Class Accuses Tile Shop Holdings of Nepotism

(CN) — A Tile Shop investor says company insiders sold off more than $100 million of their shares during two public stock offerings without revealing major conflicts of interest with its Chinese supplier that led it to sell lead-contaminated tiles.

Shareholder David Thomson filed a derivative action against CEO Chris Homeister and eight other corporate officers based on a series of alleged accounting missteps, financial misrepresentations, and lack of internal controls.

Thomson cites a report by Infitialis Research Collective, published in the influential investing blog Seeking Alpha in 2013, showing that the Tile Shop's products have "dangerous lead contaminations, up to 13,900 percent greater than the U.S. Consumer Product Safety Commission limits for products that come in contact with children."

One month later, a different firm, Gotham City Research, published a report identifying numerous conflicts of interest and financial misstatements, and making allegations of nepotism that resulted in the purchase of the lead-contaminated tiles.

"According to the Gotham City Report, Tile Shop acquired substantial amounts of product sold in fiscal 2011, 2012 and 2013 from a Chinese supplier owned and operated by defendant [former CEO Robert] Rucker's brother-in-law, Defendant Fumitake Nishi," the complaint states.

The Tile Shop's share price fell 49 percent to a low of $12.95 in the wake of these two reports, Thomson says.

The company admitted to Nishi's receipt of $1.1 million in unsubstantiated payments from Chinese vendors, according to the complaint, but denied any material misstatement in its SEC filings.

It therefore instituted no measures to improve its accounting methods, leading to its failure "to determine the correct figures for its inventory payments as well as the expense for products later sold to customers, including the reported 69-70 percent operating margins plugged by the individual defendants," the complaint says.

Prior to both of these revelations, the Tile Shop made two public offerings in December 2012 and June 2013, raising a total of $195 million.

But at the same time, company executives who knew the truth about the company's contaminated tiles and weak internal controls "sold over $112 million worth of company stock at artificially inflated prices, thus enriching themselves at the expense of Tile Shop," the complaint says.

Thomson claims he made a pre-suit demand on the board to investigate the named defendant officers, but it "failed to substantively respond."

The Tile Shop's share price has never returned to its 2013 trading levels. It closed Friday at $15.75 per share.

"To this day, the Company remains under the control and/or influence of the primary wrongdoers, namely the Board and the company's executives," Thomson says.

He claims the executives' conflicts of interest and breach of fiduciary duties have left the company "unable to self-govern," necessitating this lawsuit.

Thomson is represented by Brian Farnan in Wilmington, Delaware and Phillip Kim with The Rosen Law Firm in New York.

The Tile Shop did not immediately respond to a request for comment made after hours.

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