Kmart's Comeuppance?

It ought to be a bittersweet victory for investors in the old Kmart that the SEC has finally charged the former CEO and CFO with securities violations. Whatever investment shareholders in the company had at the time became worthless when the once-venerated discount retailer entered bankruptcy and re-emerged as a new company.

Not only did bankruptcy protection wipe out old debts, giving the company a clean slate to start over, but it also minted new shares -- so holders of the former company's stock had nothing.

The SEC issued a press release last week announcing that former CEO Charles Conaway and former CFO John McDonald had been charged with essentially making up reasons why inventory had been growing. While Conaway and McDonald said it was due to "seasonal inventory fluctuations," the SEC said that it was actually caused by "Kmart officers reckless and unilateral purchase of $850 million of excess inventory." They then withheld some $570 million in payments to vendors in an effort to deal with Kmart's liquidity problems. As a result, vendors began refusing to ship products to Kmart and the company filed for bankruptcy in January 2002.

For his efforts, Conaway received a $4 million severance package. He also received immediate forgiveness of a $5 million loan, as well as $3.9 million to pay for taxes associated with the loan. Sweet!

Of course, making loans to officers was not exactly something new to Kmart. In the year before it filed for bankruptcy, it made $30 million in severance package "retention loans" to 63 officers, ranging in size from $200,000 to $750,000. In the wake of class-action lawsuits challenging how the company was being run, it suspended the severance pay and asked 62 executives to pay back their loans at the time -- but did not include Conaway.

Since then, of course, the company has re-emerged from bankruptcy with Eddie Lampert as its CEO. He took to building up the company again by selling off its valuable real estate properties. He ultimately merged it with another of his holdings, old-line discounter Sears, to create a new retail operation called Sears Holding Corp. (NASDAQ:SHLD). The new management hopes it will be able to compete against the likes of Target (NYSE:TGT), Wal-Mart (NYSE:WMT), and Kohl's (NYSE:KSS).

Working its way up the food chain, the SEC got two small-fry Kmart employees to settle charges that they asked vendor Newell Rubbermaid (NYSE:NWL) for help in overcoming allowance shortages prior to bankruptcy. Two executives from the vendor also settled, and the four will pay a combined $90,000 in civil penalties.

Whether Conaway or McDonald is convicted on any of the charges, or is held accountable for his actions, remains to be seen, and in reality it offers little solace to the former shareholders. While returning his severance package to shareholders would amount to little compensation, it would ensure that Conaway didn't profit from his alleged misdeeds and would provide a twist of irony for those swindled by his lies.

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Fool contributor Rich Duprey owns shares of Wal-Mart but does not own any of the stocks mentioned in this article. The Motley Fool has a disclosure policy.


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