A private equity fund gets caught with its hand in the cookie jar...

The NY Times reports on a fraud at Archway and Mothers Cookie Company and, according to the article, private-equity firm, Catterton Partners, was taking out millions in management fees while doing very little to manage the company. Ultimately, the article suggests that the company was booking fraudulent sales and stuffing the distribution channels after its products deteriorated under Catterton's (mis)management.

The article describes one distributor's experience of receiving excess and damaged inventory during the period when the company was channel stuffing in order to boost its sales numbers to keep financing coming. This distributor summed up his view of Catterton's role in the failure of the Cookie Company by saying:

“What soured me on this experience is that these private equity firms that come in and buy companies don’t look at a company to grow it. Whether it sinks or swims doesn’t really matter to them ... They don’t think about the people whose livelihoods depend on that company. I hope I never have to go through that again.”

Changing trends in executive compensation

In Europe, shareholders have started rejecting the large executive compensation plans that have become so commonplace in the last decade or two. The Wall Street Journal reports:

Shell is the largest among a growing group of British companies whose shareholders have voted down compensation plans in advisory votes, including Royal Bank of Scotland Group, Bellway PLC and Provident Financial PLC.

In the U.S. however, shareholders are still very generous to executives. In comparing Europe to the U.S., the article states:

European investors are angry over bonuses that are relatively modest by U.S. standards. At Exxon Mobil Corp., the largest U.S. oil company, Chief Executive Rex Tillerson received a 2008 compensation package valued at $23.9 million, including $1.87 million in salary, a $4 million bonus and stock grants initially valued at $17.6 million, according to the company's latest proxy.

Shell Chief Executive Jeroen van der Veer was awarded 78,889 shares, worth about €1.3 million ($1.76 million at current prices), in addition to his salary, bonus and benefits of €5.7 million.

The enormous stock grants that executives have received have been blamed for creating the pressure and incentive behind many of the financial statement frauds. In many cases, executives can make millions if they can get their stock to move a few dollars. Beating analysts' expectations by reporting fraudulent financial performance is the means that some executives have used to drive their stock price up.

Warren Buffet has been outspoken about his view that executive compensation is broken. I've heard that Buffet actively works to eliminate incentive for fraud at his companies. In any case, he has long been a critic of current compensation arrangements.

Some proposals floating around should lessen the incentive to commit fraud. For example, a recent MarketWatch article lists proposals to eliminate annual equity awards and make executives wait until two years after retiring to cash in their stock options. It will be interesting to see how executive compensation packages change in the near future and whether the changes will reduce incentives to commit fraud.

Reasons why fraud spikes in a recession

A recent Time Magazine article explains: "As sure as growth slides and employment numbers tumble, so cases of fraud rise during recessions. This time is no different."

This article is interesting but I think it would be more complete if it analyzed different forms of fraud. Some may actually go down during hard times. For example, I'm of the opinion that financial statement fraud probably spikes in boom times but comes to light in a recession. On the other hand, embezzlement and scams probably spike in hard times as people are more desperate.

Finally, I disagree with the article when it says: "The slump may also prompt fraudsters to rationalize their behavior." I think a slump causes increased pressure and not necessarily a change in rationalizing behavior. The increased pressure of hard economic times is simply a harder test of a person's ability to not rationalize committing fraud that is failed by more people.