What went wrong at Royal Ahold? Lee Coppack writes

The share price of Royal Ahold dropped like a sack of groceries after this respected Dutch company and third largest retailer in the world revealed on 24 February 2003 that operating earnings for 2001 and 2002 had been overstated by an amount that "may exceed US$500m". (It turned out to be $856m over three years.)

The discovery meant net earnings and earnings per share would be significantly lower than previously indicated for the year ended 29 December 2002, and the group would have to restate financial statements for 2001 and first nine months of 2002. The Securities and Exchange Commission (SEC) and US Justice Department were soon involved. On the New York Stock Exchange (NYSE), the share price hit $2.72, when it had been $18.74 in September 2002

. Ahold placed the blame clearly on one of its US operations: "This is due primarily to overstatements of income related to promotional allowance programs at U.S. Foodservice, which are still being investigated."

The company has 60% of its worldwide sales in the US under a range of local names, such as Stop & Shop. It has built up a series of acquisitions and joint ventures, primarily in the US and Latin America, starting in 1977 and accelerating significantly in 1995. It bought U.S. Foodservice in 2000.

This was not the only problem, however. The company also announced that it was investigating the legality and accounting treatment of certain transactions at its Argentine subsidiary Disco.

Ahold's president and CEO, Cees van der Hoeven, and chief financial officer, Michael Meurs, resigned. The chairman of the supervisory board, Henny de Ruiter, was made temporarily responsible for the daily supervision of the executive board and the business affairs of the company.

Three days later, the company announced its investigation into Disco Argentina was complete and offered the following limited reassurance. There would be "no material impact on Ahold's financial results." The Disco CEO, finance director and two other directors resigned, and a new CEO and finance director were appointed. An Ahold team was sent out "to offer active support to the company, enforce controls and ensure compliance with Ahold business principles".

On March 26, Ahold announced a further review of certain transactions and related matters at Disco. During the following week, Ahold decided it wanted to quit its operations in Argentina and three other Latin American countries, having already begun negotiations to sell its holdings in Chile. The reason given was: "to concentrate on our mature and most stable markets and to generate funds to pay down debt."

Two weeks later, there was more trouble in the US. Ahold admitted that internal audit had unearthed "further intentional accounting irregularities" of approximately $29m at its US retail business, Tops Markets.

On 2 May, there was good news. Former president and CEO of Ikea, Anders Moberg, was available to take on the top job at Ahold, subject to confirmation by the shareholders. Investors liked the news, and the slight recovery in the share price gathered momentum.

At the end of May, three top executives of U.S. Foodservice resigned with immediate effect: Jim Miller, president and CEO and a member of the corporate executive board of Ahold, Michael Resnick, chief financial officer, and David Abramson, executive vice president and general counsel. At the end of June, it was the turn of Frank Curci, who had been president and CEO of Tops Markets since 2000, to go.

A week later, Ahold revealed further 'intentional accounting irregularities related to improper purchase accounting' amounting to approximately $76.5m. Total accounting irregularities discovered to date by forensic accounting investigations had reached approximately $1bn.

This was still not the end. On 5 July 2003, officials from FIOD-ECD, the fiscal and economic investigation unit of the state prosecution department, raided Ahold's corporate headquarters in Zaandam. The company said that it was co-operating fully with the investigation.

Second quarter consolidated sales announced in August brought more bad news, a drop of 12.4% 'in a difficult trading environment'. Publication of the 2002 accounts was delayed a second time and is now expected on 30 September.

Ahold called a shareholders' meeting on 4 September in The Hague to explain the further delay in release of its 2002 financial statements. Moberg's intention to announce the main principles of Ahold's recovery plan on that day, ahead of expectations, gave shareholders encouragement. The shares reached around $8.50 on the NYSE, beneath the level from which they had made their gravitational descent, but a good investment for anyone who had felt confident about the company in the dark days of the spring.

Control and compliance
As a Dutch quoted company, Ahold has a two tier board structure, with a supervisory board composed of non-executives, and an executive board, on which the chairman of the supervisory board sits. Supervision of risk assessment and internal controls is a responsibility of the audit committee, which reports to the supervisory board.

Ahold did not reply to our questions. It has not explained who discovered the problems at U.S. Foodservice, but it appears from other reports to have been the independent auditor Deloitte & Touche. Ahold's statement in February suggests there may already have been some concern about internal control. It said: 'Last year Ahold launched a company-wide initiative to strengthen controls and compliance. In view of recent events, this programme will be stepped up to ensure that the highest possible standards of controls, compliance, disclosures and codes of professional conduct apply throughout all Ahold group companies. Ahold's business principles, policy guidelines and codes of professional conduct will be strictly enforced.'

In July, as more irregularities were found, Ahold said: 'The investigations confirmed, or identified for management review, various other accounting issues and internal control weaknesses. Ahold management and the audit committee are studying the findings to assess whether additional adjustments may be required to correct any accounting errors, and to identify needed improvements in controls and procedures at relevant companies.'

A task force, consisting of members of Ahold management and outside advisors and reporting to the audit committee and the CEO, was appointed 'to address the various accounting practices and internal control weaknesses raised, or confirmed, as a result of the investigations, and will oversee implementation of required changes. It is expected that these required changes will be implemented by the end of 2003.'

A number of senior executives have left the company since the trouble started, but it appears that only one change has been made to the supervisory board. That is the addition of Jan Hommen, vice chairman and chief financial officer of Royal Philips Electronics, who in July took over as chairman of the audit committee in the place of de Ruiter.

Other than the chairman and now Hommen, no members of the supervisory board are identified in the company's 2001 annual report, nor clearly on its web site. Their names and details are available buried deep in Form 20-F, Ahold's filing of its 2001 annual results with the US Securities and Exchange Commission (SEC).

An outside view
Corporate governance at Ahold scored the lowest rating in a survey of 1,600 companies by US based GovernanceMetrics International (GMI) published at the end of July. It was one of just 16 companies that received GMI's rating of one, compared to a possible 10. GMI ranked the companies against each other in a comparative rating based on 600 metrics covering seven criteria such as board accountability, shareholders' rights, corporate conduct, financial accountability and internal controls.

Jan van de Poel is a director of GMI and former chief financial officer of ABP, the Dutch civil service pension fund. He says that the significant weakness in the Dutch system is that shareholders may not be able to challenge strategic decisions of the executive, such as acquisitions, but that this is a separate issue from internal control.

"Dutch legislation allows corporations to restrict shareholders' voting rights, which may have a negative effect on strategic decision making, but it does not exacerbate bad internal control. However, the responsibility for internal control is vested in the board of supervisors (non-executives) and that certainly is a governance issue," he says.

A company's attitude to corporate governance may, nevertheless, be symptomatic. In 2002, another independent rating agency, the London-based Corporate Governance Authority, rated corporate governance at Ahold on the basis of a detailed questionnaire. At the time, it gave the company a comparatively good rating for a European food retailer, but commented: 'On the other hand, Ahold severely lacks a commitment to good corporate governance rules, as well as to guidelines on accountability and independence. This must be of great concern to shareholders since it holds a big risk if the company gets into difficult situations."

A new code of best practice in corporate governance, including provisions for the supervision of risk management, will come into effect in the Netherlands on 1 January 2004. The code will be based on the proposals of a commission under former Unilever CEO, Morris Tabaksblat, published on 1 July 2003, and currently going through a consultation process (see panel).

According to van de Poel, the code is simply describing what already exists in most listed Dutch companies. It is an example of best practice, the major suggestion the Tabaksblat committee is advocating.

The code will not be legally binding but companies will either have to conform, or explain in their annual reports why they do not.

Lee Coppack is a risk management and insurance writer and analyst. E-mail: lee@strategicrisk.eu .

The management board is responsible for managing the risks associated with the company's activities and for financing the company. The management board shall report related developments to the supervisory board and its audit committee, with which it shall also discuss the internal risk management and control systems.

The company shall have a good internal risk management and control system. It shall, in any event, employ as instruments of the internal risk management and control system: (a) risk analyses of the operational and financial aims of the company; (b) a code of conduct (which should, in any event, be published on the company's website); (c) guides for the layout of the financial reports and the procedures to be followed in drawing up the reports; and (d) a system of monitoring and reporting.

In the annual report, the management board shall report on the operation of the internal risk management and control system during the year under review. In doing so, it shall describe any significant changes that have been made and any major improvements that are planned, and shall confirm that they have been discussed with the audit committee and the supervisory board.

The supervisory board shall arrange for the receipt, recording and handling of complaints received in respect of the financial reporting, the internal risk management and control systems, and the audit. Internal whistleblowers shall have the opportunity, without jeopardising their legal position, to report on irregularities in the above-mentioned matters and to report complaints about members of the management board to the chairman of the supervisory board.

The general duties of the supervisory board may be deemed to include supervision of the structure and operation of the internal risk management and control systems, and observance of the legislation and regulations.