Michael “Mickey” Monus – Phar-Mor

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Sam Walton couldn’t figure out how Michael “Mickey” Monus could open 300 stores in more than 30 states in just ten years.

What the Walmart founder didn’t know was that Monus had discovered a retail strategy even more powerful than everyday low prices: imaginary profits.

Monus founded Phar-Mor in his hometown of Youngstown, Ohio, in 1982 and built it into one of the fastest-growing retailers in America.

“Having reached the 300th store, there’s no stopping us now to being a national retailer and to having a store in every major market across the country,” Monus proclaimed at the top of his game.

The chain eventually boasted 25,000 employees and $3 billion in annual revenue.

There was just one problem. It was losing money.

The trouble began showing up in the numbers as early as 1988.

Phar-Mor’s gross profit margin began declining, and by early 1989 Chief Financial Officer Patrick Finn was delivering weekly reports showing disappointing results, according to facts established in an appeals court ruling.

Monus told Finn not to show the real numbers to the board.

Instead, Finn testified, Monus instructed him to inflate the company’s gross margins to historical levels, understating losses and creating profits that didn’t exist. And so began one of the largest accounting frauds of its era.

Monus and Finn created a separate accounting record, which eventually became known as “the subledger.” There they parked losses they didn’t want anyone to see.

By June 1990, the subledger contained $38.5 million in concealed losses.

Monus and Finn knew the auditors were coming. So, according to the court, they simply added $200,000 in fictitious inventory to every store they knew the auditors wouldn’t visit. They also hid losses by inflating inventory and deployed several other accounting tricks.

For a time, it worked. But by the following year, the hidden losses had ballooned to $148 million.

Monus, meanwhile, had other ambitions.

He stood about 5-foot-9, but played high school basketball. It inspired him to create the World Basketball League, a professional league initially limited to players under 6-foot-5.

The WBL had teams in smaller markets such as Youngstown and a traveling professional cheerleading squad called the All-American Girls. Monus even bankrolled a television production company to broadcast games, according to a fascinating 1994 PBS Frontline investigation.

Unfortunately, basketball fans weren’t clamoring to watch shorter professional basketball players. And the WBL hemorrhaged money.

Monus directed Finn to write 82 unauthorized Phar-Mor checks totaling about $8.8 million to the basketball league, according to the appeals court.

Monus at one point told Phar-Mor controller Stan Cherelstein he would repay the money diverted to the WBL after arranging financing to buy yet another professional sports franchise: The NBA’s Denver Nuggets, according to the appeals court.

He never bought the Nuggets. He never repaid the money.

And basketball wasn’t Monus’s only sports fantasy. He was also an original investor in the Colorado Rockies baseball team.

Soon enough, he’d be out.

Phar-Mor had outside auditors, but they didn’t find the fraud. They didn’t even look for the fraud.

Coopers & Lybrand repeatedly audited the company while Monus and his executives were hiding tens of millions of dollars in losses.

The Frontline investigation, “How to Steal $500 million,” put the auditors to shame when it demonstrated just how simple the inventory trick could be at a chain with hundreds of locations. Here’s an example from the report:

“Phar-Mor claimed every six-pack of Coke in the store was worth, say, $2.30 when, in reality, it may have sold for a buck 98. Multiply that difference by thousands of six-packs of Coke in 129 stores and you're on your way to a $12 million cover-up.”

Coopers & Lybrand checked inventory at just four stores, according to Frontline. Worse, the auditors told Phar-Mor months in advance which stores they planned to inspect, giving executives time to shift the fictitious inventory elsewhere.

Eventually, though, the fraud became so large that it was increasingly difficult to hide. And in 1992, somebody finally stopped playing along.

Phar-Mor controller Stan Cherelstein had learned about the subledger and confronted Monus and other executives. At an April 1992 meeting, Cherelstein secretly tape-recorded the discussion, according to the appeals court.

Then Finn flipped.

In July 1992, he went to the U.S. Attorney’s Office in Cleveland and exposed the scheme.

For outside observers like Sam Walton, the big mystery behind Phar-Mor’s success was solved almost immediately.

Phar-Mor’s board fired Monus and Finn.

On Aug. 4, 1992, the company announced that a special audit had uncovered $350 million in fraud and embezzlement and said it had turned its evidence over to the FBI and Justice Department.

Company officials said financial statements had been falsified to hide losses and overstate income, according to a contemporary UPI report.

The Securities and Exchange Commission would later allege that Phar-Mor had cumulatively overstated income by $290 million from fiscal 1987 through 1991 and by another $238 million in fiscal 1992. The false financial statements helped induce investors to put more than $500 million into the company, according to the SEC.

Phar-Mor filed for Chapter 11 bankruptcy protection on Aug. 17, 1992.

The WBL collapsed. Monus withdrew from the Colorado Rockies ownership group. And Youngstown watched one of its hometown business heroes spectacularly implode.

A Washington Post account published as the scandal broke described the bafflement and anxiety sweeping a city that had watched Monus become a symbol of its hoped-for economic revival.

Federal prosecutors initially indicted Monus in January 1993 on 129 counts. But it was a complex case and Monus wasn’t finished fighting.

His first trial ended in a mistrial. So prosecutors tried again.

This time they charged him in a 109-count superseding indictment with a whole store shelf of federal crimes: conspiracy, bank fraud, wire fraud, mail fraud, interstate transportation of property obtained by theft or fraud, filing false tax returns and obstruction of justice.

It was the fraud that just kept growing. Prosecutors ultimately put the total loss at up to $2 billion, including about $1 billion lost by investors.

After a month-long trial, a jury convicted Monus on all 109 counts.

The trial also established that his embezzling went beyond propping up the basketball league. Fourteen Phar-Mor checks totaling about $568,000 had been written directly to Monus or for his personal benefit, according to the appeals court.

He was sentenced to 235 months in federal prison, more than 19 years, and fined $1 million.

“The important thing is … the employees – all those dedicated, loyal and highly motivated people,” Monus told the judge at sentencing. “I want them to know the sorrow and regret that I have. The sorrow and regret will live with me for the rest of my life.”

The Sixth Circuit Court of Appeals upheld every one of his convictions in 1997 but vacated his sentence. In 1999, Monus was resentenced to 139 months and his fine was cut to $500,000.

He ultimately served about 10 years behind bars.

A subsequent bankruptcy court ruling put the consequences in perspective.

One investor alone had purchased more than $50 million of Phar-Mor stock based on financial information that Monus had falsified, and recovered nothing.

The bankruptcy court also noted that Monus had been convicted of shredding books, records and other documents concerning Phar-Mor’s payments to the basketball league.

Phar-Mor survived Monus, but not for long. The company emerged from bankruptcy under new ownership in 1995, only to file Chapter 11 again six years later.

In 2002, a bankruptcy judge approved the $141 million sale of its remaining assets. Its final 73 stores were liquidated. Competitors, including CVS, picked up the pieces, ending the chain Monus had once promised to put in every major market in America.

As for the auditors, they paid a steep price, too.

Investors and creditors filed more than 40 lawsuits against Coopers & Lybrand, which had issued clean audit opinions while the fraud continued. The firm faced more than $1 billion in claims and settled most of the lawsuits for undisclosed amounts.

In 1996, a federal jury found the accounting firm liable for fraud in one of the lawsuits. A judge later concluded there was sufficient evidence that Coopers had been reckless in its audits and would have uncovered the fraud had it followed generally accepted auditing standards.

Monus made history in the 1990s for perpetrating one of the largest corporate frauds, at least until Enron and WorldCom came along and made billion-dollar accounting fraud seem almost routine.

Sam Walton had been right to wonder how Monus could possibly grow Phar-Mor so fast while selling merchandise so cheaply.

He just couldn’t see the subledger.

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