Kmart execs, vendors charged with fraud

CHICAGO (CBS.MW) — The Securities and Exchange Commission filed charges Thursday against three former executives of what is now Kmart Holding Corp. and five former and current managers at vendor companies alleging they conspired to bloat profits by $24 million in fiscal year 2001.

At the same time, the SEC said it had settled the charges with all eight men, none of whom had to admit any wrongdoing.

Shares of Kmart
swung from an earlier gain to lose 29 cents and finish the session at $103.99.

The SEC believes that the Kmart executives plotted with those at Eastman Kodak Co.
Coca-Cola Enterprises Inc.

and PepsiCo Inc.’s
wholly owned subsidiaries, Pepsi-Cola Co. and Frito-Lay Inc.

The SEC said the eight were responsible for Kmart misleading investors with false financial statements that included improper accounting of millions of dollars worth of vendor allowances, according to the filing.

Vendor allowances are discounts retailers get from manufacturers to co-promote or market certain products or events. The SEC alleges that Kmart “pulled forward” or prematurely recognized a “significant number of allowances” based on false information supplied to the retailer’s accounting department.

To make matters worse, the SEC believes the “true terms” of the payments were set up in “side agreements” in an effort to meet the top brass’ earnings expectations. They didn’t work. Kmart filed for the largest retail bankruptcy in U.S. history on Jan. 22, 2002.

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Former Kmart executives John P. Orr, Michael K. Frank and Albert M. Abbood were charged with fraud in the scheme. Abbood paid a $50,000 civil fine, but Frank did not get one because of his “demonstrated inability to pay,” the complaint said. An SEC statement did not report any fine for Orr.

Orr, who was divisional vice president of Kmart’s photo division, and Frank, divisional vice president of Kmart’s food and consumables division, also were permanently barred from serving as an officer or director of a publicly traded company. Abbood was a divisional vice president of nonperishable products in Kmart’s food and consumables division.

Orr was fired in February 2001 and Frank in May 2002; Abbood voluntarily left the company in October 2001.

On the vendor side, charges were leveled against Darrell Edquist, a former vice president and general manager of Eastman Kodak; David C. Kirkpatrick, a former national sales director for Coca Cola Enterprises; David N. Bixler, a former national sales director of PepsiCo’s Pepsi-Cola division who is now vice president and general manager of PepsiCo; Randall M. Stone, a former national account manager for PepsiCo’s Frito-Lay division; and Thomas L. Taylor, a former director of sales for PepsiCo’s Frito-Lay division.

Edquist paid a $55,000 civil fine, Stone paid $30,000 and Taylor paid $25,000. The SEC statement did not report any fines for Edquist or Kirkpatrick.

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On the balance sheet, vendor allowances effectively reduce the cost of goods, which in turn inflate the profit margin. However, under generally accepted accounting principles, allowances should only be recorded in the period that they are earned and with the corresponding income for the period related to them. The SEC charges claim that Kmart used an accrual method to account for the allowances.

The SEC alleged that “Kmart’s profitability became increasing dependent on allowances in the years preceding bankruptcy.” In fiscal 2001, Kmart reported that it made $219 million, or 48 cents a share, excluding special charges. That appeared to be a penny ahead of Wall Street’s average expectation.

However, the results included the $24 million in unearned allowances that had contributed about 10 percent to the bottom line.

In its filing, the SEC seemed to rationalize the actions. “Kmart’s accrual methodology, together with senior management’s unrealistic earnings expectations, put tremendous pressure on Kmart officers and employees at the end of the fiscal year to collect allowances,” the complaint stated.

“A number of them responded to these pressures by submitting false information to Kmart’s accounting department.” Meanwhile, “vendors participated by co-signing false or misleading accounting documents, executing side agreements and, in some instances, providing false or misleading third-party audit confirmations.”

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Last year, federal prosecutors dropped their fraud case against former Kmart executives in the middle of their trial on charges that they conspired to beef up earnings.

The company, which is under a new name with new management, has not been charged with any civil or criminal misdoings.

The SEC said it is continuing its investigation into Kmart.

Eastman Kodak said it cooperated with the SEC and that the new charges “represent the end of the matter for Kodak.”

“Our only comment is that Eastman Kodak has not been accused of wrongdoing,” a spokesman said.

A PepsiCo spokesman said his company cooperated with the commission, but was unable “to comment on the specific employees mentioned in the SEC statement.”

A Coca-Cola Enterprises spokeswoman said her company also cooperated with the SEC investigation and that its employee named in the filing – Kirkpatrick — was terminated in January 2004.

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