THIS DOCUMENT IS A COPY OF THE FORM 8-K
PREVIOUSLY FILED ON AUGUST 24, 1994
PURSUANT TO A RULE 201 TEMPORARY HARDSHIP EXEMPTION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): August 22, 1994
ORANGE AND ROCKLAND UTILITIES, INC.
(Exact name of Registrant as specified in its charter)
Incorporated in New York 1-4315 13-1727729
(State or Other (Commission (IRS Employer
Jurisdiction of File Number) Identification
Incorporation) Number)
One Blue Hill Plaza, Pearl River, New York 10965
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code:(914) 352-6000
<PAGE>
Item 5. Other Events.
On August 22, 1994, the Special Committee of the Board of
Directors of the Company issued its Final Report summarizing the
findings and conclusions of its investigation that commenced on
August 20, 1993 following the arrest of Linda Winikow, former
Vice President of Corporate Policy and External Affairs. A copy
of the Report is filed as Exhibit 99.5 hereto and the press
release summarizing the issuance of the Report is filed as
Exhibit 99.6 hereto.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned hereunto duly authorized.
ORANGE AND ROCKLAND UTILITIES, INC.
By:/s/ Robert J. McBennett
Robert J. McBennett
Treasurer
Dated: August 23, 1994
<PAGE>
Exhibit Index
Exhibit 99.5 Final Report of the Board of Directors of Orange
and Rockland Utilities, Inc. dated August 22, 1994
(the "Report")
Exhibit 99.6 Press Release announcing issuance of the Report
<PAGE>
Exhibit 99.5
<PAGE>
I
INTRODUCTION
The Special Committee of the Board of Directors of
Orange and Rockland Utilities, ("O&R" or the "Company") was
created on August 20, 1993 following the arrest of Linda Winikow,
O&R's former Vice President of Corporate Policy and External
Affairs, on charges of grand larceny, commercial bribery, and
election law violations, and the announcement of a grand jury
investigation. The purpose of the Special Committee was to
conduct an investigation into the events surrounding the arrest
of Winikow by the Rockland County District Attorney's Office and
any related matters discovered in the course of that
investigation, in order to assure the Company's regulators,
shareholders, customers, and employees that all misconduct had
been uncovered, and that appropriate measures had been or would
be taken to prevent any future wrongdoing.
The Special Committee consisted of four outside
directors of O&R:
- Linda C. Taliaferro - Chair. Ms. Taliaferro,
a Board member since 1990 and currently a
lawyer in private practice, previously served
for over nine years on the Pennsylvania
Public Utility Commission, including several
years as chairperson.
- Ralph M. Baruch. Mr. Baruch, a Board member
since 1983, was the founder, and served as
Chief Executive Officer and Chairman of the
Board of Directors of Viacom International,
Inc., and is currently a consultant to that
company.
- James F. O'Grady, Jr. Mr. O'Grady, a Board
member since 1980, is an attorney and the
President of O'Grady and Associates, a media
brokerage and consulting firm in New York.
- John F. White. Mr. White, a Board member
since 1976, is the President Emeritus of The
Cooper Union for the Advancement of Science
and Art. Mr. White retired from the O&R
Board, and from the Special Committee, on
May 11, 1994.
The Special Committee was granted full power and
authority by O&R's Board of Directors to take whatever steps it
deemed necessary or desirable in its independent investigation,
including the retention of counsel, consultants, and other
advisors. On August 21, 1993, the Special Committee retained the
law firm of Stier, Anderson & Malone to conduct its
investigation. Stier, Anderson & Malone specializes in
conducting special investigations of major nuclear energy and
utility companies. Stier, Anderson & Malone spent over ten
months at O&R's corporate headquarters gathering and analyzing
relevant documents and evidence, interviewing numerous O&R
employees and witnesses, and reporting to the Special Committee
on its progress.
The Special Committee also retained the accounting firm
of Price Waterhouse LLP to assist Stier, Anderson & Malone in its
analysis of certain of the Company's books and accounts, and to
review the Company's internal control procedures. In addition,
the law firm of Hughes Hubbard & Reed was retained to counsel the
Special Committee on corporate governance issues.
The Special Committee's investigation has been
comprehensive and impartial. Stier, Anderson & Malone was
granted full access to all Company records and personnel, and was
given authority to investigate all relevant matters regardless of
what evidence might be uncovered. Stier, Anderson & Malone has
analyzed more than 200,000 pages of documents, has reviewed over
60,000 expense transactions, and has examined thousands of
invoices. Stier, Anderson & Malone has also interviewed 180 O&R
employees, former employees, Company vendors, past and present
Board members, and public officials in 340 sessions. Stier,
Anderson & Malone has fully documented their findings and
analysis and has submitted to the Special Committee a detailed
report of the evidence uncovered during their investigation.
This report summarizes the most important facts found
by Stier, Anderson & Malone, explains the civil litigation that
resulted from those events, reviews the steps taken by O&R to
address the problems uncovered, and sets forth the conclusions
drawn by the Special Committee from the evidence assembled by
Stier, Anderson & Malone. The Special Committee's report has
been reviewed by Stier, Anderson & Malone, and they have advised
the Special Committee that they do not differ with the
conclusions drawn by the Special Committee based on the facts set
forth in Stier, Anderson & Malone's report. Both reports are
being made available to the public.
II
ORANGE AND ROCKLAND UTILITIES, INC.
O&R is an investor-owned utility serving approximately
257,000 electric customers and 109,500 gas customers in
southeastern New York State as well as in adjacent sections of
northern New Jersey and northeastern Pennsylvania. O&R, which is
listed on the New York Stock Exchange, has approximately 23,600
shareholders and employs approximately 1,700 people. O&R has two
wholly-owned utility subsidiaries and three wholly-owned non-
utility subsidiaries. The two wholly-owned utility subsidiaries
are Rockland Electric Company, a New Jersey corporation, and Pike
County Light and Power Company, serving parts of Pennsylvania.
Rockland Electric Company has a subsidiary, Saddle River Holdings
Corp., which in turn owns and operates radio stations and markets
natural gas. The three wholly-owned non-utility subsidiaries are
Clove Development Corporation, a real estate company; O&R
Development, Inc., an industrial and corporate land development
company; and O&R Energy Development, Inc., an oil and gas
production company.
As a utility company operating in three states, O&R is
regulated by three state utility commissions: the New York Public
Service Commission ("PSC"), the New Jersey Bureau of Regulatory
Commissioners, and the Pennsylvania Public Utilities Commission.
These regulatory agencies have complete control over the rates
that O&R may charge utility customers. In addition, the utility
commissions require the Company to adhere to specific utility
operating and accounting rules which are designed to distinguish
between costs that must be charged to O&R's shareholders and
costs that may be taken into account in setting rates. Utility
commissions also have the power to conduct financial, operating
and management audits of the Company.
On January 29, 1993, the Company filed with the PSC for
an increase in electric rates to be effective January 1, 1994
(the "1993 Rate Case"). The 1993 Rate Case was pending when
Winikow was arrested, and was terminated (as described below) on
June 10, 1994.
III
EVENTS SURROUNDING THE FORMATION
OF THE SPECIAL COMMITTEE
On August 11, 1993, the campaign treasurer for a
Rockland County Executive candidate was arrested by the Rockland
County District Attorney and charged with not reporting a $9,800
contribution to that campaign from O&R. It emerged that an O&R
employee had paid $9,800 of Company funds to Legal Copies, Inc.,
a printing company, which in turn provided invitations,
envelopes, and other in-kind services to the campaign. In order
to hide the true source of the contribution, Legal Copies had
submitted invoices to O&R for this work which did not identify it
as related to the campaign, but instead appeared to be bills for
"executive invites", "stationery", and the like. The District
Attorney's undercover investigation had begun on July 6, 1993,
when the vendor, upset over the inability to obtain full payment
of these bills from O&R, went to the District Attorney and
reported the scheme.
Early the next day, August 12, 1993, the Company began
an internal investigation and quickly identified Justin Schwartz,
a budget manager in the Company's Corporate Communications
Department, as involved in the illegal arrangement with Legal
Copies. Schwartz acknowledged that he had arranged for the
campaign materials to be produced by Legal Copies, and that he
had approved the invoices for payment knowing they were campaign
services and not for work for O&R. Schwartz was promptly
suspended, and on the next day, August 13, 1993, his employment
at O&R was terminated.
On August 16, 1993, the Rockland County District
Attorney's office arrested Linda Winikow, O&R's Vice President of
Corporate Policy and External Affairs and, as head of the
Corporate Communications Department, Schwartz's superior.
Winikow was charged with grand larceny, commercial bribery, and
making political contributions under a false name. Specifically,
Winikow was charged with compelling Stanford Silverman, the
President of Devotion, Inc., a New York City advertising firm, to
make political contributions to various campaigns. Winikow was
also charged with coercing Silverman to make other payments and
contributions, totaling an average of $25,000 annually, in
exchange for the continuation of his lucrative advertising
contract with the Company. For example, Devotion paid for
personal printing for Winikow and for decorative arrangements for
her son's engagement party. In addition, Winikow was charged with
bribing a Rockland County publishing company, Community Media,
Inc., to stop printing negative articles about O&R. Winikow was
suspended the day after her arrest and was terminated from
employment at O&R on August 26, 1993. O&R filed a lawsuit
seeking to recover damages from Winikow the same day. See "IX.
Civil Litigation".
The same day Winikow was arrested, the District
Attorney executed a search warrant at O&R for Company records,
files, documents, and a computer. The District Attorney
indicated that his investigation would continue and that there
could be additional arrests, and he also called upon the PSC to
conduct a complete audit of the Company's finances. The PSC,
which began its own investigation, announced that the misconduct
could affect the Company's 1993 Rate Case.
On August 23, 1993, three days after the formation of
the Special Committee, the District Attorney arrested two former
O&R Corporate Communications Department employees, Paul Pickard
and his wife Maria Pickard, on charges of having stolen money
from O&R. The charges were based on a scheme in which Devotion
submitted fraudulent invoices to O&R for work that had not been
performed, which the Pickards arranged to have approved and paid.
Devotion then paid the money to Communications Strategies
International, an entity controlled by the Pickards.
<PAGE>
IV
COOPERATION WITH PUBLIC AUTHORITIES
At the outset of the investigation, the Special Committee
decided that it should cooperate and share information with the
District Attorney's office, the PSC, and the other utility
commissions. Despite the risk that damaging or embarrassing
information about O&R might emerge, the Special Committee and the
Board believed that it was vital to demonstrate that the Company
was committed to uncovering and correcting all wrongdoing.
On November 3, 1993, a Joint Cooperation Agreement was
signed between O&R and the District Attorney's office. Under
this Agreement, the Company agreed (i) to cooperate fully with
the District Attorney, (ii) to provide access to Company books
and records and all information uncovered by the Special
Committee's investigation, and (iii) to discontinue for five
years all political contributions and the activities of all PACs.
The Company also agreed to appoint an Inspector General to
monitor the conduct of Company management and employees for a
period of seven years after completion of the Special Committee's
investigation. In light of O&R's cooperation and the "clear
demonstration by O&R's Board of Directors of their determination
to uncover all past improper activities", and to prevent their
recurrence in the future, the District Attorney agreed to bring
no criminal charges against the Company.
The Special Committee has also cooperated fully with
the PSC and other utility commissions that regulate O&R. The PSC
has been given full access to all documents and records uncovered
as part of the Special Committee's investigation, and the Company
has responded to over 300 written data requests from the PSC.
The Company has also cooperated with the New Jersey Bureau of
Regulatory Commissioners, which has conducted a management audit
of Rockland Electric Company, including a review of operating
procedures, policies, and practices. Although the Pennsylvania
Public Utility Commission has not conducted a separate
investigation of Pike County Light and Power Company, Stier,
Anderson & Malone has periodically briefed them on the status of
their investigation.
The Company has pledged that it would refund to its
customers all misappropriated funds that may have been improperly
charged to accounts used to determine rates. To date, the
Company has refunded to New York ratepayers a total of $345,000
and to New Jersey ratepayers a total of $94,100 through fuel
adjustment charges.
On June 10, 1994, the PSC - which had previously
suspended O&R's rate application - terminated the Company's 1993
Rate Case. While the PSC recognized that the Special Committee's
investigation was an integral part of the Company's attempt to
set its house in order, the PSC concluded that the reliability
and credibility of the Company's previously submitted financial
figures were undermined by the financial improprieties that had
been uncovered. The PSC further stated that completion of the
Company's investigation and development of new credible data
would be required for O&R to proceed with a new rate plan.
V
OVERVIEW OF THE INVESTIGATION
The Special Committee began its investigation aware only
that there had been serious misconduct at O&R by one vice
president and others in her department. As we proceeded,
however, three principal subjects occupied most of our attention
and are the focus of this report.
First, it became apparent very early that the Company's
Chairman and Chief Executive Officer, James F. Smith, had not
only been lax in his supervision of Winikow and other officers,
but also that he had himself engaged in extensive misconduct.
His activities and his responsibility for the state of affairs at
O&R are described in Part VI of this Report.
Second, as we explored in detail the misconduct of
Winikow and others in her Corporate Communications Department,
including substantial misuse of the Company's relations with
vendors, described in Part VII of this Report, it became clear to
us that there had been a very serious failure of the Company's
internal controls which ought to have prevented her misconduct
and that of Smith and others.
Third, when we focused on the Company's internal
controls, we found a state of affairs very different from what
we, as Directors, had been led to expect. The Company's formal,
written rules, which the Board had from time to time approved,
were reviewed and found by Price Waterhouse to be sound. What
our investigators found, however, was that those controls had
been systematically evaded, and over time undermined, by officers
at the highest levels, including particularly Smith. With his
approval, steps had been taken to conceal this state of affairs
from the Audit Committee and the Board of Directors, so that he,
Winikow, and a few others could incur substantial and improper
expenses without accounting for them or risking exposure of their
misconduct. This erosion from within of the Company's internal
control systems, and especially of its internal audit function,
is described in Part VIII of this Report.<PAGE>
VI
INVESTIGATION OF JAMES F. SMITH
A. Introduction
The Special Committee's investigation of Smith
uncovered extensive evidence of wrongdoing on his part. As a
result, Smith's employment as O&R's chief executive officer was
terminated for cause, and the Company filed a lawsuit against him
to recover all damages to the Company caused by his misconduct
and mismanagement. After his dismissal, Smith was also indicted
by a Rockland County grand jury for illegal conduct at O&R, and
is now awaiting criminal trial on twenty-two counts of grand
larceny and falsifying business records, as well as two counts of
petit larceny. On June 10, 1994, he was removed from the Board
of Directors for cause by the shareholders. The removal proposal
was approved by 82.5% of the outstanding shares, representing
97.6% of the shares actually voting on the proposal.
B. Smith's Background at O&R
James F. Smith, now age 58, first became associated
with O&R in 1965 as a senior accountant. During the next 14
years, Smith held a number of increasingly important financial
and management positions at O&R, including assistant treasurer,
assistant secretary, and chief financial officer. In 1979, Smith
became the Chairman of the Board of Directors and Chief Executive
Officer of O&R. In 1988, Smith signed an Employment Agreement
with O&R which outlined his position, duties, and compensation
structure. This Employment Agreement, as amended, provides for
Smith's termination for cause if (i) he has been convicted of a
crime involving moral turpitude, or (ii) he has engaged in
serious misconduct or gross neglect of his duties which has
resulted in, or is likely to cause, material economic damage to
the Company.
In 1984, Smith personally recruited Winikow, then a New
York State Senator, to join O&R as the head of the Company's
political, charitable, and public relations activities. Although
Winikow technically reported to the President of the Company, in
reality she answered only to Smith. Smith encouraged Winikow's
political activities and public relations activities, giving her
free rein while insulating her from criticism and supervision.
It was widely perceived by O&R employees that Winikow could do
whatever she wanted because she had the complete support and
approval of Smith.
C. The Special Committee's Investigation Focuses on Smith
Although Smith suggested the formation of the Special
Committee at the O&R Board meeting on August 20, 1993 and made
public statements calling for a thorough investigation of all
misconduct, his actions from the outset of the investigation
belied that intent. Smith followed a course which indicated that
he was more concerned with concealing his own misconduct than
with protecting the Company.
First, while the Special Committee and the Board
decided to cooperate fully with the District Attorney's and the
PSC's investigations, Smith wanted the Company to adopt a
defensive posture in dealing with the District Attorney and only
to provide information if required to do so pursuant to a
subpoena. This view was repeated by Smith to the Board on a
number of occasions, but was ultimately rejected by the Special
Committee and the Board in favor of a policy of full cooperation.
Second, Smith tried for a period of six weeks to put
the Special Committee's investigation on hold, while two law
firms successively selected by him conducted an investigation and
dealt with the public authorities. The first of those firms
withdrew after it emerged that one of its partners had a
political relationship with Winikow. The second was dismissed
from the case because issues arising out of prior relationships
with Smith and other senior officers gave the Special Committee
concern about the credibility of the investigation. Stier,
Anderson & Malone was then given primary responsibility for
conducting the investigation.
Third, Smith took various actions to cover up his own
wrongdoing and to mislead the Company's investigators. For
example, while Schwartz was cooperating with the District
Attorney's investigation, he recorded a conversation which
indicated that O&R had provided an in-kind campaign contribution
for Smith's wife's successful June 1993 campaign for re-election
as a Trustee for the Village of Tuxedo Park. A temporary
employee in O&R's Corporate Communications Department told
Schwartz that he had done graphics work for Smith's wife's
campaign, and that the work was still on his computer. When the
District Attorney executed a search warrant on August 16, 1993,
this computer was seized along with records and disks related to
this project. The next morning, Smith directed his secretary to
determine how much money O&R had spent on the production of
campaign materials for his wife. At a meeting at O&R on August
20, 1993, Smith told members of the Special Committee that
investigators from the District Attorney's office were seeking to
interview his wife about the work done by O&R for her campaign.
However, Smith assured the Special Committee that this was
entirely above board, as the work had been properly paid for. In
fact, Smith had written a check to the Company the day before in
the amount of $1,298, but had backdated it by three weeks to make
it appear that it had been written prior to the arrest of Winikow
and the search warrant at O&R. The next day, Smith wrote another
check for $120 to cover the cost of paper, and this check was
also backdated. Smith later canceled these backdated checks and
paid O&R for this work with correctly dated checks. In addition,
other bills for Smith's personal projects were re-routed after
Winikow's arrest and processed as charitable contributions or
sent directly to Smith's home.
Smith's expenses were reviewed with the help of Price
Waterhouse, and numerous recent transactions were identified as
having involved the misuse of Company funds for personal
purposes. The Special Committee learned that Smith routinely
submitted expense reports and documents which listed personal
expenses as business-related charges. Smith had charged to O&R
thousands of dollars in first-class airfare, hotel
accommodations, and lavish meal charges during personal trips to
Europe and Russia. On numerous occasions, substantial sums were
charged to the Company for personal gifts, meals with personal
friends and neighbors, and tickets to Broadway shows. In
addition, Smith had violated the Company's internal controls by
routinely failing to submit proper documentation for a
substantial percentage of his "business expenses", and by
authorizing and approving improper expenses incurred by others.
The Special Committee also learned that Smith had purchased tens
of thousands of dollars worth of wine with Company funds in
recent years without keeping any records or inventory of his use,
and without identifying any business purpose for many of the
purchases.
Smith was interviewed by Stier, Anderson & Malone and a
member of the Special Committee on September 20, 1993. Prior to
this interview, Smith and his attorneys were provided with
documentation and records regarding certain questionable
transactions that had been specifically identified. During this
seven hour interview, at which Smith was represented by his
attorneys, Smith was unable to substantiate a business purpose
for most of his expenses and charges. On September 22, 1993,
Stier, Anderson & Malone reported to the Special Committee about
the interview with Smith, including evidence that Smith had not
been candid and forthcoming in his responses to various
questions. On September 24, 1993, the Special Committee reported
to the outside Directors on the interview with Smith.
Far from resolving the concerns of the Special
Committee and the other independent directors, Smith's responses
raised new questions regarding internal controls and expense
account practices. The Special Committee instructed Stier,
Anderson & Malone to make a further investigation of Smith's
possible misuse of corporate resources and assets a high
priority. The investigators reviewed Smith's letters, calendars,
and other documents, and continued to interview other witnesses.
Information from these sources helped to identify additional
instances of misconduct by Smith and of failures by Smith to
supervise or control Winikow.
D. The Decision to Terminate Smith's Employment
At a meeting of the Special Committee on October 4,
1993, Stier, Anderson & Malone briefed the Special Committee on
evidence of a lengthy and pervasive pattern of transactions by
Smith involving personal use of Company funds, resources, and
assets, for the benefit of Smith, his family, and his friends.
Evidence was also presented demonstrating Smith's evasions of
internal accounting and financial controls, including numerous
transactions for which it was impossible to determine any
business purpose. The Special Committee also reviewed evidence
that Smith had failed to control or supervise Winikow, and that
Smith had attempted to obstruct the Special Committee's
investigation and evade corporate controls by making false or
misleading statements, backdating checks, and rerouting invoices
for his personal projects. After a review of the then available
evidence and a discussion of all relevant factors, the Special
Committee unanimously decided to recommend to the independent
Directors that Smith's employment be terminated for cause.
The next day, October 5, 1993, the Company's
independent Directors met with the Special Committee to consider
the Special Committee's recommendation to terminate Smith's
employment for cause. Stier, Anderson & Malone presented to the
independent directors the evidence of widespread misconduct by
Smith that had previously been reviewed with the Special
Committee. After an extensive discussion of the Special
Committee's findings, as well as a discussion of the damage to
the Company that was likely to result from Smith's wrongdoing,
the independent Directors unanimously voted to terminate Smith's
employment for cause and to remove him as Chairman of the Board.
On October 7, 1993, a Notice of Termination for cause was
delivered to Smith, pursuant to his Employment Agreement, and he
was suspended from all duties immediately.
The Notice of Termination detailed the following
reasons for the unanimous decision to terminate Smith's
employment:
- Smith had engaged in transactions involving
use of the Company's resources and assets for
the personal benefit of Smith, his family,
and his friends;
- Smith had caused expenditures of Company
funds that had no adequate business purpose;
- Smith had engaged in violations and evasions
of the Company's internal controls and
policies;
- Smith had failed to properly supervise, or
cause the proper supervision, of Linda
Winikow; and
- Smith had failed to be candid and forthcoming
with the investigation and had taken steps to
hinder and obstruct the investigation.
The Notice of Termination also listed the categories of
damage that the Company had suffered, or was likely to suffer, as
a result of Smith's wrongdoing:
- Monetary losses caused by the misuse and
misappropriation of Company funds and assets;
- The adverse effect of Smith's actions on the
Company's relations with the PSC, including
especially the threatened termination of the
Company's proposed rate proceeding;
- The costs and legal exposure resulting from
civil and criminal proceedings and inquiries
that were pending or likely to arise;
- The costs of investigating Smith's
misconduct; and
- The substantial adverse effects on the
Company arising from adverse publicity and
loss of business reputation.
Smith's Employment Agreement required that he be given
an opportunity to defend himself before the Board, and to take
corrective action after being notified of the decision to
terminate his employment. On November 4, 1993, at the request of
Smith's attorney, O&R further provided Smith with a detailed
letter and 37 page itemization of improper and questionable
transactions involving his use of Company funds, assets, and
resources, and offered to arrange a meeting between Smith and the
Board. Smith did not take any corrective action or present a
defense to the Board, but instead submitted retirement papers.
On December 6, 1993, Smith's termination as chief executive
officer became fully effective.
E. Findings Regarding Smith
1. General Conclusions
Our general conclusions regarding Smith's wrongdoing
while chief executive officer of O&R are as follows:
a. Throughout his tenure as chief executive officer
and especially in recent years, Smith systematically
misappropriated Company funds, assets, and resources for the
personal benefit of himself, his family, his friends, and
organizations with which he had a personal or private
relationship.
b. Smith routinely defrauded the Company by
submitting expense-related documents that falsely represented the
true nature or purpose of the expenditure.
c. Smith subverted the Company's internal accounting
and financial controls, and violated many of the Company's
corporate policies. Smith routinely submitted expense reports
that failed to identify any business purpose or the identity of
individuals who benefited from such expenditures, and frequently
failed even to submit receipts or proper documentation for
expenses. Smith, with help of financial officers, concealed
these activities from the Audit Committee and the Board.
d. Smith created and fostered an environment that
allowed and encouraged other officers and employees to undermine
and disregard the Company's internal controls, and that allowed
misconduct to go unchecked.
e. Smith knowingly permitted, authorized, and, in
many instances, actively encouraged the personal or wasteful use
of Company assets, resources, and funds by subordinate officers.
f. Smith arranged for Linda Winikow to be responsible
only to him and made it clear throughout O&R that others should
not attempt to control her activities. He encouraged and
supported her lavish expenditures for entertainment of political
figures and her broad involvement in political fund-raising. He
established an environment in which no questions were raised by
others regarding her activities, although her open disregard for
financial and accounting controls was widely known. Because
Smith gave Winikow effectively unlimited license, he ultimately
bears responsibility for her misconduct and the resulting damage
to the Company.
g. As chief executive officer and chairman of the
Board, Smith concealed important information from, and allowed
misleading reports to be made to, the Board and its Committees.
h. Smith concealed information from the Special
Committee's investigation and took steps designed to hinder and
obstruct the investigation.
2. Specific Findings
a. Conference Center
For a number of years, O&R has owned and
maintained a lodge in Sullivan County, New York, for the purpose
of providing facilities for training sessions, seminars, and
corporate meetings. From 1981 through 1988, Smith authorized
$309,394.92 worth of improvements that transformed the Conference
Center from a simple lodge, including upgrading the kitchen
facilities, installing a temperature controlled wine cellar, and
hiring a full-time chef to prepare elaborate meals. The wine
cellar, to which only Smith and a few others had access, was
stocked with expensive wines.
Company policy permitted O&R officers to use the
Conference Center on weekends, upon payment of certain charges.
Smith, however, routinely used the Conference Center for personal
entertainment while charging O&R for all the costs associated
with his use. These costs included delicacies such as caviar,
foie gras, and pheasant, fine wines, and around-the-clock staff.
Stier, Anderson & Malone has concluded that the total documented
amount of expenses for food, exclusive of wine, incurred by O&R
as a result of Smith's personal use of the Conference Center was
$37,158.16.
Smith concealed the personal nature of some of
these weekends by submitting fraudulent forms and expense
reports, which listed the weekends as business meetings. For
example, Smith used the Conference Center on two successive
weekends in 1990 to celebrate his wife's birthday with family and
friends, listing one of the weekends as a "business meeting" on
his expense reports. On these birthday weekends Smith caused O&R
to pay over $3,600 in food costs alone, including $1,060 for
caviar.
b. Misuse of Company Vendors.
On numerous occasions over many years, Smith
caused O&R to incur costs for personal printing, graphic design,
video work, and other projects for the benefit of Smith and his
family. Smith also caused O&R to pay for substantial time and
overtime spent by Company personnel, including secretaries,
chauffeurs, and employees in the Corporate Communications
Department, handling these personal projects. Examples include
the following:
- In 1992, Smith caused O&R to pay over $1,200
for the printing of invitations to his son's
engagement party.
- In 1990 and 1991, Smith caused O&R to pay
over $2,500 for printing services for his
daughter's engagement and wedding
celebrations.
- In 1991, Smith caused O&R to pay over $800
for video work on a film produced by Smith's
son.
- In 1984, Smith arranged for his daughter to
work at another company for the summer and
have O&R pay her salary there.
- In 1993, Smith caused O&R to pay
approximately $6,500 in vehicle rentals and
repairs for the filming of a movie by Smith's
son. Smith also caused O&R to pay over
$1,300 for special security and supervision
for filming parts of the movie at O&R's
headquarters.
- For a number of years, Smith caused O&R to
pay for personal photography services,
including film processing and development,
for such things as vacation pictures, family
gatherings, and his son's honeymoon pictures.
- Over the years, Smith caused O&R to pay
thousands of dollars in legal fees for
personal legal work for himself and his
family. In 1993, for example, Smith caused
O&R to pay $6,537.65 for legal work on a
personal real estate investment. Smith had
the law firm issue a credit to O&R after
Winikow was arrested.
- On a number of occasions, Smith caused O&R to
pay for the printing of personal stationery
for Smith and his wife.
- In 1992, Smith caused O&R to pay $1,763.64
for the cleaning of his home after he had a
furnace replaced. After Winikow was
arrested, Smith directed the vendor to give
O&R a credit and send him a new bill.
- Smith charged to O&R over $3,000 to have his
daughter's belongings moved to Westchester
County, New York, and to have other
belongings moved to his vacation home in
Maine. After Winikow was arrested, Smith
again had the vendor credit O&R and send a
new bill to him.
c. Personal Travel.
Smith caused O&R to pay for personal travel for
himself and his family, including the costs of first-class
airfare, luxurious accommodations, gift purchases, and expensive
dining. In many instances, Smith concealed the personal nature
of these expenditures by submitting expense sheets that reported
these expenses as business expenses incurred in connection with
his attendance at a business conference. Examples include the
following:
- Smith caused the Company to pay over $16,000
incurred by him and members of his family during a
seven day trip to Paris in February 1993,
including first-class airfare, hotel, and meal
expenses. Smith claimed on his expense reports
that these charges were incurred in connection
with a conference which ended the day after Smith
arrived.
- In 1992, the Smiths traveled to Russia and Eastern
Europe on a "People To People" tour, which bore no
relationship to the utility business and had not
been approved by the Board. Nevertheless, Smith
charged approximately $20,000 worth of expenses to
O&R. In 1981, Smith and his wife went on a
similar trip to China, for which O&R paid over
$10,000.
- In 1982, Smith caused O&R to pay $544.50 for a
one-day trip to view the space shuttle launch in
Florida. Smith's diary lists this trip as a
"holiday" while his expense reports designate the
trip's purpose as "Engineering Delegation - NASA".
- Smith caused O&R to pay over $9,000 for first-
class airfare, hotel, and meal charges, incurred
by Smith and his wife on a vacation trip to France
in 1989.
- Smith caused O&R to pay over $4,400 incurred by
him and his wife during a vacation to Canada in
1991. Smith listed these expenses as incurred in
connection with his attendance at a business
conference.
d. Personal Entertainment.
Since at least 1979, Smith has regularly used
Company funds for the personal entertainment of family,
relatives, and friends, in amounts that increased dramatically
over the years. In almost all instances, Smith submitted expense
reports or documentation that listed these private outings and
events as business-related, or listed people who were not in fact
with him. Examples of Smith's personal entertainment with O&R
funds include the following:
- On a regular basis, Smith caused O&R to pay
the costs of entertaining family, friends,
and neighbors at The Tuxedo Club in Tuxedo
Park.
- On numerous occasions over the years, Smith
caused O&R to purchase theater tickets to be
used by Smith's family, relatives, and
personal friends. For example, since 1990,
Smith charged O&R $9,300 for theater tickets,
frequently concealing the personal nature of
these expenses.
- Smith frequently charged O&R for the costs of
entertaining friends and neighbors at dinner
or cocktail parties at his home or his club.
- On numerous occasions, Smith charged O&R for
extravagant meals - frequently costing over
$1,000 per meal - with family, relatives, and
personal friends. Smith routinely listed
these outings as "business meetings". A few
recent examples include the following:
- In 1989, Smith caused O&R to pay for a meal
at Le Cirque in New York City, costing over
$1,000, to entertain personal friends,
including his physician.
- In 1990, Smith caused O&R to pay over $700
for a meal with personal friends following a
Saturday matinee of the ballet.
- In 1990, Smith charged O&R approximately
$1,000 for a dinner at Le Cirque to celebrate
the 25th wedding anniversary of friends.
- In 1991, Smith caused O&R to pay $1,012.91
for a meal with friends at Bouley in New York
City.
e. Gift Purchases.
Throughout his tenure as chief executive officer,
Smith used Company funds to purchase extravagant gifts and
merchandise for family, friends, and relatives. Smith also
purchased quantities of watches, fine china, electronics
equipment, flowers, clothing, and other gifts without indicating
any business purpose, the recipient of the gift, and without even
submitting receipts or documentation of what was purchased.
Examples of Smith's use of Company funds for personal gifts
include the following:
- Every year, Smith caused O&R to purchase
a large number of gift baskets, in some
years costing as much as $350 to $400
apiece, for the stated purpose of giving
them as Christmas gifts from O&R to
directors, officers, and others. Smith
in fact distributed many of these
baskets, costing O&R approximately
$32,000, to members of his and his
wife's families, and to personal friend
and associates - such as his real estate
agent in Maine.
- Each year, Smith caused O&R to purchase
quantities of merchandise as gifts and
door prizes for Company-sponsored
events, and distributed many of these
items to family and friends. For
example, in 1992, Smith gave engraved
Movado watches purportedly purchased for
a Company event to his children and
their spouses.
- In 1992, Smith charged O&R for 20 five-
piece place settings of Wedgewood china
which he gave to a partner at one of the
Company's law firms.
- In 1990, Smith charged $1,750 to O&R for
paintings from an art gallery in Maine,
which were given by the Smiths as
personal wedding gifts.
f. Wine.
Every year, Smith made or authorized substantial
purchases of wine with Company funds. Stier, Anderson & Malone
has concluded that a total of $156,230.84 in wine purchases is
directly attributable to Smith. Much of the wine purchased was
used by Smith for personal entertainment at the Conference Center
or cannot be accounted for. Smith violated internal controls by
failing to identify any business purpose for tens of thousands of
dollars in wine purchases, failing to require any record to be
kept of the use of the wine, and frequently failing even to
submit receipts or documentation of the purchase.
g. Loan From Clove Development Corporation
To Hydronic Technology, Inc.
Smith and Robert V. Shupe, a long-time personal
friend of Smith, along with their spouses, have operated for many
years an active real estate investment partnership, S&S Colony
Associates, through which they have purchased condominiums and
commercial property in Florida. Smith and Shupe also regularly
see each other socially. For many years, Smith assigned his
secretary at O&R the task of maintaining the books and records of
S&S Colony Associates. On numerous occasions, Smith charged the
Company for his expenses in meeting with and entertaining the
Shupes.
In early 1984, Hydronic Technology,
Inc.("Hytech"), a small Massachusetts company that manufactured
high efficiency boilers, principally owned by Shupe, sought a
$500,000 loan from O&R. On March 8, 1984, Smith arranged a
meeting between Shupe and Patrick Chambers, Jr., then O&R's chief
financial officer who knew of Smith's relationship with Shupe, to
discuss Shupe's business plan and proposed loan.* The loan
proposal called for O&R's land management subsidiary, Clove
Development Corporation, to lend Hytech $500,000 which would be
repaid with interest over eight years. This loan, however, would
be unsecured and subordinated to a bank line of credit. In
addition, Clove was to receive 25% of the equity of Hytech.
___________________
* Chambers retired from O&R on March 31, 1994
<PAGE>
Following this meeting, Chambers evaluated the
loan proposal with his staff. In a memorandum dated March 28,
1984, Chambers recommended approval of this loan. Chamber's
memorandum concluded as follows: "We have reviewed in detail the
revenue and expense aspects of their plan and believe that their
business plan and projections are reasonable."
At the April 1984 Board meeting, Chambers
discussed the proposed loan to Hytech. Smith participated in
this discussion and supported Chamber's recommendation that Clove
loan the $500,000 to Shupe's company. Neither Smith nor Chambers
revealed to the Board the personal and business relationship
between Smith and Shupe. Based on the support of Chambers and
Smith, the Board indicated its approval of the loan, which was
the first and only transaction of its kind that Clove was ever
involved in. Less than two years later, Clove wrote off this
loan to Hytech, even though there had been no default, and
ultimately lost $726,875 in interest and principal.
Because of Smith's close personal relationship
with Shupe and the unusual terms of the loan, the Special
Committee sought to determine whether Smith improperly influenced
the decision to make this loan and whether proper Company
procedures were followed in entering into the transaction. The
Special Committee reviewed all of O&R's records relating to the
loan. The records, which appear to be incomplete, are devoid of
any support for Chamber's favorable analysis. In fact, the only
available documentation raises doubts about the wisdom of
entering into the transaction. One document, prepared by Mario
DiValentino, O&R's former controller, raised a number of serious
concerns regarding Hytech's business plan and projections -
including internal conflicts in the financial figures,
unexplained changes in gross profits, insufficient data to
support growth projections, and a number of other problems. This
document was never provided to the Board.
When interviewed, Chambers claimed that all the
questions raised by DiValentino must have been resolved as part
of his analysis of the Hytech proposal, but he had no
recollection of who answered these questions, what the answers
were, and whether he received verbal or written responses.
DiValentino is certain that he never received answers to the
concerns he raised. O&R's records contain no documentation of
the resolution of any of these issues, and everyone identified by
Chambers as likely to have participated in preparing a response
has no recollection of having done so. Shupe has refused the
Special Committee's requests for an interview and for production
of Hytech records.<PAGE>
The Special Committee has concluded that:
- The Board was not informed of Smith's
relationship with Shupe.
- Because of his relationship with Shupe,
Smith should at the very least have
excused himself from any discussion
regarding the soundness of this loan.
Instead he acted as an advocate for the
loan.
- Critical issues concerning the viability
of the transaction were not resolved at
the time Smith and Chambers recommended
the loan.
- The Board was misled as to the soundness
of Hytech's business plan and
projections.
F. O&R's Lawsuit Against Smith
On February 7, 1994, O&R commenced an action against
Smith in New York Supreme Court. O&R's Complaint, filed on March
16, 1994, asserts nine causes of action against Smith.
- Breach of Smith's fiduciary duty of
loyalty to O&R;
- Breach of Smith's fiduciary duty of care
to O&R;
- Breach of Smith's fiduciary duty of
candor to O&R;
- Inducing breaches of fiduciary duty by
others;
- Fraud;
- Waste of O&R funds and assets;
- Conversion of property belonging to O&R;
- Accounting for O&R property and funds;
and
- Unjust Enrichment.
The Complaint seeks (i) damages for all amounts that
were misappropriated, wasted, and obtained through fraudulent
means by Smith, and by others as a result of Smith's conduct;
(ii) all costs incurred by the Company in connection with
investigating Smith's wrongdoing and all costs incurred as a
result of criminal or regulatory investigations or actions; (iii)
the forfeiture of Smith's compensation during the period of his
disloyalty; (iv) punitive damages; (v) an accounting by Smith;
and (vi) restitution of all amounts misused or unaccounted for.
The Court has referred all of these claims except (iv) to
arbitration.<PAGE>
G. Indictment of Smith
Shortly after O&R filed its Complaint against Smith, he was
indicted by a Rockland County grand jury on eight counts of grand
larceny and two counts of petit larceny. According to a press
release issued by the Rockland County District Attorney on March
22, 1994, the ten count indictment charges Smith with stealing
from O&R by charging personal expenses to the Company. The
charges included the following:
- Causing O&R to pay approximately $7,300 to
rent four vans and a truck that were used by
Smith's son's film production company,
including approximately $780 worth of parking
tickets issued to a rental van and an O&R car
that was being used by Smith's son;
- Causing O&R to pay approximately $3,037 to
have Smith's daughter's belongings moved to
Westchester County on two occasions, and to
have other merchandise moved to Smith's
summer home in Kennebunkport, Maine;
- Causing O&R to pay approximately $4,600 for
assorted graphic printing, including
engagement invitations for both his children,
a wedding program for his daughter, and
printed directions to Smith's summer home;
- Causing O&R to pay approximately $7,000 for
holiday gift baskets delivered to Smith's
family members, friends, and his real estate
agent in Maine;
- Causing O&R to pay approximately $1,100 for
assorted holiday plants delivered to Smith's
home;
- Causing O&R to pay approximately $1,760 to
have Smith's home cleaned following a boiler
replacement;
- Causing O&R to pay approximately $1,098 for
printing associated with Smith's wife's
campaign for Trustee of the Village of Tuxedo
Park (which Smith subsequently repaid after
Winikow was arrested);
- Causing O&R to pay approximately $2,000 for a
surprise birthday party for Smith's wife at
the Conference center;
- Causing O&R to pay approximately $300 for
auto repairs made to Smith's son-in-law's
automobile; and
- Causing O&R to pay approximately $600 worth
of watches given by Smith to his children and
their spouses.
Smith was arraigned in court on March 22, 1994 and pleaded not
guilty.
On June 23, 1994, a Rockland County grand jury handed
up a twenty-four count superseding indictment, charging Smith
with fourteen additional felonies - seven counts of grand larceny
and seven counts of falsifying business records. According to
the press release issued by the District Attorney, the additional
charges, totaling approximately $15,000, include the following:
- In 1991, 1992, and 1993, Smith took large
groups of friends and relatives out to
Broadway shows and dinners at fine
restaurants in New York City, falsely listing
all these events as business-related on O&R's
expense reports; and
- In 1993, Smith charged to O&R restaurant and
hotel expenses while in Paris, falsely
listing these expenses as in connection with
a business conference.
Smith pleaded not guilty to all charges at his arraignment on
June 23, 1994.
H. Removal of Smith as a Director of O&R
While Smith was removed as Chairman by the Board of
Directors on October 7, 1993 in conjunction with his termination
for cause as chief executive officer, he remained a director of
the Company with a term that did not expire until 1996. Under
O&R's bylaws, a director may be removed only by the affirmative
vote of at least 80% of the combined voting power of the then-
outstanding shares of stock allowed to vote. On February 3,
1994, after Smith declined to resign, the independent Directors
determined that, under the circumstances, it was in the best
interest of the Company and the shareholders that Smith be
removed from the Board, and therefore voted to submit to the
shareholders a proposal seeking his removal. In early April
1994, proxy materials including that proposal were distributed to
all shareholders.
The annual O&R shareholders' meeting was held on May
11, 1994, and adjourned to allow additional time for shareholders
to vote on the proposal to remove Smith as a director. On May
12, 1994, Smith filed a lawsuit against O&R seeking an injunction
to prevent the reconvening of the adjourned annual meeting.
Smith's request for injunctive relief was denied in its entirety
on June 7, 1994. On June 10, 1994, at the reconvened
shareholders' meeting, it was announced that 82.5% of all
outstanding shares, representing 97.6% of all shares actually
voting on that proposal, had voted in favor of the proposal to
remove Smith. Smith was thereby removed as a director of O&R.
Despite the overwhelming vote, Smith continues to contest his
removal as a director of O&R in court.
VII
LINDA WINIKOW AND THE CORPORATE
COMMUNICATIONS DEPARTMENT
The initial focus of the Special Committee's investigation
and an ongoing concern was the misconduct of Linda Winikow and
others in the Company's Corporate Communications Department.
A. Winikow's Arrival and the Changes at O&R
Winikow joined O&R in 1984 as the Vice President of
Corporate Policy and External Affairs. Winikow was personally
recruited by O&R's former Chairman and Chief Executive Officer
James F. Smith, who created the position in order to have Winikow
oversee the Company's political, charitable, and public relations
programs. Prior to joining O&R, Winikow had served for ten years
as a New York State Senator from Rockland County.
At O&R, Winikow exercised control over all the Company's
political, charitable, and public relations activities. While
the Company had been involved in political fundraising and public
relations initiatives prior to her arrival, these efforts were
poorly organized and did not involve large sums of money. The
investigators found that Winikow greatly increased the level of
involvement in political fundraising and campaigning at O&R, and
increased and politicized O&R's charitable and public relations
efforts. In pursuing these activities, Winikow enjoyed the
unequivocal support of Smith. In fact, although Winikow reported
in theory to the President of O&R, in practice she answered
directly and exclusively to Smith.
Under Winikow, the Corporate Communications Department
became increasingly involved in political fundraising and public
relations activities:
1. Winikow and her staff became actively involved in
campaign fundraising for numerous elected officials. Winikow
directed her subordinates to devote ever-increasing amounts of
time to soliciting political contributions for candidates. O&R
vendors were a principal source of political contributions. As
Winikow expanded O&R's political fundraising activities, she
began to violate O&R's internal controls as well as state law.
Smith made no attempt to control Winikow. The general consensus
throughout O&R was that Winikow had the support and encouragement
of Smith and that it would be fruitless, and dangerous, to
oppose her in any way.
2. Winikow spent a substantial portion of her time
and lavish sums of money entertaining local, state, and national
political figures.
3. Beginning in approximately 1988, Winikow and other
O&R employees made numerous trips to Washington to attend
hearings, sponsor political events, and meet with federal
political and regulatory officials. Winikow also paid
substantial amounts of Company funds to lobbying firms in
Washington.
4. Winikow, for a time, assumed control of and
politicized the hiring process at O&R. She introduced a system
in which certain individuals were hired primarily in order to
cultivate political and other relationships that Winikow
considered to be valuable.
5. O&R's charitable contributions program became
politicized under Winikow. In many instances, contributions were
made based on the political or other benefit that would be
garnered from the donation.
6. Winikow also obtained effective control over the
Orange and Rockland Employees Political Action Committee
("OREPAC"), which was formed in 1981 and was funded through
voluntary contributions from O&R employees. While we found no
clear abuses by OREPAC, Winikow's control over OREPAC violated
OREPAC's own rules.
B. Winikow's Misconduct at O&R
On October 6, 1993, Winikow pleaded guilty to the
charges of grand larceny, commercial bribery, and making illegal
campaign contributions. Winikow admitted in court that she had
used her position to force Silverman of Devotion to spend $25,000
on political contributions and personal expenses or else lose his
large advertising account with O&R. Winikow acknowledged that
she had spent $62,400 on advertising at two papers owned by
Community Media, Inc. for the purpose of ending negative press
coverage of O&R. Lastly, Winikow admitted that she funneled a
total of $5,064 ($3,864 of which was paid for by O&R) in
contributions to a political campaign while disguising the true
source of the donation.
The Special Committee's investigation has concluded
that Winikow's misconduct exceeded the specific charges to which
she pleaded guilty.
a. Political Contributions
Winikow actively sought contributions or professional
services from O&R vendors for numerous political campaigns. In
most instances, Winikow would instruct Paul Pickard or another
employee in the Corporate Communications Department to solicit
the contributions. At the beginning, Winikow had vendors submit
their political contribution checks to her, so that she could
deliver them to the candidates while emphasizing that O&R was
responsible for soliciting them. Winikow's solicitation of
political contributions from vendors eventually reached a point
at which vendors began to refuse her requests for contributions.
As a result, beginning around 1988, Winikow and her employees
encouraged certain vendors to add the amounts of political
contributions to invoices submitted to the Company.
Contributions processed this way were therefore effectively made
with O&R money, in violation of state election laws. In
addition, Winikow sometimes had Company vendors paid to provide
in-kind benefits - contributions in a form other than money - to
political campaigns of her choosing. Winikow also directed some
O&R employees to work for political candidates while on Company
time and had her Department prepare printed campaign materials
for selected candidates.
b. Winikow's Use of Corporate Vendors for
Personal Projects
Winikow's wrongdoing was not limited to improper and
illegal political campaign and fundraising activities. Winikow
also billed O&R for personal projects performed by various
corporate vendors. As a result of poor record keeping and
invoices which concealed the personal nature of the work, the
exact cost to O&R cannot be verified. Examples of Winikow's
personal projects handled by vendors and paid for by O&R include
the following:
- Two O&R vendors billed the Company an
estimated $4,000-$5,000 for stationery that
Winikow ordered for her son;
- Winikow billed O&R for the printing of her
son's resume, renting a typewriter for her
son, and for publishing Winikow's son's
engagement announcements in newspapers in New
York and Los Angeles;
- Winikow had a vendor pay for her son to
participate in a Mardis Gras float;
- Winikow used a limousine service to take
herself and her husband on a ten and a half
hour tour of the wine country near San
Francisco;
- Winikow had O&R vendors make dolls resembling
her son and future daughter-in-law to be used
as centerpieces at their engagement party;
and
- Winikow billed O&R for personal catering
delivered to her home and for sending flowers
to family and friends.
<PAGE>
c. Winikow's Use of Employees for Personal
Purposes
According to current and former O&R employees, Winikow
frequently had O&R employees handle her personal errands and
projects on Company time. Although Smith had begun to use
Corporate Communications Department personnel and assets for
personal projects even prior to Winikow's arrival, the scope and
amount of such misuse by both of them expanded after she was
placed in charge. Because Company employees did not keep records
of the amount of time and overtime spent on her personal work,
the total cost to the Company cannot be precisely quantified.
Examples of personal errands handled at the Company's expense
include the following:
- Winikow had one of her employees drive to
Florida to deliver furniture to her
condominium;
- Winikow had two of her employees fly to
Washington, D.C. and back, posing as Winikow
and her husband, so that she and her husband
could receive frequent flyer miles;
- Winikow's employees regularly drove her
husband to work and occasionally drove her
sons around New York City and Rockland
County;
- Winikow had members of her staff help plan
her son's engagement party, wedding, and
honeymoon; and
- Winikow's employees frequently drove Winikow
to hair and nail appointments, jewelry shows,
theater outings, and personal dinners.
d. Winikow's Dealings with Community Media
As noted above, Winikow pleaded guilty to entering into
contracts with Community Media for the purpose of ending negative
press coverage of O&R. Community Media was not prosecuted, and
has vehemently denied any impropriety on its part. Although O&R
disputed the validity of these contracts, on January 5, 1994, an
agreement was reached between O&R and Community Media resolving
all disputes about these contracts.
e. Winikow's Expense Account Abuse
Winikow's expense account abuse is discussed in Section
VIII of this Report.
C. Misconduct by the Pickards
Paul Pickard worked at O&R from 1982 to 1992. His last
position at O&R prior to leaving was Director of Corporate
Communications and Public Affairs, in which job he reported to
and worked very closely with Winikow. Maria Pickard worked for
O&R as an administrative assistant, and then as a supervisor, in
the Corporate Communications Department from 1981 to 1991. In
December 1991, the Pickards formed an entity called
Communications Strategies International ("CSI") in order to steal
money from O&R.
The Pickards were arrested on August 23, 1993, after
their embezzlement was discovered by the District Attorney's
office. On August 26, 1993, the Company filed a lawsuit against
the Pickards seeking to recover damages. See "IX. Civil
Litigation". On November 10, 1994, the Pickards pleaded guilty
to stealing $199,708.80 from O&R through a phony billing scheme:
The Pickards arranged for certain vendors to submit false
invoices to O&R, the invoices were approved for payment by the
Pickards, and, following payment, the vendors paid all or part of
the money to CSI. While some of the vendors were apparently
deceived by the Pickards and believed that work had been done by
CSI, others seem to have had reason to know about the Pickard's
criminal scheme. The Pickards agreed to pay restitution of
$199,708.80 to O&R as part of their plea agreement.
Paul Pickard has cooperated with the Special
Committee's investigation, which has established that the
Pickards in fact stole a total of $293,861.80 from the Company
through the following vendors:
Top Art $116,322.00
Devotion $ 94,217.80
Loren 2 $ 35,000.00
Off-Madison Avenue $ 18,000.00
D.L. Terwilliger $ 16,322.00
New York City $ 14,000.00
Press
In December 1993, Paul Pickard was arrested in
Connecticut and charged with stealing money from Northeast
Utilities, his subsequent employer, through a similar phony
billing scheme.
D. Vendor Analysis
As a result of the evidence of political activities
involving O&R vendors and misconduct by Smith and the Pickards,
the investigators expanded their review of O&R vendor invoices in
an attempt to quantify the total financial loss to the Company
from improper payments to vendors. Stier, Anderson & Malone
analyzed all the invoices submitted to O&R by about 65 vendors,
54 of which provided services to the Corporate Communications
Department. As part of this process, the investigators reviewed
vendor invoices with a number of O&R employees, as well as with
Winikow and Paul Pickard. In all, 44 vendors were found to have
submitted improper or questionable invoices. These were
classified in one of the following categories:
1. Personal Projects for Officers and Employees
Stier, Anderson & Malone has concluded that a total of
$166,172.98 was paid to vendors by O&R for items and services
purchased for the personal benefit of officers and employees --
almost all of which was for Smith, Griffin, and Winikow.
2. Embezzlement
This category included all vendor invoices which were
fraudulently submitted to O&R at the direction of an O&R employee
in order to steal money from the Company. Invoices totaling
$301,577.80 were determined to fall into this category. As
detailed above, the Pickards embezzled $293,861.80 through their
scheme involving payments to CSI.
3. Political Contributions
This category includes all vendor invoices which were
inflated to conceal political contributions and in-kind services
made at the request of Winikow or one of her subordinates. A
total of $14,195.47 was specifically identified by Stier,
Anderson & Malone to reflect political misconduct involving O&R
vendors.
4. Vendor Fraud
This category includes any invoices which were
specifically identified as fraudulently billed to O&R for work
not completed or services not rendered. The investigators
identified two invoices submitted by Creative Camera, totaling
$830.00, which fall into this category.
5. Unclassified Invoices
This category includes all invoices which were
identified by witnesses as containing some improper portion that
could not be quantified, and invoices believed to be totally
improper but which could not otherwise be categorized. Stier,
Anderson & Malone identified 409 invoices, totaling
$1,762,355.87, which were classified in this category, but they
were not able to quantify the financial harm to O&R based on the
available records. Of the total amount, $617,512.27 is the total
for unclassified invoices submitted to O&R by Devotion, and
another $802,566.41 is the total for unclassified invoices
submitted by D.L. Terwilliger to O&R.<PAGE>
VIII
INVESTIGATION OF INTERNAL CONTROLS
A. Introduction
The most significant question confronted by the Special
Committee was to determine how the misconduct we found was able
to occur and why it was not detected and exposed earlier. A
principal reason established by our investigation is that, for
years, the chief executive officer and some other key officers
undermined the Company's internal controls mechanisms, interfered
with the Company's internal audit procedures, and actively
concealed information from the Board and its Committees which
would have brought the misconduct to light. As a result, Smith,
Winikow, and others were able to systematically misuse and
misappropriate Company assets and resources.
O&R's internal controls system consists of policies and
procedures that define appropriate uses of corporate funds and
assets, requirements for the approval and documentation of
expenditures, and checks by the Company's Internal Audit
Department. O&R's written policies and procedures were found by
Price Waterhouse to be typical for a company of its type. These
formal control elements existed at O&R throughout the relevant
period and should have assured compliance with the Company's
policies and procedures. In practice, however, as a result of
the actions of Smith and a few other senior officers, O&R's
internal control system was evaded and undermined, and improper
or inadequately documented transactions became common, during
Smith's tenure as chief executive officer.
B. Officer Expenses
1. The Restricted Disbursement Account
Early in the investigation, the Special Committee
became aware that the Company had been maintaining a bank account
called the Restricted Disbursement Account ("RDA"). The RDA was
originally established in 1976 in response to a threatened work
stoppage by the local unions for the limited purpose of
processing confidential expenditures, including sensitive
consulting work and compensation studies. The RDA was not
originally intended to be used to process officers' business
expenses, which were then processed through the general corporate
disbursement account administered by O&R's Accounts Payable
Department.
In June 1977, William Hallinan, then O&R's Internal
Auditor, reported to Smith, the chief financial officer at the
time, that a recent review had revealed that the Accounts Payable
Department had been lax in enforcing the Company's requirements
for the documentation of business expenses. Hallinan recommended
to Smith that the Accounts Payable Department be reminded of the
importance of auditing officers' expenses and that the Company
adopt a more restrictive policy regarding business expenses. A
new expense policy was put into effect shortly thereafter which
contained more stringent standards.
However, as the Internal Auditor tightened the internal
controls for the review of expenses by the Accounts Payable
Department, officers' expenses began to be shifted to the RDA.
In 1978, after it was announced that Smith would become O&R's
chief executive officer, Smith's business expenses began to be
paid through the RDA. The business expenses of other officers
also began to be processed through the RDA around this time. As
a result, officers' business expenses were not subject to the
normal accounting controls, because disbursements from the RDA
were controlled by the staff of the Company's officers, not by
the Accounts Payable Department.
As the Special Committee became aware of the extent of
Smith's abuse of his expense account, its investigation focused
increasingly on the RDA and the Internal Audit Department's role
in auditing that account. At a meeting on September 9, 1993,
Patrick Chambers, Jr., O&R's former chief financial officer, gave
the Board unqualified assurances that the RDA had been properly
managed and audited. On October 26, 1993, DiValentino submitted
a report to the Board that described the formation of the RDA and
the accounting and financial controls in place for auditing the
account, concluding that there was no problem with either. These
assurances from the Company's financial officers did not assuage
the Special Committee's increasing concerns that there may have
been systemic failures in the controls, oversight, and
enforcement of the Company's policies and procedures with regard
to officer expenses processed through the RDA.
Further investigation confirmed that the RDA had been
systematically misused. Smith's misuse of Company funds for
personal purposes began in at least 1978, the year before he
became chief executive officer, and his persistent pattern of
failing to comply with Company requirements for the proper
documentation of business expenses also began around that same
time. In addition, Thomas A. Griffin, Jr., O&R's former
president who retired in 1992, had established in the late 1970's
and early 1980's similar patterns of personal use of Company
funds and improperly documenting expenses charged to O&R. (Mr.
Griffin has declined requests for an interview by the Special
Committee.) Over time, the patterns of misconduct established by
the two top officers fostered loose expense account practices
among some of their subordinates.
<PAGE>
2. The Internal Audit Function and the RDA
In 1980, Hallinan began annually auditing officer
expenses processed through the RDA . In 1980 and 1981, Hallinan
identified Smith's and Griffin's failures to comply with
documentation requirements as serious problems that needed
correction. His 1981 report (covering 1980) specifically noted a
lack of compliance with proper expense reporting procedures,
including the failures to submit receipts, identify the
individuals entertained, and state the business purpose of travel
and entertainment. Neither report was provided to the Audit
Committee. In 1981, Hallinan also sent a separate memorandum to
O&R's Controller, R.J. Hurstak, requesting that he personally
intervene to correct the problem.
By the time of his third audit report in May 1982
(covering 1981 expenses), Hallinan believed that the problem had
not only gone uncorrected, but also that it had grown more
serious. Hallinan sent a copy of his 1982 audit report to Smith
and Griffin, accompanied by a memorandum advising each of them
that he intended to send a copy to the Board's Audit Committee.
Two days later, Griffin removed Hallinan as O&R's Internal
Auditor, giving him a choice of six months severance pay or a
transfer out of internal auditing with no reduction in
compensation. Hallinan chose the latter.
The Special Committee has reached the following
conclusions with respect to the removal of Hallinan as Internal
Auditor:
- Smith participated in the decision to remove
Hallinan.
- Although some members of the Board's Audit
Committee had previously expressed
dissatisfaction with Hallinan's performance
and believed that he had been transferred for
that reason, the precipitating cause of his
removal was his threat to expose the conduct
of Smith and Griffin.
- Hallinan's removal as Internal Auditor
prevented information concerning expense
account abuse by Smith and Griffin from
reaching the Board's Audit Committee.
- The staff of the Internal Audit Department
was aware that Hallinan intended to send the
audit report to Smith and Griffin, and
believed that Hallinan's removal was in
retaliation for his threatened exposure of
Smith's and Griffin's persistent violations
of O&R's internal controls and expense
policies. They took his removal as a
warning.
Hallinan's successor, Alden Hansell, was selected by
Smith. Hansell believed that Hallinan had been removed because
of his attempts to stop or expose the misuse of the RDA by Smith
and Griffin. As soon as Hansell was appointed, he was given
instructions intended to discourage him from any similar action:
- Griffin informed Hansell that he was walking
a "tightrope" and that any vice president, as
well as Smith, could pull him off.
- Hurstak, then O&R's Controller, instructed
Hansell that he worked for management and not
for the Audit Committee or the Board.
- Griffin instructed Hansell to allow Chambers
and K.D. Archer, O&R's then general counsel,
to review his audit reports in draft.
(Hallinan had successfully resisted earlier
pressures to submit draft reports for similar
review.)
As a result of this pressure, Hansell's audit reports
never brought the misuse of the RDA by Smith and Griffin, or by
Winikow after her arrival in 1984, to the Audit Committee's
attention. In addition, after Thomas A. Folchi, Jr. became O&R's
Controller, he further instructed Hansell not to review officers'
expenses for reasonableness or propriety. Hansell construed this
as precluding him from considering whether expenses had a
properly described business purpose, and confined his scrutiny to
whether the expenses were supported by receipts. Hansell also
allowed O&R vice presidents to review audit reports concerning
their departments and to make changes to soften findings.
After 1982, abuse of the RDA by Smith and Griffin
increased dramatically. Hansell's so-called audits of the RDA
consisted simply of determining whether a document had been
submitted to support an expense and whether there were signatures
approving the expense. Hansell did not attempt to determine
whether there was any business purpose to the expenses being
processed through the RDA. Even though Hansell met privately
with the Audit Committee at least once a year, he never reported
that he had found anything amiss with officers' expenses.
3. Officer Expense Policy Adopted By Board
In February 1989, the Audit Committee approved a new
officers' expense policy which contained specific requirements
for business expenses. For example, all expenses were to include
a description of the business purpose and were to include the
name of each beneficiary of the charge. As part of the new
policy, the Internal Auditor was required to perform periodic
test audits of officers' expenses to verify that they conformed
to Company policy.
Hansell was aware that Winikow routinely violated even
the basic requirement of submitting documentation for a large
percentage of her expenses. Winikow insisted that her frequent
entertainment of political figures required her to keep her
expenses confidential. Hansell raised the issue with Company
management. Because Winikow refused to change her methods,
Hansell was directed to prepare a so-called "supplement" to the
officers' expense policy that the Board had recently approved and
believed to be in operation. This written supplement, commonly
called the "Winikow Amendment", allowed officers to avoid the
documentation requirements (without which no proper audit could
be conducted) by verbally reporting to the President (then
Griffin) about the purpose for their expenses.
Company management, under the leadership of Smith,
decided not to inform the Audit Committee or the Board about the
Winikow Amendment. Indeed, the Winikow Amendment was
specifically intended by them not only to conceal Winikow's
flagrant abuses from the Audit Committee, but also to frustrate
the Audit Committee's directive that officers' expenses be
examined. Winikow herself did not even fully comply with the
oral reporting loophole established by the Winikow Amendment.
Hansell neither informed the Audit Committee about the
Winikow Amendment nor audited her expenses. In each of his
written reports to the Audit Committee after 1989, Hansell stated
that officer expenses conformed to the Company's policy, despite
the obvious violations by Winikow of the policy adopted by the
Board and the continued abuses by Smith and Griffin. Even in his
report covering 1993 expenses, which was issued months after the
Special Committee's investigation had begun, Hansell failed to
note any real deficiencies.
4. Expense Account Abuses by Officers Other Than
Smith
The Special Committee reviewed expenses processed
through the RDA by Griffin, Winikow, and other officers. Stier,
Anderson & Malone's analysis indicates that Griffin charged at
least $43,324.96 in improper expenses and an additional
$141,002.54 in inadequately documented expenses through the RDA
from 1976 until his retirement in 1992. The most significant
patterns of abuse involving Griffin's use of the RDA were as
follows:
- Griffin routinely failed to provide the
required documentation to support his
expenses.
- Personal entertaining such as dinners,
theater, golf, and parties were often
mischaracterized as business-related on
Griffin's expense reports.
- Griffin often charged O&R for personal and
lavish expenses associated with travel to
conferences with his wife.
- Griffin charged O&R for numerous gifts for
friends and unidentified recipients.
The Special Committee has also learned that Griffin
frequently used O&R employees and vendors to handle his personal
projects. Stier, Anderson & Malone has identified a total of
$34,842.74 paid by O&R to vendors, mostly Corporate
Communications Department vendors, who handled personal work for
Griffin from the mid-1980's until his retirement in 1992.
Examples of Griffin's personal use of Company vendors include the
following:
- In 1989, Griffin had a number of O&R vendors
put together a photo album of his trip to
China, resulting in a $18,909.90 cost to the
Company;
- In 1992, Griffin caused O&R to pay $2,661.04
to an O&R vendor to remove two trees from his
neighbor's yard;
- Griffin had O&R vendors produce a slide show
for Griffin's son to be shown at his wedding,
photo albums depicting the history of the
Griffin family, and photo albums for each of
his brothers and sisters; and
- Griffin used O&R vendors to frame family
photographs, and to provide photography and
video services for his son's engagement party
and wedding reception.
Stier, Anderson & Malone has concluded that Winikow is
responsible for at least $17,892.04 in improper expenses and an
additional $239,117.30 in inadequately documented expenses
processed through the RDA. Although Winikow failed to submit
documentation for most expenses, based on an analysis of her
expenses and on interviews with her conducted by the Special
Committee's investigators, the following patterns of abuse are
clear:
- A substantial portion of Winikow's expenses
for meals and other social gatherings were
with undisclosed guests. In many instances,
these guests were her personal friends and
family members.
- Winikow purchased numerous gifts for friends
through the RDA.
- Winikow often purchased tickets to theater
and sporting events to entertain her friends
and family at O&R's expense.
An initial review by Stier, Anderson & Malone and Price
Waterhouse indicated that numerous charges by other current and
former officers required further review, because of inadequate
documentation or apparent lack of business purpose. The Special
Committee referred its findings regarding these officers to the
Executive Committee. Representatives of the Executive Committee
of the Board met with each current officer, as well as with
Folchi and DiValentino, to review his overall use of the RDA and
the charges that were identified in the initial review as
requiring further attention.
As a result of these discussions, a large number of the
inadequately documented expenses, and some others, were explained
to the satisfaction of the Executive Committee. Several officers
were found not to have misused their expense accounts. In other
cases, some expenses were found that were not in compliance with
the Company's officer expense policy, or were not explained or
documented to the Executive Committee's satisfaction. It was
found that in some instances, questionable charges had been
specifically authorized or encouraged in advance by Smith or
another senior officer, and that virtually all expenses had been
approved by Smith or another senior officer. Based on the
Executive Committee's review and discussions with the individual
officers, four current officers and one former officer reimbursed
(or agreed to reimburse) the Company for RDA charges totaling
approximately $52,000.
The investigators also identified a total of $52,667.89
in improper expenses and a total of $468,949.16 in inadequately
documented expenses charged by other former officers and other
individuals who used the RDA but who were not interviewed.
C. Subversion of Other Control Devices
The Special Committee also reviewed certain internal
control systems outside the RDA in an attempt to determine why
misconduct in other areas failed to be identified and exposed
earlier. Two areas merit discussion; the other areas
investigated were not found to have any significant shortcomings.
1. Corporate Communications Department
Internal controls were extremely weak in Winikow's
department. As described above, Winikow instructed O&R vendors
to make political contributions and to then bill O&R for the
costs of doing so. Winikow's attitude towards enforcement of
internal controls was an open secret in the Corporate
Communications Department. Indeed, a number of her subordinates
were involved in the solicitation of illegal contributions and
the approval of fraudulent invoices. In addition, Winikow's
misconduct and open disregard for all accounting and financial
controls allowed others, such as the Pickards, to develop their
own private schemes to defraud O&R. The Special Committee has
made the following additional findings with regard to the
internal controls in the Corporate Communications Department:
- The Corporate Communications Department was
not audited by the Internal Auditor from 1981
until 1993.
- The practice of allowing vendors to inflate
and falsify invoices became accepted to the
point that employees interviewed were not
always able to tell the extent to which
invoices had been falsified. Since the
vendors disguised the nature of their work on
the invoices, an uninformed person or auditor
would believe that the work had actually
been done for O&R.
- Justin Schwartz, the Department's budget
manager for the past few years, was little
more than a personal assistant to Winikow and
neglected his duties to enforce budget
controls and procedures for approval of
invoices.
2. Conference Center
Since 1977, O&R had a policy requiring reimbursement
for the personal use of the Conference Center by officers. This
policy was reaffirmed by Smith in writing on at least two
occasions - the second time in response to a New York State
Senator who had inquired about officer use of the Conference
Center. O&R had established a fixed fee for officer use of the
Conference Center which was intended to cover linen service,
maintenance, and beverages. In recent years, this fee was set at
$50 per weekend, not to exceed $200 a year per officer. In
addition, any officer who arranged for the chef to purchase and
prepare food was required to reimburse O&R for the cost of the
food.
The available evidence indicates that most officers
paid the set fee for personal use of the Conference Center until
1988. In 1988, Folchi, who was responsible for use of the
Conference Center, inexplicably stopped collecting the fees from
any officer, and officers thereafter never paid fees for personal
use of the Conference Center. Smith appears never to have paid
the fee for personal use of the Conference Center, and also never
reimbursed O&R for the substantial additional costs of food -
including thousands of dollars worth of caviar - bought and
prepared by the chef at his request. Smith and his personal
guests also consumed quantities of expensive wine paid for by
O&R, without keeping any records of his personal consumption and
without reimbursing O&R. A few other officers also caused the
Company to incur expenses associated with their personal use of
the Conference Center.
D. Role of the External Auditor
The Special Committee reviewed the work of Grant
Thornton, the Company's outside auditor through 1993, to assess
their audits of the Company and to determine why the misconduct
described above did not come to light during those audits.
Because Grant Thornton has declined the Special Committee's
requests for interviews and for access to their accounting work
papers, the Committee's review has been limited to Company
records and personnel.
One key question the Special Committee looked into was
why no audit had revealed the pattern of misuse of the RDA
described above. As discussed above, the business expenses of
Smith and other officers began to be paid through the RDA as
early as 1978. The Committee also reviewed generally Grant
Thornton's oversight of the Company's Internal Audit function and
internal controls.
The Committee learned that the RDA (and the officers'
expenses) had not been audited by Grant Thornton since 1978;
since then, the Internal Auditor has audited the officers'
expenses paid through the RDA. The Committee also learned that
Grant Thornton had never performed any testing of the Internal
Auditor's auditing of the RDA (or officers' expenses) during this
period. In assessing Grant Thornton's oversight function, the
Special Committee also noted that Grant Thornton had not brought
to the attention of the Audit Committee the facts that (i) the
officers' expenses were being paid through the RDA and (ii) there
had been no internal audit of the Communications Department since
1981. Overall, the Special Committee is unable to express
approval of Grant Thornton's performance as the Company's outside
auditor, but the Committee is not aware of any information
indicating that Grant Thornton participated in, or had knowledge
of, misuse of the RDA or the other misconduct discussed above.
Upon the recommendation of the Audit Committee, the
Board decided to solicit bids for the performance of auditing
services for the Company for 1994. Bids were received from six
accounting firms, including Grant Thornton. Based on a full
review of the competing bids, the Audit Committee recommended
that Arthur Anderson & Co. be selected as the Company's outside
auditor, and the full Board approved the recommendation. At
O&R's 1994 annual shareholders' meeting, the shareholders
approved the selection of Arthur Anderson as O&R's auditor for
1994.<PAGE>
IX
CIVIL LITIGATION
O&R has initiated three lawsuits seeking to recover
damages resulting from the misconduct discovered in the Special
Committee's investigation.
1. On August 26, 1993, O&R filed Orange and Rockland
Utilities, Inc. v. Winikow in the United States District Court
for the Southern District of New York, against Linda Winikow,
Justin Schwartz, Stanford Silverman and Devotion, Inc., and the
Pickards and Communications Strategies International. In this
action, the Company alleges that the defendants engaged in a
conspiracy to divert funds from O&R through the submission of
false and fraudulent invoices, in order to pay personal expenses
and to provide personal services to the defendants. The Company
also charges that the defendants were engaged in a scheme to make
contributions to political candidates by diverting money and
services from O&R.
2. On August 26, 1993, O&R filed Orange and Rockland
Utilities, Inc. v. Serge Rotjan in the Supreme Court of the State
of New York, County of Rockland, against Justin Schwartz and
Serge Rotjan, the owner of Creative Camera. In this action, the
Company alleges that the defendants defrauded O&R through a
scheme in which Schwartz intentionally altered invoices submitted
by Rotjan to increase the amounts paid out to Creative Camera.
3. On February 7, 1994, as described on page 21, O&R
commenced its action entitled Orange and Rockland Utilities, Inc.
v. James F. Smith in New York State Court. The Complaint alleges
nine causes of action against Smith for breaches of fiduciary
duty, inducing breach of fiduciary duty by others, fraud,
conversion, unjust enrichment, waste, and an accounting of
Company property and funds. The Complaint seeks an accounting by
Smith of Company funds and property, restitution of all amounts
misappropriated, misused, and unaccounted for, the forfeiture of
Smith's compensation during the period of disloyalty,
compensatory damages of at least $5 million, and punitive
damages. These claims (other than for punitive damages) will be
heard in an arbitration proceeding.
A number of lawsuits have also been brought against O&R
related to the matters investigated by the Special Committee.
1. On August 18, 1993, Feiner v. Orange & Rockland
Utilities, Inc., a purported ratepayer class action complaint,
was filed against O&R in the United States District Court for the
Southern District of New York. This complaint also names Linda
Winikow, the Pickards, and CSI as defendants. The complaint
alleges that the defendants violated federal and state law by
using false and misleading testimony to obtain rate increases,
and using "ratepayer funds" to make illegal campaign
contributions and other payments. On February 18, 1994, O&R
filed a motion to dismiss this lawsuit as barred by the filed
rate doctrine. That motion is currently awaiting decision.
2. On August 31, 1993, Patents Management Corp. v.
Orange & Rockland Utilities, Inc., a purported shareholder
derivative suit, was filed against O&R, all but one of its
directors, and four former directors, in the Supreme Court of the
State of New York, County of New York. This complaint also names
Linda Winikow, Devotion, Justin Schwartz, and the Pickards as
defendants. The plaintiff charges that the Company's Directors
breached their fiduciary duties by condoning Winikow's wrongful
acts and failing to exercise appropriate supervisory control over
her.
3. On November 23, 1993, Gross v. Orange & Rockland
Utilities, Inc., a purported class action complaint by
participants in O&R's Dividend Reinvestment Plan was filed
against the Company in the United States District Court for the
Southern District of New York. This complaint alleges that O&R's
Securities and Exchange Commission filings during 1993 were false
and misleading in that they failed to disclose Winikow's
activities.
4. On March 31, 1994, Bernstein v. Orange & Rockland
Utilities, Inc., a purported shareholder class action complaint,
was filed against the Company in the United States District Court
for the Southern District of New York. Smith was also named as a
defendant in this lawsuit. This complaint makes claims similar
to those in Gross on behalf of open-market purchasers of the
Company's shares.
X
CORRECTIVE ACTIONS TAKEN BY O&R
On the basis of the Special Committee's findings and
conclusions, the Company has taken many steps to correct the
problems that have been identified and has adopted important
safeguards to prevent similar misconduct in the future. This
section recapitulates the actions and steps that have been taken
by O&R - including many which have already been described in this
report.
1. New Chief Executive Officer
On October 7, 1993, Smith's employment as chief
executive officer was terminated for cause and he was
subsequently removed from the Board of Directors for cause by
shareholder vote. D. Louis Peoples was elected as the Company's
Chief Executive Officer and Vice Chairman of the Board on
July 14, 1994.
2. Termination of Communications Department
Employers
Linda Winikow's employment as Vice President of
Corporate Policy and Internal Affairs was terminated for cause on
August 26, 1993. Justin Schwartz's employment at O&R was
terminated on August 13, 1993. The Pickards were no longer
employed by O&R when their misconduct came to light.
3. Financial Officers
In March 1994, following the Special Committee's
review of the Company's internal controls and the Internal Audit
Department, the Board terminated the employment of L. Mario
DiValentino, O&R's Vice President, Controller, and Assistant
Secretary, and Thomas A. Folchi, Jr., O&R's Vice President for
Customer Services and Human Resources and the former controller.
Subsequently, the Board terminated the employment of Alden
Hansell, the Company's Internal Auditor since 1982.
Patrick Chambers, Jr., the Company's former chief
financial officer, retired on March 31, 1994. Mr. Chambers
agreed, upon his retirement, to forego his rights to certain
performance units under an earlier award agreement with the
Company to settle claims for restitution by him of expenses
identified by the investigators as improper or inadequately
documented.
The Company is in the process of hiring a new
chief financial officer and a new internal auditor.
4. Reimbursement of Expenses
As noted above, four current officers and one former
officer have reimbursed the Company for approximately $52,000 in
expenses charged to the RDA.
5. Strengthening Internal Controls
The Company has taken a number of remedial measures to
correct problems that have been identified in the Company's
internal controls and to avoid problems in the future. These
steps include the following:
- On October 5, 1993, O&R abolished the RDA.
All officers' business expenses are now being
processed through the general disbursement
account administered by the Accounts Payable
Department.
- The Company has adopted a new, stricter
policy regarding officers' business expenses.
Certain expenses that were allowed under the
previous policy are no longer allowable, and
tighter reporting requirements are being
enforced. The Company's outside auditor will
review the officers' business expenses for
compliance with this new policy.
- Price Waterhouse was commissioned to conduct
a review of the Company's internal control
procedures, focusing on the internal audit
function, the Company's accounts payable
system, and the processing of officers'
expenses. Price Waterhouse recommended
specific changes in the procedures followed
by the Company's Internal Audit Department to
insure the independence of the Internal
Auditor, and changes in the amount and type
of information that should be presented to
the Board's Audit Committee. Price
Waterhouse's recommendations are currently
being implemented.
- O&R has expanded the staff of the Internal
Audit Department to include ten full-time
auditors.
- Arthur Anderson has performed a peer review
of the Internal Audit Department and has made
various recommendations, which the Audit
Committee has accepted and which the Company
is implementing, to improve the effectiveness
of the Department in examining and evaluating
the financial, operational, and
administrative activities of the Company.
- The Audit Committee of the Board has
completed a self-assessment process and has
modified its operating procedures in order to
enhance the effectiveness of the Committee in
fulfilling its oversight responsibilities.
The Audit Committee has also approved a
revised charter that more clearly defines the
responsibility of the Committee under the
Company's by-laws.
6. Change of External Auditors
Grant Thornton was terminated as the Company's outside
auditor and, at O&R's 1994 annual shareholders' meeting, the
shareholders authorized the appointment of Arthur Anderson & Co.
as the Company's outside auditor for 1994, replacing Grant
Thornton.
7. Rebates to Ratepayers
O&R has pledged to refund to its ratepayers
misappropriated monies that are found to have been charged to
accounts used in setting rates. To date, O&R has refunded to New
York ratepayers a total of $345,000, and has given rebates to New
Jersey customers totaling $94,100.
8. Joint Cooperation Agreement with the District
Attorney
From the outset of the investigation, the Special
Committee pledged to cooperate fully with the District Attorney's
office. On November 3, 1993, O&R entered into a Joint
Cooperation Agreement with the Rockland County District Attorney
whereby the Company agreed to cooperate fully and completely with
the District Attorney in his investigation, and to provide
unimpeded access to all evidence collected by the Special
Committee's investigation. In light of O&R's pledge of full
cooperation, and its commitment to uncovering all misconduct
committed at O&R, the District Attorney agreed not to file any
criminal charges against the Company. The Company and the
Special Committee have adhered to this agreement throughout the
investigation.
9. Closing of Lobbying Offices and Activities
The Company has agreed to discontinue for five years
all political contributions and the activities of all political
action committees. In addition, O&R has also closed its
lobbying offices in Trenton, New Jersey and Albany, New York.
10. Appointment of Inspector General
O&R has agreed to establish the position of an
independent Inspector General for a period of seven years. The
Inspector General will have the authority to investigate and
report improper or unethical conduct, as well as the ability to
take certain steps to prevent such behavior. The Inspector
General will also make regular reports to O&R's chief executive
officer, O&R's Board, the PSC, and the District Attorney's
office.
11. Ethics Task Force
O&R has formed an Ethics Task Force, including
representatives from almost every department within the Company,
which has been working on creating a Statement of Core Values and
a Code of Business Conduct, and has met with representatives of
other companies to analyze their experiences in dealing with
ethics issues.<PAGE>
XI
CONCLUSIONS
As described in this report, the Special Committee's
investigation came to concentrate on three principal areas: (i)
the misconduct of Smith; (ii) the misconduct of Winikow and
others in O&R's Corporate Communications Department; and (iii)
the evasion and subversion of the Company's internal controls.
Based on the Special Committee's review of the evidence with
respect to these problems and why they occurred that was
presented by Stier, Anderson & Malone, the Special Committee has
reached the following overall conclusions:
Corporate Communications Department
Winikow and others in the Corporate Communications
Department engaged in improper and illegal political fundraising
activities, including requiring vendors to make political
contributions and sometimes reimbursing the vendors through the
payment of falsified or inflated invoices. Winikow and others
also charged the Company for various personal expenses, and
members of her Department used Company vendors to embezzle money
from O&R. Employees and resources of the Corporate
Communications Department were also used for personal projects
for Smith, Winikow, Griffin, and others, at an aggregate cost to
the Company which the investigators could not quantify based on
available records. A few officers, primarily Smith, Griffin and
Winikow, also used Company vendors inside and outside the
Corporate Communications Department to handle a variety of other
personal projects.
An aggregate of approximately $482,776 was paid by the
Company to vendors for improper purposes, of which a relatively
small amount - approximately $14,195 - was used for improper
political activities. A much larger portion of that total -
approximately $293,861 - was embezzled from the Company by two
former employees who have pleaded guilty to theft and agreed to
pay restitution.
Questions were raised during the investigation as to
the propriety of part or (in a few cases) all of a number of
other payments to vendors, aggregating approximately $1,762,355,
but the investigators were unable to quantify the amount of any
improper payments based on the evidence available.
These misuses and misappropriations of Company funds
and resources occurred because Winikow and her department were
subject to no effective supervision, and there was little, if
any, enforcement of the Company's written internal controls
throughout the Corporate Communications Department.
Internal Controls and the RDA
When the Special Committee subjected the Company's
internal controls to scrutiny, it was advised by Price Waterhouse
that the written rules met generally applied standards for a
corporation such as O&R. The Special Committee also learned that
these formal controls had been systematically evaded and
undermined by the senior officers who should have been most
concerned to enforce them.
Beginning in around 1977, the requests of Smith and
other officers for reimbursement of expenses began to be
processed through the Restricted Disbursement Account ("RDA"),
which was not subject to the Company's normal accounting
controls. For the period 1977 through 1993, approximately
$402,842 such expense reimbursement was in fact improperly
obtained by some employees (principally Smith, Griffin, and
Winikow), not for legitimate business expenses, but for personal
benefit. Steps are being taken to recover these funds from those
no longer with the Company, and all current officers, as well as
one former officer, have already paid, or have agreed to repay,
all amounts that they were found not to have been entitled to
have been reimbursed (representing in the aggregate approximately
$52,000).
During the same period, approximately $1,340,270 was
paid from the RDA to reimburse employees for expenses that were
not adequately documented. The largest portion of these expenses
are attributable to Smith, and the propriety of his expenses is
currently being litigated. In many other cases (e.g. the current
officers), the Company has been able to determine that such
expenses were in fact incurred for a proper business purpose.
The Special Committee believes that the principal
factors leading to the abuse of the RDA were actions by Smith,
Griffin, and certain financial officers that had the effect of:
(i) rendering the Company's Internal Audit Department
ineffective; and (ii) causing the misuse of the RDA and the
undermining of the Company's internal controls to be concealed
from the Audit Committee and the Board.
Smith
In making its overall assessment of the problems
uncovered by the investigation, it became clear to the Special
Committee that Smith played a central role in the misbehavior
that occurred at O&R during his tenure as chief executive
officer. First, Smith gave Winikow free rein to do as she
pleased, actively encouraged her free-wheeling and costly
political activities, refused to take action on complaints about
her, and helped to shield her conduct from scrutiny. This had
the natural effect of allowing not only Winikow, but also those
around her, to believe that the rules could safely be ignored.
Second, as the chief executive officer of O&R, Smith ought to
have set an example of scrupulous respect for the Company's
policies, rules of ethics, and property. Instead, he
systematically exploited the Company's assets for his own
benefit. Third, Smith fostered and encouraged an environment in
which there was pervasive abuse and circumvention of internal
controls and corporate policies and a serious breakdown in
corporate responsibility. This included allowing a so-called
amendment to the officer expense policy to shield non-complying
expenses of Winikow and others from the rules adopted by the
Audit Committee, without informing the Board.
For these reasons, the Special Committee believes that
Smith must be held ultimately responsible for the misconduct
described in this report, the accompanying loss of the Company's
credibility with the state utility commissions, and the other
adverse consequences to the Company as a result of his failures
to supervise properly the affairs of the Company and its
officers. The bulk of the misconduct involved may be seen as
falling into one of two patterns: One is a pattern of
exploitation of weaknesses in O&R's internal controls that Smith
either brought about, tolerated or failed to remedy; and the
other is a pattern of emulation of Smith's example by those using
corporate assets for their own benefit. We do not state this
conclusion to absolve other persons that were at fault from their
individual responsibilities, but to emphasize how strongly we
feel that O&R's problems would never have arisen if Smith had
been mindful of his duties as chief executive officer and honest
in his dealings with the Company.
The Special Committee feels that the steps that O&R has
taken in the past year, including the removal of Smith as chief
executive officer and as a director and the overhaul of the
Company's internal controls, have addressed the problems it found
and their causes. O&R has been through a painful and difficult
year, but it has emerged as a leaner, better-managed company.
<PAGE>
The vast majority of the approximately 1700 employees of O&R had
no involvement in any of the matters described in this report and
have responded commendably to the challenges presented by the
events of the last year. We feel confident that they and the
Company are once again focused on delivering cost-efficient
energy to O&R's customers and value to its shareholders.
August 22, 1994 SPECIAL COMMITTEE OF THE
BOARD OF DIRECTORS OF
ORANGE AND ROCKLAND UTILITIES, INC.
Linda C. Taliaferro, Esq.
Ralph M. Baruch
James F. O'Grady, Jr., Esq.
<PAGE>
Exhibit 99.6
<PAGE>
OR ORANGE AND ROCKLAND NEWS
ROCKLAND ELECTRIC COMPANY For Release: Immediate
PIKE COUNTY LIGHT AND POWER CO. Contact: Mike Donovan
One Blue Hill Plaza, Pearl River, NY 10965 (914) 577-2430
EX-CEO SMITH SUPPRESSED O&R'S NORMAL FINANCIAL CONTROLS
PERMITTING HIM TO SPEND THOUSANDS ON PERSONAL EXPENSES
PEARL RIVER, NY, August 23, 1994 -- Former O&R Chairman and CEO
James F. Smith went to extraordinary lengths to engage in a
pattern of secrecy, deception and misconduct during his 15-year
tenure as chief executive officer that subverted the firm's
internal financial controls, diverted thousands of dollars in
company money to his personal expenses, improperly permitted a
select few other employees to do the same, and deceived the Board
of Directors in the process.
That's the principal conclusion reached by the Special Committee
of the Board of Directors in its report issued today on a year-
long investigation of the Company.
One result of that misconduct was O&R's paying at least $885,000
in bills that were improperly designated business costs. The
Company also spent an additional $3 million that was so badly
documented or raised sufficient questions that the investigators
could not say what portion was for proper business purposes.
Those charges ran the gamut from charges for personal trips and
political contributions to extravagant dinners and expensive
wine. In one instance, a high-ranking employee and his wife
funneled company money through false invoices for the couple's
personal enrichment.
That misconduct severely damaged the Company's credibility with
state regulators and created other adverse consequences which
directly resulted from Smith's failures to supervise the affairs
of the Company and its officers.
The Special Committee was created on August 20, 1993 and given a
broad mandate to investigate all wrongdoing at the Company,
following the arrest of Linda Winikow, who was then an O&R vice
president, on charges of grand larceny, commercial bribery, and
making illegal campaign contributions.
The Special Committee's conclusions were based on the
investigatory work performed by Stier, Anderson & Malone, a New
Jersey law firm headed by former criminal prosecutor Edwin Stier,
that specializes in investigations of utility corporations.
Stier Anderson & Malone spent over 10 months at O&R headquarters
gathering and analyzing more than 200,000 pages of documents and
over 60,000 transactions with the help of the accounting firm of
Price Waterhouse & Co.
The law firm conducted 340 interviews of O&R personnel, vendors
to the Company, present and past Board members and public
officials. That law firm's findings are presented in a 1,000
page, written report to the Special Committee, and was also
released today.
Special Committee Chairwoman Linda C. Taliaferro, Esq., said, "In
my experience, this work stands as one of the most thorough,
comprehensive investigations ever conducted into the business of
an American corporation. We promised to get to the bottom of
this matter, and we did. It's exhaustive."
Specifically, The Special Committee found that Smith abused his
authority during his tenure as Chief Executive Officer by:
...systematically engaging in the misappropriation of Corporation
funds and resources for his personal benefit.
...subverting the Corporation's internal controls and violating
many of its corporate policies.
...fostering and encouraging an environment in which there was
pervasive evasion and abuse of internal controls and concealment
of those actions from the Audit Committee and the Board of
Directors.
...failing to properly supervise, and encouraging misconduct by
Winikow and other subordinate officers.
...concealing information from the Board and its committees.
As a result of that abuse of authority, Smith's employment as
chairman and chief executive officer was terminated for cause by
the Board on October 7, 1993, and he was subsequently removed
from the Board by shareholder vote.
As described in its report, the Special Committee's investigation
came to concentrate of three principal areas:
...the misconduct of James F. Smith, as recounted above.
...the misconduct of Linda Winikow and others in O&R's Corporate
Communications Department which she had headed;
...and a pattern of evasion and subversion of the company's
internal controls that had permitted, and prevented the detection
of this misconduct.
The Committee emphasized that the vast majority of O&R's
employees had no involvement in these matters.
Besides its conclusions concerning Smith's misconduct and his
responsibility for the misconduct of others, the Special
Committee reached the following overall conclusions:
CORPORATE COMMUNICATIONS DEPARTMENT
Winikow and others in the Corporate Communications Department
engaged in improper and illegal political fundraising activities,
other members of the department used Company vendors to embezzle
money from O&R, and employees and resources of the Corporate
Communications Department were used for personal projects,
especially by Smith, Winikow and Thomas A. Griffin Jr., O&R's
former President.
An aggregate of approximately $482,776 was paid by the company to
vendors for improper purposes, of which a relatively small amount
- --- approximately $14,195 was used for political payments.
A much larger portion of the total --- $293,861 --- was embezzled
from the company by two former employees, Paul and Maria Pickard,
who have pleaded guilty to the theft and agreed to pay
restitution.
Questions were also raised during the investigation as to the
propriety of part or all of a number of other payments to
vendors, aggregating approximately $1,762,355, but the evidence
available does not quantify the amount of those payments that may
be improper.
INTERNAL CONTROLS AND THE RDA
The Special Committee found that the Company's internal controls
had been systematically evaded and undermined. The investigation
established that, beginning in 1977, the requests of both Smith
and other officers for reimbursement of business expenses began
to be processed through a special account called the restricted
disbursement account (RDA), which was not subject to the
company's normal accounting controls. That account was abolished
last fall.
For the period 1977 through 1993, approximately $402,842 of such
expenses was in fact improperly obtained by some senior officers
(principally Smith, Griffin and Winikow), not for legitimate
business expenses, but for personal benefit.
During the same time period, employees caused O&R to pay
approximately $1,340,270 through the RDA for expenses and
expenditures that were not adequately documented. The largest
portion of these expenses are attributable to Smith, and the
propriety of his expenses is currently being litigated.
In many other cases, the Company has been able to determine that
such expenses were in fact incurred for proper business expenses.
Where those expenses were not incurred for business expenses,
arrangements have been made with all current officers for
reimbursement to the company.
The Company has not yet determined what portion of the amounts
referred to above may have been improperly charged to the
accounts used in setting rates.
As a result of the Special Committee's investigation, the Company
has taken important steps to correct the problems that were found
and to prevent similar misconduct in the future. These steps
include the following:
...Besides its dismissal of Smith, the Company has terminated the
employment of Winikow, two former controllers and the internal
auditor.
...The Company has strengthened its internal controls by, among
other things, abolishing the RDA, adopting a stricter policy
regarding officers' business expenses, expanding its auditing
staff and revamping the procedure followed by the Internal Audit
Department.
...The shareholders authorized the appointment of Arthur Andersen
& Co. as the Company's new outside auditor, replacing Grant
Thornton.
...O&R has refunded a total of $345,000 to New York ratepayers
and an additional $94,100 to New Jersey ratepayers.
...O&R has agreed to discontinue for five years all political
contributions and the activities of all political action
committees.
...O&R has agreed to appoint an independent Inspector General for
a period of seven years to investigate and report unethical
conduct.
...The Company has fully cooperated with all utility commissions
that regulate O&R and with the District Attorney, and has
provided them unimpeded access to the evidence uncovered during
the course of the investigation.
Special Committee Chairwoman Taliaferro, an attorney and former
Pennsylvania Public Utility Commission member, said, "The Special
Committee is confident that the steps that O&R has taken in the
past year have addressed the problems that it found and their
causes. We recognize that O&R has been through a painful and
difficult year, but we believe that it has emerged as a better
managed company."
She said, "We feel confident that the Company and its employees,
who have responded admirably in adversity, are once again focused
on delivering cost-efficient energy to O&R's customers and value
to its shareholders."
Taliaferro's colleagues on the Board's Special Committee were:
Ralph M. Baruch, the founder and former chairman and chief
executive officer of Viacom International, Inc., James F.
O'Grady. Jr., Esq., President of O'Grady and Associates, and
(until his retirement from the Board on May 11) John F. White,
President Emeritus of the Cooper Union for the Advancement of
Science and Art.
