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Executive Summary
The report relates to The Leslie Fay Companies, a US based company and describes the fraud
indicted in its case, with special reference to the role of auditors of the company in relation to
the fraud. For this purpose, a study and research is carried out to determine a brief history of
the company, an analysis of the role of the auditors in the fraud, identification of the internal
controls that were ignored, and which if followed, could have prevented the fraud. Finally, it
aims to identify the various accounting policies which are designed to prevent any similar
future occurrence and also aims to propose a solution that would prevent a recurrence of the
situation.
The Leslie Fay Companies, Inc. is a U.S. based company which has been involved in the sale
of women apparels under different moderately priced brand names. Over a decade ago, the
company was involved in a major fraud involving its senior executives. The fraud involved
inflating the inventory and the profits of the company to the tune of $80 million. The top
executive and Chief Financial Officer of the company, Paul Polishan was involved and was
the one who masterminded the fraud. The major stakeholders who were affected as a result of
the fraud were most certainly the shareholders who filed a suit against the management for
the embezzlement. The auditors of the company, BDO Seidman, came under great public
scrutiny for being reckless in their approach and failing to carry out investigations when they
were warranted by the misleading financial statements and various accounting irregularities.
As a result of the fraud, the company went into bankruptcy and had to close its major
operations.
Brief History of the Company
The Leslie Fay Companies deals with women apparels of evening wear, career related social
occasion dresses, and sportswear through various prominent department stores across the
country. The company sells a range of brands like Leslie Fay, Joanne Leslie, and Reggio,
which are priced moderately, and also high priced brands through the name of David Warren,
Outlander Sportswear, and Hue.
The company was founded in 1947 by Fred Pomerantz and went public in 1952. However, in
1952, John Pomerantz succeeded his father, and took over as the president of the company
after graduating with an economics degree from the Warton School at the University of
Pennsylvania. The company experienced major changes in the 1980s, and it became The
Leslie Fay Companies, Inc. through a second leverage buyout which occurred in the year
1984. The mid-80s were a period of prosperity in general for the fashion industry, and
keeping in tune with it, Leslie Fay was growing along very fast. The company which had
started with manufacturing dresses for the Women’s Army Corps during the period of World
War 2, went on to acquire several companies, including Non-Stop Fashions, Inc. and NS
Petites Inc. At the same time it realized the need to bring about transformation in its image
and hence, decided to bring in new designers and adopt new marketing strategies, and thus
brought about sophistication to its dresses. However, as the 1990s began, there was a twist
leading to declining sales due to various factors including sale of its head sportswear
division, a decline in dress sales, negative responses of the retailers and consumers to its line
of apparel. To take care of this situation the management resorted to a change in marketing
strategy, reducing prices and offering high rebates to retailers. At the same time it was also
noticed that the company’s books had been manoeuvred to inflate pre-tax profits, and
Pomerantz on the other hand, had not paid much attention to the financial operations of the
company. So, this practice of cutting prices and inflating profits, which was very uncommon
for a large public company like Leslie Fay, had a negative impact on the company. Along
with this poor accounting practice, and the growing recession in the economy, the company
entered a period of bankruptcy. However, towards the end of the 1990s, the company
emerged from bankruptcy, made some acquisitions and pulled off an impressive turn around.
Auditor’s role in the fraud
During the course of examination and investigation by independent lawyers an attempt was
made to study how far the independent auditors of the company, the accounting firm, BDO
Seidman had carried out investigations into the matter. It was found that the audit reports on
the company’s financial statements were misleading and warranted further investigation, but
such...