UNITED STATES OF AMERICA
In the Matter of
STEVEN L. MORTENSEN,
|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
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 Steven L. Mortensen ("Mortensen" or "Respondent").
In anticipation of the institution of these proceedings, Respondent 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 Respondent and the subject matter of these proceedings, which are admitted, Respondent 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.
On the basis of this Order and Respondent's Offer, the Commission finds1 that
Mortensen, 41, was director of accounting at Ralphs Grocery Company ("Ralphs") from 1996 until June 1998 and reported to the controller of Ralphs. In June 1998, he was promoted to vice president of finance and controller of Ralphs and through early 1999 continued to report to the former controller who had been promoted to Chief Accounting Officer. Mortensen continued to hold the position of vice president of finance and controller until December 1999, when he left Ralphs. During the period Mortensen served as controller, Ralphs was a division of a publicly-held retail firm. Mortensen left Ralphs to become a senior vice president and CFO of another supermarket chain. Currently Mortensen is CFO of a private company, which previously was a shareholder of Ralphs. Mortensen has a MS degree in accounting, but he has no professional license or certification.
Ralphs, a Delaware corporation with its principal executive offices in Compton, California, operates retail grocery stores in southern California as a division of The Kroger Company ("Kroger"). Prior to its acquisition by Kroger, Ralphs was a subsidiary of Food 4 Less Holdings, Inc. ("Food 4 Less") and Fred Meyer, Inc. ("Fred Meyer"). From at least 1997 through October 28, 1998, when Ralphs' separate reporting obligations ceased, Ralphs issued publicly traded debt and filed periodic reports with the Commission. Ralphs fiscal year ended January 28.
Food 4 Less, was a Delaware corporation that served as a holding company for Ralphs. As discussed below, Fred Meyer and Kroger acquired Ralphs and Food 4 Less. From at least 1997 through June 1, 1998, when its separate reporting obligations ceased, Food 4 Less issued publicly traded debt and filed periodic reports with the Commission.
Fred Meyer, a food, drug and jewelry retailer in the western United States, is a Delaware corporation with its principal executive offices in Portland, Oregon. In March 1998, Fred Meyer acquired Food 4 Less including Ralphs. From at least 1997 through June 8, 1999, when Fred Meyer's separate reporting obligations ceased, its common stock was registered with the Commission pursuant to Section 12(b) of the Exchange Act and traded on the New York Stock Exchange.
Kroger, an Ohio corporation with its principal executive offices in Cincinnati, Ohio, operates retail grocery stores, food manufacturing facilities, convenience stores, and jewelry stores under its own name and through subsidiaries. In May 1999, Kroger acquired Fred Meyer, including Food 4 Less and Ralphs. Kroger's common stock is registered pursuant to Section 12(b) of the Exchange Act and trades on the New York Stock Exchange.
Ralphs operates retail grocery stores in southern California. In March 1998, Fred Meyer acquired Ralphs and its parent Food 4 Less. At that time, Mortensen was Director of Accounting, and reported to Ralphs' controller. In June 1998, Ralphs promoted Mortensen to Vice President of Finance and controller. In May 1999, Kroger acquired Fred Meyer, Food 4 Less, and Ralphs. In December 1999, Mortensen left Ralphs.
In the fall of 2000, approximately sixteen months after the acquisition, Kroger's internal auditors confirmed the existence of seven general liability accounts on Ralphs' general ledger that were used for general and unspecified purposes (the "General Liability Accounts"). These General Liability Accounts contained insufficiently supported entries. Kroger engaged outside professionals to investigate the activity in the General Liability Accounts.
On March 5, 2001, Kroger announced that as a result of its investigation it would restate earnings for fiscal years 1998, 1999, and the first two quarters of 2000 to conform with generally accepted accounting principals (GAAP). In a press release dated March 5, 2001, Kroger stated that Ralphs had engaged in certain improper accounting practices that began more than one year before Fred Meyer acquired Ralphs.
Kroger also announced specific adjustments to its financial statements. These adjustments restated amounts that had been improperly placed in the seven General Liability Accounts, and corrected the reduction of the General Liability Accounts in later periods. It affected Kroger's net income, earnings per share, and assets, and liabilities as follows:
|1998||1999||Q1 2000||Q2 2000|
|Net Income ($ millions||10||(14)||(7)||(8)|
|Basic Earnings per Share ($)||.01||(.02)||(.01)||(.01)|
Total Assets ($ millions)
|Total Liabilities ($ millions)||(42)||(31)||NP||NP|
As evidence of the effect on Kroger of the restatement, in its press release on March 5, 2001, Kroger disclosed the following changes to its prior financial statements:
|1998*||$ 0.58||$ 0.59|
|Q1, 1999||$ 0.24||$ 0.25|
|Q2, 1999||$ 0.06||$ 0.06|
|Q3, 1999||$ 0.15||$ 0.15|
|Q4, 1999||$ 0.29||$ 0.27|
|1999||$ 0.74||$ 0.73|
|Q1, 2000||$ 0.12||$ 0.12|
|Q2, 2000||$ 0.26||$ 0.25|
Kroger's adjustments also affected the fiscal year 1998 pre-tax income of Fred Meyer. In that year, the adjustments, on balance, released amounts from the General Liability Accounts that had the effect of increasing Fred Meyer's reported income (before income taxes, extraordinary items, and adjustments for GAAP changes) by $16.36 million or 8.9 percent.
For Ralphs' fiscal year 1998, Ralphs misstated its earnings. Ralphs placed excess income in the General Liability Accounts on its balance sheet instead of recognizing the income immediately through its income statement in conformity with GAAP. When an accounts receivable employee at Ralphs received an atypical, or non-recurring, check or other income receipt, Ralphs, on occasion, recorded that item in one of the General Liability Accounts that functioned without proper documentation or accounting basis as reserve accounts. Ralphs also inflated certain expenses and correspondingly built up the General Liability Accounts. Then, from time to time, Ralphs transferred amounts from the General Liability Accounts into income without proper documentation or accounting basis.
Ralphs also placed excess expense accruals in the General Liability Accounts. By the end of a period, if operating expenses reported to the accounting department (such as repairs, maintenance, and supplies) lagged behind forecasted expenses, Ralphs booked additional, estimated expenses, often conforming expenses to forecast. At period end, Ralphs transferred the amount of expenses, as adjusted, into one of the General Liability Accounts, such as account number 239133 (Other Liabilities).
In 1999, Ralphs significantly under-accrued for self-insurance and certain other expenses. In early 2000, in connection with the fiscal 1999 year-end closing, Ralphs transferred large amounts from the General Liability Accounts to meet those expenses, including $6.2 million transferred in accounting period 4 of 2000 from Account Number 239189 "Other Clearing."
In addition, Ralphs had obtained more revenue than it needed to meet its fiscal year 1999 goal. Ralphs placed the extra funds in the General Liability Accounts. In March 2000, Ralphs transferred $2,100,000 of these amounts to a grocery department income account by debiting the General Liability Accounts for $2,100,000 and crediting the money to a grocery department account.
At the end of each quarter, including year-end, Ralphs used journal entries to transfer substantial portions of the balances of the General Liability Accounts to other liability accounts. At the beginning of the next period, Ralphs automatically reversed these journal entries and restored the pre-existing balances to the General Liability Accounts. This process had the effect of reducing the balances in the General Liability Accounts at quarter end.
For the period 1997 to 1999, each of Ralphs' successive controllers made these reversing journal entries at quarter end on Ralphs' general ledger. In fact, no one other than the controller or his assistant made these adjustments to the trial balance at the end of the quarters. Ralphs continued to make unsupported adjustments, including reversing journal entries, at the end of each quarterly period for each of the three years.
Respondent served as controller of Ralphs. He generated or directed the generation of journal entries that booked income receipts into the General Liability Accounts. Respondent also created or approved journal entries that subsequently transferred amounts from the General Liability Accounts into income accounts. He also used automatic reversing entries at quarter end to disperse portions of the balances of the General Liability Accounts to other accounts. These dispersals had the effect of reducing the balances in the General Liability Accounts at quarter end below audit thresholds. As a result, Respondent circumvented the internal controls that then existed at Ralphs.
As a result of the conduct described above, Respondent Stork committed violations of Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 thereunder.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions specified in Respondent's Offer.
Accordingly, it is hereby ORDERED that:
Respondent Stork cease and desist from committing or causing any violations and any future violations of Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 thereunder.
By the Commission.
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