U.S. Securities and Exchange Commission
Litigation Release No. 18174 / June 5, 2003
Accounting and Auditing Enforcement Release No. 1796 / June 5, 2003
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)
Six Former Senior Executives of Xerox Settle SEC Enforcement Action Charging Them with Fraud
Executives Agree to Pay Over $22 Million in Penalties, Disgorgement and Interest
On June 5, 2003, the Securities and Exchange Commission filed a civil fraud injunctive action in the United States District Court for the Southern District of New York charging six former senior executives of Xerox Corporation, including its former chief executive officers, Paul A. Allaire and G. Richard Thoman, and its former chief financial officer, Barry D. Romeril, with securities fraud and aiding and abetting Xerox's violations of the reporting, books and records and internal control provisions of the federal securities laws. The complaint alleges that the executives engaged in a fraudulent scheme that lasted from 1997 to 2000 that misled investors about Xerox's earnings to polish its reputation on Wall Street and to boost the company's stock price. The scheme involved the use of accounting devices that were not disclosed to investors, many of which violated generally accepted accounting principles ("GAAP"). The complaint alleges that the defendants' fraudulent conduct was responsible for accelerating the recognition of equipment revenues by approximately $3 billion and increasing pre-tax earnings by approximately $1.4 billion in Xerox's 1997-2000 financial results. The six defendants have agreed to pay over $22 million in penalties, disgorgement and interest without admitting or denying the SEC's allegations.
The complaint names the following individuals as defendants who held senior positions at Xerox during 1997 through the publication of Xerox's 2000 financial statements:
- Paul A. Allaire: former CEO of the company until April 1999 and again from May 2000 through August 2001, and also the former Chairman of Xerox's Board of Directors and a Director throughout the period charged in the complaint;
- G. Richard Thoman: former President and Chief Operating Officer from July 1997 through April 1999, CEO from April 1999 through May 2000, and also a Director of the company from July 1997 through May 2000;
- Barry D. Romeril: former CFO from 1993 through December 2001, and executive vice president from 1997 through early 1999 and then Vice Chairman;
- Philip D. Fishbach: former Controller until his retirement from Xerox in April 2000;
- Daniel S. Marchibroda: former Assistant Controller until January 2000; and
- Gregory B. Tayler: former Director of Accounting Policy (March 1997-April 1999), Assistant Treasurer (May 1999-March 2000) and Controller (April 2000-November 2001).
The Commission's complaint alleges that the defendants relied on what Xerox internally called "one-time actions," "one-offs," "accounting opportunities" and "non-operational actions" to impose accounting adjustments on operational results for the purpose of increasing equipment revenues and inflating earnings in financial results Xerox reported to the public. These accounting actions, which were not disclosed to investors, were used at the end of each financial reporting period during 1997 2000 to "close the gap" between Xerox's actual underlying earnings and its internal targets and those of Wall Street analysts. The accounting devices improved Xerox's earnings, equipment revenues and margins in each quarter and year during 1997 2000, and allowed Xerox to meet or exceed Wall Street expectations in nearly every reporting period during 1997 1999. By 1998, nearly three out of every ten dollars of Xerox's annual reported pre-tax earnings and up to 37 percent of its reported quarterly pre-tax earnings came from undisclosed changes to its historic accounting practices and estimates.
According to the complaint, CEOs Allaire and Thoman, and CFO Romeril, set a "tone at the top" of the company, which equated business success with meeting short-term earnings targets. Romeril directed or allowed lower ranking defendants in Xerox's financial department to make accounting adjustments to results reported from operating divisions to accelerate revenues and increase earnings. Fishbach, Marchibroda and Tayler adopted and applied the accounting devices for the purpose of meeting earnings goals and predictions of outside securities analysts. Allaire and Thoman then announced these results to the public through meetings with analysts and in communications to shareholders, celebrating that Xerox was enjoying substantially greater earnings growth than true operating results warranted.
The complaint alleges that the defendants used undisclosed accounting devices to "close the gap" between underlying and desired financial results, and that the defendants were aware of Xerox's increasing dependence on such accounting actions during 1997-2000 through various internal Xerox reports, memos, e-mails and meetings that addressed the financial performance of Xerox's significant operating units and the company's overall consolidated financial results. For example, the complaint alleges:
- In a September 1997 e-mail copied to Fishbach, Marchibroda and Tayler, Romeril asked the controller of Xerox Europe about his progress in assessing a potential accounting device and stated: "This could be the crucial opportunity for making Quarter 3. I cannot see a higher priority in terms of once-offs."
- In November 1998, Romeril informed Allaire, Thoman, Fishbach and others that over the past four years Xerox's major earnings-generating market in Brazil had "$700M of unreal profits" from "non-marketing actions" and that the "[c]onceptual framework [of] our profile is illusory . . . the profits are there the question is the timing of when you take them";
- In August 1998, Fishbach told Thoman that although Xerox Europe's "operational" growth was 2 percent, "the growth that is likely to be reported is closer to 10% given headquarters adjustments for margin normalization and other accounting items";
- In October 1999, Xerox's vice chairman reported to Romeril and Thoman that Xerox Europe's underlying operational results, without accounting devices and restructuring, "have been deteriorating since 1995 and are very different than the reported results," and he provided them a chart from Xerox Europe's president illustrating operational results with and without the use of accounting devices;
- Likewise in January 2000, the president of Xerox Europe informed Thoman, Romeril and others that Europe's pre-tax profits had been "declining since 1996," that declines in 1999 profits were "driven by prior year once-offs [including accounting devices], the benefits of which started to reverse during 1999," but that "this declining trend has been fully contained in the reported profit" in part through the use of such accounting devices.
- In November 1999, Romeril told Thoman and other Xerox executives that when accounting actions and certain other items were stripped away from Xerox's overall consolidated reported revenues, Xerox was essentially a "no growth" company from 1998-1999, and in that same month Romeril provided Thoman, Fishbach, and others with documents showing the historical impact of accounting actions and certain other items in order to show the company's "true operating economics."
Specifically, the Commission's complaint alleges that all of the defendants fraudulently failed to disclose to shareholders and investors the financial impact of the two principal accounting devices Xerox used during 1997-2000. These devices, which were known internally within Xerox as "return on equity" and "margin normalization," accelerated the recognition of equipment revenue and increased earnings from leases of Xerox copiers that historically were recorded in future periods. These two accounting actions increased Xerox's equipment revenues by $2.8 billion and its pre-tax earnings by $699 million from 1997 to 2000. The complaint alleges that under Xerox's leasing arrangements, the revenue stream from Xerox's customer leases typically had three components: the value of the "box," a term Xerox used to refer to the equipment; revenue that Xerox received for servicing the equipment over the life of the lease; and financing revenue that Xerox received on loans to its lessees. Under GAAP, Xerox was required to book revenue from the "box" at the beginning of the lease, but was required to book revenue from servicing and financing over the course of the entire lease. The complaint alleges that the "return on equity" method shifted revenue to equipment that the company historically had allocated to financing, and that "margin normalization" shifted revenue to equipment that historically had been allocated to servicing. The complaint alleges defendants Romeril, Fishbach, Marchibroda and Tayler, Xerox's senior financial executives, knew or were reckless in not knowing that these accounting devices violated GAAP and should have been disclosed under GAAP.
In addition to these accounting devices, the complaint alleges that Romeril, Fishbach and Marchibroda participated in the use of other non-GAAP accounting devices that allowed Xerox to prematurely recognize revenues from price increases it negotiated with existing customers and to retroactively increase the estimated "residual values" of its equipment (the estimated value of the equipment at the end of the lease term). The complaint alleges that Tayler, as director of accounting policy, was also aware of these accounting practices.
The complaint further alleges that Romeril, Fishbach and Marchibroda knowingly or recklessly used $415 million of excess or cushion reserves and $157 million of income from tax refunds to improperly increase earnings in violation of GAAP, and that Tayler was aware of the improper use of the largest of these reserves.
Finally, the complaint alleges that all of the defendants failed to disclose the impact that approximately $400 million in sales of leases had on Xerox's 1999 operating results. The effect of these undisclosed sales was to immediately recognize income that otherwise would have been recognized in future periods. Although Xerox earlier had entered into similar transactions in small amounts, none compared in size or scope to the 1999 sales, which added $182 million in pre-tax profits to Xerox's 1999 results. The complaint alleges that all of the defendants knew or should have known that these undisclosed transactions concealed financial and operation weaknesses.
The defendants have each offered to settle by consenting, without admitting or denying the SEC's allegations, to the entry of a final judgment in the civil action that:
- Permanently enjoins each of them from violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder, and (except for Allaire and Thoman) violating Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder;
- Imposes an officer and director bar against Allaire (5 years), Thoman (3 years) Romeril (permanent), and Fishbach (5 years);
- Requires each of them to pay civil penalties in the following amounts: $1 million for Allaire; $750,000 for Thoman; $1 million for Romeril; $100,000 for Fishbach; $75,000 for Marchibroda; and $75,000 for Tayler;
- Requires each of them to pay disgorgement and prejudgment interest thereon in the following amounts:
$1,938,124 prejudgment interest;
$1,440,993 prejudgment interest;
$1,227,688 prejudgment interest;
$289,904 prejudgment interest;
$88,920 prejudgment interest;
$32,397 prejudgment interest; and
- Requires Fishbach and Marchibroda to relinquish their respective rights to certain deferred bonuses ($127,035 for Fishbach and $50,228 for Marchibroda) plus accrued interest on these amounts.
In addition, both Romeril and Tayler have agreed to the entry by the SEC of an Order pursuant to Rule 102(e) of the SEC's Rules of Practice that suspends each of them (based on the entry of the injunction in the federal court action) from appearing or practicing before the SEC as an accountant. This Order will suspend Romeril permanently and suspend Tayler for three years with a right to apply for reinstatement after the three-year period.
The Commission previously brought two other injunctive actions based on the same fraudulent scheme as is alleged against the senior Xerox executives, as well as other allegations. On April 11, 2002, the Commission brought an injunctive action against Xerox. 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. In addition, on January 29, 2003, the Commission brought an injunctive action against Xerox's former auditor, KPMG LLP, and four of its audit partners in connection with the audits of Xerox from 1997 2000. The action against KPMG and its partners is currently in litigation. Securities and Exchange Commission v. KPMG LLP, Joseph T. Boyle, Michael A. Conway, Anthony P. Dolanski and Ronald A. Safran, Civil Action No. 03 CV 0671 (DLC) (S.D.N.Y.) (January 29, 2003). See Litigation Release No. 17954 / January 29, 2003/Accounting and Auditing Enforcement Release No. 1709 / January 29, 2003.
The SEC's complaint can be found on the SEC's web site at:
The SEC's complaint in SEC v. Xerox Corporation can be found on the SEC's web site at: http://www.sec.gov/litigation/complaints/complr17465.htm
The SEC's complaint in SEC v. KPMG LLP, et al. can be found on the SEC's web site at: http://www.sec.gov/litigation/complaints/comp17954.htm
SEC Complaint in this matter (Release No. 18174)