Lawsuit Accuses Levi of Tax Fraud

Two former Levi Strauss & Co. tax managers have filed a lawsuit claiming that the jeans maker used fraudulent tax schemes to enhance its financial results and give the impression its turnaround was on track.

The claim filed by Robert Schmidt and Thomas Walsh, who were fired by Levi in December, contends that between 1995 and 2002 the apparel maker engaged in financial tricks, in some cases involving overseas tax shelters, that were intended to inflate its income and lower its tax rate.

Jeff Beckman, a spokesman for San Francisco-based Levi, called the claims “absolutely false.” He said the company launched “a thorough and independent investigation with outside legal counsel” last year after the two men raised questions about company practices while they were employed by the firm. “The investigation determined that our treatment of taxes was completely legal and appropriate,” Beckman said.

Levi is privately held but reports earnings because some of its debt is publicly traded. News of the lawsuit, first reported in the San Francisco Chronicle, sent Levi’s 12.25% bonds maturing in 2012 down nearly 11% in price, to 83.7 cents on the dollar.

“While we are encouraged that the company has reportedly flatly denied any misdeed, the fact that these allegations come from former high-level employees within” Levi’s tax department “is very concerning,” wrote Clark Orsky, an analyst with KDP Investment Advisers, in a note to clients in which he changed his recommendation to “hold” from “buy.”

The lawsuit, filed Monday in San Francisco Superior Court, contends that Levi used fraudulent tax schemes and financial statements that allowed it to declare a pretax income of about $50 million in 2002 when it would have logged a loss of at least $336 million had it complied with U.S. tax laws and accounting standards required by the Securities and Exchange Commission.

The lawsuit said that Schmidt and Walsh, then directors of Levi’s tax department, allegedly were instructed to withhold key documents from the IRS and to limit information to KPMG, then a new auditor for Levi. When they refused, they were “summarily fired” Dec. 10, five days before KPMG arrived to conduct a comprehensive audit of the company, the lawsuit states.

Levi hired KPMG after it fired longtime auditor Arthur Andersen last May after Andersen became embroiled in the Enron Corp. scandal.

KPMG declined to comment Tuesday. Levi, however, strongly defended its fiscal practices.

“We have a rigorous practice in place to ensure the integrity of our financial reporting, including internal and external reviews led by our audit committee, an outside audit firm and outside legal counsel,” Beckman said. “As a result of these review processes, we are confident in our tax position. Our financial statements are accurate.”

He said Walsh and Schmidt were fired for reasons unrelated to their complaints but declined to say why, citing “privacy reasons.”

The plaintiffs are seeking unspecified compensatory and punitive damages.

The tax rate applied to Levi’s operating revenue in part allowed Chief Executive Phil Marineau to receive a $23.5-million bonus last year, the lawsuit contends.

Had the company filed accurate financial statements and fairly reported its tax exposure, managers would have received no bonuses, or greatly reduced bonuses, last year, the lawsuit says.

Levi said Marineau’s bonus was tied to a “leadership shares” program for mid- and upper-level managers. Marineau’s “shares” were part of an incentive package that he was granted when hired in 2000, spokeswoman Melinda Gable said.

An incentive payout of $22.5 million, she said, reflected the fact that the company had “significantly exceeded” its targets. Marineau also received a basic salary of $1.2 million and an annual bonus of $1.3 million last year, bringing his total compensation to about $25 million.

After several years of slumping sales and losses, the 150-year-old company has attempted to turn itself around. But it continues to struggle. Last year, net income plunged 84% to $25 million and sales fell 3% to $4 billion.

For the first quarter ended Feb. 23, Levi reported a $24-million loss, contrasted with a $42-million profit in the prior year.