Wednesday, August 10, 2005

Krispy Kreme's Internal Investigation Reports On Accounting Problems

A special committee of Krispy Kreme Doughnuts, Inc.'s board has concluded its investigation of accounting problems and determined that the company engaged in earnings management -- usually a polite way of saying accounting fraud -- that it blames on its former CEO and COO.  A summary of the committee's report (here) adopts an interesting tone, noting that it was unable to ascertain the intent behind some of the transactions but points out that government investigators have tools available to gather more information.  The summary states:

In our view, Scott A. Livengood, former Chairman of the Board and Chief Executive Officer, and John W. Tate, former Chief Operating Officer, bear primary responsibility for the failure to establish the management tone, environment and controls essential for meeting the Company's responsibilities as a public company. Krispy Kreme and its shareholders have paid dearly for those failures, as measured by the loss in market value of the Company's shares, a loss in confidence in the credibility and integrity of the Company's management and the considerable costs required to address those failures.

The number, nature and timing of the accounting errors strongly suggest that they resulted from an intent to manage earnings. All those we interviewed have repeatedly and firmly denied having any intent to manage earnings or having given or received any instruction (explicit or otherwise) to do so. But we never received credible explanations for transactions that appear to have been structured or timed to allow for the improper recognition of revenue or improper reduction of expense. While we believe that our investigation was thorough and more than sufficient to support our conclusions, we recognize that government investigators, who have a broader array of investigatory tools than are available in a private investigation such as ours, may uncover additional facts that will better illuminate the intent behind various individuals' actions and the underlying events.

The company disclosed earlier that the SEC and U.S. Attorney's Office for the Southern District of New York have open investigations into accounting issues, and it may be that one or more officers (likely former employees) refused to cooperate in the investigation; Krispy Kreme provided the internal investigation report to the government but has not yet released it publicly. The government may be able to coax more information from the individuals through immunity grants or plea agreements, a tool not available to internal investigators.  The likely targets of the investigation are Livengood and Tate, so look for agreements with lower-level employees as the government starts to build its criminal and civil cases. (ph)

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