Accounting Bag of Tricks Produces Another Scheme in Kmart Case
Dec. 14, 2004 (Associated Press) — Another accounting sleight of hand has been exposed in the latest charges against former executives of Kmart Corp.: the allegedly premature booking of millions in promotional payments to the retailer from chips and soda suppliers.
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The foodservice industry has become a focal point for the government's investigation of accounting artifices, as evidenced by the settlement on Dec. 2 of civil fraud charges with several former Kmart officials, and ex-sales managers at vendors Eastman Kodak, Coca Cola, PepsiCo and Frito-Lay.
The Securities and Exchange Commission said in its lawsuit that payments from the vendors were prematurely counted, or "pulled forward," based on false documents provided to Kmart's accounting department. The deceptive scheme caused Kmart to overstate earnings in 2000-2001 by $24 million, or 10 percent, the SEC alleged.
The SEC has lodged similar allegations in recent months against grocery distributor Fleming Cos. and Dutch supermarket operator Ahold NV, the latter in a scandal involving its distribution subsidiary U.S. Foodservice Inc.
In the Fleming case, dairy products suppliers Dean Foods and Kemps LLC agreed to pay civil fines in settlements with the SEC. Executives of those companies, and former managers at Frito-Lay and Kraft Foods, also paid fines.
Another consumer product, pharmaceuticals, was the subject of a $150 million accounting-fraud settlement last summer between the SEC and Bristol-Myers Squibb Co., accused of manipulating its inventory of drugs to inflate earnings and meet Wall Street targets.
The drug maker has said that it overstated revenue for 1999-2001 by $2.5 billion as a result of its having given wholesalers deep discounts to buy more prescription medicine than they could sell. According to the SEC, Bristol-Myers sold excessive quantities of drugs to wholesalers and improperly booked - at the point of shipment - revenue from $1.5 billion of those sales to its two biggest wholesalers.
The insider term is "channel stuffing" - that is, packing distribution channels with excess inventory, which Bristol-Myers was alleged to have done near the end of quarters. The practice is legal, but some industry observers have called the level at the pharmaceutical giant excessive.
Accounting rules are complex and can be somewhat fuzzy in some areas, giving companies straining to hit quarterly profit targets an opportunity for creative bookkeeping.
The problems came at companies where a permissible level of practices used to manage earnings "segued into distortions and spin, and later into fraud," said Roy Smith, a finance professor at New York University.
When Enron Corp. imploded in 2001, accountants shed the last vestiges of their old image as plodding bookkeepers with sleeve garters and green eye shades. They are seen as increasingly deft at exploring the gray areas of the rule book where red ink can become black - until the regulators find otherwise.
In a scheme notable for its chutzpah, Internet titan America Online Inc. is said to have counted as revenue the free-trial subscription disks it sends through the mail and stocks in stores, as if some recipients were already signed up and paying. Many disks never see the inside of a computer.
Then there were the swaps of fiber-optic network capacity between Global Crossing Ltd. and Qwest Communications International Inc. and other telecom companies. The SEC has alleged in Qwest's case that the swaps were intended to artificially boost revenue by hundreds of millions of dollars. The regulators have been investigating whether the same was true for Global Crossing.
The SEC and the Justice Department opened a new questionable-accounting front last week, signing agreements with insurance giant American International Group Inc. under which it is paying $126 million to settle allegations of aiding accounting fraud by other companies.
AIG is said to have improperly sold insurance contracts to two companies, PNC Financial Services Group Inc. and Brightpoint Inc., to help them smooth earnings volatility from quarter to quarter. The relatively new practice, which is legal in principle and common in the insurance industry, has recently come under scrutiny by regulators for how it is executed.
AIG's sales to the companies allegedly involved what appeared to be insurance but didn't include any actual transfer of risk from them to the insurer.
The SEC said that, for a fee, AIG offered to establish special-purpose entities to which companies could transfer troubled or potentially volatile assets.
Special-purpose entities have a familiar ring. They were the linchpin at Enron that kept poorly performing assets off the balance sheets and falsely manufactured earnings, and eventually helped fuel the company's stunning collapse.
The SEC last year went after three Wall Street powerhouses - Citigroup, Merrill Lynch and J.P. Morgan Chase - for allegedly helping Enron fraudulently inflate its profit with complex financing deals. The three investment firms paid a total $316 million in settlements.
-- Marcy Gordon
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