Kmart accused of lying

["Charles Brown" <CharlesB@xxxxxxxxxxxxxxxxxxxxx>]

Kmart accused of lying
Whistleblowers claim execs misled and accountants knew

By Karen Talaski and David Shepardson / The Detroit News


  TROY -- An anonymous letter that launched a federal investigation of Kmart Corp. in January alleges that former top Kmart executives made questionable accounting moves that distorted the company's financial position and misled shareholders.
   The Jan. 9 letter, which was obtained by The Detroit News, purports to be from a group of employees in Kmart's finance division. It was sent to the U.S. Securities and Exchange Commission's enforcement division, which subsequently began a probe of the charges.
   The employees claim to have information regarding the inaccurate recording of transactions as well as recorded conversations of executives discussing financial distortions and misstatement of records.
   The two-page letter alleges that senior Kmart officials purposely violated standard accounting principles. It also charges that independent auditors from PricewaterhouseCoopers LLC knew about the accounting irregularities but didn't question them.
   Kmart has acknowledged that it is under investigation by both the SEC and U.S. Justice Department and it is cooperating with both probes.
   Assistant U.S. Attorney Steve Robinson, a lawyer in the economic crimes section assigned to the Kmart investigation, said the letter obtained by The News is identical to the one in the government's possession.
   The letter paints a portrait of widespread deception at the nation's second largest discount retail chain. Kmart sought protection from its creditors Jan. 22 under Chapter 11 of the U.S. Bankruptcy code. It is the largest retail bankruptcy in history. Kmart's stock has lost about 90 percent of its value, closing Tuesday down 2 cents at $1.16.
   The charges of accounting misconduct are being made in the wake of the collapse of Enron Corp. amid questionable accounting transactions by its auditor, Arthur Andersen LLP.
   Allegations of accounting irregularities at Kmart and scores of other companies in recent months are contributing to questions about corporate credibility in America and about whether accounting standards need to be raised to protect stockholders.
   Officials at the Troy-based retailer wouldn't comment on the letter or the resulting investigation. David Nestor, a spokesman for PricewaterhouseCoopers in New York, said the company also could not comment on the letter.
   Separately, Kmart Thursday reported a $1.02 billion loss for the month of April. Last month's loss includes about $219 million in expenses related to the store closings, such as lease terminations and severance pay. Kmart also recorded costs of $760 million as it discounted items for going-out-of-business sales and reduced prices on other merchandise to cut inventory.
   Kmart acknowledged in January that it had received an anonymous letter "expressing concern regarding unspecified accounting matters." The company has started its own investigation using an independent law firm and auditors.
   Last week, Kmart said its internal investigation prompted the company to change an accounting method that deals with payments from vendors. As a result, Kmart restated all of its 2001 earnings. The retailer reported a $2.4 billion loss for last year.
   The SEC and the U.S. Attorney's Office for the Eastern District of Michigan launched their own investigations into Kmart's accounting methods after receiving the letter. The Federal Bureau of Investigation, which is handling the investigation for the U.S. Attorney, has said its investigation could result in criminal charges, although officials were unable to give further details.
   "Kmart has been very cooperative" in the investigation, Jeffrey G. Collins, the U.S. attorney for the Eastern District of Michigan, said Thursday.
   Robinson, the assistant U.S. attorney, said that more than one letter has been received and that the government would like to talk to the anonymous authors. He said the government has the power of the federal grand jury to protect the identity of employees. However, he said that if there were an indictment, the identity of grand jury witnesses could eventually be made public.
   The unidentified authors of the letter say that in their jobs in the company's finance division they were directed to manipulate Kmart's accounts in violation of standard accounting principles.
   "Many decisions to change or restate entries were made immediately following the departure of our previous Chief Financial Officer Jeffrey Boyer, who had directed us to closely follow standard accounting principles," the letter says. "Income statements for the third quarter of our fiscal year were restated as a result.
   "We are now closing our books for the full fiscal year making even more improper entries," the letter says. "We have been clearly told that questioning any accounting practices will be viewed as unacceptable team behavior."
   Boyer left Kmart "to spend more time with his family," according to a Nov. 9 company news release.
   He was replaced by John T. McDonald Jr., who joined Kmart in September 2000 as a hire of former Kmart Chairman Charles C. Conaway. McDonald formerly worked at CVS Corp., where Conaway was president and chief operating officer. McDonald, who could not be reached for comment, left the company in March.
   Kmart's auditors, PricewaterhouseCoopers, were aware of the situation, the letter alleges.
   "Resident auditors from PricewaterhouseCoopers are hesitant to pursue these issues or even question obvious changes in revenue and expense patterns," the letter states. "We are sending this letter to PricewaterhouseCoopers regional and national offices hoping they will direct a more thorough review of practices. If questions are asked, we will provide copies of the files we have kept."
   The letter indicates that the group kept track of the alleged distortions and has a variety of documents available for investigators.
   "We have also recorded conversations during which distortions and misstatement of records were discussed," the letter says, including comments by former Kmart President and Chief Operating Officer Mark Schwartz.
   The letter concludes: "Something is very wrong at Kmart Corporation. We ask you to act immediately to protect the interests of Kmart shareholders and employees."
   Nestor, the PricewaterhouseCoopers spokesman in New York, said: "We did receive a copy of the letter, and we are working with the company in their investigation."
   As part of its bankruptcy reorganization, Kmart is closing 283 stores and is laying off 22,000 employees. None of these employees will receive severance pay.
   In the months before Kmart's filing, 26 of its top executives took home $28.8 million in "retention loans" and severance packages. These deals are now under a so-called stewardship review by the Kmart board. Among those under review are two loans worth a total of $2.5 million to McDonald and a $3 million loan to Schwartz that was forgiven.


Complaint letter
   On Jan. 9, a group describing themselves as employees in the finance department of Kmart sent a letter to the Securities and Exchange Commission raising concerns about the company's accounting practices. Some excerpts:
 "On several occasions we have been directed to post and summarize transactions in obvious violation of (generally accepted accounting) standards."
 "We are now closing our books for the full fiscal year making even more improper entries. We have been clearly told that questioning any accounting practices will be viewed as unacceptable team behavior."
 "Resident auditors from PricewaterhouseCoopers are hesitant to pursue these issues or even question obvious changes in revenue and expense patterns."

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You can reach Karen Talaski at (313) 222-2319 or ktalaski@xxxxxxxxxxxx