Ethical Obligations and Decision Making in Accounting, 4/e 1
Case 2-9 Phar-Mor
The Dilemma
The story of Phar-Mor shows how quickly a company that built its earnings on fraudulent
transactions can dissolve like an Alka-Seltzer.
One day, Stan Cherelstein, the controller of Phar-Mor, discovered cabinets stuffed with held
checks totaling $10 million. Phar-Mor couldn’t release the checks to vendors because it did not
have enough cash in the bank to cover the amount. Cherelstein wondered what he should do.
Background
Phar-Mor was a chain of discount drugstores, based in Youngstown, Ohio, and founded in 1982
by Michael Monus and David Shapira. In less than 10 years, the company grew from 15 to 310
The Cast of Characters
Mickey Monus personifies the hard-driving entrepreneur who is bound and determined to make
it big whatever the cost. He served as the president and chief operating officer (COO) of Phar-
Mor from its inception until a corporate restructuring was announced on July 28, 1992.
David Shapira was the CEO of both Phar-Mor and Giant Eagle, Phar-Mor’s parent company and
majority stockholder. Giant Eagle also owned Tamco, which was one of Phar-Mor’s major
suppliers. Shapira left day-to-day operations of Phar-Mor to Monus until the fraud became too
large and persistent to ignore.
How It Started
The facts of this case are taken from the SEC filing and a PBS Frontline episode called “How to
Steal $500 Million.” The interpretation of the facts is consistent with reports, but some literary
license has been taken to add intrigue to the case.
Ethical Obligations and Decision Making in Accounting, 4/e 2
Finn approached Monus with the bad news. Monus took out his pen, crossed off the losses, and
then wrote in higher numbers to show a profit. Monus couldn’t bear the thought of his hot
growth company that had been sizzling for five years suddenly flaming out. In the beginning, it
was to be a short-term fix to buy time while the company improved efficiency, put the heat on
Stan Cherelstein’s Role
Cherelstein, a CPA, was hired to be the controller of Phar-Mor in 1991, long after the fraud had
begun. One day, Anderson called Cherelstein into his office and explained that the company had
been keeping two sets of books—one that showed the true state of the company with the losses
and the other, called the “subledger,” that showed the falsified numbers that were presented to
the auditors.
Cherelstein and Anderson discussed what to do about the fraud. Cherelstein asked Anderson why
he hadn’t done something about it. Anderson asked how could he do so? He was the new kid on
the block. Besides, Pat (Finn) seemed to be disinterested in confronting Monus.
Accounting Fraud
Ethical Obligations and Decision Making in Accounting, 4/e 3
Misappropriation of Assets
The unfortunate reality of the Phar-Mor saga was that it involved not only bogus inventory but
also the diversion of company funds to feed Monus’s personal habits. One example was the
movement of $10 million in company funds to help start the WBL.
False Financial Statements
According to the ruling by the U.S. Court of Appeals that heard Monus’s appeal of his
conviction on all 109 counts of fraud, the company submitted false financial statements to
Pittsburgh National Bank, which increased a revolving credit line for Phar-Mor from $435
Tamco Relationship
The early financial troubles experienced by Phar-Mor in 1988 can be attributed to at least two
transactions. The first was that the company provided deep discounts to retailers to stock its
stores with product. There was concern early on that the margins were too thin. The second was
Back to the Dilemma
Cherelstein looked out the window at the driving rain. He thought about the fact that he didn’t
start the fraud or engage in the cover-up. Still, he knew about it now and felt compelled to do
Questions
1. Evaluate the role of each of the stakeholders in this case from an ethical perspective.
How do you assess blame for the Phar-Mor fraud?
This case highlights rationalizations used to justify not meeting one’s ethical obligations.
The rationalization was that all the misrepresentation was short-term so that the company
Ethical Obligations and Decision Making in Accounting, 4/e 4
could recover losses and make the reported financial statements correct. The short term
turned into long term and the losses kept mounting. Monus refused to report losses and
had taken company funds for a personal investment in the World Basketball League.
Monus failed in his fiduciary duties and acting as an ethical leader with strong values of
the correct rule should be followed. Act-utilitarianism: Requires that the act that creates
the greatest good for the greatest number of stakeholders should be selected. None of the
stakeholders benefit from an action that misstates net income. Even Phar-Mor was
harmed because the SEC imposed sanctions on it for false and misleading financial
statements. From a virtue perspective, honesty requires that the statements should be
truthful and follow generally accepted accounting principles. Objectivity requires that the
company should approach its decision about the proper accounting procedures for
investments and inventory with fair-mindedness and without partiality to one set of
stakeholders. Trustworthiness means that the accountants should not violate the
investors’ faith that the statements are accurate and reliable. Due professional care
Ethical Obligations and Decision Making in Accounting, 4/e 5
2. Assume you are in Stan Cherelstein’s position. Evaluate the moral intensity issues in
the case. How do these issues relate to Rest’s Four-Component Model of Ethical
Decision Making? What are the challenges for Cherelstein in that regard?
Cherelstein’s first step and challenge is moral sensitivity and acknowledgement of the
fraud. He understands that the fraud has been going on a long time and that as the fraud
unwinds many will be hurt: suppliers who were unpaid; employees who might lose their
jobs’; investors who might lose equity; and creditors whose financing might be at risk.
The second step would be moral judgment or solutions to solve the ethical dilemma.
3. Assume you decide to confront Monus. How would you counter the likely reasons
and rationalizations you will hear from Monus? What levers do you have to
influence Monus’s behavior?
Monus has been using the rationalization of needing more time to fix the problem, locus
of loyalty, and one-time request as reasons and rationalizations. However, the fraud is
beyond a one-time request since it has been going for some time and maybe the entire
time during which Phar-Mor was a public company.
4. What is the ethical message of Phar-Mor? That is, explain what you think the moral
of this story is.
The moral of the story is the tone at the top determines practices of a company, that pride
should not get in the way of good business and that delaying bad news may only cause
more harm. Also, accountants must be true to their values and act in accordance with the
ethics of the profession. In other words, it takes a long time in business to build trust but
not very long to tear it apart.
Extended Discussion
Case 7-5 discusses exclusivity fees in the context of “financial shenanigans” and instructors may
want to introduce students to it in the discussion of Phar-Mor and then assign it in Chapter 7. The
following is from a blog posted by Charlie Smith on November 15, 2012.
1
On July 22, 2010, the SEC charged Dell Inc. with failing to disclose material information to
investors and using fraudulent accounting practices to make it falsely appear that the company
was consistently meeting Wall Street earning targets and reducing its operating expenses.
Ethical Obligations and Decision Making in Accounting, 4/e 7
Intel’s products. However, the characteristic of these payments changed in 2001, when Intel
began to provide additional rebates to Dell and a few other companies that were outside of the
contractual agreements.
Intel Corporation made these large payments to Dell Inc. from 2001 to 2006 to not use
chips/processors manufactured by Intel’s main rival, AMD. Rather than disclosing these material
payments to investors, Dell decided it would be better to incorporate these funds in their
component costs without any recognition of their existence. The nondisclosure of these payments
caused fraudulent misrepresentation allowing Dell to report increased profitability over these
years.
Dell used an array of cookie jar reserves and manipulated these reserve accounts to manage its
financial results. This manipulation of their statements caused Dell’s financial performance look
better. “Contrary to GAPP, Dell created and maintained excess accruals in multiple reserve
accounts, which Dell used to offset the financial statement impact of future expenses.” This type
of accounting manipulation caused Dell’s financial results to be materially misstated, including
the reports submitted to the SEC.
permitted under GAAP. “The impact of Dell’s reserve manipulations materially misstated Dell’s
operating results.”
Sources: