Corporate Xerox

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ACCOUNTING FRAUD AT XEROX 2AbstractThis analysis will examine the Xerox accounting fraud scandal,its causes and effects, and theneed for best practices in business ethics,corporate governance and oversight. Xerox utilizedcreativeaccounting

techniques to misrepresent its assets and liabilities, deceiving investorsandinflating its stock. The scandal was staggering in its scope and scale:chairman and CEO Allaireand others enriched themselves to the tune ofmillions at stockholders expense (

Mills, 2003, pp.21, 30). The Xerox scandal demonstrates the need foraccountability and ethics in corporategovernance and finance: Xeroxscentral problem was its inept, short-sighted and unethicalsenior

executives.

Xerox Corporation is a global document management company whichmanufactures andsells a range of color and black-and-white printers,

multifunction systems, photo copiers,digital production printing presses,and related consulting services and supplies. Xerox established itself asthe purveyor of its xerography machines, establishing the companyname in the commonlexicon. Its Palo Alto Research Center (PARC)invented such hallmarks of digital agetechnology as the personalcomputer, graphical user interface [mouse], Ethernet, andlaser printer (

Daft, 2009, p. 4). But the high profit margins of Xeroxs copiers blinded

managementto the potential of this technological cornucopiawhichother companies rushed to exploit. By1982, Xerox was facingdrastically-reduced market shares as companies such as Canonbeganout-competing it in the copier sector (p. 4).But by 1997, Xeroxsfortunes seemed to be improving. Under the leadership of chairmanandCEO Paul Allaire (since 1990), Xeroxs stock began to increase.
http://en.wikipedia.org/wiki/Computer_printerhttp://en.wikipedia.org/wiki/Computer_printerhttp://en.wikipedia.org/wiki/Photo_copierhttp://en.wikipedia.org/wiki/Photo_copierhttp://en.wikipedia.org/wiki/Photo_copierhttp://en.wikipedia.org/wiki/Photo_copierhttp://en.wikipedia.org/wiki/Computer_printer


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However, the change wasillusory: Xerox was using creative accountingtechniques to mislead investors about its trueworth. Allaire and others inXeroxs top management were unloading their fraudulently-inflatedstocks and pocketing millions, all while closing the

gap between target and actual performance (

Lowenstein, 2004, pp. 74-75). That gap continued to grow when in 2000Xeroxcontinued to lose ground to Canon and suffered a loss (p. 76).Then came the revelation ofaccounting irregularities in Mexico

ACCOUNTING FRAUD AT XEROX 4The Securities and Exchange Commission (SEC) began to investigateand filed suitagainst Xerox in US District Court for the Southern Districtof New York.1The complaintalleged that Xerox, using a host of undisclosed accountingactions, which were often referredto as accounting opportunities and

one-offs, distorted earnings and misled investors Therewere two basicmanipulations that formed the basis for the SEC investigation. The firstwas theso-called cookie jar method. This involved improperly storingrevenue off the balance sheetand then releasing the stored funds atstrategic times in order to boost lagging earnings for a particular quarter.This is a widely used manipulation. The second methodand whataccountedfor the larger part of the fraudulent earningswas theacceleration of revenue from short-termequipment rentals, which were

improperly classified as long-term leases. The difference wassignificantbecause according to the Generally Accepted Accounting Principles(GAAP)thestandards by which a companys books are supposed to bemeasuredthe entire value of a long-term lease can be included asrevenue in the first year of the agreement. The value of a rental, ontheother hand, is spread out over the duration of the contract.In an official


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release to the press the SEC explains these accounting actionswereemployed by Xerox to close the gapbetween the marketsexpectations and actual operatingresults from 1997 to 2000, as shownin the below chart SEC created chart used to illustrate theimpact of these

accounting actions when compared to Wall Street estimates. PaulBerger,Associate Director of Enforcement for the SEC stated in thispress release, Xerox's seniormanagement orchestrated a four-yearscheme to disguise the company's true operating performance, andCharles D. Niemeier, Chief Accountant for the Division ofEnforcement,added, "Xerox employed a wide variety of undisclosed andoften improper top-side accounting

ACCOUNTING FRAUD AT XEROX 5actions to manage the quality of its reported earnings. As a result, thecompany created theillusion that its operating results were substantiallybetter than they really were.".In response to the SEC complaint, Xeroxconsented and without admitting or denying theSEC allegationsXerox agreed to pay the $10 million penalty -- the biggest fine the SEChadever levied for accounting fraud -- and to restate thecompanys financial results for 1997, 1998,1999 and 2000. Additionally,

the SEC release stated that Xerox had agreed to have its boardof directors appoint a committee composed entirely of outside directorsto review the company'smaterial accounting controls and policies. In2005, KPMG agreed to pay $22.5 million to settleSEC charges related toits audits of Xerox from 1997 through 2000. Under that arrangement,thefirm agreed to relinquish the $9.8 million in fees it received forauditing Xerox's books duringthat time, and pay $2.7 million in interestand a $10 million civil penalty. The total package was

ACCOUNTING FRAUD AT XEROX 6the largest payment ever made to the SEC by an audit firm.2


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The Securities and ExchangeCommission also charged six former seniorexecutives of Xerox Corporation, including itsformer chief executiveofficers, Paul A. Allaire and G. Richard Thoman, and its formerchief financial officer, Barry D. Romeril, with securities fraud and

aiding and abetting Xerox'sviolations of the reporting, books andrecords and internal control provisions of the federalsecurities laws.Thesix defendants agreedto pay over $22 million in penalties,disgorgement andinterest without admitting or denying the SEC'sallegations.1These are the general particulars of the case. The lengths to which Xeroxwent tomisrepresent its financial situation, however, beg questions like ;

What led Xeroxs seniorexecutives to such an unethical (and risky)course of action? , and The Boards contribution tothe scandal-

how could they have not known? .The Xerox scandal may have grabbedtheattention of the financial media and Wall Street, but theseeds forXeroxs failure were sown decades before. Asseen, Xerox developedmany technologies in the digitalageand then failed to take advantageof them.According to Daft (2009), while Xerox was ploddingalongselling copy machines, younger, smaller, and hungrier companies weredeveloping PARCtechnologies into tremendous money-making productsand services (p. 4). Not only did Xeroxfail to capitalize on newtechnologies, by 1982 its copier market share had fallen from 95 to13 percentwhen its xerography patents started to expire, Canon andRicoh were able to sellcopiers at the cost it took Xerox tomake them(p. 4).
http://investor.gov/litigation/litreleases/lr18174.htmhttp://investor.gov/litigation/litreleases/lr18174.htmhttp://investor.gov/litigation/litreleases/lr18174.htm


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ACCOUNTING FRAUD AT XEROX 7The irony is that Xerox was once the envy of the corporate world forits dedicatedemployees and a company culture that emphasizedvalues of fairness and respect risk takingand employeeinvolvement (Daft, 2009,p. 4). But Xeroxs superb companyculture wasoffset by poor decision-making at the top that stopped its

success. The SEC investigation notedthat compensation of Xeroxsenior management depended significantly on their ability tomeet[earnings] targets. Because of the accounting manipulations, topXerox executives were able tocash in on stock options valued at anestimated $35 million.When it comes to the Board ; the straight forwardanswer to the question of what couldthe Board have done to prevent ormitigate the effects of the scandal is that they could have heldtruth aboveall else and acted ethically in their financial reporting.Xerox Corp. didhave andAudit committee, and the companys independent auditors were

at the time of the scandalKPMG, LLP.Indeed, Xerox was guilty ofa considerable number of accounting tricks that involvedmanipulatingperiod reporting: according to Mills (2003) the SEC also charged Xeroxwithimproperly recognizing revenues from its leasing operationsbecause Xerox booked lease payments for future services or supplies upfront, and with attempting to increase short-termresults by overstating


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the value of future payments from leases originated indevelopingcountries (p. 21). It also failed to write off mountingbad debts, another example ofattempting to paint a rosier picture of thecompanys finances through fraudulent means in order to increase

investor confidence (p. 21). This is a well-known accounting trick, usingcookiejarreserve accounts to create the illusion ofa smoother growthpath of sales and profits in ordertoincrease investor confidence andinflate stock values (pp. 30-31).

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Mills (2003) explained that executives are able to fraudulentlymanipulate their accounting statements because accountants,banks, brokers, and attorneys all benefit fromhelping CEOs do this (p.27). Xeroxs deception was enabled by these interests; indeed, theSECcharged Xeroxs accounting firm, KPMG, with auditing Xerox toomeekly KPMG wasat least a partial intervention point: it did finallybalk at Xeroxs accounting tricks in 2001andXerox fired KPMG(Lowenstein, 2004, p. 77).One of the major factors impeding Xeroxs

feasibility to change was its organizationalculture: according toLowenstein (2004), by the time that Binghams investigation revealedthecorruption at the heart of Xerox, Xeroxs culture had declined to thepoint that directors wereculturally disinclined to questionmanagement (p. 76). It was actually in the directorsinterests, by thispoint, not to question management: directors such as George MitchellandVernon Jordan were there for the $75,000 stipend, in return forwhich management got well-known, and dependably supportive,

directors (p. 77). These men lacked the timeMitchell saton sevenboards, Jordan on twelvelet alone the desire or motivation to holdmanagementaccountable under ethical guidelines of corporategovernance (p. 77).Ethics must start with the companys leadership teamand permeate the companysculture..In 2001, Anne Mulcahy becameCEO and proceeded to systematically overhaul Xerox,cutting costs and


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closing money-losing operations, including the division she hadpreviouslyheaded (Daft, 2009, p. 5). She negotiated the scandalpersonally, communicating a newcommitment to ethical businesspractices and corporate social responsibility (p. 5). Productionwas

largely outsourced, freeing Xerox to focus on innovation and service.Mulcahy refused to

ACCOUNTING FRAUD AT XEROX 9cut research and development and customer contact (p. 5). Her

ethical, forward-thinkingleadership made the difference: Xeroxsfortunes rebounded with new products and services andgrowth in newsectors. In 2007 sales rose to more than $17 billion (p. 5).Mulcahy regainedthe trust of employees and then customers andinvestorsCurrently our society rewards those people that produce what isdesired, and give littlethought as to how the desired results wereproduced. Examples of this are everywhere:consumers purchase goodswithout giving a thought to the fact that it was produced by childlabors

living in developing countries or the toxic waste created during theproduction of the product. Until the day comes when that societyconstantly and consistently chooses integrityover personal gain scandalssuch as this and others will reproduce and multiply.Thus, Xeroxs storydemonstrates the need for morally informed businesses in aflourishingdemocracy on both sides of the coin: Mulcahys success was the creationof anorganizational culture built on a foundation of ethics andaccountability, precisely the kind of culture that Xerox lackedunder Allaire. Mulcahy also redesigned Xeroxs business modelandoverhauled its cost structure .

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