|Case 4.6 | |Instructional Notes | | | |Phar-Mor, Inc.: | |Accounting Fraud, Litigation, | |and Auditor Liability | | | |Mark S. Beasley, Frank A. Buckless, | |Steven M. Glover, Douglas F. Prawitt | |( |
• To illustrate the degree of legal exposure professional accountants face. • To define auditors’ legal liability under common and statutory law. • To demonstrate that massive fraud typically involves collusion of a number of individuals in the management team. Further, those involved in the fraud will go to extreme lengths to fool the auditors only to later attempt to use their independent auditors as scapegoats when material errors or irregularities are discovered. • To illustrate the potential independence problems that can arise when a client generates large audit and other service revenue. • To illustrate the importance of maintaining a healthy degree of professional skepticism during all audit engagements. • To illustrate the need for auditors to identify key red flags by conducting “smell tests” both on their client’s financial statements and top management’s personal integrity.
Phar-Mor had grown from 1 store in 1982 to 310 stores in 1992, with sales exceeding $3 billion. • The deep discount drug store retail business is extremely competitive. • Mickey Monus was found guilty in December 1995 of embezzling more than $10 million and sentenced to nearly 20 years in prison. • Nearly $1.14 billion were invested in this privately-held company by Westinghouse Credit Corp., Sears Roebuck & Co., Edward J. de Bartolo, and Lazard Freres & Co. Corporate Partners Investment Fund, among others. • Monus was an original equity investor in the Colorado Rockies baseball franchise. Although not discussed in the students’ case he was also the founder of the World Basketball League, a league for players 6’ 5’’ and under, and continued to financially (sometimes with Phar-Mor funds) to support franchises that were losing money until the WBL’s demise. It was noted later only a man who was supremely confident (or arrogant) would dare take on the NBA. • Monus and his CFO, Patrick Finn, manipulated income statement accounts, overstated inventory, and manipulated accounting rules in order to carry off this fraud for nearly six years. • The total loss to investors and creditors reached over $1.1 billion, making it one of the largest corporate frauds in U.S. history. • The fraud was facilitated by many factors, including lack of adequate MIS, poor internal controls, the CFO’s hands-off style, inadequate internal auditing, collusion among upper management, and the existence of related parties. • The fraud was discovered when a travel agent received a check from Phar-Mor for WBL expenses...
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