U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19344 / August 23, 2005
Accounting and Auditing Enforcement
Release No. 2295 / August 23, 2005
Securities and Exchange Commission v. Charles C. Conaway and John T. McDonald, Jr., 05 Civ. 40263 (P. Gadola, J.) (E.D. Michigan, filed August 23, 2005)
SEC Charges Kmart's Former CEO and CFO with Financial Fraud
The Securities and Exchange Commission today filed charges against two former top Kmart executives for misleading investors about Kmart's financial condition in the months preceding the company's bankruptcy. According to the Commission's complaint, former Chief Executive Officer Charles C. Conaway and former Chief Financial Officer John T. McDonald are 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 Commission alleges that, in the MD&A section, Conaway and 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 alleges 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, which was filed in the United States District Court for the Eastern District of Michigan, charges 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.
The Commission acknowledges the assistance of the United States Attorney's Office for the Eastern District of Michigan and the Federal Bureau of Investigation.
The SEC's Kmart investigation is continuing.
SEC Complaint in this matter