U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19573 / February 22, 2006
Accounting and Auditing Enforcement Release No. 2379 / February 22, 2006
SEC v. KPMG LLP, et al., Civil Action No. 03 CV 0671 (DLC) (S.D.N.Y.)
Four Current or Former KPMG Partners Settle SEC Litigation Relating To Xerox Audits
Three Partners Agree to Permanent Injunctions, Record Penalties and SEC Suspensions; Fourth Partner Agrees to SEC Censure
On February 22, 2006, the Securities and Exchange Commission announced that all four remaining defendants in an action brought against them and KPMG LLP ("KPMG") by the agency in connection with a $1.2 billion fraudulent earnings manipulation scheme by the Xerox Corporation from 1997 through 2000 have agreed to settle the charges against them. Three partners agreed to permanent injunctions, payment of record civil penalties and suspensions from practice before the Commission with rights to reapply in from one to three years. The fourth partner agreed to be censured by the Commission.
The settlements relate to Xerox's fraudulent scheme that involved various manipulations of accounting for leases of Xerox office equipment. The Commission alleged that the manipulations were necessary for Xerox to meet promises it made to Wall Street that its earnings would continue to grow. The manipulations helped Xerox to "close the gap" between its actual performance and what it promised analysts. KPMG was Xerox's independent auditor each of those years. KPMG issued unqualified audit reports asserting that Xerox's financial statements were consistent with Generally Accepted Accounting Principles ("GAAP") and that KPMG had conducted an audit each year in accordance with Generally Accepted Auditing Standards ("GAAS"). The SEC alleged in its complaint against KPMG and five KPMG partners filed in 2003 that these statements were materially false and misleading and aided and abetted Xerox's filing of false financial reports with the Commission. When Xerox retained new auditors in 2002, it restated $6.1 billion in equipment revenues and $1.9 billion in pre-tax earnings for 1997-2000. The complaint alleged that KPMG and its partners knew or should have known about the improper topside adjustments that resulted in $3 billion of the restated revenues and $1.2 billion of the restated earnings.
The defendants whose settlements were announced are Ronald Safran, the KPMG engagement partner on the Xerox audit for 1998 and 1999; Michael Conway, the senior engagement partner on the Xerox audit for 2000; Anthony Dolanski, the engagement partner on the Xerox audit for 1997; and Thomas Yoho, the SEC concurring review partner for KPMG on the Xerox engagement from 1997-2000. Safran, Conway and Dolanski each consented to the entry of final judgments against them by the U.S. District Court for the Southern District of New York. Yoho agreed to the entry of a Commission order imposing a censure pursuant to Rule 102(e) of the SEC's Rules of Practice. Each defendant entered into his settlement without admitting or denying the SEC's allegations or findings.
The final judgments, which are subject to approval by the Honorable Denise L. Cote, order the engagement partners to pay civil penalties that are the largest penalties ever imposed by the Commission against an individual auditor: Safran and Conway to each pay a civil penalty in the amount of $150,000, and Dolanski to pay a penalty in the amount of $100,000. The final judgments also order that Safran, Conway and Dolanski be permanently enjoined from violating certain provisions of the federal securities laws (Sections 17(a)(2) and (3) of the Securities Act of 1933) and from aiding and abetting violations of other securities laws (Section 13(a) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1 and 13a-13 thereunder). Safran, Conway and Dolanski each also consented to the issuance of an SEC Order based on the entry of the injunctions which will suspend them from appearing or practicing before the SEC as accountants. Safran will be suspended with a right to reapply in three years, Conway in two, and Dolanski in one.
The SEC alleged in its federal court complaint that, in the course of serving as engagement partners for Xerox, Safran, Conway and Dolanski allowed Xerox to impose topside accounting adjustments that they knew or should have known did not comply with GAAP. The SEC alleged that these partners failed to adequately test, or require Xerox to test, the assumptions Xerox used to justify its topside adjustments, nor did they test, or demand that Xerox test, to determine if the topside adjustments resulted in financial statements that fairly presented Xerox's financial results. The SEC further alleged that, as a result of this conduct and other conduct alleged in the complaint, the engagement partners failed to exercise the professional care and skepticism required under GAAS and instead authorized the issuance of the KPMG audit reports that contained the false and misleading representation that KPMG conducted its audits in accordance with GAAS, and that Xerox's financial statements presented fairly, in all material respects, Xerox's financial position and results of operations in conformity with GAAP.
The settled SEC Order against Yoho finds that he engaged in improper professional conduct by failing to exercise appropriate due care and professional skepticism when he conducted an "in depth" review during the 2000 audit. The Order finds that Yoho failed in his obligations as concurring review partner when he was informed of missing work papers, audit results that differed from reasonable expectations, lack of testing of significant topside revenue adjustments and unresolved differences between KPMG auditors in Brazil and those leading the engagement in Stamford, Conn. The Order finds that rather than pursue these issues, Yoho prepared a brief report that did not disclose any of the issues found in the "in depth" review.
The Commission previously announced settled enforcement proceedings against KPMG LLP, a KPMG relationship partner on the Xerox audit, Xerox and six former senior executives of Xerox, all in connection with the fraudulent manipulative accounting. See Litigation Release No. 19191 / April 19, 2005 /Accounting and Auditing Enforcement Release No. 2235 / April 19, 2005 (KPMG LLP settlement); Litigation Release No. 19418 / October 6, 2005 / Accounting and Auditing Enforcement Release No. 2350 / December 2, 2005 (KPMG relationship partner settlement); Litigation Release No. 17465 / April 11, 2002 / Accounting and Auditing Enforcement Release No. 1542 / April 11, 2002 (Xerox settlement); Litigation Release No. 18174 / June 5, 2003 / Accounting and Auditing Enforcement Release No. 1796 / June 5, 2003 (settlement of six former Xerox executives). The Commission obtained civil penalties and disgorgement in all of these actions in excess of $55 million.