LESLIE FAY, THE AFTERMATH
SA ASSESSES THE BLAME

Byline: Arthur Friedman

NEW YORK--How responsible--or knowledgeable--should a corporate head be about the ins and outs of the company's bookkeeping?
That's the debate on SA in the wake of the latest report on the accounting scandal at The Leslie Fay Cos. And the answer is far from simple.
Many industry executives and analysts said they could understand how John J. Pomerantz, chairman and chief executive officer of Leslie Fay, and Alan Golub, then president, could have been deceived by the company's financial experts. They further said it isn't unusual for chairmen, ceos or presidents of companies to look more at bottom-line results than make studious inspections of specific financial details.
Others insist, however, that even if Pomerantz and others "did not and could not" have known what was going on, as the investigation conducted by court-appointed examiner Charles A. Stillman concluded, they "should have known" whether the company was losing money or making money, even if they didn't know the exact amounts.
"It is top management's responsibility to be on top of every aspect of the company," said Saul Berkowitz, a senior audit partner at Goldstein Golub Kessler & Co., an accounting firm. "That's what they get paid for, and while I agree that Pomerantz may not be liable, you have to question whether he could have done a better job. The fact that he's been relieved of financial responsibility answers that question."
In September 1993, seven months after the scandal broke, Leslie Fay's directors shifted the financial responsibility of the company from Pomerantz to Michael Babcock, who replaced Golub as president and later became chief operating officer.
Morris Marmalstein, president of the Warren Group, had a more sympathetic point of view than Berkowitz.
"It's totally understandable that someone like John Pomerantz was not involved in the day-to-day financial doings of the company," he said. "I know as a president of a major company myself, although we're not as big as Leslie Fay, nor are we public, I leave those kinds of details to the professional people in the company in charge of those areas. It's their job to red-flag the financial things that need attention."
Marmalstein said it is known that Pomerantz's forte and main task at the company was to act as a liaison with major retailers.
Whatever their opinions, industry executives and financial experts agree that what happened at Leslie Fay--a fraud that overstated the company's profits by $81 million over a three-year period through 1992 and forced the company into Chapter 11--reflects the pressures on apparel companies to meet figures, given the seasonality and trend-oriented nature of the industry. And, they add, it's particularly true for public companies, which must air their laundry quarterly.
The Stillman report was released by the court on Aug. 16. It upheld earlier findings that Pomerantz, his wife, Laura Pomerantz, senior vice president Golub, and Herman Gordon, who retired as senior vice president and general counsel at the end of last year--did not engage in any wrongdoing.
However, the report also focused on some questionable accounting pressures and the drive to meet sales and profit goals. One of the practices spotlighted was prebilling, or entering invoiced amounts as sales prior to shipment, which many say is fairly common on SA but can be a precarious practice.
Janet Mangano, an analyst at Burnham Securities, reflecting a commonly held opinion, said prebilling is "absolutely not a good thing to do," even though she feels the practice is fairly widespread in many industries.
"If you have an order from a reliable customer, shipments can easily be predicted," Mangano said. "But it's always best to err on the conservative side, no matter what your line of business."
As many executives familiar with the company view the situation, management, under Pomerantz, might have created a mind-set in the company wherein the push to meet projections was so great that the controller, Donald Kenia, and chief financial officer, Paul Polishan, could have taken it upon themselves to juggle the books to achieve the desired results. Kenia and Polishan were dismissed by the company after disclosure of the fraud.
Although cleared in the Stillman report, Pomerantz and Leslie Fay still face some tough legal hurdles. There are two pending lawsuits--a shareholder class-action suit and a suit to nullify executive liability insurance on Kenia and Polishan--as well as ongoing investigations by the Justice Department and Securities & Exchange Commission. The company also faces an October deadline to file a reorganization plan in order to emerge from bankruptcy.
The Stillman report states that the accounting fraud "was a relatively simple two-part scheme."
"The first part consisted of making unsupported or false entries to the company's books," the report said. "The second part consisted of producing bogus documentation to make it appear as though the unsupported or false entries were valid, thus concealing the fraud. The false entries were made to overstate assets and income and to understate liabilities and expenses. The overall purpose was to produce financial statements that would deceive a reader into believing that the company was more profitable and had more assets and fewer liabilities than it actually did have."
Stillman said, "While simple in concept, the fraud's execution was complex: it involved hundreds of false entries to the books and records of about 17 divisions over a period of several years."
The report states that Kenia "has acknowledged that, beginning in the fourth quarter 1990 and continuing through yearend 1992, he regularly made or directed the making of unsupported adjustments to the company's financial statements," and that he took various steps to conceal the adjustments.
The report concludes that there is no evidence that Kenia, or anyone else, misappropriated assets as part of the accounting fraud scheme, so "it is difficult to understand what motivation Mr. Kenia may have had to perpetuate the accounting irregularities in light of the absence of personal financial benefit."
According to the Stillman study, Kenia asserted that Polishan directed him to cook the books, and it concludes that "there is information that may tend to corroborate Kenia's view of Polishan's role."
As reported, Polishan's attorney, Michael G. Berger, has stated that Polishan denies any wrongdoing in the matter. Referring to the pending litigations, Berger said: "There is substantial litigation going on in which the truth of the conclusions reached [concerning Polishan] will be tested."
While the report said Pomerantz and Golub did not know or participate in the perpetration of the accounting irregularities, it recites their explanations that they generally accepted the financial statements "without significant scrutiny," did not perform "significant critical analysis below the net sales line," and "relied upon Mr. Polishan" to prepare the financial statements.
According to the report, Pomerantz said he "did not understand" certain financial information, and Golub said he performed "little analysis or review of the budgets or projections."
Nevertheless, Stillman's report concluded that Pomerantz and Golub could not have identified the accounting irregularities "even if they had performed any critical analysis." The report also notes that Pomerantz and Golub received a significant portion of their salary in the form of profit-sharing, but there is "no indication that the accounting irregularities were linked to a desire by the individuals to obtain these bonuses."
With the revelations of the fraud, Pomerantz, as noted, has returned $1.6 million of combined bonus and profit-sharing payments, reducing his bonus for the two years to $1.9 million.
In addition, Stillman wrote that even if senior management had thoroughly analyzed all the documentation received, they would not likely have detected the irregularities because the materials contain no obviously revealing information--that is, no "red flags" concerning the fraud.
"In short, the direct evidence of the irregularities was several levels removed from the information management received," he wrote.
While Pomerantz declined to be interviewed for this article other than to say he "wanted to put the situation behind" him, he pointed out through a spokesman that since the scandal broke, the company has revamped its financial controls, putting in place an internal audit function and an internal auditor, Michael Brown, who operates independently from John Dubel, the firm's chief financial officer, who replaced Polishan.
Dubel and Brown report to Babcock.
"We feel very confident that the proper controls and systems have been put in place to insure that the situation that occurred could not be repeated," a Leslie Fay spokesman said.
On SA and Wall Street, meanwhile, the debate about culpability among top-level executives continues to be a hot topic.
Marie Beninati, director of retail market strategy for Kurt Salmon Associates, an apparel and retail consulting firm, said in general ceos rely on the financial experts in the company, just as they rely on merchandisers, designers and sales managers for their expertise.
"That's what makes for an effective organization," Beninati said. "The key is to have good checks and balances within the organization and fail-safe measures within the financial reporting."
Mangano at Burnham said it's not unusual for top executives to be unaware of financial details.
"It's all about supervision and where did the lines of supervision fail," Mangano said. "I think Leslie Fay has learned a hard lesson and will emerge as a better company because of it."
Marcia Lissak, director of apparel industry consulting for Richard A. Eisner & Co., an accounting and consulting company, said "it's very possible" that a chairman, ceo or president of an apparel firm might not have complete knowledge of financial details.
"The orientation of many of the people at the top of these companies is as successful salespeople or merchants," Lissak said. "As a company grows or diversifies, top executives often become somewhat removed from the day-to-day financial doings of the company."
Bud Konheim, president of Nicole Miller, said as a business grows, a ceo or a president gets more removed from the operations of the company and delegates those responsibilities.
"You rely on people like controllers and chief financial officers to perform their jobs professionally, but ultimately everything is your fault if you're the top man," Konheim said. "I preach increasing sales all the time, but I also preach squeaky clean books. One of my biggest concerns as we've grown the past few years is losing control."
Konheim said Pomerantz has always been known as an executive who had good rapport with retailers, and not as a financial expert.
Accountant Berkowitz said his firm holds monthly meetings to review his clients' financial data with top management of those companies.
"While most of our clients are small-to-medium-sized firms, in my view the same principles should be held at a larger public company," Berkowitz said. "Leslie Fay, like any company, is in business to make money, and they shouldn't be able to be fooled by the numbers. When there is an $81 million misstatement of figures, it should be impossible to hide."
Dede Shipman, president of Mary McFadden Inc., said that in a relatively small company such as hers, she doesn't see how the president or ceo could not be aware of specific financial details.
"I review all aspects of our financing," Shipman said. "Of course, I rely on our accountant to digest the information and discuss it with me, but the final responsibility lies with the president or ceo."
Shipman said the apparel industry does have "tremendous potential for deal making" because it is not a commodity business.
"The industry now is under extreme stress," Shipman said. "People are finding more and more creative ways of buying and selling. For public companies, the need to show a consistently steadily growing bottom line leads to intense pressure."
One chairman and owner of a large apparel company, speaking on condition of anonymity, said, "If you are doing your job as a ceo, you have your pulse on the business and you know how you're doing. There shouldn't be any major surprises. In general it is understood that Leslie Fay's goods were not performing well during that period from 1990 to 1992, which was a tough time in the industry and overall economy."
Among the chief findings of the investigation was that Leslie Fay's accounting firm at the time of the book doctoring, BDO Siedman, "may be liable for accounting malpractice," and that "the estates likely have viable claims worth pursuing against" the company.
BDO Siedman has denied any wrongdoing and said it was the one that was deceived.
While Berkowitz of GGK said he couldn't comment on BDO Siedman's specific role in the Leslie Fay case, he said the axiom in the public accounting world is: "If the client is out to get you and is clever about doing it, they're going to get you."
"The auditors are only testers of systems and rely on the client for financial information," Berkowitz said.
According to the report, four basic accounting areas were considered as part of the fraud: chargeback reserve, inventory reserve, sales cut-off and unrecorded liabilities.
For the chargeback reserve, Stillman said that only Polishan among senior management was or should have been aware that the chargeback reserve was intentionally or otherwise understated. The same goes for inventory reserves and unrecorded liabilities.
Concerning sale cut-offs, commonly called prebilling, the report said there was widespread knowledge and approval by Pomerantz of sales being recorded in one accounting period for goods shipped within the first three workdays of the subsequent accounting period.
It also found that a significant amount of goods invoiced by various divisions were shipped in the following period and, in certain cases, significantly later than three days after the date of invoicing. Prebilling is a violation of general approved accounting practices, Stillman said.
Marmalstein said prebilling or anticipation of shipments is not an unusual practice in the industry. For example, he said there are times when a shipment may be held up in importing for a couple of days, but had already been billed, so the invoice is recorded in the previous period.
"For a private company there is little motive to prebill a shipment," Marmalstein said. "But a public company wears its heart on its sleeve. There are often promises and projections made to stockholders and the financial community, so the temptation is there."
Prebilling is done all the time in the industry, Konheim said, admitting that in the past he used the practice but it came back to haunt him, so he stopped.
"Enough pressure can create any scenario you can imagine," Konheim said. "The pressure to achieve is one of the biggest dangers an individual or a company can face. In an industry that's as much of a pressure cooker as this one, that pressure is intensified."
Lissak at Eisner said prebilling is not something her company recommends, although there are times it is used in the industry.
"It's a dangerous but OK practice if inventories are accurate and systems are tight," said Lissak, adding that in certain circumstances, such as prepack orders that are billed but held by request of the customer, the practice is acceptable even though the goods are not actually shipped.
Lissak said public companies face a "double-edged sword" when it comes to recording their sales and earnings figures.
"There's the pressure to show sales increases versus the pressure to produce accurate, realistic figures," Lissak said. "The prospect of going public is very enticing because of the quick financial reward the principals can make, but when you're public, you're only as good as your last quarter. Since most fashion firms are involved in a noncommodity business, they are very reliant on the disposable income in the economy. Wall Street doesn't always have the best handle on that."

To Read the Full Article
SUBSCRIBE NOW

Tap into our Global Network

Of Industry Leaders and Designers

load comments
blog comments powered by Disqus