Two former Kmart vice presidents indicted Wednesday for their part in Kmart’s financial downfall could be just the first of a wave of executives to face criminal charges for pushing the century-old retailer into bankruptcy, experts predicted.
A federal grand jury in Detroit said the two executives lied to company auditors about a $42-million payment from a vendor in 2001 that allowed Kmart to mask growing losses that would ultimately total $2.4 billion for the year.
The indictment alleges that Enio Montini Jr. and Joseph Hofmeister concocted an elaborate scheme to keep Kmart’s auditors in the dark about the payment from American Greetings Corp. Montini, 51, of Rochester Hills was a vice president at Kmart, while Hofmeister, 52, of Orion Township was a divisional vice president.
A lawyer for the men said they did nothing wrong. Mark Srere of Washington, D.C., said the pair received no personal gain and that the case involves technical accounting rules about which accounting experts disagree. “The recording of the $42 million had absolutely nothing to do with Kmart declaring bankruptcy,” Srere said.
His clients were fired in May 2002 in a wave of terminations at the retailer’s Troy headquarters. Kmart filed for Chapter 11 bankruptcy on Jan. 22, 2002.
Both men were charged in the indictment with securities fraud, making false statements and conspiracy. Securities fraud carries a maximum penalty of 10 years in prison and a $1-million fine. The maximum penalty for the other charges is 5 years and $250,000.
The accompanying Securities and Exchange Commission civil complaint, filed in U.S. District Court in Detroit, urged U.S. District Judge Paul Borman to prohibit Montini and Hofmeister from ever serving as an officer or director of a publicly traded company. It also asked Borman to order Montini to repay a $750,000 loan he received from Kmart before his departure and that both men repay any money they may have made from the scheme. The criminal case was assigned to U.S. District Judge Robert Cleland.
Montini and Hofmeister are expected to be arraigned soon on the criminal charges.
Peter Henning, a law professor at Wayne State University and a former federal prosecutor who specializes in white collar crime, said the indictments are just the first in the Kmart debacle.
The company collapsed in January 2002 under a team of executives known inside Kmart as the Frat Boys, who misused corporate jets, drove luxury leased cars, and received lavish salaries while steering the company into the largest retail bankruptcy in history.
“There will be more. Theyre just getting started on this,” Henning said. Typically, prosecutors go after low- or mid-level executives first, hoping they will cooperate and point the finger at their bosses.
Detroit FBI director Willie Hulon said the government probe is ongoing. “The indictment today represents only a portion of this exhaustive investigation.”
At issue in the Montini-Hofmeister case is what is known as a vendor payment or rebate, something suppliers typically pay to a retailer in return for getting their goods stocked and promoted in stores.
According to the indictment, American Greetings agreed to make the payment when it won an exclusive 5-year contract to supply Kmart with greeting cards.
Kmart booked the vendor payment from American Greetings in a single quarter — rather than over the life of the contract, or 20 quarters, allowing the company to fraudulently overstate its quarterly earnings by six cents per share — 32-percent higher than they should have been, the indictment said.
The SEC complaint said that in mid-2000, Kmart decided to give its greeting card business, then split between American Greetings Corp. and Hallmark Cards Inc., to a single vendor and solicited bids.
American Greetings won the bid in February 2001 and agreed to pay Kmart a $42.3-million allowance — $50,000 for each store Hallmark would be leaving. Kmart paid Hallmark nearly $27.3 million to get out of its contract with the company.
The SEC said Montini’s division was struggling to meet its gross margin numbers in the second quarter of 2001.
It said Montini and Hofmeister negotiated with American Greetings in private, excluding finance and accounting personnel as well as the vice president for the finance division, who was to have served as Montini’s chief financial officer.
On three occasions, the SEC said Montini lied to the unidentified top financial officer about the deal, telling her that the $42-million allowance came with “no strings attached.” It said Montini also lied to divisional vice president’s supervisors.
In the weeks that followed, Montini allegedly dodged the vice president of the finance division, who was suspicious about the transaction. He and Hofmeister concealed from Kmart’s internal audit section the side agreement which would have alerted the company’s auditors of the need to book the allowance over the next five years, the indictment said.
A separate investigation by Kmart’s board found that 10 executives — including Montini but not Hofmeister — were fired for cause, meaning they were negligent.
And Kmart’s board said this week that former Chief Executive Officer Chuck Conaway hid issues from board members, banks, the public and vendors involving hundreds of millions of dollars. Conaway also allowed 24 executives to receive $24 million in loans shortly before the bankruptcy, at the height of Kmart’s cash crisis, the company said. In addition, Conaway received a loan of $5 million.
Anonymous letter writers claiming to be Kmart employees first alerted the SEC and Kmart’s board to the questionable use of vendor allowances early last year.
As the company’s finances were collapsing in 2001, Kmart claimed vendor allowances of $554 million that never materialized, money that was used in the books to mask growing losses. The company restated its financial reports for the first three quarters of 2001, when it wound up losing $2.4 billion.
Wednesday’s federal court actions are the latest of more than a dozen high-profile criminal proceedings brought against former executives of some of America’s biggest companies in the 15 months since the collapse of energy trader Enron Corp.
David Poplar, spokesman for Cleveland-based American Greetings, said he couldnt discuss the episode. “That’s a matter between the SEC and Kmart,” Poplar said.
Rite Aid, based in Camp Hill, Pa., announced Wednesday that Montini voluntarily resigned his position as senior vice president of category management. He had worked at corporate headquarters since his hiring in October, a Rite Aid spokeswoman said.
No one answered the door Wednesday afternoon at Montini’s posh, brick-and-stone Rochester Hills home. The four-bedroom colonial is listed for sale by Real Estate One. A flyer extols the home’s daylight basement, library, two-story foyer, vaulted great room with a fireplace, butler’s pantry, dual staircase, three-car garage and professional landscaping.
A woman who answered the door at the more modest Hofmeister home in the Orion Woods neighborhood in Orion Township said “no” when asked if Hofmeister would comment.
Kmart spokesman Jack Ferry wouldnt discuss the incident or whether it prompted Kmart to terminate Montini and Hofmeister. “Kmart has and will continue to cooperate fully with all government investigations,” he said.
