Royal Ahold acquires US Foodservice for $3.6B in April 2000 Fraud revealed in February 2003 Players: Mark Kaiser and Timothy Lee Scheme: Exploit lack of controls to over-accrue for vendor rebates Results: Overstatement of acquisition balances $90M, 2000 earnings $110M, 2001 earnings $260M, 2002 earnings $510M Overview
Aftermath Fired – Mark Kaiser, Chief Marketing Officer Fired – Timothy Lee, Exec. VP Purchasing Resigned – James Miller, CEO Resigned – Cees van der Hoeven, Ahold CEO Resigned – Michael Meurs, Ahold CFO Stock drops 61% on 2/24, 17% on 2/25 Earnings overstated $880M, Pre-Tax Charge $1B ''It is a very disappointing result,'' said Dudley Eustace, Royal Ahold's interim chief financial officer
How Was It Detected? ConAgra Late January/Early Feburary, accounting dept found unqualified sales representatives verifying inaccurate US Foodservice rebates Alerted US Foodservice and Deloitte & Touche Ahold Internal Investigation Discovered irregularities in February Deloitte & Touche Discovered irregularities during its 2002 audit Gave Ahold a clean bill of health in 2001 (~$250M in fraud)
Cause 1: Company Culture Acquisition Race CEO, Hoeven, spent $19 billion over 10 yrs to buy companies in 30 countries Opening balances at the US Foodservice was reduced by $90 million due to the fraud Due diligence conducted by Merril Lynch and Ahold Pressure to Increase Profit “go-go” atmosphere gone too far
Cause 2: Personal Gain Inflate earnings to increase bonuses Sales representatives at suppliers may have been paid off
Cause 3: Shady Industry Practice Lack of Transparency Improper acceleration of revenue recognition Rebates for volume/time/shelf-space sales False inflation of retailer's profits Explains the magnitude and the duration of the fraud
Cause 4: Weak Control Mechanism At acquisition, US Foodservice warned Ahold that internal control systems on promotional allowances were “not good at all” Efforts were made to improve control systems but no significant improvements
Due Diligence & The Issue of Fraud The Financial Times, dated 5/9/03, reported that Dudley Eustace, Ahold then interim CFO, commented that “the fraud should have been detected during the process of due diligence.” Eustace further comments that “The company [Ahold] has been flying blind with inadequate control systems. Once you added collusion to create fraud, you had a recipe for disaster.” “When you are doing due diligence, you are not looking for fraud.”
If Conducting Due Diligence, Then Questions To Be Asked Consist Of… What is the company’s current policy for tracking and accruing for rebates receivable? Are rebates receivable currently tracked or estimated? How does your company currently ensure that rebates receivable are monitored by the internal audit function for adequacy? What are the current procedures for approving rebate programs?
Financial Statement Analysis Examine & compare the ratio of rebate income to gross sales to previous year and budget Examine & compare the ratio of gross sales to rebates receivable to previous year and budget
In General, Questions To Consider Company receive rebates from vendors? If so, in what capacity? Vendor rebates based on complex & opaque formulas linked to specified volume targets? Company accrue for rebates receivable? An unexplained increase in rebate income? Rebate income increased as a percentage of gross sales? Rebates receivable increased as a percentage of gross sales?