The Leslie Fay Companies--Key Facts

1. UndertheleadershipofFredandJohnPomerantz,LeslieFayrankedas oneoftheleadingfirms in the very competitive women’s apparel industry during the latter decades of the twentieth century.

2. OneofJohnPomerantz’s closestassociates was PaulPolishan,Leslie Fay’sCFOwhoruledthe company’s accounting function with an iron fist

3 John Pomerantz insisted on doing business the “old-fashioned way,” which meant that the company’s accounting function was slow to take advantage of the speed and efficiency of computerized data processing.

4. A growing trend toward more casual fashions eventuallycreated financial problems for Leslie Fay, its principal customers (major department stores), and its leading competitors, problems that were exacerbated by a nationwide recession in the late 1980s and early1990s

5. Despite the slowdown experienced bymuch of the women’s apparel industryin the late 1980s andearly1990s,LeslieFaycontinuedtoreportimpressivesalesandearningsduringthattimeframe.

6 InJanuary1993, Paul Polishan informed John Pomerantz of a large-scaleaccountingfraudover theprevious three years that had materiallyinflated Leslie Fay’s reported sales and earnings, afraud allegedly masterminded by DonaldKenia

7. Upon learning of the accounting fraud, BDO Seidman withdrew its unqualified audit opinions on Leslie Fay’s 1990 and 1991 financial statements and subsequently resigned as the company’s auditfirmafterbeingnamedas aco-defendantincivil lawsuits filedagainstLeslieFay’sexecutives

8. The centerpiece of the Leslie Fay fraud was intentional overstatements of period-ending inventories, although several other financial statement items were also intentionallydistorted.

9. John Pomerantz was never directly implicated in the fraud, although many critics, including BDO Seidman, insisted that he had to share some degree of responsibility forit.

10 BDO Seidman ultimatelyagreed to pay$8 million toasettlementpoolto resolvenumerouscivil lawsuits stemming from the Leslie Fayfraud that named the accounting firm as a defendant

11. Paul Polishan was convicted in 2000 of engineering the Leslie Fayfraud, principallydue to the testimony of Donald Kenia.

12 Leslie Fay emerged from federal bankruptcy court in 1997 but disappeared a few years later when it was purchased by a large investment firm

Instructional Objectives

1. To provide students with an opportunityto useanalytical procedures as an audit planningtool.

2. To demonstrate the need for auditors to monitor key trends affecting the overall health of a client’s industry and to assess the resulting implications for a client’s financial condition and operating results.

3 Tohighlight the internal control issues posedforanaudit client whenits accountingfunction is dominated by one individual

Suggestions for Use

Several of the Section 1 or Comprehensive cases in this text, including the Leslie Fay case, contain exhibits that present multi-year financial statement data for a given company. These data providestudents an opportunityto applyanalytical procedures as aplanningtool Althoughacentral themeofthis casebook is the“people” aspect of independent audits, Ibelieveitisalso importantthat students be exposed to themoremundane, number-crunchingaspects of an independent audit. One way that you can extend Question 1 is to require different groups of students to collect and present (for the same time frame) the financial ratios shown in Exhibit 2 for several of Leslie Fay’s key competitors Quite often, auditors can learn more about the plausibility (or implausibility) of apparent trends in a client’s financial data by comparing those data with financial information for a keycompetitor rather than with industrynorms For example, Leslie Fay’s gross margin percentage was generallyconsistent with that of its overall industry. However, if youcompared thecompany’s gross margin percentages over the time frame of the accounting fraud with those of its direct competitors, itwouldhavebeen apparent that the marginsbeingreported byLeslie Faywere “outof line” with those of its direct competitors.

A keyfeatureof this case is the impact that Paul Polishan’s domineeringpersonalityhad on the accounting function of Leslie Fay. This “red flag” is among the most common associated with problem audit clients. Published reports never indicated exactly how Polishan was able to psychologically control and manipulate Donald Kenia and his other subordinates in “Poliworld.” Apparently, Polishan was oneof those individuals whohadan innateandenormousabilityto impose his will on subordinates You might ask students how they would deal with such a domineering superior. Since many of our students will have an “opportunity” to work for one or more strongwilled individuals during their careers, theyneed to have appropriate coping mechanisms to ensure that they do not find themselves in the unfortunate situation that faced Donald Kenia, that is, spendingtwo years in afederal correctional facility. (You mightdiscouragestudentsfromtakingthe “easy way out” by suggesting that they would simply choose not to work for such an individual. Seldom do we have the freedom to choose the disposition and personality traits of ourboss.)