Rite Aid Accounting Fraud: Vendor Bills Became Profits

Rite Aid restated cumulative pretax income by $2.3 billion after unsupported adjustments, unearned vendor credits and omitted expenses inflated its earnings, according to the Securities and Exchange Commission’s order. The accounting fraud case against the drugstore chain’s former executives alleged a scheme running from at least March 1997 through at least September 1999.

This page follows those entries into Rite Aid’s reported earnings and the documents executives supplied to support them. Our page on accounting restatements and securities fraud covers the broader question of how a correction connects to the conduct behind it.

Vendor Credits Turned Supplier Bills Into Income

The commission’s settled order described Rite Aid inflating deductions from payments owed to vendors for damaged and outdated products. For suppliers that did not require physical returns, Rite Aid destroyed the goods, reported their quantity and value, and deducted that value from a later payment. According to the order, Rite Aid inflated what it reported, taking credits the vendors had neither agreed to nor known about.

The Securities and Exchange Commission’s separate complaint against former executives alleged that employees questioned the practice with the chief executive and chief financial officer in 1995. At that point, the unsupported increase was 35%. It later rose to 50%. The complaint alleged that the executives permitted the practice to continue after hearing the concerns.

The supplier’s bill and the company’s profit moved together. In the SEC’s account, the improper credits reduced both accounts payable and cost of goods sold, increasing reported income. A vendor employee who knew what had actually been destroyed could see a different transaction from the one Rite Aid’s accounting presented.

The order described another version at the end of fiscal 1999: Rite Aid charged vendors for store markdowns while telling them the deductions concerned damaged and outdated merchandise. The vendors had not agreed to bear the markdown costs. In the SEC’s account, the supplier’s bill paid for Rite Aid’s discounts.

Tomorrow’s Rebates Entered Today’s Earnings

Rite Aid also booked vendor rebates before it earned them, according to the SEC order. On the last day of fiscal 1999, it reduced accounts payable and cost of goods sold for credits dependent on future sales. It then reopened the books after year-end to record more credits when its results were falling short of analysts’ projections. The executive complaint put the unearned rebate income at $75 million, representing 37% of fiscal 1999 pretax income.

The executive complaint added that Rite Aid had to pass some rebates through to employers using its pharmacy benefits services. Even an earned rebate would therefore require separating the amount Rite Aid could keep from the amount owed to those employers. The purchasing agreements were not yet binding at the close, and part of any earned rebate belonged to the employers.

The same question runs through supplier rebate accounting. In the SEC’s Kraft Heinz accounting case, the agency alleged that future commitments appeared as earned rebates and upfront payments concealed repayment obligations. For a purchasing employee, the promise made back to the supplier can explain why a reported saving was premature.

Quarter-End Entries Moved Expenses Out of View

Rite Aid’s quarterly adjustments changed when expenses appeared, according to the SEC order. Amounts already recorded in store and corporate expense accounts were reduced, then typically restored in the next quarter. That raised income in the quarter investors were reading and pushed the expense into another period.

The executive complaint described the support for one set of adjustments as a handwritten schedule from the chief financial officer, using large round numbers and the same accounts adjusted in the prior year’s quarter. Later adjustments arrived by fax or telephone. The SEC’s allegation ends plainly:

The order also described unsupported gross-profit entries that lowered cost of goods sold and accounts payable. In the second quarter of fiscal 1999, those entries alone overstated pretax income by approximately $100 million. The entries made during the first three quarters were reversed in the fourth, creating pressure for new entries that would lift year-end income. The reversal brought the expense back. Management needed another adjustment to make it disappear again.

Liabilities Disappeared While the Obligations Remained

The SEC order described omitted compensation expense for stock appreciation rights granted to field managers. Those rights entitled employees to cash or stock based on the increase in Rite Aid’s share price, and the company should have recorded expense as the obligation changed. Instead, the order said, Rite Aid recorded no accruals.

The executive complaint alleged that the chief financial officer denied the rights existed when speaking with an auditor, even though he acknowledged knowing about them to another employee. It also reproduced this statement from management’s May 1999 letter to the audit firm:

For someone administering the compensation program, the grant letters and the audit assurance described incompatible accounts of the same obligation. The SEC alleged that the chief executive had personally signed the letters granting the rights. The paperwork existed inside the company while the auditors were being told the program did not.

Prescriptions, Missing Inventory and Abandoned Stores

The order described a will-call payable for payments from private insurers on prescriptions customers never collected. Rite Aid reversed that liability without sufficient justification, later restored it and repaid $6.6 million to the insurers. The executive complaint alleged a further maneuver: after an employee challenged the reversal and the payable was restored, the chief financial officer directed offsetting entries in another account to achieve the same effect.

Inventory supplied another opportunity to raise earnings. According to the order, Rite Aid failed to record some losses identified by physical counts and improperly reduced estimated shrink expense at stores without a count. Together, those practices overstated fiscal 1999 pretax income by $13.8 million. The inventory count and the adjustment to the accounts told different stories about what remained on the shelves.

The order also described costs for proposed stores that Rite Aid had decided not to build. Rather than write off the associated legal, title and architectural costs when it abandoned a site, the accounting department kept them as assets and wrote off portions at a fixed monthly rate. A retail controller could connect the decision to abandon a location with the asset still appearing in the accounts.

The Criminal Indictment Describes Withheld Vendor Agreements

The criminal indictment in the Middle District of Pennsylvania alleged that executives concealed the conditions attached to vendor agreements while seeking approval of income already booked. It charged that they withheld letters of intent from KPMG showing that rebates depended on future agreements and sales. It also described an audit-committee meeting at which the chief financial officer assured the committee and auditors that a $17 million vendor litigation-settlement entry had support while concealing the document that made the settlement contingent.

The indictment alleged that the executive responsible for legal matters arranged a backdated letter about the vendor settlement. A later letter described that settlement as binding at the earlier fiscal year-end, and executives sent it to the auditors without supplying the underlying agreements executed later. For an employee who saw both sets of documents, the relevant difference was between the date asserted in the assurance and the dates and conditions in the actual bargain.

How Is Accounting Fraud Caught?

We investigate accounting fraud by connecting the reported earnings to the transaction, obligation and approval behind each adjustment. Rite Aid’s case gives a retail controller concrete records to compare with the public number. The useful knowledge may sit in purchasing, inventory, pharmacy operations or accounting, where the underlying activity is already familiar:

• Vendor deductions. Destruction and markdown records can be compared with the amounts deducted from supplier payments. Vendor agreements show what the supplier actually agreed to fund.
• The close and the reversal. Account reconciliations, adjustment instructions and later reversals connect an expense to the quarter in which it appeared. A fax or telephone instruction without support explains how the number reached the ledger.
• Liabilities and assets. Prescription-payment records, compensation grants, physical inventory counts and abandoned-site decisions test whether the balance still matches the obligation or property behind it.
• Audit requests and approvals. The request, the answer and the underlying agreement reveal whether the auditor received the transaction’s conditions. A later assurance can be checked against the agreement it describes.

The executive complaint alleged that, in the first quarter of fiscal 2000, accounting staff began resisting the chief financial officer’s commands to record improper entries. A journal entry supplies an amount and an account, while the person who worked on it may know why it was entered, who requested it and what supporting document was missing. We connect that knowledge to the statement investors received.

What Rite Aid’s Restatement Measured

Rite Aid’s cumulative net-income restatement was $1.6 billion, according to the SEC order. The order’s illustrative table shows a reported fiscal 1999 pretax profit erased by its listed adjustments. In the corrected column, a loss.

The Securities and Exchange Commission’s executive complaint alleged that the executives received more than $1.5 million in performance-related cash bonuses for fiscal 1998. Their further stock and cash incentives depended on higher reported earnings and share prices.

The SEC resolved the company proceeding through a June 21, 2002 order addressing reporting, books and records, and internal controls. Rite Aid agreed to stop the violations and cooperate with the SEC. We see a striking contrast between the scale of the false accounts and an order telling the company to keep accurate ones.

What Could a Rite Aid Accounting Insider Recognize?

A Rite Aid accounting insider could recognize the gap between a vendor agreement, a compensation grant or an unsupported instruction and the number it produced. Whistleblowing in accounting can expose the business fact missing from a ledger entry or an assurance to auditors.

The 2018 study The Significance of Whistleblowing as an Anti-Fraud Measure, published in the Journal of Forensic & Investigative Accounting, examined occupational-fraud case data. Among cases with complete detection data, whistleblowing accounted for 35.9% of detection, compared with 21.4% through internal controls. The study also found that detection through whistleblowing became more likely as more people participated in a scheme.

The 2019 working paper Do Corporate Whistleblower Laws Deter Accounting Fraud?, hosted by MIT Sloan, compared companies exposed to state whistleblower laws through state pension-fund investments with companies outside that exposure. It reported a 5% to 9% reduction in the likelihood of accounting fraud among exposed firms.

Eligible SEC whistleblowers can receive 10% to 30% of qualifying monetary sanctions collected when the SEC action exceeds $1 million in sanctions. Separately, a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. We assess which program fits the conduct you saw. If your knowledge comes from audit or compliance work, we work through the questions raised by your role with you.

You Know What the Adjustment Changed

If you saw a vendor balance, inventory figure or liability changed to reach an earnings target, speak with our whistleblower experts about the entry and the decision behind it. We develop the case with you and bring in securities fraud whistleblower lawyers who understand financial reporting and retail accounting. We stay beside you as your knowledge of the business becomes evidence the government can test.