Rite Fraud When Grass Was CEO

Rite Aid Fraud

Over the years, there have been numerous cases of financial fraud perpetuated within the organizational mainstream of major companies. Financial fraud is often a well-coordinated sort of white-collar crime that often -- but not always - requires complicity and collusion amongst financial accountants, top management and auditors. Rite Aid came to the limelight after the U.S. Securities and Exchange Commission announced that it would be filing accounting fraud charges against the company in 2002

Meanwhile, the United States Attorney for the Middle District of Pennsylvania leveled similar criminal charges accusing former CFO Frank Bergonzi, former CEO Martin Grass and former Vice Chairman Franklin Brown of perpetuating an immense accounting fraud scheme

. Compounding the crisis, according to former Rite Aid COO, Timothy Noonan, were years of legal coaching amongst staff and mid-level employees. As investigations ensued, evidence of fraudulent manipulation of accounts, corporate malfeasance, and financial overstatement emerged. What was the role of auditors in the fraud? Since the series of corporate insolvencies including Lehman, AIG, and GM, the Big 4 audit firms - Deloitte Touche, PricewaterhouseCoopers (PwC), KPMG, and Ernst & Young -- came to the limelight with allegations of aiding and abetting accounting fraud in the corporate world

. Experts claim -- and with good reason - that a competent auditor would not miss any instance of accounting fraud since they have sufficient training to detect any such gimmick. As for the Rite Aid case, there was no sufficient or conclusive evidence to indicate that KPMG, the audit firm in charge of Rite's books, was involved in any way or that it offered any such advice.

Rite Aid

As a leading drugstore chain in America, Rite Aid is a Fortune 500 company based in Pennsylvania. Listed in the New York Stock Exchange under the ticker RAD, Rite Aid's estimated market capitalization was $1.4 billion as at February 2012

. The Fortune 500 Company is one of the key players in the U.S. pharmaceutical industry along with Walgreens and CVS. Sources indicate that the late Alex Grass was the founder of the mom-and-pop health and beauty aids store. Rite Aid has been on the spotlight several times amid emerging allegations of accounting fraud, corporate malfeasance and gross abuse of ethics and corporate integrity. The U.S. Securities and Exchange Commission announced that it would be filing accounting fraud charges against Rite Aid Corp in 2002.

Meanwhile, the United States Attorney for the Middle District of Pennsylvania leveled similar criminal charges accusing former CFO Frank Bergonzi, former CEO Martin Grass and former Vice Chairman Franklin Brown of perpetuating an immense accounting fraud scheme. With the help of accounting personnel and auditors, Rite Aid top officials allegedly overstated company income through corporate malfeasance in a way that the company appeared stable and progressive. The instances of irregularities took place between the May 1997 and May 1999 financial years. As the scandal blew wide open, Rite Aid Corp was compelled to restate its net income by over $1.6 billion and its pre-tax profit by an estimated $2.3 billion. Sources retrieved from the Wall Street Journal indicate that this restatement was the largest ever recorded

Pursuant to Section 21 C. Of the Securities and Exchange Act of 1934, the Commission served Rite Aid with a cease-and-desist order barring the company from committing any violation of Sections 13(a) and 13(b) (2) of the Exchange Act or causing any such future violation of Rules 12 b-20, 13 a-1 and 13 a-13 therein

. The investigation into Rite Aid financial fraud claims came in light of the issuance of suspicious severance letters offering employees millions of dollars in bid to silence those who were privy of the accounting gimmicks. There were also signs of impending fallout between Rite Aid Corp and its auditors at KPMG after they uncovered inconsistencies in financial transactions in form of material numerical overstatement to the tunes of billions of dollars. Likewise, Rite Aid had withheld reprehensible vendor deductions by failing to disclose "up charges."

The SEC expose further indicated that Rite Aid fell short of accruing expenses for Stock Appreciation Rights (SARs) while reversing previously recorded expenses to overstate income. In bid to reduce COGS and A/P, accountants made up 'gross profit entries.'

The Commission also found Rite Aid guilty of creating vendor rebates in a manner specially designed to conceal its gross profit entries. The company also overcharged vendors after failing to disclose markdowns at the retail levels. Amnesty International informants revealed that the company had also been capitalizing expenses to establish new sites for their chain stores in the United States; Rite Aid failed to write-off the capitalized expenses after the company had a "dead deal" and withdrew the bid to establish a new store and instead ordered their accountants to continue capitalizing the expenses. The SEC expose further stated that the company was equally guilty of reversing "will-call payables" as revenue. These will-call payables were payables to insurance companies for prescription orders never collected by customers

Along with the co-accused, Martin Grass was arraigned in court to answer to the charges that he sought to enrich himself by making money-losing decisions through non-disclosure of several related-party transactions. The Securities and Exchange Commission further alleged that Grass ordered officials to fabricate Finance Committee minutes relating to a corporate loan transaction meeting; upon investigation, such meeting had occurred, as it turned out. The SEC sought to impose sanctions on Rite Aid's annual bonuses while imposing civil penalties against the defendants: Brown, Bergonzi and Grass. It also sought an order barring the defendants from serving as directors or officers of a public company by permanently enjoining the three of them from violating security laws. The charges leveled against Rite Aid top officials in reference to the fraud case revealed a very disturbing picture of duplicity, corruption and ethical lapse in the highest levels of a publicly listed company. The officials in question employed an extensive range of unscrupulous techniques including accounting gimmicks specially designed to doctor the company's reported earnings. This was a case of financial engineering aimed at defrauding Rite Aid's investors. Sources retrieved from Wall Street and Amnesty International indicates that the Rite Aid case was nothing short of an organized crime.

Former CEO Martin Grass' was, in the mean time, lining his pockets by misrepresenting the company's genuine asset value. As the house of cards wavered on the edge of disintegration, Grass engineered company records in such a way that the financial position of the company appeared stable and progressive to investors and other stakeholders. Unfortunately, this was merely a vain effort that Grass used to forestall the inevitable. The defendants would each receive up to 10 years behind bars for their respective criminal offenses. SEC, nonetheless, issued a statement stating that it had settled administrative cease-and-desist proceedings against the company and its former Chief Operating Officer and interim CEO, Timothy Noonan. This move by the U.S. Security and Exchange Commission and the related prosecution of Rite Aid top officials became an indicator that the Commission would not tolerate any such impropriety

The Noonan Dossier

Former Rite Aid Chief Operating Officer, Timothy Noonan disclosed the course of events as they unfolded. Speaking during a summons by the Business and Organizational Ethics Partnership, Noonan revealed Rite Aid ethical lapses and the pervasive professional impropriety that marred the company since the onset of the scandal in the May 1999 financial year. A composed Noonan did not apportion blame to any particular personnel neither did he give excuses exonerating himself of the charges leveled against him; he sought to remain ingenuous while giving an honest account of how things transpired. As he gave the 'Rite Aid dossier,' Noonan noted that it was a case of ethical lapse that, in retrospect, he wished he could have avoided.

Compounding the crisis, according to Noonan, were years of legal coaching where Rite Aid 'economic hit men' trained management staff and mid-level employees on how to take depositions and how to answer legal question in case of subpoenas. Legal coaching involved training them on what not to say, what to say, how to say and when to say it. These were some of the gimmicks that helped perpetuate fraud within the organization. Noonan also noted that prior to the scandal, there were retrospective red flag, which is to say that there were indicators that of a looming crisis. Looking at it in retrospective, the former COO admitted that Red Aid never discussed or deliberated on issues of ethics and professional propriety within the organization. The company repeatedly ignored the ramification of overlooking ethical considerations; there was clear lack of an ethical benchmark upon which issues of organizational integrity prevail.

Even the existent ethics and codes of conduct hotlines were merely form and no substance. There was a vacuum at the top as it appertains to positive leadership role models since the company laid much emphasis on short-term consideration rather than focusing on the long-term consideration that would boost future affairs.

Retrospective Red Flags: Pointers of Ethical Meltdown

Arizona State University business professor, Marianne Jennings of the W.P. Carey School of Business, released a list of organizations that succumbed to ethical meltdowns. By 2001, Jennings dossier comprised Arthur Andersen, Rite Aid, Merrill Lynch, General Electric, AT&T, and United Health Group among many more, in fact, a lot more that she ran out of space to accommodate them in her PowerPoint presentation slides. In a presentation dated April 5, 2007 addressed to the Business and Organizational Ethics Partnership dubbed "Seven Signs of Ethical Collapse: How to Spot Moral Meltdowns Before it's Too Late,"

Professor Jennings discussed the pointers of ethical collapse and recommended potent antidotes to thwart such a predicament. She underscored seven common threads that prompt reputable organizations to bend the ethical code of professional conduct. These pointers include conflicts of interest, pressure to achieve or retain numbers, larger-than-life CEO. Weak board of directors, innovation like no other, pervasive fear and silence, and Goodness "here" atones for wrongdoing "there." To begin with, Professor Jennings noted that 'pressure to maintain numbers' is the first indicator of impending collapse of corporate ethics. In reference to Rite Aid, there had been a remarkable double-digit rise in the rates of return in the years leading up to the fraud incident. Owing to pressure to retain the impressive numbers, the company focused on short-term goal setting thus sidelining policies that laid emphasis on long-term growth.

Echoing Jennings claim, Rite Aid former COO admitted that the emergent organizational philosophy in his firm focused on maintaining these remarkable numbers at any cost. Phrases such as 'find a way,' 'do whatever it takes,' and 'plausible deniability' became organizational catchphrases. Emphasizing on the need to achieve short-term goals steered the company away from long-term sustainability. Top management became greedy in their bid. The pathological quest for short-term growth prompted them to undertake unscrupulous accounting tactics to ensure the company books depict steady and sustainable growth.

According to Noonan, Rite Aid had a larger-than-life CEO who happened also to be the heir to his father's business empire. The younger Grass had forced his father out as CEO. Alex Grass -- the father - was the founder of the mom-and-pop health and beauty aids store. As CEO, the younger Grass undertook rapid expansion plans occasioned by numerous inventions, costly innovations and numerous acquisitions and mergers. As CEO, he was an over-achiever, according to Noonan; he spent a lot of time trying to steer the company towards progress that he forgot to focus on long-term plans. The company was walking a tight rope, recalled Tim Noonan; top management laid too much emphasis on capturing big game, which encouraged devious plans. Looking back, in retrospect, Noonan reckoned that they many mistakes that he would have corrected. For instance, Noonan admitted that he was aware of the vendor fraud since he sat in an executive meeting in which the CEO ordered the finance department to carry out the plan. Noonan reckoned that his hands were tied, as were the concerned employees and other personnel

As CEO, Grass upheld the philosophy that 'Goodness "here" atones for wrongdoing "there." According to him, doing whatever it takes was in the company's best interests. Grass' organizational philosophy was 'the ends justify the means.' Company employees and staff underwent special training as a form of indoctrination into the organizational philosophy. Making more money or appearing to make more money for the sake of investors and stakeholders was the 'end game' in Grass' philosophy. As Karl Marx espoused in his discourses, in a capitalist economy, everything narrows down to one thing: making more money. As the world's leading economy, the United States has adopted a free market enterprise in the Keynesian model

. In the political economy of the U.S., forces of demand and supply control the market; there is no government interference in the market.

Role of Accountants and Auditors

In light of all instances of corporate fraud, the spotlight is usually on accountants and auditors since they ought to be the guardians of investors' welfare as well as that of the public. According to Rachel Gibson, an economic expert at Wall Street, competent auditors can always detect any instances of financial engineering since they have sufficient training to detect any financial misstatement in the books. As such, in most instances, top officials collude with accountants and auditing agencies are often in on it too since it is often virtually impossible to doctor the books in a way that a competent auditor will not detect. This claim brings about heightened scrutiny on the professional auditing agencies.

In a dossier tabled before the U.S. Congress by lobbyists from Amnesty International, the Big 4 audit firms - Deloitte Touche, PricewaterhouseCoopers (PwC), KPMG, and Ernst & Young -- came to the limelight for aiding and abetting accounting fraud in the corporate world. This followed a report that linked the case of Lehman Brother's collapse to corporate malfeasance and financial engineering in the advent of the U.S. subprime mortgage crisis. Lehman's accounting gimmick dubbed 'repo 105' allowed the sale of company securities through a signed obligation to re-purchase them after a while so that they can do so at a lower price. This would temporarily remove such asset securities from the balance sheet. Likewise, the untimely sale of securities allowed the influx of liquid cash into the bank effectively lowering financial coverage ratios. These subtle and unscrupulous financial gimmicks happen behind closed doors keeping investors and other stakeholders in the oblivion. At Rite Aid, the financial engineering was worse since it was the largest case of income overstatement yet. Despite the contention that it is often virtually impossible to doctor the books in a way that a competent auditor will not detect, there is no evidence in the Rite Aid scandal to indicate that KPMG, the audit firm in charge of Rite's books, was involved in any way. There is not any conclusive proof to indicate that KPMG offered advice to their client suggesting any such gimmick either

Commentators reckon that audit firms have become exceedingly greedy that they essentially tolerate -- and even promote -- deceptive accounting methodologies through which firms can materially alter their financial positions. They often collude with clients through gross abuse of off-balance sheet vehicles and income overstatement to manipulate investors. Given the high integrity standards that audit firms ought to uphold, corporate malfeasance is a gross abuse of accounting standards. Information retrieved from the Wall Street Journal indicates that external auditing agencies often have a conflict of interests, which ultimately compromises the quest for transparency in oversight. They therefore become reluctant to disclose the genuine state of affairs of their client firms for fear of losing their consultancy and advisory role to competing firms.

After the audit report of a court-appointed financial examiner saw the light of day, Ride Aid former COO, Timothy Noonan admitted in writing that the financial engineering gimmicks deployed with the help of audit agencies was a systematic ploy of buying the company more time by creating a materially misleading picture of the financial position of the firm. In light of emerging studies, corporate malfeasance was one of the tactics used to defraud Rite Aid investors. Experts called it a case of 'financial engineering' denoting the art of fraudulently manipulating accounts such that the financial position of a company appears stable and progressive. With the help of accountants, top officials manipulated financial records in bid to make the companies appear more venerable to attract investors and retain clients. Rite Aid's financial engineering had gone on for a few years amid growing worries amongst top officials that the company was over-leveraged. With the advice of auditing agencies and other top officials, accountants undertook the 'financial engineering' gimmick through counterfeit records to hide their vulnerability to collapse. Auditors and accountants were well aware of the imminent collapse.

As with other disciplines, all personnel in the accounting profession ought to uphold high standards of professional ethics. All firms ought to conduct their affairs with due regard to the welfare of the parties involved, the economy, and the interests of the public in general. As such, auditors and accountants ought to be ambassadors of transparency and accountability and their conduct must indicate as much. After evaluating the books of their client firms, auditors are legally bound to report a true and fair statement of the financial position of the firm. They ought to communicate any irregularities or errors in the financial statements as part of their professional obligation.

As commentators and experts pointed a finger at auditing agencies blaming them for complicity to perpetuate fraud through corporate malfeasance, there emerged calls to introduce certain reforms in the accounting field in general. This was part of the larger plan to cultivate auditor independence and build competence in the field under the auspices of GAAP (General Applied Accounting Principles), the Sarbanes-Oxley act, and APES 110

(Australian Professional Ethical Standards). The law obliges all auditors to observe generally accepted accounting standards. The auditors reserve the discretion to determine what to report and the manner in which to communicate their findings. Independence and competence are the key pillars of the profession. In the wake of the global financial crisis, it had emerged that the integrity of the accounting profession was in question. There emerged calls to reform the field through proper oversight and reaffirming the need for independence and competence.