Phar-Mor, Inc.: Accounting Fraud, Litigation, and Auditor Liability Mark S. Beasley, Frank A. Buckless, Steven M. Glover, Douglas F. Prawitt LEARNING OBJECTIVES
After completing and discussing this case, you should be able to
Identify factors contributing to an environment conducive to accounting fraud . Understand what factors may inappropriately influence the client-auditor relationship and auditor independence Understand auditor legal liability issues related to suits brought by plaintiffs under both statutory and COmmonlaw
In December 1995, the flamboyant entrepreneur Michael "Mickey" Monus, formerly president and chief operating officer (COO) of the deep-discount retail chain PharMor, Inc., was sentenced to 19 years and seven months in prison. Monus was convicted for the accounting fraud that inflated Phar-Mor's shareholder equity by $500 million, resulted in over $1 billion in losses, and caused the bankruptcy of the twenty-eighth largest private company in the United States. The massive accounting fraud went largely undetected for nearly six years. Several members of top management confessed to, and were convicted of, financial-statement fraud. Former members of Phar-Mor management were collectively fined over $1 million, and two former Phar-Mor management employees received prison sentences. Phar-Mor's management, as well as Phar-Mor creditors and investors subsequently brought suit against Phar-Mor's independent auditors, Coopers & Lybrand LLP (Coopers), alleging Coopers was reckless in performing its audits. At the time the suits were The case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. and Douglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of an administrative situation. Copyright @ 2003 by Pearson Education, Inc., Upper Saddle River, NJ 07458. 25
Beasley / Buckless / Glover / Prawitt
filed, Coopers faced claims in excess of $1 bi11ion. Eve~ though there were never a11egations that the auditors knowingly participated in the Phar-Mor fraud, on February 14, 1996, a jury found Coopers liable under both state and federal laws. Ultimately, Coopers settled the claims for an undisclosed amount.
Between 1985 and 1992, Phar-Mor grew from 15 stores to 310 stores in 32 states, posting sales of more than $3 bi11ion.By seemingly a11standards, Phar-Mor was a rising star touted by some retail experts as the next Wal-Mart. In fact, Sam Walton once announced that the only company he feared at a11in the expansion ofWal-Mart was Phar-Mor. Mickey Monus, Phar-Mor's president, COO and founder, was a local hero in his hometown of Youngstown, Ohio. As demonstration of his loyalty, Monus put Phar-Mor's headquarters in a deserted department store in downtown Youngstown. Monus-known as shy and introverted to friends, cold and aloof to others-became quite flashy as Phar-Mor grew. Before the fa11of his Phar-Mor empire, Monus was known for buying his friends expensive gifts and he was building an extravagant personal residence, complete with an indoor basketba11court. He was also an initial equity investor in the Colorado Rockies major league baseba11 franchise. This affiliation with the Colorado Rockies and other high profile sporting events sponsored by Phar-Mor fed Monus' love for the high life and fast action. He frequently flew to Las Vegas, where a suite was always available for him at Caesar's Palace. Mickey would often impress his traveling companions by giving them thousands of do11arsto gamble. Phar-Mor was a deep-discount retail chain se11inga variety of household products and prescription drugs at substantia11ylower prices than other discount stores. The key to the low prices was "power buying," the phrase Monus used to describe his strategy of loading up on...