Rite Aid Officers Indicted on Fraud

A federal grand jury indicted three former executives of drugstore chain Rite Aid Corp. on Friday on charges of running a massive accounting fraud that experts described as brazen even when measured against other recent corporate scandals.

The 37-count criminal indictment alleged that Rite Aid’s former Chief Executive Martin L. Grass and two other senior officers used a variety of bogus accounting maneuvers to inflate the company’s earnings in the late 1990s and, in turn, the firm’s stock price and their own compensation.

The hoax alleged by the government resulted in the biggest restatement of earnings in U.S. history--$1.6 billion--when it eventually unraveled.

The Rite Aid indictment marks the third time in three weeks that prominent corporate figures have been charged with criminal be- havior, adding to the crisis of confidence that has enveloped America’s business leadership.

Earlier this month, L. Dennis Kozlowski, the deposed chief executive of Tyco International Ltd., was indicted on charges of evading New York state and city sales taxes. Last week, Samuel Waksal, former CEO of ImClone Systems Inc., was charged with insider- trading violations.

If the government’s allegations prove true, what went on at Rite Aid, the nation’s third-largest drugstore chain, would far transcend the aggressive accounting that helped cause the collapses of Enron Corp., Global Crossing Ltd. and Adelphia Communications Corp., said Seth Taube, a white- collar defense attorney at McCarter & English in Newark, N.J.

At Rite Aid, the government alleged, a top executive simply ordered underlings to alter bookkeeping records by tens of millions of dollars to make the company’s financial results appear better than they were.

When the Camp Hill, Pa.-based firm was in desperate need of a bank loan to avert bankruptcy in late 1999, Grass allegedly told lenders that a Rite Aid committee had agreed to pledge stock in a key subsidiary as collateral. In truth, the committee had never met and Grass had falsified the paperwork, the government alleged.

“This isn’t pushing the edge of the ethical envelope,” Taube said of the Rite Aid charges. “Here the envelope was torn up and thrown away. You can get a gun and rob a bank, or you can make up numbers at a public company. Either way, it’s a crime.”

The most serious charges were leveled at Grass; Franklyn M. Bergonzi, Rite Aid’s former chief financial officer; and Franklin Brown, its former chief counsel.

The charges against Grass and Brown include securities fraud, conspiracy to defraud, obstruction of justice and witness tampering. The Bergonzi charges include securities fraud, conspiracy to defraud and making false statements to the Securities and Exchange Commission.

Also named in the indictment was Eric S. Sorkin, an executive vice president and the only current employee indicted. He was charged with obstruction of justice and making false statements to a grand jury. The company suspended Sorkin on Friday.

Timothy J. Noonan, Rite Aid’s former president, cooperated with prosecutors and agreed to plead guilty to concealing knowledge of wrongdoing by others.

None of the executives responded to requests for interviews.

Grass said in a written statement that he had not read the lengthy indictment, but he added that he “did not knowingly engage in any illegal acts” and would “vigorously” defend himself.

Bergonzi’s attorney, Ira Raphaelson, said the real problem is confusing accounting rules.

“The rules are unclear,” he said.

The SEC ended an investigation of Rite Aid itself without assessing any fines against the company, which agreed to a cease-and-desist order but neither admitted nor denied wrongdoing. Current management has cooperated with investigators, the SEC said.

The SEC lodged civil fraud charges against Grass, Bergonzi and Brown that parallel many of those in the criminal charges, which were filed by the U.S. attorney’s office in Harrisburg, Pa. The SEC accused the men of masterminding the ruse to pump up Rite Aid’s earnings and share price, overstating profit by 5,533% in the second quarter of 1999 alone.

Between May 1997 and May 1999, the three men inflated the company’s income and understated expenses, frequently by cheating vendors, the SEC alleged. Improved financial results helped boost executives’ performance-based pay, the government said.

Grass also is accused of funneling $2.6 million from Rite Aid to a real estate partnership he ran with his brother-in-law. Part of the money, the government said, was used to buy an 83-acre parcel supposedly intended for a new Rite Aid corporate headquarters.

The company later spent an additional $1 million to improve the property, even though the land was owned by the partnership, not Rite Aid, authorities said.

When questioned by the media about the land, Grass transferred $2.9 million back to the company, according to the SEC. None of the transactions was disclosed to the company’s board, the SEC said.

Grass is the eldest son of Rite Aid founder Alex Grass. After taking charge of what was a regional pharmacy chain in 1995, he undertook an aggressive expansion plan that included the purchase of the Thrifty PayLess drugstore chain on the West Coast.

But Rite Aid struggled to consolidate its new purchases and the company’s earnings suffered.

In October 1999, Martin Grass was forced out as CEO as the company announced it would restate results for fiscal 1999 and the previous two years. A month later, the SEC launched a formal probe into the company’s finances. The agency had begun a review of Rite Aid’s accounting of acquisitions earlier that year.

The company is under new management but has struggled to overcome the financial strain caused by the late-1990s acquisition binge and profit restatements.

As with other financial scandals, Rite Aid shareholders have absorbed a huge shock: The stock, which traded as high as $50.94 a share in January 1999, closed Friday at $2.69, up 11 cents.

In December 2000, the company settled with aggrieved shareholders for $200 million.

The Rite Aid indictments, in tandem with the arrests of Kozlowski and Waksal, point to what may become a dramatic shift in the prosecution of white-collar crime.

Corporate executives convicted of financial crimes typically face fines and sanctions on their ability to conduct business. But the number of recent scandals and the magnitude of alleged fraud and self-dealing make it likely that some executives will go to jail, experts say.

“For these people, being barred from their jobs and having to pay fines can be very painful, but obviously going to jail is much more painful,” said Caren Pennington, assistant regional director of the SEC’s Northeast division, which brought the accompanying civil charges.

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(BEGIN TEXT OF INFOBOX)

SEC Charges Against Rite Aid Officers

A summary of Securities and Exchange Commission accounting fraud charges against Rite Aid’s former Chief Executive Martin L. Grass, former Chief Financial Officer Franklyn M. Bergonzi and Franklin Brown, former chief counsel. The U.S. attorney’s office filed related criminal charges:

* Rite Aid systematically inflated deductions it took against amounts owed to vendors for damaged and outdated products, resulting in $36 million in overstatements of pretax income for fiscal years 1998 and ’99.

* Rite Aid did not record expenses from a program allowing employees to get cash or stock tied to the company’s stock price, which should have accrued $55 million in expenses for fiscal years 1998 and ’99.

* Bergonzi told accounting staffers to make improper entries to reduce the cost of goods sold and accounts payable in each quarter except at year’s end, when financial statements would be audited. Such actions, for example, led to overstated pretax income of $100 million in the second quarter of fiscal year 1999.

* Grass did not disclose his personal interest in three properties the company leased as store locations or $2.6 million funneled from Rite Aid to a partnership he and a relative controlled.

* Grass fabricated minutes of a supposed meeting in which the company finance committee accepted a pledge of Rite Aid stock in PCS Health Systems Inc. as collateral, although no such meeting occurred and the pledge was unauthorized.

Source: Securities and Exchange Commission

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Hamilton reported from New York, Kristof from Los Angeles. Times staff writer Kelly Yamanouchi contributed to this report.