Last week, the Securities and Exchange Commission (SEC) announced that Kmart Corporation's former Chief Executive Officer, Charles C. Conaway, has been ordered to pay in excess of $10 million in disgorgement, prejudgment interest and civil penalties.
This matter dates back to August 2005, when the SEC filed an action against Mr. Conaway, alleging that prior to the company's bankruptcy, he misled investors with regard to Kmart's financial condition.
In June 2009, after a three-week trial held in the United States District Court for the Eastern District of Michigan, the jury returned a verdict in favor of the SEC. The SEC had alleged that Mr. Conaway engaged in material misrepresentations and omissions with regard to the liquidity of the company. Specifically, he was alleged to have been responsible for making these misrepresentations 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 SEC had argued in the case that Mr. Conaway, along with Kmart's former Chief Financial Officer, John T. McDonald, failed to disclose why the company had engaged in a huge overbuy in 2001 and how that had impacted the company's liquidity. The jury agreed with the SEC's allegation that the MD&A disclosure misstated the reasons for this inventory build-up. The company claimed this was due to "seasonal inventory fluctuations and actions taken to improve our overall in-stock position." The SEC's position was that this was materially misleading since the actual reason for much of this inventory mess was due to "reckless and unilateral purchase of $850 million of excess inventory."
After this occurred the company began to pull back on timely payments to vendors and by the end of the third quarter 2001, in essence had borrowed $570 from its vendors in slow payments. Then the executives misrepresented the reasons behind the failure to pay vendors and its impact on liquidity. Many vendors stopped shipping products to the company in late 2001 and the company filed for bankruptcy in January 2002.
The court's order will require Conaway to pay disgorgement in the amount of $5,000,000, prejudgment interest of $2,853,432 and a civil penalty of $2,500,000. Additional specifics are currently being negotiated by the parties with regard to the handling of a stay, pending the appeal of this matter.
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