Costco 2008 Annual Report Download - page 82

unspecified amounts, injunctive relief remedying the allegedly improper disclosures, and costs and
attorneys’ fees. A California Superior Court ruling dismissing the action on the ground that federal law
does not permit claims for mislabeling of farm-raised salmon to be asserted by private parties was
reversed by the California Supreme Court; a petition seeking review by the United States Supreme
Court is pending. The Company has not yet responded to the complaint.
Two shareholder derivative lawsuits have recently been filed, ostensibly on behalf of the Company,
against certain of its current and former officers and directors, relating to the Company’s stock option
grants. One suit, Sandra Donnelly v. James Sinegal, et al., Case No. 08-2-23783-4 SEA (King County
Superior Court), was filed in Washington state court on or about July 17, 2008. Plaintiff alleges, among
other things, that individual defendants breached their fiduciary duties to the Company by “backdating”
grants of stock options issued between 1997 and 2005 to various current and former executives,
allegedly in violation of the Company’s shareholder-approved stock option plans. The complaint
asserts claims for unjust enrichment, breach of fiduciary duties, and waste of corporate assets, and
seeks damages, corporate governance reforms, an accounting, rescission of certain stock option
grants, restitution, and certain injunctive and declaratory relief, including the declaration of a
constructive trust for certain stock options and proceeds derived from the exercise of such options. The
Company has filed a motion to stay the lawsuit pending a decision by the Washington Supreme Court
in a separate proceeding.
The other action, Pirelli Armstrong Tire Corp. Retiree Medical Benefits Trust v. James Sinegal, et al.,
Case No. 2:08-cv-01450-TSZ (W.D. Wash.), was filed on or about September 29, 2008, and names as
defendants the Company’s directors and certain of its senior executives. Plaintiff alleges that
defendants approved the issuance of backdated stock options, concealed the backdating of stock
options, and refused to vindicate the Company’s rights by pursuing those who obtained improper
incentive compensation. The complaint asserts claims under both state law and the federal securities
laws and seeks relief comparable to that sought in the state court action described above. Plaintiff
further alleges that the misconduct occurred from at least 1997, and continued until 2006, and that as a
result virtually all of the Company’s SEC filings and financial and other public statements were false
and misleading throughout this entire period (including, but not limited to, each of the Company’s
annual financial statements for fiscal years 1997 through 2007 inclusive). Plaintiff alleges, among other
things, that defendants caused the Company to falsely represent that options were granted with
exercise prices that were not less than the fair market value of the Company’s stock on the date of
grant and issuance when they were not, to conceal that its internal controls and accounting controls
were grossly inadequate, and to grossly overstate its earnings. In addition, it is further alleged that
when the Company announced in October 2006 that it had investigated its historical option granting
practices and had not found fraud that announcement itself was false and misleading because, among
other reasons, it failed to report that defendants had consistently received options granted at monthly
lows for the grant dates and falsely suggested that backdating did not occur. Plaintiff also alleges that
false and misleading statements inflated the market price of the Company’s common stock and that
certain individual defendants sold, and the Company purchased, shares at inflated prices. The
defendants have yet to file any response to the Pirelli action.
On October 4, 2006, the Company received a grand jury subpoena from the United States Attorney’s
Office for the Central District of California, seeking records relating to the Company’s receipt and
handling of hazardous merchandise returned by Costco members and other records. The Company is
cooperating with the inquiry and at this time cannot reasonably estimate any loss that may arise from
this matter.
On March 15, 2007, the Company was informed by the U.S. Attorney’s Office in the Western District of
Washington that the office is conducting an investigation of the Company’s past stock option granting
practices to determine whether there have been any violations of federal law. As part of this
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