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SEC To Hit KPMG With Civil Charges

Audit Firm Defends Its Work At Xerox

Jan 23, 2003 | Washington Post

The Securities and Exchange Commission is planning to file civil fraud charges against accounting giant KPMG LLP and several partners in connection with their audits of Xerox Corp., which was forced last year to restate $6.4 billion in revenue and pay a $10 million penalty to settle accounting fraud charges, federal sources said yesterday.

The officials would not go into details about the proposed complaint, but KPMG officials issued a strongly worded defense of their conduct, saying they expected charges to be filed in U.S. District Court against the partnership, three current and one former partner in connections with their audits of Xerox from 1997 to 2000.

Xerox, the world's largest maker of photocopiers, paid a record fine last May to conclude a two-year SEC probe into accounting irregularities that included inflated earnings and premature booking of revenue. Now the investigation is moving in a new direction that was foreshadowed in a speech by SEC enforcement chief Stephen M. Cutler last month. He said then, "It is time to adopt a new enforcement model a new paradigm: one that holds an accounting firm responsible for the actions of its partners."

The planned complaint against KPMG would be one of the first to follow that warning, although sources said the SEC is also looking at auditors in connection with allegations of massive fraud at Tyco International Ltd.

But KPMG chairman and chief executive Eugene D. O'Kelly called the SEC's planned enforcement "a great injustice to KPMG and the four partners involved."

"At the very worst, this is a disagreement over complex professional judgments. KPMG stands firmly behind our audits of Xerox's financial statements and the professional judgments made during the course of the audits," O'Kelly said.

The KPMG response offered a detailed chronology of the firm's dealings with Xerox and its role in bringing to light the accounting irregularities that led the company to restate its earnings twice.

The accounting firm said its auditors stood up to Xerox management in 2001, refusing to issue its audit of the company's 2000 financial reports until Xerox hired an outside law firm to conduct an independent investigation of its prior accounting practices. The statement said the firm cooperated fully with the SEC and insisted that Xerox restate its prior earnings and change its financial reporting structure.

"It is astonishing to us that the SEC would choose to bring this action where KPMG so clearly did the right thing. We did exactly what the independent auditor is expected to do," the statement said.

The firm contended that Xerox's basic accounting methodology was "appropriate" and said the SEC staff had never told them that the methods were fraudulent.

If the SEC complaint succeeds, KPMG could face financial penalties and limits on its ability to practice before the commission. But a legal defeat for the firm would not have the same kind of devastating impact as a criminal case. Arthur Andersen LLP disintegrated last year after being convicted of obstruction of justice related to its audit work for Enron Corp.

If the proposed complaint against KPMG is filed, it would mark a significant shift for the SEC. The agency has tended to use its scarce resources carefully, mostly scrutinizing the work of accountants at smaller auditing firms or devoting resources to pursuing insider trading and broker-dealer misconduct. And the agency almost never sued accounting firms, unless top managers were actively involved in a failed audit.

"They've been very slow to bring cases, even against individual accountants," said Bruce A. Baird, a former federal prosecutor who now defends clients in Justice Department and SEC investigations.

But even as that appears to be changing, accounting groups warned against overreacting. "We hope every time the SEC reviews a matter that it won't necessarily jump to the conclusion that the firm's at fault or that there are systemic problems," said Joel Allegretti, a spokesman for the American Institute of Certified Public Accountants.

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