Three former Rite Aid executives and a current one were indicted yesterday in connection with an accounting fraud scheme that ultimately led the company to restate its net income by $1.6 billion, the largest corporate earnings revision in history, and almost pushed the company into bankruptcy.

In the 37-count indictment, a federal grand jury named former chief executive officer Martin L. Grass, 47; former vice chairman Franklin Brown, 74; and former chief financial officer Franklyn M. Bergonzi, 57, all of whom were charged with conspiring to deprive the retailers' vendors of money, inflate the drugstore giant's earnings and enrich themselves through undeserved bonuses.

Current Rite Aid executive Eric S. Sorkin, 53, whom a company spokesman said was suspended yesterday morning, was charged with two counts. Sorkin heads Rite Aid's pharmacy services division.

The indictment was filed yesterday in U.S. District Court in Harrisburg, Pa., in the state where the nation's third-largest drugstore chain is based, after an investigation that spanned two years.

Once the No. 2 U.S. drugstore chain, Rite Aid dodged bankruptcy after the accounting irregularities came to light in 1999, and its stock tumbled 90 percent to $5.38 on Nov. 10 from $50.94 on Jan. 8.

In the months after October 1999, the company's top executives, including Grass, resigned or retired, and a new management team was brought in.

The Securities and Exchange Commission also filed a civil complaint alleging that Grass, Bergonzi and Brown conducted a wide-ranging fraud scheme that resulted in overstated company income in every quarter from May 1997 to May 1999.

"Rite Aid's former senior management employed an extensive bag of tricks to manipulate the company's reported earnings and defraud its investors," Wayne M. Carlin, director of the SEC's Northeast Regional Office, said in a statement.

"At the same time, former CEO Martin Grass concealed his use of company assets to line his own pockets. When the house of cards teetered on the edge of collapse, Grass fabricated corporate records in a vain effort to forestall the inevitable."

Multiple counts

Each of the men faces a number of criminal counts, from 36 for Grass and Brown to two for Sorkin. Most of the counts carry a maximum penalty of five years in prison and a $250,000 fine.

Also charged yesterday was Timothy J. Noonan, 60, the former company president who cooperated with investigators, including by helping them record conversations with Brown and Grass.

Noonan was charged with a single misdemeanor count related to his failure to report felonies he had witnessed.

Noonan intends to plead guilty under an agreement with the government, his attorney, David Howard, said.

In a statement yesterday, the drugstore chain, which has more than 3,400 stores and is based in Camp Hill, Pa., distanced itself from its former executives.

"The three men indicted for fraud have had no role in running this company or any relationship with this company for at least the past two years," said Rite Aid spokeswoman Karen Rugen.

"This is a new Rite Aid. The new management team that came to Rite Aid in December 1999 has changed the way Rite Aid does business, including strengthening internal financial controls. We're a ... much stronger company than we were two years ago."

Rugen said that Rite Aid's board has yet to decide whether Sorkin's suspension is with, or without, pay.

Income inflated

The indictment yesterday reads like a laundry list of alleged white-collar criminal activity. Grass - who lives in Virginia Beach, Va. - Brown and Bergonzi face charges of conspiracy, securities and wire fraud, witness tampering and obstructing grand jury proceedings.

According to the indictment, the three former executives conspired to inflate Rite Aid's pre-tax income by $44 million in 1998 and $214 million in 1999.

Bergonzi, the former chief financial oficer, coordinated the accounting fraud and instructed employees in the company's accounting department to make false entries in the company's books and records, the indictment alleges.

The government also alleges that the three inflated the quantity of damaged and outdated goods that the company reported to its vendors, which allowed Rite Aid to claim $53 million in bogus income over a four-year period through 1999.

Other criminal charges against Grass, Brown and Bergonzi are related to numerous allegations, including:

The undisclosed transfer of $2.6 million from Rite Aid to a real estate company owned by Grass and his brother-in-law.

$7.5 million in unauthorized corporate loan guarantees for an unidentified senior company marketing executive.

The submission of false corporate minutes, at Grass' orders, which said the board's finance committee had approved the use of the company's pharmacy benefits management company as collateral for an interim loan.

Grass' issuance of several back-dated letters authorizing lucrative severance packages to some employees, including three that were issued after he resigned as CEO on Oct. 18, 1999.

Grass and Brown providing false information to Rite Aid's internal investigators, destroying material evidence subpoenaed by the SEC, and submitting bogus, backdated documents to the grand jury.

Rite Aid filed nine false quarterly and annual reports containing inflated financial statements with the SEC, from the first quarter of 1998 through the first quarter of 2000, the indictment says.

Attorneys reply

Attorneys for three of the defendants returned phone calls yesterday. William H. Jeffress, Grass' attorney, declined to comment but read the following statement from his client:

"Since the time Rite Aid restated its earnings in 1999 and 2000, it has been obvious to me that civil and even criminal proceedings might be brought in an effort to hold prior management responsible.

"I have not had the opportunity to read the lengthy indictment and complaint, but can say that I did not knowingly engage in any illegal acts, and I intend vigorously to defend the charges."

Bruce Hiler, the attorney for Bergonzi, said his client denies the allegations and plans to vigorously defend against the charges.

"Our only other comment is we think this is an attempt by the government to blame everything that goes wrong in times of an economic downturn."

SEC civil case

The SEC's civil case, also filed in the U.S. District Court in Harrisburg, seeks remedies that include a court order barring each of the men from ever again serving as an officer or director of a public company; the return of performance-related cash bonuses totaling more than $1.5 million; and monetary penalties to be determined by a judge.

As part of the settlements of two separate SEC proceedings, the commission ordered both Noonan and the company to avoid future violations of certain securities laws but will take no further action against either.

"His cooperation has been very significant," Carlin said about why the SEC decided to take no action against Noonan beyond its order that he "cease and desist" with violations.

"I can't really go further than that, but the significance of his cooperation is reflected in the outcome."