CBI Management’s Fraudulent Scheme.

Notwithstanding Castello’s exertions on CBI’s behalf and a series of successful acquisitions, CBI’s accounts
receivable, inventory, and earnings, fairly stated, would not have sustained CBI’s desired level of borrowing.
Accordingly, CBI engaged in a scheme to deceive its lenders—and, lest that fraud be revealed, its auditors—as to
the Company’s true financial condition. The facts and circumstances surrounding the execution of this scheme
were, for the most part, stipulated in the Pre-Trial Order or the subject of uncontested trial testimony.

The fraud involved the active participation and/or acquiescence of all CBI managers with financial responsibility,
including, among others, Castello; Paul Rogers, CBI’s most senior financial officer; John O’Brien, the controller of
CBI’s subsidiary Commons Brothers; Raymond Gorman, the controller of CBI’s subsidiary Granain; Kevin
Mahoney, Commons Brothers’ senior accountant; Tom Ortler, Commons Brothers’ accounts payable supervisor;
and Archie Jennings, Granain’s general manager. PTO, Undisp. Facts ¶¶ 38-69.

The fraud’s effect was consistent and indisputable: it presented CBI’s financial position in a manner that facilitated
access to desired capital and credit. Because the lending agreements imposed distinct borrowing limits for each
subsidiary (id. ¶ 109), CBI both inserted entirely fictitious inventory items into its electronic records (entries
known internally as “X items”), id. ¶¶ 104-05, and effected “paper” transfers of actual inventory between
subsidiaries to free up collateral to support borrowing beyond the limits imposed by the agreements. Id. ¶ 110
(stipulating that “paper transfers were done for the purpose of increasing the borrowing ability of CBI”) (emphasis
added). The phony inventory items were deleted from CBI’s books immediately before the banks performed their
physical audits of inventory. Tr. 2513-15 (K. Mahoney). Similarly, the evidence showed that, because borrowing
limits were calculated as a percentage of only those accounts receivable that were less than three months old,

CBI’s managers and accountants systematically mis-recorded the age of various receivables. DX 807.
1
1 CBI also inflated the volume of fresh receivables, which had the greatest value as collateral, by making sales
even where prospects for payment were doubtful. Jennings dep. 173-75. See also id. at 122-25 (to inflate accounts
receivable balance, CBI intentionally delayed issuing credits to customers that returned merchandise).
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Throughout the relevant time period, CBI also circulated false monthly and quarterly earnings statements to its
lenders. Tr. 2636-38 (Brady). One method that CBI used to generate these inflated earnings was by “unrecording”
from its books and records certain liabilities that would otherwise have increased its accounts payable balances
(and thereby diminished reported earnings), Tr. 2407-08 (K. Mahoney), and by resort to what were known as the
“bogey file” (at Granain), Jennings dep. 47-53, and the “black hole” (at Commons Brothers), Tr. 1495 (Scerra)—
manila folders containing invoices that should have been entered into accounts payable records but instead were
held back.
Consistent with these false quarterly and monthly financial reports, CBI’s senior management schemed to
overstate profits reported in year-end financial statements—i.e., those audited by E&Y—by understating accounts
payable. Generally Accepted Accounting Principles (“GAAP”) require that vendor invoices received after the end
of a fiscal year must nevertheless be included as expenses for that fiscal year if the goods to which they relate
2
were received in the fiscal year. Accounting Research Bulletin (“ARB”) 43. Senior CBI officials, however, expressly
directed accounting personnel at Commons Brothers and Granain not to record those invoices. By this means,
assets appeared on CBI’s balance sheet (in
2 ARBs are one of several sources of GAAP. In re K-Tel Int’l, Inc. Sec. Litig., 300 F.3d 881, 890 (8th Cir. 2002).
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the form of inventory), but the corresponding liabilities did not, thereby artificially inflating CBI’s reported
financial condition.
CBI labored to hide (literally) these improprieties from E&Y. During the 1992 and 1993 audits, CBI secreted vendor
invoices in desk drawers and launched a series of stratagems intended to deceive the auditors and frustrate
performance of the audit. Although the hidden invoices were those with extended payment terms—the hope
being that they simply could be left unpaid until after completion of the audit, Tr. 2378-80, 2425 (K. Mahoney)—it
eventually became necessary to pay some of them while the audits were still in progress. As to those, CBI
concocted a series of false explanations to be given when the auditors inquired. First, CBI employees were
instructed to attribute to inadvertence the omission of vendor invoices that, in reality, the Company had sought
deliberately to hide—to inform auditors that, for example, particular omissions were due to keypunch errors by
data entry personnel (see, e.g., PX 5A) or that other invoices had mistakenly been left unrecorded because they
had been forwarded to CBI’s purchasing department for investigation into discrepancies between the goods
received and what CBI’s records indicated had been ordered. Tr. 1713-17 (Ferrante); PX 8B (1993 Search Memo).
Although the latter explanation was untrue with respect to the particular purchases under inquiry, it was in fact
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consistent with CBI’s practice in the ordinary course of its business. PTO, Undisp. Facts ¶¶ 30-31.
Eventually, CBI management resolved to misrepresent the payments on the hidden invoices as “advances,” i.e.,
payments made to a vendor for goods not yet delivered, to maintain balances below the vendor’s credit limits and
thereby keep the flow of goods uninterrupted. Tr. 394, 401-02 (O’Neill). Such payments—which neither were
made with respect to nor immediately applied to any particular invoice, but instead would be taken back once the
pressure of the credit limit had eased—were also consistent with CBI’s actual ( i.e., non-fraudulent) business
practices. Tr. 2382-88 (K. Mahoney); cf. Tr. 2247-48 (Rock).
Finally, at the close of the 1992 and 1993 audits, CBI—acting through its CEO, Castello, and its senior financial
officer, Paul Rogers—assured E&Y in writing, that
• “We have made available to your representatives all financial records and related data”;
• “There are no other material transactions that have not been properly recorded in the accounting records
underlying the consolidated financial statements”;
• “There have been no irregularities involving management or employees who have significant roles in the
internal control structure”; and

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• “We believe that the consolidated statements of financial position, consolidated results of operations and cash
flows are fairly presented in conformity with [GAAP].”