business news in context, analysis with attitude

The story you are about to read is true. No names have been changed to protect the innocent…because the more you find out, the more it starts to appear that nobody is innocent.

Criminal indictments filed Wednesday by the federal government charged two former Kmart executives with accounting fraud related to a $42.3 million slotting allowance paid by American Greetings Corp.

The former executives, who were dismissed by Kmart last May, are Enio Montini, who was senior vice president and general merchandise manager for the retailer's drugstore business, and Joseph Hofmeister, a vice president in the same division.

The indictment says that Montini and Hofmeister conspired to improperly book the $42.3 million payment even though it was repayable under certain circumstances and therefore should not have been fully booked in that period. The US Securities and Exchange Commission (SEC) says that the executives lied to Kmart accountants about the deal, which resulted in a 2001 second quarterly report that was $42.3 million higher than it should have been.

These charges are the first to emerge from the federal government’s probe into the Kmart accounting practices that led to the company’s bankruptcy filing in January 2002.

One legal analyst told Reuters that in all likelihood, these charges are “stalking horse indictments” designed to squeeze lower level executives into testifying against their former superiors. In this case, one of the likely targets is former Kmart CEO Charles Conaway, who was accused this week by Kmart of malfeasance in his leadership of the company. Kmart is attempting to recover $5 million in retention loans and $4 million in severance that he was granted by the board of directors.

Conaway maintains he acted honorably and in the best interests of the company.

The bankruptcy court judge yesterday tossed out Conaway’s request to get early access Kmart's insurance policies so that he could cover his legal expenses; the judge said Conaway should be treated just like other execs in the case.

Reuters reports that American Greetings management says that it has been cooperating with the investigation, and that it believes it has no exposure in the matter. For at least one of the indicted executives, however, there already appears to be some fallout. Montini, who became a senior vice president with Rite Aid Corp. last fall, resigned from the drug chain yesterday.

If convicted, Montini and Hofmeister face a maximum of 10 years imprisonment and $1 million in fines for the securities fraud, and five years in prison and a $250,000 fine for the conspiracy charges,
KC's View:
It isn’t hard to imagine that the lawyers for Montini and Hofmeister sitting down with government attorneys and suggesting that they’ll testify against Conaway and maybe a few other senior executives if the charges against them get dropped or lessened.

This all will get uglier before it gets resolved. We still think that members of the board of directors, who presided over all this nonsense, are as culpable as anyone else for the Kmart debacle.

What’s really amazing -- and somehow not at all surprising -- is that with all this legal wrangling, Kmart isn’t any closer to developing a compelling retail format that will help it survive long-term. Sure, it may emerge from bankruptcy in April…but as far as we can tell, it isn’t even close to emerging from its creative bankruptcy.

The company’s ethical bankruptcy is now exposed for the world to see.

And speaking about different kinds of bankruptcy…

What can you say about a retailing system, not limited to Kmart, that requires a manufacturer to pay tens of millions of dollars in slotting allowances just to get on the shelves of a store? What can you say about a system in which retailers make more money on the buy than the sell?

We think that a lot of daylight is going to be shed on systems and practices that legislators and consumers alike will find somewhat distasteful. It’ll be interesting to see if there is a backlash against a system that seems so out of synch with how retailers ought to be making money.