Troy, MI, August 24--The Securities and Exchange Commission on Tuesday filed civil charges against two former Kmart executives, accusing them of making "materially false and misleading" disclosures to shareholders before the retailer's 2002 bankruptcy filing.
The complaint filed in U.S. District Court in Detroit charges former chairman and CEO Charles C. Conaway and former chief financial officer John T. McDonald with securities fraud and aiding and abetting securities fraud. It also accuses them of aiding and abetting violations of rules that require publicly traded companies to file quarterly reports and to include material information in the reports so they are not misleading.
"Investors are entitled to both accurate financial data and an accurate description of the story behind the numbers," Peter H. Bresnan, an associate director in the SEC's Enforcement Division, said in a statement.
Conaway's lawyer, Scott Lassar, said in a statement that Conaway is disappointed by the action. "Mr. Conaway acted at all times in good faith and in the best interest of Kmart," the statement said.
McDonald's lawyer, Jack Sylvia, said in a statement that his client "expects to be exonerated when the facts are tested in a court of law."
The disclosures in question were part of regulatory filings Kmart made for the third quarter and nine months ended Oct. 31, 2001, and in a Nov. 27, 2001 conference call with analysts and investors, the SEC said.
Kmart filed for bankruptcy on Jan. 22, 2002, leading to the closing of about 600 stores, termination of 57,000 Kmart employees and cancellation of company stock. The Troy-based retailer acquired Sears, Roebuck & Co. in March. The new company, called Sears Holdings Corp., is based in Hoffman Estates, Ill.
Spokesman Stephen Pagnani said the company would have no comment on the charges.
According to the SEC, Kmart's filings failed to disclose the reasons for a massive inventory buildup in 2001 and the impact it had on the company's liquidity.
The company attributed the inventory increases to "seasonal inventory fluctuations and actions taken to improve our overall in-stock position." The commission alleges that was misleading because a large portion of the inventory buildup was caused by a Kmart officer's "reckless and unilateral purchase of $850 million of excess inventory," the SEC said.
According to the complaint, Conaway and McDonald dealt with the cash flow problem by withholding $570 million in vendor payments by the end of the third quarter of 2001. In response, some suppliers stopped shipping product, causing shortages of staple items in some stores.
The SEC alleges Conaway and McDonald lied about why vendors were not being paid on time and misrepresented the impact that the problem had on Kmart's relationship with its vendors.
"Our complaint does not allege that the liquidity issue directly caused the bankruptcy, however, it is our position that Kmart's deteriorating liquidity situation should have been disclosed and made bankruptcy more likely than it would have been otherwise," Bresnan said in a phone interview.
The SEC is seeking civil penalties against Conaway and McDonald and a ban on the former executives serving as an officer or director at a publicly traded company.
Last month, an arbitration panel cleared Conaway of civil accusations that he squandered millions as Kmart slid into bankruptcy.
The Kmart Creditor Trust, an organization formed to recover billions the retailer owed, sued Conaway, McDonald and four other former Kmart executives in Oakland County Circuit Court in 2003. The suit sought repayment of millions of dollars in retention loans the executives received before the company filed for bankruptcy.
The suit was split into six separate arbitration cases. The other cases are still pending.
