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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Aug 26

Written by: Jack Ciesielski
8/26/2005 7:08 AM 

Former Kmart CEO Charles Conaway may have dodged one bullet when he was cleared of civil wrongdoing by an arbitration panel. The panel found that Conaway "acted at all times in good faith and in what he believed to be the best interests of K-mart."

That's their version. The next bullet, from the SEC, is a much different version.

On Tuesday, the SEC charged Conaway with fraud, along with the former CFO, John McDonald. Their lack of forthrightness and candor in the Management's Discussion & Analysis 10-Q for the third quarter and nine months ended October 31, 2001, and also in an earnings conference call with analysts and investors, is what pulled them into the SEC's sights.

From the Commission's press release:

The Commission alleges that, in the MD&A section, Conaway and McDonald failed to disclose the reasons for a massive inventory overbuy in the summer of 2001 and the impact it had on the company's liquidity. For example, the MD&A disclosure attributed increases in inventory to "seasonal inventory fluctuations and actions taken to improve our overall in-stock position." The Commission alleges that this disclosure was materially misleading because, in reality, a significant portion of the inventory buildup was caused by a Kmart officer's reckless and unilateral purchase of $850 million of excess inventory. According to the complaint, the defendants dealt with Kmart's liquidity problems by slowing down payments owed vendors, thereby withholding $570 million from them by the end of the third quarter. According to the complaint, Conaway and McDonald lied about why vendors were not being paid on time and misrepresented the impact that Kmart's liquidity problems had on the company's relationship with its vendors, many of whom stopped shipping product to Kmart during the fall of 2001. Kmart filed for bankruptcy on Jan. 22, 2002.

The SEC's version doesn't square much with the panel's version. The actions of the executives are really a shame: in the end, the company went bankrupt anyway. Maybe it would have been over with quicker if they'd been honest about things in the first place - and the execs would have saved themselves face time in court and with the SEC.