The Securities and Exchange Commission sued KPMG LLP Wednesday, saying the accounting company fraudulently let Xerox Corp. manipulate its accounting practices to fill a $3 billion gap and make it appear to be meeting expectations.
The SEC accused KPMG, three current partners and one former partner of securities fraud in the lawsuit filed in U.S. District Court in Manhattan.
In a 59-page document, the SEC said KPMG had failed to be the watchdogs on behalf of shareholders and the public that the securities laws and the rules of the auditing profession required them to be. It sought injunctions, disgorgement of all fees and civil money penalties.
It said KPMG engaged in fraud by falsely telling the public it had applied professional auditing standards to its review of Xerox’s accounting and that Xerox’s reported results represented the company’s true financial condition.
“There was no watchdog at Xerox. KPMG’s bark sounded no warning to investors; its bite was toothless,” the SEC said.
KPMG defended its 1997-2000 audits of Xerox’s financial statements, saying that at the very worst it was no more than a disagreement over complex professional judgments. It called the SEC’s accusations unfounded and “driven, we believe, by today’s charged regulatory environment.”
The company said it “is astonishing to us that the SEC would choose to bring this action where KPMG so clearly did the right thing,” standing up to Xerox, insisting on an independent investigation and refusing to sign the financial statements until Xerox restated results for prior years.
“This is not a case in which transactions did not occur, fictitious revenue was booked or revenue was not earned. There are no suspicious related-party transactions, looting of the company’s coffers, or missing millions,” the firm added.
KPMG said it worked closely with the SEC during a 2000 audit and no one said anything was fraudulent about the accounting methods Xerox used.
In 2001, KPMG was dismissed as Xerox’s longtime auditor.
Through a new auditor, Xerox has issued a $6.1 billion restatement of its equipment revenues and a $1.9 billion restatement of its pre-tax earnings for the years 1997 through 2000, the SEC said.
Xerox recorded too much revenue from equipment contracts up front instead of over the life of leases for servicing and financing equipment. That had the effect of boosting a given year’s revenue figure.
Without admitting or denying wrongdoing, Xerox paid a $10 million civil penalty, the largest levied against a company for financial-reporting violations.
The SEC said in its suit that KPMG’s foreign affiliates in Europe, Brazil, Canada and Japan, along with KPMG auditors at Xerox’s U.S. operates facility in Rochester, N.Y., repeatedly warned KPMG officials in Stamford, Conn., and New York that Xerox’s revenue accounting was seriously deficient.
“But the defendants ignored these warnings as well as their own doubts,” the federal agency said.
“Rather than put at risk a lucrative financial relationship with a premier client, the defendants abdicated their responsibility to challenge Xerox’s improper accounting actions and make the company report its financial results accurately,” the SEC said.
“Year after year, the defendants told the public that they had conducted a professional audit and that Xerox properly prepared and reasonably presented its financial results when, in fact, the defendants knowingly or recklessly allowed Xerox to use self-serving, untested assumptions and improper accounting methods to report impressive, but fraudulent, revenues and earnings.”
KPMG said it “clearly took strong, bold steps” in the case, and that the SEC had distorted snippets from lengthy memos from other firms within KPMG International to make it seem KPMG ignored warnings about Xerox’s accounting methods.
The company said KPMG considered the comments carefully and resolved them each time to the partner’s satisfaction, “professionally, appropriately and in good faith.”
“It is also worth noting that charges of `fraud’ are completely inconsistent with the open and thoroughly documented discussion of issues that occurred here,” it added.
KPMG said Xerox’s restatement in a settlement with the SEC allowed Xerox’s new management to take nearly $2 billion in previously recognized revenue and recognize it again in 2002 and future years, actually improving the company’s results for 2000 and 2001.