JUST FOR FEET, INC.

Synopsis

Harold Ruttenberg emigrated to the United States from South Africa in 1976.In his early thirties at the time and the father of three small children, Ruttenberg wanted to escape the political and economic troubles brewing in South Africa.Over the previous decade, Ruttenberg had created a successful retail business in his home country.However, South Africa's emigration laws allowed the young businessmen to take only $30,000 of his considerable net worth with him to the U.S.Not to be deterred, the industrious Ruttenberg quickly resurrected his business career in his new homeland.

In 1988, Ruttenberg sold his existing business and founded Just for Feet, Inc., a retail "superstore" that sold principally athletic shoes.Over the next decade, Just for Feet opened more than 300 retail outlets across the United States and became the second largest retailer of athletic shoes in the nation.Ruttenberg took his company public in 1994.During the late 1990s, Just for Feet's common stock was one of the "hottest" securities on Wall Street, thanks to the company's impressive operating results, which included 21 straight quarterly increases in same-store sales.Those operating results were even more impressive when one considers the fact that the athletic shoe "sub-industry" was suffering from severe over-saturation during that time frame.

Just for Feet shocked Wall Street in mid-1999 by announcing that it would post its first-ever quarterly loss and that it might default on the interest payment that was coming due on its outstanding bonds.The potential default was particularly stunning since the company had just sold the bonds two months earlier.When Harold Ruttenberg resigned as the company's CEO in July 1999, Just for Feet's board hired a corporate turnaround specialist.Unfortunately, there was no turnaround in the company's future.In November 1999, the company filed for bankruptcy and was eventually liquidated.

Federal and state law enforcement authorities who investigated Just for Feet's sudden collapse discovered that management had orchestrated a large-scale accounting fraud to conceal the company's deteriorating financial condition in the late 1990s.The principal features of the fraud included improper accounting for so-called vendor allowances, the company's refusal to provide an appropriate reserve for inventory obsolescence, and the recording of millions of dollars of fictitious "booth" income.Eventually, regulatory authorities turned their attention to Just for Feet's independent audit firm, Deloitte & Touche.Investigations of Deloitte's audits of Just for Feet revealed serious deficiencies in those audits that resulted in the prominent audit firm being sanctioned by the SEC and being named as a defendant in multiple civil lawsuits.

Just For Feet, Inc.Key Facts

1. In 1976, Harold Ruttenberg, a successful entrepreneur in South Africa, chose to emigrate to the U.S. because of the economic and political turmoil in his home country.

2.Ruttenberg, who was forced to leave nearly all of his net worth in South Africa, quickly created a thriving retail business in Birmingham, Alabama.

3.In 1988, Ruttenberg founded Just for Feet, Inc., a retail company that marketed sports apparel, principally athletic shoes, from large "superstores."

4.From 1988 through 1998, Just for Feet's revenues and profits grew dramatically; by 1998, the company operated 300 retail outlets in the U.S. and was the nation's second largest retailer of athletic shoes.

5.In mid-1999, Just for Feet shocked the investing public by announcing that it would report its first-ever quarterly loss and that it might default on the interest payment coming due on its outstanding bonds.

6.Just for Feet's financial condition continued to deteriorate, causing the firm to file for bankruptcy in November 1999.

7.A series of investigations by state and federal authorities revealed that Just for Feet's impressive operating results during the 1990s had been the product of a large-scale accounting fraud.

8.The three principal elements of the accounting fraud were improper accounting for vendor allowances, refusing to record an appropriate reserve for inventory obsolescence, and booking millions of dollars of fictitious "booth" income.

9.An SEC investigation revealed numerous deficiencies in Deloitte & Touche's audits of Just for Feet during the late 1990s.

10. The principal criticisms of Deloitte's audits included the improper application of confirmation procedures, failure to properly audit Just for Feet's inventory valuation reserve, and the failure to thoroughly investigate the company's suspicious booth income transactions.

11. Deloitte was fined $375,000 by the SEC for its deficient Just for Feet audits; the SEC suspended the 1998 audit engagement partner for two years and the audit manager for one year.

12. At the same time that the SEC announced the sanctions imposed on Deloitte for its Just for Feet audits, the federal agency revealed that it was fining the accounting firm $50 million for its flawed audits of the scandal-ridden telecommunications company, Adelphia Communications.

Questions

Please respond comprehensively, with examples and relevant sources as applicable

1.Demonstrate the need for auditors to employ analytical procedures during the planning phase of an audit to identify high-risk accounts. Would analytical procedures been an effective audit procedure to uncover the irregularities?

2.Were there any possible inherent and control risk factors that the auditors should have considered?

3.What is the nature and purpose of audit confirmations? How could this audit procedure have helped the auditors in this case?

4.What is the SEC's oversight role for the financial reporting and independent audit functions? Do you think the position/sanction was sufficient?