SEC Announces Fraud Charges Against Former Rite Aid

SEC Announces Fraud Charges Against Former Rite Aid Senior Management June 21, 2002

Accounting Fraud Charges As a result of the fraudulent accounting practices, Rite Aid inflated its reported pre-tax income by the following amounts: 1 Q 98 38% 2 Q 98 66% 3 Q 98 16% FY 98 9% 1 Q 99 71% 2 Q 99 5, 533% 3 Q 99 94% FY 99 reported pre-tax income of $199. 6 million, when actual results were loss of $14. 7 million 1 Q 00 54%

The Securities and Exchange Commission announced fraud charges against • former Rite Aid CEO Martin Grass • former CFO Frank Bergonzi and • former Vice Chairman Franklin Brown with conducting a wide-ranging accounting fraud scheme. The charges allege that Rite Aid overstated its income in every quarter from May 1997 to May 1999, by massive amounts. When this practice was discovered, Rite Aid was forced to restate its pre-tax income by $2. 3 billion and net income by $1. 6 billion, the largest restatement ever recorded.

Upcharges — Rite Aid inflated the deductions it recorded for amounts owed to vendors because of damaged and outdated products when the vendors did not require the merchandise to be returned. Rite Aid would increase the proper amount, thus overcharging vendors by amounts ranging from 35% to 50%. Stock Appreciation Rights (SARs) — Rite Aid did not record accrued expenses for stock appreciation rights given to its employees. This allowed employees to receive cash or stock based on Rite Aid stock price increases. When Rite Aid’s independent auditors asked if any SARs existed, Bergonzi denied that any had been issued. Reversals of Actual Expenses — Several times Gergonzi directed the accounting staff to reverse expenses that had already been paid for without cause. They would then be put back on the books in a subsequent quarter, which caused the income from the previous quarter to be overstated.

"Gross Profit" Entries — Bergonzi directed his accounting staff to make improper adjusting entries to reduce the cost of goods sold without substantiation, for the sole purpose of manipulating Rite Aid’s Earnings. Undisclosed Markdowns — Rite Aid overcharged vendors for markdowns, which the retailers never agreed to pay. Rite Aid led vendors to believe that these deductions were for damaged and outdated goods. Vendor Rebates — On the last day of the fiscal year 1999, Bergonzi directd Rite Aid to reduce accounts payable based on rebates. Two weeks after year end, he had the books reopened and added $33 million in credits. Both of these were funds that Rite Aid has no legal entitlement to at the time of record. Even if they did have title to them, due to vendor agreements, more than half should have been distributed to vendors.

Litigation Settlement — Grass, Bergonzi, and Brown caused Rite Aid to receive $17 million in litigation settlements, which was recognized before the litigation was legally binding. "Dead Deal" Expense — When Rite Aid considered building new sites, fees were incurred from legal services, title searches, architectural drawing, etc. They capitalized these fees at that time. If Rite Aid decided not to follow through with that site, those fees should have been written off to expenses. Rite Aid carried them as assets, however. "Will-Call" Payables — If a customer called in a prescription and never came to pick it up, Rite Aid would already have been given payments from insurance companies. These were put in a payable account to give back to the insurance companies. Bergonzi reversed $6. 6 million that should have been paid back-Rite Aid’s general council learned of this and directed for this reversal to be cancelled. Bergonzi agreed, then secretly directed other improper offsetting entries to achieve the same effect. Inventory Shrink — If physical inventory counts were less than inventory on the books (due to damage or theft), Rite Aid should write down the books to reflect the “shrink. ” In one case Rite Aid did not record this shrink which overstated their inventory, and also reduced their “shrink” expense causing an increase to income.

Related-Party Transactions with Grass also failed to disclose personal interests in three properties that Rite Aid Leased as store locations. He funneled $2. 6 million into a non-Rite Aid partnership account with a relative, and used it to purchase a site intended for a new Rite Aid headquarters. After being questioned he transferred the money back to Rite Aid from a personal account. Fabrication of Minutes by Grass In September 1999 Rite Aid was in serious financial problems, and Grass obtained a bank line of credit as directed by a meeting that never happened. Grass created minutes for a meeting of Rite Aid’s Finance Committee, stating they authorized stock to be used as collateral. Grass signed these minutes knowing that this meeting never took place.