Royal Ahold NV - The US Foodservice Accounting Fraud

"This case is yet another deplorable example of a massive, multi-faceted fraud at a major corporation.
Today, Ahold and former top executives are charged with fraudulently overstating sales by billions of
dollars. The company is also charged with fraudulently fabricating hundreds of millions of dollars of
earnings."1

- Thomas Newkirk, Associate Director of the SEC's Division of Enforcement, in 2004.

"In the past 10 years, the company went on a big acquisition spree in Europe and the United States. Its
main strategy was to let the local operations run themselves and use acquisitions as the engine of
growth. Then Ahold looked to diversify out of groceries into the food service business, and that's where
the company ran afoul."2

- William S. Cody, Managing Director, The Jay H. Baker Retailing Initiative, Wharton, in 2003.

Introduction
In May 2006, a Dutch court charged three former executives of the Netherlands-based Royal Ahold
NV (Ahold), one of the leading retailers in the world, with fraud. These executives were found guilty in
an accounting fraud that brought the company to the brink of bankruptcy.

The former CEO of Ahold, Cees van der Hoeven (Hoeven) and Michiel Meurs (Meurs), former CFO of
Ahold, were issued nine-month suspended prison sentences and a fine of €220,0003 each. The
European executive board member of Ahold, Jan Andreae (Andreae) received a four-month suspended
sentence and a fine of €120,000.

According to the trial judge, "They have damaged the good reputation of Dutch companies in general
and Ahold in particular, and betrayed the confidence that shareholders placed in them."4

Of the total accounting fraud that led to the reduction in Ahold's pre tax earnings to the tune of US$
966 million, Ahold's wholly owned subsidiary US Foodservice (USF) accounted for about US$ 856
million. USF was the second largest foodservice distributor in the US. In February 2003, after Ahold
announced that the earnings of USF for the financial year 2000 and 2001 were overstated, its shares fell
by more than 65% to a 15-year low of €3.43 on February 24, 2003. The market capitalization of Ahold
plunged to €3.3 billion in February 2003 from €30 billion in the end of 2001. The media was quick to
term Ahold 'Europe's Enron5,' while analysts downgraded the company's stock.
According to John Hatherly, Head, Global Analysis, M&G Asset Management6, "Ahold's accounting
irregularities revive unpleasant memories. This is the main driver of the share price today as an investor
just cannot trust the company's figures."7 (Refer Exhibit I for share price chart of Ahold). The auditors
of Ahold, Deloitte & Touche8 said that it had warned Ahold about the accounting problems in the USF.
Deloitte said that Ahold had misled them and did not provide them with the information required to
investigate the irregularities. In this context, Deloitte issued a letter to Ahold on February 24, 2003,
stating that it would not stand by its earlier opinion regarding the correctness of Ahold's financial
statements as mentioned in the annual reports of 2000 and 2001.

In the letter, Deloitte stated that Ahold needed to restate its accounts for 2000 and 2001. According to
Lynn Turner, former chief accountant at The United States Securities and Exchange Commission9
(SEC), "Although Deloitte uncovered the problems in the past few weeks, it should have done so much
earlier."10
About Ahold
Ahold had been managed by the Heijn family for over three generations. Albert Heijn (Albert) took
over management of his father's grocery store in Zaandam near Amsterdam in 1887, at the age of 22.
Albert's untiring efforts made the store very popular for its high quality, reasonably priced products and
services. Soon Albert opened a second store in Alkmaar, another town in the Netherlands. By 1897, the
store count increased to 23. They were located in different parts of the Netherlands including the Hague
and Amsterdam. In 1911, the first Albert Heijn branded products were introduced...

Excerpts
Accounting Fraud at US Foodservice

Before the acquisition of USF in April 2000, Ahold was mainly involved in retail activities in the US.
After Ahold decided to acquire USF at US$ 26 per share in February 2000, two teams were sent to the
USF to conduct due diligence.

The first team carried out financial due diligence and found that in a report dated August 1999 by
KPMG, the auditors of USF, it was stated that promotional allowances had not been accounted
properly. The report mentioned that there could be an error in reporting income and recommended that
USF should adopt a more formal system to account for promotional allowances...

Events Leading to the Disclosure

In the last quarter of 2002, USF started ordering large quantities of products from its suppliers in its
efforts to meet its revenue targets. The company had realized that it would not be able to meet the
annual target of over 15% growth over 2001 sales. USF booked the rebates it was supposed to receive
from the suppliers immediately but did not make payments to them for the products ordered. In order to
meet the targets, in October 2002, top executives in USF asked all its regional managers to order large
quantities of food supplies and other products from the manufacturers...

The Investigation

Immediately after the accounting irregularities in USF were reported by Deloitte, on February 12,
2003, the company authorized an investigation by law firm White & Case LLP and by forensic
accounting advisors from Protiviti Inc. In March 2003, Morvillo, Abramovitz, Grand, Iason and
Silberberg PC (Morvillo) and PricewaterhouseCoopers (PWC) conducted additional investigations of
the accounts of USF. SEC also conducted a probe on the accounting irregularities at Ahold. In the
investigation conducted by SEC, it was found that since 1998, USF had been overstating operating
income by recording higher promotional allowances.

According to SEC, "USF artificially inflated its operating income by recording promotional allowances
that were not earned in the period recorded, and in many cases were entirely fictitious." SEC instigated
public administrative proceedings against two of the auditors of KPMG, who had audited and reviewed
financial statements of USF in the year 1999 and for the first two quarters of the year 2000...

The Aftermath
After investigations of over a year by SEC, four of the former executives in the USF, Kaiser, Lee,
Resnick, and William Carter, former vice-president were indicted. The SEC accused these executives
of pocketing huge bonuses for fraudulently meeting certain revenue targets. As their compensation was
tied to meeting the revenue target of USF, they received huge bonuses as they claimed to have met
revenue targets for 2001 and 2002. Miller, Hoeven and Meurs resigned in the wake of the scandal.
Apart from inflating the profits of USF, Lee was also accused of insider trading before the takeover of
USF.

SEC alleged that Lee provided non-public information about Ahold's plans to acquire USF. Using this
information, one of Lee's associates made profit of more than US$ 300,000 by trading in USF's stock...

The Action Taken

After Hoeven resigned, Anders Moberg (Moberg) from IKEA was appointed as the CEO in May 2003.
In April 2004, Ahold announced that a debt of €920 million would be paid back and the financial
controls in the firm were being tightened in order to prevent any more accounting frauds. Brian
Hotarek, CFO for US retail operations, was appointed as the Chief Business Controlling Officer, and
his role was to review and analyze actual performance and future plans of the company. A new division
'Business Control for Retail' was made responsible for Ahold's capital budgeting and real estate
strategies.

Larry Benjamin, who was the CEO of NutraSweet company in Chicago, was brought in as new CEO of
USF. A new leadership team with six individuals reporting to the CEO was established. The field
operations of USF were organized into seven units, which included four units divided geographically,
and the chain operations unit, national accounts sales unit and specialty operations unit...

1] "SEC Charges Royal Ahold and Three Former Top Executives with Fraud; Former Audit Committee Member Charged With
Causing Violations of the Securities Laws," US Securities Exchange Commission, October 13, 2004.

2] "Royal Ahold's Royal Hold Up," Research at Penn, www.upenn.edu, March 12, 2003.

3] As on June 05, 2006, One € = US$ 1.294.

4] Anita Awbi, "Ahold Executives Charged with Fraud," www.foodanddrinkeurope.com, May 25, 2006.

5] Enron Corporation was one of the leading energy companies in the world. The company reported revenues of US$ 101 billion
in 2000. At the end of 2001, Enron filed for bankruptcy when it was revealed that its reported financial condition was due to a
systematic, planned accounting fraud. The biggest bankruptcy of that time resulted in the dissolution of accounting firm Arthur
Anderson.

6] M&G Asset Management is Prudential Group's asset management business. Prudential, a UK based financial services
company, acquired the M&G group in 1999.

7] "Investors Slaughter Crisis Hit Retailer," www.bbc.co.uk, February 24, 2004.

8] Deloitte & Touche, also known as Deloitte, is an organization of member firms around the world providing professional
services and advice, focused on client service through a global strategy executed locally in 150 countries. The company's
revenues stood at US$ 18.2 billion in 2005.

9] The SEC is a United States government agency having primary responsibility for enforcing the Federal securities laws and
regulating the securities industry. The SEC consists of five commissioners appointed by the President with the advice and
consent of the Senate.

10] "Europe's Enron," Economist, March 01, 2003.