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Portrait of deceit at Rite Aid
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Indictment: A federal investigation reveals how desperate Rite Aid's executives became as they struggled to keep the company from bankruptcy.
By Bill Atkinson
Sun Staff
June 22, 2002
For nearly five years, Martin L. Grass spun an intricate web of lies and deceit and fraud, enriching himself while driving his sprawling drugstore chain, Rite Aid Corp., to the brink of bankruptcy, federal prosecutors and regulators charged yesterday.
The 37-count criminal indictment and a 57-page civil complaint filed by the Securities and Exchange Commission provide an extensive look into what the SEC described as "one of the largest financial frauds ever perpetrated on the investing public by senior management of a public company."
Indicted along with Grass, were two former executives: Franklyn M. Bergonzi, who served as chief financial officer, and Franklin C. Brown, who was vice chairman. Also indicted was Eric S. Sorkin, the current executive vice president of pharmacy services for Rite Aid.
The charges range from conspiracy and fraud to witness tampering and obstruction of justice.
Former Rite Aid President Timothy J. Noonan has agreed to plead guilty to concealing a felony.
The indictment alleges that the former executives misled board members, vastly inflated profits, defrauded vendors, deceived lenders and auditors and fabricated documents - even creating notes from a fictitious meeting to gain access to an $800 million emergency loan.
During that time, Grass publicly portrayed Rite Aid as a successful and profitable company driving its stock price up threefold from 1995 to 1998.
In the civil complaint, the SEC charged that Grass, Rite Aid's former chief executive, Bergonzi and Brown with orchestrating a "fraudulent scheme."
The scheme was so vast and prolonged that when it was finally discovered, the SEC said, Rite Aid was forced to restate net income by $1.6 billion, the largest restatement ever by a public company.
Like his high-flying company, Grass was a mover and shaker, not just in Pennsylvania, where the company is based, but in Maryland, where local and state officials courted him.
The signs of Grass' wealth were readily evident. He lived on a large estate in Green Spring Valley and commuted to work in a helicopter, angering his wealthy neighbors.
The son of the company's founder, Grass became chairman and chief executive in March 1995 and almost immediately embarked on a path of "dishonesty and misconduct," the SEC said.
The misconduct, according to court documents, was two-pronged. Grass and the other executives used an array of accounting schemes to manipulate the company's earnings and defraud investors, the documents alleged.
At the same time, they orchestrated a series of moves designed to enrich themselves by altering compensation agreements and concealing Grass' role in doing business dealings with Rite Aid.
The company bolstered its books by defrauding vendors such as Johnson & Johnson, Maybelline and L'Oreal, the indictment said.
Rite Aid took advantage of agreements with vendors that allowed it to take deductions for damaged and outdated products against future payments without having to return the goods, the indictment says.
The vendors relied on Rite Aid to provide accurate statements, but Rite Aid, the government charged, inflated the amount of damaged and outdated goods by as much as 50 percent.
>From fiscal 1995 to 1999, Rite Aid claimed roughly $53.1 million in bogus credits, which were reflected on the company's books, the government said.
"The effect of this practice was to overstate Rite Aid's reported net income," the SEC said. "Grass and Bergonzi both permitted the practice to continue even after other Rite Aid personnel raised with them in 1995 the question of whether the practice was proper."
The scheme expanded after Rite Aid bought Thrifty Payless, a drugstore chain headquartered in California, in 1996, the indictment says.
In the summer of 1998, Rite Aid decided to discontinue selling an array of products and sold them at substantial markdowns.
The company then billed the vendors for the lost income, falsely claiming deductions for damaged and outdated goods, which allowed Rite Aid to book an additional $29.7 million in bogus credits in fiscal 1999, the indictment said.
Grass is accused of concealing the fraud by firing Rite Aid's senior vice president in charge of category management in June 1998 and hiring a private investigator to investigate his dealing with vendors.
The fired executive sued Rite Aid and Grass, alleging in his lawsuit that the CEO had undisclosed business dealings with Rite Aid.
When Grass learned that the former executive was threatening to tell the media about Rite Aid's inflated charges to vendors, Grass and Brown quickly settled the suit for $11 million in exchange for the executive's silence, the indictment says.
While Grass and the other executives worked to prop up Rite Aid's books, they also devised a scheme that would have rewarded them with double the number of shares they were entitled to under a company incentive plan, the indictment said.
In early 1998, Brown fabricated a summary of a purported compensation committee meeting in March 1995 and then backdated letters in which shares were to be awarded to Grass, Noonan and himself in April 1995, the indictment said.
Had the alleged scheme succeeded, Grass could have gotten shares worth $36.5 million, and Brown and Bergonzi would have received shares worth $10.9 million, the government said.
The backdated modifications were never approved by the company's board or disclosed in company proxy statements, as required by the SEC, the government said.
Though they never received these payments, Grass and Brown had a Philadelphia law firm draw up a deferral plan that would have allowed them to collect their 1999 awards in later years, the indictment said.
Grass also used company money to secretly buy an 83-acre tract of land in York County Pennsylvania that Rite Aid later considered as a new headquarters site.
The land was to be purchased by CCA Associates Inc., which was controlled by Grass and his brother-in- law, Tim Harrison. Two days before the real estate venture was to forfeit its deposit on the land, Grass, Brown and Bergonzi had $2.6 million wired from a Rite Aid account to CCA's account in Harrisburg.
CCA used $1.8 million to purchase the land. The rest of the money was used to pay off debts and business expenses of Grass and his brother-in-law, according to the indictment.
Over the next year, Grass spent $1.4 million more of the company's money to develop the site as a new Rite Aid headquarters.
After The Wall Street Journal published an article about undisclosed Grass family dealings with Rite Aid, Grass secretly wired $2.9 million of his money to reimburse Rite Aid, the indictment said.
He then provided the company's board with an affidavit stating that he had no business dealings with Rite Aid, according to the indictment.
On Sept. 24, 1999, as Rite Aid's financial condition deteriorated, Grass traveled to New York to seek waivers from loan agreements and $800 million in interim financing.
Grass hid the company's financial condition from the banks and pledged as collateral Rite Aid's stock in PCS Health Systems Inc., a pharmacy benefits management company that it had acquired, the indictment said. Grass is accused of falsely reassuring the banks that the company's finance committee had approved the stock pledge.
Five days later, in a conference call with analysts, Grass denied that Rite Aid had obtained interim financing and also hid the fact that it had pledged the PCS stock, the indictment says. He also concealed the pledge of collateral from the company's board and two rating agencies, the government said.
"Later, Grass falsely told Rite Aid's general counsel the same thing and directed him to draft minutes to that effect. Grass signed these false minutes, which purported to memorialize a meeting that Grass knew never occurred," the SEC's document stated.
After Grass was forced out on Oct. 18, 1999, he signed and backdated letters on Rite Aid letterhead granting key employees, including Sorkin and Noonan, enhanced benefit packages, the government said.
Copyright (c) 2002, The Baltimore Sun
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