KPMG's Statement on SEC's Action Over Xerox Audit

KPMG LLP issued the following statement in regard to a civil complaint filed by the SEC in federal district court today against the firm, three current partners, and one former KPMG partner in connection with its audits of the 1997-2000 financial statements of its former client, Xerox Corporation:

"Today's filing was, of course, anticipated. The action is clearly an injustice to KPMG and the four partners involved, driven, we believe, by today's charged regulatory environment. 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.

KPMG finds it extremely unfortunate that the SEC has chosen to take such action, this time with a firm that so clearly took strong, bold steps with an audit client - particularly at a time when government, the business community, and the accounting profession are pursuing new levels of cooperation to help restore investor confidence.

KPMG Did The Right Thing In Xerox Audit

While we would have preferred to resolve this matter without litigation, we firmly believe we did the right thing. The action will in no way affect our ability to continue to serve our clients and help restore shareholder confidence in the capital markets, nor our ability to work with the SEC.

SEC Suit Makes Unsubstantiated Claims

The SEC's complaint filed today makes a number of unsubstantiated charges. While KPMG will not seek to refute every allegation, we note the following:

  • "Warning" from other KPMG firms. The SEC makes allegations that other member firms of KPMG International involved in the audits of Xerox's financial statements "warned" KPMG LLP regarding Xerox's accounting methodology. Snippets from lengthy memos discussing complex issues are quoted out of context in the complaint.

    These KPMG firms were simply meeting their professional responsibilities in commenting on a complex methodology which required a number of professional judgments to be made. One of the purposes of an audit is to raise questions. The comments were considered carefully by the KPMG US engagement partners and were in all cases resolved to the partner's satisfaction. We are confident that the ultimate resolution of those issues was made 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.

  • Safran replacement. Mr. Safran was not "removed" from the Xerox audit. He completed the audit of Xerox's 1999 financial statements and took bold and highly unpopular steps in doing so: insisting that the company book all of the audit adjustments the KPMG engagement team had identified, and writing a very tough letter to Xerox management regarding the improvements Mr. Safran recommended be made to Xerox's financial reporting. One such adjustment that Mr. Safran insisted upon is, in fact, referred to in the very e-mail quoted by the SEC, though only in part, in the complaint. As is clear from the part of the e-mail the SEC has left out, Mr. Safran insisted on an audit adjustment to correct the "half-baked revenue recognition" proposal referred to - and it was, in fact, corrected.

    Mr. Safran also thoroughly documented any concerns he had in the audit of Xerox's financial statements and how he addressed those concerns. Again, that documentation is utterly inconsistent with the absurd claim of fraud the SEC has made against this fine professional.

    Given Xerox's professed inability to communicate effectively with Mr. Safran, KPMG did decide to ask its highest-ranking technical partner, Michael Conway, to step in as engagement partner for the 2000 audit. It was Mr. Conway who, in the face of massive client resistance, ultimately insisted on first the Special Investigation, then the restatements, then significant changes in management personnel, and who was then dismissed by Xerox in October 2001.

  • Xerox not a case of fictitious revenues. 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. 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 SEC's allegations revolve around the methodology chosen by Xerox to account for its leases and the application of that methodology by the company.

    Xerox's June 2002 restatement, which resulted from its settlement with the SEC, represented a total about-face by new Xerox management and its current auditors regarding the lease accounting methodology. Importantly, the restatement allowed Xerox's new management to take nearly $2 billion in previously recognized revenue and recognize it again in 2002 and future years, and actually improved the company's results for 2000 and 2001. The rest of the restatement simply reallocated revenues among prior periods.

  • Independent investigation supports KPMG; Experts agree. KPMG continues to believe that Xerox's basic accounting methodology was appropriate. Three teams from PricewaterhouseCoopers, including the two involved in the special investigation in 2001 and the PwC audit team that succeeded KPMG as Xerox's independent auditors, agreed with us, as have several independent, respected accounting experts, including A. Clarence Sampson, former Chief Accountant of the SEC and former member of the Financial Accounting Standards Board (FASB). Mr. Sampson states, "In my opinion, Xerox's accounting methodology for sales type leases was a reasonable application of generally accepted accounting principles to its business model." As Chief Accountant for the SEC, Mr. Sampson was the Commission's principal advisor on accounting and auditing matters; and as a member of the FASB, Mr. Sampson was involved in establishing authoritative standards of financial accounting and reporting.

    Additionally, in an analyst conference call on January 28, 2002, Xerox chair Anne Mulcahy said: "We continue to believe that Xerox's [lease accounting] methodology produces financial results that are fairly presented in accordance with GAAP. In fact we have done substantial work to demonstrate that there is no material difference between our methodology and that of the [SEC] Office of Chief Accountant. Our current auditors, PricewaterhouseCoopers, have reviewed this work and are in agreement."

  • SEC staff had prior knowledge of audit methodology, unqualified opinion. The SEC staff was fully aware in 2001 that we were about to issue an unqualified audit report on financial statements reflecting Xerox's continued use of the accounting methodology the staff now calls fraudulent. Despite our numerous conversations with the SEC staff during the 2000 audit and the special investigation undertaken in 2001 - including our inquiry to the staff about any other concerns it might have prior to the issuance of our report - KPMG was never advised by the SEC staff that they considered that methodology fraudulent. Indeed, KPMG cooperated extremely closely throughout the investigation with the SEC staff, including keeping the SEC staff apprised at every step of the investigation and through KPMG's own expanded audit procedures. We did all these things because we believed it was the right thing to do.

    In addition, as reported in Xerox's October 2001 filing with the SEC, KPMG insisted on numerous changes in Xerox's financial reporting structure and personnel. And we provided a management letter, which we believe was unprecedented for a Fortune 500 company, identifying problems with the "tone at the top" of the company regarding financial reporting matters as a material weakness.

    KPMG's audit work for Xerox was performed with the utmost professionalism and integrity by some of the firm's most highly respected and competent personnel. In fact, KPMG took extraordinary steps to fulfill its professional responsibilities as Xerox's independent auditor, taking hard positions and doing exactly what the public expects the independent auditor to do. As Michael R. Young, a partner at the law firm of Willkie Farr & Gallagher and frequent writer and lecturer on financial reporting and liability issues, says, "Based on my close familiarity with the situation, KPMG set the example for auditors on how to do the right thing when issues are raised about an audit client's motivation in preparing its financial statements. That the SEC would bring this kind of suit in light of the tough, responsible and courageous actions taken by KPMG in 2001 is incomprehensible to me."

Addendum: Key Facts in Xerox Case

It is astonishing to us that the SEC would choose to bring this action where KPMG so clearly did the right thing. As we have pointed out repeatedly, when we learned of new information in early 2001 that raised serious concerns about Xerox management's motivation in preparing their financial statements, KPMG refused - in the face of strong client resistance - to issue its audit report on Xerox's 2000 financial statements. We immediately told the Audit Committee that Xerox must conduct a full-scale special investigation, using outside independent counsel and another audit firm.

We cooperated fully, completely and openly with the SEC staff throughout the special investigation and our own expanded audit procedures. At the conclusion of the investigation in 2001, we insisted, again over strong client opposition, that the company restate its financial statements for earlier periods. And we insisted that the company make significant personnel changes in its financial reporting structure-making all of these demands and recognizing that we risked losing a major client, which in fact we did. In short, we did exactly what the independent auditor is expected to do.

KPMG continues to believe that Xerox's basic accounting methodology was appropriate. Three teams from PwC, including the two involved in the special investigation and the PwC audit team that succeeded KPMG as Xerox's independent auditors, agreed with us, as have several independent, respected accounting experts, including A. Clarence Sampson, former Chief Accountant of the SEC and former member of the Financial Accounting Standards Board (FASB).

KPMG is confident that, when all the facts are in through the appropriate legal processes, our position will be vindicated. We stand firmly behind the individuals named in the complaint as well. This matter - while extremely disappointing to us - will not affect in any way our ability to continue to serve our clients with professionalism, integrity and the high quality of service they have come to expect of us.

These are the facts regarding the Xerox matter:

  • During the 1999 audit, KPMG insisted that Xerox book virtually every audit adjustment we identified that we did not believe complied with generally accepted accounting principles, including immaterial amounts. This is not a matter where KPMG "passed" large audit adjustments as immaterial and allowed the company to book revenue they should not have booked.

  • In the spring of 2001, during the course of the audit of the 2000 financial statements, KPMG learned of new information as a result of our expanded audit procedures and an ongoing SEC investigation of Xerox that raised concerns at the firm about the company's "tone at the top." That information raised questions about whether management's motivation in preparing their financial statements was trying to achieve certain earnings
    rather than trying to get it right.
  • Upon learning of this information, KPMG refused - in the face of strong client resistance - to issue its audit report on Xerox's 2000 financial statements and told the company's Audit Committee that Xerox must conduct a full scale special investigation, using outside independent counsel and another audit firm. The Audit Committee engaged Paul, Weiss, Rifkind, Wharton & Garrison, a prestigious New York law firm, to conduct the investigation, and Paul Weiss engaged PricewaterhouseCoopers to assist them.

  • The Special Investigation team was charged with looking into Xerox's accounting methodology for leases, as well as other accounting matters the outside investigators chose to examine and numerous others that KPMG identified. KPMG refused to sign off on the 2000 financial statements until that independent investigation and our own significantly expanded audit procedures were completed.
  • The investigation found that the fundamental lease accounting methodology used by the company complied with generally accepted accounting principles. In the process, two separate teams from PwC involved in the investigation agreed with KPMG and the company that Xerox's methodology complied with Generally Accepted Accounting Principles. After the Special Investigation concluded, KPMG also insisted, again in the face of strong client resistance, that Xerox restate its 1997 - 2000 financial statements for certain misapplications of its methodology that were discovered for the first time during the special investigation that we demanded.
  • In addition, as reported in Xerox's October 2001 filing with the SEC, we insisted on numerous changes in Xerox's financial reporting structure and personnel. And we provided a management letter, which we believe was unprecedented for a Fortune 500 company, identifying problems with the "tone at the top" of the company regarding financial reporting matters as a material weakness.
  • Despite our numerous conversations with the SEC staff during the 2000 audit and the special investigation undertaken in 2001 - including our specific inquiry to the staff about any other concerns it might have prior to the issuance of our report - KPMG was never advised by the SEC staff that they considered that methodology fraudulent. Indeed, KPMG cooperated extremely closely throughout the investigation with the SEC staff, including keeping the SEC staff apprised at every step of the investigation and through KPMG's own expanded audit procedures. The SEC staff was fully aware in 2001, through that process, that we were about to issue an unqualified audit report on financial statements reflecting Xerox's continued use of the accounting methodology the staff now calls fraudulent.

    Despite our inquiry to the staff about any other concerns it might have prior to the issuance of our report, we were never advised that the SEC staff considered that methodology fraudulent. We did all these things because we believed it was the right thing to do.

  • KPMG continues to believe that Xerox's basic accounting methodology is appropriate. Three teams from PwC, including the two involved in the special investigation and the PwC audit team that succeeded KPMG as Xerox's independent auditors, agreed with us, as have four independent, respected accounting experts, including a former Chief Accountant of the SEC.
  • Xerox's June 2002 restatement, which represented a total about-face by the company, allowed it to take nearly $2 billion in previously recognized revenue and recognize it again in 2002 and future years. The rest of the restatement simply reallocated revenues among prior periods.

Based on all of the preceding, it is incomprehensible to KPMG that this is what happens to the independent auditor after it does the right thing, serves its role, raises the right questions, and takes difficult, tough positions with its client.

KPMG stands firmly behind its audits of Xerox's 1997 - 2000 financial statements and the integrity and independence of the professionals who conducted those audits. KPMG did everything an auditor was supposed to do to ensure that the investor was protected and that we fulfilled our responsibilities.

We continue to believe it important that the SEC, the accounting profession, audit committees, management and the rest of the financial community work together toward more meaningful financial reporting and the restoration of investor confidence in the capital markets. In the meantime, we will defend our firm and our partners against these unfounded charges and look forward to vindication."

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