NEW YORK — A $42 million accounting misstatement in 2001 contributed to Kmart Corp.’s escalating financial problems and led to the indictment in Detroit Wednesday of two of its former vice presidents.
This story first appeared in the February 27, 2003 issue of WWD. Subscribe Today.
Enio Montini Jr., 51, and Joseph Hofmeister, 52, were charged with securities fraud, making false statements to the Securities and Exchange Commission and conspiracy, according to the three-count indictment unsealed by the U.S. Attorney’s office in Detroit. Both are Michigan residents.
A trial date has not been set. If convicted, Montini and Hofmeister each face maximum prison terms of 10 years on the securities fraud charge, as well as a $1 million fine for the offense. The false statements and conspiracy charges carry lesser penalties of up to five years in prison and a fine of $250,000 each. A source in the U.S Attorney’s office said that the prison terms would be served concurrently.
In addition, the SEC filed a civil action against the two on Wednesday, charging them with violations of the bookkeeping and reporting provisions of federal securities laws.
Montini was senior vice president and general merchandise manager of Kmart’s drugstore division. Hofmeister was the vice president of merchandising within the same division.
Montini and Hofmeister were both scheduled to testify in December in connection with Kmart’s internal investigation, but elected to assert their Fifth Amendment right not to testify, according to papers filed by Kmart with the bankruptcy court last month.
Montini was the recipient of a $750,000 loan, one of 25 former executives who received retention loans under circumstances that have been the subject of intense scrutiny by Kmart, the U.S. Attorney’s Office, the Detroit office of the Federal Bureau of Investigation and the SEC. That loan has since been forgiven, but Kmart might seek to have it repaid. Both Montini and Hofmeister left the company last May 10 as part of a corporate restructuring.
Kmart Corp., which on Tuesday received Chicago bankruptcy court approval to begin soliciting creditor acceptances of its plan of reorganization, was not a named party in either legal action. Kmart filed for Chapter 11 on Jan. 22, 2002, and is on course to exit bankruptcy proceedings by the end of April 2003. A confirmation is expected on April 14 or 15, according to Kmart.
Willie T. Hulon, special agent in the Detroit FBI office, said in a statement, “This is still an ongoing investigation to which the FBI will continue to devote all necessary resources. This indictment represents only a portion of this exhaustive investigation which began in February 2002.” The SEC declined further comment on the case.
Jack Ferry, spokesman for Kmart, said, “Kmart has and will continue to fully cooperate with all government investigations.”
According to the indictment, the two defendants allegedly negotiated a multiyear contract with American Greetings Corp. to be Kmart’s sole supplier of greeting cards. Its sole competitor, which held 40 percent of Kmart’s business, was Hallmark Cards Inc. Under the terms of the contract, which was signed the day before Kmart filed its Chapter 11 bankruptcy petition, American paid Kmart an “allowance” of $42.35 million on June 20, 2001. The payment represented a $50,000 takeover allowance for each store that had been stocked by Hallmark.
The $42.35 million was subject to repayment under certain circumstances, such as liquidated damages in the event Kmart terminated the agreement before its scheduled end date. It was supposed to have been recognized over the term of the agreement, per generally accepted accounting principles.
Instead, the two allegedly “conspired” from November 2000 to Jan. 21, 2002, to have the retailer improperly recognize the entire amount in the second quarter ended Aug. 1, 2001, according to the indictments and the SEC civil action. That action enabled Kmart to meet earnings expectations for the quarter.
Furthermore, the two allegedly concealed a side letter relating to the nature of the payment.
As a result, Kmart overstated its operating results by $42 million in the quarterly report filed with the SEC and understated its losses by 6 cents a share. Kmart has since restated earnings for the last three years.
The indictments handed down on Wednesday were the first of what is expected to be a flurry of legal actions to follow. Last month, Kmart said an internal investigation determined that a minimum of 10 former executives were “grossly derelict” in their duties to the bankrupt firm.
An attorney for Kmart told the bankruptcy court that it found evidence supporting possible legal recourse against former chairman and chief executive officer Charles Conaway over the stewardship of the ailing retailer. Conaway, through his lawyers, denied the claims.
Kmart’s findings will be turned over to the trustee of the Kmart Creditor Trust, which will decide whether legal action should follow. A trustee has not been appointed yet, according to Kmart’s Ferry.