(FORTUNE Magazine) – During a meeting last October, Tom Coughlin, the chief of Wal-Mart's U.S. stores, looked out at a room full of division heads and top line managers and saw that something wasn't right. He rearranged the room, asking people to sit by gender and ethnicity so that they could see what he saw: a whole bunch of white men.

This wasn't the first time that Coughlin had played musical chairs. He's done it at district-manager meetings, year-end meetings--enough meetings with Wal-Mart's managers that he doesn't remember all the wheres and whens anymore. The results--the sea of white men and a sprinkling of minorities and women--"hit me in the eye," he once said. "I've rearranged rooms by ethnicity or gender to try to drive home that we're not all recognizing what our opportunities are relative to finding people in the organization that better represent both the gender and the race issue."

Coughlin's method of instructing his subordinates on the goal of bringing more women and minorities up from the ranks is typically Wal-Mart: Get the point across, state the objective, and then trust that managers will absorb the lesson and act accordingly. It's a method that's simple, entrepreneurial, anti-bureaucratic, and built on trust. And that may be just the problem.

We know about Coughlin's management by musical chairs because he talked about it in testimony in an ongoing sex-discrimination lawsuit filed by seven female employees in California. You can trace the need for Coughlin to answer a plaintiffs lawyer's questions to a day in 1996 when Stephanie Odle found a W-2 form lying around in the Riverside, Calif., Sam's Club where she worked as an assistant manager. The W-2 belonged to a male assistant manager who turned out to be making $10,000 more a year than she was. She says she was told that her co-worker was paid more because he had "a wife and kids to support." When the single mother protested, she was asked to submit a personal household budget. She did and was granted a $40 a week raise. "It was humiliating," says Odle. And she was still making less than the male manager. Odle claims that she was eventually fired for speaking up.

Odle's 1998 EEOC complaint was the catalyst that led 18 plaintiffs lawyers from six law firms in three states to take the sworn testimony of more than 100 women. The lead plaintiff in Dukes v. Wal-Mart, Betty Dukes, says she's been trying to get promoted from the cashier ranks for nine years. Other women tell stories of management trips to strip clubs and business meetings at Hooters. One was allegedly advised that if she wanted a better job she needed to "doll up" more and "blow the cobwebs from her makeup." Another female associate testified that her boss repeatedly justified his favoritism for men by saying "God made Adam first."

On July 25 the plaintiffs lawyers will marshal their evidence and ask a federal district court judge in San Francisco to allow every female Wal-Mart employee going back to 1998 to join the suit as a class action. If the judge does so, Dukes v. Wal-Mart will become the largest discrimination suit in history--covering 1.5 million current and former employees at every Wal-Mart and Sam's Club store in the nation. Numbers can blur when they get that large, so let's think about it for a minute--that's 1.5 million people. The largest sex-discrimination case employment lawyers can think of, against Publix Super Markets, covered a measly 150,000. When Home Depot settled a sex-discrimination class action in 1997, it shelled out $104 million for a class of 25,000.

The immensity of the group is one reason Wal-Mart argues that the class should not be certified. But the real battle is over statistics and whether they show that Wal-Mart engaged in a pattern of discrimination in pay and promotion. There is, naturally, a big gap between how the two sides look at the numbers. The plaintiffs say that men in every job category are paid more than women. Their statistics expert says the average pay for a man who is a store manager--a big prize in Wal-Mart's entrepreneurial system--is $105,682, or $16,402 more than for the average female store manager, a difference that couldn't be explained by seniority. Wal-Mart's experts, on the other hand, concluded that in nine out of ten stores there is no pay difference between men and women. On the promotion front, the plaintiffs argue that women comprise 66% of Wal-Mart's hourly employees but only 33% of the salaried managers, and just 14% of store managers. Wal-Mart counters that women are promoted in the same proportion that they apply for the jobs. Now it's up to the judge to decide whose numbers are more persuasive, and whether the plaintiffs can expand their suit.

As the nation's biggest company and largest private employer, Wal-Mart gets sued a lot. By a lot we mean 6,087 times in 2002 alone, or about once every 90 minutes every day of the year. It is a natural target for the frivolous and the activist. But this suit is not just one of 6,000. What is at stake, by Wal-Mart's own admission, is its reputation as a company that treats its employees with dignity--a place where, as founder Sam Walton declared, there would be "respect for the individual." And this isn't the only challenge to the culture: Unions are trying to organize, and in dozens of suits across the country employees claim they were asked to work off the clock. That's why spokesperson Mona Williams has been on the media circuit, making Wal-Mart's case on the Today Show, CNN, NPR, and the nightly news. (Concern for its reputation as a good place to work may also have influenced the company's decision last week to include gays under its corporate antidiscrimination policies.)

The retailer adamantly denies that there is a companywide pattern of discrimination, but it acknowledges that when you've got three times as many employees as the next-largest public company, some bad stuff is bound to happen. In that sense, the suit has been a wake-up call to Wal-Mart executives to reinforce its corporate values as the company grows both in size and in geographic scope. At the company's annual meeting in June, CEO Lee Scott told shareholders: "We all believe that Wal-Mart is a good place to work. But we all have a responsibility to make sure Wal-Mart is a good place to work for everyone. Everyone must be treated fairly, with equal access to pay and promotion.... And we have a responsibility to make sure managers who don't get this do not get to stay with Wal-Mart." Or as spokeswoman Williams put it: "Clearly we have some work to do. When you have one million people working for you there are always going to be a couple of knuckleheads out there who do dumb things. But they are the exceptions. That's not Wal-Mart."

What Wal-Mart is, however, has a lot to do with its current troubles. Wal-Mart's storied culture has helped build one of the most powerful companies ever. It's a culture built on inspirational leadership, autonomy, and trust. The model is to bring employees into Wal-Mart and convert them to its principles--respect for the individual, customer service, and excellence--and its absolute imperative to buy and sell at the lowest price possible. Then the faithful scatter to stores far and wide. It works well. (See "The Ten Greatest CEOs of All Time.") But look from a different angle, and you can see the potential for barriers.

Consider something as mundane as posting jobs. Wal-Mart is famous for promoting from within; more than two-thirds of its managers started as hourly employees. Hourly jobs are posted within stores, but until the suit was filed, Wal-Mart had never posted openings for the management training position that allows hourly employees to move up to salaried jobs. Most retailers post job openings companywide, according to John Dooney, recruitment expert for the Society for Human Resources Management. They do this, in part, to protect themselves against accusations that promotion decisions are secretive and unfair. So why didn't Wal-Mart announce opportunities throughout the company, especially for entry-level management positions? Because it wouldn't be the Wal-Mart way. Wal-Mart is constitutionally intolerant of grit that slows the wheels of efficiency; Coughlin, who has run the stores division for five years, viewed postings as grit. "I am a little bit of a Doubting Thomas, I guess," Coughlin testified. "Show me how this is going to help us run the business better.... I hate to see bureaucracy grow in the business."

The Wal-Mart way is to trust that store managers will promote those who merit promotion. But from Christine Kwapnoski's vantage point, the trust was misplaced. Kwapnoski, the plaintiff who says she was told to "doll up" if she wanted to rise in the company, works in a Sam's Club in Concord, Calif. She testified that she wanted to become an hourly supervisor, but that there was no application process to follow. "I could only rely upon word of mouth or the Club grapevine. The Club's grapevine was more available to male employees, as they spent more time talking and socializing with management employees."

Take another example. A key ingredient in maintaining the Wal-Mart culture is the willingness to move for the job. Wal-Mart has been growing at an astonishing rate--almost 300 new stores open a year--and the store managers have a big job: A Supercenter can be a $100-million-a-year business with up to 600 employees. The managers make hiring, firing, and promotion decisions, and have leeway to choose products. It's easy to see how these autonomous managers, if left in place for too long, could form fiefdoms and lose touch with the Wal-Mart heartbeat. By constantly moving people around, the Wal-Mart blood circulates to the extremities.

But by the early 1990s even Sam Walton had begun to realize that the relocation imperative had erected a barrier to women. "Traditionally we've had this attitude that if you wanted to be a manager at Wal-Mart you basically had to be willing to move on a moment's notice," Walton wrote in his 1992 autobiography, Made in America (co-written with Time Inc. editorial director and former FORTUNE managing editor John Huey). "You get a call that says you're going to open a new store 500 miles away, you don't ask questions. You just pack and go, then sometime later you worry about selling your house and moving your family.... [It] really put good, smart women at a disadvantage in our company because at the time they weren't as free to pick up and move as many men were. Now I've seen the light on the opportunities we missed with women."

Today they'll tell you in Bentonville, Ark., that relocation is not the requirement it once was. But even Wal-Mart, in its brief to the court, states that "men at Wal-Mart are more willing to relocate for a promotion, thereby increasing their opportunities." Tell that to Odle, the assistant manager. She moved nine times in eight years across three states.

To its credit, the company acknowledges that it can do better. (Even women managers who don't have anything to do with the suit joke that Bentonville is one of the few places where the men's restroom line is longer than the women's.) "We've grown so quickly," says Wal-Mart's Williams. "We've spent so much time making sure we had a world-class distribution system and supplier network that we probably did not pay as much attention to making sure we got the personnel stuff right."

In part because of the suit, Wal-Mart is speeding up some changes. For one thing, the retailer is developing a posting system for all management jobs. The first management-training positions went up for five days in January. After the posting, Kwapnoski finally got her wish: She was promoted into the training program. The company is also developing a formula for pay increases based on evaluation ratings, experience, and other factors in an attempt to make raises more uniform. Later this year Wal-Mart plans to start rolling out a database that will alert employees to specific openings of interest across the country. Wal-Mart will review results for all the new human resources systems quarterly to ensure that they are getting the "fairness" right, says Williams.

One thing the company has not done much is measure diversity, which is tracked only at the district level, not at the stores. It's worth noting because Wal-Mart is famous for collecting and analyzing information. But when it comes to diversity, trust kicks in. "I discuss [it] with every single person that works for me," Coughlin said in his deposition. "I have them identify for me who it is that they've been responsible for developing, moving ahead, relative to people of color and women specifically." But when Coughlin was asked whether these discussions are put into reports or evaluations, he responded: "I'm a big believer in sitting down and talking about topics that are important."

Wal-Mart is obviously not blind to potential obstacles to women's advancement. Coughlin wouldn't be rearranging rooms if the company didn't notice something. The tricky part is making processes unequivocally fair without losing the culture that makes it special. Or as Wal-Mart's Williams says, "We need to change some of the ways we do things without changing who we are." It is, after all, a culture that even the women who are suing Wal-Mart want--or wanted--desperately to be a part of. "I wore Sam Walton's pin from the day I started to the day I got fired," says Odle from her home in Norman, Okla. "I believed in it above and beyond anything else," she says, taking deep breaths so as not to cry. "But it wasn't true."

That's the last thing CEO Scott wants to hear from a Wal-Mart associate. "What we have to realize is that our success and our size have increased our responsibilities," said Scott at the June shareholders meeting. "When we were a small, regional retailer, not much was expected of us. But today it's different." Now it is up to Scott to decide how different he wants Wal-Mart to be.

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