Fashion Firms Feel Fallout From Corporate Corruption
NEW YORK — Public fashion firms might have escaped the worst of the corporate corruption scandals so far, but they won’t be exempt from the pressures for greater transparency and oversight as companies look to restore investor confidence....
NEW YORK — Public fashion firms might have escaped the worst of the corporate corruption scandals so far, but they won’t be exempt from the pressures for greater transparency and oversight as companies look to restore investor confidence.
While the big corporate names in the news — Enron, WorldCom, Global Crossings and Adelphia — appear far removed from the retail and apparel sectors, the fashion industry does have its own Hall of Shame.
Past accounting scandals have pulled down the images of The Leslie Fay Cos., Donnkenny and Sirena Apparel. Former executives at each of the three firms have been convicted of securities fraud.
In June, three former executives of Rite-Aid, including former chief executive officer Martin Grass, were indicted for their roles in a scheme that included the recording of bogus credits from vendors for damaged goods; false accounts-payable entries and inaccurate reporting of stolen or otherwise unaccounted for inventory.
More recently, The Warnaco Group and Kmart Corp., both bankrupt, have disclosed information that suggests that their former executives might have flirted with issues of impropriety.
Warnaco said in its annual report that it had been informed by the Securities and Exchange Commission that the SEC staff intended to recommend "an enforcement action against the company and certain persons who have been employed by or affiliated with the company since prior to Jan. 3, 1999, alleging violations of the federal securities laws."
Through legal documentation, Warnaco still has a chance to convince the SEC staff that it should not recommend any action against the firm, but it is still not known which individuals are the focus of SEC scrutiny. Linda Wachner, Warnaco’s former ceo and a current board member, declined to be interviewed on the issue of corporate governance. Her publicist, Howard Rubenstein, said he didn’t know if Wachner had been contacted by the SEC, and her lawyer, Kenneth Eckstein, didn’t return phone calls seeking comment.
Kmart said in its annual report, filed with the SEC earlier this year, that both the SEC and the U.S. attorney’s office in Detroit were looking into issues that had been the subject of the retailer’s own internal investigation: accounting issues and its stewardship under previous management. The Federal Bureau of Investigation is assisting in the probe.The Kmart news went from bad to worse last month when word leaked out that the Detroit U.S. Attorney’s office impaneled a federal grand jury and issued at least 20 subpoenas to potential witnesses in connection with an investigation on the compensation deals struck with former executives at Kmart. Sources said high on the investigative agenda were former chairman and ceo Chuck Conaway and former president Mark Schwartz. No charges have been filed so far against either the two or other former members of the retailer’s management team. (For related item, see page 2,)
James Adamson, who took over the posts of chairman and ceo when Conaway left earlier this year, declined to discuss the investigation. However, Adamson said he thinks the continuing focus on corporate corruption is having positive effects and will ultimately restore investor and lender confidence.
Adamson, a director for six years, nonexecutive chairman for six weeks and currently the only "insider" on Kmart’s board, said: "The good that comes out of all this is tightened controls throughout the company. Our board is holding previous management accountable for what happened here. We began our investigation in January and involved the SEC right away. It was our form of self-policing."
Based on that experience, Adamson noted, he has become a strong advocate of limiting the number of boards that directors can serve on, as well as having a nonexecutive chairman.
He explained: "When I was a nonexecutive chairman, I was able to do a better evaluation of the management team. You’re on the ground and in the stores to see what the environment is like within the company. You see how people are managed and have a better assessment of how the organization is run."
During Conaway’s tenure and before, Adamson had served on the audit and finance committees, but had no clue that Kmart was barreling toward a Chapter 11 filing. "We asked and challenged the management team with pretty aggressive questions. I wish we had been more aggressive, but we had confidence in the ceo and you need to let the ceo run the business. We were involved in strategic investments, but at the end of the day, we are still advisers, with the ability to hire and fire the ceo," he said.Adamson’s focus now is ensuring that the company has a strong outside auditing firm and an equally capable internal auditing group. High on the agenda is the attraction of top-notch board members and implementation of the right corporate policies. The ceo is concerned that fear of personal liability will limit Kmart’s ability to attract qualified women and minorities for board positions.
Peter Siris, a former apparel executive and retail analyst who now manages a hedge fund, noted: "Retail and apparel have far more than their share of problems, with the sectors having a higher percentage of bankruptcies than any other industry except telecommunications. Historically, companies have played games with inventory, played games with barter and played games with shipment, including just putting stuff in the trucks and then claiming it was shipped."
Siris recently joined forces with Stephen Shulman to form Corporate Governance Consulting Group, a division of Shulman Weingarten & Co., where Shulman is an accounting partner. The group is a consulting service that has at its disposal experts in different fields to guide board members who may need advice, or just a sounding board, about their responsibilities.
"I’ve been talking with board members and chairmen of audit committees for months now on what is needed to help boards and committees make better decisions as certain issues come up. Our approach is to give those who ask the type of analysis that will give them a clearer picture of what they need to know to implement good decision-making," Shulman explained.
According to Siris, the problem with many boards is that they aren’t aware that they have the ability to question a ceo’s decision, or even that they should be the ones asking the tough questions.
"I knew the Grass people from Rite Aid and a lot of things happened because nobody ever said to the ceo, ‘Wait a second. I don’t think that this is the way to do it.’ If you want to attract good people to serve on boards, then they need to know that there are resources available for advice on issues such as options and compensation. A lot of companies run into trouble because nobody on the board is saying: ‘We need to take a second look at that transaction.’ Many have not yet learned how to be professional question askers," he said.Fashion executives and the financial professionals who work with them agree that improved corporate governance could supply a big boost to the sagging confidence in American corporations, but all remain wary of ideas that smack of aggressive governmental intervention. David Lamer, retail and apparel analyst at the investment bank Ferris, Baker Watts, said: "We definitely have to fine-tune our rules for stricter governance, but you don’t want to overreach and run the risk that the U.S. government begins to control the companies. It is the board that should govern.
"The honest to God truth is that companies can viciously deceive the public in their finances, and basically get a slap on the wrist. Renegade management understands that they can misguide the public and deceive it of millions, if not billions, then go to jail for five years and still get to keep their homes. That’s just obscene."
Apparel consultant Emanuel Weintraub, of the firm that bears his name, cast the current scandals against the backdrop of human nature: "We’re all greedy. When companies make money for us, we don’t care how they do it. When we’re losing money in our pension plans, we get a sense of moral outrage, with morality tied to the fact that our greed isn’t satisfied.
"Improved corporate governance is good for retail and apparel firms," he continued. "Outside directors, for example, aren’t there to run the business, but to set policy. Based on my experience on boards, I think boards need to be dominated by outside directors. That’s my idea of checks and balances."
Elizabeth Eveillard, an investment banking consultant who also serves as an outside director on three boards — Value City, Lillian Vernon and the privately held Bealls Department Store — said that outside directors often can bring a different perspective to management.
"If the directors are active — attending the meetings and vocal in their opinions — the individuals can provide a good sounding board for management. There should be a mix of insiders and outsiders on the board and I’ve seen that having individuals with a financial background is a big plus for the audit and compensation committees," she noted.Calling Kellwood Co. "ahead of the curve on the issue of governance," Hal J. Upbin, the company’s chairman, president and chief executive officer of Kellwood, noted that the firm established a governance committee two years ago and that six of its eight members are outsiders. "We also have an audit committee led by someone with financial acumen, and there are no insiders on either the audit, compensation or governance committees. The executive committee, which chairs those three, has one insider, me. The three others outweigh me on any voting."
Upbin observed: "A firm goes astray when it is willing to do things that are unethical to enhance the pocketbook. Much of that stems from trying to get the stock price up because Wall Street has been unmerciful to companies that miss" their financial projections.
He attributes many recent scandals to the combination of too much greed and too little control: "When you have stock options that allow someone to make $100 million, well, it does funny things to people when it relates to stock price because there are so many dollars at stake."
Brian Tunick, specialty retail analyst at J.P. Morgan, believes the recent scandals have been a call to action. "The level of investor confidence has been so eroded that we are only now beginning to see what needs to be done. The stock market reacts positively when people are led out of their homes in handcuffs. It restores the confidence of investors who ultimately decide where they want to be, whether in stocks, bonds or cash. We [on Wall Street] want them to know that the market is not rigged against them."
Tunick expects to see an increase in the ranks of board membership by outside directors among public firms.
"We can’t have the chairman or ceo appointing his or her friends to sit on the board. The tough decisions don’t get made when that happens and we need people to be held responsible for what they are signing off on. People don’t trust the numbers that they are seeing, and are concerned that more shoes will drop. The trend now is for people to shoot first and ask questions later," he explained.The board of Perry Ellis International is split 50/50 between inside and outside directors. Tim Page, chief financial officer at Perry Ellis International, said the firm has been in the process of adding at least one outside director for several months, but progress has been slow.
"Having people from other industries provides a different point of view; otherwise a firm runs the risk of tunnel vision. The problem is that it has been harder to find someone to serve on the board. One has to look at the potential risk and if he or she is not personally aware of the company, the individual might not want to be personally involved," the cfo noted.
Chicago-based Hartmarx Corp. last month said its board now will consist of a majority of independent, outside directors, and that no insiders will be members of key committees such as compensation and audit and finance.
New guidelines call for the full board to perform an annual evaluation of the chief executive, a position earlier this year taken by Homi Patel, and committee members and other directors to have "complete access to management and outside consultants, as they deem necessary and appropriate." Outside directors will meet "on a regularly scheduled basis without management present."
As for retailers, many analysts said that operators such as Federated Department Stores, The May Department Stores Co. and Target Corp. do a fairly good job on the corporate management front.
Ferris, Baker Watts’ Lamer observed: "In the department store channel, Federated has a very strong and conservative board, as does May. Most department stores have experienced, traditional boards governing those businesses. Apparel, I’m sure, is more mixed. However, Polo has very strong independent people, and you’ll see a flavor of expertise from all walks of life on its diverse board."
Gilbert Harrison, chairman of the investment banking firm Financo Inc., noted: "The public outcry as a result of the excesses taken by a few is hurting the multitude of companies that have straightforward accounting, proper systems and appropriate board direction. The leadership of a company still has to start from the top, with the chief executive officer leading the charge."While there’s a role to be played by outside directors, Harrison said, he isn’t sure enough is being done where the focus ought to be.
"It seems to me that many of the excesses that have taken place may lie in the role of outside auditors and outside legal counsel. With appropriate checks and balances by the outside people, the problems associated with Enron and WorldCom should not have arisen, whether the board is filled by outsiders or not," he concluded.
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