A thriller Penguin didn't want

When Penguin announced in February it had discovered that its American subsidiary was offering unauthorised discounts to customers, and set aside pounds 100m to cover costs, the book publisher's corporate parent, Pearson, portrayed the matter as regrettable but containable.

"We have moved quickly to implement a detailed plan of action to address these unauthorised practices," Marjorie Scardino, Pearson's chief executive, declared at the time. "I cannot emphasise strongly enough that this incident has no effect at all on our commitment to the profitable development of Penguin's world-class publishing programme."

Seven months after blowing the whistle on itself, however, Penguin's prospects remain clouded by the scandal. The company is fighting legal battles arising from the affair on two separate fronts.

The American Booksellers' Association (ABA), a trade group representing 4,500 small bookstores in the US, has petitioned a New York court for a reported pounds 40m pay-out from Penguin. The ABA contends that Penguin USA illegally discriminated against member bookstores in favour of large book chains when it offered the discounts - 5-10 per cent cuts for payment made within 30 days.

Meanwhile, Christina Galatro, the collection clerk fired by Penguin after the company accused her of masterminding the unauthorised discount scheme, is vigorously contesting the charges Penguin has brought against her in court. She says Penguin is making her a scapegoat. In a counter- claim to these charges, she alleges her boss sanctioned the discount scheme.

Sued by Penguin for conspiring to defraud the company and embezzle $400,000 (pounds 280,000), Ms Galatro is countersuing in the Newark, New Jersey, court hearing the case. Her lawyer charges Penguin with "maintaining an intolerable working condition and by virtue of economic coercion and threats [causing her] to perform inappropriate activities".

"Penguin brought the suit for publicity purposes," asserts Christopher Franzblau, Ms Galatro's attorney. "The intention is to shift blame."

Sifting the court documents accumulating in the New Jersey court, a picture emerges of a scandal unlikely to cost Penguin significantly more than the pounds 100m already set aside, but one that could generate considerably more bad publicity.

Penguin is the second largest English-language book publisher in the world. It puts out books under the imprints of several hardback publishers in addition to its famous bird. Authors include Stephen King, Tom Clancy, Patricia Cornwell and Dick Francis.

Last year the company earned an operating profit of pounds 31m on sales of pounds 380.2m, while parent Pearson - also the owner of the Financial Times and a range of broadcasting interests - earned pre-tax profits of pounds 281.3m on sales of pounds 2.2bn.

Penguin was founded in 1935 and quickly won renown for revolutionising book publishing with its sixpenny paperback editions. Over the next 40 years the company gradually became an institution in the literary world, but suffered as a business under pressure from newer, more aggressive paperback publishers.

In 1978 Penguin hired Peter Mayer, an American educated at Oxford and Berlin's Frei Universitat, to get the company back on its feet. Mr Mayer modernised Penguin, blending a commitment to literature with sharp commercial acumen.

Last year Mr Mayer retired. His handpicked successor - Michael Lynton, the former head of Hollywood Pictures at Disney - took over. Within months the discount scheme scandal loomed up out of the blue.

This scandal, erupting in the back office of Penguin USA - located in Bergenfield, New Jersey, a blue-collar suburb of New York City - is as convoluted as the plot of any of its thrillers.

In 1980 Penguin employed Christina Galatro to work in its credit and collection department. This department processes the bills not only of Penguin, but also other publishers sub-contracting work. Last year Penguin USA's 50 big US accounts averaged 87,000 transactions each.

In 1985 Ms Galatro retained a debt collection agency to assist her. The agency, based in Parsippany, New Jersey, has undergone various name changes over the past 12 years. But its owner has remained a man named Jerome Bedell.

Neither Mr Bedell nor his lawyer returned phone calls. But a measure of the man is revealed by his home phone answering machine. Its recorded message begins: "Hi, we don't feel like talking to anyone at the moment."

In 1992 Ms Galatro was promoted to run Penguin USA's collection department. Soon afterwards, according to court documents filed by the company, she and Mr Bedell had lunch and organised "a scheme whereby they could divert funds for their personal use". Under this scheme, according to Penguin, Mr Bedell began keeping some of the money he collected for the publisher, while Ms Galatro "undertook to cause the related receivables to be hidden within Penguin's books".

Meanwhile, Penguin had its eye on a different sort of problem. In the early Nineties the small bookstores of America began going belly-up one after the other as those book chains offering cappuccino and creches to customers ate into their business. The independents fought back, in part by accusing publishers of giving unfair discounts to the chains.

In 1994 the ABA filed a suit against a number of publishers, claiming these discounts violated US anti-trust law. In 1995 Penguin and the ABA signed a consent decree in which Penguin promised it would equalise the terms of book sales to its customers.

While the company was dealing with the ABA, Penguin asserts, Ms Galatro and Mr Bedell stepped up their illegal activities.

Court documents filed by Penguin state that the US unit's back office in New Jersey sometimes received cheques that should have been sent to the company's "lockbox" at its Chicago bank.

Penguin says Ms Galatro passed on such cheques worth $1m to Bedell. The company says he cashed these cheques and divided up the proceeds between himself and Ms Galatro.

Mr Bedell allegedly moved money to Ms Galatro by giving her one of his company American Express charge cards. Penguin cites 86 instances in which Ms Galatro allegedly used this Amex card for personal purposes. One entry listed in court documents is a $3,000 charge to Royal Caribbean Cruises in Miami. Another is a $1,537 charge to Trident Jewellers in the Virgin Islands.

On 30 June Penguin announced it was filing a civil racketeering suit against Ms Galatro and Mr Bedell. At the same time it announced it had reached an out-of-court settlement with Mr Bedell after the independent debt collector conceded the charges against him and agreed to pay back at least $1m. Ms Galatro, however, vigorously contests Penguin's complaint. She alleges in a document filed in the New Jersey court that her boss, Penguin USA financial vice-president, Anthony Ponzo, "authorised [her] to engage in the practice referred to as 'cash discounts' to customers".

Seizing on this news, the ABA approached Penguin this year and argued that the discounts put it in violation of the 1995 consent decree under which Penguin promised not to offer customers preferential terms.

ABA lawyer Jerald Jacobs calls the Penguin lawsuit against Ms Galatro "a smokescreen designed to divert attention away from the corporate culture that favoured the large chains".

A Penguin spokesman declined to comment on the company's talks with the ABA. But Mr Jacobs says: "We expect a settlement in the next few weeks. We expect it to be the largest of its kind in years."

When the settlement with the ABA comes, it will clarify how much money Penguin is actually set to lose as a result of the unauthorised discounts scheme.

But until it resolves its dispute with Ms Galatro, the scandal will remain a cloud hanging over the company.

Ms Galatro is asking for a jury trial. Her lawyer says Penguin reneged on a severance package based on her $80,000-a-year-plus bonus salary.

The ex-Penguin employee sounds like a very angry woman.