Officials of Avnet, the Phoenix-based distributor of computers and electronic components, have conceded in interviews and court documents the company has acquired cheap computer parts through unauthorized “gray market” sources to increase its profits.
Company officials said the practice, which is contrary to company policy, has been stopped, the responsible employees have been terminated and the company is taking safeguards to prevent it from reoccurring.
Gray market trading in electronic parts is at the center of a whistle-blower lawsuit filed by a former employee against Avnet, which is one of the world's largest electronics distributors and the largest corporation with headquarters in Arizona.
In the suit filed in May in U.S. District Court in Phoenix, Art J. Denardo charged the company in essence defrauded its end-user customers by supplying them with computers that contained cheap “counterfeit” parts.
When Denardo worked for Avnet, he said he was pressured by his superiors to engage in the gray market trafficking and to cover it up, causing stress that damaged his health. He alleged age discrimination, intentional infliction of emotional distress and wrongful termination and asked for unspecified actual and punitive damages.
The complaint said the “illegal profits artificially and materially boosted” Avnet's financial performance, and “Avnet materially and artificially manipulated its share prices. When Mr. Denardo discovered this fraud and informed Avnet's senior management, including corporate officers, they endorsed the scam as good for the corporate bottom line.”
The suit said the alleged fraud added $8 million a year to the company's earnings and was either not discovered or concealed by Avnet's auditor, Arthur Andersen LLP.
In an interview this week, Avnet chief communications officer Al Maag denied the wrongful termination and other charges, saying a recently completed internal investigation found that Denardo himself was at the center of the activity, which was not authorized by Avnet managers. He said the team headed by Denardo acted on its own out of misguided loyalty to the company, believing they were helping Avnet by improving its profits.
Five people who were directly involved have left the company, including Denardo, and about 10 others have been issued warnings, he said. Maag portrayed gray market trading as fairly common in the complex world of electronics distribution, tolerated by computer manufacturers themselves as a way to sell more products. In most cases the gray market components are genuine parts made by the original equipment manufacturer, but they get into the hands of unauthorized distributors who dump them on the market at low prices.
That causes problems for authorized distributors such as Avnet, which cannot match gray market prices because they are required under their agreements with the manufacturers to acquire computers and parts only from authorized sources.
“Mr. Denardo was faced with a situation where it was hard to compete, so he decided to play in the gray market,” Maag said. “(The team headed by Denardo) could purchase the parts from a broker at a reduced price and make it look like an authorized transaction.”
He added that senior management failed to supervise the group sufficiently, but the investigation found no evidence of corporate pressure to use gray market parts.
The issue of whether Denardo was told to trade in the gray market or acted on his own is likely to be a key issue if the suit reaches trial. The extent of the activity also is likely to be an issue, with Denardo saying it was widespread and Avnet saying it was limited.
The trial is scheduled to begin in July. Robert Rhee, Denardo's Tempe-based attorney, said he will present “clear evidence” that gray market trading was going on at Avnet long before Denardo came to the company in 1991. He added the evidence will show “that (Denardo's superiors) knew about the fraud and were attempting to cover it up.”
According to the suit, the practice came to light in late 2001 when auditors for Compaq Corp. found suspicious Compaq memory boards in an Avnet warehouse in Chandler and determined those parts had been acquired from an unauthorized broker. A letter from Compaq to Avnet in March 2002 described the parts as “counterfeit” and said their acquisition violated Avnet's reseller agreement with Compaq. Avnet officials were told to trace the location of the parts, some of which had already been sent to end users, and to replace them with authorized parts.
All of these actions took place before Compaq was acquired by Hewlett-Packard in May 2002.
Maag said Avnet has contacted customers who received the disputed parts and has offered to replace them. He said he is not aware of any of the parts malfunctioning. “We have had customers ask questions about this, but none has asked for a refund,” he said. “They understand the products are likely genuine.”
He said Avnet has not been able to trace the boards back to Compaq, but it was unlikely anyone was making counterfeit memory boards for Compaq computers. Maag also said Avnet's relationship with Hewlett-Packard remains strong. He pointed to a $25,000 donation given by HP earlier this year to Las Fuentes Health Clinic in Guadalupe, one of Avnet's favorite charities, to mark the 25th anniversary of the business relationship between Avnet and HP.
Maag said the company's investigation found other examples of gray market trading besides the Compaq incident but “nothing to this level. They were small and incidental.”
To prevent further such activity, the company has appointed an officer to oversee compliance with the HP agreement who will report to the finance department rather than operations people who would have a financial incentive to maximize profits. Also he said CEO Roy Vallee is urging manufacturers to better control the gray market.
“They are listening and hear us when the gray market causes us problems,” Maag said. HP officials could not be reached for comment.