Many made up of Certified Public Accountants (CPA’s),

Many people have heard of “The Bi­g Four” accounting
firms but not many people outside of the accounting/finance industries are
truly aware of the duties these firms hold and what they actually do. The big
four consist of: PWC, Deloitte, Earnest & Young and lastly KPMG which is
the firm we will focus on throughout this paper. On a large scale, these firms are
made up of Certified Public Accountants (CPA’s), Business Consultants/Analysts and
of course Auditors, which will also be a focal point of our analysis.

According to author Michael Stephens, KPMG is the
smallest of the Big Four firms by both proceeds and workforce numbers.  Small in this instance is very relative as
KPMG is still 300% bigger than the fifth largest accounting firm in the nation.
With more than 700 offices in over 160 countries and employee numbers north of
188,000 (Big 4 Accounting Firms, 2017). As previously mentioned, one of the
revenue streams steams from KPMG’s auditing services. The United States
requires publicly traded companies to hire external auditors to examine the corporation’s
financial statements in order to encourage transparency between the publicly
traded company and its stakeholders. This is with the purpose of protecting
investors from misleading information which can potentially cause individuals
to make investment decisions regarding the specific company. Misleading
information that drives investment decisions can consist of quarterly earnings
that exceeding analyst expectations. Making these decisions based on false or
misleading information can cause a monetary loss during a decline in stock
pricing.   

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One of KPMG’s largest clients in the
late 1990’s was Xerox Corporation. Xerox is
a copy machine manufacture which sells and leases copiers, as well as provide services
and supplies such as ink for the copy machines. The first products they
manufactured and provided was photograph equipment and paper. In the late 1950’s,
Xerox designed the original basic copier, this placed Xerox in the top spot as the
leading manufacture in the industry. By the late 1990’s, Xerox was the biggest provider
of copy machines in the world. Unfortunately, Xerox executives believed this
wasn’t enough to exceed analysts’ expectations and this is where the trouble
began for both Xerox and KPMG. Because top executives at Xerox believed that
the current revenues weren’t sufficient they began to illegally miniplate their
financials in order to show a significantly larger amount of revenues, this
took place between the years of 1997-2000.

By the late 1990’s, Xerox began facing some fierce
competition from other manufactures in the industry this caused the company to
lose a substantial share of proceeds. Xerox top executives used various
strategies to effectively misinform shareholders of the true revenues of the
company. The most substantial technique used to commit this scam was to fast-track
the acknowledgement of the leasing income through what is known as non-GAAP
accounting. In simple terms Xerox would lease products to companies and then
recognize all of the “revenues” made from the sale as soon as the contract was
signed even though the full payment of the lease was not made at that time.
Opposed to following GAAP and periodically claiming the revenues. According to
the SEC, “GAAP encourages businesses to only account for the payments owed to
them in the current period.”

By means of these bookkeeping methods known as
“one-time actions” or “one-offs” the company was illegitimately advancing
the worth of the leased machinery. According to the Securities and Exchange
Commission,

Relying on what it called “one-time actions,”
“one-offs,” “accounting opportunities” and “accounting
tricks” to achieve earnings targets that it otherwise could not have met,
Xerox falsely portrayed itself as a business meeting its competitive challenges
and increasing its earnings every quarter. Many of these accounting actions
violated the established standards of generally accepted accounting principles
(“GAAP”). All of them should have been disclosed to investors in a
timely fashion because, singly and collectively, they constituted a significant
departure from Xerox’s past accounting practices and misled investors about the
quality of the earnings being reported. The accounting actions improved Xerox’s
earnings, revenues and margins in each quarter and year during 1997 through
2000, and allowed Xerox to meet or exceed Wall Street expectations in virtually
every reporting period from 1997 through 1999. (SEC.gov, 2002)

 

Additional accounting procedures Xerox implemented in
order to mislead Wall Street analysts and stockholders included: exaggerating revenues
by means of “Cookie Jar” assets and interest from levy reimbursements,
inappropriate surges in worth of rented machinery, quickening of income from leased
machines and the failure of disclosing true business conditions. Xerox used this
“cookie jar” method to exaggerate numerous financial records by
almost $500 million dollars. When analyzing the financials and all the ways
Xerox executives violated the GAAP its clear to see the huge effect those
unethical efforts put forth to misguide investors into believing false margins,
revenues, and forecasted earning per share (EPS).

One might wonder how Xerox was able to “get away” with
these illegal accounting methods quarter after quarter, year after year. That
is where the auditors start being questioned and in this case, that was KPMG.
KPMG and Xerox had a longstanding business relationship for, at that time, over
40 years. Xerox was one of the KPMG’s largest accounts bringing in over 82
million dollars in revenues between the years of 1997-2000. Therefore, it was
in KPMG’s interest to keep Xerox executives pleased. This business relationship
with Xerox was so expedient that whenever the chief KPMG auditor would question
Xerox’s practices of non-GAAP accounting Xerox officials would voice to KPMG
the want for a better fitting auditor and KPMG would fulfill request.

Xerox executives also continuously assured both
stockholders and Wall Street analysts that current performance will continually
to expand year over year. What is concerning is that the analysts didn’t think
to question this information because they believed that KPMG, one of the
largest and most was ethical in their auditing prestigious firms and member of
the big four, was ethical in their auditing practices. KPMG is the reason this
fraud was able to not only continue but grow into one of the largest frauds
during that time. According to the SEC, “KPMG and its partners permitted Xerox
to manipulate its accounting practices to close a $3 billion “gap”
between actual operating results and results reported to the investing public.
Year after year, the defendants falsely represented to the public that their
audits were conducted in accordance with applicable auditing standards and that
Xerox’s financial reports fairly represented the company’s financial condition
and were prepared in accordance with GAAP” (SEC.gov, 2003). And for this
reason, KPMG was held accountable by the SEC.

The top executives responsible for the scandal, all of
whom are CPA’s, were: Michael A. Conway, Joseph T. Boyle, Anthony P. Dolanski
and Ronald A. Safran. Mr. Conway was a longtime resident of Westport, Connecticut.He
was a “Senior Professional Practice Partner” and the “National Managing
Partner” of KPMG’s Department of Professional Practice from 1990-2000 but began
his employment with KPMG in the early 1980’s. Particularly, “He was the senior
engagement partner on the Xerox account from 1983 to 1985. He again became the
lead worldwide Xerox engagement partner for the 2000 audit. Conway also is a
member of the KPMG board and is chairman of the KPMG Audit and Finance
Committee” (SEC.gov, 2003). Mr. Boyle, 59, resided in New York City during that
time and was the “relationship partner” between the years 1999-2000
during the scandal occurrences. He was also a Managing Partner of the NY KPMG
office and of the Northeast Area Assurance (Audit) Practice. “As the
relationship partner, Boyle’s chief duty was serving as liaison between KPMG and
the Xerox Board of Directors, including its Audit Committee” (SEC.gov, 2003)
where he clearly failed to do so. Mr. Dolanski, resided in Malvern, Pennsylvania
during the time he was engaged with KPMG. He was the “lead engagement partner” with
the responsibility of supervising Xerox’s audits from the year 1995 to 1997
when the scadel began. He forgave his employment with KPMG in 1998 and became CFO
of the Internet Capital Group. Mr. Safran, resided in Connecticut during his
employment with KPMG. According to SEC documents, “He was the lead engagement
partner on the 1998 and 1999 Xerox audits. He was removed as engagement partner
at Xerox’s request after completing the 1999 audit and was replaced by Conway.
KPMG or its predecessor has employed Safran since his graduation from college
in 1976” (SEC.gov, 2003).

Even though the respondents periodically voiced some worry
to Xerox executives about the so-called “topside accounting devices”
established and used by top executives to intensify income all of the previously
mentioned defendants did care or importance when Xerox overlooked the voiced concerns
and therefore sustained the illegal actions of repeatedly manipulating various
financial statements. The plaintiffs then, without much concern or care for the
risk they placed on shareholders, overthrew obvious unethical reporting and
recklessly went against the clear duties of an auditor. They did so solely to
protect a profitable business partnership with one of their largest clients.
According to SEC filings,

On April 11, 2002, the
Commission brought an injunctive action against Xerox based on the same
allegations of accounting fraud as are alleged against the KPMG defendants, as
well as other allegations. Without admitting or denying the allegations of the
complaint, Xerox consented to the entry of a Final Judgment that permanently
enjoined the company from violating the antifraud, reporting and record keeping
provisions of the federal securities laws. Xerox also paid a $10 million civil
penalty, agreed to restate its financial statements and agreed to hire a
consultant to review the company’s internal accounting controls and policies.” (Securities
and Exchange Commission v. Xerox Corporation, Civil Action No. 02-CV-2780 (DLC)
(S.D.N.Y.), 2002).

In addition to the $10 million dollars paid in civil
penalties paid in 2002, KPMG paid an additional $12 million dollars in the 2005
settlement: $9.8 million dollars of which was a repayment of the monies KPMG
“earned” during the auditing period the scandal was occurring, as well as, $2.7
million dollars in the repayment of interest. This equated to a total of $22
million dollars in penalties. Individuals who were invested in Xerox lost an
approximate 50% to 80% of market value of the stock once the news of the
scandal arose, this approximation highly depends on when the original
investment was made. For example, if an investor purchased the stock at the
market high of $155/share and sold at the market low of $12/share that investor
would have realized a 92% loss. However, if an investor purchased the stock
during the beginning phase of the scandal around 1997 at $82/share and sold in
the midst of the stock crashing at approximately $43/share (Q3 2000) this
investor would have incurred an approximate 47% loss. Overall, the significant
drop in stock price likely had a huge impact on most investors and their
portfolios including, their 401k’s. Xerox’s stock price never reached the
market high it experienced in 1998, and is currently trading at approximately
$30/share.