December 3, 2004
Kmart Securities Fraud Civil Case
The SEC filed a civil injunctive action (Dec. 2) against three former Kmart executives and five employees of three vendors related to a scheme to inflate the company's earnings by $24 million through improper accounting for vendor payments. The former Kmart employees are John Paul Orr, former Divisional Vice President of Kmart's photo division; Michael K. Frank, former Divisional Vice President and General Merchandise Manager of Kmart's food and consumables division; and Albert M. Abbood, former Divisional Vice President of non-perishable products in Kmart's food and consumables division. The vendors are Eastman Kodak Company, Coca Cola Enterprises Inc. and two PepsiCo Inc. wholly-owned subsidiaries, Pepsi-Cola Company and Frito-Lay, Inc. According to the SEC's Litigation Release:
[I]ndividuals caused Kmart to issue materially false financial statements by improperly accounting for millions of dollars worth of vendor "allowances." Kmart obtained allowances from its vendors for various promotional and marketing activities. According to the Complaint, defendants caused Kmart to recognize allowances prematurely on the basis of false information provided to the company's accounting department. A number of vendor representatives participated in the fraud by co-signing false and misleading accounting documents, executing side agreements, and, in some instances, providing false or misleading third party confirmations to Kmart's independent auditor, Pricewaterhouse-Coopers LLP. As a result, Kmart's net income for the fourth quarter and fiscal year ended January 31, 2001, was overstated by approximately $24 million or 10 percent, as originally reported. The company restated its financial statements after filing for bankruptcy to correct these and other accounting errors.
Two of the Kmart defendants, Frank and Abbood, agreed to settle the action with the entry of a permanent injunction, payment of a civil penalty of $50,000 by Abbood, and a five-year bar from serving as a director or officer of a publicly-traded company by Frank. Frank did not have to pay a penalty due to his lack of resources. Three of the vendor defendants settled with the Commission and agreed to the entry of a permanent injunction and to pay civil penalties totaling $110,000.
The SEC notes in its Litigation Release that the investigation is continuing. Earlier this year, a criminal prosecution against two mid-level Kmart executives for a similar accounting fraud involving vendor payments collapsed when the government's second witness admitted that she had received information from the executives regarding the proper accounting for the payments. The SEC subsequently dismissed its civil action against the same defendants. There were large retention payments and forgiven loans paid to senior Kmart executives not long before the company declared bankruptcy, but to this point no civil (or criminal) charges have been filed against Kmart's top managers. One wonders whether the investigation is continuing or whether it has hit a dead end, especially given how much time has passed since the company's problems were revealed. (ph)