Risk Management

Cooked Books: Pasta Company Execs Plead Guilty

Two former executives, including the CFO, of American Italian Pasta Company plead guilty to fraud. Meanwhile, the SEC settles civil charges.
Stephen TaubSeptember 16, 2008

Two former top executives of the American Italian Pasta Company plead guilty to criminal charges for conspiracy to fraudulently overstate earnings and deceive investors. AIPC, the largest producer of dry pasta in North America, also agreed to resolve the investigation by paying a $7.5 million penalty, according to the U.S. Attorney’s Office for the Western District of Missouri.

Separately, two executives, including one of the two who pleaded guilty in criminal court, agreed to settle civil accounting fraud charges brought by the Securities and Exchange Commission. The SEC also charged the company and one other executive.

In the criminal case, former President and CEO Timothy S. Webster and former CFO Warren B. Schmidgall, each pleaded guilty to one count of conspiracy to commit wire fraud.

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Webster and Schmidgall admitted to submitting materially false reports on AIPC’s financial condition to the SEC; fraudulently adjusting accounting entries to meet or exceed Wall Street’s earnings expectations; structuring round-trip cash transactions with a company AIPC acquired to give the false impression that the company being acquired reimbursed AIPC more than $2 million of costs — to make AIPC’s earnings appear higher; structuring round-trip cash transactions with a customer to give the false impression that the customer had agreed to retroactive price increases — which allowed AIPC to overstate revenue; and understating research and developments costs by approximately $1 million.

In the civil case, AIPC, Webster and former controller Stephanie S. Ruskey agreed to settle the matters without admitting or denying the allegations in the SEC’s complaints. Webster agreed to disgorge $751,978, pay prejudgment interest of $32,610, pay a civil penalty of $250,000, and to be barred from serving as an officer or director of a public company. Ruskey agreed to pay a $25,000 civil penalty.

The Commission’s case against Schmidgall and former executive vice president of corporate development and strategy David E. Watson is ongoing.

According to the SEC, from 2002 through the second quarter of fiscal year 2004, AIPC, Webster, Schmidgall, and Watson, allegedly engaged in a fraudulent scheme to mislead investors about the growth of the company’s earnings and to artificially increase the company’s stock price. Based on the Commission’s complaints, the fraudulent accounting and other errors were tied to inadequate internal controls, which resulted in the overstatement of AIPC’s pre-tax income for the relevant period by approximately $59 million, or 66 percent.

The SEC further alleged that AIPC and its former executives manipulated AIPC’s trade promotion accounting; failed to write off obsolete or missing spare parts; structured fraudulent round-tripping of cash transactions; and recorded false receivables.

The regulator also charged that Ruskey knew, or was reckless in not knowing, that AIPC’s quarterly and annual financial statements were misleading. The SEC alleged that she signed representation letters to AIPC’s auditor that falsely stated that the financial statements were prepared in accordance with generally accepted accounting principles.

“Today’s announcement brings a welcome close to an unfortunate chapter in the otherwise proud history of our Company,” said Jack Kelly, president and chief executive officer of AIPC, who joined AIPC in November 2007, and was appointed company president and CEO in January 2008.

Last October, American Italian Pasta said it would pay $25 million to settle a class action lawsuit related to alleged securities law violations. The settlement was comprised of $11 million in cash, all of which were to be contributed by the company’s insurers, and $14 million in company stock.

Officials pointed out at the time that the settlement does not include the complaint’s claims against AIPC’s independent auditor Ernst & Young LLP. In addition, the agreement did not cover derivative claims. The company’s stock was delisted from the New York Stock Exchange in April 2007.