company failed to reveal the true reason for the Luon yoga pant debacle, which was to cut costs and improve profits.

Things continue to go from bad to worse at the trendy retailer which faces its second lawsuit in the past two months. Should investors be worried? Or is this just another blip on the radar? I'll have a look.

Transparency
Lululemon, in my opinion, has always had a problem being open with investors. As long as I can remember it's done a bang-up job putting its best foot forward, even when that didn't necessarily present a complete picture of what was happening with its business. I've written extensively about its investor relations tactics when it comes to quarterly reports and the type of information it chooses to reveal to investors. It seems to change periodically to keep the "growth" story in motion. Thus, it's not surprising that the company faces its second lawsuit in the past two months. Lululemon's history of vagueness is coming home to roost.

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The first lawsuit came in May when the retirement fund for Hallandale Beach's police officers and firefighters claimed the company's compensation committee agreed to a one-third increase in its executive's bonus plan a week before recalling its Luon yoga pants over the well-documented sheerness issues. The retirement fund contends that Lululemon's board knew about the sheerness problems prior to approving the bonuses and shouldn't have given their green light considering the cost to the company.

The second lawsuit, in addition to its contention that Lululemon withheld the fact that the quality issues were a direct result of it cutting costs to increase profits, also contends that it was selling its yoga pants at a discount between March and June to maintain market share without notifying investors. In addition, the complaint contends the company undertook discussions to replace CEO Christine Day without informing investors. These are all very serious allegations; I'm sure Lululemon will vigorously defend itself.

I don't know what to make of all these allegations but as I've said in the past--where there's smoke, there's fire.

SEE: Litigation: Are Your Investments At Risk?

Reboot
It continues to make healthy profits so you could hardly call its current situation a turnaround. However, it does need to get its act together quickly or investors will abandon ship en masse. Personally, I would be more inclined to own Gap (NYSE:GPS), Nike (NYSE:NKE) or Under Armour (NYSE:UA) at this point than take a chance on the leadership vacuum that exists at Lululemon.

Christine Day stepped down as CEO of Lululemon June 10 stating it was time to move on. Speculation about whether she was pushed obviously will come out as the class-action suit makes its way through the courts. As the person responsible for its growth in the U.S., it's very plausible Day realized a reboot was necessary, something she clearly wouldn't have enjoyed, and decided leaving now would allow her replacement to put into place the steps necessary to bring back the quality it once was known for.

It's also possible that the board realized she wasn't the right person to complete this task asking her to step down before she made any further missteps permanently damaging the brand. The fact that former chief product officer Sheree Waterson is being replaced by three people: an executive vice president of design and merchandising, a senior vice president of product operations as well as the addition of a senior vice president of logistics suggests that Day had little understanding of the apparel business. Which really makes you wonder about the role played by the board in all of this. How could a company so successful allow itself to unravel so quickly? On this basis alone investors should be very concerned about its future direction.

Future Direction
Forbes suggested in June that Christine Day was working 18-hour days. Given how understaffed its executive ranks appear to have been, it makes me think she's a total control freak, which is always a bad trait to have for the CEO of a large company. Delegation is critical to successful execution. It's further troubling that a company supposedly concerned about life balance would allow Day to push herself to such an extent. It's certainly not sending the right message to the rank and file. The new CEO will have to have three things: Patience, a good understanding of both manufacturing and retail, and an appreciation for a balanced life. Lululemon will have a difficult time succeeding without all of these things present in its next leader.

Bottom Line
Many analysts recommend investors avoid Lululemon's stock until all of these issues are out in the open and its stock's volatility has dissipated. I normally don't agree with analysts but in this instance they are spot on. There are too many worrisome issues facing the company at the moment to put your capital at risk. I'd give it six months before reassessing the situation. By then it will hopefully have hired a CEO and be moving in the right direction. While it does mean you'll miss the boost its stock will get from the CEO announcement; discretion is the bettor part of valor.



Tickers in this Article: LULU, GPS, NKE, UA,

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