U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

UNITED STATES DISTRICT COURT
MIDDLE DISTRICT OF PENNSYLVANIA


SECURITIES AND EXCHANGE COMMISSION,

Plaintiff,

-against-

FRANK M. BERGONZI,
MARTIN L. GRASS, and
FRANKLIN C. BROWN

Defendants.


:
:
:
:
:
:
:
:
:

No. 1:CV02-1084 ( )

COMPLAINT

Plaintiff Securities and Exchange Commission (the "Commission"), for its Complaint against defendants Frank M. Bergonzi, Martin L. Grass, and Franklin C. Brown (collectively, the "Defendants"), alleges as follows:

PRELIMINARY STATEMENT

1. This action concerns one of the largest financial frauds ever perpetrated on the investing public by senior management of a public company. Defendants Grass, Bergonzi, and Brown are the former top executives of Rite Aid Corporation ("Rite Aid" or the "Company"), which operates one of largest chains of drug stores in the United States. From at least March 1997 through at least September 1999, the Defendants engaged in a fraudulent scheme to misrepresent Rite Aid's financial condition and results of operations, and to hide from public view the existence of certain transactions designed to enrich Grass at shareholder expense. They did this with the intent to enrich themselves through performance-based bonuses of stock and cash, and to keep the price of Rite Aid stock from falling as it would have if the public knew the truth about Rite Aid's actual financial condition and results of operations. After the scheme was discovered, Rite Aid was forced to restate its reported cumulative pre-tax income by a massive $2.3 billion dollars, and cumulative net income by $1.6 billion dollars. This was the largest restatement in history.

2. The Defendants engaged in the following fraudulent conduct: At the Defendants' direction and/or with their knowledge, Rite Aid's accounting staff entered into Rite Aid's books and records various kinds of false and misleading accounting entries based on unsubstantiated or otherwise inadequate information, frequently in violation of Generally Accepted Accounting Principles ("GAAP"). This information was generally supplied by Bergonzi but on occasion was also supplied by and/or originated with Grass or Brown. The misleading accounting entries enabled Rite Aid to report positive net income when in fact the Company should have reported materially lower income or losses for the affected periods. As a result of the misleading accounting entries, all of Rite Aid's publicly reported financial statements were materially false or misleading, as were its registration statements and other documents relating to Rite Aid's offerings of securities. In addition, the Defendants were responsible for public reports that failed accurately to disclose certain related party transactions involving Grass, and Grass made material misrepresentations to Rite Aid's lenders in order to obtain a critical loan from them based on a pledge of stock owned by Rite Aid.

3. As a result of the fraud, Grass, Bergonzi, and Brown received ill-gotten gains in the form of performance-related cash bonuses totalling more than $1.5 million. Had they succeeded at sustaining the fraud for a longer period and/or achieved certain pre-set financial goals, they could have obtained tens of millions more through stock options, stock awards, and more cash bonuses.

4. The Defendants each violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §77q(a), Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§78j(b), 78m(b)(5), and Rules 10b-5, 13b2-1, and 13b2-2 thereunder, 17 C.F.R. §§240.10b-5, 240.13b2-1, and 240.13b2-2; and the Defendants also are liable pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), as controlling persons of Rite Aid for Rite Aid's violations of Sections 13(a) and 13(b)(2) of the Exchange Act, 15 U.S.C. §§78m(a), 78m(b)(2), and Rules 12b-20 and 13a-1 thereunder, 17 C.F.R. §§240.12b-20 and 240.13a-1. In addition, as controlling persons pursuant to Section 20(a) of the Exchange Act, Grass and Brown are liable for Rite Aid's violations of Section 14(a) of the Exchange Act, 15 U.S.C. §78n(a), and Rules 14-a-9(a) and 13a-11 thereunder, 17 C.F.R. §§240.14a-9(a) and 240.13a-11, and Bergonzi is liable for Rite Aid's violation of Exchange Act Rule 13a-13, 17 C.F.R. § 240.13a-13. The Defendants have engaged, and unless enjoined by this Court, will continue to engage, in transactions, acts, practices, and courses of business of a similar type and object.

JURISDICTION AND VENUE

5. The Commission brings this action pursuant to authority conferred upon it by Section 20(b) of the Securities Act, 15 U.S.C. §77t(b), and Section 21(d) of the Exchange Act, 15 U.S.C. §78u(d)(1). By this action, the Commission seeks permanent injunctive relief against each of the Defendants, disgorgement of the funds by which each of the Defendants was unjustly enriched, prejudgment interest thereon, civil money penalties against each of the Defendants, an order barring each of the Defendants from positions as officers or directors of public companies, and such other and further relief as the Court finds appropriate.

6. This Court has jurisdiction over this action pursuant to Sections 20(d) and 22(a) of the Securities Act, 15 U.S.C. §§77t(d), 77v(a), and Sections 21(d) and 27 of the Exchange Act, 15 U.S.C. §§78u(d), 78aa.

7. Each of the Defendants, directly or indirectly, singly or in concert, has made use of the means and instrumentalities of interstate commerce and of the mails, and the facilities of a national securities exchange, in connection with the transactions, acts, practices and courses of business alleged in this Complaint. Certain of these transactions, acts, practices and courses of business occurred in the Middle District of Pennsylvania, including the falsification of books and records maintained at Rite Aid's offices in Cumberland County, Pennsylvania.

THE DEFENDANTS

8. Martin L. Grass, age 48 and a resident of Virginia Beach, Virginia, was Rite Aid's chief executive officer ("CEO") and chairman of its board of directors (the "Board") from March 1995 until his resignation on October 18, 1999. Before that, he was president, chief operating officer, and a director of Rite Aid. Grass is the son of Rite Aid's founder.

9. Frank M. Bergonzi, age 54 and a resident of Hummelstown, Pennsylvania, was Rite Aid's chief financial officer ("CFO") and an executive vice president from March 1995 until January 1999; he then served as CFO and senior executive vice president. Bergonzi resigned on October 18, 1999 after stepping down as CFO some months earlier. Bergonzi was an officer of Rite Aid since 1977. As CFO, Bergonzi was ultimately responsible for the contents of Rite Aid's financial statements.

10. Franklin C. Brown, age 74 and a resident of Harrisburg, Pennsylvania, was an executive vice president and Rite Aid's chief legal officer ("CLO") from April 1993 until July 1997, when he became vice chairman of the Board. Brown resigned as an employee in February 2000 and from the Board in May 2000. Brown previously served as Rite Aid's general counsel.

11. At the time of the transactions and events alleged in this Complaint, Grass, Bergonzi, and Brown each were controlling persons of Rite Aid for the purposes of Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a). Among other things, the Defendants each were officers, and Grass and Brown were directors, of Rite Aid; each had responsibility for, and actively participated in and directed, the management and operations of Rite Aid; and each possessed, directly or indirectly, the power to direct or control, or cause the direction or control of, and directed or controlled, the management and operations of Rite Aid.

RELEVANT ENTITY

12. Rite Aid at all relevant times was a Delaware corporation with principal offices located in Camp Hill, Pennsylvania. Rite Aid was and is one of the nation's largest drug store chains, operating more than 3500 stores located in twenty-eight states and the District of Columbia. At all relevant times, Rite Aid's common stock was registered with the Commission pursuant to Section 12(b) of the Exchange Act and was listed on the New York Stock Exchange.

RITE AID'S FALSE AND MISLEADING SEC PUBLIC FILINGS

False and Misleading Periodic Reports,
Registration Statements, and Other Information Filed With the Commission

13. Rite Aid's false and misleading financial statements were included specifically and/or incorporated by reference in periodic reports and registration statements that Rite Aid filed with the Commission during 1997, 1998, 1999, and 2000 (collectively, the "SEC Public Filings").

14. Rite Aid made the following relevant SEC Public Filings, including:

  1. An annual report for the fiscal year ended February 28, 1998 ("FY 1998 Annual Report");

  2. Three quarterly reports for portions of fiscal 1998 ("FY 1998 Quarterly Reports");

  3. An annual report for the fiscal year ended February 27, 1999 ("FY 1999 Annual Report");

  4. Three quarterly reports for portions of fiscal 1999 ("FY 1999 Quarterly Reports");

  5. A quarterly report for the period ended May 29, 1999 ("FY 2000 Quarterly Report");

  6. A registration statement dated January 5, 1998 and eleven amendments thereto (dated at various times during 1998) concerning the registration for purposes of resale of securities previously restricted by Rule 144; and

  7. A registration statement dated November 6, 1998 concerning the September 1998 reissue of $200 million of dealer remarketable securities. (The registration statements discussed in this sub-paragraph and sub-paragraph f. above shall be referred to collectively as the "Registration Statements").

15. The Registration Statements incorporated specifically or by reference Rite Aid's previously-reported financial information.

16. The Defendants each participated in the preparation of, or reviewed, the SEC Public Filings.

17. The Defendants each signed certain of the SEC Public Filings, as follows:

  1. Grass, Bergonzi, and Brown each signed the FY 1998 Annual Report and the FY 1999 Annual Report.

  2. Bergonzi signed all six of the FY 1998 Quarterly Reports and the FY 1999 Quarterly Reports.

  3. Grass signed the Registration Statements.

18. During the relevant period, Rite Aid also made private offerings of notes and debentures. According to its FY 1999 Annual Report, Rite Aid completed the sales of $700 million of such notes and debentures on December 15, 1998. The private placement memoranda through which Rite Aid offered these securities (the "PPMs") incorporated specifically or by reference Rite Aid's previously-reported financial information.

19. Rite Aid's SEC Public Filings materially misrepresented Rite Aid's financial condition and results of operations, causing Rite Aid to appear materially more profitable than it actually was. The improperly-recorded and/or unsubstantiated accounting entries described in this Complaint inflated Rite Aid's reported pre-tax income by 38%, 66%, and 16%, respectively for the first three quarters of FY 1998; by 9% for FY 1998; by 71%, 5533%, and 94%, respectively for the first three quarters of FY 1999; by an enormous but mathematically indefinable percentage for FY 1999; and by 54% for the first quarter of FY 2000.

20. In addition to the false financial statements, the Management's Discussion and Analysis of Financial Performance ("MD&A") sections of the SEC Public Filings were materially false and misleading because, among other reasons, those sections failed to disclose the fraudulent practices described herein or the effect those fraudulent practices had on Rite Aid's reported financial condition and results of operations.

21. Rite Aid also was required by Regulation S-K, Item 404, to publicly disclose certain material related party transactions involving its principals, including Grass. The FY 1998 and the FY 1999 Annual Reports, which should have contained disclosures concerning all such transactions, failed accurately to make them. Proxy statements that Rite Aid distributed to shareholders in anticipation of annual meetings during FY 1998 and FY 1999 (the "Proxy Statements") similarly were required to contain such disclosures, and similarly failed accurately to make them. Moreover, on February 9, 1999, Rite Aid filed a report on Form 8-K (the "February 1999 8-K") that purported to disclose and/or clarify Grass's interest in three properties that Rite Aid leased as store locations. In fact, not only were the purported disclosures inaccurate, the February 1999 8-K omitted all mention of an 83-acre site (the "Site") that Grass, with the knowledge of Bergonzi and Brown, had arranged to be purchased using $2.6 million of Rite Aid's funds through a real estate partnership controlled by Grass.

FRAUDULENT CONDUCT RESULTING IN THE FALSIFICATION
OF RITE AID'S SEC PUBLIC FILINGS

22. As detailed below, the Defendants engaged in fraudulent conduct that resulted in the knowing or reckless misrepresentation of Rite Aid's financial condition and results of operations in Rite Aid's SEC Public Filings.

23. At the direction of Bergonzi, Rite Aid's accounting staff recorded numerous and varied types of accounting entries that had no basis or false substantiation and/or were in violation of GAAP. Generally, these entries were made at the end of or just after a quarterly or yearly period, in order to "fill a hole" perceived by Bergonzi or others.

24. The chart below shows the quantifiable effect on reported pre-tax income of these entries during FY 1998, FY 1999, and the first quarter of FY 2000. A description of the meaning of each of these entries follows the chart.

  1st Q 2nd Q 3rd Q   1st Q 2nd Q 3rd Q   1st Q
  FY 1998 FY 1998 FY 1998 FY 1998 FY 1999 FY 1999 FY 1999 FY 1999 FY 2000
                   
Reported Pre-tax
Income ($ million)
114.3 101.5 113.7 530.0 151.3 135.2 144.7 199.6 141.1
                   
Adjustments                  
Corporate
Entries
               

17.5

Retail Entries 0.0 9.0 (4.0)   1.0 12.2 1.7   8.0
Gross
Profit Entries
25.3 26.2 5.9   47.1 100.4 39.6   23.8
Undisclosed
Upcharges
2.6 1.7 1.5 7.6 5.9 6.5 7.0 27.8  
Undisclosed
Markdowns
              29.7  
Vendor
Rebates
              75.6  
Litigation
Settlement
              17.0  
Dead Deals               10.6  
SARS 3.4 3.6 12.6 22.1 9.0 13.7 21.9 33.2  
Will-Call
Payables
              6.6  
Inventory
Shrink
              13.8  
Depreciation       14.6          
Total Adjustments 31.3 40.5 16.0 44.3 63.0 132.8 70.2 214.3 49.3
                   
Corrected Pre-tax
Income/(Loss)
83.0 61.0 97.7 485.7 88.3 2.4 74.5 (14.7) 91.8
                   
Overstatement
Percentage
38% 66% 16% 9% 71% 5533% 94% N/A1 54%
                   
Notes:

1) Reported Pre-tax Income for the 2nd quarter of FY 99 is before a pre-tax charge for store closings of $289.7 million

2) This table does not purport to show a complete listing of the adjustments recorded in Rite Aid's restatements.

Accounting Entries Affecting All Quarterly and Annual Financial Statements

25. Rite Aid improperly accounted for certain vendor deductions known within the company as "vendor upcharges." From at least the first quarter of FY 1998 through the first quarter of FY 2000, Rite Aid inflated net income by reducing its vendor accounts payable and cost of goods sold for unearned vendor credits. For these periods, Rite Aid also failed to record as an expense the cost of the Company's stock appreciation rights program.

Improper Vendor Deductions/"Upcharges"

26. Rite Aid systematically inflated deductions it took against amounts owed to vendors for damaged and outdated products ("D&Os"). For those vendors that did not require Rite Aid to return D&Os to them ("deduct vendors"), Rite Aid had the product destroyed and reported to the deduct vendors the quantity and dollar value of the destroyed product. Rite Aid then deducted the dollar value of destroyed product from a future remittance to the vendor. Rite Aid improperly inflated the quantities and dollar value of D&Os reported to the deduct vendors through the vendor upcharge practice. The vendors did not agree to or know about the upcharge. The effect of this practice was to overstate Rite Aid's reported net income. In FY 1998 and FY 1999, Rite Aid overstated reported pre-tax income by approximately $8 million and $28 million, respectively, as a result of the undisclosed vendor upcharges.

27. Each of the Defendants knew about the upcharge pratice and permitted it to continue. Grass and Bergonzi both permitted the practice to continue even after other Rite Aid personnel raised with them in 1995 the question of whether the practice was proper. At the time that Rite Aid personnel expressed these concerns to Grass and Bergonzi, they informed Grass and Bergonzi that the "unsupported" upcharge was 35%. It later increased to 50%. Brown became aware of the upcharges no later than the Spring of 1998, through discussions with other Rite Aid personnel, and also permitted the practice to continue. After the Wall Street Journal published an article in early 1999 alleging other improprieties at Rite Aid, Grass arranged an $11 million dollar settlement with a disgruntled employee so that the employee would not tell the Wall Street Journal about the upcharges.

Stock Appreciation Rights

28. Rite Aid improperly failed to account for stock appreciation rights ("SARS") granted to employees. In May 1995, Rite Aid granted SARS to certain field managers. These SARS gave the holders the right to receive in cash or Rite Aid stock an amount equal to the change in the price of Rite Aid's stock between the date of grant and the vesting date. Under GAAP, Rite Aid should have recorded an accrued expense each quarter based on the then-current market price of Rite Aid stock. Rite Aid never recorded any such accruals. In FY 1998 and FY 1999, Rite Aid should have recorded an accrued expense of approximately $22 million and $33 million, respectively.

29. Grass personally signed the letters addressed to each individual employee receiving the SARS. Although Bergonzi falsely told a member of Rite Aid's audit firm that no SARS had been issued, he later acknowledged to another Rite Aid employee that he knew about the SARS.

Accounting Entries Affecting Quarterly Financial Statements Only

30. Rite Aid had a practice of making unsubstantiated quarterly adjustments to cost of goods sold and expense accounts, and then reversing the adjustments in later periods. The initial adjustments and subsequent reversals were not based on GAAP. The practice had the effect of inflating earnings in the quarters that the adjustments were made, while deflating earnings in the quarters that the reversing entries were made.

Reductions of Previously-Recorded Expenses

31. Rite Aid improperly reduced previously-recorded expenses in certain quarters from at least the first quarter of FY 1998 through the first quarter of FY 2000. Rite Aid reduced amounts already booked for various expenses incurred in its retail stores and at the corporate level. Rite Aid typically reversed these expense reductions in the quarter subsequent to the one in which it had entered the reductions, thus returning the expenses to its books but reflecting them in an incorrect period.

32. For example, in connection with the closing of Rite Aid's books for the second quarter of FY 1998 (August 1997), Rite Aid credited its retail stores general ledger expense accounts for the month of August by a total of $9 million across eleven separate accounts. The amounts credited in August were reversed in the following month, September. The effect of the expense reductions was to overstate Rite Aid's pre-tax income for the second quarter of FY 1998 by $9 million. The reversal in the following month had the effect of understating pre-tax income in the third quarter of FY 1998.

33. The only documentation backing up these entries was a hand-written schedule prepared by Bergonzi, showing eleven separate accounts that he wanted credited. All of the amounts were in large round numbers. All accounts chosen were the same ones adjusted in the prior year's quarter. In later periods, Bergonzi sent similar faxes or simply called in his adjustments to the accounting department. In all cases no rationale or supporting documentation was ever provided.

Gross Profit Entries

34. In addition, from at least the first quarter of FY 1998 through the first quarter of FY 2000, Rite Aid also made improper adjusting entries known as "gross profit" entries. This practice had the effect of lowering cost of goods sold and accounts payable. These entries caused material overstatements of Rite Aid's net income in each quarterly period in which they were made. In the second quarter of FY 1999, for example, Rite Aid improperly reduced cost of goods sold and accounts payable by approximately $100 million. As a result of these "gross profit" entries alone, Rite Aid overstated pre-tax income by $100 million in the second quarter of FY 1999. In each of the relevant years, the gross profit entries made during the first three quarters of each fiscal year were reversed in the fourth quarter of that fiscal year.

35. Bergonzi personally determined the gross profit entries without input or review by anyone. These entries were completely unsubstantiated.

Accounting Entries Recorded in the Fourth Quarter
That Affected the FY 1999 Financial Statements

36. The reversal of the gross profit entries described above created an understatement of fourth quarter income that necessitated the recording of new entries in the fourth quarter that would overstate income in the fourth quarter by at least a like amount. Some of these entries were recorded just as the fiscal year was ending or just after the year ended. Rite Aid's reported net income of $143 million for fiscal year 1999 was materially overstated as a result of these entries. In fact, without such entries Rite Aid would have suffered a net loss for FY 1999.

Undisclosed Markdowns

37. In addition to the improper vendor deductions discussed in paragraphs 26 and 27 above, Rite Aid overstated its FY 1999 net income by charging the vendors for undisclosed markdowns relating to vendor products. The vendors did not agree to share in the cost of the price markdowns and, in fact, were never even told of the markdowns. Instead, Rite Aid misled the vendors into believing that the deductions taken by Rite Aid in February 1999 were for D&Os. These purported D&Os resulted in an overstatement of FY 1999 pre-tax income of approximately $30 million. Rite Aid's pre-tax income was overstated because the credits taken by Rite Aid were unearned in FY 1999. The amounts were unearned because the vendors never agreed to the credits prior to the close of FY 1999 and they were lied to about the nature and calculation of the credits.

38. Grass and Bergonzi knew, or were reckless in not knowing, about the undisclosed markdowns. A Rite Aid employee responsible for this area specifically told Grass and Bergonzi that Rite Aid's failure to charge back the vendors for the markdowns would negatively impact earnings by $30 million. Although Rite Aid was able to unilaterally record credits totaling $30 million, Rite Aid could not actually obtained that benefit without charging the underlying amounts back to specific vendors. Grass and Bergonzi also knew, because they were told, that the relevant markdown information received by Rite Aid's accounting department from hundreds of stores had to be resorted by vendor in order to properly charge back the vendors for the markdowns, but that the volume was so great that the sorting process was impossible to complete by year-end. Grass was also told that there were $35 million in unprocessed credits, and Grass knew that some of the affected vendors no longer did business with Rite Aid (and therefore could not be charged back). Grass and Bergonzi were told that the eventual credits claimed would be based on a percentage of purchases from the vendors rather than the actual dollar value of the markdowns. Thus, Grass and Bergonzi knew that the credits were arbitrarily determined (and likely wrong).

39. Vendor complaints regarding the size of the chargebacks became the subject of a number of Wall Street Journal articles in March of 1999. Rite Aid claimed to the newspaper and the vendors that the chargebacks were appropriate and part of its long-standing business practices. Rite Aid did not tell the press or the vendors that Rite Aid had misdescribed the amounts involved as pertaining to D&O product. In response to the Wall Street Journal's accusation that Rite Aid was inflating its earnings by overstating the amount of D&Os, Bergonzi was quoted as saying that Rite Aid "did not inflate earnings in the fourth quarter with these returns allowances and things like that." On March 31, 1999, in response to a Wall Street Journal article, Rite Aid issued a press release stating that "[v]endor deductions and chargebacks have only a minimal impact on our financial results in any quarter, and credits for damage or unused goods have no impact."

40. In fact, earnings were significantly inflated because the chargebacks were for markdowns, not D&Os, and thus went straight to the bottom line. Grass and Bergonzi knew this, or were reckless in not knowing it.

Vendor Rebates

41. Rite Aid also improperly accounted for certain vendor rebates. On the last day of FY 1999, Rite Aid recorded reductions to accounts payable and cost of goods sold totaling $42 million. The reductions were based upon expected credits from two vendors which in fact were expressly contingent upon Rite Aid's future sales of these vendors' products. At Bergonzi's direction, Rite Aid reopened its books to record an additional $33 million of credits on March 11, 1999, subsequent to the close of the fiscal year, when it was readily apparent that the Company's results would fall short of Wall Street analysts' projections. These entries violated GAAP because the credits were unearned at the time Rite Aid recorded them, in FY 1999. Moreover, the purchasing agreements pursuant to which Rite Aid might have earned these credits in the future were not consummated in legally binding form as of that time. The $75 million in income recognized from these rebates represented 37% of Rite Aid's pre-tax income for FY 1999.

42. Rite Aid was obligated to pass through a portion of any vendor rebates it received to third-party employers that used Rite Aid as their pharmaceutical benefits manager to dispense drugs to their employees. Thus, even if Rite Aid had been justified in recognizing the vendor credits immediately, Rite Aid could have kept only $33 million for itself. The remaining $42 million in vendor rebates would have been recorded as a payable to third-party employers under Rite Aid's pass-through obligation and not as income.

43. Representatives of the vendors informed Grass that any amounts payable under the agreements represented rebates owed only if Rite Aid dispensed sufficient quantities of the vendors' products so as to maintain market share. None of the credits were to be paid up front and all amounts were to be earned in the future. Grass signed or initialed letters of intent with two vendors on the last business day of the fiscal year (February 26, 1999). The letters expressly referred to contingencies that had to occur before the deals between Rite Aid and the vendors could be final. These letters of intent were shown to Bergonzi in Brown's presence.

Litigation Settlement

44. In the fourth quarter of FY 1999, Rite Aid prematurely recognized $17 million relating to a litigation settlement with one of the two vendors referenced in paragraph 42 above. Rite Aid should not have recognized this sum in that period because the settlement offer was expressly contingent upon the execution of a formal settlement agreement which did not take place until May 20, 1999. Moreover, the litigation settlement was also contingent upon the execution of a purchasing agreement that was not finalized until May 18, 1999. Both of these contingencies were expressly stated in the February 26, 1999 letter of intent signed by Grass.

45. Each of the Defendants knew, or was reckless in not knowing, about the settlement and its contingent nature, and furthermore each of them knew, or was reckless in not knowing, that Rite Aid had recorded the $17 million in the wrong period. Brown originated the idea of using the settlement in order to help plug what Bergonzi in January 1999, and then again on March 11, 1999, told Grass and Brown was a $100 million shortfall that otherwise would have to be reported for FY 1999. After Grass agreed that the settlement should be used, Bergonzi instructed the accounting staff to record the $17 million settlement as income, even though Bergonzi was aware that the settlement was contingent.

46. Although the settlement income already had been recorded, Brown actively worked on finalizing the formal settlement agreement with the vendor between February 26, 1999 and May 20, 1999. Even though he knew that because of its contingent nature the settlement was not binding until finalized on May 20, 1999, Brown convinced outside counsel to provide an opinion letter that erroneously stated that the litigation settlement was binding and enforceable as of February 26, 1999. The purpose of this erroneous opinion letter was to provide support for Rite Aid's inappropriate recording of the $17 million settlement in FY 1999.

"Dead Deal" Expense

47. In addition to the accounting irregularities described above, Rite Aid also improperly accounted for expenses it had incurred for legal services, title searches, architectural drawings, and other items relating to sites considered but later rejected for new stores. Rite Aid capitalized these costs at the time they were incurred. During FY 1999 (and during prior periods), Rite Aid determined not to construct new stores at certain of these sites. Under GAAP, Rite Aid should have written off the capitalized costs relating to each site at the time that Rite Aid decided not to develop that site. Such write-offs would have adversely affected Rite Aid's reported net income in the relevant periods. Rather than write off these expenses (which Rite Aid called "dead deal" expenses), Rite Aid continued to carry them on its books as assets. By February 27, 1999, the accumulated dead deal expense totaled approximately $10.6 million.

48. Although writing such amounts off over time (based on a budget) was contrary to GAAP, Rite Aid's accounting department wrote off portions of these expenses at a fixed rate of $125,000 per month (later increased to $250,000 per month), rather than writing off the full amount of dead deal expenses. Bergonzi knew about this improper practice because the accounting department employee responsible for recording the budgeted expense provided Bergonzi with a written report and updates of the dead deals. The report and updates told Bergonzi that the dead deal costs were growing and that they needed to be written off. Bergonzi failed to respond to this information.

"Will-Call" Payables

49. Rite Aid often received payment from customer insurance carriers whether or not the customers actually picked up medication ordered by telephone. Beginning in 1997, a member of Rite Aid's accounting staff recorded a "will-call" account payable that represented the total amount of payments received from private insurance carriers for prescription orders never picked up by customers. Rite Aid reversed the $6.6 million will-call accounts payable in the fourth quarter of FY 99 without sufficient justification or basis, and in violation of GAAP.

50. When the accounting department employee responsible for will-call payables found out about this reversal, he told Rite Aid's general counsel, who agreed that the reversal was inappropriate and directed that these payables be reinstated on Rite Aid's books. Bergonzi had little choice but to order the accrual reinstated. He then directed that improper off-setting entries be recorded in the general ledger in a different account, which achieved the same improper effect as had the original reversal.

Inventory Shrink

. 51. When the physical inventory count was less than the inventory carried on Rite Aid's books, Rite Aid wrote down its book inventory accordingly to reflect this "shrink" (i.e., reduction of inventory presumed due to physical loss or theft). In FY 1999, Rite Aid failed to record $8.8 million in shrink. For retail stores in which a physical inventory was not conducted, Rite Aid recorded a shrink accrual, reflecting Rite Aid's estimate of the shrink during the period. In FY 1999, Rite Aid improperly reduced the accrued shrink expense for 2,000 stores, resulting in an aggregate increase to income of $5 million. As a result of this improper accounting for shrink, Rite Aid's pre-tax income for FY 1999 was overstated by $13.8 million. Bergonzi knew of Rite Aid's practice of under-accruing for shrink and permitted it to continue.

Depreciation Changes Affecting FY 1998 Income

52. Rite Aid retroactively increased the estimated lives (periods of time) over which some groups of assets were depreciated. These retroactive depreciation changes violated GAAP, which requires such changes to be done prospectively. There was no legitimate business purpose or supporting documentation for these changes. The effect of the retroactive depreciation changes resulted in increases to income, and caused some asset groups to have a negative depreciation expense. These changes resulted in an approximately $14.6 million overstatement of FY 1998 pre-tax income.

Additional Misrepresentations and Omissions
Misleading Disclosures of Related Party Transactions

53. In addition to misrepresentations concerning its financial condition and results of operations, Rite Aid made material misrepresentations concerning related party transactions involving Grass. Prompted by a series of newspaper articles in January 1999, Rite Aid filed a Form 8-K on February 9, 1999 purporting to disclose Grass' interest in three properties that Rite Aid leased as store locations. Based on Grass' inaccurate responses to questionnaires completed annually by all of Rite Aid's officers and directors concerning related party transactions, Rite Aid had not previously disclosed these matters. The Form 8-K acknowledged that Grass owned one of the three properties in a partnership with his relatives (in contrast with Grass' prior public comments). The Form 8-K inaccurately stated that (1) the second property was owned by Grass' brother-in-law but that Grass had no interest in the second property; (2) the third store was now on a new property controlled by an "unrelated entity;" and (3) Grass had no participation in approval of any real estate deals in which "a related party or any person with whom he has business relationships is involved." In fact, on February 9, 1999, (1) Grass was still a partner in the second property; (2) the third store was now on property controlled solely by a man with whom Grass had multiple real estate partnerships, including joint ownership of the store's previous location; and (3) Grass approved the terms of the lease for the third location with the new "unrelated entity."

54. The February 9, 1999 Form 8-K also did not disclose dealings that Grass had involving the 83-acre Site (referred to in paragraph 21 above) which had been considered as a relocation site for Rite Aid's headquarters. Grass provided an affidavit to the Board misleadingly stating that other than the interests disclosed in the Form 8-K, no entity in which he "has or had" any interest "has or had any business dealings with Rite Aid Corporation." In fact, in January 1998, with the knowledge of Brown and Bergonzi, Grass caused $2.6 million to be transferred from Rite Aid to a partnership controlled by Grass and a relative (the "Partnership"). The Partnership used $1.8 million to purchase the Site in its own name, and most of the balance to pay off debts of other partnerships involving the same partners. Rite Aid subsequently paid over $1 million in costs connected to the Site even though it was owned by the Partnership and not by Rite Aid. These costs were capitalized in Rite Aid's Land Holding account.

55. Just before the February 1999 Form 8-K was filed, Grass transferred $2.9 million to Rite Aid from a personal bank account. Shortly after the Form 8-K was filed (with no mention of the Site), a published report questioned whether Rite Aid intended to relocate its headquarters to the Site. Grass then provided the above-referenced affidavit to Rite Aid's Board. None of these facts were disclosed by Rite Aid in the February 1999 Form 8-K, the Proxy Statements that Rite Aid distributed to shareholders for FY 1998 and FY 1999, the FY 1998 Annual Report, or the FY 1999 Annual Report.

56. Grass and Brown subsequently attempted to conceal the facts concerning the above-referenced Site transaction by means of a false email and a back-dated document.

Misleading Disclosures in Connection with Debt Financing Issues

57. In January 1999, Rite Aid acquired PCS Health Systems Inc. ("PCS"), a pharmacy benefits manager, for $1.5 billion. In order to finance the PCS deal, Rite Aid issued short-term commercial paper ("CP") backed by a $1.3 billion line of credit. By the end of September 1999 Rite Aid could not roll over its CP for a variety of reasons. Rite Aid approached its lenders in late September 1999 and asked to draw down on the credit line in order to repay maturing CP, but the request was denied because the creditors discovered that the company was not in compliance with covenants.

58. Grass falsely told the lead bank on the credit line that the Board's finance committee had approved a pledge using PCS as collateral for an interim loan. Later, Grass falsely told Rite Aid's general counsel the same thing and directed him to draft minutes to that effect. Grass signed these false minutes, which purported to memorialize a meeting that Grass knew never occurred.

59. After paying $5 million in fees, Rite Aid successfully obtained the desired interim facility on September 24, 1999 and used it to pay off immediately-maturing CP. Four days later, the lending syndicate waived the covenant violations on the credit line, allowing Rite Aid to pay off the interim loan as well as additional maturing CP. Rite Aid's interest in PCS was again used as collateral for the newly amended credit line. Rite Aid did not timely disclose its violation of the original loan covenants, the interim loan, or the pledge of PCS. In fact, during a conference call with analysts on September 29, 1999, Grass affirmatively denied that Rite Aid had used any sources other than the credit line to pay off CP, and failed to mention any of the other financing problems.

PROVISION OF FALSE AND MISLEADING
INFORMATION TO AUDITORS

60. Rite Aid engaged the accounting firm now called KPMG LLP ("KPMG") to audit Rite Aid's financial statements for FY 1998 and FY 1999 and to perform other duties. Bergonzi provided, and directed his staff to provide, false and misleading information to KPMG. The false information included, among other things, Rite Aid's books and records, unaudited financial statements, and bank records.

61. In addition, Bergonzi, Grass and Brown each provided misleading information and/or omitted to disclose material information to KPMG with respect to the litigation settlement discussed in paragraphs 44-46 above. During its audit, KPMG sought documentary support for a $17 million legal settlement that Bergonzi caused Rite Aid to record in the fourth quarter of FY 1999. In response, Brown gave KPMG the opinion letter he obtained from outside counsel (described in paragraph 46 above), even though Brown knew that the deal was highly contingent and therefore knew, or recklessly disregarded, that in fact the entry of the $17 million in the February 1999 period was not proper. Moreover, during a conference call in late March 1999 among KPMG's audit partner, Grass, Bergonzi, and Rite Aid's audit committee, neither Grass nor Bergonzi disclosed the contingencies or the existence of the relevant February 26, 1999 letter of intent, even though the KPMG partner explicitly asked during the call for more support for the settlement transaction. Had anyone provided KPMG with the letter of intent or accurately told KPMG that the settlement was contingent as of the end of February, KPMG likely would not have signed off on the recording of the $17 million during the February 1999 period.

62. Finally, Grass and Bergonzi provided KPMG with two "management representation letters" dated April 14, 1998 and May 28, 1999. While these management representation letters assured KPMG that it could rely on the information received from Rite Aid, and stated that all relevant information had been provided to KPMG, in fact the letters contained and reaffirmed numerous false statements. For example, in the May 28, 1999 management representation letter Grass and Bergonzi made and affirmed the following false statements:

  1. The financial statements provided by Rite Aid concerning KPMG's audits of the consolidated balance sheets of Rite Aid and subsidiaries as of February 27, 1999 and February 28, 1998, and the related consolidated financial statements of income, stockholders' equity, and cash lows for each of the years in the three-year period ended February 27, 1999 are presented in conformity with generally accepted accounting principles.

  2. There have been no instances of fraud involving management or employees who have significant roles in internal control.

  3. There have been no violations or possible violations of laws or regulations, the effects of which should be considered for disclosure in the financial statements or as a basis for recording a loss contingency.

  4. There are no material transactions that have not been properly recorded in the accounting records underlying the financial statements.

  5. There are no events that have occurred subsequent to the balance sheet date and through the date of this letter that would require adjustment to or disclosure in the financial statements.

  6. Related party transactions have been properly recorded or disclosed in the financial statements.

  7. The unaudited interim financial information accompanying the financial statements for the years ended February 27, 1999 and February 28, 1998 has been prepared in conformity with generally accepted accounting procedures.

  8. The Company has not granted any stock appreciation rights and has no plans or intentions to convert existing stock option grants to stock appreciation rights.

The April 14, 1998 management representation letter contained several similar false statements.

THE RESTATEMENTS

63. Rite Aid's June 1, 1999 Form 10-K, reporting the financial statements for FY 1999, also contained restatements for FY 1997, FY 1998, and the first three quarters of FY 1999. Bergonzi continued to direct the accounting department to record inappropriate accounting entries for the first quarter of FY 2000, but the accounting department began to resist his commands. In October 1999, the Board announced that Rite Aid would again restate its earnings downward for previous periods and announced Grass' resignation; Bergonzi, who previously had stepped down as CFO, also left the Company. KPMG resigned the next month and withdrew its report on Rite Aid's consolidated financial statements for the three-year period ending February 27, 1999. The Board hired a new executive management team and commenced an internal investigation with an outside law firm and a new auditing firm.

64. Rite Aid restated its reported financial statements on July 11, 2000 and October 11, 2000 in a Form 10-K and an amended Form 10-K for fiscal 2000. The Forms 10-K and 10-K/A restated reported cumulative pre-tax income by $2.3 billion dollars and cumulative net income by $1.6 billion dollars.

RITE AID'S INEFFECTIVE INTERNAL CONTROLS

65. Rite Aid failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit preparation of financial statements in conformity with GAAP or other relevant criteria, or to maintain accountability for assets. As controlling persons of Rite Aid, the Defendants, and each of them, were responsible for Rite Aid's failure to do this.

66. Each of the Defendants engaged in the fraudulent conduct described in this Complaint, and thereby each of the Defendant circumvented whatever internal accounting controls Rite Aid did have and prevented Rite Aid from recording its financial transactions accurately and appropriately.

ILL-GOTTEN GAINS

67. Grass, Bergonzi and Brown profited from the fraud through cash bonuses tied to financial performance (in addition to their large salaries) for FY 1998. (Because bonuses were tied to financial performance, they ultimately received no bonuses for FY 1999.) Grass received a performance bonus of $898,000 (in addition to salary of $1 million), Bergonzi received a performance bonus of $299,774 (in addition to salary of $445,000), and Brown received a performance bonus of $336,825 (in addition to salary of $500,000).

68. The Defendants had other financial incentives to engage in the fraudulent activities discussed above, although they apparently did not realize the benefits of these incentives before the scheme unraveled. Rite Aid put in place a number of performance incentive plans that promised the Defendants lucrative awards if Rite Aid recorded increasingly higher earnings per share and achieved certain stock price levels for an extended period. For example:

  1. By the end of 1999, stock options held by Grass, Bergonzi, and Brown were worth multiple millions of dollars. Rite Aid's June 14, 1999 Proxy Statement calculated their value as of February 27, 1999 (when the stock price closed at $41.38 per share) as follows: Grass had exercisable options worth $83.2 million and unexercisable options worth a potential $11.0 million; Bergonzi's exercisable options were worth $16.4 million and his unexercisable options were worth $4.3 million; and Brown's exercisable options were worth $23 million and his unexercisable options were worth $4.8 million.

  2. In addition to their stock options, the Defendants were eligible to participate in long-term incentive plans (LTIPs) involving outright grants of valuable stock or cash equivalents based on increases in earnings per share ("EPS"). LTIP I (covering the period from March 1995 through February 1999) allowed participants to receive 20% of their "targeted" number of shares if average EPS increased by at least 8% during that period. The maximum award (100%) of target shares) was payable for an increased EPS of 12.5% or higher, and average annual EPS increases between 8% and 12.5% incrementally increased the number of shares awarded. No shares were awarded if the average annual growth in EPS was less than 8%. Pursuant to LTIP I, Grass, Bergonzi, and Brown respectively could have earned (for an 8% increase in EPS), 200,000, 60,000, and 60,000 shares, and (at 12.5%), 1 million, 300,000, and 300,000 shares.

  3. Rite Aid also implemented another LTIP (LTIP II) that covered the period from March 1997 though February 2001. As described by Rite Aid's 1998 proxy statement, under LTIP II each participant could earn shares based on annual increases in EPS exceeding 9%, with a maximum payout at 12%. LTIP II also had a stock multiplier provision that incrementally increased the number of shares as the thirty-day average price of Rite Aid stock exceeded $30.00, up to a maximum doubling of the shares if the price reached $49.50 or higher. Pursuant to LTIP II, Grass, Bergonzi, and Brown respectively could have earned (at a 9% average EPS and a stock price below $30.00), 400,000, 120,000, and 120,000 shares, and (at 12% and a price of at least $49.50), 2 million, 600,000, and 600,000 shares.

FIRST CLAIM FOR RELIEF

Violations of Section 17(a) of the Securities Act,
15 U.S.C. §77q(a), and Section 10(b) of the Exchange Act,
15 U.S.C. §78j(b), and Rule 10(b)-5 Thereunder,
17 C.F.R. 240.10b-5

(Against All Defendants)
(Financial Fraud; Fraudulent Periodic Reports and Registration Statements;
Fraudulent Proxy Statements and Press Release;
Fraudulent Misrepresentations in Connection with Stock Pledge)

69. The Commission realleges and incorporates paragraphs 1 through 68 by reference as if fully set forth herein.

70. As described in paragraphs 1-68, and more specifically in paragraphs 1-4, 7, 12-62, and 65-68, and the Defendants, singly or in concert, directly or indirectly, knowingly or recklessly, by the use of the means or instrumentalities of interstate commerce, and/or of the mails and telephone lines, or of a facility of a national securities exchange, in the offer or sale and in connection with the purchase or sale of Rite Aid securities, each: (a) used or employed devices, schemes or artifices to defraud; (b) obtained money or property by means of, and otherwise made, untrue statements of material fact, or omitted to state material facts necessary in order to make statements made, in light of the circumstances under which they were made, not misleading; and (c) engaged in acts, practices and courses of business which operated as a fraud or deceit upon purchasers of Rite Aid securities and upon other persons.

71. As described in paragraphs 13, 14.a, 14.b, 17.a, 19-20, and 22-52, Rite Aid's FY 1998 Annual Report and FY 1999 Annual Report, which was signed by the Defendants and filed with the Commission, misrepresented Rite Aid's financial condition and results of operations, and omitted information concerning such misrepresentations. Such misrepresentations and omissions were material.

72. As described in paragraphs 13, 14.b, 14.d, 14.e, 17.b, 19-20, and 22-35, Rite Aid's FY 1998 Quarterly Reports and FY 1999 Quarterly Reports, which were signed by Bergonzi and filed with the Commission, and Rite Aid's FY 2000 Quarterly Report, misrepresented Rite Aid's financial condition and results of operations, and omitted information concerning such misrepresentations. Such misrepresentations and omissions were material.

73. As described in paragraphs 13, 14.f, 14.g, 15, 17.c, 19-20, and 22-52, Rite Aid's Registration Statements, which were signed by Grass and filed with the Commission, and which incorporated specifically or by reference the materially false and misleading financial information previously reported by Rite Aid, similarly were materially false and misleading.

74. As described in paragraphs 13, 18, 19-20, and 22-52, Rite Aid's PPMs for private offerings of securities, which incorporated specifically or by reference the materially false and misleading financial information previously reported by Rite Aid, also were materially false and misleading.

75. As described in paragraphs 1-51, defendant Grass, directly or indirectly, singly or in concert, knowingly or recklessly, engaged in various fraudulent conduct involving, among other things, the falsification of Rite Aid's books and records and financial statements. Specifically, as alleged in paragraphs 8, 11, 16, 17.a, 17.c, 19-20, 26-29, and 37-46, Grass knew, or was reckless in not knowing, that Rite Aid failed to account properly for upcharges, SARs, undisclosed markdowns, vendor rebates, and the $17 million litigation settlement. As a result, Grass knew, or was reckless in not knowing, that Rite Aid's FY 1998 Annual Report, FY 1999 Annual Report, Registration Statements, and PPMs were materially false and misleading.

76. As described in paragraphs 1-52, defendant Bergonzi, directly or indirectly, singly or in concert, knowingly or recklessly, engaged in various fraudulent conduct involving, among other things, the falsification of Rite Aid's books and records. Specifically, as alleged in paragraphs 9, 11, 16, 17.a, 17.b, 23, and 25-52, Bergonzi knew, or was reckless in not knowing, that Rite Aid failed to account properly for upcharges, SARS, undisclosed markdowns, vendor rebates, the $17 million litigation settlement, "dead deal" expense, will-call payables, inventory shrink, and depreciation charges, and that Rite Aid improperly reduced previously recorded expenses and made improper gross profit entries. As a result, Bergonzi knew, or was reckless in not knowing, that Rite Aid's FY 1998 Annual Report, FY 1999 Annual Report, FY 1998 Quarterly Reports, FY 1999 Quarterly Reports, FY 2000 Quarterly Report, Registration Statements, and PPMs were materially false and misleading.

77. As described in paragraphs 1-52, defendant Brown, directly or indirectly, singly or in concert, knowingly or recklessly, engaged in various fraudulent conduct involving, among other things, the falsification of Rite Aid's books and records. Specifically, as alleged in paragraphs 10, 11, 16, 17.a, 26-27, and 44-46, Brown knew, or was reckless in not knowing, that Rite Aid failed to account properly for upcharges and the $17 million litigation settlement. As a result, Brown knew, or was reckless in not knowing, that Rite Aid's FY 1998 Annual Report, FY 1999 Annual Report, Registration Statements, and PPMs were materially false and misleading.

78. In addition, as a result of the facts described in paragraphs 21 and 53-56, Rite Aid's February 1999 Form 8-K was materially false and misleading, because the related party transactions set forth therein involving Grass were inaccurate and because the February 1998 Form 8-K, which purported to disclose all such related party transactions, omitted material information concerning the Site.

79. For the same reasons set forth in paragraphs 21 and 53-56, and referenced paragraph 78 above, Rite Aid's Proxy Statements for FY 1998 and FY 1999 were materially false and misleading, because they omitted to disclose material information concerning related party transactions involving Grass.

80. For the same reasons set forth in paragraphs 21 and 53-56, and referenced in paragraphs 78 and 79 above, Rite Aid's FY 1998 Annual Report and FY 1999 Annual Report were materially false and misleading, because they omitted to disclose material information concerning related party transactions involving Grass.

81. As alleged in paragraphs 8, 10, 11, 16, 21, and 53-56, Grass and Brown knew, or were reckless in not knowing, that the Rite Aid's February 1998 Form 8-K, Proxy Statements for FY 1998 and FY 1999, and FY 1998 Annual Report and FY 1999 Annual Report were materially false and misleading with respect to their misrepresentations and omissions concerning related party transactions involving Grass. Such misrepresentations or omissions concerning related party transactions involving Grass were material.

82. Finally, as alleged in paragraphs 57-59, Grass made, knowingly or recklessly, material misrepresentations of fact in connection with a stock pledge. A stock pledge underlying a loan is a purchase or sale of a security. Grass' misrepresentations concerning the stock pledge were material.

83. By reason of the foregoing, the Defendants, singly or in concert, directly or indirectly, have violated, and unless permanently enjoined will again violate, Section 17(a) of the Securities Act, 15 U.S.C. §77q(a), Section 10(b) of the Exchange Act, 15 U.S.C. §78j(b), and Rule 10b-5, 17 C.F.R. §240.10b-5.

SECOND CLAIM FOR RELIEF

Violations of Section 13(b)(5) of the Exchange Act,
15 U.S.C. §78m(b)(5), and Rule 13b2-1 Thereunder,
17 C.F.R. §240.13b2-1

(All Defendants)
(Falsification of Corporate Books and Records
and Circumvention of Internal Controls)

84. The Commission realleges and incorporates by reference paragraphs 1-83 as if fully set forth herein.

85. As described in paragraphs 1-52, and more specifically in paragraphs 65-66, the Defendants each knowingly circumvented or knowingly failed to implement a system of internal accounting controls and knowingly falsified, directly or indirectly, or caused to be falsified books, records and accounts of Rite Aid that were subject to Section 13(b)(2)(A) of the Exchange Act, 15 U.S.C. §78m(b)(2)(A).

86. By reason of the foregoing, the Defendants, singly or in concert, directly or indirectly, have violated, and unless enjoined will again violate, Section 13(b)(5) of the Exchange Act, 15 U.S.C. §78m(b)(5), and Rule 13b2-1 thereunder, 17 C.F.R. §240.13b2-1.

THIRD CLAIM FOR RELIEF

Violations of Exchange Act Rule 13b2-2,
17 C.F.R. §240.13b2-2

(All Defendants)
(Misrepresentations to Accountants)

87. The Commission realleges and incorporates by reference paragraphs 1-86 as if fully set forth herein.

88. As described in paragraphs 1-52, and more specifically in paragraphs 60-62, the Defendants, singly or in concert, directly or indirectly, each made or caused to be made materially false or misleading statements, or omitted to state or caused another person to omit to state material facts necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading to an accountant, in connection with (i) audits and examinations of the financial statements of Rite Aid required to be made pursuant to Commission regulations, and (ii) the preparation and filing by Rite Aid of documents and reports required to be filed with the Commission.

89. By reason of the foregoing, the Defendants, singly or in concert, directly or indirectly, each have violated, and unless enjoined will again violate, Exchange Act Rule 13b2-2, 17 C.F.R. §240.13b2-2.

FOURTH CLAIM FOR RELIEF

Violations of Sections 13(a) of the Exchange Act,
15 U.S.C. §78m(a), and Rules 12b-20 and 13a-1,
Thereunder, 17 C.F.R. §§240.12b-20, 240.13a-1

(All Defendants as Controlling Persons of Rite Aid)
(Periodic Corporate Reporting Violations)

90. The Commission realleges and incorporates by reference paragraphs 1-89 as if fully set forth herein.

91. As a result of the conduct described in paragraphs 1-62 and 65-66, Rite Aid failed to file with the Commission, in accordance with the rules and regulations prescribed by the Commission, such annual reports on Form 10-K as the Commission has prescribed and Rite Aid failed to include, in addition to the information expressly required to be stated in such reports, such further material information as was necessary to make the statements made therein, in light of the circumstances in which they are made, not misleading, in violation of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-1, 17 C.F.R. §§240.12b-20 and 240.13a-1.

92. As described more specifically in paragraphs 13, 14.a, 14.c, 19-21, and 24, as part of and in furtherance of this violative conduct, Rite Aid filed with the Commission the FY 1998 Annual Report and the FY 1999 Annual Report, each containing financial statements that materially misrepresented Rite Aid's financial condition and results of operations for FY 1998 and FY 1999, and making other material misrepresentations and omissions. As a result, the FY 1998 Annual Report and the FY 1999 Annual Report were materially false and misleading.

93. As alleged in paragraph 11, at all relevant times each of the Defendants was a controlling person of Rite Aid for the purposes of Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a). Moreover, as alleged in paragraphs 70-71, 75, 76, and 77, and as described in the paragraphs referenced therein, the Defendants each participated in conduct that resulted in the falsity of Rite Aid's annual periodic reports, and, in so doing, did not act in good faith.

94. By reason of the foregoing, the Defendants each are liable as controlling persons pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for Rite Aid's violations of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-1 hereunder, 17 C.F.R. §§240.12b-20 and 240.13a-1, as alleged in paragraphs 91 and 92; and unless they are enjoined, the Defendants will again engage, as controlling persons, in conduct that would render them liable, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-1 thereunder, 17 C.F.R. §§240.12b-20, 240.13a-1, and 240.13a-13.

FIFTH CLAIM FOR RELIEF

Violations of Sections 13(a) of the Exchange Act,
15 U.S.C. §78m(a), and Rules 12b-20 and 13a-13,
Thereunder, 17 C.F.R. §§240.12b-20, 240.13a-13

(Defendant Bergonzi as Controlling Persons of Rite Aid)
(Quarterly Reporting Violations)

95. The Commission realleges and incorporates by reference paragraphs 1-94 as if fully set forth herein.

96. As a result of the conduct described in paragraphs 1-52 and 65-66, Rite Aid failed to file with the Commission, in accordance with the rules and regulations prescribed by the Commission, such quarterly reports on Form 10-Q as the Commission has prescribed and Rite Aid failed to include, in addition to the information expressly required to be stated in such reports, such further material information as was necessary to make the statements made therein, in light of the circumstances in which they are made, not misleading, in violation of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-13, 17 C.F.R. §§240.12b-20 and 240.13a-13.

97. As described more specifically in paragraphs 13, 14.b, 14.d, 14.e, 19-21, and 24, as part of and in furtherance of this violative conduct, Rite Aid filed with the Commission the FY 1998 Quarterly Reports, the FY 1999 Quarterly Reports, and the FY 2000 Quarterly Report, each containing financial statements that materially misrepresented Rite Aid's financial condition for the relevant quarterly periods, and making other material misrepresentations and omissions. As a result, the FY 1998 Quarterly Reports, the FY 1999 Quarterly Reports, and the FY 2000 Quarterly Report were materially false and misleading.

98. As alleged in paragraph 11, at all relevant times Bergonzi was a controlling person of Rite Aid for the purposes of Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a). Moreover, as alleged in paragraphs 72 and 76, and as described in the paragraphs referenced therein, Bergonzi participated in conduct that resulted in the falsity of Rite Aid's quarterly periodic reports, and, in so doing, did not act in good faith.

99. By reason of the foregoing, Bergonzi is liable as a controlling person pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for Rite Aid's violations, as alleged in paragraphs 96 and 97 above, of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-1 thereunder, 17 C.F.R. §§240.12b-20 and 240.13a-1; and unless he is enjoined, Bergonzi will again engage, as a controlling person, in conduct that would render him liable, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-1 thereunder, 17 C.F.R. §§240.12b-20 and 240.13a-13.

SIXTH CLAIM FOR RELIEF

Violations of Sections 13(a) of the Exchange Act,
15 U.S.C. §78m(a), and Rules 12b-20 and 13a-11,
Thereunder, 17 C.F.R. §§240.12b-20, 240.13a-11

(Defendants Grass and Brown as Controlling Persons of Rite Aid)
(Current Reporting Violations)

100. The Commission realleges and incorporates by reference paragraphs 1-99 as if fully set forth herein.

101. As a result of the conduct described in paragraphs 21 and 53-56, Rite Aid failed to file with the Commission, in accordance with the rules and regulations prescribed by the Commission, such current reports on Form 8-K as the Commission has prescribed and Rite Aid failed to include, in addition to the information expressly required to be stated in such reports, such further material information as was necessary to make the statements made therein, in light of the circumstances in which they are made, not misleading, in violation of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-11, 17 C.F.R. §§240.12b-20 and 240.13a-11.

102. As described in paragraphs 21 and 53-56, as part of and in furtherance of this violative conduct, Rite Aid filed with the Commission the February 1999 Form 8-K that purported to disclose all related party transactions involving Grass, but that in fact did not disclose such transactions either accurately or at all. As a result, the February 1999 Form 8-K was materially false and misleading.

103. As alleged in paragraph 11, at all relevant times Grass and Brown were controlling persons of Rite Aid for the purposes of Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a). Moreover, as alleged in paragraphs 21 and 53-56, Grass provided false or misleading information, and Grass and Brown failed to provide material information, to Rite Aid concerning Grass' related party transactions. Therefore, Grass and Brown participated in conduct that resulted in the falsity of Rite Aid's current report, and, in so doing, did not act in good faith.

104. By reason of the foregoing, Grass and Brown are liable as controlling persons pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for Rite Aid's violations, as alleged in paragraphs 101-102 above, of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-11 thereunder, 17 C.F.R. §§240.12b-20 and 240.13a-11; and unless they are enjoined, Grass and Brown will again engage, as controlling persons, in conduct that would render them liable, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Section 13(a) of the Exchange Act, 15 U.S.C. §78m(a), and Rules 12b-20 and 13a-11 thereunder, 17 C.F.R. §§240.12b-20 and 240.13a-11.

SEVENTH CLAIM FOR RELIEF

Violations of Section 14(a) of the Exchange Act,
15 U.S.C. §78n(a), and Rule 14a-9(a)
Thereunder, 17 C.F.R. §240.14a-9(a)

(Defendants Grass and Brown as Controlling Persons of Rite Aid)
(Proxy Statement Violations)

105. The Commission realleges and incorporates by reference paragraphs 1-104 as if fully set forth herein.

106. Rite Aid directly or indirectly solicited proxies for its annual meetings based on statements that, at the time and in light of the circumstances under which they were made, were false or misleading with respect to material facts, or which omitted to state material facts necessary in order to make the statements made therein not false or misleading, in violation of Section 14(a) of the Exchange Act, 15 U.S.C. §78n(a), and Rule 14a-9 (a) thereunder, 17 C.F.R. §240.14a-9(a).

107. As part of this violative conduct, and as described in paragraphs 21 and 53-56, Rite Aid's Proxy Statements contained a section titled "Related Party Transactions" that purported to set forth the material facts of all related party transactions, but in fact did not disclose such transactions either accurately or at all. These misrepresentations and omissions were material. As a result, the Proxy Statements were materially false and misleading.

108. As alleged in paragraph 11,Grass and Brown were controlling persons of Rite Aid. As alleged in paragraphs 21 and 53-56, Grass provided false or misleading information, and Grass and Brown failed to provide certain material information, to Rite Aid concerning Grass' related party transactions. Therefore, Grass and Brown participated in conduct that resulted in Rite Aid disseminating materially misleading Proxy Statements.

109. By reason of the foregoing, Grass and Brown are liable as controlling persons pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for Rite Aid's violations of Section 14(a) of the Exchange Act, 15 U.S.C. §78n(a), and Rule 14a-9(a) thereunder, 17 C.F.R. §§240.14a-9(a); and unless they are enjoined, Grass and Brown will again engage, as controlling persons, in conduct that would render them liable, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Section 14(a) of the Exchange Act, 15 U.S.C. §78n(a), and Rule 14a-9(a) thereunder, 17 C.F.R. §240.13a-11.

EIGHTH CLAIM FOR RELIEF

Violations of Section 13(b)(2) of the Exchange Act,
15 U.S.C. §78m(b)(2)

(All Defendants as Controlling Persons of Rite Aid)
(Corporate Record-keeping and Internal Controls Violations)

110. The Commission realleges and incorporates by reference herein paragraphs 1-110 as if fully set forth herein.

111. As described in paragraphs 22-52 and 63-66, and as a result of the conduct alleged thereto, Rite Aid failed to (a) make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflected the transactions and dispositions of its assets; and (b) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions were executed in accordance with management's general or specific authorization; (ii) transactions were recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and to maintain accountability for assets; (iii) access to assets was permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets was compared with the existing assets at reasonable intervals and appropriate action was taken with respect to any differences, in violation of Section 13(b)(2) of the Exchange Act, 15 U.S.C §78m(b)(2).

112. As alleged in paragraph 11, at all relevant times, each of the Defendants was a controlling person of Rite Aid for the purposes of Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a). Moreover, as alleged in paragraphs 65-66, 71-77, and 85-86, and as described in the paragraphs referenced therein, the Defendants each engaged in conduct that resulted in the falsity of Rite Aid's books, records, and accounts and they each failed to devise and maintain an adequate system of internal accounting controls; and, in so doing, they did not act in good faith.

113. By reason of the foregoing, the Defendants are each liable as controlling persons pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for Rite Aid's violations, as alleged in paragraph 111 above, of Section 13(b)(2) of the Exchange Act, 15 U.S.C §78m(b)(2); and unless they are enjoined, the Defendants will again engage, as controlling persons, in conduct that would render them liable, pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), for violations of Section 13(b)(2) of the Exchange Act, 15 U.S.C §78m(b)(2).

PRAYER FOR RELIEF

WHEREFORE, the Commission respectfully requests a Final Judgment:

I.

Permanently enjoining the Defendants, their agents, servants, employees and attorneys and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §77q(a), and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§78j(b), 78m(b)(5), and Rules 10b-5, 13b2-1, and 13b2-2 thereunder, 17 C.F.R. §§240.10b-5, 240.13b2-1, and 240.13b2-2.

II.

A. Permanently enjoining each of the Defendants, their agents, servants, employees and attorneys and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from engaging in conduct as controlling persons that would render them liable pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Sections 13(a) and 13(b)(2) of the Exchange Act, 15 U.S.C. §§78m(a), 78m(b)(2), and Exchange Act Rules 12b-20 and 13a-1, 17 C.F.R. §§240.12b-20 and 240.13a-1;

B. Permanently and permanently enjoining Bergonzi, his agents, servants, employees and attorneys and all persons in active concert or participation with him who receive actual notice of the injunction by personal service or otherwise, and each of them, from engaging in conduct as a controlling person that would render him liable pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Exchange Act Rule 13a-13, 17 C.F.R. §240.13a-13; and

C. Permanently enjoining Grass and Brown, their agents, servants, employees and attorneys and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from engaging in conduct as controlling persons that would render them liable pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. §78t(a), for violations of Sections 14(a) of the Exchange Act, 15 U.S.C. §78n(a) and Rule 13a-11 and 14a-9(a) thereunder, 17 C.F.R. §§240.14a-9(a) and 240.13a-11.

III.

Ordering the Defendants each to disgorge the ill-gotten gains he received as a result of his violations of the federal securities laws, plus prejudgment interest thereon.

IV.

Ordering the Defendants each to pay civil money penalties pursuant to Section 20(d)(2) of the Securities Act, 15 U.S.C. §77t(d)(2), and Section 21(d)(3)(B) of the Exchange Act, 15 U.S.C. §78u(d)(3)(B).

V.

Barring each of the Defendants, pursuant to Section 20(e) of the Securities Act, 15 U.S.C. §77t(e), and Section 21(d)(2) of the Exchange Act, 15 U.S.C. §78u(d)(2), from serving or acting as an officer or director of any issuer that has a class of securities registered under Section 12 of the Exchange Act, 15 U.S.C. §78l, or that is required to file reports pursuant to Section 15(d) of the Exchange Act, 15 U.S.C. §78o(d).

VI.

Granting such other and further relief as the Court may deem just and proper.

Dated: June 20, 2002

Respectfully submitted,

____________________________
WAYNE M. CARLIN (WC 2114)
Attorney for Plaintiff
SECURITIES AND EXCHANGE COMMISSION
Northeast Regional Office
233 Broadway
New York, New York 10279
(646) 428-1510

Of Counsel:

Edwin H. Nordlinger
Caren Nelson Pennington

Plaintiff's attorneys have filed a petition pursuant to LR 83.9.5 seeking special admission for Wayne M. Carlin, Esq. pursuant to LR 83.9.1 as an attorney for a government agency.

_______________________
1 Although Rite Aid's overstatement was enormous for this period, no specific numerical percentage can be defined because the corrected pre-tax figure showed a loss (a negative number) when the originally-reported figure showed a profit (a positive number).


http://www.sec.gov/litigation/complaints/complr17577.htm

Modified: 06/21/2002