Kmart says it found evidence of mismanagement by ex-managers

Alexandra R. Moses

Monday, Jan. 27, 2003 | 9:34 a.m.

DETROIT -- One year after filing the largest retail bankruptcy, Kmart Corp. revealed Friday that a months-long internal review showed that some former managers violated their responsibilities to the company.

Kmart filed a disclosure statement Friday with the federal bankruptcy court in Chicago that included details of its investigation into the company's accounting practices and former management.

Among the items under scrutiny were $28.8 million in retention loans given to 25 top executives and the use of the company's fleet of jets by executives. Kmart also is under investigation by the Securities and Exchange Commission and the FBI.

"We have made information public today that there is credible and persuasive evidence demonstrating that certain former managers of Kmart violated their stewardship responsibility to Kmart, its employees and stakeholders," Julian Day, Kmart's chief executive and president, said in a statement.

According to Kmart's filing, in the summer of 2001 a former senior executive directed initiatives that resulted in $850 million in excessive inventory purchases without sufficient analysis or oversight. The filing says the purchases "significantly contributed" to Kmart's liquidity crisis in the fall of 2001.

Other findings detailed in the filing:

--In 2000-2001, former management hired many people without completing formal applications or proper interviews, and some dictated the terms and compensation packages offered to the new employees without consulting human resources.

--Former management in 2001 authorized spending $12 million to buy corporate aircraft -- money that wasn't included in the company's capital budget. Some former executives also abused an "already generous" corporate aircraft policy by "masking personal travel as store visits."

Day also announced "for cause" terminations of 10 former managers and the establishment of a creditors' litigation trust to allow for legal action related to the investigation. A week ago, Kmart fired the five remaining executives who received retention loans just months before the retailer filed for bankruptcy protection.

Kmart launched a review of its accounting practices last year, after receiving anonymous letters claiming to be from employees. In May, Kmart said it also was investigating the way the company was managed under former chief executive Charles Conaway, who left last March amid sweeping management changes. He gave a two-day deposition on Wednesday and Thursday.

Nineteen other executives and three third-party witnesses also were deposed as part of the investigation.

One two-page anonymous letter alleged that senior Kmart officials purposely violated standard accounting principles. It also charged that independent auditors from PricewaterhouseCoopers LLC knew about the irregularities but didn't question them.

The company's president and chief operating officer, Mark S. Schwartz, and chief financial officer John T. McDonald, Jr., were among the top executives who left Kmart in January shortly before the filing.

Kmart has subpoenaed an undisclosed number of its former employees, interviewed former executives and scoured corporate flight and expense records. Kmart's lawyers also have met with people including private investigators, an FBI agent and a sergeant with the Oakland County Sheriff's Department.

Kmart has conducted more than 570 interviews of current and former employees and has reviewed more than 1.5 million pages, including accounting records, audits, and e-mails, according to its investigation report. The company also has processed more than 620,000 pages of documents in response to subpoenas and requests including those from the SEC and Congress.

The company says it believes its investigation is complete, except for a few remaining depositions.