Prescription for trouble got priority at Rite Aid

March 03, 2002|By Jay Hancock

ON Feb. 9, 1999, Rite Aid chief executive Martin Grass invited company Controller Stephen Kindler into his office and urged him to inflate revenue so Rite Aid's profits would look bigger than they were, according to a document filed in U.S. District Court in Philadelphia.

"Everyone needs to pull together," Grass told Kindler, according to an amended shareholder lawsuit filed last year and prepared with cooperation from the drug chain's present management.

As added inducement, Kindler's direct boss, Chief Financial Officer Frank Bergonzi, offered the controller $20,000 and said, "We're going to have to get dirty here," the document alleges.

Kindler demurred, taking a stress-related medical leave the next day.

But Rite Aid still got dirty, all right - to the tune of $1.6 billion in profit overstatements over several years, according to revised financial statements filed by managers who replaced Grass and Bergonzi at the helm.

Enron's collapse, the dot-com dive and the related storm of accounting scandals have eclipsed the Rite Aid irregularities, which occurred from fiscal years 1997 through 1999. But recall that the Rite Aid case, which is the subject of continuing federal investigations, involved one of the larger earnings "adjustments" in recent history - more than twice the $600 million in fictitious profits revealed at Enron so far.

Federal prosecutors in Harrisburg, Pa., where Rite Aid is based, have been investigating whether the company's financial irregularities involved criminal fraud, say people familiar with the matter.

The Securities and Exchange Commission has been conducting a civil fraud investigation, and the Labor Department is investigating how Rite Aid's 401(k) retirement plan was hurt by the collapse of the company's stock after the accounting revisions, according to Rite Aid regulatory filings.

Grass and Bergonzi, through their lawyers, deny any wrongdoing. Grass attorney Andrew Weissman specifically disputes the shareholder lawsuit's account of the Kindler meeting in Grass' office three years ago.

"Mr. Kindler before the meeting decided that he was going to go on medical leave, and the meeting involved a discussion of that and a discussion of Mr. Kindler's future when he returned from medical leave," Weissman said in an interview. "There was no suggestion that Mr. Kindler join in any misrepresentation of the company's finances."

Reached at his Rite Aid office, where he is now vice president of inventory control, Kindler declined to comment.

Rite Aid is faring far better than Enron as a post-scandal enterprise. The company was strong enough to avoid bankruptcy proceedings after the disclosure of its accounting problems and is trying to regroup under new bosses.

But fallout from the financial irregularities promises to float around Rite Aid for some time, although the company has settled the shareholder claim by agreeing to pay $200 million.

Much of the government's investigative paperwork on Rite Aid was housed in the SEC's office in New York's World Trade Center, federal officials have said in court. The Sept. 11 terrorist attacks that destroyed the building dealt a setback of many months to the government's Rite Aid case, including the work of criminal prosecutors who were working closely with the SEC.

Authorities' resources were already stretched before the Sept. 11 outrage. Now, between the loss of documents and the explosion of accounting messes at Enron, Global Crossing and the like, the federal investigation machine is overheating and spouting smoke.

The Rite Aid case is too big to be slighted by enforcement agencies, however.

Bergonzi lawyer Jeffrey Kilduff declined to go into detail about the allegations against his client but said that the former Rite Aid financial officer denies the claims and that the shareholder suit "significantly mischaracterized some of the accounting issues at hand."

Grass is claiming an ignorance of accounting problems under his watch that is similar to what we're hearing from Enron bosses Kenneth Lay and Jeffrey Skilling.

"He's the CEO, and this entire restatement is about relatively complicated judgments being made about accounting issues" by trained subordinates, said Weiss- man, Grass' lawyer. "He's not a CPA, and he's not someone who could make those decisions."

Weissman also denied an allegation in the shareholder suit that Grass pledged corporate assets as loan collateral without getting approval from the board. Grass, Bergonzi and the former Rite Aid president, Timothy Noonan, have appealed the company's settlement of the shareholder litigation, as has former Rite Aid auditor KPMG.

It seems absurdly unlikely that Grass was as out of the loop as he claims. What's a chief executive doing there if he's clueless about financial issues at his own firm?

"If you get paid the big bucks, you should know" what lieutenants are doing, Treasury Secretary Paul H. O'Neill said a few days ago. "It's not OK to say I wasn't trained in this or I wasn't trained in that or I relied on somebody else. Responsibility and accountability at the end of the day means no excuses."

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