Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Case 5- 9
Royal Ahold N.V. (Ahold)
Summary of the Charges against Ahold
On October 13, 2004, the SEC charged Royal Ahold N.V. (Ahold) with multiple violations of Section 17(a) of the
Securities Act, Section 10(b) of the Exchange Act, and Exchange Act Rule 10b-5. Charges were also filed against
three former top executives: Cees van der Hoeven, the former CEO and chair of the executive board; A. Michael
Meurs, the former CFO and executive board member; and Jan Andreae, the former executive vice president and
executive board member. The commission also filed a related administrative action charging Roland Fahlin, a
former member of Ahold’s supervisory board and audit committee, with causing violations of the reporting, books
and records, and internal controls provisions of the securities laws.
As a result of two frauds and other accounting errors and irregularities that are described in the following text,
Ahold made materially false and misleading statements in SEC filings and in other public statements for at least FYs
1999 through 2001 and for the first three quarters of 2002. The company failed to adhere to the requirements of the
Exchange Act and related rules that require each issuer of registered securities to make and keep books, records, and
accounts that, in reasonable detail, accurately and fairly reflect the business of the issuer. The company also failed to
devise and maintain a system of internal controls sufficient to provide reasonable assurances that, among other
things, transactions are recorded as necessary to permit preparation of financial statements and to maintain the
accountability of accounts.
About the Company
Ahold is a publicly held company organized in the Netherlands with securities registered with the SEC pursuant to
Section 12(b) of the Exchange Act. Ahold’s securities trade on the New York Stock Exchange and are evidenced by
American Depositary Receipts (ADRs).
As a foreign issuer, Ahold prepared its financial statements pursuant to Dutch accounting rules and included, in its
filings with the commission, a reconciliation to U.S. GAAP and condensed financial statements prepared pursuant to
U.S. GAAP.
U.S. Foodservice (USF), a food service and distribution company with headquarters in Columbia, Maryland, is a
wholly owned subsidiary of Ahold. USF was a publicly held company with securities registered with the SEC
pursuant to Section 12(b) of the Exchange Act prior to being acquired by Ahold in April 2000.
Summary of Complaint
The SEC’s complaints, filed in the U.S. District Court for the District of Columbia, alleged that, as a result of the
fraudulent inflation of promotional allowances at USF, the improper consolidation of joint ventures through
fraudulent side letters, and other accounting errors and irregularities, Ahold’s original SEC filings for at least FYs
2000 through 2002 were materially false and misleading. For FYs 2000 through 2002, Ahold overstated net sales by
approximately $30 billion. Ahold overstated its operating income and net income by approximately $3.3 billion and
$829 million, respectively, in total for FYs 2000 and 2001 and the first three quarters of 2002.
Ahold agreed to settle the commission’s action, without admitting or denying the allegations in the complaint, by
consenting to the entry of a judgment permanently enjoining the company from violating the antifraud and other
provisions of the securities laws. Various officers of the company also settled charges, without admitting or denying
the allegations in the complaint, by consenting to permanent injunctions and officer and director bars.
The SEC did not seek penalties in the enforcement actions because the Dutch Public Prosecutor’s Office, which
conducted a parallel criminal investigation in the Netherlands, requested that the commission not seek penalties
against the individuals because of potential double jeopardy issues under Dutch law. Because of the importance of
this case in the Netherlands and the need for continued cooperation between the SEC and regulatory authorities in
other countries, the commission agreed to the Dutch prosecutor’s request.
The commission did not seek a penalty from Ahold because of, among other reasons, the company’s extensive
cooperation with the commission’s investigation. Ahold self-reported the misconduct and conducted an extensive
internal investigation. On its own initiative, Ahold expanded its internal investigation beyond the fraud at USF and
the improper joint venture accounting to analyze accounting practices and internal controls at 17 operating
companies. Ahold promptly provided the staff with the internal investigative reports and the supporting information
and waived the attorney–client privilege and work product protection with respect to its internal investigations.
Ahold also made its current personnel available for interviews or testimony and significantly assisted the staff in
arranging interviews with, or testimony from, former Ahold personnel located in the United States and (of even
greater importance) abroad. Ahold promptly took remedial actions including, but not limited to, revising its internal
controls and terminating employees responsible for the wrongdoing.
In a separate action, on June 17, 2009, Ahold reached a final settlement with plaintiffs in a class action securities
lawsuit that requires the company to pay the lead plaintiffs $1.1 billion to resolve all claims against Ahold. The
settlement applies to all qualifying common shareholders around the world and covers Ahold, its subsidiaries and
affiliates, the individual defendants, and the underwriters.
Statement of Facts
The following summarizes the main facts of the case with respect to transactions between Ahold and USF.
Budgeted Earnings Goals
From the time it acquired USF in April 2000, Ahold and USF budgeted annual earnings goals for USF.
Compensation for USF executives was based on, among other things, USF’s meeting or exceeding budgeted
earnings targets. USF executives each received a substantial bonus in early 2002 because USF purportedly satisfied
earnings goals for FY 2001. USF executives were each eligible for a substantial bonus if USF met earnings targets
for FY 2002. Certain USF executives engaged in or substantially participated in a scheme whereby USF reported
earnings equal to or greater than the targets, regardless of the company’s true performance.
Promotional Allowances
A significant portion of USF’s operating income was based on payments by its vendors, referred to in various ways
such as “promotional allowances,” “rebates,” “discounts,” and “program money” (referred to below as “promotional
allowances”). During at least FY 2001 and 2002, USF made no significant profit on most of its end sales to its
customers. Instead, the majority of USF’s operating income was derived from promotional allowances.
In a typical promotional allowance agreement, USF committed to purchase a minimum volume from a vendor.
The vendor in turn paid USF a per-unit rebate of a portion of the original price it charged USF, according to an
agreed-upon payment schedule.
Sometimes the volume-based promotional allowances were paid as they were earned, but it was a common
practice for the vendor to “prepay” on multiyear contracts at least some portion of the amounts that would be due if
USF met all of the projected purchase volume targets in the contract. Promotional allowances were critical to USF’s
financial results—without them, USF’s operating income for FY 2001 and 2002 would have been materially
reduced.
False Confirmations and Statements to Auditors
USF executives engaged in or substantially participated in a scheme whereby USF reported earnings equal to or
greater than its earnings targets, regardless of the company’s true performance. The primary method used to carry
out this fraudulent scheme to “book to budget” was to improperly inflate USF’s promotional allowance income. USF
executives booked to budget by, among other things, causing USF to record completely fictitious promotional
allowances sufficient to cover any shortfall to budgeted earnings.
USF executives covered up the false earnings by making it appear that the inflated promotional allowance income
had been earned by (1) inducing vendors to confirm false promotional allowance income, payments, and receivable
balances; (2) manipulating the promotional allowance accounts receivable from vendors and manipulating and
misapplying cash receipts; and (3) making false and misleading statements, and material omissions, to the
company’s independent auditors, other company personnel, and/or Ahold personnel.
USF executives falsely represented to the company’s independent auditors that there were no written promotional
allowance contracts for the vast majority of promotional allowance agreements when, in fact, they knew, or were
reckless in not knowing, that such written contracts existed. These executives falsely represented that USF had only
handshake deals with its vendors that a USF executive would renegotiate at the end of each year to arrive at a
mutually agreed-upon final amount due from each vendor for the year. They knew, or were reckless in not knowing,
that these representations were false when they were made.
Nonexistent Internal Controls
USF had no comprehensive, automated system for tracking the amounts owed by the vendors pursuant to the
promotional allowance agreements. Instead, USF, for purposes of interim reporting, purported to estimate an overall
“promotional allowance rate” as a percentage of sales and recorded periodic accruals based on that rate. Information
provided by USF executives caused the estimated rate to be inflated. The intended and actual result of inflating
USF’s promotional allowance income was that USF, and Ahold, materially overstated their operating incomes.
Corrupting the Audit Process
USF executives participated in a systematic effort to corrupt the audit process to keep the fraud from being
discovered. Ahold’s auditors attempted at the end of each FY to confirm with the vendors that they actually paid, or
still owed, the promotional allowances recorded by USF. To satisfy the auditors, USF executives successfully
convinced vendors to sign audit confirmation letters even though they knew that the letters were false.
For each vendor subject to the confirmation process, USF executives prepared a schedule purportedly reflecting
the promotional allowances earned by USF for the year, the amount paid by the vendor, and the balance due. USF
executives grossly inflated the figures contained in these schedules. The schedules were used both by USF to
support the related amounts recorded in its financial statements and by its auditors to perform the year-end audit.
USF executives provided information used to prepare confirmation request letters that they signed and that were
sent to major vendors reflecting the inflated aggregate promotional allowances purportedly paid or owed to USF
during the year. The promotional monies earned, paid, and receivable that were stated in the confirmations were
grossly inflated and in many cases were simply fictitious, having no relationship to the actual promotional
allowances earned, paid, or receivable.
Fraudulent Acts by Management
As a further part of the fraud, USF executives contacted or directed subordinates to contact vendors to alert them
that they would receive confirmation letters and to ask them to sign and return the letters without objection. If a
vendor balked at signing the fraudulent confirmation, USF executives pressed the vendor by, for example, falsely
representing that the confirmation was just “an internal number” and that USF did not consider the receivable
reflected in the confirmation to be an actual debt that it would seek to collect. USF executives sent, or directed
subordinates to send, side letters to vendors who continued to object to the fraudulent confirmations. The side letters
assured the vendors that they did not, in fact, owe USF amounts reflected as outstanding in the confirmation letters.
USF executives attempted to prevent the discovery of the fraudulent scheme by making accounting entries that
unilaterally deducted material amounts from the balances that USF owed to certain vendors for the products USF
had purchased, and simultaneously credited the promotional allowance receivable balance for the amount of such
deductions. These “deductions” were made at year-end and had the net effect of making it appear that USF had
made material progress in collecting promotional allowance payments allegedly due.
The large year-end deductions facilitated the fraudulent recording of promotional allowance income because these
deductions made it appear that the amounts recorded had been earned and paid. The USF executives concealed the
fact that the deductions were not authorized, were not legitimate, and that a substantial percentage of the deductions
were reversed in the early part of the following fiscal year.
USF executives also knew, or were reckless in not knowing, that the amounts paid by some vendors included
prepayments on multiyear contracts. But they falsely represented to USF personnel, Ahold personnel, and/or the
company’s independent auditors that none of the promotional allowance agreements included such prepayments. As
a result, USF treated the prepayments by vendors as if they were payments for currently owed promotional
allowances. This made it falsely appear that USF was making material progress in collecting the inflated
promotional allowance income it had recorded.
Role of the Auditors
Deloitte & Touche had been Ahold’s group auditor (the consolidated entity) since the company went public. A few
years after Ahold had acquired USF and the accounting fraud surfaced, investors sued the firm for being engaged in
deceptive conduct and recklessly disregarding misstatements in Ahold’s financial statements. The charges were
dismissed because it was concluded that Deloitte was being deceived by Ahold executives, many of whom went to
great lengths to conceal the fraud.
When Deloitte took over the auditing of USF after being taken over by Ahold, the firm uncovered multiple
accounting errors that not only had a material effect on USF’s profits, but also materially distorted the net income of
Ahold as well.
Financial Statement Misstatements and Restatements
As a result of the schemes already described, USF materially overstated its operating income during at least FY
2001 and FY 2002. On February 24, 2003, Ahold announced that it would issue restated financial statements for
previous periods and would delay filing its consolidated 2002 financial statements as a result of an initial internal
investigation based, in part, on the overstatement of income at USF. Ahold announced in May 2003 that USF’s
income had been overstated by more than $800 million since April 2000. Ahold’s stock price plummeted from
approximately $10.69 per share to $4.16 per share.
On or about October 17, 2003, Ahold filed its Form 20-F (filing with the SEC for foreign entities) for the fiscal
year ended December 29, 2002, which contained restatements for the FY 2000 and FS 2001, corrected accounting
adjustments for FY 2002, and restated amounts for FY 1998 and FY 1999 included in the five-year summary data.
The restatements indicated that, in its original SEC filings and other public statements, Ahold had overstated (1) net
income by approximately 17.6, 32.6, and 88.1 percent for the FY 2000, FY 2001, and first three quarters of FY
2002, respectively; (2) operating income by approximately 28.1, 29.4, and 51.3 percent for the FY 2000, FY 2001,
and first three quarters of FY 2002, respectively; and (3) net sales by approximately 20.8, 18.6, and 13.8 percent for
the FY 2000, FY 2001, and the first three quarters of FY 2002, respectively. Ahold and three of the individual
defendants agreed to settlements with the commission.
Ahold Today
Ahold operates a number of grocery chains throughout the United States and Europe. Its common shares are listed
and traded on the NYSE Euronext.
Questions
1. Explain how Ahold used promotional allowances to manipulate earnings. Refer to the fraud triangle
described in this chapter and analyze the incentives, pressures, and opportunities to commit fraud at Ahold.
Promotional allowances are referred to as rebates, slotting fees, or vendor allowances and are fees paid to the
vendors in exchange for various marketing and promotional activities, such as inclusion in a supermarket’s weekly
circular. Ahold recognized an inflated amount of the promotional allowances in income or recognized the revenue
2. Utilize the COSO Integrated Framework and discussion of risk assessment in the chapter and evaluate the
deficiencies in the internal control system at Ahold. Include in your discussion whether Ahold adequately
monitored its internal controls as suggested in COSO’s Guidance on Monitoring Internal Control Systems
discussed in the chapter.
Based on the limited facts from the case, the corporate governance system had limited influence over the operations
of the company. The budgeted earnings goals and the performance compensation provided pressures and incentives
for manipulation of the financial reporting. There seemed to be little control over the processes of interim and annual
financial reporting. In the external audit, USF was able to induce vendors to confirm false promotional allowances.
3. The court ruled that Deloitte was not responsible for the fraud at Ahold because its management deceived
the auditors and hid information from the firm. How does such deception relate to the Deloitte auditors’
obligations to identify material misstatements in the financial statements of Ahold and provide an opinion
that the statements present fairly financial position, results of operations, and changes in cash flows? Do you
believe auditors should be let off the hook with respect to their ethical and professional obligations because of
management deception?
The Deloitte auditors had an obligation to plan and perform the audit to detect material misstatements. As part of
that obligation, the auditors need to assess the risk of fraud, gather and assess evidence, and perform the audit with a
healthy dose of skepticism. For instance, the external auditors received confirmation letters from vendors which
overstated promotional allowances to USF by more than 100 percent. USF was able to pressure the vendors into
signing the fraudulent confirmations or gave side letters assuring the vendors that the amounts reflected as
outstanding in the confirmation letters was actually owed. The auditors did not maintain control over the
Optional Questions
4. In addition to the deficiencies in accounting for promotional allowances, Ahold engaged in joint venture
transactions that materially misstated the financial statements. Review the litigation referred to in the case
and describe the nature and scope of the joint venture transactions and what problems existed with the
company’s accounting and financial reporting and answer the following two questions.
a. Evaluate the operation of internal controls with respect to accounting for the joint venture transactions.
How might the company have strengthened its controls?
Ahold fully consolidated several joint ventures in its financial statements, despite owning no more than fifty percent
of the voting shares. To justify the full consolidation of those joint ventures, Ahold gave its independent auditors
side letters to the joint venture agreements, signed by Ahold and its joint venture partners, which stated that Ahold
controlled the joint ventures. The case does not disclose if the auditors confirmed these side letters. In fact, the
b. From a corporate governance perspective, what were the deficiencies that seem to have contributed to the
fraud in accounting for and reporting the joint venture transactions? Can you identify corporate governance
mechanisms that might have helped prevent or detect the fraud at Ahold but that were nonexistent?
Internal controls seem to have been nonexistent or ignored. The corporate governance system of Ahold needed a
