The Securities and Exchange Commission charged two former executives at supermarket operator Penn Traffic Co. with inflating reported income by improperly accounting for promotional rebates and other vendor allowances.
The two – former chief marketing officer Leslie H. Knox and former vice president Linda J. Jones – were also indicted on related criminal charges, according to the U.S. Attorney’s Office for the Northern District of New York.
Promotional allowances – also referred to as rebates, slotting fees, or vendor allowances – are sums paid by vendors in exchange for marketing and promotional activities in the retail store, such as inclusion in a supermarket’s weekly circular or prime shelf space.
The SEC said that between fiscal year 2001 through at least the final quarter of fiscal 2003, Knox and Jones “orchestrated” a scheme to inflate Penn Traffic’s income and other financial results by prematurely recognizing promotional allowances at the Syracuse-based grocery chain. The company operates 108 BiLo, P&C, and Quality supermarkets in Pennsylvania, upstate New York, Vermont, and New Hampshire.
In addition, the complaint charged that the former executives “knowingly misled” Penn Traffic’s chief executive, chief financial officer, and chief accounting officer about “pre-billing or pulling forward promotional announcements.”
Attorneys for Knox and Jones did not immediately return CFO.com’s calls requesting comment. However Penn Traffice officials noted in a regulatory filing that the investigations were in progress before the company emerged from bankruptcy in April 2005. The company has been cooperating with authorities since that time.
In addition, the filing disclosed that no liability has been recorded in connection with the alleged violations. However, it added that the chain could be subject to damage claim, fines, or penalties, although the likelihood of an “unfavorable” outcome could not be estimated.
The company fired Knox and Jones after an interim audit committee report found that the duo “engaged in certain improper practices” related to premature recognition of vendor allowances — which had largely ceased by the time the company filed for bankruptcy protection in May 2003.
Indeed, the SEC alleged that Knox and Jones directed a plot to fraudulently meet internal budget plans, inflating their own performance-based compensation. Purportedly, the two former executives “routinely” submitted false invoices and other information to Penn Traffic’s accounting department so that promotional allowances were booked before they were actually earned, the SEC claimed. As a result, Penn Traffic accelerated $10 million in operating income, a “material” amount that was eventually reported in the company’s public financial statements allegedly in violation of securities laws.
Knox was eligible for an annual bonus representing 40 percent of his base salary if Penn Traffic achieved particular internal budget goals, says the SEC’s complaint. For example, the regulator contends that for fiscal year 2002, the pre-billing scheme allowed Knox to collect $13,725 in bonus money that was not owed to him. In total, Knox received $73,200 that year for meeting budget thresholds that triggered payouts, added the SEC. For the same fiscal period, Jones received an $11,250 bonus based on the fudged allowances, according to the SEC. Her total bonus for meeting the budget goals in fiscal 2002 was $19,687.
The SEC is seeking an order against both defendants enjoining them from violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. The government also wants the duo to disgorge of all ill-gotten gains with prejudgment interest, pay civil monetary penalties, be barred from acting as an officer or director of a public company.
Since emerging from bankruptcy, the Pink Sheet-listed company continues to struggle financially, and have trouble meeting its SEC filing requirements. For instance, the company did not file its fiscal 2006 annual report until August 17, 2007, at which time Penn Traffic revealed a net loss of $3.8 million for the 41 weeks ended January 28, 2006. The company says that it is continuing to complete outstanding quarterly reports for fiscal 2006, 2007 and 2008, as well as its Form 10-K for fiscal 2007.
Not all the summer news was gloomy for Penn Traffic, however. In July, it received something of a reprieve when lenders agreed to waive default provisions of its working capital credit facility and to extend the deadline for filing its 2006 annual report with the SEC. The waiver also extended the debt covenant terms for filing the company’s 2007 annual report, giving the grocer until September 30, 2007 to complete the task without incurring penalties or being considered in default.