eroz Keller Graduate School of Business | Xerox Fraud Examination | Forensic Accounting and the Legal Environment

Xerox is a leading business process and document management company headquartered in Norwalk Connecticut. Xerox employees 136,000 people worldwide and has annual sales of 22 billion dollars (Xerox, 2011). On April 11, 2002 the SEC filed charges against Xerox alleging that the company intentionally defrauded investors by accelerated the company's recognition of equipment revenue by over $3 billion and increased its pre-tax earnings by approximately $1.5 billion (Berger & Niemeier, 2002). Xerox settled the case by paying a 10 million dollar penalty, restating the financial statements for years 1997-2000, and to have a committee of outside directors review the company’s accounting controls and policies. The official complaint filed by the SEC highlights the problems that led to the senior management engaging in fraud to boost their financial figures. According to the SEC: “Companies that failed to meet Wall Street's earnings estimates by even a penny often were punished by significant declines in stock price. In addition, compensation of Xerox senior management depended significantly on their ability to meet increasing revenue and earnings targets (SECURITIES AND EXCHANGE COMMISSION V. XEROX CORPORATION, 2002).” The underlying problems that led to the accounting fraud was the compensation for senior management being tied to stock options and the stock prices relying on meeting their Wall Street earning projections. These problems are directly tied to one another; for an executive to make a high wage the company must perform well financially or else the stock prices and inevitably the wages of the executives declines. No system is perfect and tying executive compensation to the financial output of the company is to ensure that the management team works to increase stock value to benefit the company and its shareholders and sometimes this leads the executives to defraud the public. This pay model is not going away any time soon so the inherent problem that leads to this type of fraud exists in most corporations which is why auditing and forensic auditing are so important to find these schemes and deter them in the future. After the settlement between the SEC and Xerox 6 of the executives: Paul A. Allaire Chairman of the Board, G. Richard Thoman Chief Operating Officer and CEO, Barry D. Romeril Chief Financial Officer, Philip D. Fishbach Corporate Controller, Daniel S. Marchibroda Assistant Controller, and Gregory B. Tayler Director of Accounting Policy were charged with Fraud by the SEC (Securities and Exchange Commission v. PAUL A. ALLAIRE, G. RICHARD THOMAN, BARRY D. ROMERIL, PHILIP D. FISHBACH, DANIEL S. MARCHIBRODA AND GREGORY B. TAYLER, 2003). The six executives settled the suit by paying $22 million in penalties, disgorgement, and interest (Norris, 2003). The remaining player in the Xerox scandal, their auditor KPMG agreed to settle a suit charging that they caused and willfully aided and abetted Xerox's violations of the anti-fraud, reporting, recordkeeping and internal controls provisions of the federal securities laws for $22.475 million (Berger & Kidney, 2005). Xerox and the 6 Senior Executives were able to settle without admitting fault or guilt. Xerox paid fines, restated their financial records and had to make changes to their accounting procedures to which I find to be fair punishment for the crimes and to prevent future ones. In addition to the fines many of the executives were barred from holding executive office or practicing accounting in another firm. I think the judgments were fair in the case against the executives as well they had to pay back money that they made as a result of the fraud and were punished by not being able to practice in their fields. KPMG was the only part that was officially found to be in violation of Section 10A of the Exchange Act and ordered to pay fines and make changes to prevent future fraud cases like the Xerox one. This judgment is fair and like the others against Xerox and the executives the SEC shows how forward thinking of an agency it is by attaching reforms and structural changes to the punitive settlements to ensure that the likelihood of this fraud recurring in the future is reduced. Xerox was just one of many financial scandals between the mid 1990’s to the early 2000’s; there was also Enron, WorldCom, Adelphia, and Tyco just to name a few. SAS 99 requires “brainstorming” sessions to determine how and where they believe the entity's financial statements might be susceptible to material misstatement due to fraud, how management could perpetrate and conceal fraudulent financial reporting, and how assets of the entity could be misappropriated (Crumbley, Heitger, & Smith, 2009). This is a way that auditors can assess the company for shortfalls in their controls and to help guide the audit on what to look for. The requirement that auditors inquire management of fraud risks would have helped in the auditing of Xerox. The auditors are required to ask management and others within the company if they are aware of any fraud or fraud allegations, have knowledge of the fraud risks, and how a company communicated its views on business practices and ethical behavior. SAS 99 gives guidance on conditions such as being denied access to security or IT personnel in determining whether there is the possibility of fraud present. SAS 99 requires audit documentation including: (1) how and when the brainstorming session occurred and who participated, (2) procedures performed to obtain information to identify and assess fraud risk, (3) specific risks of material misstatement due to fraud (must specifically include discussion of revenue recognition) and the auditor’s response to those risks, (4) results of the procedures performed to address the risk of management override of controls, (5) conditions and analytical relationships that led to additional audit procedures or other responses, and (6) nature of communications about fraud made to management and others (Christensen, 2009).
Bibliography

SECURITIES AND EXCHANGE COMMISSION V. XEROX CORPORATION, 02-272789 (UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK April 11, 2002).
Securities and Exchange Commission v. PAUL A. ALLAIRE, G. RICHARD THOMAN, BARRY D. ROMERIL, PHILIP D. FISHBACH, DANIEL S. MARCHIBRODA AND GREGORY B. TAYLER, 03 CV 4087 (UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK June 5, 2003).
Berger, P. R., & Kidney, J. A. (2005, April 19). U.S. Securities and Exchange Commission. Retrieved November 11, 2011, from KPMG PAYS $22 MILLION TO SETTLE SEC LITIGATION RELATING TO XEROX AUDITS: http://www.sec.gov/news/press/2005-59.htm
Berger, P. R., & Niemeier, C. D. (2002, April 11). Xerox Settles SEC Enforcement Action Charging Company With Fraud. Retrieved November 10, 2011, from U.S. Securities and Exchange Comission : http://www.sec.gov/news/headlines/xeroxsettles.htm
Christensen, H. M. (2009). Key Components of SAS 99. Retrieved November 11, 2011, from Forensic & Valuation CPAs: http://fvcpas.net/SAS_99.aspx
Crumbley, D. L., Heitger, L. E., & Smith, G. S. (2009). FORENSIC AND INVESTIGATIVE ACCOUNTING. Chicago: CCH.
Kay, J. (2002, July 1). Xerox restates billions in revenue: yet another case of accounting fraud. Retrieved November 10, 2011, from World Socialist Website: http://www.wsws.org/articles/2002/jul2002/xero-j01.shtml
Norris, F. (2003, June 6). Former Xerox Executives to Pay $22 Million. Retrieved November 11, 2011, from New York Times: http://www.nytimes.com/2003/06/06/business/06XERO.html?pagewanted=all
Xerox. (2011). About Xerox. Retrieved November 10, 2011, from Xerox: http://www.xerox.com/about-xerox/enus.html