Thursday, October 21, 2010

Interesting Issues in Timing of Green Mountain Insider Stock Sales and Disclosure of SEC Inquiry

Interesting timing

On Monday, September 20, 2010, Green Mountain Coffee Roasters (NASDAQ: GMCR) was notified of a Securities and Exchange Commission informal inquiry and request for voluntary information concerning “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.”

On Tuesday, September 21, 2010, executive officer Michelle Stacy exercised 5,000 options and immediately sold her shares at $37 per share. Of the 5,000 shares bought and sold, options for 4,375 shares did not expire until November 3, 2018 and options for 625 shares did not expire until March 12, 2019. What was the urgency in exercising her options so soon?

After the stock market closed on September 28, 2010, Green Mountain finally disclosed the SEC inquiry to investors in an 8-K filing which included certain other material disclosures.

On September 29, 2010, Green Mountain stock dropped $5.95 per share to close at $31.06 per share, a 16.1% drop in market value that day.

According to the SEC:
Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.
Michelle Stacy will have to answer questions about the timing of her option exercise and simultaneous sale of stock after Green Mountain received notice of the SEC inquiry, but before the company disclosed it to investors. The SEC might want to find out if Stacy any prior knowledge of  the SEC inquiry when she sold her stock before it was disclosed to investors.

Will Stacy claim that even though she is among the five most highly-paid executive officers of the company and is President of its key Keurig business segment, that she did not know anything about the SEC inquiry and her sale of stock was a mere coincidence?

Green Mountain Coffee Roasters Code of Ethics

According to Green Mountain’s Code of Ethics:
As a publicly traded company, GMCR is required to adhere to federal laws and regulations prohibiting the disclosure of "insider information." The sending or posting of confidential information is against GMCR policy and is subject to laws and Securities and Exchange Commission (SEC) regulations with respect to insider information. These laws and rules make it illegal to use information - obtained as an employee – about the Company that is not generally available to the public for purposes of personal profit or to advise others in order that they may profit. GMCR submits periodic filings (10-Q's, 10-K's and 8-Ks) to the SEC that disclose Company information. Information not in these documents is confidential information and may not be discussed outside the Company by any GMCR employee. If you have questions about whether certain information may be disclosed, please check with our Chief Financial Officer or the VP of Human Resources and Organizational Development.
Note: Bold print and italics added by me.
Apparently, information not yet disclosed in Green Mountain's “10-Q's, 10-K's and 8-Ks” is considered "confidential information" and the company prohibits its employees from using such “confidential information” for personal profit. When Michelle Stacy sold her stock, news of the SEC inquiry was not yet disclosed to investors and such information could be considered confidential under Green Mountain's Code of Ethics.

If Michelle Stacy claims that she did not know about the SEC inquiry when she sold her shares, did Green Mountain Coffee have any procedures in place to alert executive officers of certain possible undisclosed material events, such as an SEC inquiry, before they sell their stock?

Should Green Mountain have disclosed the SEC inquiry a few days earlier?

If Green Mountain considered SEC inquiry material enough for disclosure it when it filed its 8-K report on September 28, why didn’t the company notify investors earlier? 8-K reports are required “to be filed or furnished within four business days after occurrence of the event.” Why didn’t the company disclose the inquiry on September 25 or “within four business days after occurrence" of that specific event?

SEC guidance on materiality

Green Mountain should have checked out the SEC's website for some guidance on materiality:
Information is material if "there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision.  To fulfill the materiality requirement, there must be a substantial likelihood that a fact "would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available."
As I detailed above, Green Mountain’s shares dropped $5.95 per share to close at $31.06 per share or a 16.1% drop in market value after the company disclosed the SEC inquiry to investors. Apparently, investors thought that news of the inquiry was material. The old adage taught in securities law classes “When in doubt, disclose.” seems to apply here.

Other insider stock sales and potential issues

In the weeks before Green Mountain was notified about the SEC inquiry, Michelle Stacy and Scott McCreary, President of Green Mountain's other key business segment, the Specialty Coffee Business Unit, simultaneously exercised and sold large amounts of shares.

On August 13, 2010, Michelle Stacy exercised 30,000 options at $6.20 per share and simultaneously sold those shares at $30.95 per share for gross proceeds of $928,500. On September 13, 2010 she exercised another 5,000 options at $6.20 per share and sold those shares at $35.40 for gross proceeds of $177,000.

On August 18, 2010, Scott McCreary, President of Green Mountain's other key business segment, the Specialty Coffee Business Unit, exercised 200,000 options and $1.47 per share and simultaneously sold his shares at $33.08 per share for gross proceeds of $6.616 million.

If the SEC does find malfeasance in Green Mountain's “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors” the agency will investigate whether or not Stacy or McCreary knew anything about them before they sold any of their stock.

Closing comment

After Green Mountain disclosed the SEC inquiry to investors, several lawsuits seeking class action status were filed against the company and its officers alleging securities law violations. On one side, the company and its officers will have to contend with the SEC who has almost unlimited resources and on the other side they must contend with hungry class action lawyers with a profit motive who smell blood. Back in my criminal days, I hated them both equally.

Right now, there is an only an "informal inquiry" by the SEC and "request for voluntary information." If the informal SEC inquiry turns into a formal investigation and the regulator issues subpoenas compelling witnesses to testify and the production of documents, Green Mountain and its officers will have a lot more to worry about.

In any case, it looks like an early Christmas for lawyers representing the company and its officers as they prepare to rack up huge legal fees in defending their clients. Hopefully, a lesson learned by the Antar family, who ran Crazy Eddie back in my criminal days, does not apply here, "Your lawyers will defend you to your very last dollar."

Written by,

Sam E. Antar

Follow up Blog Post:

December 2, 2010 - Green Mountain Coffee Roasters, Time to Spill the Beans?

Recommended Reading:

WCAX.COM - Whistleblower alleges insider trading at GMCR

Seeking Alpha - Green Mountain Coffee: Beware the Valley Below

One More Cup of Coffee Addendum

Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of our family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower.

For example, I exposed GAAP violations by Overstock.com (NASDAQ: OSTK) which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

In addition, the SEC is now investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them about the company's inventory accounting practices.

I do not own any securities in any of the companies listed in this blog post, long or short.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

My investigation of Overstock.com, Bidz.com, and Green Mountain Roasted Coffee is a freebie for securities regulators to get me into heaven, though I doubt I will ever get there

Thursday, October 14, 2010

Does Overstock.com CEO Patrick Byrne Know When to Shut Up, Especially While the SEC Investigates his Company?

During an ongoing SEC investigation into financial reporting violations by a public company, competent lawyers will advise management that the wisest course of action is to simply shut up. Not so, with Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne. He does not know when to stop blabbing away, misleading investors, and lying to the media – even during an ongoing SEC investigation of his antics.

For example, in 2009, I correctly reported in my blog that Overstock.com violated Generally Accepted Accounting Principles (GAAP) in accounting for its recoveries of certain offsetting costs and reimbursements amounts due to the company from its fulfillment partners (suppliers) who were under-billed in previous reporting periods, from Q1 2007 to Q 2 2008. Overstock.com should have restated its financial reports to recognize income when those offsetting costs and reimbursements were actually earned by the company in those previous reporting periods.

Instead, the company improperly recognized income as those amounts were collected in future accounting periods (Q4 2008 to Q3 2009) on a non-GAAP cash basis. In one instance, Overstock.com improperly reported Q4 2008 profits, even though the company should have reported a loss under accounting rules.

Despite many emails from me, Patrick Byrne stubbornly refused to correct his company's GAAP violations and even fired Grant Thornton as its auditor for agreeing with my recommendations. Instead, Byrne opened up his big mouth and attacked me on a stock market chat board and during various earnings calls in an effort to discredit me. Byrne even hired internet stalker Judd Bagley to interfere with my divorce and pretext my children and relatives on Facebook after I pointed out the company's accounting violations.

Patrick Byrne while intoxicated
The company's pretexting operation also targeted dozens of other journalists, bloggers, critics, and their minor children, too. Big Picture (over 140,000 subscribers) blogger Barry Rithholtz called Judd Bagley a "possible pedarast." His family was spied on, too. Eventually, Facebook booted Bagley.

Eventually, the SEC started investigating Overstock.com and the company was forced to restate its financial reports. Patrick Byrne will have a difficult time explaining to SEC investigators why they should not find that Overstock.com’s GAAP violations were a deliberate scheme to manipulate earnings. At the very least, it seems that the company was reckless in continuing to issue reports that violated accounting rules after being notified by me numerous times in emails which were also cc'd to the SEC.

Patrick Byrne’s more recent antics

More recently, Patrick Byrne gave a series of interviews which raise serious questions of possible illegal insider trading and misleading hype about the company’s financial performance to investors. In trying to explain his actions, Byrne raised more questions than answers about troubling issues concerning his recent sale of stock in late May 2010.

On May 6, 2010, the Salt Lake Tribune interviewed Byrne for an article headlined “Salt Lake City-based Overstock expects to break even in the next two quarters” and reported:
… Byrne anticipates the online discount retailer will just break even during the next two quarters -- and he isn't too concerned.

"If we can break even through September then we can then go on to make tens of millions of dollars during the fourth quarter," Byrne said, pointing to Overstock.com's busiest time of the year.
From May 20 to May 24, 2010, Patrick Byrne's 100% controlled High Plains Investments LLC dumped 140,000 company shares and collected over $3 million in proceeds, according to SEC filings. That was the first time that Patrick Byrne had ever sold any Overstock.com shares under his control.

On July 9, 2010, nine days after Q2 2010 ended, but before Overstock.com reported earnings, Byrne continued to hype Overstock.com’s prospects despite concerns expressed by Investor’s Business Daily that the company would not meet analysts’ forecasts:
But break-even might be a tough goal for the second quarter. Analysts polled by Thomson Reuters expect the company later this month will report a loss of 4 cents a share, compared with a 2-cent profit a year earlier
Investor’s Business Daily reporter Doug Tsuruoka asked Patrick Byrne:
You predicted that Overstock would only break even in the second and third quarter, but didn't seem too concerned by that. Why?
Byrne responded:

Given that in 2009 we had close to $40 million of free cash flow (and $8 million net income), I think we should just continue building the intrinsic value of the business right now.
Apparently, Byrne still led investors to believe that Overstock.com was going to report break even earnings and beat analysts’ estimates, by citing the previous year’s free cash flow numbers and reported income.

Judd Bagley pretexted minor children
However, Patrick Byrne did not tell Investor’s Daily that Overstock.com's free cash flow for the most recent six months ended June 30, 2010 was negative $54.8 million compared to negative $35.8 million in the previous year's comparable period or about $19 million lower. He made no effort to explain that Overstock.com was going to report a Q2 2010 loss, instead of break-even earnings.

Later, I will detail how Information Week interviewed Byrne and reported that Overstock.com's management "can roll up its profit-and-loss position in two hours, giving executives accurate, up-to-date insight for fast decision-making."

Overstock.com reports a dismal Q2 2010 loss and fails to meet Wall Street analysts' expectations

On August 5, 2010, Overstock.com issued its Q2 2010 10-Q (quarter ended June 30) report and surprised investors by reporting a $1.4 million loss or a loss of $0.06 per share compared to a small $319,000 reported profit or earnings per share of $0.01 in the previous year’s comparable quarter, despite higher revenues.  Overstock.com failed to meet consensus analyst expectations for earnings, too. Overstock.com’s reported loss of $0.06 per share was far worse than analyst expectations of a $0.04 per share loss or a 50% higher loss than expected.

Overstock.com shares dropped $3.40 to per share to close at $16.78 or a 16.85% decline in market value. In other words, Overstock.com's market capitalization dropped over $50 million as investors reacted to the company's surprise earnings announcement.

Patrick Byrne was luckier. But recall, Patrick Byrne's 100% controlled High Plains Investments LLC sold 140,000 shares and pocketed about $3.1 million in proceeds in May, at an average selling price of $22.11 per share. That was $5.33 per share higher than Overstock.com's closing price per share.

Concerns of possible insider trading and misleading statements

On August 6, 2010, I reported that:
The company’s latest earnings report yesterday raises still new questions, concerning possible insider trading and misleading statements by the company’s CEO, Patrick Byrne.
In his respective interviews with the Salt Lake Tribune before he dumped his stock and Investor's Daily after he dumped his stock, Patrick Byrne led investors to believe that Overstock.com would beat analysts' consensus estimates of a $.04 per share loss and report breakeven earnings.


Patrick Byrne attempts to refute possible insider trading claims in Forbes interview

On August 19, 2010, Forbes published a blog headlined “Overstock.com’s CEO Refutes Insider Trading Claims” and reported that:
He said during today’s interview, “I said we’d break even in the first 9 months and would come out ahead full-year. I don’t worry about each quarter and worry about what Wall Street’s estimates are. I believe we’re right on track.”
Note: Bold print and italics added by me.
That claim contradicts what the Salt Lake Tribune reported in May, as I detailed above:
… Byrne anticipates the online discount retailer will just break even during the next two quarters -- and he isn't too concerned.

Note: Bold print and italics added by me.
This time, Byrne tried deceive Forbes by claiming that Overstock.com was going to breakeven in the first three quarters of 2010 as a whole, rather than the second and third quarters separately.

In addition, Investor’s Daily had expressed reservations about Overstock.com beating analysts’ estimates, but Byrne continued to lead them to believe that the company would breakeven and beat analysts’ estimates by not reporting losses.

In a follow up video interview with Forbes, Patrick Byrne went on claim that:
I don’t, we don’t pay any attention to the stock price. I have no idea what Wall Street’s earnings consensus are, anything like that. We pay zero attention.
Forbes asked:
Knowing what you know now, would you have done it differently, would you have waited?
Patrick Byrne responded:
We don’t pay too much attention to the stock market, what people say, what people say on Wall Street. My sale had nothing to do with what I was thinking five weeks into the quarter. It’s all nonsense.
Oh really? Over the years, Overstock.com has authorized numerous stock repurchase programs buying back over $80 million in stock. In addition, the company has an ongoing repurchase program to buy back its convertible debt. Overstock.com’s recent 2009 10-K report contradicts Byrne’s claim that “I don’t, we don’t pay any attention to the stock price” by disclosing that:
We made the repurchases because we believed that the stock was trading at attractively low prices, that we had sufficient cash on hand for all reasonably possible contingencies, and that the use of the cash to repurchase shares was in the best interest of the Company and the stockholders.
Note: Bold print and italics added by me.
In addition, the issue is what Byrne knew or should have known 7 1/2 weeks into the quarter when he sold his stock and not what he "was thinking five weeks into the quarter."

What did Patrick Byrne know when he dumped his stock?

On October 13, 2010, Information Week published another interview with Patrick Byrne and reported:
Online discount retailer Overstock.com is recognized as a world-class technology organization. Using advanced information management technology, for instance, it can roll up its profit-and-loss position in two hours, giving executives accurate, up-to-date insight for fast decision-making.

Note: Bold print and italics added by me.
A world-class technology organization? So far, from 1999 to Q3 2009, every single financial report issued by Overstock.com had to be restated at least once, sometimes twice or even three times to correct material accounting errors. The company claimed that its last two restatements were caused by technology problems.

In its 2009 10-K report, Overstock.com claimed:
Information technology program change and program development controls were inadequately designed to prevent changes in our accounting systems which led to the failure to appropriately capture and accurately process data.
In its latest Q2 2010 10-Q report, Overstock.com still claimed material weaknesses in internal controls because it still had not finished "implementing improvements to our information system."

If it is true that Overstock.com “can roll up its profit-and-loss position in two hours” why did Byrne lead the Salt Lake Tribune and Investors Daily into believing that Overstock.com would breakeven and beat forecasts, when it was already losing money during Q2 2010? What did Patrick Byrne really know about Overstock.com's numbers when he dumped his stock last May?

In any case, Patrick Byrne's inconsistent and contradictory claims will give the SEC plenty more issues to investigate. For them, I am sure that Patrick Byrne is a gift that keeps on giving.

Written by:

Sam E. Antar

Blog note:

New contributor Eva Ogonowska will soon be blogging here about other white-collar crime topics not previously covered in this blog. She has a graduate degree in Criminal Justice from John Jay College of Criminal Justice.

Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

I do not own any Overstock.com securities long or short. My investigation of that company is a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

Monday, October 11, 2010

Crazy Eddie Documentary: How We Screwed the Government, Wall Street, Investors, Consumers, and Everyone Else

We were cold-blooded ruthless crooks who committed our crimes for fun and profit. Former Wall Street Journal columnist Herb Greenberg once asked me during an interview why we did it.

My response:
We committed crime simply because we could. Criminologists like to analyze white collar crime in terms of the 'fraud triangle' -- incentive, opportunity, and rationalization. We had no rationalization. Simply put, the incentive and opportunity was there, but the morality and excuses were lacking. We never had one conversation about morality during the 18 years that the fraud was going on.

Why is the world safer for criminals?

Unfortunately, our policy makers in Washington and even Crazy Eddie's former auditors still apparently have not learned any lessons from the past and continue to make white-collar crime easy for the criminals. For example, the Dodd-Frank Act watered down Sarbanes-Oxely by exempting small companies from internal control audits. Crazy Eddie would have been exempted under those provisions, too. KPMG (Crazy Eddie's former auditors) was recently cited by the United Kingdom’s Financial Reporting Council for singing off on audits too early, the same mistake they made at Crazy Eddie.

In this blog, I exposed GAAP violations by Overstock.com (NASDAQ: OSTK) which caused the company to restate its financial reports for the third time in three years. Why did Overstock.com's former auditors at PricewaterhouseCoopers miss those accounting violations and certify the company's financial reports? The SEC is looking for those answers as it investigates the company.

Likewise, the SEC is investigating Bidz.com (NASDAQ: BIDZ) I alerted them about the company's inventory accounting practices.

More recently, I identified seven public companies that did not follow SEC guidelines for computing a non-GAAP financial measure known as EBITDA (earnings before interest, taxes, depreciation, and amortization): Overstock.com (OSTK), Comtech Telecommunications (NASDAQ: CMTL), Penson Worldwide (NASDAQ: PNSN), A. H. Belo Corporation (NYSE: AHC), FirstService Corporation (NASDAQ: FSRV), Animal Health International, Inc. (NASDAQ: AHII), Schawk Inc. (NYSE: SGK), and Penn National Gaming Inc. (NASDAQ: PENN). Don't their CFOs know how to read SEC rules?

In all of the above cases, I simply read company disclosures and compared them to applicable accounting rules. What were those companies cited above, their CFOs, their audit committees, and their auditors doing?

Written by:

Sam E. Antar

Recommended reading:

FraudBytes:
While I am glad that business schools have pushed to increase ethics education as part of the standard curriculum, I think that Sam has a great point--we can't rely on character alone (i.e. lack of rationalization) to prevent fraud, especially in an environment where opportunities and incentives for fraud tend to be incredibly high.
Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of our family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the valiant efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. As an independent whistleblower, I often refer cases to them.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

Hopefully, by teaching people about the nature of white-collar crime I may get into heaven. However, I doubt that I will ever get there because my sins are unforgivable.

Sunday, October 03, 2010

Will KPMG Ever Wake Up and Finally Learn Its Lesson after Being Duped into Completing Crazy Eddie’s Audits Too Early Twenty Three Years Ago?

Sometimes I wonder what it will take for major accounting firms like KPMG to finally wake up and learn the lesson of how criminal management teams dupe them into signing off on clean audit opinions before completing the field work, just as I did as the criminal CFO of Crazy Eddie back in the day.

KPMG cited by British authorities for prematurely signing off on audits

Recently, Adam Jones of the Financial Times reported that KPMG was “rapped for signing off on audits” before the completion of field work by the United Kingdom’s Financial Reporting Council:
KMPG has been rapped over the knuckles by the accounting watchdog for signing off on audits before all necessary work had been completed.

The criticism was made by the Financial Reporting Council as it told Deloitte, Ernst & Young, KMPG and PwC, the four biggest auditors, to do more to avoid conflicts of interest and be more sceptical of management claims.

The annual evaluations of the Big Four auditors comes amid increased regulatory scrutiny of the profession and its role in the financial crisis.

In the case of KPMG, the FRC’s Audit Inspection Unit looked at 15 audits and found that in three cases the auditor’s report had been signed too soon. Significant changes were subsequently made to the accounts in one case.
Paul George, director of auditing at the FRC’s Professional Oversight Board, which includes the AIU, said the early sign-off problem was not limited to KPMG: “It is a profession-wide challenge to some degree.”
KPMG said it accepted the AIU’s comments. “We are pleased to note that in no case did they think that the audit opinion we issued was incorrect,” said Oliver Tant, head of its UK audit arm.
The next day, popular Going Concern blogger Caleb Newquist was cynical of Oliver Tant’s remarks attempting to minimize the gravity of his firm’s negligence:
Okay, sure signing off early on 20% of the audits sampled sorta looks bad but at least the numbers weren’t wrong. It would be really awkward to explain that
KPMG was plain lucky that no audit opinions had to be changed as a result of their negligence. Back in my criminal days as main architect of the Crazy Eddie fraud, KPMG was not so lucky. If KPMG had taken the time to properly complete its filed work, they would have uncovered Crazy Eddie’s massive fraud.

How I duped KPMG back in my criminal days

In the hope of providing a wake up lesson to accounting firms like KPMG, below is my story about how I was able to dupe them into certifying Crazy Eddie’s financial reports before the completion of field work and giving Crazy Eddie a clean audit opinion in fiscal year 1987.

1987 was a year of desperation at Crazy Eddie

From the early 1970’s to 1984, Crazy Eddie was a profitable private company. Our frauds were focused primarily on understating our profits by skimming cash to commit income tax evasion and steal sales taxes.

In 1984, Crazy Eddie hired Main Hurdman as its auditors because we needed a large accounting firm to add a false sense of credibility to our financial reporting. In 1987, Main Hurdman merged with another large accounting firm Peat Marwick and was called Peat Marwick Main (PMM). Today, Main Hurdman and Peat Marwick are the US audit partners of large international accounting firm KPMG They are the “P” and “M” in KPMG.
 
As a public company from 1984 to 1986, our frauds concentrated on inflating profits or overstating income to help certain members of the Antar family ultimately sell about $100 million in stock at inflated prices.

However, in 1987, Crazy Eddie started losing money for the first time in almost two decades because of increased competition and a steep decline in consumer electronic prices which reduced revenues. We resorted to desperate measures to report profits instead of losses.

Fraudulently increasing the value of assets like inventories and fraudulently decreasing liabilities such as accounts payable or amounts owed to vendors inflates reported income or understates reported losses. We fraudulently inflated our inventories by approximately $30 million, but that feat was still not enough to avoid reporting massive losses. Therefore, we conceived of a plan to generate $20 million in phony debit memos which were supposed to be charge backs or offsets against amounts owed to vendors for such items as advertising rebates, volume discounts, and other reimbursements due the company. Those phony debit memos helped us show smaller accounts payable balances or lower amounts owed to vendors on our books and records.

Our accounts payable was only $70 million. Therefore, reducing our reported accounts payable by almost 30% through the issuance of $20 million in phony debit memos was a huge undertaking and we risked scrutiny of those debit memo from our auditors. However, we were desperately trying to cover up massive losses in 1987.

We needed to keep KPMG on a very short string

The lesser the amount of  time that KPMG (at that time called Peat Marwick Main) had available to audit Crazy Eddie’s books and records, the  easier it was for us to dupe them into issuing clean audit opinions on our falsified financial reports. It was my job to make sure that KPMG did not have enough time to properly complete its audit field work and appropriately examine Crazy Eddie’s books and records.

To accommodate Crazy Eddie’s management, KPMG regularly signed off on its audits about 60 days after our fiscal year ended. For example, in the fiscal year ended March 3, 1985, KPMG signed off on Crazy Eddie’s audit on May 2, 1985. KPMG signed off on Crazy Eddie’s fiscal year ended March 2, 1986 audit on May 1, 1986. Likewise, we hoped that KPMG would sign off on Crazy Eddie’s audit for the fiscal year ended March 1, 1987 on April 30, 1987 in following previous year’s practices.

Ultimately, I was successful in pressuring KPMG to sign off on Crazy Eddie’s 1987 audit on April 28, two days earlier than expected, despite the fact that major audit work was incomplete!

Note: Crazy Eddie’s fiscal year ended on the first Sunday in March which explains the difference in dates for the end of fiscal year’s 1985, 1986, and 1987.

Crazy Eddie’s audit was expected to last about eight weeks and KPMG planned to complete its field work in regular increments during that period. For example, by the sixth week (of eight), KPMG expected to have about 75% of its field work completed and 25% of its work left to do.

My job was to stall KMPG into having only 25% of its field work completed by week six and having 75% of its work left to do during the remaining two weeks of the eight week audit. Thus, KPMG had to do three times the usual amount of field work in the remaining two weeks. To get the work done and satisfy Crazy Eddie’s management, KPMG would skimp on certain key procedures. The plan worked!

Understanding the human frailties of auditors and taking advantage of them

As a general practice, most large accounting firms use relatively inexperienced kids right out of college to do much of the basic audit leg work. They are supervised by slightly more experienced senior auditors who unfortunately depend on feedback from these inexperienced kids in making informed decisions on the conduct of the audit. During the 1980s, both these kids and their supervisors were mostly young single males between the ages of 22 and 29.

As a 28 year old CPA myself, I understood that audits are very boring, tedious, and mundane for these young single male auditors. It was difficult for them to pay close attention to their work. It was relatively easy for me to distract them from performing their jobs without blaming me for stalling them or obstructing their audit work.
Photo from Going Concern blog

Rather than overtly obstructing our auditors’ field work, I engaged in a calculated plan to subtly distract them. I made sure that most of our auditor’s interactions were with cute Crazy Eddie female employees reporting to me, even if some of those females had no knowledge of our cooking the books.

I encouraged my female employees to flirt and get friendly with their young male KPMG counterparts and discuss audit issues with them over lunch and dinner on Crazy Eddie’s tab. Meanwhile, I spent much of my time taking certain higher level KPMG counterparts to pick up bars and other establishments frequented by good-looking women.

My female staffers provided the perfect distraction for KPMG auditors as they engaged in constant small talk and wasted precious time. By April 26, just a few days before the scheduled audit sign off, KPMG had not even started many key procedures and still had many unanswered questions.

Unanswered questions and unfinished audit work

In the previous fiscal year, 1986, we had falsified our store level inventories (not warehouse inventories) by $3 to $4 million. However, in fiscal year 1987, Crazy Eddie's store level inventories were inflated by $15 to $20 million as we desperately tried to cover up staggering losses.

In stores that existed in both 1986 and 1987, where the auditors observed inventory counts, those gross inventory levels increased from $21.95 million to $37.47 million or a staggering 71%, despite a huge drop in consumer electronic prices. On April 26, 1987, I was able to convince a certain audit partner not order a re-count of store inventories despite his questioning the unusual increase in store level inventories during a period of dropping prices.

Better yet, the audit test work on verifying the validity of $20 million of charge backs to vendors, which were actually phony debit memos, did not even start because of the effectiveness female employees in distracting the male auditors from doing their work. Moreover, the audit partner respected me as a responsive client and trusted me - a grave mistake.

In past years, I always gave in to his recommendations on being “conservative” and reducing reported income, even though I was only giving back the excesses of my inflated fraudulent numbers. I effectively played poker with a marked deck, giving back the cards I did not need. Therefore, I was able to convince that audit partner to sit on a board of directors meeting the next day on April 27, where the board approved Crazy Eddie’s numbers after questioning him and me.

On April 28, 1987, KPMG formally signed off on Crazy Eddie’s financial reports and issued a clean audit opinion, despite red flags in store inventory levels and uncompleted field work in verifying $70 million of accounts payable that was fraudulently reduced to $50 million by our issuance of $20 million in phony debit memos.

Taking advantage of the inexperience of our auditors

The audit staff member who was responsible for leg work on accounts payable had no prior experience in auditing accounts payable and only started working for KPMG six months earlier fresh out of college. He first learned about offsetting charge backs to vendors against amounts purportedly owed them or debit memos during the Crazy Eddie audit, much of it from me.

Since the audit was already officially completed, KPMG only examined the accounts payable or amounts owed by Crazy Eddie to three major vendors, out of thousands of possible vendors. Each of those three vendors reported significant discrepancies in amounts they claimed that Crazy Eddie owed them due to our issuance of phony charge backs to vendors or debit memos.

For example, Sony claimed that Crazy Eddie owed them about $5 million more than Crazy Eddie claimed it owed them because Sony never acknowledged receiving any such debit memos. The auditors never did any follow up contact with any of the companies, whose accounts payable balances they examined, concerning any discrepancies in amounts owed by Crazy Eddie.

On April 28, 1987, the inexperienced auditor finally started his test work on Sony (which contained about $5 million of the $20 million in phony debit memos), the very same day our auditors signed off on the audit according to his testimony in a sworn deposition.

The questions below were asked by Stephen Howard, Attorney from Milbank, Tweed, Hadley, & McCloy, who represented the Oppenheimer-Palmieri Fund, L.P., one of the major shareholders who in November 2007 took over Crazy Eddie in a hostile takeover:
Question: There’s a date at the bottom of the page which appears to be 4/28/87. Do you see that?

KPMG staffer: Yes, I do.

Question: Is that your handwriting.
KPMG staffer: Yes, it is.
Question: What does that signify?

KPMG staffer: It was my policy to date my workpapers when I began to perform test work.
Question: So that tells us you started this work on the 28th but it doesn’t tell us when you finished it?

KPMG staffer: That is correct.
In his other sworn testimony, young inexperienced auditor said that he continued his field work for more than one day, but couldn’t recall how many days it took for him to complete his work. In any case, KPMG already had signed off on Crazy Eddie’s audit.  KPMG had no incentive to do any additional significant field work that may cause them to change their audit opinion.
  
Key audit procedures missed

Crazy Eddie Antar mug shot after arrest
In previous years, we generated an accounts payable aging schedule for our auditors to review. That schedule provides detailed information about every invoice owed to vendors, any offsetting charge backs to vendors such as debit memos, and how long those items have remained outstanding.

However, for fiscal year 1987, we did not generate accounts payable aging analysis.  Therefore, our auditors were unable to determine the how long the phony debit memos were on Crazy Eddie's book and records and why, after the passage of time,  they were not used as an offset against payments to vendors.
  
In addition, the sheer volume of phony debit memos caused our books and records to show many vendors owing Crazy Eddie money, rather than the other way around! Those negative accounts payable balances were red flags that were never properly scrutinized by our auditors.

An excerpt from KPMG’s work papers said:
... traced all debit memos into A/P status report as of 03/01/87. No further work necessary.
An “A/P status report” simply lists all invoices owed to vendors and offsetting debit memos. Therefore, the debit memos were traced to a report listing the phony debit memo, in other words known as “garbage in, garbage out.” Our auditors simply traced the phony debit memos to the books and records that reflected them, but did no work to confirm the validity of those debit memos.

Weeks later, a senior staff member finally did conduct an interview of Crazy Eddie's Accounts Payable Manager (a female co-conspirator) and his work paper is dated May 22, 1987 or 24 days after KPMG issued its clean audit opinion of Crazy Eddie’s books and records.

Conclusion

KPMG may have dodged the bullet by not having to change any of its audit reports as a result of its recent failure in “signing off on audits before all necessary work had been completed.” If history is any guide, KPMG demonstratively failed to learn the lesson of their misdeeds during the Crazy Eddie audit. I wonder if they are at least better in covering up their mistakes this time around.

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of our family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the valiant efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. As an independent whistleblower, I often refer cases to them.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

Hopefully, this blog post can get me into heaven, though I doubt I will ever get there.