Royal Ahold NV - The US Foodservice Accounting Fraud

The case examines the accounting fraud

at US Foodservice (USF); a subsidiary of
the Netherlands based retailer - Royal
Ahold NV. It discusses in detail the system
followed by USF to account for
promotional allowances. The case
highlights the role of USF's management
in the accounting fraud who intentionally
booked higher promotional allowances to
show higher income in order to get extra
bonuses. It also examines the reasons
that lead to accounting frauds such as
poor financial and accounting controls,
weak internal control system of the
parent company over its subsidiaries, lack
of transparency in accounting procedures
and linking of management's
compensation with the achievement of
revenue targets.

The case then describes the measures taken by Ahold to regain shareholders'
confidence and strengthen its control systems and governance practices.

Issues:

» Understand the accounting of supplier rebates in the food retailing business

» Study the reasons for lack of proper rules and standards to account supplier
rebates due to which it is susceptible to misappropriation and fraud

» Examine and analyze the accounting scandal at USF and the circumstances
that led to the continuation of fraudulent accounting practices

» Study the reasons for overlooking the observations of financial due diligence
team by Ahold during the acquisition of USF

» Examine the methods adopted by USF employees to account for promotional

allowances and the role played by the suppliers who provided false confirmations

» Examine the necessity of centralized control system for companies like Ahold,
which have grown over the years through acquisitions

» Analyze the corrective measures taken by Ahold to regain shareholders'

confidence
"This case is yet another deplorable example of a massive, multi-faceted fraud
at a major corporation. Today, Ahold and former top executives are charged with
fraudulently overstating sales by billions of dollars. The company is also charged
with fraudulently fabricating hundreds of millions of dollars of earnings."1

- Thomas Newkirk, Associate Director of the SEC's Division of

Enforcement, in 2004.

"In the past 10 years, the company went on a big acquisition spree in Europe
and the United States. Its main strategy was to let the local operations run
themselves and use acquisitions as the engine of growth. Then Ahold looked to
diversify out of groceries into the food service business, and that's where the
company ran afoul."2

- William S. Cody, Managing Director, The Jay H. Baker Retailing

Initiative, Wharton, in 2003.

Introduction
In May 2006, a Dutch court charged three
former executives of the Netherlands-
based Royal Ahold NV (Ahold), one of the
leading retailers in the world, with fraud.

These executives were found guilty in an

accounting fraud that brought the
company to the brink of bankruptcy.

The former CEO of Ahold, Cees van der

Hoeven (Hoeven) and Michiel Meurs
(Meurs), former CFO of Ahold, were issued
nine-month suspended prison sentences
and a fine of €220,0003 each. The
European executive board member of
Ahold, Jan Andreae (Andreae) received a
four-month suspended sentence and a
fine of €120,000.

According to the trial judge, "They have damaged the good reputation of Dutch
companies in general and Ahold in particular, and betrayed the confidence that
shareholders placed in them."4

of the total accounting fraud that led to

the reduction in Ahold's pre tax earnings
to the tune of US$ 966 million, Ahold's
wholly owned subsidiary US Foodservice
(USF) accounted for about US$ 856
million.USF was the second largest
 foodservice distributor in the US. In
February 2003, after Ahold announced
that the earnings of USF for the financial
year 2000 and 2001 were overstated, its
shares fell by more than 65% to a 15-year
low of €3.43 on February 24, 2003. The
market capitalization of Ahold plunged to
€3.3 billion in February 2003 from €30
billion in the end of 2001. The media was
quick to term Ahold 'Europe's Enron5,'
while analysts downgraded the
company's stock.
According to John Hatherly, Head, Global
Analysis, M&G Asset Management6,
"Ahold's accounting irregularities revive
unpleasant memories. This is the main
driver of the share price today as an
investor just cannot trust the company's
figures."7 (Refer Exhibit I for share price
chart of Ahold). The auditors of Ahold,
Deloitte & Touche8 said that it had
warned Ahold about the accounting
problems in the USF. Deloitte said that
Ahold had misled them and did not
provide them with the information
required to investigate the irregularities.
In this context, Deloitte issued a letter to
Ahold on February 24, 2003, stating that
it would not stand by its earlier opinion
regarding the correctness of Ahold's
financial statements as mentioned in the
annual reports of 2000 and 2001.

In the letter, Deloitte stated that Ahold needed to restate its accounts for 2000
and 2001. According to Lynn Turner, former chief accountant at The United
States Securities and Exchange Commission9 (SEC), "Although Deloitte
uncovered the problems in the past few weeks, it should have done so much
earlier."10

About Ahold

Ahold had been managed by the Heijn

family for over three generations. Albert
Heijn (Albert) took over management of
his father's grocery store in Zaandam
near Amsterdam in 1887, at the age of
22. Albert's untiring efforts made the
 store very popular for its high quality,
reasonably priced products and services.
Soon Albert opened a second store in
Alkmaar, another town in the
Netherlands. By 1897, the store count
increased to 23. They were located in
different parts of the Netherlands
including the Hague and Amsterdam. In
1911, the first Albert Heijn branded
products were introduced...

Accounting Fraud at US Foodservice

Before the acquisition of USF in April
2000, Ahold was mainly involved in retail
activities in the US. After Ahold decided to
acquire USF at US$ 26 per share in
February 2000, two teams were sent to
the USF to conduct due diligence.

The first team carried out financial due

diligence and found that in a report dated
August 1999 by KPMG, the auditors of
USF, it was stated that promotional
allowances had not been accounted
properly. The report mentioned that there
could be an error in reporting income and
recommended that USF should adopt a
more formal system to account for
promotional allowances...

Events Leading to the Disclosure

In the last quarter of 2002, USF started ordering large quantities of products
from its suppliers in its efforts to meet its revenue targets. The company had
realized that it would not be able to meet the annual target of over 15% growth
over 2001 sales. USF booked the rebates it was supposed to receive from the
suppliers immediately but did not make payments to them for the products
ordered. In order to meet the targets, in October 2002, top executives in USF
asked all its regional managers to order large quantities of food supplies and
other products from the manufacturers...

The Investigation

Immediately after the accounting

irregularities in USF were reported by
Deloitte, on February 12, 2003, the
 company authorized an investigation by
law firm White & Case LLP and by forensic
accounting advisors from Protiviti Inc. In
March 2003, Morvillo, Abramovitz, Grand,
Iason and Silberberg PC (Morvillo) and
PricewaterhouseCoopers (PWC)
conducted additional investigations of the
accounts of USF. SEC also conducted a
probe on the accounting irregularities at
Ahold. In the investigation conducted by
SEC, it was found that since 1998, USF
had been overstating operating income
by recording higher promotional
allowances.

According to SEC, "USF artificially inflated its operating income by recording

promotional allowances that were not earned in the period recorded, and in
many cases were entirely fictitious." SEC instigated public administrative
proceedings against two of the auditors of KPMG, who had audited and reviewed
financial statements of USF in the year 1999 and for the first two quarters of the
year 2000...

The Aftermath
After investigations of over a year by SEC,
four of the former executives in the USF,
Kaiser, Lee, Resnick, and William Carter,
former vice-president were indicted. The
SEC accused these executives of
pocketing huge bonuses for fraudulently
meeting certain revenue targets. As their
compensation was tied to meeting the
revenue target of USF, they received
huge bonuses as they claimed to have
met revenue targets for 2001 and 2002.
Miller, Hoeven and Meurs resigned in the
wake of the scandal.

Apart from inflating the profits of USF, Lee

was also accused of insider trading before
the takeover of USF.

SEC alleged that Lee provided non-public information about Ahold's plans to
acquire USF. Using this information, one of Lee's associates made profit of more
than US$ 300,000 by trading in USF's stock...
The Action Taken

After Hoeven resigned, Anders Moberg (Moberg) from IKEA was appointed as the
CEO in May 2003. In April 2004, Ahold announced that a debt of €920 million
would be paid back and the financial controls in the firm were being tightened in
order to prevent any more accounting frauds. Brian Hotarek, CFO for US retail
operations, was appointed as the Chief Business Controlling Officer, and his role
was to review and analyze actual performance and future plans of the company.
A new division 'Business Control for Retail' was made responsible for Ahold's
capital budgeting and real estate strategies.

Larry Benjamin, who was the CEO of NutraSweet company in Chicago, was
brought in as new CEO of USF. A new leadership team with six individuals
reporting to the CEO was established. The field operations of USF were organized
into seven units, which included four units divided geographically, and the chain
operations unit, national accounts sales unit and specialty operations unit...