Doris Hajewski – Milwaukee Journal Sentinel
Koss Corp.’s current loss of millions of dollars due to alleged fraudulent accounting is not the first time the Milwaukee company has suffered because of the actions of a manager.
The 51-year-old family-controlled business went through bankruptcy in the mid-1980s after a manager recommended borrowing large amounts of money to expand the company beyond its core stereo headphone products. Now Koss, publicly traded but still controlled by the founding family, is in the midst of a financial scandal blamed on another manager, its former vice president of finance, who is accused in a federal charge of embezzling $4.5 million from Koss.
A week after the charge was filed against Sujata “Sue” Sachdeva, trading of the company’s stock has not resumed. The impact on Koss might be far greater than the $4.5?million detailed in the federal charge. On Thursday, the company said its internal investigation indicated that “unauthorized transactions” over the last four years could exceed $20 million.
The situation has left investors and others wondering how a company as small as Koss, with sales of $38?million in the most recent fiscal year, could have lost so much money without anyone’s noticing. The embezzlement came to light, according to the federal complaint, after American Express alerted Koss that money was being transferred from a company bank account to pay Sachdeva’s multimillion- dollar charges for clothing and jewelry.
Executives at Koss, or members of the board of directors, should have noticed the diversions, Tracy L. Coenen, a certified public accountant who specializes in forensic accounting and fraud investigation, said Monday. If Sachdeva spent millions on herself, as alleged, the financial statements should have looked unusual, Coenen said.
“It’s likely that her spending was dumped into cost of goods sold, a line item which can vary with market conditions,” Coenen said. “Nonetheless, the other executives at Koss should know enough about their own business and the market conditions to question whether cost of goods sold looks higher than it should.”
Sachdeva, 46, was a longtime and valued employee of Koss, according to company documents and news reports. The Mequon woman was appointed vice president of finance in 1992, a year after Chief Executive Officer Michael Koss took over the business from his father, John Koss.
Several stories published in various media during the mid-1990s say that Sachdeva was so valued by the Koss family that she was allowed to telecommute to her job when the Sachdevas moved to Texas. At the time, the arrangement was considered to be unusual, particularly for a financial manager.
“People in her position are in a unique position to pull this off,” said a Milwaukee attorney familiar with criminal fraud prosecutions. He declined to be identified because of a possible conflict of interest if the firm becomes involved in a Koss suit in the future.
Michael Koss, who has the triple title of CEO, chief operating officer and chief financial officer, has a degree in anthropology. In a 1994 interview with the Journal Sentinel, Koss said he wanted to go to business school, but his dad discouraged him from that choice of major.
“He said the problems I would have for the rest of my life would not be business problems. They would be people problems,” Koss told an interviewer at the time.
Koss has not responded to requests for an interview since the embezzlement came to light.
The company has said its financial statements going back to 2006 are no longer reliable and will be restated. Because of the uncertainty, money managers expect Koss shares to decline when trading resumes, and they predict shareholder lawsuits. The Koss family owns 73% of outstanding shares, and the stock is thinly traded.
“I’d be very surprised if minority shareholders haven’t contacted their attorneys already,” said George Reis, who leads GVR Investment Management in Two Rivers. Reis and his clients do not hold any Koss shares.
The company has several ways to attempt to recover its losses from the embezzlement, according to the attorney familiar with such cases. Koss’ first route would be to make a claim against its liability insurance policy that protects against acts of employee dishonesty. Koss also could attempt to collect directly from Sachdeva.
Koss Corp. does have its books audited annually by an outside firm, Grant Thornton. But traditional financial-statement audits are unlikely to detect embezzlement, Coenen said. She said audits aren’t designed to uncover fraud and that the auditors wouldn’t know enough about the business to seriously question the variances in expenses caused by a scheme such as the one that Sachdeva allegedly engineered.
Because of its size, Koss hasn’t been required to have its outside auditor assess the effectiveness of the company’s internal controls over its financial reporting. Grant Thornton’s annual statements specify that Koss did not contract with the accounting firm to conduct such reviews.
But Koss and other small, publicly traded companies will have to begin doing that in 2010, just as larger firms have been required to do for the last few years under the Sarbanes-Oxley Act of 2002.
The management of Koss has, however, conducted its own evaluations of the company’s internal controls for at least the last two fiscal years. Both times, according to the company’s annual reports, management concluded the controls were effective.
“However,” the firm added, “because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.”
In a 2007 interview with Family Business magazine, Michael Koss complained about the burdens of being a public company. Koss became public through an indirect route several decades ago, when founder John Koss purchased a small public company in New York that was bankrupt. Koss kept the Nasdaq listing and changed the trading name to Koss.
In the interview, Koss said the new costs associated with Sarbanes-Oxley were particularly galling to his family, who “pride themselves on being good stewards of their company.”
“We’ve always complied with government regulations,” Koss told Family Business. “So it’s annoying having to deal with this extra layer of bureaucracy. Small companies like ours are spending hours in auditing committees that would be better spent on strategic planning.”