The Securities and Exchange Commission yesterday filed a civil complaint against KPMG LLP and four current and former partners, saying the accounting giant should forfeit its fees and pay penalties for allegedly ignoring red flags raised by its own employees and international affiliates during its 1997-2000 audits of Xerox Corp.
The defendants include Michael A. Conway, one of KPMG's senior managers, and Ronald A. Safran, whom the SEC says was replaced as “engagement partner” after Xerox complained about his questioning of its accounting methods during the 1999 audit.
“The investing public counts on the audit profession to do their job with unfailing dedication to the principles of accounting, regardless of the wishes of their audit clients,” SEC Associate Director of Enforcement Paul R. Berger said in a statement. “The failure by the audit firm and its partners in the Xerox case represents a troubling episode and one that cannot and should not be repeated.”
Xerox has already restated $6.1 billion in revenue from that period and paid a $10 million civil fine to settle an SEC investigation into inflated earnings and premature booking of revenue from long-term leases of photocopy equipment. Xerox did not admit wrongdoing.
Spokesmen and lawyers for KPMG and the partners strongly defended their actions, saying the auditors stood up to Xerox management and the internal questions raised about the accounting methods were simply part of a normal comment process. They said they intend to fight the SEC allegations in U.S. District Court in Manhattan, where the complaint was filed.
“The action is clearly an injustice to KPMG and the four partners involved, driven, we believe, by today's charged regulatory environment,” the firm said in a statement. “The basic issue is the timing of revenue realized by Xerox on its leases and, at the very worst, this is a disagreement over complex professional judgments.”
The case underscores the SEC's newly aggressive strategy of going after accountants. “The spectacular upheaval in the corporate landscape over the last year highlights the critical responsibility that auditors have in the financial reporting process,” said Stephen M. Cutler, the SEC's enforcement director, in a statement. “In their audits of Xerox, KPMG and its partners abdicated that responsibility.”
According to the SEC, Xerox turned to accounting tricks as early as 1995 and by 1999 they accounted for up to 25 percent of reported pretax earnings.
In 1997, KPMG employees in Rochester, N.Y., and Canada questioned the way the company was accounting for copier financing, the complaint said. In 1998, the accounting firm's Brazil affiliate questioned the financial rates used in their calculations. That same year, KPMG's British affiliate asked questions about Xerox's accounting of service contracts.
But the audit team approved both the 1997 and 1998 results. By the third quarter of 1999, Safran was so concerned about Xerox's methods he told Conway that Xerox's audit committee should be informed. That never happened and Safran signed off on the 1999 results. Conway took over for Safran the next year.
The SEC acknowledged that KPMG did at times raise questions with Xerox management, but the complaint argues the auditors did not do enough. “Although the defendants sometimes meekly challenged manipulative topside accounting devices at Xerox, they were easily satisfied by untested, self-serving management explanations,” the complaint said.
Lawyers for Safran, Conway and defendant Joseph T. Boyle said they intend to challenge the SEC's version in court.
“Mr. Safran did just what investors would want him to do: When he believed it to be warranted, he challenged management's accounting practices and insisted that appropriate adjustments be made in Xerox's financial statements before they were issued,” said his attorney, Martin L. Perschetz.
An attorney for former KPMG partner Anthony P. Dolanski did not return phone messages.
The accounting firm said, “In the Xerox matter, KPMG did the right thing. We stood up to the client and asked the tough questions. We insisted on an independent investigation, and we refused to sign the company's financial statements until Xerox restated results for prior years.”
The SEC's decision to press forward, coupled with KPMG's feisty response, may mean that this case — unlike most SEC actions — will go to trial, outside analysts said.
“It sounds as if KPMG has drawn a line and they want to fight this to the bitter end. . . . Xerox can settle this and move on with their business. For KPMG this is their business . . . they can't cast this as being a rogue partner or lone person who fell down on the job,” said former federal prosecutor Seth Farber.