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?

Answer 1

Requirement 1

As for internal auditors, I am only entitled to become a whistleblower if I am in three situations. The first one, is if the confession to the SEC is necessary to thwart “substantial injury” to the financial interest of an entity or its investors. Second, I must “reasonably believe” after careful reflection that Rite Aid is unsettling investigation of the misconduct. Lastly, I must first report the issue internally and wait for at least 120 days to see if any action will be taken place before they can report externally. In general, it is the duty of an accountant to regulate whether the defilements made have a material effect, quantitatively or qualitatively, on the financial statements. If the amount of documented inventory is above the limit, then yes, the account is material. The second step, you want to wait and see if management or the board of directors, cause the management to take instant action on the issue such as reporting the defilement externally if means necessary. But, in the case that management has not done anything, then the auditor on the engagement must make a official report of its inferences and give the report to the board of directors so they are aware of the condition. Then, the board has up to one day to alert the SEC and provide a copy of the communication to the external auditor. However, if our firm does not get a copy within one business day, then we must take matters into our own hands. First option would to give a copy of our report to the SEC within on business day. The second option is that our audit team can quit from the appointment and provide a copy of the report to the SEC within one business day of resignation

Requirement 2

Yes, I would notify the external auditors about the fraud. According to rule 102 of the AICPA code, "in the enactment of any professional service, a member shall maintain objectivity and integrity, shall be free of clashes of interest, and shall not meaningfully misrepresent facts or secondary his or her judgment to others." This necessitates me to report this to the external auditors because it is my duty to notify them of Findling's and Foster's fraud in order for the external auditors to do their jobs. They have to be cognisant of all details in this situation, and I would want to have integrity and do the right thing. What Findler and Foster are doing is wrong, and I would want them to take accountability for their actions. I don't agree with what they are doing, and believe that this can cause harm to the employers and the company and also to the public. I would want to inform the external auditors to also protect the public interest.

Requirement 3

If I met all the necessities to blow the whistle under Dodd-Frank, I would because it is ethically essential when it is required at all. I have a moral duty to report this to avert severe harm to the public and to others. I would want Findling and Foster to take accountability 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 damage to the company and its employees and to the public, so by blowing the whistle, damage may be avoided. Also, by blowing the whistle, this would notify others in the organization and they will be fortified to become budding whistleblowers as well.