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Report sheds light on evolution of Phar-Mor scandal.

YOUNGSTOWN, Ohio -- As Phar-Mor Inc. cofounder and former president and chief operating officer Mickey Monus prepares to go to trial March 2 for allegedly masterminding the fraud and embezzlement scheme that plunged the deep-discount drug chain into bankruptcy, a picture is emerging of a retailer run for six years by autocratic executives who used the company coffers as if they were their personal pocketbooks.

In a 1,000-page, two-volume report released last month, an independent bank examiner tells how some Phar-Mor officials at the highest levels kept two sets of financial records, funneled corporate money into outside businesses and falsified earnings reports to deceive investors.

The report also documents the use of $10.5 million of the chain's money to finance the failed World Basketball League and the diversion of more than $75,000 from company funds to build an addition to Monus' house.

The report, ordered by Judge William Bodoh of the U.S. bankruptcy court and prepared by bank examiner Jay Alix, head of Jay Alix Associates of Southfield, Mich., comes after almost a yearlong inquiry into the near collapse of the chain.

Phar-Mor filed for protection from its creditors under Chapter 11 of the bankruptcy code in August 1992 after disclosing that three of its top executives had engaged in a fraud and embezzlement scheme for six years. At the time, Phar-Mor estimated the plot had cost the company about $500 million. Alix' report puts that figure at nearly $1 billion.

"A broad spectrum of people were falsely led to believe that Phar-Mor was a healthy, growing company that was a good investment, a good customer and a good employer," says Alix.

From 1987 until 1992 quarterly and annual financial reports showed Phar-Mor to be earning healthy profits and expanding rapidly. The company's supposed success attracted many big-name investors. But now it appears that the retailer never earned a penny of profit in the five years before it filed for bankruptcy protection.

According the report, the fraud scheme touched the highest levels of Phar-Mor's administration. While it was previously believed that Monus was the highest-ranking official involved, Alix's report suggests that another member of the company's board of directors, Nathan Monus (Mickey Monus' father), may have been aware of and profited from some of the deception.

Mickey Monus, who continues to profess his innocence and says the plot was masterminded by former chief financial officer Patrick Finn, was indicted by a Federal grand jury in Cleveland last year on 129 counts of fraud and conspiracy. If convicted on all charges Monus could face 1,400 years in prison and more than $33 million in fines.

In reality, says John Sammon, the assistant U.S. attorney who will prosecute the case, Monus would likely be sentenced to some 15 years in prison and be required to pay less than $1 million in fines if convicted on one or more counts. On March 3, 1993 Finn pleaded guilty to charges of bank fraud, mail fraud, wire fraud, engaging in a monetary transaction in criminally derived property and preparation of false and fraudulent tax returns. In November he was sentenced to 33 months in prison and fined $7,000.

A month earlier former vice president of finance Jeffrey Walley pleaded guilty to two counts of engaging in a transaction involving illegally obtained money and one count each of aiding and abetting bank fraud and aiding and abetting wire fraud. He was sentenced to six months house arrest.

Both men are expected to testify against Monus.

Alix' report says that, while Monus, Finn and Walley were the only Phar-Mor executives indicted in the case, several others, including former controller John Anderson; Stanley Cherelstein, the former controller of Tamco Distributors Co., a Phar-Mor subsidiary; Joel Arnold, Phar-Mor's vice president of operations who was asked to resign in September 1992; Richard Jones, former assistant to the controller who voluntarily resigned in June 1993; Thomas Rothbauer, currently a Phar-Mor staff accountant; and Chris Brautigam, currently Phar-Mor's special projects manager "may have had knowledge that facts were being misreported or that improper accounting for transactions occurred." Phar-Mor chairman and former chief executive officer David Shapira and all other members of the company's board of directors were apparently unaware of the fraud, the report says.

But questions still surround Nathan Monus, a board member and an associate of his son in various business ventures outside of Phar-Mor. The bank examiner's report says that Mickey Monus often selected his own outside businesses to act as vendors to Phar-Mor.

In one such case, Phar-Mor bought jewelry from a middleman, Jewelry 90, a company owned by David Karzmer, a business partner of Mickey Monus. If Phar-Mor had bought the jewelry directly from a wholesaler it could have saved about $2 million, the report says. Nathan Monus, who once held a 50% stake in another Karzmer company, acted as a paid consultant to Jewelry 90 for two years. During the first six months of 1992 he was paid close to $355,000 by the company. Both Monuses declined to be interviewed by Alix and investigators, citing their Fifth Amendment rights against self-incrimination.

Shapira, while apparently unaware of the misdeeds at Phar-Mor, occasionally showed bad judgment, the report suggests. In one instance, after receiving a confidential 12-page memo from Phar-Mor general counsel Charity Imbrie that raised questions about possible irregularities--including Monus' diminished attention to Phar-Mor's business and the use of the retailer's employees for noncompany activities -- Shapira told Imbrie to rip up all copies of the memo, saying he felt it contained false, misleading and possibly defamatory statements. On the advice of outside counsel, Imbrie retained a copy of the memorandum.

Shapira's action in this instance is an example of the blind eye Phar-Mor executives turned toward the fraud and embezzlement within their own ranks, Alix says.

"There are several possible reasons to explain why astute businesspeople may have continued to advance capital and credit to do business with Phar-Mor," says Alix.

The continual growth of the retailer may have led investors and insiders to become greedy, he says, while the feeling of power and the collusion by those aware of the plot helped conceal the deception.

"All along we got consistent audits and unqualified financial statements from extremely qualified accountants," Shapira told The Wall Street Journal last month. "Everyone came to the conclusion that this was a sound company growing quickly."

But it was only because of doctored financial records that the perception continued to exist.

According to Alix' findings, Monus ruled Phar-Mor like "an autocrat," demanding complete loyalty from his subordinates and frequently ordering them to alter financial records, inflate store inventories to bolster the value of the company's holdings, and, when cash became short, falsify the amount of outstanding debt so the company would look attractive to Wall Street.

The altered financial records allowed Monus to obtain more than $1 billion of credit and capital for the company from such investors as Sears Roebuck & Co., Westinghouse Electric Corp., real estate developer Edward DeBartolo Sr., and Corporate Partners, an investment firm affiliated with Lazard Freres. In reality, Alix says, Phar-Mor had $238 million in pretax losses in 1992 alone and would have never been able to attract the money if its true financial condition were known.

The deception worked for a long time, the report says, allowing Phar-Mor to appear to be one of the 1980s' retailing success stories. In less than a decade the chain built 300 stores and saw its sales climb to more than $3 billion. But behind the scenes, Monus, Finn, and to a lesser extent Walley, were using the company's assets as if they were their own money, diverting more than $15 million to the World Basketball League and covering up their actions by keeping two sets of financial records: "the David report," falsified records that were passed on to Shapira and the company's directors so that the bottom line appeared to be growing, and another one accessible only by Monus and Finn that carried the nickname "the cookies."

The report says the conspirators were able to conceal the wrongdoing by moving fraudulent asset account balances to store inventory account balances at the end of each fiscal year. Advance payments from exclusivity contracts were also used to hide fiscal irregularities.

The scandal caused Phar-Mor to close about half of its stores, which at one time totaled more than 300. It currently operates 168 units in 23 states. Chief executive officer Tony Alvarez, who began running the chain in September 1992, says the company is regaining its fiscal health faster than expected and that it could emerge from Chapter 11 as early as September.
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Title Annotation:Phar-Mor Inc.
Publication:Chain Drug Review
Date:Feb 14, 1994
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