Summary: The Case of Phar-Mor Inc.
The Phar-Mor Inc. a deep discount drug store chain, came into existence in 1982 as an affiliate of family-owned grocery chain Giant Eagle, which also owned a distribution company, Tamco Distributors Co. and the deep discount concept consisted of using “power buying” or purchasing the largest possible amount of product at best term, then selling at discounts of up to 25% - 40% off retail prices. Phar-Mor Inc. had fictitious inventory, fund diversions and a fraud cover-up by management which costed its investors 500 million dollars. The first indication of financial problem came to light in 1988, when investigation of lower-than-expected profit margins revealed that Phar-Mor was being billed for inventory it had not received from its sister company, Tamco, a primary supplier. The receiving records had not been maintained by Phar-Mor for the purchases made from Tamco. And this led to the difficulty of substantiating products received. The analysis of this shortage by Phar-Mor accountant indicated that the inventory shortage or overbilling was around 4 million dollars. However, a settlement had been made by the two subsidiaries of Giant eagle for an amount of $7,000,000 giving Phar-Mor $2,000,000 profit for the year and this resulted in a nearly identical gross margin as prior year. In addition to this, another source of problems for Phar-Mor had began with the formation of the World Basketball League (WBL) in 1987 which led for the embezzlement of $15,000,000 by Monus who owned 60% of each of the 10 teams having a responsibility for that portion of each team’s losses. More over a diversion of $200,000 had been made by Monus for improvements of his personal residence and meals at a country club and profit margins continued to deteriorate. The President, Monus, crossed off the reported loss and wrote in profit. The losses were charged to what the senior staff involved in the fraud called “bucket account” in which cover up activities were recorded and reallocated to the inventory of the existing stores. It was known that the auditor, Coopers and Lybrand, did not audit accounts with zero balances; thus the activities in the “bucket accounts” that was reallocated was not reviewed. The auditor only tested four stores instead of observing all stores and rolled the inventory value forward from the test counts. Furthermore, Coopers told Phar-Mor in advance which stores would be tested, allowing Phar-Mor to ensure that a good “representative count” was taken at those stores, which then allowed the allocation of the bucket account balances as phantom inventory to the other uncounted stores, thus allocating a loss of $12,000,000. The drop-off of inventory right after June 30 year end was also explained by the high volume of July 4 sales. Fictitious inventory on the books to cover up operating losses, charging Monus’s personal expenses to the bucket accounts and charging World Basketball League expenses to the bucket accounts were the fraudulent activities being covered up. It was not easy to carry out such fraudulent activities without having a great deal of understanding of audit procedures and how to circumvent them. Here is what was accomplished by three of key financial executives among four. “The perpetrators lied, forged documents and carefully scrubbed everything the auditors saw to hide any indications of malfeasance”. Due to the reason that the auditor, Coopers, did not review zero balance accounts, this made them successful in allocating such balances to inventory at year end and was done by parking erroneous amounts in the bucket accounts. The group that auditors referred to as the “fraud team” consisted of the following:- 1. Monus, the President 2. Patrick Finn, chief financial officer, a former Coopers and Lybrand auditor. 3. Jeffrey Wally, vice president of finance, a former Coopers & Lybrand auditor, and 4. John Anderson, accounting manager, hired right out of Youngstown State University.
Finally, Phar-Mor with the disclosure of what become $500 million accounting fraud, filed for chapter 11 bankruptcy, closed 167 of 310 stores and laid off 15,000 employees. The president, Michael Monus, was indicted on 129 counts of fraud by a federal grand jury in 1993. A hung jury resulted in a mistrial, after which a second grand jury brought more than 100 new charges against him and was found guilty of embezzling more than $10 million and sentenced to 19years and seven months in prison. Vice president of finance, Jeffrey Wally cooperated with authorities, pleaded guilty to four counts of fraud and was sentence to six months of house arrest. Chief financial officer Patrick Finn was sentenced to 33 months in federal prison and fined $7,000 after pleading guilty and cooperating with authorities. Auditors Coopers & Lybrand were sued $1 billion for fraud, settling for undisclosed amount. 1. Could SOX have prevented the Phar-Mor fraud? How? Which specific sections of SOX?
Answer: Yes, by applying Title II, section 203, “Audit partner rotation” it provides that a registered public accounting firm may not provide an audit if the lead audit partner or the reviewing audit partner has performed audit services for that issuer in each of the five previous fiscal years of the issuer, by applying Title II section 206 “Conflict of interest” applying this section makes it unlawful for a registered public accounting firm to perform for an issuer any audit service, if a chief executive officer, controller, chief financial officer, chief accounting officer was employed by that registered independent public accounting firm and participated in any capacity in the audit of that issuer during the one year period preceding the date of the initiation of the audit, by applying Title III, section 302, “Corporate responsibility for financial reports” forcing the principal financial officers and principal executive officer to certify in each annual or quarterly report, by applying Title IV section 404, “Management assessment of Internal Controls” it requires management to include in annual reports an internal control report and by applying Title IV section 406 “Code of ethics for financial officers” will enable to promote full, fair accurate, timely and understandable disclosures in the periodic reports. 2. Research the Waste Management scandal from the late 1990’s. Describe the scandal. Could SOX have prevented this scandal?
Answer: - Waste management’s scandal was described as inflating of profits by $1.7 billion to meet earnings target and reap millions in ill-gotten gains while defrauded investors’ loss more than $6 Billion. It is all about a systematic scheme to falsify and misrepresent Waste Management’s financial results between 1992 and 1997. The scandal was performed by the founder of Waste Management and five other Top officers and are, Dean L. Bunt rock, Waste Management’s founder, chairman of the board of directors, and chief executive officer during, Phillip B. Rooney, president and chief operating officer, director and CEO of a portion of the relevant period; James E. Koenig, executive vice president and chief financial officer; Thomas C. Hau, vice president, corporate controller, and chief accounting officer; Herbert Getz, senior vice president, general counsel and secretary; and Bruce D. Tobecksen, vice president of finance and the improper accountings are described below * avoided depreciation expenses on their garbage trucks by both assigning unsupported and inflated salvage values and extending their useful lives, * assigned arbitrary salvage values to other assets that previously had no salvage value, * failed to record expenses for decreases in the value of landfills as they were filled with waste, * refused to record expenses necessary to write off the costs of unsuccessful and abandoned landfill development projects, * established inflated environmental reserves (liabilities) in connection with acquisitions so that the excess reserves could be used to avoid recording unrelated operating expenses, * improperly capitalized a variety of expenses, and * Failed to establish sufficient reserves (liabilities) to pay for income taxes and other expenses.
Finally, If SOX was enacted before the occurrence of the fraud It could have been prevented with the fact that the law contains different sections to fight corporate fraud and accountability. 3. Research the Enron scandal from the early 2000’s. Describe the scandal. Could SOX have prevented this scandal?
Answer:- Enron’s scandal was misrepresentation of its earnings report to the shareholders and employees as well as embezzlement of money by officials from the firm while reporting fraudulent earnings to investors. Eventually, the company went bankrupt because of fraudulent earnings reports and embezzlement.
Finally, If SOX was enacted before the occurrence of the fraud It could have been prevented with the fact that the law contains different sections to fight corporate fraud and accountability along with ethical issues and penalties.