U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 21065 / June 1, 2009
Securities and Exchange Commission v. Charles C. Conaway and John T. McDonald, Jr., 05 Civ. 40263 (E.D. Michigan, filed August 23, 2005)
Jury Trial Results in Verdict for SEC and Against Former CEO Of Kmart; Former CFO Settles Prior to Trial
The Securities and Exchange Commission announced today that on June 1, 2009, a jury returned a verdict in its favor on all charges against Charles C. Conaway, the former Chief Executive Officer of Kmart Corporation. Conaway was charged with misleading investors about Kmart's financial condition in the months preceding the company's bankruptcy. According to the Commission's complaint, Conaway was responsible for material misrepresentations and omissions about the company's liquidity and related matters in the Management's Discussion and Analysis ("MD&A") section of Kmart's Form 10-Q for the third quarter and nine months ended October 31, 2001, and in an earnings conference call with analysts and investors. The verdict followed a three-week trial in Ann Arbor, Michigan, before Magistrate Judge Steven D. Pepe of the United States District Court for the Eastern District of Michigan.
The Commission alleged that, in the MD&A section, Conaway and Kmart's former Chief Financial Officer, John T. McDonald, failed to disclose the reasons for a massive inventory overbuy in the summer of 2001 and the impact it had on the company's liquidity. For example, the MD&A disclosure attributed increases in inventory to "seasonal inventory fluctuations and actions taken to improve our overall in-stock position." The Commission alleged that this disclosure was materially misleading because, in reality, a significant portion of the inventory buildup was caused by a Kmart officer's reckless and unilateral purchase of $850 million of excess inventory. According to the complaint, the defendants dealt with Kmart's liquidity problems by slowing down payments owed vendors, thereby effectively borrowing $570 million from them by the end of the third quarter. According to the complaint, Conaway and McDonald lied about why vendors were not being paid on time and misrepresented the impact that Kmart's liquidity problems had on the company's relationship with its vendors, many of whom stopped shipping product to Kmart during the fall of 2001. Kmart filed for bankruptcy on January 22, 2002.
The Commission's complaint charged Conaway and McDonald with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and aiding and abetting violations of Sections 10(b) and 13(a) of the Exchange Act and Rules 10b-5, 13a-13, and 12b-20 thereunder by Kmart, and seeks as relief permanent injunctions, disgorgement with prejudgment interest, civil penalties and officer and director bars. McDonald agreed to settle shortly before trial. Without admitting or denying the Commission's allegations, McDonald consented to a permanent injunction prohibiting further violations of those provisions of the federal securities laws, a five (5) year officer and director bar and $120,000 civil penalty and to an administrative order suspending his privilege to appear and practice before the Commission as an accountant for three (3) years. The court will determine the appropriate remedies against Conaway at a later date.