Risk Management

Bad Play: Mattel Sued for Keeping Mum on Toy Defects

Lapsed reporting was standard policy at Mattel for years, leading to repeated false and misleading financial reports, the complaint charges.
Stephen TaubOctober 10, 2007

Mattel shareholders have filed a derivative lawsuit alleging that the company regularly delayed contacting federal regulators about possible defects in its toys after learning about the problems. Some of the delays date back to the 1990s, the suit claims.

The lawsuit was filed in Delaware Chancery Court by law firm Grant & Eisenhofer on behalf of Sterling Heights Police & Fire Retirement System, the public pension fund of the police and fire departments of Sterling Heights, Mich. The fund, which continues to be an investor in Mattel, brought the action on behalf of all Mattel shareholders.

The suit points out that since August, Mattel has initiated three major recalls, resulting in the removal of 21 million toys from store shelves worldwide.

Some of the take-backs were the result of illegal lead paint that Mattel claims was used without company knowledge by a Chinese subcontractor. But a large segment of the recalls derived from what Mattel has admitted were its own design flaws for toys containing small magnetic parts that, if ingested, could cause serious internal injuries, according to a press release from Grant & Eisenhofer.

The investors accuse the company of breaching fiduciary duties by flaunting consumer protection laws. They also charge Mattel executives and board members of hiding behind the delays “to make substantial insider profits” on stock sales before the bad news became public with regulatory disclosures and large-scale recalls.

The investors are seeking a disgorgement of profits by company insiders “who dumped large amounts of Mattel shares ahead of the worst of the disclosures earlier in 2007.”

The Mattel investors are also asking for compensatory and other damages as a result of what they allege to be “the board’s ongoing failures to manage its product woes, including making timely disclosure to regulators.”

The lawsuit further alleges that lapsed reporting was standard policy at Mattel for years and led to repeated false and misleading financial reporting to investors, who saw Mattel’s share price fall more than 20 percent in the wake of the recalls.

Under strict reporting requirements by the Consumer Protection Safety Commission, companies are obliged to contact the agency within 24 hours with any information about possible safety issues of a product, especially if it “contains a defect which could create a substantial risk of injury to the public or presents a … risk of serious injury or death,” according to the investors. They also point out that under other sections, the CPSC instructs manufacturers and distributors to “immediately inform the Commission” of any defects or risk stemming from a product sold.

“However, as it turns out, Mattel appears to have operated under its own timetable in informing the CPSC when problems arose in its quality control,” they investors add. “News reports indicate that the company knew about serious risks associated with magnetic parts in its toys long before the recall, but waited many months to contact the Commission pending the outcome of its own internal inquiries.”

The complaint alleges that similar delays held up reports of lead paint findings, even though the amount of lead particles detected in some Mattel toys ultimately tested at levels 180 times greater than the trace amounts allowed under U.S. law.

“While no one is accusing Mattel of intentionally bringing shoddy and dangerous toys to market, our suit makes the case that the company has repeatedly shirked its responsibilities under the law to come clean with regulators, consumers and investors when problems have arisen with its products that could jeopardize public safety, especially when those problems could lower sales and put a dent in earnings,” said Grant & Eisenhofer partner Jay Eisenhofer, who represents the pension fund.

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