We will be following the case of United States v. Stockman, 07-0220 (S.D.N.Y. filed Mar. 21, 2007) through a series of posts as the case progresses. This post outlines the background of the case as well as the Grand Jury charges found in the Indictment.

The Grand Jury charges flow from activities between 2000 and 2005 of Collins & Aikman, Inc., (“C&A”), which was a public company listed on the NYSE. C&A was a global automotive parts supplier, who by 2005 had grown to be one of the largest suppliers in the world. In 2001, a private equity firm, formed in part by David Stockman, acquired a controlling interest in C&A. Stockman, served as CEO and Chairman of the Board of Directors of C&A. Under Stockman’s control, C&A availed itself to a variety of sources of debt financing including: notes, revolving credit lines, and securitizing accounts receivables. C&A’s debt financing was subject to certain financial covenants and failure to comply with these covenants would constitute a default by C&A and warrant demand for immediate payment. The covenants required C&A to maintain a certain ratio of performance measured by C&A’s net debt divided by EBITDA.

In general, the Indictment alleges that in response to these operational pressures and covenants to keep C&A’s financial performance at certain levels, Stockman orchestrated a scheme joined by the other defendants to defraud C&A’s investors, banks, and creditors by manipulating C&A’s reported revenue and earnings. The other Defendants include – Michael Stepp, who at various times served as CFO and on the Board of Directors of C&A; David Cosgrove, C&A’s vice president of finance; and Paul Barnaba, Director of Financial Analysis for C&A’s Purchasing Department.

At the forefront of the alleged scheme to defraud was C&A’s improper “rebate” accounting practices. The alleged “rebate” scheme came in three varieties. The first variety took the form of C&A asking for lump sum payments from a supplier, which C&A would characterize as a supplier “rebate.” However, according to an agreement C&A would have with the supplier, C&A systematically repaid this money through additional purchases. Under this variety, C&A improperly recognized what was essentially a loan as a current reduction in costs or “rebate.” Thus, increasing EBITDA and improperly inflating C&A’s current financial performance.

The second variety of “rebate” occurred when C&A negotiated upfront payments called “slotting fees” or “rebates” from its suppliers in exchange for future business. Because C&A’s right to retain the rebate was conditioned on C&A’s promise of future business, GAAP required C&A to recognize these “rebates” as a reduction in cost of sales only after C&A satisfied all the contractual terms entitling it to the lump sum. However, in order to inflate its EBITDA for the current period Stockman and Cosgrove directed C&A’s employees to obtain separate documents that falsely attributed the supplier rebate to past purchases to justify its characterization.

The third variety of “rebate” involved accounting for capital equipment. Under GAAP, discounts on the price of capital assets result in the reduction of the cost basis of the asset, and would have no impact on EBITDA. For the purpose of inflating C&A’s EBITDA, C&A employees, under Stockman’s direction, negotiated contracts whereby C&A agreed to pay a higher price for capital equipment than originally requested by the supplier. In return for the higher price, C&A received a “rebate,” coupled with documentation that falsely attributed the “rebate” to other items, which decreased current expenses. The Indictment alleges that due to the three “rebate” schemes mentioned above, between 2001 and 2004, C&A improperly inflated their operating income by approximately $43.6 million.

It is charged that in furtherance of this scheme, Stockman and the other Defendants made repeated public statements in which they falsely described C&A’s operating performance and financial results, and in order to mislead, omitted material facts necessary to make C&A’s financial performance complete and accurate. In addition, Stockman and the other Defendants caused C&A to file financial statements with the SEC that materially misrepresented C&A’s operating performance and financial results.

The Indictment includes eight counts dealing with the alleged fraudulent activity mentioned above. The first count charges all Defendants with a conspiracy to commit the substantive offenses contained in counts two through eight. (false statements in financial records and documentation, lying to auditors and engaging in bank fraud, wire fraud, and obstruction of an agency proceeding).

Counts two through four charge all Defendants with Securities Fraud violations of 10b-5 in connection with the purchase or sale of common stock, 10.75% senior subordinated notes, and 12.875% senior subordinated notes respectively.

Counts five and six charge Stockman with Bank Fraud, under 18 U.S.C. § 1344, for knowingly executing schemes to defraud General Electric Capital Corporation (“GECC”) and JP Morgan Chase respectively.

Count seven charges Stockman with Wire Fraud, under 18 U.S.C. § 1343, arising from misleading and false statements made during a due diligence conference telephone call with Credit Suisse to obtain $75 million in financing.

Count eight charges Stockman and Stepp with Obstruction of an Agency Proceeding by knowingly causing false and misleading information to be provided to the SEC.

DU Corporate Governance website website.