Leslie Fay Companies was a clothing conglomerate that produced lines of women's clothing and lingerie under the brand names Leslie Fay, Joan Leslie, Albert Nipon, Theo Miles, Kasper, Le Suit, Nolan Miller, Castleberry, and Castlebrook. In early 1993, it was discovered that senior Leslie Fay executives, in an effort to inflate profits and to mask an actual loss of $13.7 million, had perpetrated an

Question

accounting fraud. Paul Polishan, Leslie Fay's chief operating officer, was placed on leave without pay in January 1993, along with Donald F. Kenia, the corporate controller. Mr. Kenia had first alerted the company to the accounting manipulations and worked with auditors to untangle the books. By April 1993, Leslie Fay, under intense pressure from creditors, filed for Chapter 11 bankruptcy (reorganization) in Manhattan. Both Mr. Polishan and Mr. Kenia were fired. Mr. Kenia, charged with two counts of filing false statements with the SEC, has entered into a plea bargain with the U.S. Attorney in exchange for his cooperation in the continuing investigation of the Leslie Fay accounting improprieties. Also in April 1993, two new outside directors were named to the Leslie Fay board. The audit committee of the board discovered, through continuing investigation, that accounting irregularities had inflated the company's profits for at least five quarters beginning in the fall of 1990. As Leslie Fay continued its climb from bankruptcy, it was discovered that its law firm, Weil Gotshall & Manges, had failed to disclose its close ties to two board audit committee members. A federal bankruptcy judge ordered the law firm to pay fines totaling $800,000, which was the cost of having an independent review of the law firm's representation and conduct in the case. In March 1995, Leslie Fay placed its flagship dress and retail business up for sale and offered its CEO a success fee of $1.5 million if those businesses were sold. Also in March 1995, a report detailing accounting improprieties was released by the audit committee of the Leslie Fay board. The board found that when executives realized they would not meet pre-established goals, they would ship goods out to a Wilkes-Barre, Pennsylvania, facility to inflate sales. The executives also forged inventory tags, multiplied the value of inventory, developed phantom inventory and altered records to meet sales target. Some goods were invoiced to be shipped in the final day of a quarter even though they were not actually shipped until the next quarter. Numerous shareholders have filed suit against the Leslie Fay board and BDO Seidman, the company's auditor during this period. John Pomerantz continued as CEO from 1993 onward. The company has tried to find a buyer but has remained unsuccessful in doing so.
a. What signals about the importance of earnings at Leslie Fay were sent to the officers who committed the accounting improprieties?
b. Wouldn't employees have been aware of the financial fraud? Why didn't they speak up? Why didn't they tell someone?
c. How might Leslie Fay have prevented what happened?
d. If you were the new chief financial officer, what message would you most want to impress upon all Leslie Fay employees?
e. Of what significance are the law firm's ties to the board's audit committee members? Did these ties set a poor tone at the top?

Answer 1

a. The pressure to make quarterly earnings was so intense that the officers were willing to engage in deception, fabrication, shifting of sales, etc. to meet the earnings figures.

b. Employees may very well have been aware of the fraud, but with an ethical culture in which the officers were involved, it wouldn't have done any good to speak up. In a culture such as this one, employees would be afraid to bring such matters to anyone's attention.

c. Changing the signals to officers would have helped. The intense focus on earnings and pressure to meet goals set the stage for the deception.

d. The message would be:

Earnings the Right Way
Earnings Through Sales and Satisfaction
Integrity Without Compromise

e. There are conflicts of interest. Legal counsel for a business (which owes its business and account to the company) is not a good source for audit committee members. The ties suggest "good ol' pal network" and "you scratch my back..."..