Case 3-2 Rite Aid Inventory Surplus Fraud Occupational fraud comes in many shape

Question

Case 3-2 Rite Aid Inventory Surplus Fraud

Occupational fraud comes in many shapes and sizes. The fraud at Rite Aid is one such case. On February 10, 2015, the U.S. Attorney’s Office for the Middle District of Pennsylvania announced that a former Rite Aid vice president, Jay Findling, pleaded guilty to charges in connection with a $29.1 million dollar surplus inventory sales/kickback scheme. Another former vice president, Timothy P. Foster, pleaded guilty to the same charges and making false statements to the authorities. Both charges are punishable by up to five years’ imprisonment and a $250,000 fine.

The charges relate to a nine-year conspiracy to defraud Rite Aid by lying to the company about the sale of surplus inventory to a company owned by Findling when it was sold to third parties for greater amounts. Findling would then kick back a portion of his profits to Foster.

Findling admitted he established a bank account under the name “Rite Aid Salvage Liquidation” and used it to collect the payments from the real buyers of the surplus Rite Aid inventory. After the payments were received, Findling would Page 176send lesser amounts dictated by Foster to Rite Aid for the goods, thus inducing Rite Aid to believe the inventory had been purchased by J. Finn Industries, not the real buyers. The government alleged Findling received at least $127.7 million from the real buyers of the surplus inventory but, with Foster’s help, only provided $98.6 million of that amount to Rite Aid, leaving Findling approximately $29.1 million in profits from the scheme. The government also alleged that Findling kicked back approximately $5.7 million of the $29.1 million to Foster.

Foster admitted his role during the guilty plea stage of the trial. He voluntarily surrendered $2.9 million in cash he had received from Findling over the life of the conspiracy. Foster had stored the cash in three 5-gallon paint containers in his Phoenix, Arizona, garage.

Assume you are the director of internal auditing at Rite Aid and discover the surplus inventory scheme. You know that Rite Aid has a comprehensive corporate governance system that complies with the requirements of Sarbanes-Oxley and the company has a strong ethics foundation. Moreover, the internal controls are consistent with the COSO framework. Explain the steps you would take to determine whether you would blow the whistle on the scheme applying the requirements of AICPA Interpretation 102-4 that are depicted in Exhibit 3.13. In that regard, answer the following questions.

Questions

1. What steps must you take to be eligible to blow the whistle to the SEC under the Dodd-Frank Financial Reform Act?
2. Would you inform the external auditors about the fraud? Explain.
3. Assume you met all the requirements to blow the whistle under Dodd-Frank. Would you do so? Why or why not?

Explanation / Answer

1. As per the Dodd-Frank Financial Reform Act there are three specific circumstances under which internal auditors can become eligible for whistle blowing. These steps are: (1) The financial interest of the business entity and/or its investors are protected by disclosing to the SEC. (2) The whistleblower is of the opinion that the business entity is blocking the progress of any investigations towards its misconduct. (3) Whistleblower has already reported the matter internally but no action has been taken within at least 120 days from first reporting the matter.

The steps that I will take are - first, I would determine if the fraud has a material effect on the financial statements. If yes, management or the board of directors would have to take action and if no, I have to make a formal report of what has occurred and provide it to the board of directors. I would have to demonstrate that the management responsible was aware of an imminent violation and weren't taking steps to prevent it.

2. Yes, I would inform the external auditors about the fraud. According to rule 102 of the AICPA code, "in the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others." This requires me to report this to the external auditors because it is my duty to inform them of Findling's and Foster's fraud in order for the external auditors to do their jobs. They have to be aware of all details in this situation, and I would want to have integrity and do the right thing. I would inform the external auditors so as to protect the interests of public, employees and other stakeholders of the company.

3. If I met all the requirements to blow the whistle under Dodd-Frank, I would because it is morally required in this case. I have a moral obligation to report this to prevent serious harm to the public and to others. I would want Findling and Foster to take responsibility for their actions. As director of internal auditing, I have the duty to report any type of fraud to higher management and to the external auditing firm. I believe that this fraud can cause harm to the company and its employees and to the public, so by blowing the whistle, harm may be avoided. Also, by blowing the whistle, this would inform others in the organization and they will be encouraged to become potential whistleblowers as well.

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