A shareholder lawsuit accuses Costco Wholesale
Corp. insiders of illegally backdating stock options, and it proposes
removing senior managers and board members involved.

· Read the complaint (PDF)

The lawsuit alleges that Costco leaders were part of a scheme to
manipulate information to "secretly maximize" personal profits. The
scheme reaches back to 1997, the lawsuit says.

Shareholder Sandra Donnelly, with the help of Bellevue and San Diego
law firms, filed the suit in King County Superior Court on July 17 on
behalf of Costco against 20 of its current and former leaders.

"Costco's business reputation has been severely damaged by
defendants' selfish actions, which portray a company compromised by a
systemic lack of managerial integrity," the suit says.

Issaquah-based Costco, the largest U.S. wholesale club chain, would
not comment on pending litigation, a spokesman said Thursday.

The U.S. Attorney's Office opened a grand jury investigation into
Costco's stock option granting practices March 15, 2007, to determine
if the company had violated federal law. That investigation was
continuing as of Thursday.

"The evidence is in the complaint and the complaint is based on
publicly available sources," said Jim Fosler of Fosler Law Group Inc.,
the Bellevue company co-handling the suit. The primary Bellevue lawyer
in the case was not available Thursday because of a death in the
family, and Fosler did not know how to reach the plaintiff.

The San Diego law firm Robbins Umeda & Fink LLP, which specializes in shareholder litigation, did not return repeated calls.

Before June 2006, Costco used stock options to compensate executives
and more than 1,000 of its employees. Stock option grants are a widely
accepted compensation practice that gives the recipient the option to
buy stock at a certain price. (For example, if someone has an option to
buy stock for $10, and the stock's market price rises to $25, then the
option is worth the difference, because someone can exercise the option
and immediately sell the stock, netting a $15 profit.)

Stock options are designed to align the interests of executives and
shareholders, because executives benefit when the price rises.

Backdating is when a company misrepresents the date of a stock
option grant to make it appear as if the stock was awarded at a cheaper
price. The practice can line executives' pockets with shares they can
sell for a profit without risk. Backdating also cuts tax expenses,
resulting in tax fraud.

The lawsuit against Costco executives alleges, "Several options
grants were consistently dated at monthly lows." The odds that the
company would have by chance picked the lowest price of a particular
month for an option award are 1 in 694, according to statistical
analysis cited in the lawsuit.

The Securities and Exchange Commission, the Justice Department and
the Internal Revenue Service have opened investigations into more than
100 companies suspected of backdating options.

"Backdating isn't just a way for insiders to distort how much
they're really paying themselves and others in the company � it also
involves issuing stock at cheaper prices than what would be paid if the
rules had been followed," SEC Chairman Christopher Cox said in a May
2007 speech in New York. "For that reason, it threatens a company's
shareholders in a very direct way."

The 67-page Costco lawsuit carries some serious accusations, but it
appears to make at least one math error. On page two, the lawsuit notes
that Costco executives received grants March 13, 2000, when the price
was $43, and that the company's share price "more than doubled over the
following four weeks."

For that to be true, the price would have had to be more than $86,
when in reality, on April 13, 2000, the stock closed at $54.63. Costco
stock has never closed above $80.

Costco acknowledged in October 2006 some "imprecision" in its option
dating owing to sloppy record-keeping, but not illegal behavior. In
light of a growing awareness of stock option scandals, the company had
commissioned its own review of its stock option practices.

Directors Dan Evans, a former governor and U.S. senator; Bill Gates
Sr., the father of Microsoft's Bill Gates; and Charles Munger, vice
chairman of the board for Berkshire Hathaway Inc., conducted the review
along with independent counsel and forensics experts. (Munger is one of
the 20 named in the shareholder lawsuit.)

The three directors found that in April 1997, Chief Executive Jim
Sinegal and Chairman Jeff Brotman each benefited from up to $200,000 in
questionable stock option grants. Chief Financial Officer Richard
Galanti also had received grants for which record-keeping was not done
properly. Both Galanti and Sinegal opted not to receive bonuses in 2006.

"I take full responsibility for the fact that the administration of
our stock option program did not live up to the high standards we
follow in other aspects of our business," Sinegal said in 2006. "We
believe that the steps we have taken should put this issue behind us
both from a financial statement and a controls standpoint."

After Costco disclosed the grand jury investigation, Wall Street
reacted with a yawn � the stock price rose 26 cents � suggesting that
shareholders were not alarmed.

On March 26, 2007, Sinegal voluntarily paid $200,000 to Costco, "to
avoid any question about whether he personally benefited from the
original measurement date," the company said.

Stock option grants are no longer used at Costco. In June 2006,
Costco abandoned them in favor of restricted stock units � in keeping
with a trend among publicly traded companies. (An option gives one the
right to buy shares at a certain price, whereas, a restricted stock
unit is a reward of a certain number of shares at face value, with no
set "buy" price.)

The suit seeks unspecified financial damages and internal company reforms.

Costco's shares closed Thursday at $62.68. They've traded between $56.09 and $75.23 in the past year.