corporate governance at ahold mcs case

License to print 540 copies to IBS Gurgaon, for Sem III, Class of 2013.

CGOV/005

IBS Center for Management Research

Corporate Governance at Ahold

This case was written by Sachin Govind, under the direction of Sanjib Dutta, IBS Center for Management Research. It was

compiled from published sources, and is intended to be used as a basis for class discussion rather than to illustrate either

effective or ineffective handling of a management situation.

2006, IBS Center for Management Research. All rights reserved.

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CGOV/005


"This (granting of an inquiry) is a huge victory for the shareholders. Until yesterday Ahold was hoping that our request for an inquiry would not be granted. The pressure that Ahold has been exerting on the VEB – from placing the VEB’s activities on the shareholder agenda to placing display ads asking us to call a halt to these activities – has yielded no result. The Court too shares the view that the background to the biggest stock exchange fraud in Dutch history cannot stay under wraps.”

1

– Peter Paul de Vries, Director, VEB2 in 2005.

"We learned that as a company you can lose your reputation overnight, but it takes some time to rebuild it and restore trust.”

3

– Anders C. Moberg, CEO and President, Ahold in 2004.

“Ahold has put in place a series of measures that will give the company the ability to more closely monitor the financial activities of its operating companies.”

4

– Peter Wakkie, Chief corporate governance counsel, Ahold in 2004.

INTRODUCTION

In November 2005, Ahold NV (Ahold), the Dutch retail giant with several operating companies in US and Europe, (Refer Table I for Ahold‟s operating companies) reached a worldwide settlement worth US$ 1.1 billion with shareholders who had purchased its stock between July 30, 1999 and February 23, 2003. The compensation was intended to settle the class-action suit which Ahold‟s shareholders had filed against it after serious accounting irregularities were unearthed at US Foodservice, its subsidiary in the US. Ahold derived more than 60 percent of its revenues through its subsidiaries in the US. To the shock of investors, Ahold announced on February 24th 2003 that it had overstated profits by almost 1 billion euros for the period between January 2000 and September 2002.

Compared to the compensation demands that WorldCom Inc. and Enron Corp. faced, the US$ 1.1 billion settlement was seen as small. The settlement was welcomed by Ahold‟s management. Peter Wakkie (Wakkie), executive board member and chief corporate governance counsel, Ahold observed that the settlement was fair to all parties concerned, including the company itself. He said, “It is a substantial compensation for shareholders of between US $1 and US$ 1.30 per share. This is not so high that it will bring Ahold into problems.”

5 The VEB shareholders lobby also was

happy with the deal. Peter Paul de Vries, Director, VEB said, “It‟s a very quick solution and leaves behind a black chapter at Ahold. They can focus on the future.”

6 The shareholders‟ lobby (VEB)

1 “Major investigation into mismanagement at Ahold,” www.veb.net, January 13, 2005.

2 VEB (Vereniging van EffectenBezitters or Dutch Investor‟s Association), headquartered in The Hague, is

an independent association which represents investor‟s interests. 3 Kerry Capell, “Royal Ahold: From Europe‟s Enron to Model Citizen?” www.businessweek.com,

May 17, 2004. 4 “Former Ahold executives indicted over fraud,” www.nutraingredients-usa.com, July 28, 2004.

5 “Ahold settles scandal suit for $1.1 billion,” www.money.cnn.com, November 28, 2005.

6 Alexander Hudson & Wendel Broere, “Ahold settles US lawsuit for $1.1 billion,”

www.yahoo.reuters.com, November 28, 2005.



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which acted as the mediator was compensated with € 2.5 million to cover its expenses. Investors also expressed their optimism over the deal. One investor commented, “The damage is not too big and can easily be paid out of Ahold‟s cash pile.”

7 Ahold considered the settlement as the last

significant civil case it would have to face because of the accounting scandal. However, Ahold was still under investigation by U.S. Department of Justice (DoJ).

The financial scandal caused serious trouble for Ahold. For the year 2002, Ahold showed losses of around € 1.2 billion. The period following the scandal, the company faced a severe cash-crunch and was close to bankruptcy. In 2003, it was rescued by an emergency credit line offered by its banks. Some of Ahold‟s ex-employees including the vice-president of US Foodservice were facing criminal charges. Many members of the management who had occupied responsible positions were forced to resign in the months after the fraud came to light. The company vowed to comply strictly with the revised Dutch Corporate Governance Code which came into effect on January 01, 2004. In 2004, the new management embarked on an ambitious revival program christened “Road to Recovery”. Corporate Governance was to be an integral part of the three-year program.

Table I: Ahold’s Operating Companies

As of 2005

Name of the

Company Country

Ahold’s

Stake

Nature of

Operations

Year

Established

Joined

Ahold in

Stop & Shop USA 100% Retail 1914 1998

Giant-Landover USA Retail 1936

Giant-Carlisle USA 100% Retail 1923 1981

Tops USA 100% Retail 1962 1991

Albert Heijn The

Netherlands

100%* Retail and

Distribution Centers

1887 1887

Etos The

Netherlands

100%* Specialty Retail

(Health and Beauty

care)

1918 1974

Gall & Gall The

Netherlands

100% Specialty Retail

(Alcohol)

1884 1989

Ahold Polska Poland 100% Retail 1995 1995

Ahold Czech

Republic

Czech

Republic

99% Retail 1991 1991

Ahold Slovakia Slovakia 100% Retail 2001 2001

Schuitema

(C1000)

The

Netherlands

73.2% Retail and

wholesale

1888 ---

ICA Ahold Sweden,

Norway

50%

Joint

venture

Retail and

Wholesale

1917 2000

Jeronimo

Martins Retail

Portugal 49%

Joint

venture

Retail 1792 1992

US Foodservice USA 100% Food service 1989 2000

Note: Some Albert Heijn and Etos stores were franchisees.

Source: www.ahold.com.

7 “Ahold settles scandal suit for $1.1 billion,” www.money.cnn.com, November 28, 2005.



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BACKGROUND NOTE

The origins of Ahold can be traced back to 1887, when 22 year-old Albert Heijn (Heijn) took over his father‟s small grocery store in Zaandam, Holland. Due to Heijn‟s untiring efforts, the store, which was named after him, became popular for its high quality, reasonably priced products and services. Soon Heijn opened a second store in Alkmaar, also in Holland. By 1897, Heijn increased the store count to 23. These were located in different parts of Holland including The Hague and Amsterdam. In 1911, the first Albert Heijn branded products was introduced (cookies baked by Heijn himself). In 1948, Albert Heijn was listed on the Amsterdam stock exchange. Albert Heijn opened its first self-service supermarket chain in 1955. In 1973, to take the growth story forward, the Heijn family established Ahold as a parent company with Albert Heijn as the main subsidiary. In the same year, Ahold entered into specialty retailing with Alberto (a liquor chain) and Etos (a health and beauty care chain).

AHOLD’S ACQUISITIONS

Albert Heijn made its first acquisition in 1951 when it acquired the Netherlands-based Van Amerongen store chain. In 1977, Ahold entered the US market by acquiring the BI-LO supermarket chain (which had stores in Georgia, North & South Carolina). This was followed by the acquisition of Giant food stores (based in Carlisle, Pennsylvania) in 1981 and Finast (based in Ohio) in 1988. With these acquisitions, Ahold strengthened its position in the US.

The 1990s was a period of rapid expansion. In 1991, Ahold opened a wholly-owned supermarket chain called Mana in the Czech Republic (later renamed Albert). In 1992, Ahold entered into a joint venture with the Portuguese chain Jerónimo Martins to form Jerónimo Martins Retail (JMR). The company also continued expanding in the US by acquiring Tops Markets (based in New York) in 1991, Red Food Stores‟ 55 supermarkets (based in Tennessee and Georgia) in 1994, Mayfair (based in New York) in 1995, and Stop & Shop (based in New England) in 1996. In 1996, Ahold entered several other countries including Thailand, Malaysia, China, Brazil, Spain, Poland, and Singapore, through partnerships. Taking advantage of newly liberalized regimes, the company stepped up its expansion in emerging markets in the late 1990s. In 1998, Ahold entered into a joint venture with Velox Retail Holdings (Velox). The joint venture took majority stake in the Disco supermarket chain in Argentina and the Santa Isabel chain in Chile, Peru, and Paraguay. In 1999, the company partnered with La Fragua – a leading retailer in Central America with a good presence in Guatemala, El Salvador, and Honduras. In 2000, Ahold entered into a joint venture with the Scandinavia-based ICA Group. In March 2000, Ahold acquired US Foodservice. It also acquired around 150 supermarkets in Spain (Refer Exhibit I for Ahold‟s Acquisitions during 1991-2001).

According to many analysts, Ahold was a loose union of disparate entities. The companies which came under the Ahold fold adopted different practices. The management and employees of these companies took pride in their history and unique identity. Ahold allowed them to operate in the manner that suited them. Several analysts felt that Ahold‟s lack of control of its subsidiaries was the primary reason for the occurrence of the accounting scandals.

THE SCANDALS

On February 24, 2003, Ahold announced that its earnings for 2002 financial year would not be

as high as previously estimated. It also declared that its 2000 and 2001 financial statements

did not reflect its true financial status and would have to be restated. Ahold‟s auditors Deloitte

& Touche (D&T)8 detected accounting irregularities at various operating companies in Europe

and Latin America. However, the eye of the storm was the scandal at US Foodservice.

Altogether, the accounting irregularities at Ahold‟s various operating companies amounted to

around US$ 1 billion.

8 Deloitte & Touche is the US accounting arm of Deloitte Touche Tohmatsu. The company offers auditing,

management consulting and other related services. Deloitte & Touche has operations in 90 US cities.



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US FOODSERVICE

US Foodservice was a service company which distributed food. Its clientele included hotels,

restaurants, cafeterias, health care facilities, schools, etc. The company was headquartered in

Columbia, Maryland, and had more than 100 distribution centers spread across the US. The Ahold

group acquired US Foodservice in 2000. US Foodservice came to become the epicenter of the

scandal that shook Ahold.

The scandal involved US Foodservice executives colluding with employees at Sara Lee

Corporation9 (Sara Lee), ConAgra

10 and some other companies to mislead auditors. US

Foodservice was given rebates by companies like Sara Lee for selling certain amounts of its

products. Taking advantage of lax controls, the accused employees at US Foodservice overstated

the rebates and took bonuses from the company. Linda Chatman Thomsen, Deputy Director,

Division of Enforcement, Securities and Exchange Commission (SEC) said, “Executives at US

Foodservice went to extraordinary lengths to perpetuate the illusion of stellar financial

performance. Their fraud created the appearance that they had met their budgets and allowed them

to line their own pockets with unearned bonuses.”11

Executives of Sara Lee and other supplier

companies, who seemed to have been hand in glove with the accused officials of US Foodservice,

misled D&T regarding the value of the rebates. Thomas Newkirk, Associate Director, Division of

Enforcement, SEC said “To cover up their scheme, the defendants needed false confirmations

from suppliers to defeat the audit process. It is disappointing that the defendants so successfully

corrupted the audit and confirmation process.”12

US Foodservice included the overstated rebates in

its annual accounts which led to inflated earnings. Initially, Ahold issued a press statement which

put the overstatement at US$ 400 million, but finally, the number was significantly higher at US$

850 million. The overstatements caused Ahold to restate its results for the years 2000, 2001 and

the first three quarters of 2002. (Refer Exhibit II for Ahold‟s financials and Exhibit III for

Restatements).

The accused employees at US Foodservice included former chief financial officer, Michael

Resnick, former chief marketing officer, Mark Kaiser, (they insisted that they were not guilty of

any crime); former Vice-Presidents of US Foodservice – Timothy Lee and William Carter (they

accepted their guilt). The four executives were sacked immediately after the scandal came to light

in February 2003. Following the scandal, the chief executive and founder of US Foodservice, Jim

Miller, resigned from his position.

The employees at Sara Lee who gave false information regarding the rebates were dismissed in

August 2003. Top officials at Sara Lee tried to avoid the media attention that their company was

receiving when the link with the Ahold scandal was established. “While this is a serious matter, we

want to emphasize that Sara Lee is not the focus of this investigation (by the US Securities and

Exchange Commission), and this discovery (concerning rebates) in no way affects our financial

results. Sara Lee‟s accounting for our business with US Foodservice is both accurate and

appropriate,”13

said C. Steven McMillan, chairman, president and chief executive officer, Sara Lee.

9 Sara Lee, which started as a small distribution company in 1939 has grown to become a global

manufacturer and marketer of essentially three product lines – Food & Beverage, Household & Body

care, and Branded apparel. Some of its brands are Hanes, Kiwi, Ambi Pur etc. 10

ConAgra owns a diverse range of brands such as Van Camp’s (tinned pork), Armour (hot dogs), Hunt’s

(tomato products), Eckrich (smoked sausages, franks), Wesson (cooking oil) etc. ConAgra Foods has

grown to become North America‟s largest packaged food companies serving retailers, restaurants and

other establishments. 11

“Former Ahold execs indicted over fraud,” www.foodanddrinkeurope.com, July 28, 2004. 12

“SEC charges former top executives of US Foodservice with $ 700 million securities fraud,”

www.sec.gov, Press Release, July 27, 2004. 13

“Sara Lee executives implicated in Ahold scandal,” www.nutraingredients-usa.com, August 04, 2003.



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OTHER OPERATING COMPANIES

In February 2003, almost simultaneously with the US Foodservice scandal, Ahold announced that

four joint ventures namely – ICA, Jeronimo Martins Retail, Bompreco (sold in March 2004),

Disco (sold in March 2004) and Paiz Ahold (sold earlier) should not have been fully consolidated

in its accounts. The Ahold group did not hold a 100% stake in the joint ventures and its

consolidation of 100% of the joint ventures‟ profits in its accounts was tantamount to fraud.

Investor associations felt that Ahold and its auditors D&T were aware or irresponsibly ignored the

fact that Ahold never had a basis for consolidating the financial results of the joint ventures.

On further investigation, it was found that the practice of consolidation had been followed from the

late 1990s. Though D&T warned Ahold on several occasions about the inappropriateness of the

accounting practice, it continued to approve Ahold‟s accounts. D&T sent a letter to Ahold as early as

August 24, 1998 mentioning that consolidation of joint venture financial results was appropriate only

if Ahold had control over the joint ventures. The letter also conveyed D&T‟s belief that Ahold did

not have control over any of its joint ventures. D&T, however, agreed to approve Ahold‟s accounts

because Ahold indicated that it would adjust the joint venture agreements by executing „control‟

letters – letters that would supposedly indicate Ahold‟s control over the joint ventures. In 1998, the

then chief financial officer, Michael Meurs drafted, and D&T approved, the „control‟ letters after

which the company fraudulently consolidated the financial results of the joint ventures in its

accounts. Again in early 2002, D&T sent a letter to Ahold communicating its concern that SEC

would find the consolidation of joint venture accounts inappropriate. However, Ahold continued to

consolidate the joint ventures‟ accounts till the issue came to light in February 2003.

Meanwhile, issues concerning Ahold‟s joint venture in South America also cropped up. Ahold had

entered into a deal with Velox of Argentina in 1998, where it bought a share (34%) in Disco

supermarkets. The deal included a clause which required Ahold to buy out Velox (which held

44.1% in Disco) in case the latter became bankrupt. Ahold‟s management kept details of the clause

hidden from its shareholders. It was only in the 2001 annual report that the company cared to

mention the clause. In 2002, Velox filed for bankruptcy, and Ahold had to shell out US$ 492

million to the Peirano family, the owners of Velox. In March 2003, the Dutch Foundation for the

Investigation of Corporate Information (referred as SOBI) demanded that D&T disclose the name

of the auditor who endorsed the Velox deal. Peter Lakeman, the founder of SOBI filed a

disciplinary complaint against the employee14

of D&T for “willful negligence” which carried a

maximum punishment of suspension from practice.

In the period succeeding the initial announcement regarding overstatement of accounts at US

Foodservice, news of fraud and mismanagement at some of Ahold's other operating companies

came thick and fast. In February 2003 itself, Ahold directed internal investigations into all its

operations.

The internal investigations exposed other irregularities as well. In May 2003, accounting

irregularities involving “earnings management and misapplications of generally accepted

accounting principles (GAAP)” were discovered at Tops, a US based subsidiary. Ahold‟s

management also stated that there was a high probability that the accounting irregularities at Tops,

which totaled approximately US$ 29 million (€ 24.5 million), were “intentional”.

Referring to the internal investigations, one of the company‟s officials said, “The investigations

completed thus far have also preliminarily identified or confirmed various accounting issues and

internal control weaknesses. Management is studying the findings to assess whether additional

adjustments may be required to correct any accounting errors that may affect results of operations

and to identify needed improvements in controls and procedures at the relevant companies.”15

14

Dutch law entertained disciplinary complaints only against individuals and not against companies. 15

“Ahold delays audit results as fraud deepens,” www.foodanddrinkeurope.com, May 26, 2003.



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Shareholders were livid on hearing about the new discoveries. One of them commented, “… now

we have to worry about the possibility that they might uncover more and more problems as they go

through the books.”16

THE AFTERMATH

The accounting scandals had a significant impact on the market standing of Ahold. Soon after the news about the scandals spread, Merrill Lynch gave a neutral rating on Ahold‟s stock and one of its analysts, Andrew Fowler, published a note titled „The beginning of the End‟ in which he said “The emergence of the accounting irregularities and the fact that Ahold will now be a forced seller in a global bear market prevents us to turn any more positive on its shares.”

17 Ahold‟s long-term debt was

downgraded by Standard & Poor to BB+ or junk status. Criticism poured in from all quarters. Christopher Gower, Analyst, Lehman Brothers observed, “With no management, no clarity on accounts, no clarity on financing, future strategy, or disposals, it‟s a long road back.”

18 However,

some industry observers expressed optimism about Ahold‟s revival, given its high sales turnover.

A week after the scandals came to light, Ahold‟s CEO Cee van der Hoeven and CFO Michael Meurs resigned from their posts. Almost immediately, several investors filed securities fraud lawsuits against Ahold; these were consolidated into a single class-action suit. The scandals proved costly for Ahold with professional bills amounting to more than US$ 117.2 million in 2003. The huge bill was to be paid to lawyers, accountants and external consultants. Apart from these, the company‟s earnings in 2003 were affected by low margins at US Foodservice. Ahold‟s accounting procedures were being investigated by the US SEC, US DoJ and Dutch regulators.

After the announcement relating to the accounting frauds, Ahold‟s shares had plummeted to US$ 6.53 (Refer Exhibit IV for Ahold‟s share market performance from 2001-05). A trader at Madoff Securities, London said, “It remains to be seen if Ahold can recover from this credibility crisis.”

19

Owing to the scandal and the investigations into the scandal, Ahold suspended the reporting of its 2002 financials. Ahold‟s supervisory board was successful in securing a lifeline credit of € 2.65 billion to meet its working capital and other contingencies.

In April 2003, the Dutch Public Prosecutor announced that it has begun a probe into the irregularities at Ahold. The probe was to focus on the improper consolidation of Ahold‟s joint venture, specifically the Sweden-based ICA - in its accounts. It was to investigate the details about control letters that Ahold had drafted to fraudulently claim that it controlled ICA and other joint ventures.

Anders C. Moberg (Moberg), a 54-year old Finn, was appointed as the acting CEO of Ahold in May 2003. Moberg had successfully headed Ikea and Home Depot before joining the Ahold group. Hannu Ryopponen (Ryopponen), also a Finn and Moberg‟s colleague in Ikea, took over as CFO in mid-2003. In October 2003, Ahold replaced Miller with Lawrence Benjamin (Benjamin) as the new CEO of the scandal-ridden US Foodservice.

In October 2003, Ahold released the 2002 audited consolidated financial results. The company had posted a huge loss of € 1.2 billion. However, the saving grace was an operating profit of € 2.4 billion and sales of € 62.6 billion. Ahold was obliged to adjust its reported sales downwards by 40 billion euros over the period beginning 2000 and ending with the third quarter of 2002 as well as entering a downward adjustment of 970 million euros to posted profit. The loss in terms of stock value was estimated to be € 23 billion.

On November 7, 2003, Moberg launched a comprehensive recovery program called “Road to

Recovery”. The three year program included financial planning and a clear-cut strategy aimed to

bring the company back to profitability. The program intended to turn the company around by

16

“Ahold admits new accounting scandal,” www.bbc.co.uk, May 26, 2003. 17

“Ahold shares tumble,” www.money.cnn.com, February 24, 2003. 18

Jason Karaian, “Retail therapy,” www.cfoasia.com, June 2005. 19

“Ahold shares tumble,” www.money.cnn.com, February 24, 2003.



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improving its business focus and putting a fool-proof accounting and control mechanism in place.

The plan also aimed to mobilize resources by selling Ahold‟s non-core assets and its stake in

several subsidiaries in Latin America and Asia (Refer Exhibit V for Ahold‟s Divestment spree).

The annual general meeting held on November 26, 2003, the first after the scandals came to light, gave small investors an opportunity to confront the management of the company. Around 563 shareholders, representing 40.5% of Ahold‟s shares outstanding, attended the meeting. At the meeting, Ahold‟s management admitted that profits at US Foodservice were overstated by US$ 880 million and that other accounting irregularities have been detected at other operating companies. The atmosphere at the meeting was charged as investors demanded details about the scandal. One investor insisted that senior Ahold executives who resigned at the time of the scandal not receive any form of pay-off; rather that the company should begin legal action to extract damages from them.

At the annual general meeting, Moberg was officially appointed as the President and CEO of Ahold. Though shareholders were supportive of Moberg‟s appointment as CEO, they raked up the issue of Moberg‟s remuneration. Moberg had demanded an annual base salary of € 1.5 million for the first two years and a guaranteed bonus of € 1.5 million. He was also expecting performance-based payments, 250,000 shares in the company and 1 million stock options. As part of the deal, he was guaranteed an exit package of 2 years salary and bonus (twice the usual bonus) – which came to a whopping € 10 million! Shareholders wanted to know why Moberg was being paid such a high remuneration package, especially when the company was financially weak. Ahold‟s supervisory board gave in to the pressure and annulled Moberg‟s exit package and made his bonuses performance-based. Responding to the outcry about his compensation, Moberg said, “What I learned was that remuneration is a heavy issue in a stressed company.”

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At the annual general meeting, Wakkie, a famous Dutch lawyer, was appointed as Ahold‟s chief corporate governance counsel – a new position created to oversee the business practices of the group. The shareholders adopted the restated financial statements and the audited financials for 2002 at the meeting. The shareholders also approved the rights issue which was expected to give a fillip to Ahold‟s precarious financial position. Post-scandal, Ahold was reeling under a debt burden of € 12 billion, and had already withdrawn close to €1.2 billion from its emergency credit facility. The company had two options to raise money – it could have sold US Foodservice, or raised money through a rights issue. Considering that US Foodservice was the center of the accounting scandal, Ahold feared that it wouldn‟t be in a position to extract the right price for the tainted company. Therefore, Ahold chose to go with the second option by announcing a 2-for-3 rights issue in December 2003. Ahold raised US$ 3.5 billion from the equity issue which it used primarily to reduce its debt pile.

In 2004, Ahold appointed PricewaterhouseCoopers to conduct a forensic audit21

as part of Ahold‟s internal investigation into the scandal. The audit identified lax internal controls and poor financial and accounting practices at Ahold‟s U.S. operations as the underlying cause for the fraud. Out of the 470 accounting irregularities identified, 275 were directly related to weak internal controls. The audit concluded that Ahold‟s aggressive growth strategy in the U.S. overlooked the fundamental rules of control in a decentralized organization. The complete absence of strict internal, financial and accounting controls across the organization was the major cause of the accounting irregularities.

On September 30, 2004, Ahold announced that it would pay € 8 million as a fine to the Dutch

Public Prosecutor which was probing the „control letters‟ issue. The Dutch Public Prosecutor

promised that it would not bring about proceedings against Ahold. On October 13, 2004, the

Securities & Exchange Commission (SEC) announced the filing of enforcement actions charging

20

Ben McLannahan, “Strings attached,” www.cfoeurope.com, March 2004. 21

Forensic audit facilitates the prevention, detection, and investigation of economic crimes. It involves the

examination of evidence with respect to a claim and whether the evidence corresponds to established

standards. These audits are carried out in a manner suited to the relevant court.



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Ahold and three of its employees – Cees Van der Hoeven (former CEO and chairman of executive

board), Michael Meurs (CFO) and Jan Andreae (former executive vice-president) with fraud and

other violations. SEC also charged Roland Fahlin (former member of the supervisory board and

audit committee) “with causing violations of the reporting, books and records, and internal

controls provisions of securities laws”22

. Ahold agreed to settle SEC‟s action. The company neither

owned up nor refuted the allegations. However, Ahold scrupulously provided documents and

assistance in the commission‟s investigations. Appreciating Ahold‟s “extraordinary” cooperation,

SEC let off the company without fines. Ahold‟s lawyer from White & Case LLP (New York),

Lawrence Byrne said, “The settlement with the SEC is another important step for the company to

continue to move forward.”23

MAJOR INVESTIGATION

On January 6, 2005, the Enterprise Section of the Amsterdam Court of Appeals granted the request

made by VEB to verify Ahold‟s practices and whether the company was professionally managed

during the period leading up to the scandal. VEB had filed the request on February 12, 2004. The

court concluded that the request was valid and that there was a need to check whether sound

management principles had been followed in Ahold. The court ruling resulted in a thorough

inquiry by independent experts chosen by the Enterprise Chamber into the management of Ahold.

The inquiry was expected to bring to light the goings on at Ahold and the identities of the persons

and the units that were either involved or bore responsibility for the fraud. The inquiry probed the

period between January 1, 1998 and December 13, 2003. Three investigators were appointed and

the budget for the inquiry was € 250,000, which was the highest figure ever allocated for an

inquiry by the court.

The inquiry was primarily focused on two areas - the financial mismanagement at U.S.

Foodservice, and the inappropriate consolidation of Scandinavian-based ICA in the accounts of

Ahold. The investigation covered the fraud involving vendor allowances (or rebates) at U.S.

Foodservice. The inquiry was centered on whether enough was done to place internal controls

against the risk of fraud. Regarding the accounting irregularity concerning Ahold‟s joint ventures

including ICA, the inquiry tried to gather information on whether the Executive Board Directors

and the Supervisory Board Directors were aware of the specifics relating to the consolidation issue

or should have known about it.

The court included two other issues in the investigation. The first issue concerned Ahold‟s

discretion in acquiring U.S. Foodservice. The court was of the view that Ahold did not investigate

contracts with suppliers during its pre-purchase appraisal of US Foodservice. The second issue was

regarding the controls employed over the operating companies. The court noted that Ahold‟s poor

control and reporting system with respect to its operating companies could have been the cause of

the accounting fraud at US Foodservice. Further, the court also pointed out that Ahold had been

going through a period of unrestrained expansion (In the period between 1998 and 2002, the

company spent €10.5 billion on acquiring companies). The court “doubted whether Ahold was

following sound principles of management in terms of its supervision of operating companies, in

terms of planning for and executing internal controls at operating company level and ensuring

proper reporting to corporate headquarters.”24

Ahold objected strongly to the inquiry petition. But the court observed that Ahold‟s objections

were not valid. Ahold argued that an inquiry was not necessary because it was taking measures to

correct the situation. The court, however felt that remedial measures could not dispel doubts about

22

“SEC charges Royal Ahold and three former top executives with fraud…” Press Release, www.sec.gov,

October 13, 2004. 23

Carrie Johnson, “Ahold settles SEC fraud charges,” www.washingtonpost.com, October 14, 2004. 24

“Major investigation into mismanagement at Ahold,” www.veb.net, January 13, 2005.



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the past. Another argument advanced by Ahold was that there were enough inquiries into Ahold

and there was no need for another. But the court observed that the other inquiries were of a

different order and were commissioned for specific issues like non-compliance with Article 28H25

of the Listing and Issuing Rules, allegations of criminal behavior, etc.

On November 28, 2005, Ahold reached a worldwide settlement with its shareholders. The company agreed to pay US$ 1.1 billion to shareholders who had bought Ahold‟s shares between July 30, 1999 and February 23, 2003. It was estimated that after deductions for legal and administrative fees, the shareholders would get any where between $1 and $1.30 per share. VEB which brokered the deal was compensated with US$ 2.5 million. According to the agreement, VEB also promised not to proceed further irrespective of the findings of the inquiry ordered by the Amsterdam Court of Appeals. VEB agreed as it was incurring heavy legal and other incidental expenses and moreover the settlement provided the shareholders, whom VEB represented, a quick and satisfactory solution.

AHOLD’S ATONEMENT

The magnitude of the accounting frauds at Ahold shook Europe, particularly the company's home country, Holland. The irregularities at Ahold brought to the fore the need for a revision of existing corporate governance standards in the Netherlands. At the instance of several government and non-government bodies, the Tabaksblat committee

26 adopted and published the Dutch Corporate

Governance Code (Refer Exhibit VII for a brief write-up on Dutch Corporate Governance Code) in December 2003, which replaced the Corporate Governance in the Netherlands Reports: the Forty Recommendations of the Peter‟s Committee. The revised Code was considered to be a major step towards the empowerment of the shareholder.

The Dutch Corporate Governance Code, which was issued on December 09, 2003, came into effect on January 01, 2004. The Code, which was seen as a direct outcome of the Ahold scandal, included a number of measures that attempted to resolve issues raised by the Ahold episode, such as announcing an individual‟s proposed remuneration package prior to nomination, severance arrangements, etc.

On February 16, 2004, Ahold declared that it would comply with the Dutch Corporate Governance Code. The company convened an extraordinary general meeting of shareholders on March 03, 2004. At the meeting, Ahold‟s shareholders agreed to all the proposed changes to the corporate governance structure (Refer Exhibit VIII for Ahold‟s Revised Corporate Governance Structure). The company declared that it was adhering to all the provisions, barring two, of the Dutch Corporate Governance Code. The first exception was that executive board members at Ahold were allowed to sell their shares (obtained under long-term incentive plan) after three years, whereas the Dutch Corporate Governance Code, best practice principle II.2.3 recommended that corporate executive board members keep shares for five years after vesting. This deviation from the best practice was agreed to by the shareholders in the remuneration policy adopted in the extraordinary general meeting. The second anomaly was the Vice-Chairman of Ahold‟s Supervisory Board holding chairmanship/membership of six supervisory boards when the Dutch Corporate Governance Code, best practice principle III.3.4 expected board members to hold not more than five memberships/chairmanships. The Supervisory Board promised to make right the deviation from the code in due course which was agreed to by the shareholders.

The company constituted a new executive leadership team and tightened controls over its financial

systems. Ryöppönen said, “The overhaul of internal finance functions reflected the need to ensure

reliable and transparent reporting and underlined improvements to the company‟s control

25

Article 28H of the Listing and Issuing Rules required listed companies to expeditiously publish

information/facts or events concerning the company, if such information could have a direct and material

effect on the price of its shares (Source: www.euronext.com). 26

The Corporate Governance Committee often referred as the Tabaksblat committee published the Dutch

Corporate Governance Code on December 09, 2003. Morris Tabaksblat was the chairman of the committee.



10

environment.”27

The chief financial officer for Ahold‟s US operations, Brian Hotarek was

appointed as the chief business controlling officer. He was given the additional responsibility to

implement the new accounting controls across the company‟s retail operations and coordinate the

real estate strategies and the capital budgeting process of the entire group. The corporate

accounting and control department, rechristened „accounting and reporting‟ (A&R) department

was given complete responsibility regarding all issues concerning accounting and reporting. In

July 2003, Joost Sliepenbeek was appointed as the senior vice-president and controller responsible

for the A&R department.

In April 2004, Ahold stated its plan to overhaul its internal accounting controls to make them more

stringent. The company also stated that it would retire some of its debt by selling its stake in some

of its operating companies. The company hoped that the news of Ahold‟s debt reduction would

send a strong signal that the company was firmly on the path to recovery. The company also

planned to redeem its 4% convertible subordinated notes28

which matured in 2005. According to

the company, the accounting controls that it was placing were part of the “Road to Recovery” plan,

which it introduced immediately after the scandal. The plan aimed to recover € 2.5 billion by the

sale of non-core assets by 2005. The plan also targeted an investment grade credit rating by the end

of 2005.

Additionally, a new corporate governance office was created in US Foodservice to oversee the

operations and business practices of the company. “US Foodservice has taken numerous actions

over the course of the past year and a half to ensure this conduct (financial fraud) does not occur

again,”29

said Wakkie in July 2004. In 2005, Ahold also effected a structural change in US

Foodservice to make it more profitable and to maximize control. Moberg said, “Our management

team has accomplished a major organizational overhaul at U.S. Foodservice during the past two

years, integrating the past acquisitions, strengthening the operations, improving internal controls,

enhancing corporate governance and restoring employee pride.”30

In December 2005, Ahold‟s US Foodservice organized a „training program‟ on ethics for its

28,000 employees including its CEO, Lawrence. As part of the training, employees were asked

quiz-style questions about situations that involved conflicts of personal interest and financial

integrity.

The accounting fraud that surfaced at US Foodservice and other operating companies dealt a

severe blow to Ahold‟s finances, but more importantly its credibility and reputation as a respected

corporate citizen was seriously damaged. The company understood that a solid foundation of

corporate governance and effective accounting standards were more important than growth and the

top line. By the end of 2005, the company had managed to settle most of the legal hassles that it

was tied up with after the scandal and was slowly inching towards profitability. It had also put in

place an improved corporate governance mechanism to prevent recurrence of such fraud. Still, it

remains to be seen whether Ahold can redeem its reputation and establish itself as a respected

corporate citizen.

27

“Ahold unveils new accounting procedures,” www.investorsassociation.org, March 2003. 28

Subordinated notes are instruments of debt. In the event of bankruptcy, the subordinated note-holders are

paid after the main debt holders are paid out. 29

“Former Ahold execs indicted over fraud”, www.foodanddrinkeurope.com, July 28, 2004. 30

“Ahold announces US Foodservice long-term strategy and financial targets” www.biz.yahoo.com,

November 29, 2005.



11

Exhibit I

Ahold’s Acquisitions (1991-2001)

Month and

Year Company Country

% of

Acquisition Value

February 1991 Tops Markets US 100% €332.67

September 1992 Jeronimo Martins Retail

(JMR)

(Joint venture with

EstabelecimentosJeroni

mo Martins & Filho)

Portugal 49% N.A

February 1994 Red Food Stores US 100% €116.08

August 1995 Mayfair US 100% N.A

March 1996 Stop & Shop US 100% €2,307.82

November 1996 Bompreco Brazil 50% €215.55

May 1998 Giant- Landover US 100% €2436.62

December 1998 Disco

(Joint venture with

Velox Retail Holdings)

Argentina 34% €506.71

December 1999 ICA

(Joint venture with ICA

Forbundet/ Canica)

Norway/Swe

den

50% €1800

December 1999 Paiz Ahold#

(Joint venture with

CSU)

Guatemala 50%

March 2000 US FoodService US 100% €3,776.04

May 2000 Bompreco Brazil 50% €240.18

September 2000 Superdiplo Spain 97.64% €1,250.00

December 2000 PYA/Monarch* US 100% €1843.49

November 2001 Alliant Exchange US 100% €2,467.52

December 2001 Bruno‟s supermarkets US 100% €556.90

Compiled from various sources.

N.A – Not Available; * Merged with US Foodservice; # Paiz Ahold had a controlling stake in La Fragua, the

leading supermarket chain in Guatemala.



12

Exhibit II

Ahold’s Financial Data

Year Total Assets

(€ million)

Debt-to-

Equity

Ratio

Interest

Coverage

Ratio

Operating

Cash Flow

(€ thousands)

Net Income

(€ Thousands)

Earnings per

Share (€)

1976 356,121.7 1.88 3.80 N.A 12,962.2 0.13

1980 567,239.3 2.05 5.25 N.A 23,534.4 0.18

1984 1,293,441.1 1.93 2.82 N.A 49,243.8 0.25

1989 1,925,612.3 1.70 2.70 232,887.7 88,304.3 0.32

1990 1,939,454.8 1.67 4.10 302,804.4 110,408.8 0.38

1991 2,439,055.0 2.83 3.00 349,182.1 125,159.4 0.42

1992 2,873,652.6 3.00 2.90 343,592.9 138,422 0.45

1993 3,623,135.1 2.39 2.49 307,956.6 155.698.3 0.45

1994 3,705,389.5 2.30 2.92 462,267.3 185,841.6 0.52

1995 4,195,437.7 2.63 3.12 693,630.3 207,187.4 0.57

1996 6,747,687.8 3.79 3.32 522,655.4 286,982 0.65

1997 8,548,869.9 3.64 3.04 924,692 423,753.6 0.80

1998 11,426,373.3 4.75 3.18 1,257,694.1 547,198.6 0.93

1999 14,285,642.0 5.17 3.36 2,699,879 752,107 1.15

2000 25,460,624.0 6.45 2.80 2,600,734 1,115,991* 1.51

2001 32,236,464.0 3.59 2.65 2,375,721 1,113,521* 1.73

2002 24,738,000.0 7.47 0.24 2,486,000 -1,246,000 -0.85

2003 23,399,000.0 3.31 0.75 1,909,000 -39,000 -0.04#


# - 2003 EPS after dividends on cumulative preferred shares; * - 2000 and 2001 Net income were restated;

N.A – Not Available.



13

Exhibit III

Restatements In euros

Item 2000 2001

Net income under Dutch GAAP as previously reported 1,116,000 1,113,000

Correction of errors

Deconsolidation 0 0

Deconsolidation adjustments -10,000 -5,000

Vendor allowances -103,000 -215,000

Acquisition adjustments -8,000 -36,000

Provisions -38,000 -33,000

Real estate transactions -26,000 -2,000

Other -21,000 -53,000

Change in accounting principles

Pensions 11,000 16,000

Revaluations -1,000 -4,000

Restructuring provisions - -35,000

Net income under Dutch GAAP as restated 920,000 750,000


Exhibit IV

Ahold’s Stock Market (NYSE) Performance (2001-05)

Source: www.washingtonpost.com.



14

Exhibit V

Ahold’s Divestment Spree

S. No. Company/Operations

Divested or Sold

Year of

Divestment Country/Region Buyer

01. Ahold‟s operations Apr 2003 Indonesia Hero

02. Ahold‟s operations Apr 2003 Argentina,

Paraguay, Peru &

Brazil

---

03. Jamin Winkelbedrijf B.V Jun 2003 Holland ---

04. Santa Isabel Aug 2003 Chile Cencosud S.A

05. Supermercados Sept 2003 Paraguay A.J.Vierce

06. Golden Gallon Oct 2003 USA The Pantry Inc

07. 2 Ahold Hypermarkets Nov 2003 Poland Carrefour

08. Supermercados Santa

Isabel S.A

Dec 2003 Peru Groupo Interbank

& Nexus Group

09. Bompreco Mar 2004 Brazil Wal-Mart

10. Disco S.A Mar 2004 Argentina Cencosud S.A

11. CRC Ahold Mar 2004 Thailand Central Group

12. Ahold‟s operations Oct 2004 Spain Permira Funds

13. BI-LO and Bruno Jan 2005 USA Lone Star Funds

14. Hypernova hypermarkets Jan 2005 Poland Carrefour

15. G.Barbosa Comercial Apr 2005 Brazil ACON

investments

16. Tops* June 2005 USA ---

17. Deli XL Sep 2005 Benelux Bidvest Group

18. CARHCO Sep 2005 Central America Wal-Mart

Compiled from www.ahold.com.

* As part of its strategy to redefine its core market, Tops sold its stores in the Eastern New York and

Adirondack regions of the US.



15

Exhibit VI

Brief Write-up on Dutch Corporate Governance Code

The Ministry of Finance and Economic Affairs of the Dutch government drafted the Dutch

Corporate Governance Code in December 2003, at the instance of Euronext Amsterdam, the

Netherlands Centre of Executive and Supervisory Directors, the Foundation for Corporate

Governance Research for Pension Funds, the Association of Shareholders, the Association of

Security-Issuing Companies, and Confederation of Netherlands Industry and Employers. The

Code replaced the „Corporate Governance in the Netherlands Reports: the Forty

Recommendations of the Peters Committee‟. It applied to all companies who had their

registered office in the Netherlands and whose shares were officially listed in a government-

recognized stock exchange.

The code was drafted by the Dutch Corporate Governance Code committee, also referred as the

Tabaksblat committee. The committee was composed of Morris Tabaksblat (Chairman of the

committee), Rients Abma (Secretary), Marco Knubben (Assistant Secretary), and the following

members – Frederik van Beuningen, Prof.Japp Glasz, Giles Izeboud, Jan Kalff, Peter de

Koning, George Moller, Rob Pieterse, Peter Paul de Vries, Arie Westerlaken, and Prof. Japp

Winter. The Code, which came into effect from January 1, 2004, outlines the principles and

provisions that management, board members and stakeholders should follow in relation to each

other. It requires companies to follow the principles and make it known to all the stakeholders

in the annual report (the code, however, does not prescribe any format). It consists of specific

provisions which are standards concerning the conduct of management board, supervisory

board and shareholders. Under the code, listed companies are expected to include a chapter on

Corporate Governance in their annual reports. Listed companies have the choice of not

following some or all the provisions. But the company is, however, obliged to explain why it

couldn‟t follow the principles („apply or explain‟ clause). Analysts have been appreciative of

the Code and note that even when the code does not suggest unrestrained freedom for the

companies, it is sufficiently flexible.

Adapted from www.lbicon.com.



16

Exhibit VII

Revised Corporate Governance Structure at Ahold

Ahold is managed by a Corporate Executive Board (CEB). The Supervisory Board (SB)

oversees the CEB.

CORPORATE EXECUTIVE BOARD

The CEB consists of a minimum of three members. The members are appointed by the

shareholders in the general meeting for a term of four years. If reelected, the members can

retain membership for another term. The shareholders have the power to dismiss, or suspend the

members of CEB by casting an absolute majority of votes.

DISCLOSURE AND COMPLIANCE COMMITTEE (D&CC)

The D&CC supervises the collection and analysis of financial and non-financial information of

Ahold and its operating companies. A sub-committee assists D&CC in the coordination of

annual report process and another manages the website.

SUPERVISORY BOARD

The SB decides for itself the maximum number of members. The members are appointed for a

term of four years. Each member can serve for a maximum of three terms (12 years). The SB

supervises the policies of CEB and the general management of Ahold and its operating

companies. According to Ahold‟s articles of association, the SB has to approve the following –

issuing shares, acquisitions, redemptions, repurchases of shares, reduction in issued and

outstanding shares etc. The SB oversees its performance. The appointment, suspension or

dismissal of the members of SB is decided in the general meeting of the shareholders by casting

a majority of votes. Ahold‟ SB consists of members who are independent, as required by the

Dutch Corporate Governance Code. The SB has formed the following committees:

AUDIT COMMITTEE: Tasks include pre-approval of audit, assessment of risk management

and control, etc.

SELECTION AND APPOINTMENT COMMITTEE: Tasks include recommendation of

candidates for CEB & SB.

REMUNERATION COMMITTEE: Assessment of executive remuneration and suggests

remuneration policy for CEB.

INTERNAL CONTROLS AT AHOLD POST-SCANDAL

Immediately after the fraud came to light, Ahold made several changes to its governance

structure. The company introduced measures which enhanced its control over its operating

companies and provided a fool-proof system of accountability. Some of the controls it has put

in place are:

The Ahold Global Code of Professional Conduct and Ethics. The code came into effect on

March 01, 2005.

A uniform whistleblower procedure in its operations in US and Europe.

Vendor allowance tracking system introduced at US Foodservice in June 2004. The system

enables the methodical tracking and reporting of corporate-based allowances. A vendor

allowance accounting and control project has been executed at Ahold‟s US operations in order

to improve the initiating, recording, processing, and reporting of vendor allowances.

Contd...



17

Contd...

Centralized internal audit function. The internal audit reports directly to the CEO and

chairman of the audit committee. In the fourth quarter of 2004, a new audit approach which

included financial controls and operational controls was introduced.

Uniform control standards relating to financial closing process, bill of authority, contract

handling, real estate, relations with external auditors, and compliance with accounting manual

have been worked out.

Reorganizing the finance department. A new department called “Retail Business Control

department” has been constituted. The departments‟ main tasks include assisting the CEB to set

targets and key performance indicators, and managing the annual budget; and assisting the

board in the management of capital budgeting process for investments. The Corporate

Accounting & Reporting (A&R) Department has been strengthened. The A&R department has

been given the responsibility of accounting policies, financial reporting, controls, consolidated

internal reporting, and the appointment, training, and assessment of accounting associates

throughout the group. A dual reporting model has been put in place.

A financial integrity program for key associates has been introduced

US Foodservice Advanced Service Technologies (USFAST) has been introduced with the aim

of reducing complications with respect to US Foodservice‟s disparate systems.

Training of accounting staff on GAAP, IFRS, Sarbanes-Oxley Act.

Ahold also put an end to all business practices at US Foodservice and other operations in the

US which were recognized by the audit committee as unethical business conduct, and were not

in keeping the standards mentioned in the Code of Ethics.

Adapted from www.ahold.com.



18

Additional Readings & References:

1. Ahold to sell off non-core business as profits fall, www.foodanddrinkeurope.com,

November 19, 2002.

2. Scandal-ridden Ahold posts large losses, www.buzzle.com, February 10, 2003.

3. Ahold shares tumble, www.bbc.co.uk, February 24, 2003.

4. Ahold facing lawsuit over accounting fiasco, www.foodanddrinkeurope.com, February 26, 2003.

5. Peter Gumbel, Get Ahold of the Problem, www.time.com, March 03, 2003.

6. Ahold to sell Latam operations, www.bbc.co.uk, April 03, 2003.

7. Royal Ahold scandal investigation deepens, www.refrigeratedtrans.com, April 14, 2003.

8. Dutch authorities probe Ahold, www.bbc.co.uk, April 16, 2003.

9. Ahold turns to Ikea’s ex-boss, www.bbc.co.uk, May 02, 2003.

10. Ahold accounting scandal worse than expected, www.foodanddrinkeurope.com, May 09, 2003.

11. Ahold boss quits over scandal, www.bbc.co.uk, May 13, 2003.

12. Ahold admits new accounting scandal, www.bbc.co.uk, May 26, 2003.

13. Ahold delays audit results as fraud deepens, www.foodanddrinkeurope.com, May 26, 2003.

14. Ahold management bows to pressure, www.nutraingredients-usa.com, September 17, 2003.

15. Ahold appoints new US Foodservice chief, www.fruitnet.com, October 14, 2003.

16. Ahold troubles continue as new CFO is appointed, www.foodanddrinkeurope.com,

November 03, 2003.

17. Ahold results disappoint, www.nutraingredients-usa.com, November 08, 2003.

18. Ben McLannahan, Strings attached, www.cfoeurope.com, March 2004.

19. Ahold unveils new accounting procedures, www.investorsassociation.org, April 16, 2004.

20. Ahold is looking fresh again, www.businessweek.com, November 07, 2005.

21. Alexander Hudson & Wendel Broere, Ahold settles US lawsuit for $1.1 billion,

www.yahoo.reuters.com, November 28, 2005.

22. Ahold announces US Foodservice long-term strategy and financial targets,

www.biz.yahoo.com, November 29, 2005.

23. www.ahold.com

24. www.money.cnn.com

25. www.bbc.co.uk

26. www.foodanddrinkeurope.com

27. www.nutraingredients-usa.com

28. www.bizjournals.com

29. www.businessweek.com

30. www.deloitte.com

31. www.euronext.com

32. www.usdoj.org