Ex-Kmart CEO loses bid to reverse fraud verdict

Former Kmart Corp. Chief Executive Officer Charles Conaway lost a bid to reverse a 2009 jury verdict finding him liable for misleading shareholders in the months before the retailer filed for bankruptcy in 2002.

The U.S. Securities and Exchange Commission sued Conaway in 2005, accusing him of duping investors in the management discussion and analysis, or MD&A, portion of a third-quarter 2001 securities filing and during a Nov. 27, 2001, conference call. Conaway failed to tell investors that Kmart faced a cash shortage and was delaying payments to vendors in the months before it filed for bankruptcy, the SEC said.

A federal jury in June found Conaway hid information about the company's cash shortage, aiding and abetting Kmart's misstatements. U.S. Magistrate Judge Steven Pepe in Ann Arbor, Michigan, today denied Conaway's request for a new trial or a judgment erasing the jury's finding.

"The record supports a conclusion that Conaway provided 'substantial assistance' to Kmart in the commission of the fraud and the MD&A inadequacies," Pepe said in his 211-page decision. "The jury could conclude that Conaway was the driving force behind the fraud in its inception, and in the lies and non- disclosures that perpetuated it."

The judge didn't rule on the SEC's request for other penalties including fines.

Penalties SoughtThe SEC asked Pepe in court filings on Sept. 25 for $12.7 million in penalties, including the return of a $5 million retention loan to Conaway that Kmart had forgiven. The SEC initially sought more than $20 million. The SEC also asked Pepe to bar Conaway from working as an officer in a public company."We are very disappointed," Scott Lassar, Conaway's lawyer, said in an e-mailed statement. "We will wait until the judge rules on the SEC request for penalties" before deciding whether to appeal, he said.Kmart sought bankruptcy protection Jan. 22, 2002, subsequently shedding 599 stores and firing about 57,000 workers. Conaway was fired in March 2002.The company exited bankruptcy in May 2003. Kmart Holding Corp. later bought Sears, Roebuck Co., creating Sears Holdings Corp., based in Hoffman Estates.The SEC said Conaway was responsible for the company's failure to disclose that delaying vendor payments was a primary source of working capital.'Never Honest'Conaway hid the company's financial situation from the Kmart board and "was never honest with the vendors," SEC lawyer Alan Lieberman told the jury in Ann Arbor at the beginning of the civil trial in May. Lieberman said today the agency would provide a statement later.Kmart began delaying payments because of a cash crunch set off by an "extraordinary" $850 million purchase of inventory in the summer of 2001 by the company's chief operating officer, "made without the approval or knowledge of other senior managers of the company," the SEC said in its complaint. Kmart didn't disclose the "inventory overbuy," the government said.In the third-quarter conference call, Conaway blamed slow payments on a new system that had caused invoices to be dropped, the SEC said in its complaint. "These statements were false and misleading," the government said.Conaway testified at a hearing in September that he didn't withhold any important financial information.Kmart did experience a cash crunch in late 2001 and used payment slowdowns to help deal with it, Conaway testified. "We reversed and corrected it and it worked," he said.Liquidity CrisisConaway testified that Kmart faced a new liquidity crisis in January 2002 as a result of slow sales and a tight credit market. This was compounded by an analyst's report that month saying the company was heading for a strategic bankruptcy, he said. The report set off "the proverbial run at the bank," Conaway testified."I made plenty of mistakes," Conaway testified of his management of Kmart. He said he spent too much time in the field while trying to turn around the struggling retailer, leaving corporate governance and legal issues to others at the company.In a lawsuit brought by Kmart creditors, Conaway was cleared of allegations that he contributed to the bankruptcy, his lawyer said in court in September. An arbitration panel determined Conaway did nothing wrong, Lassar said.The jury found the statements in the 2001 quarterly filing were materially misleading and Conaway was responsible in part, Pepe said.'Stubborn Refusal'"The jury could reasonably assume that Mr. Conaway knew, or was reckless in his stubborn refusal to acknowledge, that Kmart's liquidity discussion in its MDA for the third quarter could not cavalierly ignore the most significant liquidity crises in Kmart's history," Pepe said."The jury could also find that Mr. Conaway took multiple and decisive steps, including repeated deceptions, to assure that these disclosures were not made," he said.The case is Securities and Exchange Commission v. Conaway, 05-cv-40263, U.S. District Court, Eastern District of Michigan (Ann Arbor).