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Rite Aid Plea Is Bellwether In Fraud Cases

Ex-CEO of drugstore chain is expected to plead guilty

Jun 17, 2003 | Philadelphia Inquirer

By early 1999, Rite Aid Corp. chief executive officer Martin L. Grass seemed to be reaping the benefits of a bold expansion. The drugstore chain posted a huge growth in income, the stock was soaring, and Grass boasted about the company's rosy financial picture.

A federal indictment, however, ultimately called that robust image a "ruse and a mirage," and this morning, Grass, 48, is scheduled to plead guilty in a case that scholars say is emblematic of the accounting scandals that followed the stock market euphoria of the late 1990s.

The plea, set for U.S. District Court in Harrisburg, will come 12 days after former chief financial officer Franklyn M. Bergonzi pleaded guilty to taking part in the accounting-fraud conspiracy. A third defendant, former chief counsel Franklin C. Brown, is scheduled for trial, beginning Monday.

Legal experts have been watching the case closely because it was one of the first in a series of corporate fraud cases to reach the trial stage, and because whatever happens to Grass could be a jolt to other former executives faced with the possibility of prison sentences and former colleagues waiting to testify against them.

Grass would be the first former CEO to plead guilty in a major accounting-fraud case since the collapse of Enron Corp. 18 months ago led to increased regulatory scrutiny of corporate America.

Just last week, ImClone Systems Inc. founder Samuel Waksal was sentenced to more than seven years in prison the maximum on insider-trading and related charges.

The prospect of such lengthy sentences "can be a motivator," said Gilbert Geis, a professor emeritus at the University of California at Irvine who is an expert on criminology and white-collar fraud. "You think twice."

The 96-page Rite Aid indictment paints a vivid portrait of the behind-the-scenes activity at the Camp Hill, Pa.-based company as it grew into one of the world's largest drugstore chains and then nearly plunged into ruin under the weight of huge debt and poor cash flow as the alleged fraud started to unravel.

In October 1999, after a new acting financial officer uncovered the alleged fraud, Grass resigned as the company announced it would substantially restate results for fiscal 1997, 1998 and 1999. Nine months later, the company announced a $1.6 billion restatement at the time, the largest accounting revision in U.S. history.

When the federal indictment was returned last June, shareholders had taken a huge hit: Company stock, which had traded as high as $50.94 a share in January 1999, had plummeted to $2.69 as the charges were announced. Yesterday, the stock closed at $4.43 on the New York Stock Exchange.

The case is just one result of an array of corporate investigations that have rocked Wall Street. Enron, WorldCom Inc., Adelphia Communications Corp., Cendant Corp. and Tyco International Ltd. are just some of the now-familiar names of companies caught up in more than a year of corporate intrigue. So far, federal charges have been filed against former officers of at least 40 companies. Most of them are awaiting trial.

First Assistant U.S. Attorney Martin C. Carlson declined yesterday to say what charges would be the focus of the plea in the Grass case. Grass' attorney, William H. Jeffress, did not return phone calls seeking comment.

Joseph U. Metz, an attorney for Brown, said his client intended to proceed to trial. He said Brown still owned "hundreds of thousands of shares" of Rite Aid stock and "from day one" has denied any wrongdoing.

"He's a 75-year-old lawyer. He's got no accounting background at all," Metz said, adding that Brown spent most of his time overseeing real estate acquisitions as the company bought as many as two or three stores a day during its expansionary spree. "It's just not his department."

Metz said that while he had no insight into why Grass had decided to plead guilty, one factor might be that he was facing "many, many years" in prison if convicted and that he might be hoping to shave some time off any sentence.

Rite Aid, meanwhile, has worked hard, with a new management team, to repair the damage.

"This is a new Rite Aid," company spokeswoman Karen Rugen said. The defendants "haven't had anything to do with running this company for nearly four years. We've overhauled the way Rite Aid does business, established a new corporate culture, put in strict financial controls, and significantly improved our operations, financial performance and balance sheet."

The indictment accuses the former Rite Aid executives of conspiring to cook the books by cheating on expenses, making phony deductions, prematurely reporting income, improperly reversing expenses into income, and fiddling with a panoply of other items.

And on top of it all, the indictment said, the executives rewarded themselves with more than $4 million in bonuses, along with millions of dollars in stock options. If the true numbers had been disclosed, the defendants would not have gotten a dime in bonus money, the indictment said.

James D. Cox, a professor of securities law at Duke University, said the case was an example of "runaway jury-rigging of the numbers" and how executives can become "driven by a quest" to inflate the numbers and personally reap the benefits.

"There was a systematic manipulation of the books, and, to me, Rite Aid is just a classic illustration of that," he said.

Cox said the case also showed how shareholders suffer. "This one has real victims," he said.

Geis, the California professor, said the same pattern has emerged in case after case in which executives have been accused of cooking the books - fraud.

"Essentially, it's a general kind of operation in which CEOs are under tremendous pressure to look good on the accounting," Geis said. "They get unbelievable kinds of rewards for it. It's almost irresistible."

Grass also is accused of trying to obstruct the investigation. One whistle-blowing executive secretly recorded conversations with Grass for the FBI. In one taped discussion in May 2001 about the FBI's effort to find a computer that had generated some letters sought as evidence, Grass boasted that investigators would never locate that computer "unless they use a Trident submarine."

The alleged wrongdoing also triggered civil litigation by shareholders. In December 2000, Rite Aid agreed to pay $193 million. In March, KPMG, Rite Aid's auditor until it resigned in late 1999, announced that it would pay $125 million. In April, Grass agreed to pay $1.45 million.

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