David Stockman — former president, chief executive officer, and chairman of Collins & Aikman, and a budget director under President Reagan — faces criminal and civil charges for allegedly concealing the auto-parts maker’s declining performance from investors and lenders.
Michael Garcia, the U.S. Attorney for the Southern District of New York, unsealed an indictment Monday that charges Stockman with conspiracy, securities fraud, bank fraud, wire fraud, and obstruction of an agency proceeding.
The criminal indictment also names three other former C&A executives: chief financial officer J. Michael Stepp, controller David R. Cosgrove; and director of purchasing Paul C. Barnaba. Federal prosecutors also recently filed criminal informations against four other ex-executives of the company: treasurer John G. Galante; Christopher M. Williams, executive vice president of the Business Development Group; Gerald E. Jones, chief operating officer and executive vice president of the Fabrics Division, and Thomas V. Gougherty, controller of the Plastics Division.
In a related announcement, the Securities and Exchange Commission filed civil fraud charges against Stockman, the other seven individuals, former board member Elkin B. McCallum, and Collins & Aikman itself.
The SEC alleged that between 2001 and 2005, Stockman personally directed fraudulent schemes to inflate C&A’s reported income by accounting improperly for supplier payments. The commission also alleged that Stockman and others obtained false documents from suppliers designed to mislead the company’s external auditors. When the schemes began to unravel in March 2005, according to the SEC, Stockman embarked on a public campaign to mislead investors, potential financiers, and others by minimizing the extent of the fraudulent accounting and hiding the company’s dire financial condition.
According to the criminal indictment, beginning in December 2001, Stockman, Stepp, and others knew that C&A’s operating performance and financial results were not meeting internal and external expectations. Rather than make disclosures that might trigger default on the financial covenants governing C&A’s credit facilities and impede its ability to raise capital, Stockman, Cosgrove, Stepp, Barnaba and others allegedly joined in a scheme to defraud investors, banks, and creditors by manipulating reported earnings.
More specifically, alleged the indictment, the four individuals and their co-conspirators inflated EBITDA (earnings before interest, taxes, depreciation, and amortization), operating income, and other financial metrics by prematurely recognizing cost reductions based on supplier rebates.
When C&A found itself in a liquidity crisis after its true operating results substantially deteriorated, the indictment also charged, Stockman directed a scheme to further defraud creditors. This scheme included, among other things, misrepresenting to General Electric Capital Corp. the nature of its portfolio of accounts receivable, against which GECC was permitting C&A to borrow more than $100 million.
In the beginning of 2005, the indictment continued, as the company’s improper rebate-accounting practices came under auditor scrutiny, Stockman allegedly made numerous false statements to the public and creditors concerning the company’s liquidity, its forecasted EBITDA for the first quarter of 2005, and the scope of the improper practices that were coming to light.
According to the indictment, when the C&A board of directors discovered that the company had run out of cash and had misled investors about its true operating performance, C&A went into bankruptcy, its common stock became nearly worthless, and the value of its bonds plummeted, resulting in hundreds of millions of dollars in investor and creditor losses.
The SEC, which cited Collins & Aikman’s “significant remedial steps” and extensive cooperation, announced that the company had settled charges against it, without admitting or denying the allegations, by agreeing not to violate the antifraud, reporting, record-keeping, and internal controls provisions of the federal securities laws.
Garcia, the U.S. Attorney, announced a non-prosecution agreement under which C&A will continue to cooperate with the government.
Stepp’s attorney, Gandolfo V. DiBlasi of Sullivan & Cromwell, told CFO.com that his client is innocent of the charges. “Mr. Stepp is not an accountant and never worked as one,” said DiBlasi. “He relied on the company’s accountants to make sure that rebates were properly booked.”
Barnaba is innocent, said his attorney, Solomon Wisenberg; “we look forward to our day in court, and we are confident that we will prevail.” The attorney, a partner with the Washington D.C. law firm Wisenberg and Wisenberg, added that Barnaba intends to fight the SEC charges as well.
Michael Shapiro, a lawyer for Galante, declined to comment. Attorneys for Stockman, Cosgrove, Galante, Williams, Jones, Gougherty, and McCallum could not immediately be reached for comment.
Tim Reason and Sarah Johnson contributed additional reporting.