Costco Accused of Hiding Sources of Luxury Products

MINNEAPOLIS (CN) – An investment company says it lost millions over Costco’s use of shady middlemen to erase the true origin of luxury goods for its treasure-hunt promotions, a tactic used because luxury manufacturers won’t sell directly to the warehouse-club retailer.

Ritchie Capital Management Ltd. and Ritchie Special Credit Investments Ltd. sued Costco Wholesale Corporation in Hennepin County District Court on Friday, claiming Costco has been forming relationships with middlemen who obtain luxury goods from authorized dealers and divert those goods to the retailer.

Costco sells these exclusive high-end, luxury-brand items for a limited time during its treasure-hunt promotions, according to the lawsuit.

“Costco Wholesale Corporation draws customers into its membership warehouse stores to ‘hunt’ for the ‘treasure’ of luxury goods at significantly discounted prices. One week it might be designer handbags. The next, flat-screen televisions,” the complaint states. “To lure customers for each ‘treasure hunt,’ Costco must continually locate and stock new luxury goods. That, however, is easier said than done because manufacturers of luxury goods often won’t sell to Costco for fear that doing so will tarnish and devalue the luxury image of their brands.”

Ritchie Capital claims Costco has found away to go around the distribution restriction of these luxury manufacturers by creating a "grey market" of distribution channels, which involves moving products from authorized-sale chains to Costco through the use of "middlemen diverters.”

Once Costco finds a desired product, it issues a purchase order to a middleman for the requested goods, according to the complaint. After the middleman locates a supplier and obtains financing, Costco allegedly cancels the original purchase order and reissues the order to the financier.

Then, Costco and the financier enter into a contract that designates the financier as the "vendor" of the goods, before the financier pays the supplier who in turn ships the products directly to Costco, according to Ritchie Capital.

To protect its middlemen and its access to these luxury goods, Ritchie Capital alleges Costco routes these goods through "sanitation warehouses" to remove, obscure or falsify the packaging, shipping labels, SKUs and paper work relating to the goods. After these products are "sanitized," Ritchie Capital says the manufactures, consumers, and lenders have no way of tracing them.

One of the middlemen who served as a diverter and financer for Costco was Ponzi-schemer Tom Petters, according to the lawsuit. Petters was convicted of 20 counts of fraud in 2010 and is now serving a 50-year sentence in federal prison.

Before that, in March 2008, Ritchie Capital and Ritchie Special Credit loaned $31 million to Petters so that he could purchase 232,500 Sony PlayStation 3 video-game consoles for sale to Costco, the complaint states.

Ritchie Capital says it was unable to obtain the promised security interest in the video-game consoles because of Costco's practice of hiding the true origin of the goods through what Ritchie Capital calls the "sanitation process."

The investment company alleges it lost the $31 million as a direct result of Costco's "sanitation fraud” after Petters was busted by the FBI.

“Plaintiffs, who financed the purchase of millions of dollars in luxury goods for Costco treasure hunts, were unable to obtain security interests in financed goods due to Costco’s violations of Minnesota’s consumer statutes and lost their investment in those goods,” the complaint states.

Once Petters' fraud came to light, Costco immediately tried to downplay the relationship, according to the complaint, including a senior manager testifying at the Petters trial that Costco did "very little" business with him in 2000, and neither Costco nor its affiliates were doing business with him by 2008.

Ritchie Capital says it learned in 2014 that Costco's testimony at Petters' trial was misleading. According to the complaint, Costco used Petters in 2000 as a middleman diverter to assist in the purchase and delivery of $11 million worth of Razor-brand scooters. In 2003, Petters allegedly acted as a middleman in three separate transactions totaling $20 million, this time involving handbags for luxury brands Fendi, Prada, Coach, Christian Dior and Burberry.

Sony Televisions, "Precious Moments" figurines, Nike clothing, and Tumi luggage are also luxury-brand goods that have been "sanitized" by Costco, according to Ritchie Capital.

Ritchie Capital seeks damages against Costco in excess of $50,000 for claims of consumer fraud and deceptive trade practice. It is represented by Lawrence M. Shapiro with Greene Espel PLLP in Minneapolis.

Costco declined Tuesday to comment on the lawsuit.

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