COMPANY BACKGROUND

History of Xerox
Xerox Corporation, while incorporated in New York, is headquartered in Norwalk Connecticut,
and competes in the industry of document management technology and services (Xerox, n.d.).
It offers leading technology in digital systems including color, black and white printing,
publishing systems, digital presses, copiers, and fax machines. Beginning in 1906 in Rochester,
NY, the companys rebound from heavy R& D costs was slow; but in the 1960s revenues
increased into the millions due to the introduction and prominence of the model 914, first
demonstrated to the public via television Sep. 19, 1959. This revolution in the industry was the
first plain paper photocopier (Xerox timeline, n.d.). Investors of the company benefitted
handsomely in this timeframe. The industry market for Xerox remained competitive, particularly
with international market developments. In the 1990s competitive factors increased, and Xerox
began to have trouble sustaining revenue growth. The emphasis was on making benchmarked
goals, using lead competitors as benchmarks. In addition, Wall Street placed great emphasis on
the company to reach certain goals, or else suffer a severe decrease in value (SEC No. 311905, April 19, 2005). Such high competition and pressure led Xerox officials to turn to
fraudulent and manipulative reporting practices. to conceal the true financial performance from
1997 to the year 2000. In 2002, an initial SEC complaint was issued against Xerox (SEC Civil
Action No. 02-272789, April 11, 2002). Company management had used measures to
accelerate the recognition of equipment revenue by over $3 billion and increase pretax earnings
by around $1.5 million (SEC Immediate Release 2005-59, April 19, 2005). Misstatements and
violations were enabled by the external audit firm KPMG, who was lax in its audit.

XEROX FRAUD CASE

Introduction
Barry D. Romeril was Xeroxs chief financial officer (CFO) since 1993 and was credited, along
with then chairman and chief executive, Paul Allaire, of leading Xerox through a difficult period
in the late 1990s. During this time Xerox was faced with stiff competition from foreign markets
while losing a considerable portion of their core small copier business to desktop printers. Also
a new internal reorganization had been poorly implemented, putting salespeople in unfamiliar
territory and tying the billing department up in knots. During this period, Xerox also lost millions
of dollars on their diversification effort into insurance and financial services.
Yet, through all of this, Mr. Allaire and Mr. Romeril seemingly managed to keep Xerox headed in
the right direction, and meeting Wall Street earnings expectations every quarter, keeping stock
prices rising and investors happy.
However, Allaires prediction of an impending crisis turned out to be truer than most people
would have expected. Unknown to outsiders, Xerox top executives had adopted an attitude of
win at any cost and they turned to their accounting department to help them do this. By the mid1990s Xerox management had decided they were going to have their accountants come up with
some pretty creative accounting if they were going to be able to keep showing Wall Street and
their stockholders that they were still able to meet their earnings expectations.

SEC Investigation
For Xerox it all started to publicly unravel in May 2000, when Xerox made its first public
announcement that they had discovered accounting irregularities associated with its XeroxMexico operations. As the problems at Xerox-Mexico became public, in June of 2000 the
Securities and Exchange Commission (SEC) launched an investigation into what was
happening at the Xerox-Mexico subsidiary. At the same time Xeroxs audit committee hired the
Washington DC law firm of Akin, Gump, Strauss, Hauer, & Feld to conduct an independent
investigation about what was happening at the Mexican subsidiary with explicit instructions to
limit the scope of their investigation to the Mexico division. When the law firm found indications
that aggressive accounting practices may have been used in other areas, they were told by
internal Xerox lawyers to stick with Mexico only and that Xerox management, including CFO Mr.
Romeril, would look into accounting issues outside of Mexico.
In February 2001, with the SEC starting to look beyond the Mexican unit, in an effort to reassure
company investors, Mr. Allaire presented the conclusions of the Akin, Gump investigation. He
announced that some of the problems found during the investigation in Mexico included failures
to write off their mounting bad debts and improper classification of transactions. Mr. Allaire went
out of his way to distance corporate executives from the problems in Mexico by blaming a small
group of Xerox Mexico and Latin American executives, accusing them of acting in collusion to
circumvent company policies and procedures. As a result of the investigation, 13 managers
were fired or removed and Xerox had to write-off $120 million in 2000.
Shortly after Xerox released the results of the Akin, Gump report, Xerox also released results of
the internal world-wide investigation. For the first time, Xerox said that some of the problems
went beyond Mexico, forcing it to increase reserves in some smaller Latin American countries,
while at the same time suggesting there were no accounting issues found in any other major
units. Following closely, Mr. Romeril also publicly announced for the first time that the SEC had
widened its investigation beyond Mexico.
Xerox executives frequently assigned accountants numerical goals to produce profits through
accounting actions. It just became standard operating procedure to look to the accountants to
find income. Xeroxs underlying business was deteriorating and no one was doing anything to
try to fix it except using accounting trickery.

Xerox had some criticisms of the change in booking for services and supplies as part of the
companys leasing agreements, but the bigger concern was how the company was making
overly inflated assumptions about the value of future leases in developing countries. Xerox
would rapidly reduce the discount rate too far below the local interest rate, allowing them to
book more revenue. While this doesnt fabricate revenue, it shifts revenue to current period
from future periods. Xerox was using the lower rates because there was no other way that the
managers in developing markets were going to meet their revenue goals for 2000. Xerox had
improperly booked $447 million in pretax income over the previous six years using the
understated discount-rate assumptions when booking leases, primarily in Latin America.
The SEC investigation and review by KPMG, the auditors, revealed internal memos in which
senior Xerox management actually discussed accounting practices that could be used to
increase earnings in line with Wall Street expectations. While Xerox officials dismissed this as
simple brainstorming that was encouraged at Xerox, KPMG insisted that fake transactions and
illegal revenue recognition should never be discussed and refused to sign the 2000 annual
report despite threats from Mr. Allaire that this could lead to bankruptcy.

Findings
The SEC findings after investigation found that from 1997 through 2000, Xerox "pumped up its
earnings by nearly $500 million through the release into income of excess or `cushion' reserves
originally established for some other purpose," and Xerox committed a worse violation under the
rubric of another earnings-management favorite: revenue recognition. The company improperly
sped up the recognition of equipment revenue by over $3 billion, according to the commission.
In the end, the SEC extracted a $10 million fine and three years of restated results from Xerox
but no admission of guilt.
Interestingly, observers say that such high- profile SEC investigations seem to be dampening
executives' enthusiasm for over-the-top earnings management. So, too, have various rule
changes promulgated by the Financial Accounting Standards Board. In addition, Standard &
Poor's new "core earnings" metric could also make it harder for companies to set up phony
reserves.
According to SECs complaint, the accounting violations committed by Xerox are:
Accelerating leasing revenue
Xerox allegedly repeatedly changed the way it accounted for lease revenue but failed to
disclose that the associated gains were the result of accounting changes rather than improved
operating performance. Moreover, many of the practices used failed to comply with GAAP. For
example, Xerox used a return on equity allocation method that involved calculating the
estimated fair value of the equipment as the portion of the lease payments remaining after
subtracting the estimated fair value of the services and financing components. As the estimated
fair value of services and financing declined, the equipment sales revenue that was recognized
immediately increased. Xerox was also accused of accelerating the recognition of revenues by
immediately recognizing as the revenue price increases and extensions of existing lease rather
than recognizing the increases over the remaining life of the lease.
Improper increases in residual values of leased equipment
Xerox allegedly adjusted the estimated residual value of leased equipment (that is, its remaining
value at the end of the lease term) after the inception of the lease in violation of GAAP. SEC
alleges that this write-up in the residual value of equipment was used to credit the cost of sales,

were recorded close to the end of quarterly reporting periods as a gap-closing measure to help
Xerox meet or exceed internal and external earnings and revenue expectations.
Acceleration of revenues from portfolio asset strategy transactions
Selling investors the revenue streams from portfolios of its leases that otherwise would not have
allowed for immediate revenue recognition. SEC alleges that Xerox used these transactions to
recognize revenue that would have otherwise been recognized in future periods and failed to
disclose this practice.
Fraudulent manipulation of reserves and other income
Xerox allegedly increased its earnings by releasing excess reserves that were originally
established for some other purpose into income in violation of GAAP. Xerox also allegedly
systematically released a gain associated with the successful resolution of a dispute with the
Internal Revenue Service to improperly increase earnings from 1997 through 2000. Although
GAAP required that the entire gain be recognized upon the completion of all legal contingencies
in 1995 and 1996, Xerox used most of it to meet its earnings targets.
Failure to disclose factoring transactions
Xerox allegedly failed to disclose factoring transactions that allowed it to report a positive year
end cash balance, instead of a negative one. This factoring involved Xerox selling its
receivables at a discount in order to realize instant cash instead of a future stream of cash.
According to SEC complaint, analysts looked to Xerox to increase its liquidity and called for
stronger end-of year cash balances in 1999. Unable to generate cash, Xerox management
instructed its largest operating units to explore the possibility of engaging in factoring
transactions with local banks. These transactions materially affected Xeroxs 1999 operating
cash flows but these transactions were not disclosed in its 1999 financial statements. In some of
the factoring transactions involved buy-back agreements in which Xerox would reacquire the
receivables after the end of the year. By accounting for these transactions as true sales, Xerox
violated GAAP. Not only did Xerox fail to disclose the agreements, it failed to reverse them in
the next year.

Without admitting or denying the allegations of the complaint, Xerox consented to a final
judgment that includes a permanent injunction from violating the antifraud, reporting and
recordkeeping provisions of the federal securities laws, specifically Section 17(a) of the
Securities Act of 1933 and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange
Act and Rules 10b-5, 13a-1. 13a-13, 12b-20 and 13b2-1 promulgated there under. In addition,
Xerox agreed to restate its financials for the years 1997 through 2000 and pay a $10 million civil
penalty. As part of this agreement, Xerox also agreed to have its board of directors review the
companys material internal accounting controls and policies.
The Consequences that followed Xerox Corp. agreed to pay $670 million while KPMG LLP had
to pay $80 million, to settle an eight-year-old securities lawsuit filed on behalf of Xerox investors
who claimed Xerox committed accounting fraud to meet Wall Street earnings expectations.
The case of Carlson v. Xerox Corp., filed on behalf of purchasers of Xerox common stock and
bonds from between February 1998 and June 27, was something of a high profile one for the
pre-Enron era.
In April 2002, Xerox had already agreed to a $10 million fine as part of a settlement with the
Securities and Exchange Commission. The fine was the largest ever paid by a company to
settle with the SEC at that time.
The SEC charged that the copier company schemed to defraud investors during a four-year
period by using what it called \"accounting actions\" and \"accounting opportunities\" to meet or
exceed Wall Street expectations and disguise its true operating performance. The commission
stated at the time that most of the actions violated generally accepted accounting principles, and
thus accelerated the company's recognition of equipment revenue by more than $3 billion and
increasing its pretax earnings by approximately $1.5 billion.
In 2005, KPMG agreed to pay $22.5 million to settle SEC charges related to its audits of Xerox
from 1997 through 2000. Under that arrangement, the firm agreed to relinquish the $9.8 million
in fees it received for auditing Xerox's books during that time, and pay $2.7 million in interest
and a $10 million civil penalty. The total package was the largest payment ever made to the
SEC by an audit firm.
The Securities and Exchange Commission also charged six former senior executives of Xerox
Corporation, including its former chief executive officers, Paul A. Allaire and G. Richard
7

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 six defendants agreed to pay over $22 million in penalties, disgorgement and interest
without admitting or denying the SEC's allegations. The SEC intended to have these funds paid
into a court account pursuant to the Fair Fund provisions of Section 308(a) of the SarbanesOxley Act of 2002 for ultimate distribution to victims of the alleged fraud.