INTRODUCTION
After graduating from West Virginia University in 1984 with a
degree in accounting and finance, Gregory Podlucky decided
to work with his father Ga
iel, who had a small business
empire in western Pennsylvania that included a chain of
auto parts stores, an ethanol fuel company, several real estate
properties, and the Jones Brewing Company, best known for
its line of Stoney’s beers.
In 1989 Gregory Podlucky decided to strike out on his
own. Using the funds he obtained from cashing out his
ownership interest in his father’s businesses, Podlucky
established a water bottling venture in Latrobe, Pa.,
the hometown of golfing great Arnold Palmer. In 1992,
entrepreneur and former CPA Podlucky expanded his
product line to include a wide range of flavored water, fruit,
and tea drinks.
Despite being in the hypercompetitive beverage
industry, Podlucky’s company, which he ultimately named
Le-Nature’s Inc., grew rapidly. By 2006, the company was
the 33rd largest beverage producer in the United States,
with annual reported sales approaching $290 million and a
workforce of several hundred employees. One year earlier,
Podlucky had rejected a $1.2 billion offer to sell Le-Nature’s.
Instead of selling, Podlucky decided to take his company
public. Unfortunately for him, his fellow investors, and his
company’s many creditors, that dream was never realized.
STRATEGIC FINANCING
Podlucky served as Le-Nature’s chief executive officer
(CEO) and relied principally on his family and wide circle
of friends and business associates to staff the company’s
other key positions as it expanded over the years. He hired
his
other Jonathan to serve as Le-Nature’s chief operating
officer (COO) and placed his 22-year-old son Jesse in charge
of the day-to-day accounting for Le-Nature’s large subsidiary
that produced bottled tea products. Among the friends that
he appointed to management positions at Le-Nature’s was
Robert Lynn, who held different titles during his years with
the company, including executive vice president of sales.
Despite serving as Le-Nature’s CEO, Gregory Podlucky
was also heavily involved in the company’s routine
accounting functions.1 Tammy Andreycak, another close
friend of Podlucky, held the title of director of accounting,
and was the organization’s chief accountant. But Andreycak
was a single mother who did not have a college degree
or formal training in accounting. According to company
insiders, her primary role within Le-Nature’s was serving
as Podlucky’s confidante. When dealing with third parties,
Podlucky often refe
ed to Andreycak as his secretary.2
A shortage of capital is a common problem for rapidly
growing small companies. Therefore, Podlucky relied on
a variety of different strategies to finance his company’s
expanding operations. During the 14 years that he served as
Le-Nature’s CEO, the articulate and outgoing Podlucky raised
almost $1 billion of debt and equity capital for the company.
IMA EDUCATIONAL CASE JOURNAL XXXXXXXXXXVOL. 8 , NO. 4 , ART. 1 , DECEMBER 20151
ISSN 1940-204X
Le-Nature’s Inc. Fraud: What Happened and Why?
Michael C. Knapp
McLaughlin Chair in Business Ethics and
Professor of Accounting
University of Oklahoma
Carol A. Knapp
Assistant Professo
University of Oklahoma
©2015 IMA
In 1999, Podlucky retained a financial consulting firm
to identify potential investors for Le-Nature’s. In 2000 and
2002, that consulting firm a
anged for two investment funds
to collectively purchase eight million shares of Le-Nature’s
prefe
ed stock, which they had the right to convert into the
company’s common stock. If the two funds had exercised
the convertibility option, they would have controlled 45% of
Le-Nature’s outstanding common stock. Instead, Podlucky
owned all of his company’s outstanding common stock
throughout its existence.
The sales of prefe
ed stock raised nearly $30 million
for Le-Nature’s. Those transactions directly affected Le-
Nature’s corporate governance structure because each of the
investment funds that purchased the prefe
ed stock had
the right to appoint an individual to the company’s board of
directors. The majority of the board consisted of “inside”
directors including Podlucky, his
other Jonathan, and other
senior company executives.
Podlucky also used long-term equipment leasing as
a financing technique. In one such transaction, Podlucky
etained a North Carolina leasing agent to contract with a
Wisconsin-based company that was a subsidiary of a German
manufacturing firm. The German firm manufactured
equipment Le-Nature’s used in its bottling operations. With the
North Carolina leasing agent serving as an intermediary, Le-
Nature’s leased the equipment from the Wisconsin subsidiary
of the German firm. The leasing agreement required Le-
Nature’s to make a large escrow deposit with the leasing agent;
Le-Nature’s bo
owed the funds to make that deposit from
a U.S. lender. In total, Podlucky financed the acquisition of
approximately $300 million of equipment in this manner.
Podlucky used conventional long-term bo
owing
a
angements as the primary method for raising funds for
his company. Wachovia, a diversified financial services
firm based in North Carolina, a
anged or underwrote
approximately $500 million of long-term debt for Le-
Nature’s.3 In 2005, for example, Wachovia marketed a $150
million bond issue for the company. The high-yield or
“junk” bonds were sold primarily to pension and retirement
funds such as CalPERS (California Public Employees
Retirement System), the nation’s largest pension fund.
Podlucky relied heavily on Le-Nature’s audited financial
statements to bo
ow funds for his company. For example,
in the case of the $150 million bond issue, Wachovia
included Le-Nature’s audited financial statements with the
promotional materials for those bonds. Likewise, Moody’s
Investors Services accessed and relied on Le-Nature’s
financial statements to assign credit ratings to those bonds—
and the company’s other outstanding debt obligations.
SUSPICIONS AND RESIGNATIONS SPARK
INVESTIGATION
In August 2003 Le-Nature’s independent audit firm, Ernst
& Young (EY) was completing its review of the company’s
financial statements for the second quarter of fiscal 2003.
During the EY quarterly review, a standard procedure was
to ask a client’s senior executives whether they suspected or
were aware of any fraudulent activity within the organization.
When Richard Lipovich, the EY audit engagement partner,
posed that question to John Higbee, Le-Nature’s CFO at the
time, Higbee candidly replied that he had significant doubts
about the reliability of his company’s recorded sales figures.
Lipovich received similar responses from Le-Nature’s
chief administrative officer (CAO) and its vice president of
administration (VPA). The day after communicating their
concerns to Lipovich, the three company officials submitted
letters of resignation to Gregory Podlucky.
In their resignation letters, the three former executives
suggested that Podlucky was “engaging in improper conduct
with Le-Nature’s tea suppliers, equipment vendors, and
certain customers.”4 Higbee—who had served for 20 years
as an audit partner with Arthur Andersen & Co., including
16 years heading up the audit practice for that firm’s
Pittsburgh office—reported that Podlucky had repeatedly
efused to provide him with documentation supporting key
transactions reflected in Le-Nature’s accounting records. He
considered Podlucky’s failure to provide such documentation
“an astonishing and extremely improper restriction for
any executive officer to impose upon a company’s chief
financial officer.”5 Those restrictions made it impossible
for Higbee to satisfy his CFO-related corporate governance
esponsibilities.
Higbee also identified what he considered to be several
material weaknesses in Le-Nature’s internal controls. Those
weaknesses included Podlucky’s “absolute control” over
the company’s “detailed financial records” and the lack of
“checks and balances” for key assets of the company, such as
the large escrow deposits for its long-term equipment leases
and its product inventories.6
The startling statements by Higbee and his two former
colleagues in their resignation letters prompted Lipovich to
write a letter to Le-Nature’s board of directors. In that letter,
Lipovich requested that Le-Nature’s retain an independent
law firm to investigate and file a report regarding the
allegations made by the three former company executives.
Lipovich informed Le-Nature’s board that EY would not be
associated with any of the company’s financial statements
until the law firm completed its investigation, EY reviewed
IMA EDUCATIONAL CASE JOURNAL XXXXXXXXXXVOL. 8 , NO. 4 , ART. 1 , DECEMBER 20152
the report, and EY determined if it had to undertake any
other investigative procedures.
Le-Nature’s board responded to Lipovich’s letter by
creating a Special Committee to investigate the allegations
made by the three former executives. That committee was
made up of the outside members of the company’s board,
which included the directors appointed by the investment
funds that had purchased Le-Nature’s prefe
ed stock. The
Special Committee retained an independent law firm, K & L
Gates (one of the 10 largest legal firms in the United States)
to supervise that investigation. In turn, K & L Gates hired an
independent accounting firm, Pascarella & Wiker, to assist in
the investigation.
In late November 2003, K & L Gates submitted a draft copy
of its report to Podlucky, who was not a member of the Special
Committee. The CEO provided feedback regarding the report
to the law firm. One week later, K & L Gates provided a revised
copy of the report to the members of the Special Committee.
The report “found no evidence of fraud or malfeasance,”7
although it did identify multiple internal control weaknesses.
Among the suggestions made to remedy those internal control
weaknesses were strengthening the segregation of duties
for key transactions such as equipment leases and inventory
purchases, adopting more rigorous documentation standards
for those transactions, and establishing an audit committee
consisting of outside directors.
The outside directors on the Special Committee accepted
the findings of the investigative report and indicated that
they would work with the other members of Le-Nature’s
oard of directors to address the identified internal control
problems. Shortly thereafter, Le-Nature’s dismissed EY as its
independent audit firm and retained BDO Seidman, which
would ultimately audit the company’s 2003 through 2005
financial statements.
FRAUD ALLEGATIONS RESURFACE
Following the 2003 investigation, Gregory Podlucky
ededicated himself to enhancing his company’s stature
and size in the beverage industry. Le-Nature’s impressive
financial data caught the attention of several private equity
funds in 2005 when Wachovia prepared and distributed a
confidential memorandum to sell the company to the highest
idder. The initial bid received for the company was $1.2
illion. To the disappointment of the company’s prefe
ed
stockholders, Podlucky rejected that offer. The prefe
ed
stockholders claimed that Podlucky intentionally sabotaged
the sale of Le-Nature’s by refusing to allow the potential
uyer access to the company’s accounting records. Podlucky
dismissed that allegation and instead maintained that he had
ejected the buyout offer because the price had been too low.
In May 2006, the prefe
ed stockholders filed a lawsuit
against Le-Nature’s, Podlucky, and other top executives to
force an outright sale of the company. Despite that lawsuit,
Podlucky began preparing an initial public offering (IPO) for
Le-Nature’s with the assistance of K & L Gates. At the same
time, Wachovia was in the process of a
anging more than
$300 million of additional long-term loans for Le-Nature’s.
Podlucky’s plans for his company were disrupted when
allegations of an accounting fraud within Le-Nature’s
esurfaced. The CEO responded to those allegations by
pointing to the fact that his company’s financial statements
had received an unqualified audit opinion each year from Le-
Nature’s independent auditors. Podlucky also insisted that “the
financial stability of Le-Nature’s has never been stronger”8 and
oldly predicted that Le-Nature’s sales would nearly quadruple
over the next four years from approximately $290 million to
more than $1 billion annually. In October 2006, Le-Nature’s
prefe
ed stockholders requested a restraining order against
the company in a petition they filed with a Delaware court.
In the petition, the prefe
ed stockholders refe
ed the court
to a fraudulent equipment leasing transaction a
anged by
Le-Nature’s. One of the lenders that provided the financing
for the company’s long-term leases had determined, with the
assistance of a handwriting expert, that certain documents for
the given transaction had been forged. The forged documents
had resulted in $20 million of the lease escrow deposit financed
y the lender being improperly transfe
ed to Le-Nature’s.
The Delaware court issued the requested restraining order,
evicted Podlucky from the company’s corporate headquarters,
and appointed Steven Panagos of Kroll Zolfo Cooper (a
consulting firm specializing in corporate turnarounds and
estructuring) to serve as the custodian of Le-Nature’s assets
and operations. Less than one week later, Panagos filed an
affidavit with the court that presented evidence of a massive
accounting fraud within the company. He also reported that he
had found evidence that Podlucky had “frantically shredded
company documents”9 before he was forced to leave Le-
Nature’s corporate headquarters. Even more troubling was the
custodian’s discovery that the company had been maintaining