On Friday, the U.S. Attorney in Harrisburg, Pennsylvania, handed down a 37-count indictment against four former and current executives of drugstore chain Rite Aid—including former CFO Frank Bergonzi.

The Securities and Exchange Commission simultaneously filed accounting fraud charges against Bergonzi and several other senior executives for what federal prosecutors called "a wide-ranging accounting fraud scheme that resulted in the largest earnings restatement ever."

The "portrayal of Rite Aid as a profitable company was a ruse and a mirage," according to published citations from the indictment. "The deception was accomplished through massive accounting fraud, the deliberate falsification of its financial statements and intentionally false [Securities and Exchange Commission] filings."

Bergonzi, 57; Martin L. Grass, 47, former chairman and chief executive officer; and Franklin Brown, 74, former chief counsel and vice chairman; face charges of conspiracy to defraud and making false statements to the SEC.

According to the charges, their actions forced Rite Aid to cut stated earnings by $1.6 billion. That's the largest earnings restatement in U.S. corporate history.

The fourth person named in the indictment, Eric Sorkin, currently executive vice president for pharmacy services, was charged with conspiracy to obstruct justice and making false statements. He was suspended Friday, according to press reports, citing a company spokesperson.

Timothy J. Noonan, former Rite Aid president and chief operations officer, cooperated with investigators and will plead guilty to withholding information from internal investigators, according to reports.

In addition to the record restatement, the SEC's complaint alleges that Grass caused Rite Aid to fail to disclose several related-party transactions. The commission claims the onetime Rite Aid CEO used those off-balance-sheet vehicles to enrich himself—at the expense of Rite Aid's shareholders. The SEC also alleges that Grass fabricated finance committee minutes for a meeting that never occurred, in connection with a corporate loan transaction.

The commission is seeking disgorgement of annual bonuses and imposition of civil penalties against Bergonzi, Grass, and Brown.

"The charges announced today reveal a disturbing picture of dishonesty and misconduct at the highest level of a major corporation," said Wayne Carlin, regional director of the SEC's northeast regional office. "Rite Aid's former senior management employed an extensive bag of tricks to manipulate the company's reported earnings and defraud its investors. At the same time, former CEO Martin Grass concealed his use of company assets to line his own pockets."

Among other things, the commission's complaint alleges that:

• Rite Aid inflated reported pretax income for nine quarters, ending the first quarter of fiscal 2000, ranging from 9 percent to 5,533 percent.
  
  

• Management at the drugstore chain systematically inflated the deductions it took against amounts owed to vendors for damaged and outdated products.
  
  

• Rite Aid failed to record an accrued expense for stock appreciation rights the company had granted to employees. That rights program gave the recipients the right to receive cash or stock in amounts tied to increases in the market price of Rite Aid stock.
  
  

The SEC and U.S. Attorney in Harrisburg claim Bergonzi was heavily involved in the fraud, often using his position as chief financial officer to help tart up Rite Aid's financial statements.

During certain quarters, for example, the U.S. Attorney claims Bergonzi directed Rite Aid's accounting staff to reverse amounts that had been recorded for various expenses incurred and already paid. According to the complaint: "These reversals were completely unjustified and, in each instance, were put back on the books in the subsequent quarter, thus moving the expenses to a period other than that in which they had actually been paid."

In addition, the complaint alleges that Bergonzi directed Rite Aid's accounting staff to make improper adjusting entries to reduce cost of goods sold and accounts payable in every quarter from the first quarter of fiscal 1997 through the first quarter of fiscal 2000 (but not at year-end, when the financial statements would be audited).

Further, the SEC charges that on the last day of fiscal 1999, Bergonzi directed that Rite Aid record entries to reduce accounts payable and cost of goods sold by $42 million, to reflect rebates purportedly due from two vendors. But on March 11, 1999—nearly two weeks after the close of the fiscal year—Bergonzi allegedly directed that the books be reopened to record an additional $33 million in credits. "All of these entries were improper," said the SEC.

Indeed, the commission claims Rite Aid management repeatedly inflated earnings by booking revenue illegally. One example: in the fourth quarter of fiscal 1999, Grass, Bergonzi, and Brown allegedly caused Rite Aid to recognize $17 million from a litigation settlement. The SEC says recognition was improper, as the settlement was not in fact consummated in legally binding form during the relevant period.

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