Merry-Go-Round trustee sues turnaround firm Chain failure blamed on negligence, fraud

December 02, 1997|By Mark Ribbing | Mark Ribbing,SUN STAFF

The bankruptcy trustee for Merry-Go-Round Enterprises Inc. sued Ernst & Young International Inc. yesterday for negligence and fraud, charging that the accounting and consulting firm's handling of the Maryland clothing retailer's turnaround led to its collapse.

In the lawsuit, filed in Baltimore Circuit Court, trustee Deborah Hunt Devan seeks $1 billion in compensatory damages and $3 billion in punitive damages, plus costs and interest.

"We have not yet seen a copy of the complaint. We have no comment beyond that," said Patrice Ingrassia, a spokeswoman at Ernst & Young's New York headquarters.

Randal Picker, who teaches bankruptcy law at the University of Chicago, said it was unusual for a bankruptcy trustee to sue a turnaround expert, but added that similar suits could become more common.

"I'm not aware of any other case in which that has happened," he said. "As you have more and more companies providing these specialized turnaround services, presumably they'll become targets of suits just like companies providing other services. This will be an interesting case to see if it becomes part of a pattern."

The suit portrays Merry-Go-Round as an eminently salvageable company, stating that in early 1994, just after its Chapter 11 bankruptcy filing, Merry-Go-Round had $113 million in cash, $18 million in refundable taxes, $71 million worth of inventory, and negligible secured debt.

"E&Y's untimely and incompetent performance of its duties was a direct and proximate cause of the failure of MGRE

[Merry-Go-Round Enterprises] to be reorganized and restructured successfully and a direct and proximate cause of the 1996 demise and liquidation of MGRE," the suit alleges.

Devan, a Baltimore attorney, began serving as Merry-Go-Round's bankruptcy trustee in March 1996 after the Joppa-based company's Chapter 11 reorganization case was converted into a Chapter 7 liquidation.

The chain was a Baltimore success story, founded in 1968 by Leonard "Boogie" Weinglass and the late Harold Goldsmith. At its peak it had nearly 1,500 stores and 14,000 employees. When it went out of business in February 1996, it had fewer than 600 stores and 6,000 workers, including 630 at its Joppa headquarters.

According to Devan's suit, the retailer hired Ernst & Young on the advice of its law firm, Washington-based Swidler & Berlin, in December 1993 to set up a turnaround strategy. The company's sales and earnings had sagged as the result of a merchandising bet on "hip-hop" fashions, which failed to attract the youthful buyers it depended on.

But Ernst & Young, the lawsuit contends, committed fraud in concealing that Swidler & Berlin was defending it in a West Virginia fraud case and in fact "affirmatively represented" to Merry-Go-Round that it had no ties with any of Merry-Go-Round's lawyers.

That relationship was discovered this year, although the attorneys representing Devan -- Stephen L. Snyder, Arnold M. Weiner and Robert J. Weltchek of Pikesville -- declined to discuss how.

"By knowingly concealing from MGRE its pre-existing relationship with the Swidler & Berlin law firm, E&Y was able to eliminate an otherwise rigorous and competitive selection process," the suit states. " had full disclosure been made to MGRE, E&Y would not have been engaged."

The suit further alleges that when Merry-Go-Round filed for Chapter 11 reorganization in January 1994 on Ernst & Young's advice, Ernst & Young partner Warren Petraglia made a sworn declaration in the application to the Bankruptcy Court that the firm had no connection with Merry-Go-Round's attorneys.

Swidler & Berlin's managing partner, Barry Direnfeld, refused to comment. Petraglia could not be reached for comment.

Ernst & Young then mishandled the reorganization, Devan's suit charges, by assigning inexperienced people to the case and moving too slowly to stem the bleeding of cash and capital.

For example, the suit claims that Ernst & Young's strategic plan for Merry-Go-Round came out in November 1994, eight to nine months later than it should have and too late to affect the all-important 1994 back-to-school and Christmas shopping seasons.

And when Ernst & Young undertook a cost reduction program at the behest of creditors in the fourth quarter of fiscal year 1995, its tentative plan -- never fully enacted -- would have shaved "only" $11 million, the suit says.

"This reduction was insignificant in light of MGRE's $186 million loss at the close of its 1995 fiscal year," the complaint states.

What's more, the suit claims, the cost-cutting program was poorly timed, including the closing of 230 stores in the fourth quarter of fiscal year 1995. The suit says that closing deprived the company of much-needed Christmas sales and wasted already-purchased seasonal goods.

The plaintiff claims that these and other miscues doomed Merry-Go-Round, but benefited Ernst & Young.

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