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Former Managers Allege Pervasive Inventory Fraud at

Walmart. How Deep Does the Rot Go?


(AP Photo/Damian Dovarganes)
In 2012, Erica Davidson, a Walmart veteran and store manager, took on the daunting task of turning
around a struggling store on the outskirts of Greensboro, North Carolina. The store had run through
its share of managers, Davidson said, and she viewed it as the sort of challenge that could make or
break a person's career.
Davidson said that one of her primary tasks was to reduce the troubled store's high rate of
"shrinkage"--defined as the value of goods that are stolen or otherwise lost--to levels deemed
acceptable by the company's senior managers for the region. As a result of fierce competition, profit
margins in retail can be razor thin, making shrinkage a potent--sometimes critical--factor in
profitability.
Prior to her arrival, Davidson said, the Greensboro store could see annual shrinkage losses as high
as $2 million or more--a sizable hit to its bottom line. There had even been talk of closing the store
altogether, she recalled.
For years, Walmart's senior management in North Carolina had been waging a war on shrinkage,
Davidson said; it had become a central priority of the company's local leadership and a source of
constant strain for store managers. Though the unrelenting pressure weighed on her, Davidson said
she became an asset in Walmart's battle against shrinkage--so much so that, in 2011, the North
Carolina regional team named her a "subject matter expert" on reducing shrinkage and would send
her to meetings in the Walmart regional office in Charlotte. There, she recalled, she would train
district managers on her practices in the presence of the company's most senior officers for the
state.
The only problem, Davidson said, was that her superiors' preferred methods for improving this vital
metric were not always aboveboard; they included an array of improper techniques to conceal
shrinkage losses and make the inventory numbers--and profit margins--look better on paper than
they were in reality.
According to Davidson, inventory results that "should have raised red flags" were actually lauded by
those significantly higher in Walmart's regional chain of command. One recently departed senior
vice president, for instance, would send her handwritten notes commending such numbers, she said.
"Those things were just like money in the bank to them," Davidson told The Nation. "It was like, oh,
great job. There was never any accountability or any investigation that went into why--not just in my
store but in any store throughout the region."
Then, in late summer of 2013, all of that came screeching to a halt, Davidson said.
During the last days of August, Davidson's annual inventory audit showed a massive reduction in her
new store's shrinkage rate that surprised even her: down to less than $350,000 from roughly $2.1
million the previous year, she said. In the days that followed, however, none of the usual praise for
delivering spectacular numbers came showering down from her superiors. Davidson knew then that
something was amiss: "There was none of that 'rah-rah, congratulations' stuff that I got the previous
years," she recalled.
Soon Davidson would learn that company fraud investigators had arrived in the state to examine
allegations of irregular inventory accounting. In response to detailed questions from The Nation,
Walmart spokeswoman Brooke Buchanan acknowledged for the first time that the company is
conducting a "thorough review" of "store level processes," though she didn't elaborate on the scope
or details of the review.
As the investigation continued into 2014, a number of Davidson's superiors departed from the
company. Ronny Hayes, the head of Walmart's North Carolina operations, retired; so did his
superior, Henry Jordan, who led the company's massive Eastern Seaboard Division. Walmart's
regional asset-protection manager for North Carolina, who was intimately involved with inventory
tracking in the state, was fired in May, according to a number of sources. The reason for their
departures is unknown, and Walmart did not respond to questions from The Nation regarding why
they are no longer with the company.
Davidson was also fired in May, after nineteen years at the company, as was Victor Hernandez, one
of her co-managers (or "shift managers") at the Greensboro store. The reason for Davidson's firing
was listed as "Gross Misconduct-Integrity Issue," according to an exit-interview form she shared
with The Nation. Davidson, however, believes that she is among the casualties of an effort by
Walmart to clean house and thereby limit its exposure to allegations of accounting fraud. She said
that her superiors within the company's Eastern Seaboard Division tolerated and even encouraged
managers to falsify inventory accounting records to hide shrinkage losses.
Hernandez, Davidson's co-manager, supported these allegations in conversations with The Nation,
as did a third manager who works at a different North Carolina store and wished to remain
anonymous. All three stated that irregular inventory accounting practices pervaded Walmart's
operations in the state. They also said that based on what they had seen on an internal company
database containing the inventory numbers for thousands of Walmart stores nationwide, peculiar
inventory numbers do not appear to be confined to North Carolina alone.
The three managers' comments buttress the account given to The Nation last year by Sylvester
Johnson, a former Walmart district manager who was once Davidson's boss. Johnson alleged that
Walmart's regional leaders in North and South Carolina often set inventory targets that were
impossible to meet ethically, and that they commonly pressured managers into using misleading
accounting tricks to conceal shrinkage losses in order to achieve such numbers. These reduced
"shrink rates," Johnson claimed, artificially inflated the profitability of stores on a large enough scale
to boost the company's bottom line.
Johnson was fired by Walmart in 2009, after which he filed an unsuccessful discrimination suit
alleging that improper inventory accounting was pervasive at the company and that he had been
singled out for termination because he is black. Walmart has previously denied these allegations.
It is unclear how far the inventory accounting practices described by Johnson, Davidson, Hernandez
and the anonymous manager extend beyond North Carolina. However, conversations with several
former managers who worked in states ranging from Georgia to Idaho suggest that the problem
might reach deeper into the Walmart empire.
Most of the managers interviewed said that irregular accounting practices concealed shrinkage
losses and were an effort--tolerated and even promoted by their superiors--to inflate the stated
profitability of stores. Several, however, offered a different interpretation of events. One former
assistant manager spoke of the irregular accounting that resulted simply from low staffing levels,
causing overstretched employees to fabricate inventory numbers because they didn't have time to
perform a proper count of physical merchandise. And a former district asset-protection manager said
he had never seen tolerance of inventory irregularities of any kind while working at Walmart.
Among the big questions raised by these allegations is whether irregular inventory accounting
practices are widespread and systemic throughout the company, or the result of a few local rogue
operations. And, if the practices are widespread--and not corrected for on the company's financial
statements--are they significant enough to inflate the company's profitability and, in the process, its
stock price?
When asked to respond to a list of questions regarding allegations of irregular inventory accounting,
Walmart spokeswoman Brooke Buchanan responded with a brief statement:
Walmart takes allegations of improper conduct seriously and we have strong programs in place to
prevent, detect and remediate issues that may arise.
We have initiated a thorough review of our store level processes to help ensure we have the right
policies and controls in place.
The review is ongoing and it would be inappropriate to comment until its conclusion. Through the
course of our review, appropriate action will be taken if it is determined that there are areas where
we can strengthen our systems or if any associate violated our policies or procedures.
Walmart's statement aligns closely with comments made by the North Carolina managers
interviewed for this article, who said that the company appears to be taking measures to correct the
problems. Yet much uncertainty remains. As the review continues, perhaps the most pressing
question is how it will play out. Will it be an exercise in scapegoating, with a handful of lower-level
managers taking the fall, or a real attempt to address any improper practices?
The Enemy of Profitability
In his 1992 memoir Made in America, Sam Walton, Walmart's legendary founder, penned a brief
indictment of shrinkage. "Shrinkage, or unaccounted-for inventory loss--theft, in other words--is one
of the biggest enemies of profitability in the retail business," he wrote with his trademark vinegar.
Walton was not wrong. The National Retail Security Survey has pegged shrinkage losses at roughly
$35 billion a year in the retail industry, and even a 1 percent shrinkage rate at a company like
Walmart can cost it billions a year. Yet Walton's response was notable by the standards of the time:
to combat the shrinkage threat, he instituted a "shrink incentive plan" in 1980, which consisted of
setting rigorous company-wide shrinkage goals. If the workers at a given store beat these goals--by
banding together to keep sticky fingers in check, both within their ranks and outside them--they
were awarded bonuses of as much as $200.
"This is sort of competitive information," Walton confided, "but I can tell you that our shrinkage
percentage is about half the industry average."
More than twenty years later, analysts believe that Walmart continues to have a below-average
shrinkage rate. Although the retailer doesn't publicly report its exact shrinkage numbers, in both
2009 and 2010 Walmart cited favorable shrinkage results as among the primary drivers of its
increasing profit margin. At the same time, Sam Walton's aggressive goal-setting approach remains
a hallmark of the company, part of the model that has catapulted Walmart to its position as the
world's largest corporation and the United States' largest private employer.
Yet the company's famously hard-driving management goals have also come at a cost. Labor groups
have long complained that the company issues meager payroll targets that force managers to
underpay hourly employees while simultaneously trimming their hours. More recently, The New
York Times uncovered a bribery scandal in Walmart's Mexico operations that allegedly stemmed, in
part, from the company's overambitious efforts to dominate the Mexican market. In its article
exposing the scandal, the Times quoted a whistleblower saying that "very aggressive growth goals"
pressed managers to do "whatever was necessary" to obtain permits to build new stores. Walmart is
now under criminal investigation by the Justice Department for possible violations of the Foreign
Corrupt Practices Act.
Former managers told The Nation that Walmart has employed a series of incentives, both negative
(such as firing) and positive (such as promotion and the aforementioned bonuses), to compel
managers to meet or exceed their shrinkage targets. Indeed, Erica Davidson alleged that producing
favorable shrinkage numbers could make a significant difference in a manager's yearly pay, and that
a high shrinkage rate could jeopardize a store manager's bonus.
"If your store 'shrinks out' [reports unacceptably high shrinkage], then you don't hit your target;
then you don't hit your P&L [profit-and-loss statement] for the year," Davidson said. "Shrink is a
huge part of it."
One obvious way to reduce shrinkage is by preventing theft, and Walmart stores have "asset
protection" personnel on staff to keep too many goods from walking out of stores. However, the
managers interviewed for this article said that they also have access to a number of inventory tricks
that can help conceal shrinkage.
One of these, according to Davidson, involves simply declaring that missing items are not in fact
missing. "You could go to the hardware counter and count screwdrivers," Davidson explained, "and if
the on-hand count was off--as in, you were supposed to have five but you only had two--you could
say, 'Well, we used those missing three in the store, for store operations.' They were probably
actually stolen, but you're telling the system that you have possession of them and that you're using
them in the building. That way, you take them out of your financial inventory and you're accounting
for them so that, on inventory day, you're not going to shrink on those items that are missing."
Another basic way to pad an inventory count to hide losses--and a method that several former
managers spoke of--involves manipulating changes in the price of merchandise, especially during
Walmart's famous "markdowns." In its most stripped-down form, this approach involves managers
going into their stores' computerized inventory system during a markdown on a batch of items and
then reducing the computer value of that merchandise by an excessive amount. What's critical is
that the managers slash the value of the merchandise in the inventory system more than they slash
the actual price that consumers pay for those goods at the register. The result is that the value of
that batch of real, on-hand merchandise can be more than the value listed for that batch in a store's
financial books.
"It's not like it was a secret or it's hard to do," said Davidson. "Any salaried manager has access to
that [inventory] screen."
Such tricks, according to former managers like Davidson, often caused certain departments in a
store to see inventory "overages." An overage occurs when a batch of inventory expands--on paper,
at least--to become larger than was ever supposedly shipped to the store in the first place. This
unaccounted-for growth of goods is generally a sign of counting errors or the manipulation of
inventory numbers.
"Significant overages, or overages at all on any consistent basis, don't quite make sense," explained
Michael Stevenson, former treasurer and vice president of finance at the apparel retailer
Abercrombie & Fitch. "If you're over one or two items or a hundred bucks in one department just
one time, that's not a red flag. But if there are overages consistently, count after count, whether it's
a hundred bucks or a thousand bucks, that would be harder to chalk up to human error; that would
raise [the need for] an investigation."
Several managers told The Nation that overages were commonly seen in the stores' most seasonal
product categories, such as apparel or lawn and garden, which were subject to frequent price
changes and thus offered more opportunities for manipulation. Such overages, they said, were
essentially used to offset departments that had higher shrinkage in order to reduce a store's overall
shrinkage rate. Stevenson, who is now a partner and forensic accountant at Clarus Partners in
Columbus, Ohio, confirmed that consistent overages could have the effect of reducing the overall
shrinkage rate at a given store and could even affect its reported profit. (It is worth noting that
managers interviewed for this article said that inventory numbers are tabulated by third-party
auditors, like RGIS, whose job is simply to take the count, not to scrutinize the integrity of the
results, they said.)
When asked about these overages by Sylvester Johnson's lawyers during a 2012 deposition, a
divisional asset-protection director named Art Binder conceded that there were apparel overages at
Walmart. "As a company, we have experienced some overages in apparel departments in most
stores," Binder said, "and the company cannot understand why those overages are there. So there's
a case of an unexplainable overage."
Beyond North Carolina
Cody Champagne told The Nation that during his six months working as an assistant manager at a
Walmart in Fort Worth, Texas, he saw unusual accounting practices. They bore a distinct
resemblance to those described by the managers who worked more than a thousand miles away in
North Carolina.
Champagne referred to these practices as "the madness" and said fellow managers at his store
tolerated and even encouraged unethical inventory accounting. These practices, he asserted,
contributed to his leaving Walmart in 2012. Champagne said he suspected that the odd inventory
accounting was not only misrepresenting his store's profit margin but--worse for his day-to-day work
life--was constantly thwarting his team's efforts to maintain a proper count of the merchandise and
keep the shelves stocked. "I'm someone who believes that rules exist for a reason," Champagne said.
"And when you're not being honest about your inventory, you're lying to a lot of people."
Champagne said that the store's unusual accounting practices led him to access the company's
central system of inventory records. He said he was astonished by the consistency of suspicious
numbers across stores--specifically, the regularly occurring overages in "soft line" categories such as
apparel. "That was the straw that broke the camel's back," he said. "It put everything in perspective
for me. I didn't even dig much deeper because, at that point, I knew I was going to leave the
company."
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Champagne believes that, although occasional overages can be explained by one-off accounting
errors, there is no excuse for consistent overages. "How in the hell you grow inventory like that?" he
asked rhetorically. "You can't. Inventory doesn't do that--or at least it shouldn't--but it was
happening across the board."
The people that he worked alongside would sometimes even directly indicate that they were
concealing losses, Champagne added: "If we were missing a high-ticket item, like a thousand-dollar
TV, they'd say, 'Oh, don't worry about it--we'll make it up at the end of the year with clothing.'"
According to Champagne, he perceived his store's irregular accounting practices to be the result of
the unintended effects of understaffing as well as deliberate efforts to falsify the inventory records.
To Champagne, much of the corner-cutting he described came down to employees' and managers'
seeking to look good on Walmart's detailed employee performance evaluation reports, called
"scorecards." He is unsure whether the accounting tricks were part of a concerted effort by the
company.
"It's a chicken-and-egg question," Champagne said. "Did the company passively sign off on these
practices by not correcting them, or did they actively promote them? I don't have the answer to
that."
Vikki K. Gill said that misleading inventory accounting was a common practice throughout the five
states in which she managed Walmart stores. She said that her superiors induced the practice by
forcing stores to meet unrealistically low shrinkage targets, which were impossible to achieve
without manipulation.
"To 'shrink out' was a career-ending decision," said Gill, who left Walmart in 2009 and now works for
the United Food and Commercial Workers' campaign to press Walmart for higher wages and better
conditions for its hourly workers.
Gill said that her superiors pushed improper inventory accounting through an almost daily series of
winks and forceful nudges. "When there was no one around," she recalled, "they would tell you: 'You
know what you need to do. Now go do it. And if you have a problem with it, find another job--you're
paid well for this.'" Achieving targets not only protected managers from firing or demotion, Gill said,
but also contributed significantly to the tens of thousands of dollars that the managers could receive
in bonuses.
Gill said that, in her experience, it was common practice for managers to use price changes to create
inventory overages in seasonal categories to bring down a store's overall shrinkage rate. "Cosmetics,
electronics and sometimes sporting goods were high-shrink," she explained. "The departments that
you could create overages in were the seasonal categories, where it was easier because they weren't
followed or watched as much--you never got in trouble for an overage." Gill said the dynamic was
similar during her time managing stores in Idaho, Illinois, Mississippi, Oklahoma and Missouri.
Karen Youstin said that during nearly two years as a Walmart district manager in Georgia, she was
mystified by the unrealistic inventory targets that the company set for her stores. She felt the goals
couldn't be met through ethical practices. "What they wrote on paper and what my boss told me I
needed to achieve were completely different," Youstin said. "I would ask my boss how on earth I
would do this with this number of people. She just said: 'Muscle through it.' I still don't know what
she meant by that." Despite this, Youstin said she never witnessed inventory fraud at Walmart.
Chaos Theory
Last year, Bloomberg News reported that Walmart's inventory management was in shambles, with
too few employees to carry products from the stores' back rooms to the sale-floor shelves. Interviews
conducted for this article indicate that this may be only part of the picture, and that employee
shortages might be contributing to the stores' inventory accounting woes as well. Several managers
interviewed for this article repeated the point that Walmart's high-tech inventory tracking system is
only as good as the numbers it receives.
One former assistant manager, who worked at Walmart stores in Georgia and South Carolina and
wished to remain anonymous, said that, as with Cody Champagne, dishonest inventory accounting
helped drive him from the company. Yet he was unsure whether the irregular accounting that he
described had any effect on his stores' profitability, and he never saw inappropriate markdowns or
deliberate "padding" of inventory. Rather, he said, understaffing created a situation in which
employees simply had no time to take an accurate count of inventory. These physical counts of
goods--often required each time a line of merchandise changed in price--would be fabricated in order
to save time, he said. Often, the person conducting the inventory count would simply take the
number of items that the computerized system had listed for the sales floor and then manually enter
that number as the up-to-date physical count, he said.
"When you punch in those wrong numbers, the system no longer knows what you really have," this
former assistant manager pointed out. Like Champagne, he also observed that inaccurate
information entered into the company's inventory system caused almost daily operational headaches,
including problems with properly stocking shelves. "There are times when you audit a bin and [the
system] tells you there's nothing in there, and [the bin] is stacked with items. Calling it chaos is an
understatement."
One of the interesting paradoxes raised by these staffing cuts is that, as Walmart has trimmed its
workforce, including the greeters and other workers who keep an eye on merchandise, one would
expect to see theft--and therefore shrinkage--rise. And in fact, John Marshall, a financial analyst at
the United Food and Commercial Workers' Capital Stewardship Program, told The Nation that "over
the past few months, hundreds of associates from all over the country have reported to us that
shrink is a significant problem in their stores--in areas including electronics, grocery, apparel and
pharmacy, among others--and that it has been getting worse due to staffing cuts." Yet Walmart
hasn't cited shrinkage as a problem in recent years, raising the question, once again, of how the
company has managed to keep theft losses in check.
For J. David Fuller, a former Walmart district manager of asset protection, inventory manipulation
had nothing to do with it. In an interview with The Nation, Fuller stated emphatically that he never
saw any tolerance for inventory padding or even consistent overages. "In my many years with the
company, up until I left in 2009, I never saw any such thing at Walmart," he said.
Fuller, whose job as an asset-protection manager required him to keep a keen eye on the stores'
inventories and anti-theft protocols, worked in Nebraska, New Mexico, Texas and even Brazil during
his tenure with the company. Fuller said that he was intimately involved with the mechanisms by
which such fraud would have to take place, and that there were simply too many people within the
company aware of the inventory numbers for such widespread manipulation to be plausible. "There
can be isolated incidents of this," Fuller said, "but it is not an endemic issue."
Fuller said that in his seventeen years with Walmart, he had firsthand knowledge of only one
manager's cooking his books in the manner described by Davidson and others--and that manager
was swiftly fired. At the time he left, Fuller added, the company expected its store managers to keep
their shrinkage under 0.8 percent of sales. Fuller called this a "stretch" for some stores, but
stipulated that it was not impossible to achieve through ethical means.
Fuller said that he never saw consistent overages in the product departments at Walmart, but he
agreed with the basic premise that overages are either the result of error or intentional
manipulation. He said that at Walmart persistent inventory overages would likely be investigated.
A Brief History of Manipulation
Walmart is not the only retail company that has been accused of distorting shrinkage numbers
through mechanisms like inappropriate price changes.
According to Thomas Yake, a retail and financial consultant based in Kennebunk, Maine, who has
served as an expert witness on inventory accounting issues for the Securities and Exchange
Commission and the IRS, shrinkage figures are an especially easy way for companies to falsely boost
their bottom lines. Yake said there is precedent for other retailers massaging these numbers.
The discount retailer called Zayre, which was sold to Ames in 1988, is a prime example. Yake worked
at Zayre from 1964 to 1973 and said he saw the inventory manipulation happening firsthand. "In
later years at Zayre, this system, which centered on manipulation of 'the shrink figure,' became
more refined and better orchestrated," Yake wrote in a newsletter he published roughly two decades
ago. "To a great extent," he continued several paragraphs later, "the store managers' job
performance was evaluated according to their ability to manipulate the shrink figure. Some were so
successful that stores actually showed large overages in merchandise--a 'positive shrink'--at year
end!"
Yake said that, as a consultant in the 1990s, he worked on a case involving F.W. Woolworth
Company, which he said was distorting its inventory figures to prop up its faltering bottom line.
Woolworth stores commonly saw total-store overages while the manipulation was occurring, Yake
recalled. However, a major problem with obscuring shrinkage numbers is that it doesn't help a
company over the long term and can even cause shrinkage to run rampant, because management
remains in the dark about much the company is actually losing.
According to Charles Mulford, the director of the Georgia Tech Financial Reporting and Analysis
Lab, if such overages do exist at a large retailer, the business should--and likely would--correct for
such errors on its annual financial statements, which are inspected by third-party auditors. "When it
comes to the annual financial statements, that physical count is so important," Mulford said. "The
auditors are going to spend a lot of time making sure that's a good number."
Even so, a number of other publicly traded companies have been charged with misreporting
inventory figures and profits. In 2002, the Securities and Exchange Commission cited the pharmacy
chain Rite Aid for distorting its inventory accounting and misreporting its shrinkage figure by failing
to disclose roughly $13.8 million in losses. It was part of an elaborate stew of schemes that the
company's top executives had conceived to understate the chain's expenses while overstating its
income. Rite Aid settled with the SEC, and several executives pleaded guilty to a host of criminal
charges brought in a related Justice Department case.
Fall Guys?
When The Nation spoke with Victor Hernandez, one of Erica Davidson's co-managers at the
Greensboro store, he was still reeling from losing his job over a practice that, he said, did not start
with him.
"I was following direction from above and then I got fired for following that direction," Hernandez
said. "This is how we were doing it for the nineteen years I was with the company. Those inventory
numbers are visible within the company--everyone knew what we were doing."
Hernandez felt that because top regional managers were aware of the irregular accounting, it
seemed useless to question the ethics of the arrangement. "[They] knew--so where do I go? Who was
I going to ask?" he said.
Hernandez also said that before the company abruptly decided to root out the accounting
irregularities, he was never given a chance to correct his inventory practices. "They could have come
down and said, 'Look, stop what you're doing or we'll fire you,'" Hernandez said. "But no one ever
told us to stop. Throughout my whole time at the company, as long as you had an overage [in some]
departments, you were good."
Davidson recalled that there was just one moment in her time with Walmart--in 2009, shortly after
the company had fired Sylvester Johnson--when she was told to use restraint in applying markdowns.
The order came, she said, from Art Binder, the asset-protection director who had testified against
Johnson. Davidson said she complied with Binder's directive and, in short order, her store's
shrinkage rate rose to a higher level.
Within a year, however, Binder was promoted to director of asset protection for the Eastern
Seaboard Division and, with the arrival of North Carolina's new management team, Davidson said,
she was told to ignore Binder's warning and was again under heavy pressure to conceal inventory
losses. She said she felt that refusing to comply with this new directive could imperil her job.
But the tide may be shifting in Walmart's North Carolina operations, if not beyond; according to
Davidson, the company appears to be determined to show that it used aggressive measures in
dealing with improper inventory accounting.
"I think they're trying to avoid issues with the SEC or whoever else may get involved with issues of
inventory inaccuracies," Davidson said. "So they're doing whatever they can to show that they held
people accountable, even if it wasn't for just cause. They're putting forth the effort--or at least
making it appear that they did."
Spencer Woodman is a freelance writer based in New York. You can reach him at
Contactspencerwoodman@gmail.com or follow him on Twitter via @spencerwoodman.
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