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U.S. Securities and Exchange Commission

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION

Securities Exchange Act of 1934
Release No. 50783 / December 2, 2004

Accounting And Auditing Enforcement
Release No. 2148 / December 2, 2004

Admin. Proc. File No. 3-11764


In the Matter of

Thomas L. Taylor,

Respondent.



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ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934

I.

The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), against Thomas L. Taylor ("Taylor" or "Respondent").

II.

In anticipation of the institution of these proceedings, Taylor has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over him and the subject matter of these proceedings, which are admitted, Taylor consents to the entry of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.

III.

On the basis of this Order and Taylor's Offer, the Commission finds that:

A. RELEVANT ENTITIES

1. Kmart

Kmart Corporation ("Kmart" or the "company") was a Michigan Corporation headquartered in Troy, Michigan, during the relevant period. On January 22, 2002, Kmart filed a voluntary petition for reorganization relief under Chapter 11 of the Bankruptcy code. The company's common stock was registered with the Commission pursuant to 12(b) of the Exchange Act [15 U.S.C. 78l(b)] and traded on the New York Stock Exchange until December 19, 2002, when trading was suspended. Kmart's fiscal year ends the last Wednesday in January.

2. PepsiCo/Frito-Lay

PepsiCo Inc. ("PepsiCo") is a North Carolina corporation headquartered in Purchase, New York. PepsiCo is one of the world's largest beverage and snack companies and a major Kmart vendor. PepsiCo's common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and is listed on the New York and Chicago Stock Exchanges.

Pepsi's business was organized into several divisions during the relevant period, including Frito-Lay, Inc. ("Frito-Lay"). Frito-Lay manufactures, markets and sells to independent distributors and retailers brand name snacks such as Lay's, Doritos, Cheetos, Fritos, Tostitos, Ruffles, Rold Gold, Sun Chips and Cracker Jack. Frito-Lay's divisional headquarters are in Plano, Texas, and it has a field office in Plymouth, Michigan.

B. RESPONDENT

Thomas L. Taylor ("Taylor") was Frito-Lay's Director of Sales in charge of the Kmart snack account during the relevant period. Taylor worked out of Frito-Lay's Plano, Texas, headquarters.

C. FACTS

1. Kmart Improperly Recognized Vendor Allowances

Kmart improperly recognized millions of dollars worth of vendor "allowances" prior to bankruptcy. Kmart obtained allowances from its vendors for various promotional and marketing activities. A significant number of allowances were recognized prematurely - or "pulled forward" -- on the basis of false information provided to Kmart's accounting department, while the true terms of the payments were set forth in undisclosed side agreements. As a result of these accounting irregularities, Kmart's cost of goods sold was understated, and earnings were materially overstated, for the fourth quarter of fiscal year ended January 31, 2001.

2. Kmart's Vendor Allowance Tracking System ("VATS") Forms

The principal document involved in the pulling forward of vendor allowances was Kmart's Vendor Allowance Tracking System ("VATS") form. VATS forms summarized the basic terms of vendor allowances for the company's accounting department. Bookkeepers inputted information from the VATS form into the company's computerized accounting system, where it was eventually posted to the general ledger. To ensure proper accounting for an allowance, the VATS form should have reflected the true purpose of, and effective dates for, the payment. To pull forward an allowance, this information was misrepresented on the VATS form to make it look like the payment was for past performance, when in truth it related to future obligations. Kmart had a number of safeguards designed to ensure the accuracy of the VATS forms and proper recognition of vendor allowances. These included the requirement that vendors co-sign VATS forms.

3. Taylor Co-Signed Three Misstated VATS Forms

Towards the end of Kmart's fiscal year ended January 31, 2001 ("fiscal year 2000"), Taylor learned that Kmart needed Frito-Lay's help in overcoming a profit shortfall in the food and consumables division. As Taylor was aware, this projected shortfall was caused in part by Frito-Lay's refusal to pay Kmart a $2.3 million "growth incentive" in late-December 2000. With Taylor's knowledge and assistance, Frito-Lay agreed to make a $2.8 million "space payment" in January 2001. Taylor understood that the purpose of the $2.8 million was to secure favorable placement of Frito-Lay product within Kmart stores during calendar year 2001. Taylor understood this in part because around the same time he helped draft a written agreement that explained the $2.8 million was a "pre-payment" of allowances to be earned by Kmart during calendar year 2001.

Taylor co-signed VATS form Nos. 224301, 224302, 224303 on January 4, 2001. These VATS forms misrepresented the effective dates of the allowances as 1/1/01 to 1/31/01. They were also misleading in that they failed to indicate that the $2.8 million was a "prepayment" against calendar year 2001 activity. On or about January 19, 2001, Kmart's accounting personnel entered the false or misleading VATS information into the company's computerized accounting system, where it was eventually posted to the general ledger. As a result, Kmart's cost of goods sold was understated by $2.8 million in fiscal year 2000.

4. Kmart's Earnings Were Overstated

On March 13, 2001 Kmart filed its Form 10-K for the period ended January 31, 2001 ("fiscal year 2000"). According to the financial statements incorporated into the Form 10-K, Kmart reported net income for the fourth quarter of $249 million or $0.48 per share, exceeding Wall Street analyst expectations of $0.47 by a penny. Kmart's accounting irregularities caused net income for the quarter to be overstated by approximately 1.135 percent.

D. CONCLUSION

As a result of the foregoing, Taylor committed violations of Rule 13b2-1 of the Exchange Act and caused Kmart's violations of Sections 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 promulgated thereunder.

IV.

In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Taylor's Offer.

Accordingly, IT IS HEREBY ORDERED that Respondent Taylor cease and desist from committing or causing any violations and any future violations Rule 13b2-1 of the Exchange Act and causing any violations and any future violations of Sections 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 promulgated thereunder.

By the Commission.

Jonathan G. Katz
Secretary


http://www.sec.gov/litigation/admin/34-50783.htm


Modified: 12/02/2004