By: Keith Ecker

October, 2005, Corporate Legal Times

The sweet success of Krispy Kreme Doughnuts Inc. went sour when an internal investigation revealed deficient governance practices, the cause of which have been traced back to former top executives.

Following a 10-month investigation into the company's questionable accounting practices, a special committee, composed of two outside directors, issued a report detailing a surprising lack of internal controls that led to an accounting scandal that borders on fraud. Perhaps the company's biggest misstep was not having a general counsel in place for two year after going public.

"Even when a general counsel joined the company, he was not extensively involved in the franchise acquisitions or preparation of the company's public disclosures," the report said. This, in conjunction with changing CFOs three times in four years, left the company ill-prepared to function as a public company in a post-Sarbanes-Oxley world.

"During a period of time with significant change and challenges taking place at the company, it makes it all the more critical to have a general counsel," says Walter Scott, a professor at Northwestern University's Kellogg School of Management.

The special committee places blame for the company's financial restatement and plunging stock price on former Chairman and CEO Scott Livengood and former COO John Tate.

"[Livengood and Tate] bear primary responsibility for the failure to establish the management tone, environment and controls essential for meeting the company's responsibilities as a public company," the report stated.

The committee also chastised Livengood for excessive spending. In two years, he surpassed the board's limit for personal-flight costs by $ 320,000. Additionally, he had Krispy Kreme sponsor a "storytelling festival" in his hometown at a cost of $ 500,000.

The committee outlined a series of actions for the board to take to bolster the company's governance practices. Included in these actions are a reshuffling of the members of the board and increased communication to board members about accounting practices, including changes in compliance regulations. The report also recommended the company clearly define the role of the general counsel.

"The board and new management must clarify and reinforce the role of the company's general counsel to be certain the responsibilities we believe are critical to the role, in the areas of transactions, corporate approvals, disclosure and legal risks, are fulfilled," the report said.