Prosecutors Drop Kmart Fraud Case

Star witness contradicts herself on the stand; jury is ''openly incredulous.'' Also: Vanguard presses governance issues; SEC's jewelry probe widens; PriceSmart restates results; and more.


Two Kmart executives are off the hook after U.S. prosecutors dropped their fraud case against the individuals.

It seems the government’s star witness contradicted herself during testimony, making it difficult for the government to get a conviction, according to Reuters, citing a lawyer for one of the defendants.

“In light of the testimony and evidence presented during the trial to date, it was more likely than not that the evidence would not sustain a conviction,” said Jeffrey G. Collins, U.S. Attorney for the Eastern District in Michigan, in a statement issued Friday.

In February, Enio A. “Tony” Montini Jr., a former Kmart senior vice president and general merchandise manager, and Joseph Hofmeister, a divisional vice president of merchandising, were indicted for allegedly engaging in a $42.3 million fraud to enable the company to meet financial targets. They were charged with securities fraud, making false statements to the Securities and Exchange Commission, and conspiracy to commit those offenses, according to published reports.

In addition, the SEC accused Montini and Hofmeister of accounting fraud.

According to the indictment, Montini and Hofmeister negotiated a multiyear contract with one of Kmart’s vendors — American Greetings Corp. — for $42.3 million. The two individuals lied to Kmart accounting personnel and concealed a side letter that called for the repayment of the money under certain circumstances, the indictment notes.

As a result of the scheme, Kmart improperly recognized the entire amount in the quarter ended August 1, 2001, instead of over a period of time, according to the SEC’s complaint. The alleged deceptions also caused Kmart to understate losses.

“The government’s case collapsed completely when the star witness was shown to be a liar on the stand, and the jury was openly incredulous at her testimony,” Jonathan Graham, a lawyer for Montini, told Reuters.

Graham also said that he thought a separate case against Montini and Hofmeister, filed by the SEC, would have to be dismissed. “It’s the exact same case based on the exact same witnesses, filed on the exact same day,” Graham told the wire service.

In Monday’s Wall Street Journal, Tom Newkirk, associate director of the SEC’s enforcement division, said, “We’re going to review the evidence, take a fresh look and decide how to proceed. We have a different standard of proof” than the Justice Department. Because the SEC brings its cases in civil court rather than criminal court, it does not need to prove its case “beyond a reasonable doubt,” but rather by a preponderance of the evidence.

(To learn more about how the company has dealt with questionable accounting, see “Kmart: Out of the Box?“, part of our special report on corporate cleanups.)

Vanguard Presses Governance Issues

Vanguard Group, the mutual funds giant whose obsession with very low fees has made it the unofficial champion of the small investor, is turning up the governance heat on Corporate America.

In a letter fired off last week, the second-largest mutual fund company warned the chief executive officers of several hundred of its largest holdings that “there is much more change needed” in corporate governance,” according to The Wall Street Journal.

This is not merely tough talk. Vanguard has recently demonstrated a willingness to oppose companies in hundreds of proxy votes. For example, this year Vanguard voted for only 29 percent of the full slates of directors proposed by companies in which it has investments. This compares with the 90 percent that it approved last year, according to the Journal.

Vanguard also voted in favor of 79 percent of its companies’ auditors, also down from 100 percent the prior year, according to the paper. What’s more, Vanguard approved 36 percent of employee-option plans, the same number as last year.

Vanguard now votes against directors who are on the board’s audit, nominating, or compensation committees if they are not considered independent of management, the paper said.

Vanguard is clearly not a renegade — shareholder activism in general seems to be catching fire. For example, this year a record number of proposals from shareholders was approved, the paper noted.

According to Institutional Shareholder Services Inc., 164 shareholder resolutions attracted majorities for issues such as staggered boards and executive compensation. Last year, a then-record 106 resolutions received majorities.

Now, don’t forget these resolutions are not binding. But they do send a powerful message to management.

SEC’s Jewelry Probe Widens

Jewelry retailer Whitehall Jewellers Inc. said last week it received a subpoena from the SEC as part of a formal investigation regarding a lawsuit brought by Capital Factors.

Whitehall is one of 14 defendants in the lawsuit. The company said the SEC is seeking documents related to the matter and will continue to cooperate fully with the SEC’s formal investigation.

Capital Factors, a wholly-owned subsidiary of Tennessee bank Union Planters Co., alleges that Cosmopolitan Gem Corp., another former vendor, defrauded Capital into advancing funds to Cosmopolitan by misrepresenting Cosmopolitan’s finances and the profitability of its operations. Capital also alleges that Whitehall, among other jewelry retailers, helped or participated in the alleged fraud.

In addition, the United States Attorney for the Eastern District of New York is conducting a criminal investigation related to the issues raised by Capital Factors in its lawsuit. Whitehall said it is a subject of a criminal investigation and is cooperating fully with the United States Attorney.

In early October, jewelry retailer Friedmans Inc. said it was the subject of a U.S. Justice Department investigation into the Capital Factors allegations.

PriceSmart Restates Results

PriceSmart Inc. said it will restate its financial results for fiscal year 2002 and the first three quarters of fiscal 2003 after overstating revenues by more than $29 million.

The restatement, however, will not affect the company’s net profit or loss per share or its balance sheet, the company added. PriceSmart, which operates membership shopping warehouses, said several transactions that took place between October 2001 and May 2003 did not satisfy revenue recognition criteria and were improperly recorded as net warehouse sales on the company’s statements of operations.

As a result, net warehouse sales were overstated during fiscal 2002 by about $16.6 million (2.7 percent), and during the first nine months of fiscal 2003 by roughly $12.7 million (2.5 percent).

The company said the decision to restate centers around information obtained by its internal audit and accounting departments and additional information gathered as part of an independent investigation. After deciding to restate these results, PriceSmart said it also decided to correct other “known errors,” which it insists are not material to the company’s consolidated 2002 financial statements.

In addition, in the process of closing its financial statements for fiscal 2003, the company said it identified accounting errors that occurred primarily in the company’s Guam and Philippine operations, which will be corrected in the appropriate prior periods.

As a result of the restatement, the company said it expects to delay the filing of its annual reports by more than two weeks.

Despite the restatement, Ernst & Young LLP, the company’s independent auditors, will not withdraw its report on the company’s financial statements for fiscal year 2002, the company said.

Short Takes

  • Two more top mutual fund executives have lost their jobs due to the widening controversy over market timing of fund shares. On Monday, Alliance Capital Management said it forced out two top executives who had responsibility over its Alliance Capital mutual fund unit.

John Carifa resigned as president, chief operating officer, and director of Alliance Capital and as chairman of the board of its mutual funds, and Michael Laughlin resigned as chairman of Alliance Capital’s mutual fund distribution unit.

“The special committee of independent directors, the Board of Directors and I, acting in concert, requested their resignations because they had both senior and direct responsibility over the firm’s mutual fund unit which, as previously reported, allowed inappropriate market timing transactions, some of which had an adverse impact on mutual fund shareholders,” Lewis Sanders, Alliance Capital’s chief executive officer, said in a statement.

  • Forest products company Georgia-Pacific Corp. said on Monday its board of directors approved the expensing of all stock options awarded in 2003 and thereafter. It added the financial impact on 2003 full-year earnings will not be significant.
  • Tupperware Corp. promoted Michael Poteshman to finance chief, succeeding Pradeep Mathur, who is leaving for personal reasons. Poteshman most recently served as CFO of Tupperware Europe, Africa and the Middle East.
  • TIAA-CREF, the pension fund giant, said CEO Herbert M. Allison Jr., a one-time CFO of Merrill Lynch, would earn at least $9 million this year. Last week, Allison was named one of eight members of a new independent board proposed for the New York Stock Exchange.
  • Reliant Resources in the third quarter took a $985 million charge for goodwill impairment related to the company’s investment in its wholesale segment.
  • Chicago Federal Reserve President Michael Moskow on Monday signaled that the Fed does not have plans anytime soon to raise interest rates. “We have said in our statement that monetary policy can be accommodative for a period of time and I don’t see any reason for us to be changing that at this point,” he told reporters after giving a speech in Prague, according to Reuters.

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