(The news featured below is a selection from the news covered in Federal Securities Law Reporter, which is distributed to subscribers of Federal Securities Law Reporter.)

Senior Kmart Executives Charged with Fraud

The SEC filed charges in the United States District Court for the Eastern District of Michigan against two former top Kmart executives. The complaint alleged that the officers misled investors about Kmart's financial condition in the months preceding the company's bankruptcy. According to the Commission's complaint, former Chief Executive Officer Charles C. Conaway and former Chief Financial Officer John T. McDonald were responsible for materially false and misleading disclosure about the company's liquidity and related matters in the management's discussion and analysis section of an SEC filing and in an earnings conference call with analysts and investors.

Linda Chatman Thomsen, director of the Division of Enforcement, said that "the SEC has repeatedly emphasized the important role MD&A disclosure is intended to play in giving shareholders the ability to examine a corporation "through the eyes of management," and Kmart senior management deprived its shareholders of that opportunity." Peter H. Bresnan, an associate director in the Division of Enforcement, stated that "investors are entitled to both accurate financial data and an accurate description of the story behind the numbers." He added that "Kmart's senior management failed to honestly inform investors that Kmart faced a liquidity crisis in the third quarter of 2001, how the company's own ill-advised action had caused the problem and what steps management took to respond to it."

The SEC alleged that, in the MD&A section of a Form 10-Q, the senior officers failed to disclose the reasons for a massive inventory overbuy in 2001 and the impact it had on the company's liquidity. For example, the MD&A disclosure attributed increases in inventory to "seasonal inventory fluctuations and actions taken to improve our overall in-stock position." The Commission alleged, however, that this disclosure was materially misleading because, in reality, a significant portion of the inventory buildup was caused by a Kmart officer's purchase, described by the SEC as "reckless and unilateral," of $850 million of excess inventory.

The complaint stated that the defendants dealt with Kmart's liquidity problems by slowing down payments owed vendors, thereby withholding $570 million from them by the end of the third quarter. According to the complaint, the officers misrepresented the reasons why vendors were not being paid on time and the impact that Kmart's liquidity problems had on the company's relationship with its vendors.