U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19191 / April 19, 2005
Accounting and Auditing Enforcement
Release No. 2235 / April 19, 2005
SEC v. KPMG LLP, et al., Civil Action No. 03 CV 0671 (DLC) (S.D.N.Y.)
KPMG PAYS $22 MILLION TO SETTLE SEC LITIGATION RELATING TO XEROX AUDITS
On April 19, 2005, the Securities and Exchange Commission announced that KPMG LLP has agreed to settle the SEC's charges against it in connection with the audits of Xerox Corp. from 1997 through 2000. As part of the settlement, KPMG consented to the entry of a final judgment in the SEC's civil litigation against it pending in the U.S. District Court for the Southern District of New York. The final judgment, which is subject to approval by the Honorable Denise L. Cote, orders KPMG to pay disgorgement of $9,800,000 (representing its audit fees for the 1997-2000 Xerox audits), prejudgment interest thereon in the amount of $2,675,000, and a $10,000,000 civil penalty, for a total payment of $22.475 million. The final judgment also orders KPMG to undertake a series of reforms designed to prevent future violations of the securities laws.
In addition, the SEC today entered an Order finding that KPMG caused and willfully aided and abetted Xerox's violations of the anti-fraud, reporting, recordkeeping and internal controls provisions of the federal securities laws. The Order also finds that KPMG violated its obligations to disclose to Xerox illegal acts that came to its attention during the Xerox audits. The Order censures KPMG and orders it to cease and desist from committing or causing these violations. KPMG consented to the entry of the Order without admitting or denying the SEC's findings.
The SEC's Order finds that from 1997 through 2000, KPMG permitted Xerox to manipulate its accounting practices to close a $3 billion "gap" between actual operating results and results reported to the investing public. During this period, Xerox used topside accounting actions at the end of financial reporting periods to increase equipment revenue and earnings through the improper acceleration of revenue from long term leases of Xerox copiers and through manipulation of excess or "cookie jar" reserves. Most of Xerox's topside accounting actions violated generally accepted accounting principles (GAAP) and all of them inflated and distorted Xerox's performance but were not disclosed to investors. These undisclosed actions overstated Xerox's true equipment revenues by at least $3 billion and overstated its true earnings by approximately $1.5 billion during the four-year period.
According to the Order, in each of the years 1997-2000, KPMG issued audit reports containing unqualified opinions stating that KPMG had applied generally accepted auditing standards (GAAS) to its review of Xerox's accounting, that Xerox's financial reporting was consistent with GAAP and that Xerox's reported results fairly represented the financial condition of the company. However, the Order finds that throughout this period KPMG failed to comply with GAAS and allowed Xerox to utilize accounting actions that did not comply with GAAP. By doing so, KPMG allowed Xerox to manipulate its accounting practices to distort the company's financial results, failed to insist that Xerox disclose those practices and their financial impacts in the company's annual and quarterly reports, and allowed Xerox to falsify its books and records and to fail to maintain adequate internal controls over its accounting.
The Order finds that KPMG was intimately familiar with the accounting actions Xerox used on a quarterly and annual basis to increase reported revenues and earnings during 1997-2000. KPMG's audit partners received many warnings from member firms of KPMG International in Europe, Brazil, Canada and Japan that methods adopted by Xerox to "close the gap" between actual and desired results were not based on adequate evidentiary support. Even KPMG's U.S. office in Rochester, N.Y., where Xerox had a major manufacturing and administrative center, warned that topside adjustments were creating unnecessary internal accounting control weaknesses. Nevertheless, from at least 1997 through 2000, KPMG ignored these warnings and did not demand evidence sufficient to establish that these accounting actions and the assumptions Xerox asserted to justify their use were in fact grounded in business realities or fairly reflected the company's performance.
Although KPMG at times suggested to Xerox management that it test the assumptions and results of its accounting adjustments to ensure they accurately portrayed Xerox's business, year after year Xerox management ignored KPMG's requests, and KPMG exerted no pressure on its client to perform such testing. KPMG did not demand that Xerox test, and KPMG itself never adequately tested, the assumptions Xerox used to justify its topside accounting actions. Nor did KPMG test -- or demand that Xerox test -- to determine if the topside accounting actions Xerox used resulted in financial statements which fairly presented Xerox's financial results.
In addition, the Order finds that during its audits of Xerox's 1997-2000 financial statements, KPMG became aware of information indicating that illegal acts had or may have occurred as a result of Xerox's use of accounting actions. Although KPMG at times raised concerns to Xerox's management about certain of these accounting actions, KPMG failed prior to the SEC's investigation in this matter to inform Xerox's board of directors or its audit committee about these illegal acts. Moreover, in 1999 when Xerox complained to KPMG's chairman about the performance of KPMG's audit engagement partner, KPMG replaced the partner after completion of the 1999 audit.
As a result of these findings, the SEC's Order finds that KPMG willfully violated Section 10A of the Securities Exchange Act of 1934 (Exchange Act) and caused and willfully aided and abetted Xerox's violations of Section 17(a)(2) and (3) of the Securities Act of 1933 and Sections 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13 and 13b2-1 promulgated thereunder. The SEC ordered KPMG to cease and desist from committing or causing these violations and censured the firm pursuant to Rule 102(e)(1)(iii) of the Commission's Rules of Practice.
In the separate federal court litigation, KPMG consented to the entry of a final judgment finding that it violated Section 10A of the Exchange Act and ordering it to pay the disgorgement, interest and civil penalty identified above. As part of the settlement, the SEC agreed to dismiss the other claims asserted against KPMG in the federal court action. In addition, KPMG consented to perform remedial undertakings designed to prevent future violations of the securities laws that arose from circumstances that were present in this case. The remedial undertakings include reforms in the following areas:
- examination of an audit client's justification for using accounting practices that depart from GAAP;
- examination of an audit client's justification for departing from its existing accounting systems in favor of making material period-ending adjustments;
- documenting in audit work papers consultations with individuals outside the audit engagement team to the extent the consultation is relied on for purposes of designing the audit program, expressing an opinion on the financial statements or for purposes of client retention;
- reviewing and documenting the circumstances surrounding any change in authority, reassignment or termination of an engagement partner from an audit, other than changes to comply with rules of the SEC concerning independence and partner rotation; and
- establishment of "whistle-blower" channels of communication within KPMG to enable any member of an audit engagement team (including foreign affiliates that provide services in connection with the audit) to express concerns on a confidential and anonymous basis regarding audit procedures or the reasonableness of judgments made in the course of an audit engagement.
- The Chairman of KPMG is required to certify to the SEC that these undertakings have been complied with and to provide the SEC with evidence of such compliance.
- Two years after successfully certifying that the undertakings have been completed, KPMG is required to retain a consultant qualified to examine and assess compliance with these undertakings, who shall certify to the SEC that the undertakings continue to be in effect, are being complied with and appear to be effective in achieving their overall goals.
- The consultant shall also make such recommendations to KPMG as he or she deems appropriate to upgrade and improve the undertakings to make them more effective.
The SEC's civil fraud injunctive action against the five KPMG audit partners involved in the Xerox audits during 1997 through 2000 is ongoing. That action was originally filed against four partners (and KPMG) on January 23, 2003. The SEC filed an amended complaint on October 3, 2003, to include charges of fraud against an additional KPMG partner. Securities and Exchange Commission v. KPMG LLP, et al., Civil Action No. 03 CV 0671 (DLC) (S.D.N.Y.). See Litigation Release No. 17954 / January 29, 2003/Accounting and Auditing Enforcement Release No. 1709/ January 29, 2003; Litigation Release No. 18389 / October 3, 2003.
On April 11, 2002, the Commission brought an injunctive action against Xerox based on some of the same allegations of accounting fraud as are alleged against the KPMG defendants, as well as other allegations. Without admitting or denying the allegations of the complaint, Xerox consented to the entry of a Final Judgment that permanently enjoined the company from violating the antifraud, reporting and record keeping provisions of the federal securities laws. Xerox also paid a $10 million civil penalty, agreed to restate its financial statements and agreed to hire a consultant to review the company's internal accounting controls and policies. Securities and Exchange Commission v. Xerox Corporation, Civil Action No. 02-CV-2780 (DLC) (S.D.N.Y.) (April 11, 2002). See Litigation Release No. 17465 / April 11, 2002 / Accounting and Auditing Enforcement Release No. 1542 / April 11, 2002.
On June 5, 2003, the Commission also brought an injunctive action against six former senior executives of Xerox - Paul A. Allaire, G. Richard Thoman, Barry D. Romeril, Philip D. Fishbach, Daniel S. Marchibroda, and Gregory B. Tayler -- based on some of the same allegations of accounting fraud as are alleged against the KPMG defendants, as well as other allegations. Without admitting or denying the allegations of the complaint, each of these six former senior executives consented to the entry of a Final Judgment that permanently enjoined them from violating the antifraud, reporting and record keeping provisions of the federal securities laws. Together, they paid over $22 million in penalties, disgorgement and interest. That final judgment also barred Allaire, Thoman, Romeril and Fishbach from serving as officers and directors of public companies for certain periods - Allaire (5 years), Thoman (3 years), Romeril (permanently) and Fishbach (5 years). In addition, Romeril and Tayler agreed to the entry by the Commission of an Order pursuant to Rule 102(e) of the Commission's Rules of Practice that suspends each of them from appearing or practicing before the SEC as an accountant. This Order suspended Romeril permanently and suspended Tayler for three years with a right to apply for reinstatement after the three-year period. Securities and Exchange Commission v. Paul A. Allaire, G. Richard Thoman, Barry D. Romeril, Philip D. Fishbach, Daniel S. Marchibroda and Gregory B. Tayler, Civil Action No. 03-CV-4087 (DLC) (S.D.N.Y.) (June 5, 2003). See Litigation Release No. 18174 / June 5, 2003 / Accounting and Auditing Enforcement Release No. 1796 / June 5, 2003.
See Also: Administrative Proceeding Release No. 34-51574