Byline: Rich Wilner, with contributions from Arthur Friedman and Jeff Siegel

NEW YORK — The Leslie Fay Cos. mess got uglier Tuesday.
The cloudy and uncertain future of the maker of dresses and suits was rocked when BDO Seidman, the manufacturer’s former accountant, said it would file claims today against John J. Pomerantz and other senior and middle management, charging them with falsifying company books.
BDO Seidman, which itself has come under attack in the wake of the accounting scandal, charged that Pomerantz and others took part in the fraud to enhance the company’s prestige and justify “handsome compensation” packages in an otherwise recessionary retail economy.
“Quite simply, I knew nothing about the accounting irregularities until the weekend before they became public,” said Pomerantz Tuesday, in response to BDO’s charges.
In other developments:
Leslie Fay shareholders, who expect their shares to be wiped out by the company’s reorganization, won bankruptcy court approval Tuesday to pursue claims against BDO Seidman for not detecting the scandal that overstated earnings by $119 million over three years.
A recently unsealed report by the audit committee of Leslie Fay took Pomerantz to task for not performing any “significant critical analysis” of regular internal financial reports that might have unearthed the accounting scam. While finding that Pomerantz was not actually involved with the fraud, the committee found that the chief executive “did not understand” much of the financial information forwarded to his desk.
The U.S. Attorney in Scranton, Pa., said he was continuing his criminal probe of Leslie Fay and could very well use the charges turned up in the audit committee report and BDO claims in that probe.
A Leslie Fay shareholder filed an objection to a proposed employment contract for Pomerantz. As a result, Leslie Fay will have to defend the salary and perks within the offer in light of the news in the unsealed committee report and the BDO claims.
The storm of charges and counter-charges certainly won’t help Leslie Fay deal with its current troubles. The company, which was forced into Chapter 11 reorganization in April 1993 because of the accounting fraud, recently decided to put its core dress business on the block.
Pomerantz has been mentioned as the likely purchaser of that business. As reported, Leslie Fay’s Sassco division — its most valuable unit — is also on the block, and a deal to sell the business to Arthur Levine, its chairman, is said to be close.
Regarding BDO’s charges, Leslie Fay issued a statement calling them “unsubstantiated and unfounded” and charged the accounting firm with dealing in “revisionist history.”
“In 1994,” Leslie Fay said, “a court-appointed independent examiner, Charles A. Stillman, concluded preliminarily that ‘it is likely BDO Seidman acted negligently in performing accounting services’ for Leslie Fay, that ‘viable claims likely exist against BDO Seidman’ for that negligence, and that ‘substantial damages could be awarded against BDO Seidman.”
“There is no new evidence to support BDO Seidman’s allegations, which are completely without merit,” Leslie Fay added.
Elaborating on the company’s statement, Pomerantz said he has been twice cleared of any wrongdoing in the accounting fraud and that those who suggest he took part in the scam do “a tremendous disservice to me.”
Separate from the new battle between Leslie Fay and BDO, the two-year-old audit committee report that was unsealed late Friday brought out details of how the fraud was conducted.
Specifically, it concluded that Pomerantz did not perform any “significant critical analysis” of regular internal financial reports despite badly eroding sales and profitability.
“They accepted the financial statements without significant scrutiny,” the report said.
“Although [they] appear to have been knowledgeable of difficulties in meeting budgeted shipping, increases in sales erosion and inventory, and weakness in going-in-margins,” the 369-page report noted, “they did not critically question the reasonableness of financial results showing relatively stable percentages of overhead and gross profit to net sales.”
The report determined, however, that the lack of questions by Pomerantz was not a result of any nefarious intent but simply that Pomerantz “did not understand certain of the information provided to him.”
Pomerantz, the report found, does not have “the financial sophistication and training which might have permitted them to raise probing questions with respect to the financial information,” which ultimately resulted in overstating earnings by $119 million and forcing the once-successful dress maker into Chapter 11.
The report comes down hard on Paul F. Polishan, former senior vice president of finance and chief financial officer, and Donald F. Kenia, former corporate controller. Kenia has pleaded guilty to filing false financial instruments with the Securities and Exchange Commission and is believed to be cooperating with the U.S. Attorney in Scranton, Pa.
On several occasions, Kenia fingered Polishan as knowing of and aiding in the furtherance of the accounting scam. Polishan denies those accusations and has not been charged with any crime.
In the report, though, the audit committee said it has “obtained substantial information and performed analyses which, collectively, may be viewed as corroborating Kenia’s assertions.”
The audit committee, which did not have subpoena power, appears to contradict this point, saying that various information it collected supported Polishan’s denial.
According to the report, Kenia said many “unsupported entries” were recorded in the third month of various quarters. For example, the report called into question an “unusually low overhead expense amount” for June 1992 compared to July, even though June had higher net sales.
“It might be expected that [such] an unusual variation… would result in a query by an individual who is responsible for analyzing the schedule that depicts the unusual amounts,” the report said. “In this instance, the audit committee found no evidence that Mr. Polishan questioned this unusual variation.”
The audit committee report also analyzed inventory manipulations as of Jan. 2, 1993, the end of the 1992 fiscal year. According to its analysis, the value of inventory was overstated by unsupported entries in the amount of $27,813,015. There were two main manipulations used in connection with the overstated inventory: false journal entries and phony documentation.
The report sates that Kenia recorded or directed the recording of falsely inflated levels of inventory in the company’s general ledger, which was accomplished by overstating inventory. The company’s accounting system then automatically pre-billed as orders all inventory, as well as the inventory purchased in the period. As a result the cost-of-sale expense would be overstated, which would keep expenses more in line with the inflated sales.
“At year-end 1992, Mr. Kenia experienced difficulty in preparing sufficient supporting material for the additional inventory, in fact, and it was during the course of his efforts to complete manipulation that Mr. Kenia revealed the accounting irregularities.”
According to the report, Kenia said he had directed the acting cost department manager to change the standard costs on certain styles and to run a printout. Then, after the printout was provided to the independent auditors, Kenia said he directed the cost manager, Karen Carey, to return the standard costs to their original amounts. This occurred in January 1993, with the falsely inflated inventories totaling close to $3 million.
The audit committee also identified specific changes made to overstate other categories of inventory totaling $22.1 million, with the bulk of the additions allocated to the Sassco Fashions division.
“It may have been thought that it would appear less unusual there, since Sassco imports a high volume of goods from the Far East and has a substantial volume of goods in transit normally,” the report states. “In addition, finished goods inventory in transit can only be audited by a review of the related documentation, since there are no goods present for the independent auditors to physically inspect at year-end.”
In the area of shrinkage expense, the audit committee found that it was deliberately reduced, then eliminated during the latter half of 1992. Kenia said Polishan told him to do it, but Polishan denied it, the report said.
“Mr. Polishan had available to him information regarding the reported shrink expense which would have prompted him to inquire, and thereby may have permitted him to detect the misstatement of at least the company’s gross profits in its financial statements,” the report said. “However, Mr. Polishan apparently chose not to analyze that information.”
Polishan told the committee that while he may have observed the recording of low or negative shrinkage expense, he would not have questioned the numbers because “if I’m getting favorable results, why should I question it?”
Polishan explained that it was the company’s objective to have no shrinkage but did not explain what steps the company had taken to achieve “a result which is probably unprecedented in the apparel industry,” the report states.”
Andrew Jassin, a partner in the consulting firm Marketing Management Group, said Leslie Fay, as an existing company, is “tarnished to the point that it can’t keep on operating for too much longer.”
“The primary value in the company is Sassco, and Arthur Levine has made it clear he wants it back, and I believe he will get it back when the board and the creditors feel it’s the right time,” Jassin said. “I think one of the problems holding up the deal is the problem of trying to get sufficient credit to fund a $360 million company, which will basically be a startup operation when it’s sold.”
If that deal is consummated, Jassin said, Leslie Fay as a trademark can still have some value to the consumer, but “it needs to change its environment.”
“If it can form a strategic partnership with a white knight in the form of an outside party who may or may not want to bring Pomerantz along as a goodwill ambassador, then the name can continue to have life. But there’s no way it can continue under present circumstances.”
However, Jassin still believes “somebody pulled the wool over Pomerantz’s eyes,” regarding the accounting fraud.
Saul Berkowitz, a senior partner in the accounting firm Goldstein, Golub, Kessler & Co., said that given the multiplicity of accounting irregularities, “if reasonable audit steps were taken and reasonable controls were in place, the internal and external audit tests should have picked something up.”
“The only motivation I believe exists is that someone was promised a bonus if certain results were achieved, as is referred to in the audit committee report,” said Berkowitz, whose company handles many apparel industry firms. “The people that gave the orders must have had similar motivation involving their own performance bonuses and stock holdings.”
Meanwhile, Arthur Levine, chairman of Sassco, continues to express his desire to buy back the company he sold to Leslie Fay 12 years ago.
“It’s almost over; it’s close to being done. What else can I say?” Levine told WWD Tuesday.
As far as the audit committee report on the accounting scandal, Levine said, “It’s old news. There are no new revelations.”
He would not comment on possible motive or guilt in the fraud.
Separately, Bankruptcy Judge Tina L. Brozman gave Leslie Fay’s equity committee permission to purse claims against BDO Seidman.
Benjamin Waisbren, of Lord Bissell & Brook, Chicago, counsel to the equity committee, refused to comment on the nature of the committee’s claim but said the group has set aside a budget for “a near-term investigation that will take place before and after a lawsuit is filed.”
The committee has until April 5 to file charges against BDO Seidman. An agreement between the committee and the accounting concern that would have pushed back the statutorial deadline fell through.
“The [committee’s] claim needs to be preserved above all else,” said Brozman.