Updated from 9:33 a.m. EST
said Friday it was cooperating with the
Securities and Exchange Commission
after the company received an anonymous letter questioning its accounting.
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The SEC has told Kmart it will be requesting documents, according to Jack Ferry, a Kmart spokesman. "The letter suggested the company may want to look into some accounting matters," Ferry says. "It doesn't really contain any specifics."
News of the regulatory probe comes just as accounting and corporate disclosure have become hot-button words on Wall Street and beyond. In the wake of the
saga, in which a huge, supposedly highly profitable company collapsed with little apparent warning, investors are highly sensitive to any whiff of scandal involving a public company's books. Heightening the drama, Congress is investigating the actions of Enron executives and employees as well as those of its outside auditors. Shares in Kmart, which earlier this week became the biggest retailer ever to seek Chapter 11 protection, dropped 7 cents to 86 cents in NYSE trading.
Kmart said that upon receiving the letter, which expresses "concern regarding unspecified accounting matters," it hired an outside lawyer and accounting consultants to conduct an investigation. The company also said it "contacted the SEC, which has subsequently authorized a private investigation."
Kmart said it would cooperate with the SEC. As a matter of policy the SEC doesn't discuss cases it may or may not be investigating, an agency spokesman says.
Kmart didn't say when it received the letter, which "purports to come from employees of the company" and was addressed to its board, its auditors and the SEC. Kmart's auditor, PriceWaterhouseCoopers LLC, didn't immediately return a call seeking comment.
The head of Kmart's audit committee, James Adamson, couldn't be reached for comment Friday. A call to the company requesting an interview with Adamson wasn't immediately returned. Audit committees are designed to oversee the participation of management and auditors in the financial reporting process.
How It Works
According to one attorney whose firm is in competition to represent Kmart's creditors in the bankruptcy proceedings, accounting investigations are typically handled "in the context of the bankruptcy process."
"If there is any truth to it, one of the remedies under Chapter 11 is for the judge to appoint an examiner," says Gerry Munitz, a lawyer with the Chicago law firm Goldberg Kohn Bell Black Rosenbloom & Moritz. "It is a frequently used remedy."
However, Jack Ferry, the Kmart spokesman, says, "my knowledge is this is separate from the bankruptcy process."
Kmart filed for Chapter 11 protection Tuesday, after a poor holiday selling season punished its already weak cash flows, impairing its ability to service its mountainous $4.7 billion in debt. The company's stock had plunged in the New Year as investors began to speculate that the Troy, Mich., discount retailer wouldn't be able to continue without reorganizing.
Why It Matters
Kmart's is the second-largest U.S. bankruptcy filing ever, after Enron's. Enron filed for protection from creditors Dec. 2 after investors lost faith in the company's financial statements, effectively shutting off funding for its cash-hungry core trading operation. A notable turning point in the scandal surrounding Enron came when Sherron Watkins, an Enron vice president, wrote a letter to then-CEO Ken Lay questioning whether the company's accounting was proper. Watkins initially made her comments anonymously but later identified herself to top management. Lay maintained that the company's accounting was indeed proper, but abundant evidence has suggested otherwise, as
Peter Eavis has written.
Besides Enron, questions about corporate responsibility have recently arisen in the case of biotech firm
, which critics have accused of misleading investors about the prospects for its lead cancer drug. On Friday, ImClone said it has
received an inquiry from the Justice Department, bringing to three the number of federal agencies that are believed to be probing the firm.
To be sure, there has been no indication of any wrongdoing on the part of Kmart regarding its accounting. And while the anonymous letter offers a striking parallel with the Enron case, in many ways the Kmart situation lacks many of the ingredients that has made Enron's plunge into bankruptcy such a high-profile disaster.
For one, Enron stock was long a highflying Wall Street favorite. Dozens of shareholder lawsuits have been filed alleging that Enron executives knowingly falsified the company's financial statements in order to boost its stock price, allowing the executives to profit by selling their own stock. Enron was valued at more than $80 billion at its peak barely more than a year ago.
By contrast, Kmart stock has long underperformed the market; Kmart shares haven't surpassed $25 since the early 1990s and have dropped more than 90% since they hit a 52-week high in August. The relative torpor of its stock seems to reduce the prospect that executives were getting rich by cashing out scads of stock options while investors sat in the dark, assuming all was well. A look at insider stock transactions at Kmart shows none of the company's top executives sold any stock in 2001.
The Cost Question
Moreover, long before the company collapsed, Enron's accounting was a matter of some speculation among short-sellers, who seek to profit from a stock's fall. Even at the height of its popularity it was widely agreed that Enron's financial statements were at best incomprehensible and and at worst significantly misleading. The most skeptical investors, such as the short-sellers, long believed that Enron was hiding something from Wall Street; those fears were only heightened when the company began disclosing the existence of off-balance sheet transactions that served to make Enron's finances look healthier than they were.
Short-sellers of Kmart stock, on the other hand, tended to focus on more mundane concerns, such as the persistent advances of discounting rivals
, the company's massive $4.7 billion debt load and its sharply deteriorating cash flows. Indeed, it was the cash-flow shortage that eventually forced Kmart into bankruptcy -- but no one on Wall Street believed that the company was hiding anything.
"I don't think the short story with Kmart was ever an accounting problem," says one hedge fund manager. "The cost structure at Kmart was 20% of sales, while at Wal-Mart it is 5% to 10% less. What more do you need to know?"
Still, in the wake of the Enron fiasco, in which shareholders and employees lost a fortune while top executives cashed out stock options to the tune of millions of dollars, investors have become far more sensitive to accounting questions than they ever were before. The question of auditor independence, too, has come to the fore in the wake of Enron's travails and the performance of its auditor, Arthur Andersen.
And while there hasn't been a scintilla of doubt about the work that auditor PriceWaterhouseCoopers has done for Kmart, skeptics will surely note that Kmart's 2001 annual report lists $12.8 million in fees for PWC. Only $1.1 million, or 9% of that figure, covers the audit itself.