Case Summaries 5.10 - Caterers and the Duplication of Overhead Recovery Carts, Candies and Caviar is a caterer that is based in Phoenix, Arizona. Since the business was first founded in 1974 by Cindy Callstone, it has experienced rapid growth. In 1991, Cindy made over one million dollars in sales, which prompted Cindy to seek financial planning assistance. In 1992, Cindy brought in two senior business students from nearby universities as interns. Cindy put them in charge of not only creating a plan for financing CCC’s growth, but also for the construction of new kitchen facilities.
The two business students that were selected were Vera Dickerson and Ralph Dunn. Cindy gave them total access to all of the books, records, and contracts of CCC. While looking through the various documents, Vera and Ralph came upon interesting and unique business practices in Cindy’s billing. Cindy had billed all of her computer-time to “cost-plus” customers, which involved the customers being contracted into paying all catering costs and a specific profit for CCC for computer time. In the timeframe of a month, Cindy recovered all of her time spent on the computer from fifteen customers. These same “cost-plus” customers were also billed for full-time kitchen use, with an overhead amount for kitchen facilities based on a per hour or per day basis.
If a dinner preparation would take a full day, Cindy would bill the individual customer for one-thirtieth of the monthly cost of her kitchen facilities. Since Cindy seldom allowed the kitchen to be devoted for a single customer, the same dinner would be prepared for numerous customers at a single time.
However, each customer would still be billed for a full day of kitchen facilities. Among the records, Vera also discovered that Cindy would negotiate discounts with soda vendors. Soda vendors would give Cindy a discount, such as fifteen percent discount, as they viewed Cindy’s usage of their product as advertisement. However, Vera also discovered many instances in which the customer would pick the soda vendor on their own and then pay them directly, but Cindy would still charge the customers for the soda. When Vera questioned Cindy about this, Cindy said that if someone catches the charge, she will refund them, but otherwise keeps the money.
She makes the claim that it is “just the way things are done in this business. ” When Vera brought this to Ralph’s attention, stating that Cindy was ripping off her customers, Ralph condoned Cindy’s actions. He agreed with Cindy’s reasoning that that is how the business is run. If the customers catch the mistake, the caterers admit to it; if not, the caterer makes an additional profit. 5.12 - Salomon Brothers and Bond Pricing Salomon Brothers is an investment banking firm that was founded in 1911.
Before the summer of 1991, it was the most powerful dealer on Wall Street in the $2.3 trillion U. S. Government bond market. On August 9, 1991, Salomon announced that two managing directors and two other employees would be suspended for violating the 35 percent rule. This rule states that firms are prohibited from gaining more than 35 percent of the Treasury notes and bonds at government auctions. This rule prevents one firm from buying enough of the market to dictate the prices of the instruments.
Along with the suspensions came the discovery of other problems in regard to this 35 percent rule. In December 1990, Salomon bought 35 percent of an $8.5 billion four-year-note Treasury auction item and then submitted, via a customer, an additional $1 billion bid on the same notes. The additional $1 billion was for Salomon Brothers, which ended up with 46 percent of the offering. In February 1991, another $1 billion order was placed for thirty-year Treasury bonds, again through a customer. The order was meant to be bogus, but the deal still went through and was booked to Salomon.
Due to Salomon’s cornering of the Treasury market, small-bond trading housing and commercial banks experienced a hefty loss with $100 million from the May auction alone. Richard Breeden, chairman of the SEC, stated that the issue was not so much that there were a few bad apples in the Treasury market, but that the structure of the market was faulty. Since then, the Treasury has altered auction operations, requiring verifications of large bids and actual receipt of bonds. Before the trading scandal broke, Salomon Brothers had the top profits of all the Wall Street firms.
After the scandal, Salomon’s stock dropped 30 percent. In the final quarter of 1992, Salomon’s profits had gone down 93 percent; for the complete year, 74 percent. In 1995, the earnings level did recover in the third quarter, but the third quarter of 1996 brought with it a 60 percent drop. In May 1992, Salomon settled with the SEC for a $290 million penalty and a two-month suspension from trading. Former Treasury secretary William Simon believed that the harsh penalty would send a warning to Wall Street that infractions with be dealt with in very harsh ways.
In 1993, Salomon Brothers settled claims with 39 states on the bond trading. They agreed to pay $4 million, with half of the settlement going to a special fund to fight fraud and abuse in the brokerage industry.