THE PROMOTIONAL-ALLOWANCE 'DRUG' BEHIND AHOLD'S TUMBLE 2004-08-02 (1)

David Merrefield

About a year and a half has elapsed since the day in February 2003 when the industry was stunned by revelations from Ahold that bogus accounting at its U.S. Foodservice unit had caused earnings overstatements amounting to $500 million.

That was just the beginning of it. In ensuing months, an internal investigation, eventually involving Ahold units in addition to USF, showed overstatements to be more than $1 billion over time.

It was known immediately that USF's troubles had to do with vendor allowances. It has long been apparent how allowances could be manipulated by recipients, although it wasn't known precisely what was done at USF. It wasn't known, that is, until last week, when four former USF executives were charged by the U.S. Attorney's office in New York in a securities fraud scheme. Two pleaded not guilty; and two, guilty. A fifth defendant, a USF vendor, pleaded not guilty to an insider-trading accusation. See Page 1.

The four are charged in an astonishingly brazen scheme, specifically that they reduced USF's product acquisition costs -- and therefore boosted its profitability -- by falsely booking wildly inflated promotional-allowance amounts due, or by simply booking allowances that weren't due at all. Those falsehoods were masked from USF's internal auditors with the cooperation of some vendors. Here's how: A USF purchasing officer would approach vendors and ask them to sign documentation falsely stipulating that big allowance payments were due. At the same time, the vendors received assurances or side letters from USF asserting that USF would make no effort to collect the bogus sums. In instances cited by the court, the false-to-true dollar spread was huge. Vendors would certify that payments in amounts up to several millions of dollars were due USF, knowing all the while that little or nothing was due.

Why do it? Accusations are that USF officers were seeking to meet company revenue goals so as to net performance bonuses worth hundreds of thousands of dollars among them -- cheap coin for selling out an entire company. It's less evident why vendors would participate. Most likely, it was to curry favor with USF to win continuing and future business, or perhaps to receive favors such as those mentioned in the insider-trading accusation. (It was an unidentified vendor who spilled the beans.)

It's disturbing to see the ease with which collusion proceeded. It would be comforting to suppose that such situations are confined to USF and to those vendors weak enough to succumb to USF's entreaties. But such can't be the case. One indication: As was reported in SN earlier, three manufacturers have stipulated they are subjects of an investigation into a revenue booking situation at Fleming prior to its bankruptcy filing of April 2003. (For more on Fleming, see Page 6.)

There can be little doubt these practices are far more common than is imagined. There also can be little doubt that investigators will take a close look now at the practices of numerous distributors and manufacturers. The ultimate enabler of this situation is the practice of promotional allowances itself. The practice has often been likened to a "drug" that the industry can't shake off. It's an apt metaphor.

David Merrefield VP, Editorial Director [email protected]