SEC SETTLEMENT SHEDS LIGHT ON FLEMING'S ACCOUNTING

MARK HAMSTRA

WASHINGTON -- The Securities and Exchange Commission here last week said it reached settlement agreements with Fleming Cos., Dallas, and several of its suppliers related to an ongoing investigation involving inflated vendor rebates and other accounting improprieties.

An SEC spokesman told SN that investigations of "individuals or other entities" that were involved in the Fleming accounting scandal continue. The SEC said it would not seek monetary damages from Fleming (which recently emerged from bankruptcy as a convenience store distributor) because of the bankruptcy and of the company's cooperation in the investigation.

The suppliers settled for amounts ranging from $100,000 to $400,000. Certain individuals employed by suppliers agreed to pay smaller sums.

A former Fleming accountant who testified in the SEC investigation told SN last week that an overwhelming push by the company's top management to increase sales at any cost led to the company's accounting woes, which the SEC said included prematurely recorded vendor rebates and artificially inflated same-store sales.

"[They] kept saying, 'You've got to make your numbers. You've got to make plan.' Those who didn't got fired, and people who made up numbers got rewarded," said David Enholm, who was director of financial accounting at Fleming during the period the company's problems surfaced in 2002 and 2003. The wholesaler, which once was the largest grocery distributor in the industry with annual sales of more than $20 billion, filed for Chapter 11 bankruptcy protection last April. It sold or shuttered all of its retail and supermarket distribution assets.

In a statement disclosing the settlements, the SEC said Fleming undertook several initiatives in 2001 and 2002 to disguise its declining sales and profits as its customers' performance declined in order to "bridge the gap between Wall Street expectations and disappointing actual operating results."

As previously reported, those initiatives included obtaining "misleading" letters from suppliers to justify accounting recognition of rebates before those rebates had actually been earned.

The companies the SEC alleged had assisted Fleming in inflating its earnings and that settled with the SEC without admitting guilt were: Dean Foods Co., Dallas, which agreed to pay $400,000; Kemps, formerly known as Marigold Foods, Minneapolis, $150,000; and Digital Exchange Systems, Tampa, Fla., $100,000. Several executives from those companies, as well as one executive each from Frito-Lay, Plano, Texas, and Kraft Foods, Northfield, Ill., also agreed to pay smaller fines.

Enholm said in each of those cases, the vendors provided letters stating they owed Fleming rebates before those rebates were actually due.

"I was able to prove that they were in cahoots with the vendors," he said, noting one instance in which a supplier sent a letter indicating that it owed Fleming $2.5 million, when in fact the contract stated that the $2.5 million was to be earned over a three-year period.

During his testimony to the SEC, Enholm said, he learned that an executive at Fleming had drafted a document that essentially had been used to "coach" vendors on how to write the letters.

For his part, Enholm said he reported the improprieties to Fleming executives and to the company's auditors, who he said warned Fleming to stop, but did not make it restate its earnings.

"It wasn't until later that I could see the whole house of cards that was being built," he explained.

The SEC also said Fleming improperly inflated earnings by buying excessive inventory toward the ends of quarters "solely to generate cash and volume discounts, which Fleming recorded immediately." The company also reported "sizeable accounting reserves" without justification in order to increase earnings, and did not establish reserves against known losses, the SEC said.

Had Fleming properly accounted for those transactions, its pretax earnings for 2001 would have declined almost 40%, according to the SEC.

The SEC also said Fleming "repeatedly changed how it calculated same-store sales, without disclosing to investors that it was making those changes." It also inflated sales at its retail stores by including financing transactions disguised as sales. As a result, the SEC said, Fleming was able to report gains in same-store sales when in fact those sales were declining.

Enholm said he learned during his testimony of one way in which the company inflated same-store sales: counting sales from new stores as improvements over sales from other stores that had been shuttered. For example, Fleming opened a new Food 4 Less store in Phoenix after closing down an Abco store in the market months earlier, but reported sales from the new store, which was much larger, as same-store sales gains over the sales from the shuttered store, which had been performing poorly.

Harold F. Degenhardt, the SEC's administrator in Fort Worth, Texas, told SN the commission was continuing its investigation.

"Any individuals or entities that were involved in Fleming's problems should take little comfort in this settlement," he said. "We recognize that Fleming's problems were not caused by the company itself but by individuals."

The SEC also identified several employees from the vendor companies who had agreed to pay penalties in the case. They were John D. Robinson, a senior executive at Dean Foods, who agreed to pay $50,000; James Green, chief executive officer, Kemps, who also agreed to pay $50,000; Christopher Thorpe, vice president of financial services, Kemps, $50,000; Steven Schmidt, president, Digital Exchange Systems, $75,000; Rosario Coniglio, principal, Digital Exchange Systems, $75,000; Bruce Keith Jensen, director, national accounts, Frito-Lay, $25,000; and John K. Adams, regional manager, Kraft Foods, $25,000.