UNITED STATES ISTRICT COURT
DISTRICT OF ONNECTICUT
RUSSELL CARLSON, Individually and On
Behalf Of All Others Similarly Situated
Case No. 3:00-CV- 1621 ( A
ALL CASES
l ' y
43
Plaintiff,
V5.
XEROX CORPORATION, KPMG LLP,
PAUL ALLAIRE, G. RICHARD THOMAN,
ANN MULCAHY, BARRY ROMEREL,
GREGORY TAYLER and PHILIP
FISHBACH,
Defendant.
Andrew M. Schatz ct40643
Jeffrey S. Nobel ct04855
Patrick A. Klingman ct17813
Schatz & Nobel, P.C.
330 Main Street 2nd Floor
Hartford, Connecticut 06106-1851
(860) 493-6292
JURY TRIAL DEMANDED
August 8, 2002
J. Daniel Sagarin ct04289
Margar et E. Haering 010818
Hurtwitz & Sagarin, LLC
147 N. Broad Street
Milford, Connecticut 06460
(203) 877-8000
:. mss
^ Counsel
Keith M. Fleischman ctl0468
Francis P. Karam ct21194
Elizabeth A. Berney
Cary L. Talbot ct21193
Milberg Weiss Bershad Hynes & Lerach LLP
One Pennsylvania Plaza 49th Floor
New York, New York 1011 9-0165
(212) 594-5300
Jeffrey C. Block
Michael T. Matraia
Leslie R. Stern
Sara B. Davis
Berman DeValerio Pease Tabacco
Burt & Pucillo
One Liberty Square
Boston , MA 02109
(617) 542-8300
Dennis J. Johnson
Jakob B. Perkinson
Johnson & Perkinson
1690 Williston Road
South Burlington, Vermont 05403
(802) 862-0030
Co-Lead Counsel
TABLE O1' CONTENTS
Page
Introduction ..................... I.......................... . ............ 1
II.
Basis of Allegations ............... I .......... _ ............... _ .......... I 1
III.
Jurisdiction and Venue . . ....... . ... I.............. _ ........... _ ........... 11
IV.
Parties .......................... I........ ......................... .....12
V.
A.
Plaintiffs .......... ............._.._.........._.._...__.._....._..12
B.
The Xerox Defendants ...._.
.....................................13
C.
KPMG LLP ..............
................ ..................... 18
Substantive Allegations ............
.....................................19
A.
Background ............. ..1.......... . .. ........................ 19
B.
Xerox's Initial Efforts to Limit it "Problems" to Mexico ........ . ......... 19
C.
Bingham's Allegations _.. ...
D.
Xerox Delays Fiscal 2000 Form 10-K Filing ...... . .......... . ......... 31
E.
SEC Investigation Broadens ..
F.
1
Xerox's First Restatement .... 1
....................................28
....... _ .... . . ................. . ... . 34
..... . .......... . .......... . ... . ... 35
1.
The Mexican Accounting rregularities . . .. . . .. . ...... _ _ .. _ _ ...
2.
Misapplications of GAAP Under SFAS 13, "Accounting for
Leases" .............. ....................................38
3.
The Improper $ 100 Million Rank Reserve . . . ..... . .............. 38
35
G.
The SEC Notifies Xerox That its Accounting Methods are Improper ..... _ ... 42
H.
The SEC Complaint Details Xero 's Accounting Irregularities ............. 46
i
I.
The SEC's Allegations of Accounting Improprieties ....... .......... _ .. 50
J.
Xerox' s Second Restatement . ................ . . . .................... 56
1.
Improper Application of SFAS 13 (Lease accounting) .............. 58
a.
Revenue Allocations in Bundled Arrangements ..... . ... . ... 58
b.
Latin America - Lease Accounting (Transactions Not
Qualifying as Sales-Type Leases) ... _ . . .................. 59
c_
Other Transactions Not Qualifying as Sales-Type Leases ...... 59
d.
Accounting for the Sale of Equipment Subject to Operating
Leases ..............................................59
2.
Other Revenue Issues .. . . . ................................... 60
3.
South Africa Deconsolidation ..... . . ..... . .... ............... 60
4.
Purchase Accounting Reserves .. . ... . . ........................ 61
5.
Restructuring Reserves ...... ......... . ................. .....61
6_
TaxRefinds ...............................................62
7.
C)t dr' Adjustments . . ... . ........ . .... . .... . ......... . ....... 62
'RY
K.
Other Facts Confirming the Existence of Defendants' Accounting
Manipulations ...................................................62
1.
Xerox Improperly Allocated Costs Associated With Long-Term
Leases ....................................................62
2.
Xerox Used Artificially Inflated Unguaranteed Residual Values to
Increase the Earnings it Derived From Long-Term Leases ........... 63
3.
Xerox Improperly Used Low Discount Rates to Artificially Boost
Revenue on Long Term Leases . .... . ...... . ... . ...... . ........ 64
4_
Xerox Prematurely Booked the Maintenance , Supply and Labor
Portions of Its Long-Term Leases .............................. 68
ii
5.
Significant Risk of Nonpayment or Cancellation on LTL Contracts ...69
6.
Xerox Improperly Recognized Revenue From the Sale of Future
Revenue Streams from its Long-Term Rentals to Banks .. ........... 70
7.
Improper Income ' Recognition Prior to Equipment Installation . _ ..... 74
8.
Improper Accounting of LTL Contract Revisions and/or
Modifications .............................................. 75
VI.
9
"Of the Books" Inventory . . ............... . ........ . ......... 76
10.
Failure to Write-off Bad Debts ....... . .....................
.. 76
The Xerox Defendants' Scienter ... _ ...... ...... . ... . ..... . . ... . .. . ... . . .. 77
A.
The Xerox Defendants Had Direct Knowledge of and Directly Participated
in the Fraud ..................................................... 78
B.
The Xerox Defendants Tracked Impact of "Accounting Actions" ..... _ ..... 80
C.
The Xerox Defendants' Knowledge of Mexico Accounting Problems ........ 81
D.
The Xerox Defendants' Knowledge of Accounting Problems Beyond
Mexico .................................................
.........
E.
The Xerox:Defendants Created a Corporate Culture Focused On Revenues
And Meeting Analysts' Expectations Through Deceptive Accounting ... _ .... 86
F.
Violations Of Simple, Unambiguous Accounting Principles . . ............. 87
G.
The Magnitude of the Fraud Strongly Indicates All Defendants' Scienter ..... 87
H.
The Xerox Defendants' Attempts to Conceal the True Extent of the
Accounting Irregularities Indicates They Acted with Scienter . . . . ..... . ... . 88
1.
The Xerox Defendants' Lack of Cooperation with the SEC ................ 91
J.
The Xerox Defendants Were Financially Motivated to Participate in and/or
Recklessly Disregard Accounting Violations at Xerox and Conceal the
Company's True Financial Condition . ... . . .. . ..... . .................. 91
J.
Debt and Stock Offerings ..... ..... ........ .......... ................6
iii
K.
VII
Xerox's Need to Raise Capital to Avert its Impending Liquidity Crisis ....... 97
...........
KPMG's Scienter .............................................
A.
Background .....................................................99
B.
KPMG Had Full and Complete Access to Information .......... _ _ _ ...... 100
C.
KPMG's Actual Knowledge of or Reckless Disregard of the Fraud ......... 101
I.
KPMG Knew or Recklessly Disregarded that Xerox Regularly and
Arbitrarily Manipulated Assumptions Used to Calculae Revenues
from Long Term Leases .............. ......... ........... ... 102
2.
KPMG Knew or Recklessly Disregarded that Xerox Improperly
Used Price Increases and Extensions of Leases to Boost its
Financial Results . ......................................... 103
3_
D.
KPMG Knew or Recklessly Disregarded that Xerox's Internal Accounting
Controls were Materially Deficient . . .... . ...... . ....... . . ........... 104
E.
KPMG Ig ,tired Red Flags .. . ....... . ...... . . ........... _ .... _ ...... 106
F.
VIII
KPMG Knew of or Recklessly Disregarded that Xerox
Retroactively Increased Residual Values of Leased Equipment ...... 103
1.
Non-Standard Journal. Entries . .. . ....... . .................... 107
2.
KPMG Recklessly Disregarded Trends Further Indicating Fraud _ .... 108
3.
KPMG Knew of or Recklessly Disregarded Improper Reserves ...... 108
4.
Bi.ngham' s Allegations and',the SEC's Investigation ............... 109
5.
KPMG Knew of or Recklessly Disregarded Significant Risk
Factors . ................................................. 109
KPMG' S Efforts to Cover Up the Fraud ...... . ........ . .............. 110
Defendants' Additional Materially False and Misleading Earnings Releases, Financial
Statements , Guidance of Future Results and Audit Reports . ........ . ........... 112
iv
A.
KPMG's False and Misleading Audit Opinions ............. . ........... 112
B.
The Xerox Defendants' False and Misleading Statements ....... . ......... 117
C.
The Xerox Defendants Begin to Selectively Disclose the Existence of
Their Accounting Machinations .................................... 150
D.
The Xerox Defendants' Materially False And Misleading Statements
Regarding The Full Extent of The Results of Its Investigation Into The
Mexican Accounting Irregularities ........ . ..... . ................... 164
IX
Additional Applicable Accounting Principles and Rules . . ........... . ..... . . .. 173
X
KPMG's Violations of GAAS ........................ . .... . .... . . ........ 176
XI
Plaintiffs' Class Action Allegations ..... . ... .................. . .......... . 187
XII
Applicability of Presumption of Reliance and The Fraud-on-the-Market Doctrine .. _ 189
XIII
No Safe Harbor ........... ............................................ 189
XIV
Counts ............................................................... 190
XV
Jury Trial Demand ..................................................... 194
v
f
1
Introduction
I.
Introduction
1.
Throughout the early and mid- I990s, Xerox Corporation ("Xerox" or the
"Company") was heralded as a success story. Its digital copying products had acquired
significant market share in the industry. The Company's financial reports reflected healthy,
consistent growth. A March 5, 2001 Business Week article, for example, noted that Xerox's
"[o]perating income [in the 1990's] was bounding upward in regular quarterly increments, while
revenues now were rising at a double 'digit rate."
2.
By the late 1990s, however, Xerox faced increasing competition from Japanese
competitors in the digital copier market. According to Business Week "jb}y mid-1998,
[Defendant] Thoxnan [then CEO of the Company] had concluded that Xerox had to make
changes in its business strategy to deliver on its emphatic promises ofdouble-digit revenue
growth." Id (emphasis added). Xerox regularly issued quarterly earnings reports that reaffirmed
the Company's "commitment" to maint aining aggressive earnings per share growth rate in the
"mid-to-high teens." But-unbeknownst to investors, Xerox's earnings growth was solely due to.
accounting manipulations.
3.
Xerox achieved Wall Street earnings expectations only by engaging in massive
accounting fraud- Revenues throughout 1997-2001 were misstated by a stunning $6.4 billion and
pre-tax earnings were overstated by a staggering $1.411 billion. In fact, during the years 1997-
1999, pre-tax earnings were overstated by $1.93 billion.
4.
The SEC recently charged Xerox with securities fraud , alleging that:
From at least 1997 through 2000, Xerox ... defrauded investors. In a scheme
directed and approved by its senior management, the individual defendants
herein], Xerox disguised its true operating performance by using undisclosed
accounting maneuvers - most of which were improper - that accelerated the
recognition of equipment revenue ....
Securities and Exchange Commission v Xerox Corp, Civ. No. 02 272759 (DLC) (S.D.N.Y. Apr.
11, 2002) ("SEC Complaint" or "SEC Compl.", incorporated herein and annexed hereto as
Exhibit A). In April 2002, Xerox settled the SEC's fraud charges by, among other things , paying
a record $10 million fine. In addition, the SEC sent "Wells Notices" to defendants Allaire,
Romeril, and Michael Conway of defendant KPMG LLP ("KPMG"}, the Company's outside
auditor, requesting an explanation as to why fraud charges should not be brought against each of
them as well.
5.
The revelation of Defendants' accounting fraud was one of the significant events
that shook the very foundations of American investors' confidence in the financial markets. As
Federal Reserve Board Chairman Alan Greenspan recently testified:
our market system depends critically on trust - trust in the word of our colleagues
and trust in the word of those with whom we do business. Falsification and fraud
are highly destructive to free-market capitalism and, more broadly to the
underpinnings of our society.
Testimony of Chairman Alan Greenspan, Federal Reserve Board's semiannual monetary policy
report to the Congress , Before the U. S. Senate Committee on Banking, Housing, and Urban
Affairs, July 16, 2002 ("Chairman A. Greenspan Senate Comm . Testimony, 7116/02").
6.
Top Securities and Exchange Commission ("SEC") officials recently condemned
Defendants' immense betrayal of Xerox's shareholders and bondholders:
Xerox used its accounting to burnish and distort operating results rather than to
describe them accurately .... For Xerox, the accounting function was just
another revenue source and profit opportunity. As a result, investors were misled
and betrayed.
2
SEC Director of Enforcement Stephen M. Cutler, SEC Release No. 2002-52, Apr. 11, 2002
("SEC 4111/02 Release," attached as Exhibit B hereto).
Xerox's senior management orchestrated a four-year scheme to disguise the
company's true operating performance .... Such conduct calls for stiff sanctions,
including, in this case, the imposition of the largest fine ever obtained by the SEC
against a public company in a financial fraud case. The penalty also reflects, in
part, a sanction for the Company's lack of full cooperation in the investigation.
SEC Associate Director of Enforcement Paul R. Berger, Id.
Xerox employed a wide variety of undisclosed and often improper top-side
accounting actions to manage the quality of its reported earnings. As a result, the
company created the illusion that its operating results were substantially better
than they really were.
Chief Accountant for the SEC Division of Enforcement Charles D. Niemeier, Id.
It boggles the mind that a company this size and its executives can make an error
of $6.4 billion and no one sees it until years later," said Lynn E. Turner, who was
chief accountant of the SEC during the Clinton Administration. "It should make
investors wonder if the auditors would even notice Mount Everest if they were
driving by it.
Former SEC Chief Accountant Lynn E. Turner, quoted in the Washington Post, June 29, 2002.
7.
This Compla int asserts claims against Xerox, and six of its senior executives,
under Sections I d(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"),
and against KPMG under Section 10(b) of the Exchange Act, as amended by the Private
Securities Litigation Reform Act of 1995 (the "PSLRA "). Xerox shareholders and bondholders,
who all purchased their securities at prices artificially inflated by Defendants, were severely
damaged, many losing their life savings.'
€ "Defendants" refers collectively to all defendants: Xerox; Xerox senior executives Paul Allaire,
G. Richard Thoman, Anne Mulcahy, Barry Romeril, Gregory Tayler, and Phillip Fishbach (collectively,
the "Individual Defendants") and Xerox auditor KPMG. "Xerox Defendants" refers to all defendants
other than KPMG.
3
8.
Defendants continuously hid from the public the inventive "accounting
opportunities" and "accounting tricks" they employed to misstate Xerox's financials from
February 17, 1998 through June 28, 2002 (the "Class Period"). SEC Compl.12. Whenever an
inkling of a potential accounting misdeed surfaced, Defendants denied or downplayed the deed,
disparaged and/or demoted (or fired) the information's source. All the while, Defendants stayed
fully apprised of the difference between reality and their public presentation of Xerox's financial
statements. According to the SEC Complaint:
Xerox separately tracked these accounting actions to quantify their impact on the
financial results reported to the public as compared to the company's underlying
operating results, but knowingly or recklessly failed to disclose that its underlying
financial performance was dramatically different from what it reported to
investors.
SEC Comp/. 14 (emphasis added).
9.
To make matters worse, the SEC Complaint, filed after factual discovery into
Xerox's accounting fraud , made clear that Xerox's outside accountant, KPMG, had sold out its
independent auditing fuiictidn and was, itself, fully aware of Xerox's accounting manipulations:
Xerox knew or was reckless in not knowing the impact its accounting actions had
on its equipment revenues and earnings. Xerox documented the impact in
schedules and lists of "one offs," year-over-year causal reports and monthly and
quarterly performance summaries that were distributed to and discussed by
Xerox's financial management. Xerox's operating units also documented the
impact of accounting actions on their financial performance, comparing
"reported" and "underlying" results- Xerox also regularly received information
from its outside auditor quantifying the impact ofits accounting actions.
SEC Compl.1 28 (emphasis added).
10.
There can be no doubt that all of the Defendants here were involved and aware of
Xerox's "accounting tricks." The fraud at Xerox resulted in Xerox paying the highest SEC
penalty in history in a consent decree entered into in April 2002. See SEC 4/11/02 Release
4
(Exhibit B). In words particularly apropos to Xerox's corporate culture of using accounting
tricks as another source of revenue and earnings, Alan Greenspan recently explained,
if a CEO countenances managin g reported earnings, that attitude will drive the
entire accounting regime of the firm. If he or she instead insists on an objective
representation of a company's business dealings, that standard will govern
recordkeeping and due diligence. It has been my experience on numerous
corporate boards that CEOs who insist that their auditors render objective
accounts get them. And CEOs who discourage corner-cutting by subordinates are
rarely exposed to it.
Chairman A. Greenspan Senate Comm . Testimony, 7/16/02.
11.
On June 28; 2002, Xerox disclosed a $6.4 billion restatement of its 1997-2001
financial statements (the "Second Restatement"). Prior to June 28, 2002, only limited, piecemeal
information reached the public, colored by Defendants' deceptive minimiza tion and denials of
these limited revelations.
June 2000 -- Minimization to Mexico : The first inkling of Xerox's accounting
problems surfaced in June 2000 when Xerox revealed that the SEC was
investigating possible accounting irregularities at Xerox Mexico. Defendants
repeatedly informed investors that any accounting problems were isolated to
Mexico and were ely the result of a few rogue employees in Mexico who
intentionally circumvented Xerox's established accounting policies.
February 1, 2001 -- Worldwide Review Whitewash : Xerox announced that a
worldwide review of internal controls did not uncover problems similar to Mexico
"at any other major unit." Xerox chairman and CEO, defendant Allaire, blamed
"special circumstances conducted by a small group of seniorXerox Mexico and
Latin American group executives acting in collusion."
February 6, 2001 -- Blasting Bingham : he Wall Street Journal reported former
Xerox assistant treasurer James F. Bingham's allegations of wider accounting
irregularities at Xerox, that went beyond. Xerox's Mexican subsidiary. Xerox
responded, "The allegations made by Mr. Bingham are absolutely untrue and
without merit" and that The Wall Street Journal report was "based almost entirely
on the allegations of a disgruntled employee who was fired for cause last year."
April 2, 2001 -- Downplayed Delayed Annual Report: Xerox delayed
publication of its annual report after KPMG said it wanted to examine documents
related to accounting practices at Xerox's Mexican unit. Xerox downplayed the
import of the delayed annual report, stating: "KPMG hasn`t raised any specific
issues, nor have they alleged any wrongdoing. We are convinced that this review
will not lead to any issues that will raise a problem for the company."
May 31, 2001 -- First Restatement : Xerox partially restated its 1998, 1999, and
2000 financial statements, reflecting (i) $170 million for financial irregularities at
Xerox's Mexican subsidiary; (ii) a $100 million reserve improperly established
and used by defendants to "manage" Xerox's 1998 and 1999 earnings (the "Rank
Reserve"); and (iii) improper accounting for certain lease revenues. The net effect
of the First Restatement, for the three year period, was a reduction of pre-tax
income by $140 million. The First Restatement was Xerox's and KPMG's attempt
to whitewash massive accounting irregularities, and to limit an ongoing SEC
investigation.
May 31, 2001 -- Changes of Past Assumptions : Although not restating its
previously issued financial statements, Xerox revealed in its financial statements
included in its 2000 Form 1.0-K that "changes in estimates of fair values and
related margins" applied to its bundled lease transactions resulted in increase in
revenue of $193 million, $202 million, and $141 million for 2000, 1999 and 1998,
respectively, and increases in pre-tax income in 2000, 1999 and 1998 of $44
million, $102 million; and $101 million, respectively. As the SEC would find in
its complaint, "such changes should have been disclosed under GAAP."
January 7, 2002 - SEC Concludes That Xerox Violates GAAP : Xerox filed a
Form 8-K revealing that the SEC's office of the Chief Accountant had advised
Xerox that its m'etho'dology for accounting for sales-type leases did not follow the
methodology required by Financial Accounting Standard ("SFAS") No. 13.
Xerox falsely informed investors that its results were in accordance with GAAP
and that, in any event, there is no material difference between the SEC's method
and Xerox's method.
April 11, 2002 -- SEC Settlement: The SEC announced a settlement with Xerox
whereby Xerox agreed to: (i) consent to the entry of an injunction for violations of
the federal securities laws; (ii) restate its financial statements for the years 1997 to
2000;' (iii) allow a committee of outside directors to conduct a special review of
the Company's accounting controls; and (iv) pay an unprecedented $10 million
penalty. SEC 4/11/02 Release (Exhibit B). The SEC contemporaneously filed a
complaint in the U.S. District Court for the Southern District of New York,
2 The restatement Xerox agreed to issue in its April 2002 settlement with the SEC was not forthcoming until June 28, 2002_ Thus, the full extent of Xerox's fraud was unknown until the end of dune
2002.
alleging „that from at least 1997 through 2000, Xerox used a variety of what it
called 'accounting actions' and 'accounting opportunities, to meet or exceed Wall
Street expectations and disguise its true operating performance from investors."
Id; see also SEC CompI. (Exhibit A)_ Xerox issued a press release stating that the
required restatement could involve a reallocation in excess of $2 billion of
equipment sales. In addition, it was publicly reported that the SEC sent "Wells
Notices" to defendants Allaire and Romeril, KPMG, and Michael Conway of
KPMG, requesting an explanation as to why fraud charges should not be brought
against each of them.
June 28, 2002 -- The Second Restatement: Xerox revealed that its restatement
would reflect the reallocation of $6.4 billion of equipment revenues and a
decrease of pre-tax income of $1.411 billion. After Xerox's June 28, 2002
announcement, SEC Chairman Harvey Pitt acknowledged that the Second
Restatement was significantly larger in magnitude than the amounts disclosed in
Xerox's settlement with the SEC in April 2002, and that, at the time of the April
2002 settlement, "We knew there was more, and we didn't stop at what we knew.
We told [Xerox], not only must you disclose and restate what we know, we want
to know everything. And that's what they've done now. And now those who are
responsible will pay."
12.
Defendants knew of, and actively directed, Xerox's accounting fraud throughout
the Class Period. For example:
Tracking real yews reported results throughout the Class Period As the SEC
Complaint alleges, both the Xerox Defendants and KPMG tracked Xerox's
"underlying" or real financial results versus what Defendants fraudulently
reported to the public . SEC Compl. IN 4, 28. Demonstrating Defendants'
knowledge of the accounting manipulations, defendant Romeril informed senior
managers in 1999 that, absent such accounting actions, the Company was showing
no growth.
July 2000 Bingham report: While defendants Romeril and Allaire were
downplaying the accounting problems in Mexico and assuring investors that this
was an isolated problem, former Xerox assistant treasurer James F. Bingham
("Bingham") wrote a detailed memorandum to Romeril disclosing the fact that the
accounting irregularities in Mexico extended across the board at Xerox. Rather
than investigating the charges, Xerox fired Bingham.
Akin Gump and PwC Investigation: To mollify investors that allegations were
supposedly being independently investigated , Xerox hired the law firm of Akin,
Gump, Strauss , Hauer & Feld ("Akin Gump"), a firm to which Xerox director
7
Vernon E. Jordan, Jr.' is "of counsel," to investigate the accounting fraud in
Mexico. Akin Gump in turn retained PricewaterhouseCoopers LLP ("PwC")
During the course of its investigation, Akin Gump uncovered information strongly
indicating that the fraud extended beyond Mexico. Instead of receiving a mandate
to expand its investigation, Xerox expressly instructed Akin Gump to investigate
Mexico and Mexico alone. Notably, PwC was retained both by Xerox's audit
committee and management, raising substantial doubt about PwC's independence.
March 2007 SEC confrontation with KPMG auditpartner Ronald Safran: In
March 2001, the SEC summoned KPMG audit partner Ronald Safran to
Washington, D.C. and confronted Safran with numerous "smoking guns"
regarding Xerox's improper accounting practices. Safran and KPMG immediately
informed Xerox that it should delay the release of its 2000 Form 14-K. Rather
than causing Xerox to restate its financials to correct the glaring accounting
irregularities of the past and all the "smoking guns" with which the SEC
confronted KPMG, KPMG caused Xerox to issue a minor restatement of its 1997
through 1999 financial statements in an effort to satisfy the SEC and convince it
to drop its investigation.
13.
Thus, Xerox's financial statements remained inaccurate for years -- from 1997 to
June 28, 2002 . During this period, and especially during the 1997-1999 period in which Xerox's
restatement dramatically lowered revenue and pre-tax profits, the Xerox Defendants reportedly
sold over $55 million in„ tuck at the height of the fraud.
14.
Defendants used a smorgasbord of methods to misstate Xerox's earnings, revenues
and margins in virtually every reporting period throughout the Class Period. Xerox repeatedly
and improperly changed the manner in which it accounted for lease revenue, pulling forward
nearly $3.1 billion in equipment revenue and $717 million of pre-tax earnings into 1997 through
2000, and improperly failed to disclose that these gains were a result of accounting changes
3 Mr_ Jordan was senior executive partner at Akin Gump prior to assuming "of counsel " status
to the fine in January 2000 . According to Xerox's Proxy Statements filed on 7113/01 and 7/3/02, Mr.
Jordan is also Chairman of the Xerox Board of Directors ' Nominating Committee , and a member of the
Xerox Board's Finance and Executive Committees.
8
rather than improved operational performance, thereby misleading investors. See SEC Compi.
¶ 3 5. Xerox's other improper accounting methodologies throughout the Class Period included:
ROE: Xerox used artificially low interest rate assumptions to artificially inflate
the recognized "present value" of long-term leases. In fact, the Akin Gump report
specifically determined that KPMG expressly approved Xerox's use of such
artificially depressed interest rates in Mexico and Brazil when calculating
revenues from leases. The SEC concluded that ROE was a series of "top-side"
adjustments directed by Xerox corporate headquarters, and that KPMG never
tested Xerox's claim that the top-side adjustments were necessary to arrive at the
actual prevailing equipment finance rates appropriate to the customer. SEC
Compl. ¶' 11, 42, 43.
Reallocating Revenues Via Assumed Margins, or "Margin Normalization":
Xerox reallocated revenues from service to the equipment portion of sales-type
leases by ass uming an artificial gross margin differential between the two lease
components (or an assumed profit margin) that had no basis in economic reality.
Equipment margins were in fact falling. Xerox used this method to pull forward
$517 million of equipment revenues from 1997-2000. Internally, KPMG referred
to this method as "half-baked revenue recognition." SEC Compl. ¶'1 47-48.
Price Increases and Extensions: In certain contracts, principally in Brazil, Xerox
negotiated or unilaterally imposed price increases and loan extensions on existing lease
customers . While Xerox immediately recognized revenues from these increases and
extensions , GA ,required Xerox to realize such revenues over the life of the lease.
According to the SEC, in 1999, KPMG informed Xerox that this practice violated GAAP,
but Xerox refused to follow this advice. Nevertheless, KPMG certified Xerox's 1999 and
2000 financial statements . SEC Compl. IM 50, 5I .
Residual Value Adjustments: Xerox recorded adjustments of at least $95 million as a
result of retroactive revisions to residual values. GAAP prohibits increasing the
estimated residual values of leased equipment for any reason after it is first established.
By relying on this methodology, from 1997 to 1999, Xerox inflated its pre-tax earnings
by a net of $43 million. According to the SEC, in 1996, KPMG objected to this practice
as violating GAAP but, after arguments with Xerox senior management, approved its
implementation in 1998, while continuing to criticize its use. SEC Compl. 1153, 54.
Undisclosed Factoring Transactions : Xerox fraudulently failed to disclose
$288 million of 1999 year-end factoring transactions, resulting in a reported
positive year-end cash balance, instead of the actual negative number, and
misleading investors by falsely appearing to generate cash from operations while
receivables were in reality sold at a discount. SEC Compl. 172.
9
Cookie Jar Reserves: Xerox pumped up earnings by nearly $500 million by
systematically releasing into income excess or "cushion" reserves established for
other purposes, thereby violating GAAP, and fraudulently failed to disclose this
use of reserves. SEC Compl.158. For example, when Xerox acquired the Rank
Group Plc, in June 1997, Xerox established a $100 million reserve. According to
the SEC, by year-end 1997, Xerox had informed KPMG that Xerox had no
contingent liabilities arising from that acquisition. Nevertheless, Xerox used, and
KPMG permitted, Xerox to use the reserve to absorb expenses, thereby hiding
material expenses, causing Xerox's earning to be artificially inflated by $24
million in 1998 and $76 million in 1999. SEC Compl. ¶ 62.
Any one of Xerox's practices listed above, or detailed herein, would constitute securities fraud;
the combination of practices here constituted fraud of near epic proportions.
15.
Without such accounting manipulations, Xerox would not have met earnings
expectations in 11 of 12 quarters during 1997-1999. SEC Comp1. ¶ 13. Moreover, by 1998,
almost $3 of every $10 of annual pre-tax reported earnings and up to 37% of Xerox's reported
quarterly pre-tax earnings were generated though undisclosed accounting manipulations. SEC
Compl. ¶ 3. SEC Chief of Enforcement Stephen Cutler's statement that "for Xerox, the
accounting function wri
16.
st another revenue source and profit opportunity" was surely apt.
On a post-split basis, Xerox's stock traded during the Class Period as high as
$63.69 per share. As news of Defendants' accounting problems and inability to meet Xerox's
baseless projections of earnings and revenues was released, in piecemeal fashion, Defendants
coupled such creeping disclosures with additional affirmative misrepresentations designed to
downplay the problems and mitigate the effect of negative information . Notwithstanding such
efforts, and even though the full extent of Defendants' fraud could not be ascertained until June
28, 2002, the repeated partial disclosures had a direct and immediate negative impact on Xerox
stock. Furthermore, on numerous occasions , Defendants' affirmative misrepresentations issued
throughout the Class Period had a demonstrable effect on Xerox's stock, causing it to rise.
10
Absent such misrepresentations, Xerox's stock would not have traded at inflated levels. Had
Plaintiffs and the Class known of Defendants' misrepresentations, they would not have purchased
Xerox's stock or bonds.
IT.
Basis of Allegations
17.
Plaintiffs, by their undersigned attorneys, make the following allegations based
upon all of the facts set forth below which were obtained through an extensive investigation
made by and through their attorneys. Plaintiffs' investigation included, among other things,
reviewing Xerox`s SEC filings, the SEC Complaint, the Bingham complaint, reports and
advisories by and about Xerox, press releases and other public statements issued by Xerox and
the Individual Defendants, media and analyst reports, and interviews with former employees
knowledgeable of the conduct complained of herein. Many of the facts alleged herein are the
product of the SEC's review of the Defendants' documents and testimony from the principle
individuals at Xerox and KPMG. Except as alleged herein, the underlying information
concerning Defendants' n is onduct, and the particulars thereof, are not available to Plaintiffs and
lie within the possession and control of Defendants. Based on the evidence already developed,
Plaintiffs believe that substantial additional evidentiary support will exist for the allegations set
forth herein after a reasonable opportunity for farther discovery.
III.
Jurisdiction and Venue
18.
This Court has jurisdiction over the subject matter of this action pursuant to 28
U.S.G. §§ 1331 and 1337 and § 27 of the Exchange Act (15 U. S.C. § 78aa).
11
The claims asserted herein arise under and pursuant to § § 14(b) and 20(a) of the
19.
Exchange Act (15 U.S.C. §§ 78j(b) and 78t(a)) and Rule IOb-5 promulgated under § 14(b) by the
SEC (17 C.F.R. § 240 . 10b-5).
Venue is proper in this District pursuant to § 27 of the Exchange Act and 28
20.
U.S.C. § 1391(b). Many of the acts charged herein, including the preparation and dissemination
of materially false and misleading information, occurred in substantial part in this District.
Additionally, Defendants maintained their chief executive offices and principal place of business
within this District during the Class Period.
In connection with the acts alleged in this Complaint, Defendants, directly or
21.
indirectly, used the means and instrumentalities of interstate commerce, including, but not
limited to, the mails, interstate telephone communications, and the facilities of the New York
Stock Exchange ('NYSE'), a national securities exchange.
IV.
Parties
A.
Plaintiffs
22.
Lead Plaintiffs the Louisiana State Employees ' Retirement System, Paul Dantzig,
and Thomas Zambito purchased Xerox common stock at artificially inflated prices during the
Class Period, as set forth in the Certifications attached to their Motions for Appointment as Lead
Plaintiffs and incorporated herein by reference, and were damaged thereby.
23.
Plaintiffs SCUTHBank - FSB and Alvin Feder purchased Xerox bonds at
artificially inflated prices during the Class Period and were damaged thereby. SOUTHBank -
FSB purchased bonds of Xerox Corporation on May 18, 2000, with an 8.0% yield due on May
14, 2004. On July 31, 2002, SOUTHBank purchased bonds of Xerox Corporation with an
12
8.791 % yield due on May 15, 2002. Alvin Feder purchased bonds of Xerox Capital Europe on
August 4, 2000 with a 5.875% yield due on May 15, 2004. On September 14, 2002, Alvin Feder
purchased bonds of Xerox Corporation with a 5.25% yield due on December 15, 2003.
B.
The Xerox Defendants
24.
Defendant Xerox is a New York corporation with its principal executive offices
located at 800 Long Ridge Road, Stamford, Connecticut 06904. Xerox purports to be the
world's leading document processing company. The Company develops, manufactures, markets,
services, and finances a range of products and services designed to allow businesses to increase
productivity by creating faster and easier access to inform ation and documents.
25.
At all times relevant to this action, Xerox common stock was actively traded on
the NYSE under the ticker symbol "XRX" and was registered pursuant to § 12 of the Exchange
Act (I5 U.S.C. § 781). During the Class Period, the market for the Company' s common stock
was open, well-developed, and efficient. Also, during the Class Period, Xerox filed annual,
quarterly, and other reports-With the SEC in accordance with the Exchange Act.
26.
The Individual Defendants served, at all times material to the claims set forth
herein, in the following positions and personally profited as set forth below:
a.
Defendant Paul Allaire ("Allaire") served as Chief Executive Officer of
Xerox from May 1991 to April 1999 and from May 2000 to July 2001, and was Chairman of the
Board of Directors from 1991 to the end of 2001 , after which defendant Mulcahy succeeded him,
and has served as a member of Xerox's Board of Directors since 1986. Allaire has also served as
Chairman of the Xerox Board of Directors' four-member Executive Committee.
13
During the Class Period, Allaire sold 400,000 shares of Xerox, reaping total proceeds of
over $22.73 million. Allaire was paid . an annual base salary of $1,200,000 in 2001, $1,125,000
in 2000, $975,000 in 1999, and $975,000 in 1998. Allaire also received cash bonuses of
$1,500,000 in 2001, $121,875 in 2000, and $4,524,133 in 1998 under the Executive Performance
Incentive Plan (the "EPIP"), the CEO Challenge Award, and the 1991 Long-Term Incentive Plan
(the "1991 Plan"). Under EPIP, a participant is entitled to a percentage of a pool of the
Company's Document Processing profits, before tax, for a given performance period (in 2000, for
example, Allaire received 10% of the pool, whereas other participants received 5%). The CEO
Challenge Award and the 1991 Plan were contingent upon earnings per share reaching a
specified level. Also during the Class Period, Allaire received 4,300,040 in restricted stock and
1,093,846 in underlying options. Allaire's additional cash compensation during the Class Period
amounted to $50,954 in 2001, $162,881 in 2000, $118,644 in 1999, and $177,310 in 1998;
b.
Defendant G. Richard Thoman ("Thoman") served as President and Chief
Operating Officer from June 1997 to April 1999, Chief Executive Officer from April. 1999
through May 11, 2000 and as a member of the Executive Committee and a member of the Board
of Directors from June 1997 through May 2000. During the Class Period, Thoman sold 320,000
shares of Xerox for total proceeds of over $18,516,130_ Thoman was paid an annual base salary
of $326,087 in 2000, $900,000 in 1999, and $700,000 in 1998. Thoman also received cash
bonuses of $487,500 in 2000, and $3,029,341 in 1998 pursuant to the EPIP, the CEO Challenge
Award, and the 1991 Plan. Also during the Class Period, Thoman received 1,793,683 in
restricted stock and 728,690 in underlying options. Thoman's additional cash compensation
during the Class Period amounted to $107,971 in 2000, $189,642 in 1999, and $374,636 in 1998.
14
Thoman now receives a lifetime pension from Xerox in the amount of $800,000 a year. This
pension is extraordinary because it is calculated as if Thoman had worked at Xerox for 22 years,
even though he worked at the Company for only three years;
c.
Defendant Barry Romeril ("Romerii") has served as Executive Vice
President and Chief Financial Officer of Xerox since 1993 until his retirement in the end of 2001,
Vice Chairman of the Board of Directors since April 1999, and a member of the Board of
Directors since April 1999_ During the Class Period, Romeril sold 128,044 shares of Xerox
stock, reaping proceeds of over $7.18 million. Romeril was paid an annual base salary of
$675,000 in 2001, $641,667 in2000, $575,000 in 1999, and $513,333 in 1998. Romeril also
received cash bonuses of $ 1,175,000 in 2001, $57, 500 in 2000, and $3,397,740 in 1998 , pursuant
to the EPIP , the CEO Challenge Award, and the 1991 Plan. Also during the Class Period,
Romeril received 2,913,403 in restricted stock and 820,537 in underlying options . Rorneril's
additional cash compensation during the Class Period amounted to $49,089 in 2001, $132,515 in
2000, $175 ,351 in 1999, and $138 , 049 in 1998;
d.
Defendant Philip Fishbach ("Fishbach") was Vice President and Controller
from 1995 through April 2000, when he retired from the Company. During the Class Period,
Fishbach sold 5000 shares of Xerox stock for proceeds of over $300,000;
e.
Defendant Gregory Tayler ("Tayler") has been Vice President and
Controller since April 1, 2000, when he replaced defendant Fishbach. Effective as of November
1, 2001, Tayler was reassigned to the position of treasurer;
f.
Defendant Ann Mulcahy '("Mulcahy") was President of General Markets
Operations for Xerox from January 1999 until May 11, 2000, when she was appointed as
15
President and COO of Xerox to replace defendant Thoman. In July 2001, Mulcahy was named
CEO. Mulcahy was a member of Xerox's Board of Directors throughout the Class Period.
Mulcahy succeeded defendant Allaire as Chairman effective January 1, 2002. During the Class
Period, Mulcahy sold 22,000 shares for proceeds of over $1.37 million. Mulcahy was paid an
annual base salary of $1,000,000 in 2001, $721,667 in 2000, $425,000 in 1999, and $312,500 in
1998. Defendant Mulcahy also received cash bonuses of $1,250,000 in 2001, $45,063 in 2000,
and $862 , 804 in 1998, pursuant to the EPIP, the CEO Challenge Award , and the 1991 Plan.
Also during the Class Period, Mulcahy received 3,837,500 in restricted stock and 2,308,972 in
underlying options. Mulcahy's additional cash compensation during the Class Period amounted
to $45,616 in 2001, $115,023 in 2000, $88,647 in 1999, and $62,791 in 1998.
27.
It is appropriate to treat the Individual Defendants as a group for pleading
purposes and to presume that the false, misleading, and incomplete information conveyed in the
Company's public filings, press releases, and other publications, as alleged herein, are the
collective actions of the'nar owly defined group of defendants identified above. Each of the
above officers and directors of Xerox, by virtue of their high-level positions with the Company,
directly participated in the day-to-day management of the Company, was directly involved in the
daily operations of the Company at the highest levels, and was privy to confidential proprietary
information concerning the Company and its business, operations, products, growth, financial
statements, and financial condition, as alleged herein. The Individual Defendants were involved
in drafting , producing , reviewing, and/or disseminating the false and misleading statements and
information alleged in this Complaint.
16
28.
The Individual Defendants, because of their positions of control and authority as
officers and directors of the Company, were able to, and did, control the contents of the
Company's financial reports, press releases , and other public statements . Each Individual
Defendant was provided with copies of the financial statements and documents alleged herein to
be false and misleading prior to, and/or shortly after, their issuance, and had the ability and
opportunity to prevent their issuance or to cause them to be corrected. Accordingly, each of the
Individual Defendants is responsible for the accuracy of the financial statements and public
reports and releases detailed herein and each is primarily liable for the representations contained
therein.
29.
As officers, directors, and controlling persons of a publicly-held company whose
common stock was, and is , registered with the SEC pursuant to the Exchange Act, traded on the
NYSE, and governed by the provisions of the federal securities laws, the Individual Defendants
each had a duty to promptly disseminate accurate and truthful information about the Company's
financial condition and p:+.Yermsnuance ,growth, operations, financial statements, business,
products, markets, management, earnings, and present and future business prospects, and to
correct any previously-issued statements that had become materially misleading or untrue, so that
the market price of the Company's publicly-traded securities would be based upon truthful and
accurate information. The Individual Defendants' misrepresentations and omissions during the
Class Period violated these requirements and obligations.
30.
The Individual Defendants participated in the drafting, preparation, and/or
approval of the various public, shareholder, and investor reports and other communications
complained of herein and were aware of, or recklessly disregarded, the misstatements contained
17
therein and omissions thereffirom. Because of their Board membership and/or executive and
managerial positions with Xerox, each of the Individual Defendants had access to the adverse
undisclosed information about Xerox's busines^ prospects and financial conditions and
performance, as particularized herein, and kne
(or recklessly disregarded) that these adverse
facts rendered the positive representations mad by or about Xerox and its business by the
Company materially false and misleading.
C.
KPMG LLP
31.
Defendant KPMG is an accounting and consulting firm and is the U.S. member
firm of KPMG International. KPMG served as Xerox's outside auditor until October 4, 2001.
KPMG has 145 offices in the United States, including one located at 3001 Summer Street,
Stamford, Connecticut 06905, which handled Xerox's outside audits. KPMG falsely represented
that it audited Xerox's financial statements for the fiscal years ended 1997 through 2000 in
accordance with Generally Accepted Auditing Standards ("GARS") and issued materially false
and misleading unqualified-audit opinions as to those financial statements, claiming that they
were prepared and presented in accordance with Generally Accepted Accounting Principles
("GAM"). Additionally, KPMG consented to the use of its unqualified opinion letter for
Xerox's financial statements contained in Xerox's 1997 through 2000 Form 104Ks.
32.
Each Defendant is liable as a direct participant in a fraudulent scheme and course
of conduct that operated as a fraud or deceit on Xerox common stock and bond purchasers by
disseminating materially false and misleading statements and/or concealing material adverse
facts.
18
ty
Substantive
Allegations
V.
Substantive Allegations
A.
Background
33.
In the mid-1990s, Xerox accelerated a shift from renting or selling equipment to
long-term leasing ("LTLs") of the equipment.
34.
When Xerox leases a copier to a customer, it typically bundles into a single
monthly fee a payment for equipment financing, service and supplies . By 2000, bundled
arrangements represented 64%, 65% and 57% of the total value of transactions in the U.S.,
Europe and developing markets.
35.
SFAS 13 sets forth the rules accountants must follow under GAAP in accounting
for leases . Under SFAS 13, monthly payments due under operating leases are recognized as
revenue only as they become due during the lease term whereas a "sales-type" lease is accounted
for as if the lessor sold the equipment and provided financing for the sale, resulting in immediate
revenue recognition of the equipment portion of the lease, with a smaller portion being
recognized ratably as finan
income over the lease term.
B.
Xerox's Initial Efforts to Limit its "Problems" to Mexico
36.
The first hint of problems with Xerox's accounting surfaced on June 16, 2000,
when Xerox announced that it would fail to meet its estimated Second Quarter earnings in part
because of an "unexpected" discovery of bad debts in its Mexican subsidiary which would lead to
a 5 to 6 cent reduction in EPS. In connection with this disclosure , Xerox downplayed the effect
of this revelation to analysts, cl aiming it was an isolated incident.
19
37.
Notwithstanding Defendants' attempt to minimize its accounting problems, the
price of Xerox's shares dropped $429 per share to $20.62 per share on June 16, 2000. The
market was keenly focused on the Company's problems in Mexico. For example:
a.
The June 16, 2000 Dow Jones Business News reported:
In addition to the sales shortfall -- which more than offsets expected revenue
growth from document outsourcing, color copiers and printers -- Xerox said
second-quarter earnings were hurt by "significant unexpected" provisions in its
Mexico operations, which could reduce earnings by six cents a share. Chief
Financial Officer Barry D. Romeril said in a conference call Friday that the
company's troubles in Mexico appear to have been caused by problems with
customer receivables accounts.
b.
The June 19, 2000 issue of The Wall Street Journal noted:
More unsettling, the new Xerox chiefcited several new problems bedeviling the
company, including trouble collecting bills in Mexico..."It's apparent that Xerox
has yet to get its house in order," said Steven Milunovich, analyst for Merrill
Lynch & Co. Its "internal controls are not up to snuff, and the restructuring of its
sales force appears to be facing lots of readjustments."
In an apparent move to dispel speculation that something is amiss at the
company's internal controls, Chief Financial Officer Barry D. Romeril told
analysts there wa & na reason to believe the Mexican problem would spread to
other countries.
38.
Analysts also focused on the Company's revelations regarding Mexican
accounting problems . Thus:
a.
On June 16, 2000, PaineWebber issued a report on Xerox, downgrading it to
Neutral, and stating:
We are also particularly concerned about an "unexpected " receivables problem in
Mexico that should hit EPS this quarter by up to $0.06 per share. This
development calls into question management's systems and controls. While
management stated this is an isolated incident, we believe that it is difficult to
know whether this could lead to another land mine down the road.
b.
On June 19, 2000, JP Morgan issued a report on Xerox entitled "Sprung Another
Leak." In this report, JP Morgan stated:
20
The troubling aspect of this is that it points to lapses of control, which seem to be
general and somewhat endemic throughout the company. Not necessarily to the
same extent as where felony might be involved, but certainly emblematic of less
than air-tight business processes throughout Xerox; and
c.
On June 20, 2000, analyst Merrill Lynch issued a Xerox report noting:
Financial controls need scrutiny. The poor implementation of the restructuring
and consequent receivables problems suggest internal controls aren't fully up to
snuff. This quarter's Mexican receivables problem came out of the blue. Last
quarter it sounded like there would at least be steady improvement the balance of
the year, but that hasn't happened.
39.
On June 29, 2000, Xerox issued a press release announcing that the SEC had
begun an investigation of accounting issues at the Company's Mexico business. Xerox stated
that it " intends to cooperate fully with the commission in this investigation ." Xerox stock
dropped $1.44 per share to $18.56 per share on June 29, 2000.
40.
On July 26, 2000, Xerox issued a release announcing its second quarter results.
As opposed to the $.05 per share charge previously disclosed due to the accounting problems in
Mexico, Xerox revealed that it took an $0.11 per share charge associated with its Mexican
^y
subsidiary. Xerox's release, however, misrepresented that the Company's accounting problems
were limited to Mexico:
Allaire also commented on the situation in Mexico, which is the subject of ongoing investigation by the company and the SEC. Over a period of years, several
senior managers in Mexico had collaborated to circumvent Xerox accounting
policies and administrative procedures, resulting in a charge primarily for
uncollectible receivables and unrecorded liabilities.
"We have no reason to believe that the special circumstances that existed in
Mexico are replicated in any other country," Allaire said. "We regret this
unfortunate episode, but we have dealt swiftly with it and are cooperating fully
with the SEC."
21
41.
Despite the Xerox Defendants' misrepresentations as to the limted geographical
scope of its accounting problems and even though. Xerox's reported earnings were in line with its
prior forecasts, Xerox stock dropped on July 26, 2000 from $18.19 to $15.25 on trading volume
of almost 33 million shares, or eight times the volume of the prior day.
42.
The press again focused on the Company's accounting issues. Thus:
a.
In a July 26, 2000 interview between CNN financial news anchor Kathy
Pil grim and CNN fn correspondent Allan Dodds, the following transpired:
FRANK: In addition to having sales force problems, increased competition, they
also reported a tremendous problem and an SEC investigation into their
operations in Mexico ... and that is going to cost $78 million. It's pretty
astonishing because apparently what's happened is they fired the top executive for
Xerox Mexico and the chief financial officer there - there are what they call
accounting irregularities but what it really means is the customers weren't paying
their bills or what the customers were paying for bills may have been - being
siphoned off somehow. Its' a big mess, now Xerox says that maybe just isolated
in Mexico but --
PILGRIM: Right. It certainly is a big hit to the bottom line, $78 million.
FRANKS: $78 million is a big hit_ It's I I cents a share. That is 24 minus 11, that
tells you how muchIIt is -- I mean it is a big number and the question, of course, is
what were management systems in place in Mexico? Were they in fact, as the
company said, isolated or in other companies where the corruption is somewhat a
way of life, could this also have been going on without headquarters back in
Stamford, Connecticut being on the ball about it. We don't know whether
company has actually got it under, and
b.
On the July 26, 2000 edition of CNNfn, Morning Market Coverage, the
following transpired:
GREG CLARKIN, CNNfn STOCKS EDITOR: Xerox (URL:
http://www.xerox.com/) - remember that situation in Mexico, they had a problem
with collecting on accounts, basically, and some accounting problems there still
continues to plague the company. Xerox coming out this morning with their
numbers for the quarter, as well as some comments on the situation in Mexico.
Right now, the SEC as well as an internal investigative team at Xerox are looking
into the situation. Xerox tells us that the folks there have been removed, the folks
in earnings this morning from Xerox, it says per a period of years, several senior
22
managers in Mexico had collaborated to circumvent Xerox's accounting policies.
So the company taking a charge this quarter equal to about I I cents a share to take
care of some of that problem. Back in June, they said they would take a change of
5 to 6 cents share. So it was a lot steeper than initially expected. But they say at
this point, they think they have got the financials of its cleaned up, although there
is the possibility that they may have to take another charge, once the
investigations get concluded and some real results are found here.
SCI3AFFLER: Because we've covered this story so much and you were reporting
the problems in Mexico before. This sounds like a complete nightmare. If they're
saying senior managers decided to fudge the books a little bit? Is that what they're
saying in that statement?
CLARKIN: That is the layman's translation, Rhonda, there it is .. .
CLARKIN: Right, and "circumventing ," I think, means "not doing things the
proper way," or "going around the proper way," rather. So it looks like that
situation Xerox this morning - we spoke to the folks there and they said that they
think they've got - you know, the people removed -- well, they know they have the
people removed that were in question here. They think they've got the financial
end of it pretty much tied up. But again, they wanted to point out that there is the
possibility that when these investigations are concluded internally as well as by
the SEC, there could be another charge taken to the bottom line- And, again, this
company has really suffered greatly already on this problem.
43.
On July 27,.2000, the following day, Xerox 's stock dropped another $.06 per share
to $15.19, as The Wall Street Journal and numerous other publications reiterated the above.
44.
The analysts also reported on the increased size of the Mexican charge included in
Xerox' s second quarter results . A July 26, 2000 PaineWebber report reported:
Xerox also recorded an $0.11 after-tax charge ($115 million pre-tax) related to the
"Mexican receivables debacle." This amount was about $0_O5 per share more
than we had anticipated. In Mexico, several senior managers collaborated to
circumvent company accounting policies and procedures, resulting in a charge for
uncollectible receivables and unrecorded liabilities. Xerox's independent auditors
and the SEC are each still investigating the situation and we do not yet know
whether Xerox will need to restate results. Xerox is also embarking on an
extensive review of its practices in other countries.
23
45.
On August 3, 2000, a day which Xerox's stock declined $.013 per share to close at
$14.75 per share, the National Post reported that "Mr. Allaire also uttered the two dirtiest words
on Wall Street: accounting irregularities ..."
46.
After the close of the market on October 2, 2000, the Company pronounced its
likely results for the third quarter 2000. As to Mexico, the Company stated:
The investigation related to accounting issues in Mexico is continuing and the
company will provide an update at the time it reports third quarter earnings.
47.
The following day, October 3, 2000, Xerox stock dropped $3.94 to $11.37 per
share on volume of 40.3 million shares or 10 times the prior day's volume. The press again was
focused on the Mexican accounting irregularities. Thus,
a.
The October 2, 2000 Associated Press Online reported:
The company and the Securities & Exchange Commission are investigating the
accounting irregularities in Mexico.
Earlier this year, Xerox fired several top Mexican executives, including the
general manager .And finance director after learning they had collaborated to
circumvent Xerox accounting policies.
The company said it would provide an update on that investigation when it reports
its third-quarter earnings later this month.
b.
The October 2, 2000 Dow Jones Business News reported:
Also late Monday, Xerox said the Securities and Exchange Commission
investigation into accounting issues at the company's Mexican operation is
continuing. The company will also update that issue when the third-quarter results
are released.
When Xerox released its second-quarter results in July, the company said it took a
$78 million, or 11. cents a share, charge for the Mexican unit. That amount was
twice what Xerox previously had forecasts The company said several unnamed
senior executives in Mexico had "collaborated to circumvent Xerox accounting
policies" and had been dismissed or had left.
24
Xerox' s Mexican operations include manufacturing and distribution and represent
about $400 million of the company's total operations.
48.
On October 13, 2000, Fitch downgraded Xerox's debt ratings due, in part, to
„uncertainties surrounding the company's business model and operating strategy going forward..,
On Monday, October 16th, The Wall Street Journal reported:
Adding to the concern, Salomon Smith Barney analyst Jonathan Rosenzweig
yesterday said the company was in danger of violating covenants under the bank
credit.line because of its deteriorating net worth.....
Mr. Rosenzweig said he believed the company will have to take big charges to
restructure and sell assets. A write-of ofonly $300 million, which the analyst
termed a conservative estimate, wouldput the company close to the networth
threshold, he said, possiblyforcing the frm to have to renegotiate with its
banks ....
... The Securities and Exchange Commission is investigating the company's
accounting of its Mexican operation, whose bad debts led Xerox to take a big
charge this year.
49.
As later revealed, Xerox's pre-tax earnings during the Class Period were
overstated by $1.4 billiox. e Thus, Xerox would have been in default of its bank facility had it
fully disclosed its accounting fraud. On Friday, October 13, 2000, Xerox's stock dropped $.81
per share and, on Monday, October 16, 2000, it declined another $2.69 per share.
50.
On October 24, 2000, the Company issued a release announcing third quarter
results in line with, those previously announced on October 2, 2000. Newly announced, however,
was the fact that Xerox had been forced to take "a $55 million pre-tax provision associated with
the company's previously announced issues in Mexico, the third quarter net loss was. $167
million." The Company misrepresented , however, that "[n)o additional provisions related to
Mexico are anticipated." On October 24, 2000, Xerox's stock dropped $.32 per share to close at
$8.81.
25
51.
The following day, numerous publications carried stories noting the additional
Mexican charge , prompting a future decline in the stock . For example, on October 25, 2000, The
Wall Street Journal reported:
For the third quarter, Xerox posted a net loss of $167 million, or 26 cents a share.
The results included a charge of $41 million, or six cents a share, related to
previously announced accounting irregularities at its Mexico subsidiary, which is
under a continuing SEC investigation.
Excluding charges, the loss was 20 cents a share, at the upper end of the range of
15 cents to 20 cents the company predicted last month. Analysts expected a loss
of 19 cents a share, according to First Ca1VThomson Financial....The Mexico
problems, which Xerox said resulted from executives there circumventing
company guidelines, caused the company to take a charge of $78 million, or 11
cents a share, in the second quarter. Xerox said it doesn't expect any further
charges for the Mexican operations.
52.
In response to the October 25, 2000 stories, Xerox's stock dropped $.31 per share
to close at $8.50.
53.
The above-referenced price. declines occurred despite the fact that the Xerox
Defendants consistently,dwnplayed Xerox's accounting troubles and concealed the extent of
those troubles. Thus, in addition to those statements set forth above:
a.
On June 29, 2000, the Company revealed only that the SEC investigation focused
on problems with accounts receivable in Mexico;
b.
On July 27, 2000, defendant Romeril downplayed the accounting problems by
stating:
We believe the issues are confined to Mexico . Collusion amongst the several top
local management who participated was helped by certain organizational
structures and operational alignments that were somewhat unique to the Mexican
Company;
26
c.
On August 14, 2000, Xerox's Second Quarter Form 10-Q.falsely stated that "[t]he
charge represents the Company's best estimate of the impact of currently known events" and that
the financial statements in the Form I O-Q were in accordance with Xerox's accounting policies
and complied with GAAP;
d.
On October 24, 2000, when announcing that it would be required to take yet
another charge due to its Mexican accounting irregularities, this time for $55 million pre-tax, the
Company falsely stated that "[n]o additional provisions related to Mexico are anticipated";
e.
On October 25, 2000, PaineWebber issued a report noting that: "Xerox stated that
it did not anticipate any further related charges and that the problems were isolated;"
f
On November 14, 2000, Xerox's Third Quarter Form 10-Q falsely claimed that
"[njo further provisions are expected," attempted to limit the scope of the reported problems to
"several senior managers in Mexico [who] had collaborated to circumvent Xerox accounting
policies and administrative procedures," and falsely stated that Xerox's financial statements in the
Form 10-Q were in accor&ice with Xerox`s accounting policies and compliant with GAAP; and
g.
On February 1, 2001, Xerox announced the results of its "independent
investigation of its Mexican subsidiary," falsely representing that its accounting problems were
confined to Mexico and stating that:
We are confident that this unfortunate and regrettable incident was the result of
special circumstances conducted by a small group of senior Xerox Mexico and
Latin American group executives in collusion to circumvent our policies and
practices. We can say with confidence that the appropriate corrective actions
were taken and that those who were responsible were removed54.
Indeed, the press release went so far as to assure investors that:
Xerox launched a worldwide review of its internal audit controls to ensure that the
issues identified in Mexico were not present elsewhere. This review was recently
27
completed. The issues identified in Mexico were not found in any other major
unit operated by Xerox.
C.
Bingham's Allegations
55.
On February 6, 2001, The Wall Street Journal reported Binghams' allegations
Xerox's accounting problems were not limited to Mexico but were worldwide.
56.
The Wall Street Journal article described a meeting on August 28, 2000 between
Bingham, Romeril, and two other senior executives, during which Bingham critiqued Xerox's
financial practices. Contrary to the Xerox Defendants' attempts to paint the Mexico situation as
an aberration, Bingham told his superiors at the August 28 meeting that that Company's
accounting irregularities were not limited to Mexico and that there was a "high likelihood" that
Xerox had issued "misleading statements and public disclosures."
57.
Bingham's presentation also addressed Xerox's interest-rate manipulations in
developing countries, which added $447 million to Xerox's pre-tax income over a five-year
period.
58.
Bingham also alerted senior executives that Xerox recorded the $100 million
Rank Reserve on its books in 1997 "without any basis."
59.
Bingham also said that Xerox entered into complex transactions with banks and
other financial institutions to boost reported results. Specifically, Bingham claimed that, to raise
cash, Xerox sold rights to the future income streams from certain equipment rentals at a discount,
thereby enabling Xerox to book revenue and profit upfront rather than over time. Bingham also
stated that Xerox corporate officers offered "verbal and written assurances" to some banks, that
the Company "will never allow [these] transactions to go bad," and that the disclosure of these
guarantee agreements to investors was "inadequate." As a result, Xerox should not have booked
28
profits upfront from these sales, because they
in effect, loans from the banks. Bingham
stated that, for the previous five-year period,
reported improperly $247 million in pre-tax
ina, and Mexico, as well as the U.S.,
income from sales of rental streams in Brazil,
Canada, and Europe.
60.
article, as early as July 2000, Bingham
According to The Wall Street
informed senior management of these
irregularities . At that time, Bingham sent a
memorandum to Treasurer Eunice Filter
, warning that Xerox's accounting troubles
extended beyond Mexico. According to
Filter instructed him not to distribute the
memorandum , asking him if he "wanted people 0 go to jail ." Bingham then sent a revised
Filter's assistant told Bingham to recall the
memorandum to Romeril and Mulcahy.
memorandum and "destroy" it.
61.
A few days after Bingham's Au
st 28, 2000 presentation, citing Bingham's
purportedly "disruptive and insubordinate behavior," Xerox fired him. As the Associated Press
reported on February 6,'2661, Xerox characteriz d Bingham as a disgruntled ex-employee
dismissed "for cause." Moreover, Xerox said Biigham's allegations had no merit.
62_
On February 7, 2001, The Wall S eet Journal carried yet another extensive story
on Xerox. In this story, former Mexican official reported that Xerox's U. S. headquarters
ignored early signs about the accounting problem in Mexico and instead intensified pressure to
meet profit goals, supporting the accuracy of Mr. IBingham's allegations.
63-
The revelations contained in the F^
widely reported as were Defendants' denials that
6, 2001 Wall Street Journal article were
s accounting issues involved anything
other than Mexico. For example, on February 6, ^00l the-Dow Jones Business Wire reported:
29
Current and former Xerox Mexico exec,
about the leasing transactions. They alsc
reason behind the accounting problems:
corners to make up for deteriorating bus
term results. Many executives, Mr. Bind
attitude: "There is no accounting standa
.ves support Mr. Bingham's allegations
agree with Mr. Bingham about the
\. corporate culture that cut bookkeeping
ness fundamentals and maximize short-
Xerox fired Mr. Bingham a few days z
and insubordinate behavior." Calling 1
situation," Xerox Controller Greg Tay
and were presented to the audit
auditors, KPMG LLP.
r his presentation, citing his "disruptive
Bingham's firing "an unfortunate
says his allegations were taken seriously
e of the board and to the company's
nn said, had developed a troubling
we can't beat."
"We took a look at the issues he raised,"
factually without merit." Xerox , Mr. Tay
reporting in terms ofgenerally accepted
signed off on the company's fourth-quail
considering Mr. Bingham's concerns. A
64.
spokesman declined to comment.
the Xerox Defendants continued to assure
In the face of Bingham's
investors that Xerox adhered to the highest
of ethics and complied with all applicable
accounting requirements. On February 7, 2001,
A Xerox spokest an said the company
results anytime. done who does so,"
65.
r. Tayler says. "We believe they are
adds, is "quite comfortable with our
:ounting principles." He says KPMG
and 2000 financial statements after
Dow Jones Business News reported:
not trade off our ethical standards for
added, "does so at their own peril."
In response to The Wall Street
article, Xerox again reiterated the results of -
its internal investigation. The New York Times
on February 9, 2001:
Indeed, Xerox's internal investigation "
receivables in other countries," acknova
spokeswoman. Xerox has set aside rese
as a result.
find limited instances of exposed
ted Christa Carone, a Xerox
in. several Latin American countries
Mr. [Paul A. Allaire] also said that the au
closely questioning KPMG, Xerox's extei
accounting procedures everywhere are pr
procedures." He noted that Xerox hired h
after its own investigation had confirmed
and that Xerox promptly fired the
fraud.
committee, particularly, had been
auditors , "to make sure that our
x and in accordance with our
pendent investigators in Mexico only
at accounting fraud was taking place
executives who had committed the
30
66.
The market noted the
of Bingham's allegations. Morgan Keegan
issued a February 6, 2001 report on Xerox
If the number associated with questior
the negative implications for creditors
other accounting practices were simila
an issue might develop going to the w
validity of reported financial informat
67.
le accounting practices were near correct
be relatively modest. However, if
loose in other parts of the organization
core underlying assumption of the
used to assess credit risk.
("CSFB") noted the risk inherent in
Similarly, Credit Suisse First
Bingham's allegations in a'report on Xerox
February 8, 2001, stating:
We believe that when considered within he timeline of events and other known
facts, the allegations of financial and acc ui ting regularities warrant investor
scrutiny and further analysis.
It is not hard to visualize a slippery s
in tiny increments in the pursuit of e
is troubling that the company could I
short period of time. We believe the
already high risk profile of Xerox.. .
68.
where accounting integrity is degraded
gs consistency. In the case of Xerox, it
ae so financially distressed in such a
ter of these allegations enhances the
Despite the false denials of
6, 2001 Wall Street Journa. -eaused Xerox's
allegations, the revelations in the February
to drop $.53 per share to $7.39. The following
day, the stock dropped another $.48 per share, to
at $6.91.
D.
Xerox Delays Fiscal 2000 Form ^dI( Filing
69.
After the close of trading on Apri1J2, 2001, the Company issued a press release
announcing that it would delay filing its Form 10LK.
70.
The Wall Street Journal reported On April 3, 2001:
Xerox Delays Annual Report in Dispute Vyith Its Auditor Over Accounting Issues
Xerox Corp. delayed filing its annual repo^ due to a disagreement with its outside
auditor over accounting issues, according o people familiar with the matter. The
unusual delay may deepen concerns about the financial health of the copier giant,
which has suffered from a series of financial and operational setbacks over the
past year. Xerox also is facing a widenirig
Securities and Exchange Commission ...
audit committee believe its accounting
Xerox audit committee and KPMG be]
given the SEC probe....
probe of its accounting practices by the
Xerox also said the company and its
Dies are "appropriate," but said the
a more complete review is warranted
The impact and materiality of
delayed filing can hardly be understated.
Xerox stock dropped $1 . 05 on April 3, 2002.
, S&P, on April 3, 2002, noted the dire
71.
consequences that would befall the Company if
additional "surprises" were revealed or
Street Journal reported on April 4, 2001 :
Xerox did not promptly resolve its audit. The
Ratings agency Standard & Poor's Corp. while reaffirming an investment-grade
rating for Xerox debt, warned yesterday that "additional surprises" or lack of a
result in a rating review and/or
prompt resolution of the audit review,
downgrade of debt.
A further downgrade could have financt consequences for Xerox, much of
whose debt is already at the bottom of it .stment grade at S&P and has already
been downgraded to noninvestment, or j ik, status by the other major ratings
agency, Moody's Investors Service Inc.
72.
Xerox attempted to downplay
comments . USA Today reported on April 4,
2001:
Standard & Poor's warned Tuesday that "'any additional surprises" would result in
a review and/or downgrade of Xerox co orate bonds to junk status, but Xerox
spokeswoman Christa Carone said: "Who 's important is that our rating held firm.
It's important to note that KPMG has not lleged any wrongdoing."
73.
Analysts noted the nexus between the delayed filing and the Company's debt
ratings . The April 3, 2002 Wall Street Journal also reported:
Gibboney Huske, an analyst at Credit Sui se First Boston, called Xerox's failure
to file its annual report on time "troubling " The move "heightens an already highrisk profile," Ms. Huske said. If Xerox's ficial statements need to be revised
downward, Ms. Huske added, that could "pave huge negative implications in
terms of the stock price" and the companyls bond rating.
32
74.
Street Journal, the Xerox Defendants went
As set forth in the April 3, 2001
had no particular basis for withholding its
to great lengths to impart the perception that
opinion:
Thomas C. Theobald, chairman of the a^dit committee, said in a statement that
the company's accounting practices wer appropriate. "Until last Monday, we had
every reason to believe that KPMG would sign the audit in time for the company
to meet the filing deadline," he said. "In ^Inumerous interactions this past week,
KPMG has not advised the Audit Committee of any specific transactions or
accounting matters of concern. "
People familiar with the matter say KPMG was recently called to testify before
the SEC investigators. Concerns about its liability in such a highprofile
accounting case may have sparked KPMG's caution, people familiar with the
matter said- KPMG is reviewing all docth nents submitted by Xerox to the SEC, a
Xerox spokeswoman said.
75.
Notwithstanding Defendants' fals6 assurances regarding the delay in the filing of
Xerox's Form 1 Q-K, the failure to timely file Xeilox's I a-K remained a sore spot for Xerox
investors. For instance, a Salomon Smith Barney report issued on April 16, 2001 stated:
Of course, any good news will be tempered to some extent by concerns over the
delayed T OIL filing,.] rior reports of accounting irregularities, and the ongoing
SEC investigation. We maintain our neutral position on the shares.
76.
Analyst UBS Warburg's report of April 20, 2001 revealed that unless Xerox
completed its restatement by May 31, 2001, it copid default under its debt covenants:
Xerox has been unable to deliver audited financials to lenders as required under
certain debt agreements. If Xerox cannot 'provide the audited financials in a
timely manner, it could be declared to be in default of certain credit agreements
and be required to pay the full outstanding debt amount upon request. The earliest
date this could happen would be May 31 for about $220 million. Xerox is
currently seeking a waiver in the case that it cannot provide audited financials at
that time, but there is no guarantee that the waiver will be granted.
77.
In response to the revelation of the dire consequences which would befall Xerox if
it did not meet the deadline, Xerox stock declined $.30 per share on April 20, 2001.
33
78.
On April 19, 2001, Xerox took
a highly unusual step of announcing its
preliminary financial results for year 2000 whil its annual SEC filings were delayed. This
a materially positive effect on the market price
announcement of fraudulent financial results h
for Xerox stock, causing it to rise from $6.40 to'. $8.90, on volume of 24.5 million shares, almost
six times the prior day's volume. The Wall Street Journal reported on April 20, 2001:
Xerox Corp. reported a narrower-than-e*pected operating loss and more progress
in shoring up its balance sheet, alleviating some concern about its financial health
and igniting a 39% gain in its share price.
The timing of the release was somewhat unusual. Xerox still hasn't filed an
audited financial report for last year. The company's auditors and its board audit
committee said they need more time to complete a full review in light of a
continuing securities and Exchange Commission investigation of accounts,
including the Mexican problem. Xerox had been scheduled to report quarterly
results at the end ofthe month but moved the announcement up because, a
spokesman said, "we felt it was important to get the good news out as soon as
possible."
79,
Analysts took comfort in the release of Xerox's preliminary numbers. Salomon
Smith Barney reported on April 20, 2001:
While the news [of Xerox's restatements and I OK filing] does not necessarily
correlate with the ongoing SEC investigation, it may at least mitigate some of the
concerns over the company's accounting practices and the risk of further
I
adjustments.
E.
SEC Investigation Broadens
80.
On May 22, 2001, Dow Jones reported that the SEC had broadened its
investigation into Xerox's accounting practices:
SEC Examines Xerox's Unusual Transactions With Citibank
The Securities and Exchange Commission, in a widening probe of Xerox Corp., is
examining unusual transactions between le company and Citibank, which a
former Xerox finance executive has claimIed may have been used to artificially
boost the copier company's revenue and profit, Tuesday's Wall Street Journal
reported.
34
Xerox executives sought the deals with itibank to mask deteriorating results
from operations, Mr. Bingham has told 35EC investigators, according to a
transcript of his two-day deposition test orgy. The Citibank deals had the effect
of accelerating into just two quarters m ch of the revenue and profit from renting
copiers to customers in Brazil in the next several years.
81.
Xerox again denounced Bingham's allegations . The May 22, 2001 Wall Street
Journal reported:
Xerox spokesman Bill McKee told Dow Jones Newswires Tuesday that the
allegations are being raised came from a former disgruntled employee. He said
Xerox looked "carefully" into the issues raised by Mr. Bingham, who is suing the
company for wrongful termination, and has found them "untrue and without
merit."
"The type of allegations being discussed ^ are routine and entirely legitimate," said
Mr. McKee. "These type of transactions ve been done over the years in various
geographies in complete compliance wi the generally accepted accounting
practices."
82.
Notwithstanding the Xerox Defendants' false statements , analysts noted that the
accounting issues may extend beyond Mexico. The May 22, 2001 Wall Street Journal reported:
Gregory Smith, ananalyst at H&R Block Financial Advisors, told Dow Jones
Newswires that first there were problems in Mexico, and now there could be
issues in Brazil. "It's a concern to us bec use we're really not sure how far or how
extensive the issue is," he added. "There are a lot of unknowns here."
83.
In response to the May 22, 2001 Wall Street Journal story, Xerox stock dropped
$.60 per share on that date.
F.
Xerox's First Restatement
84.
On May 31, 2001, Xerox issued the First Restatement, which restated Xerox's
financial results for 1998, and 1999 and revised its 2000 results. The First Restatement indicated
that Xerox's 1998 pre-tax income was overstated y $184 million, or $.19 per share, and 1999
pre-tax income was overstated by approximately $ 128 million, or $.13 per share. Pre-tax loss for
35
2000 was reduced by $ 172 million, or $.19 per share, because certain revenue was prematurely
recognized in 1998 and 1999 rather than durin 2000. Thus, over the three-year period, pre-tax
income was reduced by $ 140 million on a net asis.
85.
According to Allaire, the First Restatement occurred "[a]fter rigorous reviews of
Xerox's accounting, no fictitious transactions -were found and the company's liquidity [was] not
impacted." Similarly , Xerox's Form 10-K for 2000 stated:
A review of our worldwide internal controls to determine that the issues identified
in Mexico were not present elsewhere has been completed. The issues identified
in Mexico were not found to be in evidence in any other major unit in which we
operate however several small Developing Markets Operations affiliates were
found to have used imprudent business practices resulting in certain adjustments
and contributing to the impact of the restatement.
86.
The First Restatement involved : (1) accounting irregularities in Mexico; (2)
misapplications of GAAP under SFAS 13, "Ac ounting for Leases "; and (3) an improper $100
million Rank Group acquisition reserve. The fo lowing chart depicts the impact of the First
Restatement:
Year ended December 31 (in 000s),
1
1998
1999
2000
Mexico
$(13)
$(53)
$69
Accounting for Leases, net
(165)
83
87
(24)
(76)
6
18
82
10
184
128
172
Increase (decrease) to pre-tax income (loss):
Rank Group acquisition
Other, net
Total
1.
87.
The Mexican Accounting Irregularities
Xerox admitted that its Mexican # naneial results were materially overstated due
to the following accounting irregularities: (1) reserves were not established for uncollectible
36
long-term receivables; (2) liabilities due to concessionaires were improperly recorded and (3)
revenue was improperly recorded from con
that did not meet the requirements as sales-type
leases.
88.
The First Restatement allocated 170 million previously taken as charges against
and Third Quarter of 2000 ($55 million),
earnings in the Second Quarter of 2000 ($115
by $13 million; (b) 1999 pre-tax income was
as follows: (a) 1998 pre-tax income was
reduced by $53 million; and (c) $101 million
charges related to uncollectible receivables,
particular reporting period.
which the Company was unable to allocate to
89.
As to the first Mexican
iMg irregularity , Xerox officials in Mexico
improperly recorded revenues from customers
knowing that those revenues would never
be received. Xerox's internal investigation
ineffective collection actions which resulted in
long overdue bills with no hope of being
inappropriate re-aging of past due accounts,
as well as billing inaccuracies and insufficient
debt reserves- The Mexican operations' senior
officers all assert that they mere merely
ir* Xerox's accounting policies and directions
from corporate headquarters.
90.
As the SEC later confirmed, in
relaxed its credit standards and leased eq
mid-I990s, Xerox`s Mexican operations
to high risk customers at low initial monthly
rates that doubled or tripled after a short i
period. This practice enabled Xerox to
boost short term results but at the same time ere 1 ed increasing delinquent receivables. Under
GAAP, Xerox was required to write down the re eivables or establish sufficient reserves . Xerox,
however, concealed the increasing delinquent receivables by continually renegotiating contracts
37
with delinquent customers to record an artificially low number of delinquent receivables and
avoid material write-offs.
91.
As to the second Mexican acco
ting irregularity, the Mexican unit was incurring
liabilities to concessionaires but was simply no recording those liabilities on its books.
92.
counting irregularity, the Mexican unit was
Finally, as to the third Mexican
improperly recording as current revenue certai' portionsof long-term lease contracts that should
have been recorded over the life of the lease as iervice and supplies were provided. Adriana
vealed that Xerox corporate headquarters
Rios, the finance manager at the Mexican unit,
directed the Mexican unit to not segregate sexvi a and supply revenue from equipment rental
revenue long-term lease contracts.
2.
93.
Misapplications of GA. P Under SFAS 13, "Accounting for Leases"
The First Restatement also relat l to Xerox's misapplications of GAAP under
SFAS 13, "Accounting for Leases," reduced pr tax income in 1998 by $165 million and
increased 1999 and 2000-pre-tax income by $8 million and $87 million, respectively. The net
increase in pre-tax income over the three year 1 iod was $5 million. These adjustments
primarily related to the accounting for lease me ifications and residual values as well as certain
other items3.
94.
The Improper $100 Million Rank Reserve
At the time of the Rank acquisition in 1997, Xerox recorded a "cookie jar reserve
of $100 million to account for what it claimed were "unknown risks" of Xerox Limited. The
reserve amounted to 6.6% of the total purchase p ice.
38
95.
wholly improper reserve recorded solely to
The term " cookie jar reserve" m
provide a cushion against earnings shortfalls in later periods, when those reserves can be drawn
into income. Under GAAP, reserves may only e recorded when there is an identifiable basis for
the happening of an event that is "probable," and the effects on the financial statements are
"reasonably estimable ." Statement of Financials Accountings Standards No. 5.
96.
tted that no charge was necessary for future
In its 2000 Form 10-1K, Xerox a
I
liabilities associated with the Company' s acquisition of Xerox Limited at the time the charge was
recorded. Xerox' s 2000 Form IO-K stated:
In connection with our acquisition of the remaining 20 percent of Xerox Limited
from Rank Group, Plc in 1997 , we recorded a liability of $100 million for
contingencies identified at the date of acquisition . One ofthe investigations
conducted by the .Audit Committee ofthe Board ofDirectors expressed a
judgment that this liability should not have been recorded. (emphasis added).
Thus, Xerox's own Audit Committee determineq that management recorded improperly the $100
million reserve. Xerox recorded the $100 miiiio i charge solely to manage its earnings and did
not use any of the Rank`Resbrve for liabilities related to the Xerox Limited acquisition.
97.
Instead, beginning in mid-1998,
erox began charging expenses against the Rank
Reserve for items unrelated to any risks arising from the acquisition. Xerox admitted it used the
reserve to absorb expenses related to the consolidation of European back office operations
(entirely unrelated to Xerox Limited), thereby hiding material expenses and causing Xerox's
earnings to be artificially inflated by $24 million in 1998 and $76 million in 1999. Xerox
referred to this reserve as an "Interdivisional a
rtunity" or an "Unencumbered Reserve" that
was used by the Company to boost its reported r ults to meet earnings expectations.
39
98.
against taking improper reserves
The SEC has repeatedly warned
during acquisitions which are then used to hide
ing expenses and smooth earnings in future
quarters. In his well-known "Numbers Game"
at New York University in 1998, former
SEC Chairman Arthur Levitt decried the use of^"cookie jar" reserves to create future earnings.
99.
The Xerox Defendants' denials ofwrongdoing were widely reported. For
example, the Chicago Sun reported on May 31, '2001:
Xerox admits non-compliance, says no fraud
Xerox Corp. admitted today it did not c 'mply with generally accepted accounting
principles, but said an independent audi of its financial statements found no
fraudulent transactions.
100.
On June 1, 2001, the Company's
Restatement were reported over all the major
statements regarding the First
outlets. For example, Christa Carone was
quoted in The Wall Street Journal claiming that the restatement effectively rebutted Bingham's
allegations because the Company's auditors and board investigation found "only one" of
Bingham's charges "to hav&'some merit." A separate Journal article on the same date it reported:
"[a] Xerox spokeswoman said the Company had used proper accounting assumptions . . . "
141.
On the same date, in the National Post, Allaire, said "After rigorous reviews of
Xerox's accounting, no fictitious transactions we
found..." In the same article, Xerox
spokesman, Bill McKee, said "[The delay in filing its annual report] is not related at all to the
SEC investigation ...."
102.
Analysts noted that, with the revs tion of the year end results, Xerox could avoid
a default on its debt covenants. AFX reported on May 31, 2001:
UBS Warburg analyst Benjamin Reitzes said he believes this is good news for
Xerox shares because it lifts a "cloud of uncertainty" surrounding its accounting
40
in credit agreements.
practices and satisfies covenants of
the 8K will allow Xerox
of 220 min usd of one of its credit
"Today's filing of the audited financ
to avoid the possible accelerated rel
agreements, which could have been
today," he added.
its by Xerox that it is continuing to
ion into its accounting practices ....
Furthermore, analysts welcomed
cooperate with the current SEC i
103.
reported on June 1, 2001:
Similarly, Credit Suisse First B
Like the calvary to a last minute rescue,
completed its audit of Xerox's 2000 rest
audit would have caused a covenant vio
104.
'MG, Xerox's accounting firm,
the day before the lack of such an
on on one of Xerox`s debt issues.
The Xerox Defendants` continued denials caused Xerox shares to rise sharply. As
a result of Defendants' false and misleading statements issued on May 31, 2001, Xerox's stock
rose $ . 88 per share , to $991. Moreover, as a result of Defendant' s continuing deception on June
1, 2001, Xerox's stock rose an additional $. 69 p r share on that date, to $10.60.
105.
The First Restatement had its innded affect. For example:
a.
The June , .001 Wall Street Journal reported:
Jack L. Kelly, an analyst at Goldman Sachs Group, said he found some of the
accounting issues that caused the restatement "surprising" and evidence of "poor
accounting," but said investors were relieved because they had feared the
problems could be even deeper or more widespread within Xerox.
b.
The New York Times on June 1 , 2001 reported:
`The restatements are pretty benign and have little to do with anything that could
be remotely called malfeasance,' Daniel R. Kunstier, an analyst with J.P. Morgan
Chase, said.
As these analyst reports and news stories demonstrate , Defendants' false and misleading
statements issued in conjunction with the revelation of the First Restatement negated any
negative effect which may have accompanied the disclosure of limited violations of GAAP.
41
G.
The SEC Notifies Xerox That its Accounting Methods are Improper
106.
On January 7, 2002, Xerox di
in a Form 8-K that the SEC's Office of Chief
that Xerox' s accounting methodology for
Accountant ("OCA") advised Xerox that it
sales-type leases did not follow the
of SFAS 13. However, Xerox disagreed with
a methodology that accounts for the fair
the OCA's assessment and stated "[Xerox]
values of the components that it believes results in no material difference between the
application of its methodology and the OCA's iew. Thus, [Xerox] believes the financial results
is added).
it reports are in accordance with GAAP." (emp
107.
Analysts viewed Xerox's statemnt as positive. For example, a January 7, 2002
Lehman Brothers report noted:
XRX stated that it believes that there is no material difference between where it
stands versus the SEC. This is incremerjtal new news that we think could be a
positive. However, Xerox did not give In update on the other parts of the SEC
investigation. We also think that this is a positive because it could be an
indication that the SEC investigation may be close to some resolution. (emphasis
added).
108.
Similarly, on January 8, 2002
Smith Barney noted:
The company still "disagrees" with the
ief Accountant's fording that the
allocation of gross lease payments amc
the various elements was flawed. That
said, management notes that even folio
tg the SEC methodology would not
result in a material change in financial results. While any ruling against the
company is certainly a psychological negative for the shares short term, one could
argue that there is at least a "ray of sunshine" IF Xerox is correct about the lack of
any material impact on the historical financials. Among thefactors weighing on
the stock has been afear ofa major restatement derivingfrom an adverse SEC
ruling. (emphasis added).
109.
Also, Merrill Lynch, on January 1 , 2002, reported:
Xerox has responded that utilizing either is current methodology or that favored
by the SEC yields the same results. therefore, it does not expect the SEC to
require an earnings restatement. (emphasis added).
42
110.
on January 7, 2002, Xerox's stock dropped
Despite Defendants' false
of 16.5 million shares.
from $10.05 per share to $9.88 per share, on
l 11 _
its fourth quarter 2001 results reporting a
On January 28, 2002, Xerox
(excluding one-tim e charges). Xerox
net loss of $4 million, but earnings of -$108
. Mulcahy claimed that the results represented
reported that revenues fell 13% from the year
a "return to operational profitability,
ive of the new Xerox," and that Xerox was
that "they've finally fixed Xerox" and that the
"getting the house in order." Mulcahy also
fourth quarter results were "a signal that Xerox is on solid ground." In addition, Xerox also
stated that it did not anticipate any delays in
filing of its Form I O-K for 2401, in a January 29,
2002 article in The Wall Street Journal.
112.
conference call, Mulcahy again assured
On January 28, 2002, during an
investors that Xerox was complying with
So let me begin with the SEC investigation of our lease accounting. As we
disclosed earlier l ins month, Xerox has been in discussions with the SEC's Office
of the Chief Accountant regarding the methodology we use for the accounting for
sales-type leases. We continue to believe that
X's methodology produces
financial results that are fairly representative in accordance with GAAP. In fact,
we have done substantial work to c
Irate that there is no material difference
between our methodology and that
OCA. Our current auditors, PwC, have
reviewed this work and are in agret
In addition, KPMG, our former auditor
were fully supportive of our lease z
Ling in 2000 and earlier years.
113.
The January 29, 2002 Wall
reported Mulcahy's statements:
Chief Executive Anne Mulcahy also said that Xerox's new auditor,
Pricewaterhouse Coopers LLP, agrees with the company' s accounting
methodology on equipment leases . , . .
Ms. Mulcahy's comment suggested that ^,ricewaterhouse was likely to sign off on
Xerox's anticipated audited annual 14-K
rt, despite the objections of the
SEC's accounting unit, which were disci ed by Xerox this month. A spokesman
for Pricewaterhouse decliwd to comment.
43
Christa Carone, a Xerox spokeswoman, said the company anticipated no delays in
the filing of its 10-K. Last year 's filing was delayed amid differences over
itor then, KPMG LLP. (emphasis added).
bookkeeping between Xerox and its
114.
Again, the analysts gave great i portance to Mulcahy's statements. Thus, on
January 29, 2002, Deutsche Bans Alex Brown noted:
Xerox bundles its products and services and is in discussions with the SEC to
resolve the differences. The company his stated, and we believe, that there is no
material difference between the methodology used by Xerox and that preferred by
the SEC. We expect this matter to be resolved sometime in 2002.
115.
Mulcahy's false statements on J*uary 28, 2002 caused Xerox's stock price to rise
from $9. 90 to $11.24, and from $11.24 to $11.41'5 on January 29, 2002.
116.
On April 1, 2002, Associated Press Newswires reported that, under a proposed
agreement with the SEC, Xerox would pay a $16 million penalty, restate its financial statements
for 1997 through 2000, and adjust previously issued 2001 results. Xerox was quoted as stating
that the "restatement will primarily reflect
in timing and allocation of lease revenue
and could involve a re4pcation of equipment
revenues in excess of $2 billion from 1997
its revenue-allocation methodology.
through 2000." Xerox announced it would ch;
Additionally, Associated Press reported, the
"will include adjustments that could be
more than $300 million due to the
and release of certain reserves before 2001 and
other miscellaneous items.
117.
In reporting on the prepared
read by Xerox on April 1, 2002, Dow Jones
Business News, on the same date, reported:
`We have proven that, when faced with c
actions that will serve Xerox best for the
value proposition for our customers and
Chairman and CEO] said. "That's why v
44
icult decisions, we take the appropriate
ng term, strengthening the company's
ireholder," [Anne M.] Mulcahy [Xerox
believe Xerox is best served by putting
these issues with the SEC behind us anO focusing on restoring the company to
good health, sustained profitability and
growtIL"
118.
Market commentators noted
April 2, 2002 issue of the The Washington
severity of the $10 million fine. For example, the
reported:
paid by a public company to settle a
to date is $3.5 million, which America
trges that it improperly inflated earnings.
The $10 million fine would be the larl
case brought by the SEC. The largest
Online Inc. paid in May 2000 to settle
Although Xerox has mostly sought to characterize the matter as a technical
disagreement over accounting methodology, the fraud charges and size of the
penalty indicate that the SEC considers the case to be far more serious.
"That's a pretty substantial penalty," said Adam C. Pritchard, a securities law
professor at the University of Michigan. "That's the SEC saying this was an antifraud violation and not record-keeping 'olations."
119.
Furthermore,. 'he Washington Post noted that Xerox and KPMG had disagreed on
how to address the accounting issues raised in the SEC's investigation:
As the investigation widened, Xerox fired its auditor, KPMG LLP, and disclosed
that the SEC was disputing the accounting method the company used to book
revenue from the-lease of copiers and other equipment. The disagreement centered
on whether Xerox sfould spread the revenue over the life ofthe lease.
KPMG spokesman George Ledwith said his firm and Xerox disagreed over how
to address the accounting issues raised b the investigation.
120.
Notwithstanding Xerox's agreement to restate its prior results, KPMG continued
to insist that the initial methodology employed
Xerox was correct and downplayed the
restatement. The Wall Street Journal reported on April 2, 2002:
After Xerox announced the settlement, George Ledwith, a KPMG spokesman,
defended his fine's work for the company, saying KPMG "firmly believed then
and believes now that Xerox's fundament l accounting methodology is sound and
complies with" generally accepted accounting principles. He added that "teams of
other auditors" called in by Xerox have a^geed with KPMG's assessment.
45
Mr. Ledwith also noted that "the reallocation of $2 billion in equipment lease
revenues involves a period in which X ox's total revenue was $75 billion."
121.
The market took comfort in the EC's release and the Xerox Defendants'
statements suggesting it had put the issue behind the Company. Thus, on April 2, 2002, UBS
Warburg noted, in a Xerox report, "assuming approval [of its agreement in principle with the
SEC] the agreement itself and its limited imps
on cash lifts a cloud hanging over Xerox's
shares." Similarly, on April 2, 2002, Lehman
rothers informed its clients: "The SEC
investigation is out of the way lifting a cloud
, t has been hanging over the stock."
H.
The SEC Complaint Details Xerox's Accounting Irregularities
122.
On April 10, 2002 , it was widely reported that the SEC had widened its probe of
Xerox's accounting fraud. The Wall Street Journal reported that Allaire and Romeril, KPMG,
and Michael Conway, a KPMG partner who co-1-headed the Xerox audits, had received Wells
Notices. Such a Notice notifies a recipient that he SEC's Enforcement Division is close to
recommending to the ii j Commission an actin against the recipient and provides the recipient
the opportunity to set forth his version of the law or facts. As reported by the Journal, according
to Howard Schif rin, a securities attorney at Dickstein, Shapiro, Morin & Oshinsky, the SEC is
clearly "widening the circle of who they're holding responsible." Xerox's stock price declined,
on April 10, 2002, from $10.28 per share to $9-4 per share.
123.
On April 11, 2002, the SEC announced a settlement with Xerox whereby Xerox
agreed to: (i) consent to the entry of an injunction for violations of the federal securities laws;
(ii) restate its financials for the years 1997-2000; (iii) allow a committee of outside directors to
conduct a special review of the Company's accof rating controls; and (iv) pay an unprecedented
$ 10 million penalty. SEC 4/11/02 Release.
46
124.
At the same time, the SEC
District Court for the Southern District
its compl aint against Xerox in the United States
York, and issued a release announcing its filing.
This release stated:
"Xerox used its accounting to burnish end distort operating results rather than to
describe them accurately," said Stephen M. Cutler, the SEC's Director of
Enforcement. "For Xerox, the accounting function was just another revenue
source and profit opportunity- As a result, investors were .Misled and betrayed."
"Xerox's senior management orchestrated a four-year scheme to disguise the
company's true operating performance," said Paul It Berger, Associate Director
of Enforcement. "Such conduct calls for stiff sanctions, including, in this case, the
imposition of the largest fine ever obtained by the SEC against a public company
in a financial fraud'case. The penalty al reflects, in part, a sanction for the
company's lack of full cooperation in th investigation." Charles D. Niemeier,
Chief Accountant for the Division of Enforcement, added: "Xerox employed a
wide variety of undisclosed and often improper top-side accounting actions to
manage the quality of its reported earnings. As a result, the company created the
illusion that its operating results were substantially better than they really were."
125.
In a press release issued simultaneously with the filing of the SEC Complaint,
Xerox informed investors that the restatement could "primarily reflect adjustments in the timing
and allocation of lease revenue and could involve a reallocation of equipment sales revenue in
excess of $2 billion from 1997 through 2000," and would also include adjustments of more than
$300 million because of the establishment and release of certain reserves before 2001 and other
miscellaneous items. The press widely reported Xerox' s statements.
126.
Nonetheless, Mulcahy, according to the April 11, 2002 Dow Jones Business
News, reiterated that "the settlement with the commission effectively resolves Xerox's
outstanding issues with the SEC." Additionally, Mulcahy also stated: "with the SEC matters
now behind us, we are better positioned to continue fortifying our business through operational
improvements and future growth opportunities."
47
127.
stock price declined on April 11, 2002
In response to the SEC Release,
from $9.94 per share to $9.70 per share.
128.
, Xerox informed analysts that "Xerox has put
In an April 24, 2002 conference
[its accounting] issues behind it." Based on
assurances, Xerox stock rose from $9.54 to $9.72
per share on April 24, 2002.
129.
After the market closed on May 1, 2002, Moodys Investors Service announced
that it downgraded Xerox's debt ratings by two eveis. Xerox's stock dropped the following day,
May 2, 2002, from $11.08 to $10.70 per share. Analysts noted that the company's accounting
cloud was part of the reason for the downgrade.I As reported in the May 2, 2002 Dow Jones
Business News:
While Xerox has said it expects to renegIptiate its credit revolver, strong language
used in a recent Securities and Exchang9 Commission filing cast a cloud of doubt
on its ability to work out a deal with the banks.
Last month Xerox said in a filing that its viability would be in doubt if it failed to
refinance part ofd k $7 billion credit agreement that matures Oct. 22. News of the
filing sent the stoek4ower and Xerox was forced to issue a statement in which it
said its expects to strike a deal with the banks by the end of June.
130.
The SEC Complaint and resultant settlement were the product of an almost two-
year investigation. SEC complaints are filed o
after the SEC's Enforcement Division has
obtained documentary and testimonial discovery, assembled evidence, provided the "targets"
with the opportunity to present their case thmug t a Wells submission, and presented evidence to
the SEC, which must then approve filing the proposed complaint. In a settlement, the contents
and wording of the complaint typically are negotiated between the SEC's staff and the "targets.
I
Thus, the SEC Complaint's stark portrayal of Xerox`s
wrongdoing still may not reveal all of
Xerox's improper conduct.
48
131.
a myriad of "one-time actions," "one-
The SEC concluded that Xerox
offs," 'laccounting opportunities," and r'
ing tricks" to achieve earnings it otherwise could
Restatement, the SEC found that from 1997 to
not have met. In stark contrast to the limited
1999, Xerox's accounting machinations enabled the Company to overstate its revenue by $3
billion and overstate income by a stunning $1.5 billion. These amounts were in addition to
Xerox's prior restatement. Specifically, for i 9 7, 1998, and 1999, the SEC determined that
Xerox's pre-tax earnings were overstated by $4 5 million, $656 million, and $511 million,
respectively.
132.
The SEC's investigation also revealed that if Xerox properly reported its revenues
and earnings from 1997-2000, Xerox would have failed to meet Wall Street earnings
expectations in 11 of 12 quarters . Moreover, by 1998 , almost $3 of every $10 of annual pre-tax
reported earnings and up to 37% of its reported:quarterly pre-tax earnings was generated though
undisclosed accounting manipulations-
133.
One of the most striking revelations was that during the Class Period, Xerox and
KPMG separately tracked accounting manipulations and documented the impact of accounting
actions, comparing "reported" with "underlying" results. The impact of Xerox's accounting
manipulations on estimated earnings per share, based on the SEC' s analysis, is set forth below:
49
Xerox Coil
Impact of Accounting Manip
For Quarters Ended
1st Qtr
1997
2nd Qtr
3rd Otr
4th Qtr
MAccounbi
let Qtr
1998
on Raoorted EPI
1997-1999
2nd Qt
I
3rd Ott
4th Qtr
1st Qtr
1999
2nd Ott'
3!d Qtr
4th Qtr
M2nipulatiosi EPS AUrndei1 ying EPS According to SEC Ca lcu lation s
1.
The SEC's Allegations of Accounting Improprieties
134.
For sales-type leases, SFAS 13 required Xerox to record the equipment "sale" at
I
the equipment's fair value. According to the SEC Complaint, Xerox claimed that it was impracticable to estimate the fair value of its equipment. Instead, Xerox employed a "unique and
undisclosed,," methodology in allocating lease payments among the equipment price, the
financing income and any service elements included in its bundled lease arrangements- Xerox
estimated the fair value of the equipment as the portion of the lease payments remaining after
subtracting the estimated fair value of the servic and financing components. Xerox's method
50
and financing, and increased the equipment
decreased deferred revenues attributed to
sales revenue that was recognized i
135.
used a variety of improper lease accounting to
The SEC concluded that
disguise its true financial performance, including:
a.
Equity ("ROE"): Xerox increased reported
Manipulated Return
equipment revenues by decreasing the finance
of sales-type leases by applying
baseless discount rates to estimate an assumed
it value of the fnance component. Xerox
thereby reduced the revenue related to the
component (which was required to be
deferred) and recognized more revenue it .medistely . This improperly recognized revenue was
one of several techniques by which Xerox "mortgaged" its future; the same revenue could no
longer be recognized in the future quarters for
ich it should have been deferred and recorded.
The SEC referred to this as the "ROE
" because Xerox limited its assumed ROE on its
finance operations to 15 percent even though
rates fell below Xerox's own incremental
borrowing rates . The 15 percent assumed ROE
an arbitrary figure that enabled Xerox to
justify allocating more of the bundled lease
to the equipment and thereby recognize more
revenues immediately. Between 1997-2000, Xerox continually depressed its estimate of the fair
value of financing, increased reported equipment revenues by expanding its ROE method to new
geographic areas, and changed factors and ass
ptions used to calculate the lease interest rate
that would produce a 15 percent ROE.
Application of ROE was a "top-se" adjustment directed by corporate
headquarters, rather than by "rogue" employees. I Operating units allocated lease cash flows to
the box, service and finance components according to long-established procedures. However,
51
before financial results were publicly
supplied by corporate headquarters,
Xerox's regional headquarters, using data
the allocations to insure that Xerox's financing
regardless of its own capital or
operations realized no more than a 15 percent
administrative costs or the interest rates paid br the customer to lease a copier. Xerox used this
technique to pull forward $2.2 billion of reven1e and $301 million of earnings from 1997-2000,
none of which resulted from the sale of any additional Xerox product. SEC Compl. IM 3 9-44;
Margin Normalization : A similar method by which Xerox accelerated
b.
revenue recognition and "mortgaged" its future was an accounting action Xerox referred to as
d to "margin normalization" as "half-baked
"margin normalization." Internally, KPMG re
revenue recognition." This method arbitrarily rleallocated revenues from the service to the
equipment portions of sales-type leases by assuming an artificial gross margin differential
between the two lease components. Xerox recalculated its revenues in Europe, Brazil, Canada,
Mexico, and Argentina to achieve relative profit margins on the service and equipment portions
of its bundled leases than ire identical to those existing in the United States. Even though these
assumed profit margins had no basis in economic reality (Xerox was, in fact, faced with falling
margins on equipment abroad under pressure from Japanese competition), from 1997 through
2000, Xerox pulled forward $617 million of equipment revenues by applying this methodology.
SEC Compi.1 45-48;
c.
Price Increases and Extensions : Xerox also accelerated revenue
recognition through price increases and extensions of existing leases. Additional income
realized from lease renegotiation is required to bL recognized over the remaining life of the lease,
according to GAAP. Indeed, in early 1999, KPMGG informed the Company that Xerox's
52
accounting for price increases and lease
GAAP, Xerox merely reduced the amount of
pull forward approximately $300 million in
violated GAAP. Rather than complying with
it recognized. Xerox used this technique to
pment revenue and $200 million in pre-tax
earnings . SEC Compl. ¶'1 49-51;
d.
Residual Values Adi
earnings and revenue expectations, Xerox i
upwardly revising net residual values of
Argentina, and Mexico units by $95 million.
an internal accounting policy created by Xerox
notwithstanding that these adjustments
In 1996, when this policy was presented to
objected that the policy violated GAAP.
arguments with Xerox senior financial
: From 1997 to 1999, to meet or exceed
its pre-tax earning s by a net of $43 million by
in its Europe, Brazil , United States,
upward adjustments were made pursuant to
financial management in late 1996,
GAAP and were prohibited by SFAS 13 and 23.
, the audit engagement partner initially
only approved this methodology following
but kept criticizing the practice through
•siY
1998. SEC Compl. ^152 55; and
e.
Portfolio Asset
revenue recognition by engaging in a PAS, by
portfolios to investors to recognize revenue i
unsustainable business model in Xerox Brazil,
("PAS") Transactions: Xerox also accelerated
ich Xerox sold revenue streams from its lease
In 1999, largely as a result of an
recorded five times more revenue from
PAS transactions than in the previous year.
very same year, however, Xerox switched from
sales-type to lease rental contracts, the revenue
which GAAP precluded from being recognized
immediately. KPMG noted that Xerox relied
PAS transactions to close the gap between
actual and expected results. Nevertheless, at the expense of future periods, Xerox manipulated
its results and earnings trends for 1999 by pull ng forward $400 million in revenue and $182
million in profit before taxes. SEC Compl. ¶¶ 6.57.
136.
Additionally, the SEC conclud
that Xerox used the following additional
machinations to further manipulate its reporte results:
a.
The Rank Reserve: A discussed above, Xerox used the Rank Reserve
to boost its Europe division's reported results.
b.
EC Compl. IN 61-63;
Other Excess or Cushi n Reserves : Xerox fraudulently released into
income 20 other excess reserves totaling $396
'Ilion from 1997 through 2000. These included:
(i) $120 million of over-accrued vacation pay,
hich was systematically and improperly released
into income at a rate of $7.5 million per quart ; (ii) $40 million of an SFAS 106 reserve
(originally created to account for employee pos -retirement benefits), which was systematically
released into income at $5 million per quarter
en no additional liabilities remained; and (iii)
$24 million of reserves on other current assets. Internally, Xerox referred to the reserve as an
"Interdivisional Opportunit3 "or "Unencumbered Reserve." SEC Comps. ¶¶ 64-67;
c.
Tax-Related Income:
rider GAAP, Xerox was required to recognize the
full $237 million of a tax refund as income in 1 95 and 1996. Instead, Xerox recognized only
$80 million, and used the balance on an as-need d basis as another tool to "close the gap"
between actual and expected results. Indeed,
also included it on a List of Unencumbered and
rox kept track of this fund as a "cushion," and
er Reserves available to help meet
performance targets. In 1998, a senior financial fficer noted that Xerox used the fund's interest
to cover unusual expenses and "to meet plan"
y engaging in this practice, Xerox understated
its earnings for 1995 and. 1996 by a total of $15 million and overstated its earnings for 1997-
results and earnings trends. SEC Compl.
2000 by the same amount, further distorting
1168-7 1;
d.
: To boost liquidity and year-end cash balances
Factoring
in the fourth quarter of 1999, Xerox instructed its largest operating units to sell future streams of
transactions totaled $288 million, thereby
cash at a discount . In 1999, undisclosed
allowing the Company to report a positive
cash balance of $126 million instead of a
negative number. Xerox failed to disclose
transactions in its 1999 financial statements and
characterized them internally as "expensive"
"merely window dressing." Indeed, Xerox
management believed that if the market learn of Xerox's cash problems, this would signal
"major operational/control issues." Xerox also violated GAAP by accounting for $54 million of
the $288 million in factoring transactions as
sales, even though they were subject to buy-
back provisions . SEC Compl . ¶¶ 72-75;
e.
Xerox Mexico: From 1
through the first quarter of 2000, to meet
Xerox corporate managertteht's demanding
and revenue targets, senior management of
Xerox's Mexico subsidiary fraudulently
revenue by $170 million. This overstatement
was accomplished by concealing $129 million i4 uncollectible receivables (through, among other
things, constantly renegotiating contracts with
customers and changing invoice dates
to make overdue receivables appear current),
to record $27 million in notes due to third-
party resellers of Xerox equipment (which was
ished by secretly renting warehouses to
store trade-ins to prevent the accounting system
third-party resellers of Xerox equipment), and i
automatically generating credits due to
recognizing $14 million in revenue
from equipment leased to government customer (such contracts did not meet the three-year lease
55
nade it necessary to recognize these
term and set minimum monthly payment re,
contracts immediately). SEC Compl.'[ 77
J.
Xerox's Second Restatemei
137.
Notwithstanding its previous
concerning the correctness of the
Company' s accounting and completeness of its'disclosures, on June 28, 2002, Xerox announced
that it would restate its previously reported financial statements for 1997-2001 (the "Second
Restatement"). Remarkably, the Second Resta ement exposed accounting manipulations of even
greater magnitude than the'SEC's investigation had uncovered. Xerox conceded that it overstated
its pre-tax income by a stunning 36% or $1.41 billion over the past five years. For 1997, 1998,
and 1999, pre-tax income was overstated by a staggering 43% or $1.93 billion. For 1998, Xerox
revealed that it had a pre-tax loss of $13 million compared to the $579 million pre-tax profit it
had previously reported.
138.
The Second Restatement also id ntified $6.4 billion in equipment sales revenue
that Xerox improperly booked over the five-ye
period including: (a) $2.8 billion from Latin
7
America equipment sales which should have been: considered rentals; (b) $2.4 billion incorrectly
designated as equipment sales within bundled leases; (c) $1.1 billion originally misclassified as
sales-type leases and now reported as operating leases; and (d) $100 million from deconsolidation of a South African affiliate.
139.
The graph below sets forth Xero "s pre-tax income as: (i) originally reported; (ii)
reflected in the First Restatement; (iii) reflected n the SEC's conclusions; and (iv) reflected in
the Second Restatement:
56
Revenue Overstatement
$2,500
$2,000 -f', -
$1,500
o'
$1,000
$500 -f'
$(500) ^
1997
1998
1999
■ Pre-Tax (IO5
2000
came. Originally reported
Pa-Tax (lose) inaame , restated May 31, 2001 (First Restatement)
a Pre -Tax (foss) income, acwrdiV to SEC April 11, 2002
(a)
140.
Cornpany did not restate for 1597.
o Pi-Tax ( loss) income, restated dune 28 , 2U)2 ( Second Restatement)
Specificat-ly;'the Second Restatement involved the following issues: (1) SFAS 13
(lease accounting); 2) other revenue issues; 3) South Africa deconsolidation 4) purchase
accounting reserves; 5) restructuring reserves; 6) tax refunds; and 7) other miscellaneous
adjustments. The effect of these is as follows:
Pre-tax income (loss)
Total
2001
2000
1999
1998
1997
Pre-tax (loss) income, previously reported
$ 3,971
$ (137)
$ (384)
$ 1,908
$ 579
$ 2,045
(626)
68
(74)
(252)
(281)
(87)
(138)
335
80
39
(238)
(354)
(158)
54
12
(50)
(74)
(100)
(76)
91
11
(162)
19
(35)
Revenue restatement adjustments:
Revenue allocations in bundled
arrangements
Latin America - operating lease
accounting
Other transactions not qualifying as salestype leases
Sales equipment subject to operating
57
leases
Sales of receivables transactions
South Africa deconsolidation
Other revenue items, net
Subtotal
(2)
(35)
(8)
12
(10)
10
18
(11)
12
(32)
(8)
22
(6)
(31)
(21)
(1,043)
560
48
(443)
(611)
(597)
(29)
(2)
(7)
(20)
-
Other restatement adjustments:
Purchase accounting reserves
Restructuring reserves
Tax refunds
Other, net
104
(87)
65
(12)
138
(153)
(290)
31
(89)
(14)
(131)
(97)
(22)
(42)
(79)
Subtotal
(368)
(58)
(31)
(177)
19
(121)
(1,411)
502
17
(620)
(592)
(718)
(13 )
$ 1,287
Increase (decrease) to pre-tax income
(loss)
Pre-tax ( loss) income, restated
I.
$ 365
$ 36
$ 1,288
$
Improper Application of SFAS 13 (Lease accounting)
a.
141.
$ 2,560
-
Revenue Allocations in Bundled Arrangements
Xerox's revenue allocations for the multiple deliverable elements of its bundled
sales-type leases did not comply with SFAS 13, because Xerox did not use a discount rate which
caused the aggregate present value of the minimum lease payments, excluding executory and
service income, and any unguaranteed residual value, to equal the fair value of the equipment.
Thus, revenues and pre-tax income were overstated for the five years ended December 31, 2001,
by $641 million and $626 million, respectively.
b.
142.
Latin America - Lease Accounting (Transactions Not
Qualifying as Sales-Type Leases)
Sales-type leases in Xerox's Latin American unit were reversed and accounted for
as operating leases. During the Class Period, Xerox erroneously classified these leases as salestype leases despite the fact that "historically, and during all periods presented, a majority of
leases were terminated significantly prior to the expiration of the contractual lease term."
58
143.
Specifically, Xerox disclosed in its 2001 Form 10-K that the Company does not
"generally collect the receivable from the initi 1 transaction, upon termination of the contract or
during the subsequent lease term, the recoverability of the lease investment was not predictable
at the inception of the original lease term."
144.
As a result, the net cumulative reduction in revenue and pre-tax income for the
five years ended December 31, 2001 was $633 million and $138 million, respectively.
c.
145.
Other Transactions Not Qualifying as Sales-Type Leases
During the five years ended December 31, 2001, Xerox improperly estimated the
economic life of its products used for classifying leases. Rather than using an economic life of
three to four years as the Company did the proper duration should have been five years.
146.
As such, many shorter, duration leases which were accounted for as sales-type
leases did not meet the criteria under SFAS 13 to be accounted for this way. The net cumulative
effect of this misapplication of GAAP resulted in a reduction of revenues and pre-tax income of
$201 million and $158 million, respectively.
d.
147.
Accounting for the Sale of Equipment Subject to Operating
Leases
Xerox improperly recognized revenue from the sale of equipment subject to
operating leases to third-party finance companies. Xerox immediately recorded the transactions
as sales at the time equipment was accepted by the thirdparty finance companies despite the fact
that "the transactions at inception included retained ownership risk provisions for [Xerox] or
other contingencies that precluded these transactions from meeting the criteria for sale treatment
under the provisions of SFAS No. 13."
59
148.
$243 of revenues and $162 million in
As a result, Xerox improperly
decreased revenues for the three years ended
pre-tax income in 1999. The Second
December 31, 1999 by $220 million.
2.
149.
Other Revenue Issues
imately $2 billion in finance receivables to
During 1999-2001, Xerox sold
Special Purpose Entities ("SPEs"). However, 4s a result of a change in the economic lives of the
equipment to five years, certain leases transferifed did not meet the sales-type lease requirements
and should have been accounted for as operating leases. This change disqualified the SPEs from
non-consolidation resulting in Xerox being required to record the proceeds as debt rather than as
sales. Xerox's debt was increased as a result
$490 million, $418 million, and $950 million, at
December 31, 2001, 2000, and 1999,
150.
$288 million in receivables , of which $57
In addition, during 1999 Xerox
) was determined not to qualify as sales as
million (including $14 million in the First
a result of Xerox agreeing tv reacquire the recearables in 2000." These changes resulted in an
increase in revenues of $97 million and a reduction in pre-tax income of $2 million.
3.
151.
South Africa
Since 1998, Xerox improperly consolidated a South African affiliate. Because the
minority joint venture partner had substantive p4rticipating rights, all assets, liabilities, revenues
and expenses should have been deconsolidated. The cumulative reduction in revenues and pretax income through December 31, 2001 was $269 million and $35 million, respectively.
° This manipulation not only overstated revenue but also inflated Xerox's cash position at
December 31, 1999.
60
4.
152.
Purchase Accounting
isition of XL Connect Solutions, Inc., Xerox
In connection with the 1998
recorded liabilities aggregating $65 million
contingencies identified at the date of the
acquisition. The Second Restatement
that $ 51 million of these liabilities did not meet
the criteria to be recorded as purchase accounting reserves. During 1999 and 2000, $29 million
of the liabilities were either reversed into Xerox's income or certain costs related to ongoing
activities of the acquired business were charged against these liabilities. Thus, Xerox's pre-tax
I
income for the five years ended December 31, 2001 was overstated by $29 million and its assets
(goodwill) were overstated by $51 million since the acquisition date in 1998.
5.
153.
Restructuring Reserves
In connection with its restructurings in 1998 and. 2000, Xerox recorded reserves.
Xerox improperly released the reserves into earnings in violation of GAAP. The Second
Restatement increased pre-tax loss in 2001 by $67 million and decreased pre-tax loss in 2000 by
$65 million due to corrections regarding the tuning of the release of reserves. Xerox should have
reversed the applicable reserves in late 2000 when information was available demonstrating that
its original plan had changed and the reserves were no longer necessary. Instead, Xerox had
recorded the reversal in early 2001.
154.
The Second Restatement reduced 1999 pre-tax income by $12 million because
Xerox improperly released these restructuring reserves. In 1998, Xerox improperly recorded a
restructuring provision of $138 million which dih not meet the criteria to be recorded as initial
restructuring reserves. Such charges did not qualify as exit costs or appropriate separation costs
I
under GAAP.
61
155.
pre-tax income by $104 million for the five
In total, these adjustments
year period ended December 31, 2001.
6.
156.
Tax Refunds
In 1995, Xerox received a
favorable court decision entitling it to a tax
with tax refunds and related interest from
refund. Xerox improperly recorded income
1995 through 1999, rather than in periods
to 1997. These adjustments decreased pre-tax
income by $153 million for the five year
ended December 31, 2001.
7.
157.
Other Adjustments
In addition to the above items, Xerox improperly accounted for certain non-
recurring transactions, the ti ming of recording and reversing certain liabilities, and the timing of
recording certain asset write-offs. These adjustments decreased pre-tax income by $290 million
for the five years ended December 31, 2001.
K.
Other Facts Confirming the Existence of Defendants' Accounting
Manipulat pus
1.
158.
Xerox Improperly Allocated Costs Associated With Long-Term
Leases
Xerox materially understated the :costs booked upon execution of LTLs associated
with the provision of services and labor costs over the life of the LTLs. According to a former
Xerox Business Services Manager ("XBS") in the Developing Market Operations ("DMO"), in
or about 1993, approximately 201/v of the total minimum payments on LTLs were estimated as
service costs (executory costs). Thereafter, and prior to the Class Period, Xerox arbitrarily cut
service costs by approximately 50%, reducing its estimated executory costs to approximately
i
10% of an LTL's total minimum lease payments . The estimated executory costs did not actually
62
decrease. Consequently, the amounts of such
TLs allocated to "equipment," as opposed to
d, enabling Xerox to improperly boost current
supplies and labor costs, were improperly incr
revenues and profits through revenue acceleration and failing to adequately reserve for known
and probable costs associated with LTLs.
159.
Defendants never disclosed thatIthe boost in current revenues was a result of
accounting changes rather than improved operational performance. Defendants knew or
I
recklessly disregarded that such material char. es required disclosure under GAAP and that the
investing public would be misled by failure to disclose such changes. APB Opinion No. 20
("APB No." 20), entitled Accounting Changes, provides that: "The nature and justification for a
change in accounting principle and its effect on income should be disclosed in the financial
statements of the period in which the change is made." Moreover, APB No. 20, requires that the
disclosure "explain clearly why the newly adopted principal is preferable."
2.
160.
Xerox Used Artificially ^nflated Unguaranteed Residual Values to
increase the Earnings i Derived From Long-Term Leases
In order to record more profit at the inception of a lease, Xerox used artificially
inflated unguaranteed residual values ("RVs") When valuing its leases. RVs were determined by
Xerox headquarters, not by Xerox offices in individual countries.
161.
SFAS 13 allows the lessor to immediately recognize as revenue the present value
of the minimum rental payments due under the lease agreement. To measure its revenue, a
company discounts the future lease payments to the fair value of the leased equipment, thereby
determining its present value. To determine its profit on a particular lease, the company is then
required to subtract the net cost of the equipment from the revenue thereon. The net cost of the
equipment consists of the cost of the equipment less its RV (because the equipment will be
63
returned to the company and will ostensibly retain some value). By increasing the RV, whether
warranted or not, a company can reduce the ne cost of the equipment so that it can report a
higher profit by subtracting a lower amount from its revenue. Here, by using unreasonably high
RVs, Xerox improperly recorded more profit at the beginning of the lease term.
162.
Xerox headquarters determined the RVs. Xerox published tables for each country
detailing the RV for every machine. According to the Company's Form 1 Q-Ks, RVs increased
from 2.4% to 5.1 % of finance receivable from 1995 to 1999 - an increase of approximately
113%. There is.no explanation for this unreasonably high increase.
163.
By assigning unreasonably high RVs to leased property, Defendants disregarded
GAAP's requirement that the RV be the estimated "fair value" of the leased property at the end of
the lease term, allowing the Xerox Defendants to artificially inflate its current income, earnings,
and finance receivables, throughout the Class Period.
3.
164.
Xerox Improperly Used Low Discount Rates to Artificially Boost
Revenue on Long Term Le
SFAS 13 states that a lessor shall use a discount rate that, when applied to the
minimum lease payments, causes the aggregate present value at the beginning of the lease term
to be equal to the fair value of the leased property.
165.
Under SFAS 13, companies must discount, or reduce, the future sums owed under
leases to translate them into present dollars. To discount these future sums, a discount rate must
be selected. This rate is usually tied to a market interest rate. By utilizing a lower discount rate
in such calculations, a company is able to incre
the up-front revenue and profits booked from
such leases. Conversely, a higher rate diminishes the present value of the lease, thereby reducing
64
near-term revenue and profit (Le. lowering the discount rate decreases the amount of unearned
income and increases current revenues at the outset of the leased tenn).
166.
Statement of Financial Concepts No. 7 ("CON 7") requires that present value
measurements should reflect the uncertainties inherent in the estimated cash flows; otherwise,
items with different risks may appear similar.
pecificaily, ¶ 25 states that "present value should
attempt to capture the elements that taken together would comprise a market price if one existed,
that is, fair value ." Paragraph 29 of CON 7 sta{es that the objective of fair value measurement of
future cash flows is "to approximate the rate which would have resulted if an independent
borrower and an independent lender had negotiated a similar transaction under comparable terms
and conditions with the option to pay the cash price upon purchase or to give a note for the
amount of the purchase which bears the prevailing rate of interest to maturity."
167.
According to Kimber Bascom, a. fellow at the Financial Accounting Standards
Board ("FASB"), in booking sales-type leases in high inflation countries, the discount rate
employed should be the implicit interest rate used to set payments in the lease contract and
should be "close to local interest rates." This is necessary to reflect the true value of the longterm lease. In very high inflation rate countries, it is more likely that future lease payments will
be worth significantly less due to inflation and currency devaluation.
168.
Contrary to SFAS 13 and CON 7, Xerox used artificially low interest rate
assumptions in valuing long-term leases in high inflation countries to boost its short-term results.
According to Bingham, at the direction of Xerox headquarters, Xerox managers used the low
interest to rates to meet Company revenue targets. In fact, Xerox managers were rewarded for
coming up with ways to lower the discount rate, typically toward the end of a quarter.
65
169.
reduced the discount rate used in valuing
In Mexico, for example, Xerox
its long-term leases far below local interest
between 1996 and 1999, according to a
confidential internal report commissioned by
Xerox board's audit committee (the "Akin
(Jump Report"). The Akin Gump Report
that Xerox Mexico booked leases using a
discount rate of 20% in 1996 for contracts
in Mexican pesos. At the direction of Xerox
headquarters, the unit reduced that rate to 18%
1997, 10% in 1998, and 6% in 1999.
During the same period,
ing to the Organization for Economic Cooperation
and Development, the average Mexican
rate on 10-year bonds fell to 22.5% in 1997 from
170.
ing two years. In 1999, when Xerox was
34.4% in 1996 but then jumped up slightly the
assuming a 6% discount interest rate, the
10-year rate was a staggering four times
higher, or 24.1 %.
171-
According to Mr. Bascom ofthe; FASB, booking a lease using a 6% discount rate,
compared with 24%, would result in a "huge i
act" in the amount of revenue a company can
•Fi P.
book up-front. Mr. Bascom 'f .rther stated that a company could book about 50% more revenue
up front with the lower discount rate.
172_
According to a Wall Street Journal article dated June 1, 2001, a Xerox internal
document, "marked 'confidential,' lists the discount-rate shift as the largest of 10 'one-time'
accounting 'actions' used by Xerox Mexico that had the effect of boosting results in 1999."
173.
Xerox also used similarly favoral le interest-rate assumptions in Brazil. Brazil
was one of Xerox's largest markets, annually contributing between 8 to 10% of corporate revenue
from 1996 to 1998. To artificially boost revenu on long-term leases in Brazil, Xerox used a
financing rate of 8% in early 1997, then dropped the rate to 7% in the third quarter of 1997,
66
eventually reducing the rate to no more than
through the second quarter of 2000. An
accurate rate would have been approximately
Brazilian treasury- bill rates from 1997 to
1999 ranged between 24.8% and 28.6% as an
average, according to the International
Monetary Fund. The SEC estimates that, had
used even its own borrowing rates as an
revenues reported for Brazil would have been
estimate of prevailing financing rates,
reduced by approximately $757 million
174.
1997 through 2000.
stated that, in May 1998, Xerox used a 15%
A former XBS manager in the
discount rate for Venezuela . By July 1999,
Xerox was using a substantially lower
discount rate of 8 to 9%. By contrast, Central
of Venezuela data indicates that average
interest rates for 1998 and 1 999 were 45.21%
175.
31.89%, respectively.
According to Paul R. Brown,
of the accounting department at the Stem
School of Business at New York University,
as reported by The Wall Street Journal on
February 6, 2001, the interest rate practice des
by Bingham and other former Xerox
executives constituted 'd clew violation of
rules. Mr. Brown also stated that "this is a
serious matter because it has a potential for a se ere overstatement of profits."
176.
Xerox revealed for the first time, when it released its amended Form 8-K on May
31, 2001 announcing its three year restatement of its financial statements, that it changed the
methodology it employed to determine the interest rate for its leases in high interest countries
such as Mexico and Venezuela.
177.
Xerox failed to disclose that it manipulated the discount rate applied to leased
copiers and the effect on the Company's earning violated the regulations of the SEC and
67
national stock exchanges. Specifically, Item
(a)(3)(ii) of Regulation S-K, promulgated by the
to:
SEC under the 1934 Act, requires a public
Describe any known trends or uncer
reasonably expects will have a mate:
sales or revenues or income from co
of events that will cause a material c
revenues (such as known future incr
increases or inventory adjustments),
disclosed.
ies that have had or that the registrant
y favorable or unfavorable impact on net
wing operations. If the registrant knows
ge in the relationship between costs and
s in costs of labor or materials or price
change in the relationship shall be
17 C.F.R. §229343(a)(3)(ii).
4.
178.
! the Maintenance, Supply and Labor
Leases
Xerox Prematurely Be
Portions of Its Long-T
Under applicable accounting rules, Xerox was allowed to book revenue and profit
related to the equipment portion at the commencement of such leases, notwithstanding that
customers paid for this portion of the lease ov
a period of several years . Xerox, however, was
not permitted to book revenue for service ands pplies at the inception of the lease. Such
revenue must be recogni ed under GAAP only
179.
hen customers ' monthly payments were due.
Specifically , SFAS 13, ¶ 17c. st es that "The present value of the minimum lease
payments (net of executory costs, including any profit thereon), computed at the interest rate
implicit in the lease, shall be recorded as the sales price." Therefore , revenue for a sales-type
lease, which is recognized upon inception of the", lease, may Only include the amount related to
the cost for use of the equipment. All other costs included in the lease contract, such as
maintenance, insurance, taxes, supplies, etc., are considered executory and are not recognizable
as revenue upon inception of the lease. Rather,
ey are required to be recognized, as earned,
over the term of the lease.
68
180.
in No. 90- 1, Accounting for Separately Priced
Moreover, FASB Technical
Extended Warranties and Product
Costs, directs that "revenue on extended
warranty and product maintenance contracts . I . should be recognized in income evenly over the
contract period ..."
181.
Statement of Financial Concepts No. 5 ("CON 5"), ¶ 83b, states that "revenues are
considered to be earned when the entity has substantially accomplished what it must do to be
entitled to the benefits represented by the revenues."
182.
To conceal deteriorating operations, Xerox improperly recorded as immediate
revenue from long-term leases the amounts paid on those lease contracts attributable to services
and supplies. A former XBS manager at Xerox corporate headquarters stated that it was
common practice to immediately recognize revenues for the maintenance to be provided over the
life of the lease . For example, if a portion of a three-year XBS agreement was attributable to
equipment maintenance, the entire portion would be recognized immediately, rather than over the
three-year period. Accordidg to this former XBS manager, this practice occurred in Brazil and
Mexico.
183.
Adriana Rios, the finance manager at the Mexican unit, said that Xerox corporate
headquarters directed the Mexican unit to routinely book portions of services and supplies upfront in violation of SFAS 13.
184.
By manipulating its assumptions about the value assigned to these lease
components, Xerox was able to book more income up-front instead of over time.
5.
Significant Risk of Non ayment or Cancellation on LTL Contracts
69
185.
SFAS 13, 1 8(a), states that
direct finance lease (LTL) is that "[c
predictable." Barring such collectibility, a
of the criteria to classify a lease as a sales-type or
of the minim um lease payments is reasonably
must be classified as an operating lease, from
which income is earned over the lease term as it becomes receivable . From the inception of such
contracts, collectibility was in question.
186.
Xerox knew or recklessly di
contained significant risks of nonpayment.
Company's DMQ at Xerox headquarters,
contracts, because the Company routinely did Fusi
that many contracts recorded as LTLs
to a former XBS manager in the
cancellation was a known concern on such
with companies that were credit risks,
particularly in Venezuela and Chile.
187.
According to an XBS manager ii the DMD, Xerox also recognized revenue with
certain customers in Mexico without having a
agreement, there would only be a "letter of u
instances, there was no documentation at all.
contract. Instead of an enforceable
between the parties. In other
also booked fictitious or inflated invoices in
Mexico, resulting in collectible accounts receivable. For example, certain Xerox customers with
$10,000 contracts received invoices for $25,00 to inflate Xerox' s revenues.
6.
188.
Xerox Improperly Reca
Revenue Streams from i
In a further effort to mask deterio Ling results from operations, Xerox improperly
booked revenue from sales to banks of revenue
189.
sized Revenue From the Sale of Future
Long-Term Rentals to Banks
Under accounting rules, when
from its long-term rentals ("LTRs")
rents equipment, revenue is supposed to be
recognized over the life of the rental agreement. By selling to banks rights to future income
streams from rentals, Xerox recognized revenue ^nd profit up-front rather than over time- This
conduct was in blatant violation SFAS 13,12 , which required Xerox to account for such
transactions as collateralized borrowings.
190-
According to a former strategy .tanager in the DMO, "revenue growth was very
slow, so the culture, in general, was what else 4an we do to help results." The perception was
that there were fundamental problems with the ^usiness because revenue was not growing. At
the end of each quarter, the senior managers, concerned with their bonuses, would turn their
attention toward achieving the results necessar to justify such bonuses. One particular method
relied upon by management to accomplish this
called PAS ("Portfolio Asset Strategy"), by
which revenue would be generated by taking
machines - which could only be booked as
revenue over a period of time. - and selling then to banks or other financial institutions, which
would, on the surface, create a rationale for booking the related revenue up-front. This activity
occurred at the direction of the DMO (located ' Stamford). According to Michael Festa
("Festa"), a former Vice President of Finance f
the DMO, senior management actually
discussed utilizing PAS'asi. way of boosting r
is at the end of various quarters throughout the
Class Period.
191.
According to a former XBS manger in the Company's DMO, the Company sold
future revenue to Citigroup for LTRs in Brazil (nd possibly Argentina) over the past three years.
Festa and another Xerox executive, believed to le named Phillip Devon, established the
guidelines for such transactions. XBS followed these guidelines, selling future revenue streams
to generate $26 million in revenue in the fourth
192.
of 1998 alone.
In sworn testimony to the SEC,
stated that in 1999, defendant Romeril
"directed underlings to boost income by selling
the rights to future revenues from Xerox
7.1
copiers" that were on rentals to customers.
practice enabled Xerox, in a five-quarter period
beginning in the second quarter of 1999, to
a total of about $321 million in revenue and
$182 million in profit in five transactions
three banks. Two of these transactions involved
Citibank and had the effect of accelerating into just two quarters much of the revenue and profit
from renting copiers to customers in Brazil
Xerox would have received over the next several
years. Xerox did not disclose this practice to
who were unaware that the Company
future quarters to boost short-term results.
was essentially stealing revenue and profits
193.
According to Bingham and as
by The Wall Street Journal on May 22,
2001, "Xerox executives were careful not to do too many rental transactions like the Citibank
deal in any one quarter to avoid reaching
that would be defined as material by the SEC and
therefore require disclosure of the one-time
to investors. `They're not worth doing if you
have to disclose them' was the prevailing
at Xerox."
194.
The first Citibank deal a llowed
revenue and $34 million iii:-pre-tax profits in
to book approximately $61 million in
second quarter of 1999. This enabled Xerox to
report earnings for the quarter that were in line
analysts' expectations. In fact, Bingham
testified to the SEC that Leslie Varon, Xerox's
of investor relations, told him "how much
she needed that revenue" in the second quarter to show investors that Xerox was continuing to
experience solid growth.
195.
On February 6, 2001, The Wall
Journal reported that Bingham, in a
presentation to Romeril and Kevin Colburn
director of internal audit), stated that Xerox
corporate officers offered verbal and written ass4rances to banks, guaranteeing payment on
72
rentals connected with these revenue stream s les. Because Xerox assumed this responsibility,
such sales were, in essence, bank loans to Xer x.
196.
With respect to the Citibank trsaction, Bingham told the SEC that before the
agreement was finalized, Bingham received a all from Citibank executive Jim Walsh. Walsh
informed Bingham that the bank "couldn't do this transaction without a guarantee" that the rental
revenue would not fall below projections. To satisfy Citibank, Bingham testified that Romeril
not let the transaction go bad.
gave an oral assurance to Citibank that Xerox
197.
After the transaction was
Bingham testified, Xerox took extraordinary
steps to ensure that Citibank did not lose
from the deal. The Wall Street Journal, reported
that, when the actual rental revenue from the ec ui
covered in the transaction began to fall
below what was guaranteed to Citibank, Xerox
pressured managers in its Brazil unit "to
boost it in later months by giving priority to
y re-renting those machines - instead of other
machines not in the Citibank deal. -when they
198.
ere returned to customers."
An internal memorandom to Bin
am from a Xerox Brazil manager dated
October 26, 1999 confirms this practice, statinglthat the rental revenue shortfall would be
remedied by giving "priority" to the Citibank
rental machines "in order to ensure a shorter
off-lease time" for them.
199.
As Bingham testified, in a later
with Citibank, which involved the
rights to future revenues from copiers in the U. S 1, Xerox's internal controls were inadequate and
could not distinguish the revenue that belonged o Citibank machines from that attributable to
other machines. Nonetheless, Xerox paid Citiba.k the monthly sum that it had originally
73
projected would be generated by the machines thereby guaranteeing Citibank a return and
confirming the inappropriateness of Xerox's
200.
ing applied to such transactions.
sale of future revenue streams from equipment
The recognition of revenue for
blatantly violated GAAP . Paragraph 22 of SFAS
rentals to banks and other financing
to a third party of lease payments due under
13 provides that the sale or assignment by the
an operating lease should be accounted for as 4 collateralized borrowing.
201.
Furthermore, by offering a guarantee, the risks associated with future payments
remained with the Company, which, according to SFAS 13, precludes the booming of the
SFAS 13 states that "[t]he sale of property
proceeds of such sales as revenues. In this
subject to an operating lease, ... shall not be
as a sale if the seller ... retains substantial
risks of ownership in the leased property."
202.
Thus, the Company's
of revenue upon the sale of the LTR revenue
streams was improper, as was its failure to
disclose the existence of these guarantee
arrang ements to investors: ,:,
203.
Furthermore, Defendants' failure to disclose that Xerox was improperly
recognizing revenue from the sale of future rev
ue streams from its LTRs violated Item
303(a)(3)(ii) of Regulation S-K.
7.
204.
Improper Income Reco
'lion Prior to Equipment Installation
According to a former XBS manager in the DMQ, Xerox improperly recognized
revenue on equipment prior to installation. For example, in 1998-1999 Xerox prematurely
recognized approximately $1 million in revenu
for equipment in connection with a First
Boston contract, despite the fact that the equipm
74
t was not installed until 5-6 months later.
Improper Accounting of LTL Contract Revisions and/or
Modifications
205.
Xerox also engaged in what a former manager in the XBS in the DM4 described
as "churning contracts." Churning occurred frequently with respect to Venezuelan and Chilean
contracts, as customers in these countries constantly requested that revisions and modifications
be made to their contracts . For LTLs in these countries, Xerox recorded up-front all revenues
associated with these LTLs. When a contract was churned, however, a new agreement for new
equipment would be executed prior to the expiration of the then-existing LTL. The unpaid
amounts due on the old lease would be built into the new agreement and Xerox recorded the
entire amount of the new lease as up-front revenue without writing-off or otherwise accounting
for the fact that the unpaid lease revenues were double-counted.
206.
For example, if there was a five year $250,000 lease, Xerox would record as
revenue the entire $250,000 up-front. When the lease was canceled, if there was $100,000
outstanding on a contract:wi h two years remaining, Xerox would add the $100,000 to the price
of the new agreement, payable over the entire term of the new agreement. But Xerox did not
reduce unearned revenues by the $100,000. Contracts would be repeatedly churned so that the
customer's obligation to pay the Company would be continuously extended over lengthy periods
and Xerox continually double-counted revenues.
207.
By so doing, the Company was able to boost its revenues by artificially inflating
the value of the new LTL since it failed to offset! the value of the original LTL agreement. For
example, according to a former Xerox XBS manager in the DMD, in 1999, Xerox engaged in a
transaction in Argentina that should have property resulted in an immediate $2.8 million write-
75
off of revenues and corresponding receivables on a modified LTL. Xerox did not record the
charge, however, until 2000 -- more than one
9.
208.
later.
"Off the Books"
goods to warehouses to be stored as
Xerox also routinely shipped
unreported inventory. For example, according1to a former Xerox employee in the Company's
manufacturing plant in Aguas Calientes, Mexico, from at least June 1996 to August 1999, Xerox
minimized inventory by shipping products from that plant, which manufactured copiers for
export to the United States, to an outside
These finished goods were not included on
this was "a common practice" that
the plant's books. According to that former
allowed them to "work on target." The former
explained that inventory would be sent
elsewhere if targets were exceeded to create the appearance that they had actually been achieved.
10.
209.
Failure to Write-off Bad Debts
In addition, Xerox failed to write-off mounting bad debts and improperly
classified transactions to i late current revenu^,s. Thus, Xerox delayed recording write-offs on
finance receivables when existing LTLs were
For example, according to a former
employee, in 1999, Xerox engaged in a
in Argentina that should have properly
resulted in an immediate $2.8 million write-off a modified LTL agreement. Xerox, however,
of
did not record the charge until 2000, more than a year later. This is in addition to the $100
million debt related to Mexico, as discussed supra.
210.
Xerox violated GAAP by not properly recording bad debt allowances related to
long-term receivables. Specifically, the Comp
a.
y violated:
SFAS No. 5, Accounting for Contingencies, which states that a contingency exists if, at the date of the financial statements, an enterprise does
76
Xerox Defendant's
Scienter
not expect to collect the full amount of its receivables. Under this
scenario, an accrual for loss contingency must be charged to income if
both of the following conditions exist:
b.
VI.
A.
lnforma ' n available prior to issuance of the financial
statemen s indicates that it is probable that an asset had
been imp gred or a liability had been incurred at the date of
the financial statements. It is implicit in this condition that
it must b4 probable that one or more future events will
occur corifrming the fact of the loss; and
B.
The amount of loss can be reasonably estimated; and
CON5 , Recognition and Measurement in Financial Statements ofBusiness
.Enterprises, which state that "[a3n expense or loss is recognized if it
becomes evident that pr ousiy recognized future economic benefits of an
asset have been reduced or eliminated ......
The Xerox Defendants' Scienter
211.
The Xerox Defendants knew of, Participated in, and/or recklessly disregarded the
fraud at Xerox. Among other things, the Xerox' Defendants knew of or recklessly disregarded: (1)
that Xerox' s equipment sales were declining
accounting manipulations were used to achieve
favorable financial rests; (ii) Defendants'
KPMG's) tracking of the impact of
"accounting actions" versus actual, underlying
ial results; (iii) that "accounting action"
directives emanated from Xerox senior
at corporate headquarters, as confirmed by
numerous sources; (iv) the Xerox Defendants' creation of a corporate culture focused on revenues
and on meeting analysts' expectations; (v) that Xerox's accounting irregularities violated simple,
unambiguous accounting principles; (vi) the enormous variety and magnitude of accounting
manipulations that pervaded the entire company (vii) Defendants' efforts to conceal the true
extent of the fraud wherever they were confront
Xerox Defendants' failure to cooperate with the S.
77
with evidence of its existence; and (viii) the
in its investigation.
212.
The Xerox Defendants were
tivated to commit securities violations to, inter
alia: (i) enable the Individual Defendants to sell material portions of their stock holdings and
reap tremendous proceeds; (ii) increase the
specifically linked to Xerox's yearly financial
offerings for nearly $9 billion worth of debt
down resulting from a Brazilian currency
idual Defendants' compensation, which was
(iii) enable Xerox to conduct at least four
(iv) offset an impending $1 billion writeion; (v) enable Xerox to make various credit
payments in light of its impending liquidity cri is; and (vi) enable Xerox to obtain third-party
financing of equipment sales critical to increasng Xerox's liquidity.
A.
The Xerox Defendants Had
the Fraud
213.
The Xerox Defendants'
propriety of Xerox's Class Period financial
evidence which was known or recklessly
214.
Knowledge of and Directly Participated in
regarding Xerox's accounting practices and the
were squarely contradicted by internal
by them.
The Xerox,Defendants knew of erox's accounting manipulations and knew that
they were done to enable the Company to meet
all Street's earning s estimates . The Xerox
Defendants approved of and expressly directed he use of "accounting actions." The SEC
concluded that "Xerox Senior Management wasl informed of the most material of these
accounting actions and the fact that they were
`closing the gap' to meet performance targets.
approved by senior Xerox management,
knew the actions distorted their operational
215,
During 1997 through 2000,
for the purpose of what the Company called
accounting actions were directed and
over protests from managers in the field who
" SEC Compl.116.
senior management included defendants Allaire
(CEO), Romeril (CFO), Thoman (President and ^DQ), Fishbach (VP and Controller), Tayler
(VP and Controller), and Mulcahy (President Of General Markets Operations). The SEC sent
Wells Notices to Allaire and Romeril, as well s to at least six other Xerox executives.
216.
Moreover, in its Complaint and in interviews, the SEC repeatedly acknowledged
fraud- Thus, the April 12, 2002 Dow
that senior Xerox personnel were aware of the
Jones Business News reported:
Xerox insiders even referred to as
by $1.5 billion from 1997 through 2000,
The improper moves, which the SEC
"accounting tricks," boosted pretax p
the complaint said ....
officials were scathing in describing a
in which accounting manipulation was
s. "Senior management had no
priate conduct," said Paul Berger,
in the complaint and in interviews, SE(
Xerox culture that had gone off the rails
an accepted tool at the very highest levf
compunctions about engaging in inappi
associate director of enforcement at the
217.
recognized that a fraud on the scale of the one
The Xerox Defendants
committed in Mexico alone was "deplorable." A Xerox February 1, 2001 release stated:
"Several managers of Xerox Mexico ci umvented well-established corporate
accounting and ethics policies and prat :es, and engaged in collusion," said Barry
Romeril, chief finAn6ial officer of Xert Corporation. "Their actions were
deplorable. These managers were prom ' fly removed from their positions as soon
as we learned of the problems. We subsequently terminated them after
confirming the nature and extent of their involvement. However, their actions
resulted in a broken trust with our custa ers and a troubling sense of dishonor
shouldered by all of our conscientious X rox Mexico employees who abide by
Xerox ethics policies and practices."
B.
The Xerox Defendants
218.
Significantly, the SECS
Impact of "Accounting Actions"
revealed that Xerox documented the impact
of its improper accounting in schedules and lists
so-called "one-offs,," in yearly reports and in
monthly and quarterly performance su „maries. 1these reports were distributed to and discussed
79
units also documented the impact of
by Xerox's financial management . Xerox's
accounting actions on its financial
219-
tracking "reported" versus "underlying" results.
underlying results with reported results,
In addition to its own reports
Xerox also regularly received information fror KPMG quantifying the impact of the Company's
improper accounting actions.
220.
In addition to the above
in November 1999, Romeril informed Xerox
senior management , including Allaire and
that without the benefit of the accounting
actions, Xerox essentially had "no growth"
the late 1990s. Xerox's vice. chairman,
William Buehler, conveyed the same conclusi
in October 1999 with respect to Xerox Europe
after reviewing information on the subsidiary's performance in the late 1990s. The president of
Xerox Europe, Pierre Danon, confirmed this cohclusion, stating that Xerox Europe's profit before
tax was in steady decline from 1996-1999, but one time "accounting actions" helped contain the
declining trend in reported profit.
221.
Xerox also- documented, in an i
presentation that was over 70 pages long,
how one Xerox unit could make up for an
deficiency by using a variety of accounting
manipulations . These manipulations included
boosting revenues by retroactively
changing the accounting methods used in
222.
quarters for equipment-leasing transactions.
Defendants were also aware that
fraudulently released into income excess
corporate reserves . According to the SEC
"senior management reviewed these
excess reserves on a quarterly basis and released1them when needed to close the gap between
operational earnings and Wall Street expectation." In fact, Xerox's corporate accounting
80
schedules called "Interdivisional
department tracked these excess reserves by
Opportunities" and "List of Unencumbered &
Reserves."
of Mexico Accounting Problems
C.
The Xerox Defendants'
223.
According to a number of form4r Xerox employees, problems with the Company's
accounting were brought to the attention of Xetox senior management by the beginning of the
Class Period or sooner. For instance, 77ie Watt Street Journal reported on February 7, 2041 that
Xerox senior management was informed of the problems existing in Mexico:
former Xerox Mexico executives claim
levels ofbad debt three years before X
special charge.
they warned U.S. officials ofrising
said the problem would result in a
Sandeep Thakone, the former Mexico
last year, warned his superior at the re,
to $18 million in unpaid bills in mid-1
Larry Rolnick. Early in the following
request for a $6 million to $8 million i
was rejected by Mr. Weber.
ace director who was forced to resign
ial division, Don Weber, of $16 million
, according to Mr. Thakone's lawyer,
r, the lawyer says, Mr. Thakone's
rve to offset some of the problem debts
In January 20OQ,
ton d o Robles, the fo
r Xerox Mexico general manager,
says he alerted Michel Festa, vice pr'esi eni of finance for developing markets, to
what Mr. Robles described as a $40 mil 'or to $50 million problem with unpaid
bills from customer accounts in Mexico.
But instead ofcorrective actions, M. k^' tiles says, the response from headquarters was "crazy. " He says his unit's pret vc profit goalfor 2000 was set by
Stamford headquarters at $154 million, a 20% increase from the $128 million
attained in 1999, despite the mounting bill troubles. A Jan. 27, 2000 , memo from
Gordon Nicol, a vice president in the developing markets group in Stamford,
includes the $154 million target. (emph .sis added).
224.
According to a former XBS m
ger in Xerox 's DMO , key individuals at the
DMO were fully aware of Mexico's accounting radices, including Festa and Pat Martin, the
general manager of Xerox' s Latin American divil ion. Xerox corporate headquarters personnel
provided local offices with the discount rates and RVs to be applied to leasing agreements.
81
225.
Moreover, a former Xerox XB$ manager who worked in the DMD stated that
Mexico's accounting practices were brought uO on numerous occasions during Mexican monthly
meetings were attended by the vice
management and business meetings. These
employees were discouraged from
presidents of various Xerox business groups,
discussing accounting issues at these
ings^ For example, Doug Willard, a former Xerox
ing issues and problems. When accounting issues
Vice President , refused to discuss such
were raised, Willard cut off the discussion by
that "it was not part of the agenda." The
refusal of senior Xerox officers to discuss
issues creates a strong inference that the
home office was well aware of those issues and refused to correct them.
226.
in the DM4, beginning about four years
According to a former XB.S
ago, the gross margins in Mexico became
large . In the first quarter of 1999, Xerox
instituted the use of monthly reports called
Page Managers." The One Page Managers for
Mexico , which were sent to Douglas Lord, a Vi
President in the DMD ("Lord"), sometimes
showed millions of dollars A month being capita
at 90-100% gross margin. The normal
gross margin on a contract, however, was
These figures facially indicated that the
allowances for services and labor expenses on
contracts were grossly understated.
Similar practices occurred in Chile, Argentina,
and parts of Europe. In 1999, Lord was
provided with monthly management letters on a least three separate occasions , warning of the
unreasonably high gross margins in certain
prematurely recognizing non-equipment
due to the Company's practice of
portions of lease contracts, and its concurrent
failure to account for expenses associated with
contracts. The same issues were raised in a
1999 conference call with Lord and other DMD members.` No corrective action was taken.
82
227_
I Florez, who served as Xerox's Mexico General
Furthermore , lawyers for R
accounting practices at Xerox Mexico were
Manager from 1994 until 1999, noted that
"arrived at with the consultation, if not the di ection of the Xerox Corporation accounting
both Mr. Florez and Mr. Thakone told the
department." According to The Wall Street
all accounting policies in Mexico.
SEC that Xerox corporate headquarters app
228.
ing Adriana Rios, a former Xerox Mexico
Former Xerox employees,
7, 2001 Wall Street Journal article, and former
finance manager who was cited in the Fel
XBS managers in the DMO, stated the
corporate headquarters routinely issued orders
to book portions of services and supplies
in violation of accounting rules.
D.
The Xerox Defendants' I
ge of Accounting Problems Beyond Mexico
229.
The Xerox Defendants'
or reckless disregard of accounting problems
extending beyond Mexico is equally clear. I
., the Xerox Defendants' reaction to Bingham's
report setting forth these problems, and their
ipts to conceal the information contained
therein, is telling of their ' state of mind.
230.
According to a former XBS n
accounting and finance offices were "in cons
ger in the DMO, personnel in Xerox's
battle with the sales force" over the revenue
recognition issues, with Xerox's corporate
quarter's personnel generally supporting the sales
force, which favored the improper, early
ition of revenues to meet sales targets.
231.
A former senior business
analyst for Xerox in Stamford stated that
management knew of accounting irreg
ieO because employees questioned how revenue was
booked on leased equipment - Xerox "
adhered to its estimates, thereby pressuring
83
ve revenue recognition techniques, including
employees . The Company thus fostered
delaying recording liabilities so that
232.
EPS numbers could be reached.
2000 Complaint against Xerox, Bingham
According to Bingham's N
Mulcahy and Romeril - on a trip to certain
accompanied senior Xerox management -
Xerox offices, including Xerox Mexico, in 1uir 2000. In connection with that trip, Bingham
prepared a memorandum outlining "si
accounting and reporting irregularities being
perpetrated by ... Xerox."
233.
Bingham's memorandum
that Xerox's accounting irregularities extended
beyond Mexico. This memorandum was ci
to Xerox Treasurer Eunice Filter. According
to the February 6, 2001 Wall Street Journal
describing Bingham's lawsuit, Filter told
Bingham to not distribute the memo and asked
"if be'wanted people to go to jail."' But
Bingham persisted and sent his memorandum to Romeril and Mulcahy. Filter's assistant ordered
Bingham to recall and "destroy" the
234.
Thereafter; Filter removed Bin
am from his position as Assistant Treasurer of
the Company. Romeril subsequently met with ¶inham and offered him a different position
within Xerox, but later withdrew the offer wh
Bingham indicated that he intended to pursue
the disclosure and correction of Xerox's
235.
and financial irregularities.
On August 28, 2000, Romeril,
in Colburn (Xerox's director of internal audit),
and another executive, met with. Bingham, who
a report outlining that many of the
accounting irregularities found in Mexico
in other Xerox operations around the world.
Bingham concluded in his report that there was 4 "high likelihood" that, in recent years, Xerox
had issued "misleading financial statements and }public disclosures."
84
236.
allegations , the Xerox Defendants fired him.
Instead of investigating Bi
30, 2000, his termination was the result of his
According to his termination letter dated
later admitted that, although PwC and
"disruptive and insubordinate behavior." The
Akin Gump conducted an investigation into tl a Mexico irregularities, this investigation did not
, when Akin Gump subsequently
include an analysis of Bingham's allegations.
contacted Xerox to suggest that its
is n be expanded beyond Mexico, the Xerox
Mexico only.
Defendants restricted Akin Gump to
237.
Bingham testified before the SF}C that Romeril, in 1999, directed underlings to
boost income by selling banks the right to
revenues from Xerox copiers that were in short-
term rentals to customers.
238.
Bingham also testified before th^ SEC that Xerox executives frequently assigned
accountants numerical goals to produce profits
"accounting actions." Bingham further
procedure that, you know, you look to the
testified that "[i]t just becomes standard
accountants to find incur
239.
Bingham further testified that Leslie Varon, Xerox's investor-relations chief,
warned him in early 1999 to "get rid of" his
options because Xerox was "falling apart at the
seams" and "everything is broken." Bingham
that operational problems prompted an
increase in accounting gimmickery to make up the shortfall.
240.
Bingham also testified that,
revelations of the Mexican accounting
problems in 2000, he attended a meeting in the
of Kevin CoIburn, Xerox's director of
world-wide audit, in which he, Colburn and Pet* Gallagher, an accounting manager, discussed
85
more than $500 million in special accounting ctions in 1998 and 1999 and Xerox's need to do
'everything" it could "to keep the investigatio to Mexico."
E.
The Xerox Defendants
and Meeting Analysts'
a Corporate Culture Focused On Revenues
ions Through Deceptive Accounting
241.
The Xerox Defendants'
of Xerox's improper accounting practices is
focused on its revenues and meeting Walt
also established by the fact that Xerox was
Street expectations. The Xerox Defendants paid close attention to meeting analysts' earnings
projections and closely managed the
242.
earnings to meet analysts' expectations.
throughout 1998-2000, the prices of high-tech
The Xerox Defendants knew
stocks of companies reported earnings even twb cents short of analysts' expectations were
severely punished by the market. As reported ih the April 2, 2002 issue of The Grand Rapids
Press:
"Everybody was trying to boost earningf to beat" analysts' earnings estimates,
said D. Larry Crumbley, accounting professor at Louisianna. State University. "If
you missed by-4-4 ?:
y, you got killed i the stockmarket," he said.
243.
Consistent with the SEC's concl
ions that Xerox's accounting function was
another revenue source and profit opportty,
Xerox Defendants created a culture where
revenues were everything and revenue goals
met no matter what it took to achieve them.
According to a manager in DMQ in Stamford,
growth was very slow, so the culture
became "what else can we do to help results."
244.
According to a former Xerox
at the end of each quarter the Company
would engage in a number of accounting mani
to boost results. In fact, sales of rental
streams were specifically timed to occur toward he end of each quarter . Festa, the VP of
8^
Finance in the DMQ, described it as a way to bo st results at the end of each quarter. Partial
asset sale agreements were "talked about in gen
245.
" and were well known within the DMD.
Further confirming the inappropriate corporate culture at the Company, in a Form
8-K filed with the SEC on October 5, 2001, Xerox stated:
KPMG emphasized the importance for internal control of the tone set by the
Company's top management KPMG noted that, as a result of its audit and
information reported by Special Counsel, it believed there was evidence that
management was not successful in setting the appropriate tone with respect to
financial reporting. It recommended that the Company take steps to remediate
appropriately those issues. Certain personnel changes are being made based in
part on KPMG views offered to the Audits Committee and management.
F.
Violations of Simple, Unambiguous Accounting Principles
246.
Many of the Xerox Defendants' accounting irregularities involved simple and
unambiguous accounting principles, giving rise to the inference that Defendants knew of or
recklessly disregarded their existence.
G.
The Magnitude of the Fraud Strongly Indicates All Defendants' Scienter
247.
Former SECChief Accountant, Lynn E. Turner, concluded that the $6.4 billion
misapplication of revenues must have been apparent. The June 29, 2002 Washington Post
reported:
"It boggles the mind that a company this size and its executives can make an error
of $6.4 billion and no one sees it until years later," said Lynn E. Turner, who was
chief accountant of the SEC during the Clinton administration. "It should make
investors wonder if the auditors would even notice Mount Everest if they were
driving by it."
248.
Mr. Turner expressed the same sentiment as to KPMG. As set forth in the
June 29, 2002 issue of the Los Angeles Times:
"These numbers have gotten so large that its akin to auditors driving past Mount
Everest and saying they never saw it How can you miss $6 billion?" said Lynn
87
Turner, former Securities Exchange Con
at Colorado State University. "It's a shah
gotten into the mind-set that this is OK."
249.
These comments are even more
fission chief accountant and a professor
that corporate America has somehow
given the fact that the Second Restatement
was in addition to the First Restatement.
H.
The Xerox Defendants' A
Accounting Irregularities
to Conceal the True Extent of the
es They Acted with Scienter
250.
In light of the Xerox Defendants'
knowledge of the Mexico accounting
problems well before the SEC investigation. commenced, and that these problems extended
beyond Mexico, the Xerox Defendants' continued denials and assurances that Xerox's accounting
was proper is telling of their true state of mind. Time and time again, when faced with
challenges to Xerox's practices, which Defendant knew were meritorious, the Xerox Defendants
simply denied and reiterated to the public that Xerox's accounting was correct. Time and time
again, however, Defendants' statements were proien to be demonstrably false.
251.
The Xerox Defen dants repeatedly downplayed the Mexican problems as a few
rogue employees' wrongdoing, which the Company had dealt with promptly and definitively.
252.
The Xerox Defendants consciously attempted to limit the scope of any
investigation into its accounting irregularities to Xerox's Mexican unit. Thus, while Xerox
publicly stated that its Audit Committee had hired Akin , Gump to conduct an "independent
investigation ," according to the April 10, 2002 Wall Street Journal, the Audit Committee told
Akan, Gump its mandate was limited to the Mexican unit. The Jurnal also reported that:
When Akin Gump lawyers ran across indications that aggressive accounting used
in Mexico on equipment leases had oecurr in other parts of the company,
internal Xerox lawyers told them to stick to Mexico, says a person familiar with
the matter. Xerox said a separate inquiry by its own management was looking at
88
accounting outside of Mexico. Overseei this inquiry, in part, was Mr. Romeril,
who as CFO was also responsible for tho a same accounting practices.
Xerox General Counsel Christina Clayton and Associate General Counsel Martin
Wagner intervened repeatedly as Akin Gnp was preparing its report, according
to the person familiar with the probe, who says the Xerox lawyers "would secondguess everything."
When Xerox released results of the Akin Gump probe in February 2001, the
Xerox news release quoted the company's Mr. Romerii as saying that the actions
of rogue managers at Xerox Mexico were "deplorable." But the company's
separate world-wide review, the release said, had concluded that these problems
didn't exist in any other Xerox unit.
1
253.
In the February 1, 2001 press release, Allaire stated: "We are confident that this
unfortunate and regrettable incident was the result of special c ircumstan ces conducted by a small
group of senior Xerox Mexico and Latin American group executives in collusion to circumvent
our policies and practices. We can say with confidence that the appropriate corrective actions
were taken and that those who were responsible were removed."
254.
During PwC's investigation, Bingham told Xerox senior management about
pervasive accounting irregularties. Xerox has specifically admitted these allegations were not
probed by PwC. When Bingham's allegations of accounting fraud beyond Mexico were made
public, Xerox flatly denied the allegations and painted Bingham as a disgruntled former
employee. The Xerox Defendants claimed that Binghara's allegations had been investigated and
dismissed. Tayler stated: "We took a look at the issues he raised" and "[w]e believe they are
factually without merit." Tayler added that Xerox is "quite comfortable with our reporting in
terms of generally accepted accounting principles."
255.
The Xerox Defendants continued to assure investors of the veracity of Xerox's
accounting methods even after an internal review by KPMG delayed the filing of its Form I d-K
89
for 2000. The Xerox Defendants continued to deny any wrongdoing, stating that the Company's
accounting policies and procedures were approp ' ate and consistent with GAAP.
256.
The Xerox Defendants' denials c
tinued when the SEC expanded its investiga-
tion of Xerox from Mexico operations to include other countries and transactions, including
those in Brazil. Xerox spokeswoman Christa Caron stated: "It's not appropriate for us to
comment in light of the SEC investigation, except to say the company's financial matters are in
line with generally accepted accounting principles."
257.
In connection with Xerox's First Restatement, which was nothing more than a
whitewash, Xerox Defendants stated: "After rigorous reviews of Xerox's accounting, no fictitious
transactions were found and the company's liquidity is not impacted."
258.
When shareholders expressed concern about the Mexico accounting irregularities
at the annual shareholder meeting on August 28, 2001, Mulcahy admitted that Xerox could not
predict the outcome of the SEC probe but repres rated that "jt]here's been a tremendous amount
of due diligence done."
-
259.
On October 5, 2001, Xerox filed alForm 8-K discussing the firing of KPMG. The
filing set forth various weaknesses in Xerox's ac
unting controls known to KPMG. KPMG
noted that, "there was evidence that management vas not successful in setting the appropriate
tone with respect to financial reporting." Xerox spokeswoman Christa Carone termed the firing
a change in auditors reflecting a desire to "approach the 2001 audit with a clean slate," and said
that Xerox feels "pretty strongly that the issues o Xerox's past accounting practices are behind
us." Xerox's Form 8-K stated that Xerox had "commenced actions in fiscal 2000 and expanded
90
actions in fiscal 2001 which, collectively, it believes have effectively addressed the abovediscussed matters.,'
260.
On December 7, 2001, Mulcahy riet with SEC Chairman Pitt, in an effort to
convince the SEC not to proceed against Xerox. I Although the SEC staff had told Mulcahy that
the Xerox investigation was off limits as a topic, ^ Mulcahy raised it anyway. According to news
reports, Chairman Pitt listened, but did not respond.
261.
When the SEC informed Xerox, on January 7, 2002, that its accounting
methodology for bundled leases did not comply with GAAP, Xerox informed investors that its
methodology did conform to GAAP and falsely stated that the differences between the two
methodologies was immaterial.
1.
The Xerox Defendants ' Lack of Cooperation with the SEC
262.
The Xerox Defendants falsely represented that they were cooperating with the
SEC. As reported in the April 12, 2002 Dow Jones Business News, when announcing Xerox's
agreement to pay the unprededented $ 10 million fine, SEC officials noted:
While Xerox has repeatedly said it cooperated fully with the SEC, federal
regulators said the opposite was true. "One of the things we took into
consideration was the lack of cooperation on the part of the company," said Mr.
Berger, explaining why the agency imposed such a hefty fine on Xerox. "We hope
it sends a signal [to other companies] that the appropriate thing to do is to be the
good corporate citizen and cooperate fully with law-enforcement authorities."
J.
The Xerox Defendants Were Financially Motivated to Participate in and/or
Recklessly Disregard Accounting Violations at Xerox and Conceal the
Company's True Financial Condition
263.
The Individual Defendants were motivated to engage in the fraudulent practices
alleged herein to, among other things, sell their Xerox shares at inflated prices.
91
264.
The Individual Defendants' positions within the Company made them privy to
confidential , propriety information concerning the Company's business, services, markets,
i
financial conditions and future business prospects.
265.
Notwithstanding their duty to refrain from trading Xerox stock or to disclose the
insider information before selling such stock, the Individual Defendants sold, prior to disclosure
of material adverse facts described above, shares of Xerox stock at prices that bad been
artificially inflated by defendants' materially false representations.
266.
Collectively, the Individual Defendants sold over 810,000 shares of Xerox
common stock during the Class Period at prices as high as $62.56 per share for total proceeds of
more than $55 million, as depicted on the following charts:
PAUL ALLAIRE
DATE
OPTION
OPTION
SHARES
SUBSEQUENT
TOTAL SALES
EXERCISE
EXERCISE
SOLD
SALES PRICE
PROCEEDS
PRICE
GAIN ON SALESEXERCISE
PRICE DIFF.
07/29/98
88,278
$13.1770
88,278
$54.5568
$4,816,160.78
$3,652,921.57
47/29/98
88,278
`'$13.1770
88,278
854.5568
$4,816,160.78
$3,652,921.57
07/29/98
23,444
$13.1774
23,444
$54.5568
$1,279,028.45
$970,106.86
Total on
200,000
$10, 911,350.00
$8,275,950.00
200,000
07/29/98
02/04/99
67,510
$13.1770
167,510
859.0937
$3,989,415.69
$3,099,836.42
02/04/99
130,490
$17.7604
130,490
$59.0937
$7,711,136.91
$5,393,580.14
©2104199
2,000
817.7604
2,000
$59.0937
$118,187.40
$82,666.57
Totalon
02/04/99
200,000
$11,818,740.40
$8,576,083.13
Total
400,000
$22,730,090. 00
$16,862.033.13
200,000
92
G. RICHARD THOMAN
DATE
OPTION
EXERCISE
OPTION
EXERCISE
PRICE
SHARES
SOLD
SUBSEQUENT
SALES PRICE
TOTAL SALES
PROCEEDS
GAIN ON SALESEXERCISE
PRICE DIFF.
02/01/99
200,000
$34.8125
200,000
$61.2025
$12,240,505.00
$5,278,005.00
02/03/99
100,000
534.8125
100,000
$61.1250
$6,112,500.00
$2,631,250.00
20,000
$8.1563
$163,125.00
$163,125.00
$18,516,130.00
$8,€ 72,380.00
10/2712000
Total
320,000
300,000
BARRY ROMERIL
DATE
OPTION
EXERCISE
OPTION
EXERCISE
PRICE
SHARES
SOLD
SUBSEQUENT
SALES PRICE
TOTAL SALES
PROCEEDS
GAIN ON SALESEXERCISE
PRICE DIFF.
04/28/98
30,162
519.2813
30,162
$55.6842
$1,679,546. 84
51 ,128,147.78
04/28/98
77,358
$18 .2813
77,358
$55.6842
$4,307,618.34
$2,893,417.41
$5,987,165.18
$4,021,565.18
$1,200,654.00
$1,200,654.00
$7,187,819. 18
$5,222,219.18
Total
02/04/99
Total
107,520
107,520
$0.0000
107,520
20,524
$58.5000
128,044
*Based upon assumption tflat s fares sold were granted via incentive program, essentially free shares; Form 4's
from 1996 - 1999 contain no open market purchases or option exercises without simultaneous sales.
ANNE AL MULCAHY
DATE
OPTION
EXERCISE
OPTION
EXERCISE
PRICE
SHARES
SOLD
SUBSEQUENT
SALES PRICE
TOTAL SALES
PROCEEDS
GAIN ON SALESEXERCISE
PRICE DIFF.
02/01/99
20,000
$18.2800
20,000
$62.500
$1,250,000.00
$884,400.00
02/01/99
2,000
$18.2800
2,000
$62.5550
$125,110.00
$88 ,550.00
$1 ,375,110.00
$972,950.00
Total
22,000
22,000
93
PHILIP D. FLSHBACH
DATE
SHARES
SOLD
SUBSEQUENT
SALES PRICE
TOTAL SALES
PROCEEDS
GAIN ON SALESEXERCISE
PRICE DIFF.
02/11/99
5,000
550.8750
$304 ,375.00
$304,375.00
Tota l
5,000 1
$'304,3475.00
$304,375.00
267_
OPTION
EXERCISE
OPTION
EXERCISE
PRICE
1
The Individual Defendants' stock sales during the Class Period were unusual and
suspicious in their amount because:
a.
During the Class Period, Allaire sold at least 400,000 shares of Xerox common
stock, resulting in a pre-tax profit of $16,862,033. In the two-year period preceding the start of
the Class Period, Defendant Allaire had no sales of Xerox common stock;
b.
During the Class Period, Thoman sold 320,000 shares of Xerox common stock,
resulting in a pre-tax profit of $8,072,380. From the time he joined Xerox in 1997 until his first
stock sale, Thoman had no sales of Xerox common stock;
c.
During the Class Period, Romeril sold 128,044 shares of Xerox common stock,
resulting in a pre-tax proft'of $5,222,219. In the two-year period preceding the start of the Class
Period, Romeril had no sales of Xerox common stock;
d.
During the Class Period, Mulcahy sold 22,000 shares of Xerox common stock,
resulting in a pre-tax profit of $972,950. In the two-year period preceding the start of the Class
period, Mulcahy had no sales of Xerox common stock; and
e.
During the Class Period, Fishbach sold 5,000 shares of Xerox common stock,
resulting in a pre-tax profit of $304,375. Fishbach had one sale in each of the two years
preceding the start of the Class Period, resulting in combined proceeds of less than $150,000.
94
268.
The Individual. Defendants' stock sales were unusual and suspicious in timing
because they were all made in close proximity to Xerox's announcements of positive quarterly or
year-end results. Most of the Individual Defendants had a significant sale within the two and
half week period after Xerox's positive fourth quarter and year-end 1998 earnings release on
January 26, 1999. In addition, Allaire sold 200,000 shares of Xerox common stock a mere six
days after Xerox announced positive results for the second quarter of 1998 on July 23, 1998, and
Romeril and Thoman each had large sales in the two week period following Xerox's
announcement of positive results for the third quarter of 2000 on October 24, 2000. Finally,
pursuant to a December 21, 1999 Registration Statement, Allaire registered to sell over 3.1
million Xerox shares; Romeril registered to sell 652,329 shares; and Thoman registered to sell
over 2.4 million shares of Xerox stock. The fact that these defendants registered for sale
virtually every share owned by them or which could be acquired by them pursuant to the exercise
of options, confirms their attempt to dump their shares prior to a full revelation of the extent of
Xerox's accounting fraud.259.
The Individual Defendants' stock sales are also unusual and suspicious in timing
because the sales were concentrated, with each of the Individual Defendants selling stock within
the same week or two week period.
270.
The Individual. Defendants were further motivated to engage in fraudulent
practices to garner enormous bonuses and stock options. According to a former manager in the
DM4, Xerox senior managers were always pushing to get revenue results because their bonuses
were tied to them. A former XBS manager in the.DMD stated that Xerox's accounting practices
95
were a source of heated debate within the
. The supporters of the practices were
typically the individuals who were "somehow
271.
using that model."
The Individual Defendants were
based on the Company's financial
performance. According to the Company's Aprii 14, 2000 proxy statement:
Base salaries are determined by the [Compensation] Committee [of the Board of
Directors], in its judgment, taking into account the competitive data referenced
above. In addition, a substantial portion, generally two-thirds or more of targeted
total compensation, of each executive Officer's total compensation is at risk and
variable from year to year because it is linked to specific performance measures of
the business.
272.
The SEC Complaint noted that at the height of Xerox' s accounting fraud, Xerox
executives were making tens of millions of dollars in bonuses and stock sales.
J.
Debt and Stock Offerings
273.
Additionally, the Company offered debentures and preferred stock during the
Class Period, the completion of which was essential given increasing liquidity crisis would have
been curtailed if the un¢isel.osed accounting violations and the Company's true financial
condition had come to light. For example:
a.
Pursuant to a registration statement (Form S-3) dated July 17, 1998, Xerox
sold convertible subordinated debentures due 201.8 at the issue price of $568.07 per $1,000
principal amount at maturity for a maximum aggregate offering price of $586 ,447,278;
b.
In May 1999, the Company, through Xerox Capital (Europe) plc, an
indirect wholly-owned subsidiary of the Company, issued 5.75% debentures maturing May 15,
2002 for net proceeds of $496 million;
Pursuant to a registration statement (Form S-3) dated March 10, 1999,
Xerox issued preferred stock for $4,000,000,000;
96
d.
Also in the fourth quarter of 2001, Xerox raised more than $1 billion
through an offering of convertible trust preferred securities. Xerox conducted the offering to
raise cash after its credit rating was downgraded, making it more expensive to borrow money;
and
In the first quarter of 2002, Xerox raised a net $746 million from its
unregistered sale of $600 million plus 225 million euros ($198 million) of 9.75 percent senior
notes. Net proceeds from the sale comprised US $559 million and 209 million euros.
K.
Xerox's Need to Raise Capital to Avert its Impending Liquidity Crisis
274.
The Company's impending liquidity crisis, which made it essential for the
Company to have access to the securities market to make its various credit payments, served as
an additional motive for concealing the undisclosed accounting violations. Although Xerox had
a $7 billion credit facility at the beginning of fiscal 2000 the Xerox Defendants knew that the
Company had debt of $17.2 billion as of the beginning of 2000, and faced debt payments of $1.1
billion in 2000 and another.-S 2.5 billion in 2001.
275.
Some of the Company' s credit problems were revealed in November 2000, when
Bloomberg Business News reported that Xerox would be forced to repurchase derivative
contracts worth $240 million if its credit ratings fell below investment grade, and a downgrade to
junk bond status would require Xerox to refinance $315 million in asset-backed securities. In
December 2000, the Company was required to repurchase $425 million in derivative contracts
and asset backed securities because Moody's Investor Services lowered the Company's long-term
senior credit rating and short-term rating.
97
276.
Xerox's October 2000 turnaround plan hinged on its ability to reduce debt and
increase its liquidity. According to analysts, increased liquidity would provide Xerox with
important leverage in renegotiating its $7 billion revolving line of credit, which was exhausted in
2000 and would mature in October 2002. Of critical importance to Xerox's debtreduction plan
was its ability to obtain tbird-party financing of its equipment sales, 75% - 80% of which
historically had been financed by Xerox. By the end of 2001, Xerox had entered into
agreements, primarily with G.E. Capital, to exit its customer-financing business in the United
States, Canada, France, Germany, the Netherlands, and the Nordic region. The agreements
raised approximately $3.2 billion, comprised of loans secured by lease receivables and sales of
lease receivables- The Xerox Defendants intentionally boosted Xerox's revenues by improperly
accounting for leases to make the business appear stronger than it actually was and to overstate
the value of the receivables to induce G.E. Capital to purchase Xerox's third-party financing
operation.'
277.
Xerox's ST-billion credit agreement expired on October 22, 2002. The Company's
October 23, 2001 release revealed that Xerox had recently initiated discussions with its agent
banks to refinance this line of credit. In Spring 2002, Xerox openly acknowledged that if the line
of credit were not refinanced, the bank group could declare a payment default and accelerate
'On November 27, 2001, Xerox announced that it received previously announced funding from
G.E. Capital, including $835 million secured by Xerox's U.S. lease receivables and $450 million secured
by U.K. receivables. On December 28, 2001, Xerox announced that it received $340 million from G.E.
Capital, secured by portions of its U.S. lease receivables. On March 27, 2002, the Company announced
that it received $266 million of financing from G.E. Capital, secured by portions of Xerox's U.S. lease
receivables. This was said to be in addition to the $1.2 billion received from G.E. Capital in 2001.
Additionally, Xerox announced the receipt of $291 million of financing from G.E. Capital for certain
Canadian lease receivables. On May 13, 2002, Xerox announced that it received S-496 million in
financing from G.E. Capital, secured by portions of the Company's U.S. lease receivables.
98
J
Statements
n
as.
maturity of the outstanding balance. On April 7, 2002, Xerox stated that such circumstances
could raise substantial doubt about its ability to continue as a going concern. On June 24, 2002,
Xerox announced that it had renegotiated its line of credit. Just four days later, Xerox stunned
the market by announcing that its prior accounting irregularities were twice as large as previously
disclosed.
278.
Xerox's 2001 bank facility had a;$3.2 billion tangible net worth covenant. As of
the third quarter of 2001, Xerox had a net worth cushion ofjust $200 million. In a June 11, 2002
report, Salomon Smith Barney estimated that the proposed restatement in connection with the
SEC Complaint, reducing pre-tax income by $115 billion, would reduce Xerox's tangible net
worth by $600 million, leaving Xerox in violation of its covenant.
VII.
KPMG's Scienter
A.
Background
279.
Defendant KPMG is a worldwide firm of certified public accountants, auditors
and consultants. Through its Stamford, Connecticut office, KPMG served as Xerox's auditor and
principal accounting firm prior to the Class Period and through October 4, 2001 . KPMG was
required to audit the Company's financial statements in accordance with GAAS, and report the
audit results to Xerox, its board of directors, its audit committee, and the members of the
investing public, including Plaintiffs and the other members of the Class. With knowledge of
Xerox's true financial condition, or in reckless disregard thereof, KPMG certified the false and
misleading financial statements of Xerox described below and provided unqualified Independent
Auditors' Reports, dated January 23, 199 8, January 25, 1999, January 25, 2000, and May 30,
2001, which were included in the Company's SEC filings and publicly disseminated statements.
99
ualified audit opinions and reports, the fraud
Without these materially false and misleading
alleged above could not have been perpetrated.
280.
G and Xerox dates back at least 30 years.
The close relationship between
role to Xerox, both as auditor and business
During the Class Period, KPMG served in a
largest clients of KPMG' s Stamford office.
consultant to the Company. Xerox was one of
just audit fees from Xerox.
As a result of its dual role, KPMG earned more
281.
Xerox was an extremely lucrative client for KPMG. Between 1997 and 2000,
Xerox paid KPMG $62 million, of which more than half was for consulting services. According
1, Xerox paid KPMG $11.3 million for audit
to Xerox's Proxy Statement filed on July 13,
services and $7.5 million for services unrelated
282.
Additionally, because the
ion of the KPMG partners is related to the
the KPMG partners on the Xerox
fees produced by the clients for whom they are
engagements have a direct financial motive to
the retention of Xerox as KPMG's client
and thereby ensure the co tihuation of millions
283.
the audit during the fiscal year 2000.
dollars in annual fees.
As a result , in violation of GAAS, KPMG's independence was directly
compromised by the receipt of such non-audit
B,
KPMG Had Full and Complete Access to Information
284.
KPMG, by virtue of its position a^ independent accountant and auditor of Xerox,
had access to the Company's files and key employees at all relevant times- KPMG personnel
were frequently present at Xerox's corporate headquarters throughout each year, and had
continual access to and knowledge of Xerox's co
100
dential internal corporate, financial, operating
states the following, inter alia, with respect
and business information . Indeed, KPMG's
to its close involvement with the Company at a# times during the fiscal year:
Year Round
[K.PMG's Business Measurement Proce s) provides you with a continuous audit
process. Your auditor stays in touch wi you year-round - keeping current with
your business and changing market con -tions, and providing you with ongoing
feedback on how your business decisio could affect your financial results.
Moreover, The Financial Statement A udit_ Why a New Age Requires An Evolving Methodology,
a publication prepared by KPMG and available t its website, states: "'Few are privy to as much
information as an auditor."' Id at 15.
285.
In addition, KPMG personnel had the opportunity to observe and review the
to test the Company's internal and publicly
Company's business and accounting practices,
reported financial statements, as well as the
internal controls and structures. More-
over, KPMG had access to, and regularly vi
286.
Xerox's Latin American divisions.
According tp a former Xerox
employee, KPMG frequently reviewed
sales transactions and always acted as advisors irk large transactions- Xerox's guidelines for
determining the amount to be attributed to the eq.i
extensively reviewed and approved by KPMG,
portion of such a lease were all
was thus aware of the existence of the very
revenue recognition issues at the crux of this
C.
KPMG's Actual Knowledge of o^ Reckless Disregard of the Fraud
287.
KPMG had actual knowledge of
most pervasive aspects of the fraud: the i
fraud. KPMG knew critical details of one the
recognition of revenue from leasing
transactions . The Akin, Gump Reportrevealed
approved of, all changes in lease assumptions.
101
KPMG had actual knowledge of, and
288.
machinations and regularly provided
KPMG even tracked Xerox's
Xerox with documents quantifying the impact ot the Company's accounting actions. In the 2000
Form 10-K filed in early June 2001, as part of the First Restatement, Xerox disclosed changes in
historical lease rate assumptions which added o^er half a billion dollars in revenues during 19971999 and a quarter of a billion dollars in pre-tax learnings. KPMG knew about the change in the
lease rate assumptions. Both the SEC and PwC concluded (and Xerox itself has admitted) that
the lease rate assumptions advocated by KPMG
289.
GAAP.
the Senior Audit Engagement Partner at
Sometime during 1997, Ronald
KPMG confronted Xerox management about
of the Company's accounting practices that
did not comply with GAAP. In response, the
Defendants did not provide explanations or
refute accusations of questionable accounting
but rather demanded that KPMG assign a
new engagement partner to Xerox. In a startling
of its duty to act as the public's
"watchdog," KPMG acquiesced and replaced ;
with Michael Conway in early 2000.
KPMG did not engage iii` ither investigation
issues raised by Safran.
1.
290.
KPMG Knew or Reckles
Arbitrarily Manipulated
from Long Term. Leases
As set forth above, Xerox used
in normalization" to artificially boost the
amount of revenue it received from LTLs.
knew this practice violated GAAP and
internally referred to the practice as "half-baked"
291.
Disregarded that Xerox Regularly and
sumptions Used to Calculae Revenues
Although KPMG expressed to
-recognition.
its concern about the frequency with which
the LTL revenue recognition methodology was
ing, KPMG took no corrective action and
permitted Xerox to recognize the revenue in violo on of GAAP.
102
292.
artificially low interest rate assumptions in
KPMG also knew that Xerox
:s to boost its short-term results. The Akin,
valuing long-term leases in high inflation
expressly approved Xerox's using such
Gump Report specifically determined that
artificially depressed interest rates to calculate
2.
from leases.
Disregarded that Xerox Improperly Used
ans of Leases to Boost its Financial Results
KPMG Knew or RE
Price Increases and
To accelerate the recognition of
through price increases and extensions
of leases on existing lease customers, in certain
ions, principally Brazil, Xerox negotiated or
293.
unilaterally imposed price increases and lease e
on existing lease customers. GAAP,
including SFAS 13 and SFAS 27, require that additional income realized from renegotiation of
existing leases be recognized over the remaining life of the lease. Xerox, however, immediately
recognized the revenue from the price increases
294.
KPMG knew of or recklessly di
lease extensions.
this practice and even informed Xerox
in early 1999 that the CoTpany's accounting for rice increases and lease extensions was in
flagrant disregard of GAAP. Xerox did not eeas this practice but merely reduced the amount of
revenue it recognized . Nonetheless, KPMG
3.
295.
off on the Company's financial statements.
KPMG Knew of or R
Increased Residual V
;sly Disregarded that Xerox Retroactively
of Leased Equipment
KPMG knew that, from 1997 to 1 ^99, Xerox recorded adjustments of more than
$95 million for retroactively upward revisions to the net residual value on machines in Europe,
GAAP requires that at the inception of the
Brazil, U.S., Argentina and Mexico operating
lease, the lessor must establish and record the
residual value" of the leased equipment.
SFAS 23 prohibits increasing the estimated residiial value•for any reason after it is first
103
established.
296.
In late 1996, Xerox's senior financial management presented the internal
accounting policy, called ACC 603, to KPMG, which called for the retroactive increase in RVs.
Initially, Safran, the KPMG audit partner, objected on the grounds that this practice violated
GAAP. However, after heated debates with management, KPMG approved its implementation
in 1997 and allowed the practice to continue through 1998.
D.
KPMG Knew or Recldessly Digs garded that Xerox' s Internal
Accounting Controls were Mate ially Deficient
297.
KPMG issued unqualified audit o inions on Xerox's financial statements for fiscal
years 1997, 1998, 1999 and 2000, turning a blind eye to Xerox's systemic accounting problems,
as well as the Company's weak and/or
298.
internal controls.
At all times relevant hereto,
recording and processing of financial
transactions exhibited significant internal control
formal policies and proeedires, which subjected
financial statement misstatements. Xerox
including the lack of appropriate
Company to significant risk of material
the existence of internal control deficiencies
in Mexico in its June 30, 2000 Form IO-Q:
the Audit Committee of the Board of Directors has launched an independent
investigation into the Mexican operation and an extensive review of the
Company's worldwide internal controls wis initiated to ensure that the issues
identified in Mexico are not present elsewhere.
299.
Likewise, in a July 27, 2000 eonfefence call, Romerii admitted that "self-
contained" units in Xerox Mexico had
for all facets of the business, and that this
"unique lack of separation of duties" was, in
300.
part, the cause of the accounting irregularities.
KPMG knew of or recklessly
the lack of internal controls and
104
segregation of duties within Xerox Mexico. Because these inadequacies, and the failure to
segregate was readily apparent to KPMG, K.PM
may be fairly imputed with knowledge of these
conditions.
301.
KPMG was aware of significant problems in Xerox's internal controls. The Form
8-K filed by Xerox announcing the Company's change in accountants stated, in part:
As a result of observations during its 2000 audit, and other information discussed
with the Audit Committee, KPMG reported certain material weaknesses in the
Company's internal control systems and made recommendations concerning
certain components of the Company's business- KPMG emphasized the importance for internal control of the tone set by the
Company's top management. KPMG nosed that, as a result of its audit and
information reported by Special Counsel it believed there was evidence that
management was not successful in setting the appropriate tone with respect to
financial reporting. It recommended thatt the Company take steps to remediate
appropriately those issues. Certain personnel changes are being made based in
part on KPMG views offered to the Audiit Committee and management.
- Customer Business Operations in the Company's North American Solutions
Group. KPMG noted issues with regard to CBO's ability to bill customers
accurately for services, and noted that difficulties in that area had resulted in
unfavorable billing: djustm.ennts during 2000. Although KPMG recognized that
the Company had initiated several steps to address this issue, it concluded that it
remained unclear when those changes would result in sustained improvement in
reducing non-cash resolution adjustments of billing differences. It acknowledged
that this weakness did not suggest that the net trade receivable account balance is
unreasonably stated at December 31, 2000, but that proper reporting required
extensive evaluation of billing adjustmen4s during the fourth quarter. KPMG
suggested various business and operational changes to address this issue.
- Communication of Accounting and Control Policies. KPMG noted that policy
documents need to be updated, among other things to address issues identified by
the Company's worldwide audit function, !Special Counsel and KPMG, and
recommended that the Company also proTide increased formal training to ensure
that its personnel understand the accounts and control guidance in its policies.
- Consolidation and Corporate-Level En es. KPMG observed that the
Company's quarterly consolidation process is manually intensive, requiring
numerous adjustments at corporate financial reporting levels. It recommended
105
that the Company's Consolidated Fina
enhance the monitoring and review of
further that the Company ensure adeqi
and approval of such entries.
I Information System be augmented to
)orate-level and manual entries, and
segregation of duties in the preparation
- Appropriatelness of the Concessionaire Business Model in Latin American
Countries. KPMG noted that during 200 , analysis by the Company's worldwide
audit function indicated that certain issues existed with respect to this business
model, including that certain concessionaires may lack economic substance
independent of the Company, and that certain business practices involving
concessionaires resulted in allowances with respect to receivables in 2000.
KPMG suggested periodic assessment of!the financial position of prospective and
existing concessionaires, and that the Company monitor its business relationship
with them to ensure that they are substantive independent distributors of the
Company's products.
302.
Ina letter to the SEC dated October 4, 2001, KPMG stated that it agreed with the
disclosures made by Xerox (with the exception of disclosures that it could not independently
verify as a result of its termination). Thus, KPMG had actual. knowledge of internal control
problems at Xerox, particularly with respect to sd called "Corporate Level Entries," which were
found by the SEC to be a principal part of the fraud perpetrated by Xerox.
E.
KPMG Ignoied Red Flags
303.
There were seemingly countless red flags waving at KPMG, alerting it to the
misstatements in Xerox's financial statements . If these red flags had been investigated by
KPMG, as it was obligated to do under GAAS, KMG would not have issued unqualified audit
I
opinions. In certifying Xerox's fiscal 1997-2UUU financial statements, KPMG falsely issued
unqualified audit opinion letters stating that it had conducted its audits in accordance with
GAAS. In reality, KPMG repeatedly refused to see the obvious or to investigate the doubtful,
and its audit judgments in numerous respects were such that no reasonable accountant or auditor
would have made the same decisions if confronted: with the°same facts and circumstances.
106
1.
304.
Non-Standard Journal
As revealed in the SEC
ifit, Xerox carried out the fraud primarily by
books in order to bridge the gap between actual
recording so-called "top-side" adjustments to
is also referred to as a non-standard
and desired financial results. A "top-side" adj
journal entry or one which is manually
instead of resulting automatically from the
normal operations of a company's
accounting system. In 1998, the American
Institute of Certified Public Accountants ("
A") issued Audit Risk Alert "98-2, Professional
Alert states , in part:
Skepticism and Related Topics." This Audit
Non-standard journal entries are ones tlN
business, such as the provision for loan I
obsolescence and cut-off or period-end a
may pose increased risk to the auditor in
management to manipulate earnings and
account.
are made outside the normal course of
;ses, provision for inventorsustments. Non-standard journal entries
lat they might conceal attempts by
in be recorded in practically any
Because of the risk associated with
auditors should review
entries , the AICPA counseled that
I ron-standard journal
to ensure they are not being used to
to the AICPA from the SEC in October of
manipulate financial results. Moreover, in a let
2000, the staff of the SEC stated:
In its final report, the Panel on Audit Effe
misstatements are often perpetrated by us
fictitious transactions or other events and
of the reporting period. The Panel's quasi
15% of the engagements reviewed, audits
understanding of the client's system for pi
standard entries. Furthermore, the Panel
procedures to identify and review non-sta
engagements reviewed. Given the Panel',
should review non-standard journal entric
subject to further detail testing.
tiveness found that financial statement
ig non-standard entries to record
;ircumstances , particularly near the end
peer review disclosed that in about
s did not have an adequate
'P
g, processing, and approving non)und that auditors did not perform
dard entries in about 3I /e of the
findings, the staff believes auditors
to identify those entries that should be
In light of the AICPA and the SEC warnings, KPMG either knew of the non-standard journal
107
entries or was reckless in not reviewing them to insure that management was not manipulating
Xerox's financial results.
2.
305.
KPMG Recklessly Disre garded Trends Further Indicating Fraud
As alleged above, in Mexico, Brazil and Venezuela, countries with extremely high
inflation rates, Xerox was rapidly reducing the i scount rate used in valuing its long-term leases
far below the local interest rates, even though G, kAP required the use of a discount rate
commensurate with the local borrowing rate. Ch oss margins in Mexico were also becoming
unreasonably large. While the normal gross = gin on equipment was 40-45%, Xerox often
recorded transactions at a gross margin of 90-10 %. These figures facially indicated to KPMG
that Xerox was severely understating its expens .
306.
KPMG ignored rising levels of
d debt. For example, former Xerox Mexico
executives stated that in 1997 they warned exec Ives in Xerox headquarters of the rising levels
of bad debt on long-term receivables. The bad de bts resulted in approximately $120 million in
write-offs of long-term receivables for the year
307.
ded December 31, 2000.
Moreover, the majority of Xerox' accounting actions occurred toward the end of
each quarter. For example, the sales of rental str
s occurred toward the end of each quarter to
boost results. The suspicious timing of this reve ue recognition was yet another classic "red
flag" heightening KPMG's awareness of the inac uracy of Xerox's financial statements.
3.
308.
KPMG Knew of or Rec essly Disregarded Improper Reserves
Asset forth above, Xerox violated GAAP by improperly establishing a $100
million reserve in connection with its June 1997 a cquisition of Rank. According to the SEC,
Xerox informed KPMG, by the end of 1997, that ,Xerox did not need the reserve for costs
108
allowed Xerox to record the reserve.
associated with the acquisition, but KPMG
Thereafter, the reserve was used for purposes
than the costs related to the acquisition.
Importantly, the Company's Audit Committee
fined that the charge was improperly
recorded at the time it was taken
4.
309.
the SEC's Investigation
Bingham ' s Allegations
Form 10-K, KPMG was aware of Binge's
Prior to signing off on Xerox's
alle gatin _ s that Xer
ices extended well beyond Mexico and that
's fraudulent accounting
into Xerox's accounting practices.
the SEC was conducting a Wide-scale investigg
310.
h of the SEC's investigation by virtue of the
KPMG was also aware of the
fact that the SEC subpoenaed KPMG partner I
d Safran in March of 2001 and confronted
Safran with a multitude of internal documents
discussed the Company's use of "accounting
actions" to meet or exceed earnings targets- In i
presentation that was over 70 pages in length, d
for an earnings shortfall by`employing a numbe,
311.
Nonetheless, KPMG ultimately s
Safi-an was shown a Xerox internal
the ways one Xerox unit could make up
accounting manipulations.
xd off on Xerox's 2000 Form 10-K after
Xerox made relatively minor restatements of its
financials . Significantly, the First
Restatement represented less than ten percent of
actual overstatement of pre-tax income
during the Class Period.
5.
312.
KPMG Knew of or
Risk Factors
Disregarded Significant
AU § 316 gives many examples o risk factors relating to misstatements arising
from fraudulent financial reporting, each of whic were present at Xerox during the Class Period.
For example:
109
a.
compensation is represented by bonuses,
A significant portion of
is contingent upon the entity achieving
stock options, or other incentives, the value of
unduly aggressive targets for operating results;
b.
Management displays excessive
in maintaining or increasing the entity's
aggressive accounting policies;
stock price or earnings trend through the use
c.
financial targets and expectations for
management sets unduly
operating personnel;
d.
High degree of competition,
e.
Especially high vulnerability to
F.
KPMG' S Efforts to Cover Up
313.
Notwithstanding KPMG's
ied by declining margins, and
in interest rates.
Fraud
that it stood up to Xerox by requiring the
First Restatement, that restatement was a
by KPMG, designed to cover-up the
massive accounting fraud at Xerox.
314.
The First Restatement was only
after Safran was subpoenaed to appear
with numerous "smoking guns" with regard
before the SEC in March 2001 and was
to the numerous accounting irregularities
315.
in by Xerox.
Thus, while KPMG claims to be
shareholders' advocate, the facts paint a
vastly different picture. As reported in the May 6, 2002 Wall Street Journal:
The SEC begs to differ. Determined to crack down on shoddy auditing in the
wake of the Enron Corp. scandal., the ag icy is training its sights on KPMG and
its handling of Xerox's financial reports. ' What KPMG did, SEC staffers believe,
was too little, too late. In a complaint file against Xerox last month, the SEC
charged that the company conducted wid ,spread fraud that resulted in improper
booking of $1.5 billion in pretax profits
m 1997 to 2000. KPMG placed its seal
of approval on Xerox reports for each one, of those. four years.
110
In its complaint, the SEC cited a numb
allegedly knew about what the agency,
accounting techniques at Xerox. One )
case - shifting revenues the company e
service to equipment sales so they coin
auditors, the SEC complaint said, even
"half-baked revenue recognition."
of instances in which KPMG auditors
aims were improper or misleading
rox maneuver at the heart of the SEC's
pected to receive from supplies and
be reported sooner -- was allowed by
tough KPMG internally referred to it as
Far from heroically standing up to Xem , I 'MG is portrayed in the SEC
complaint against Xerox as a virtual. pu over. When Mr. Safran challenged some
improper Xerox accounting techniques, e SEC claims, Xerox asked to have him
replaced. "The audit firm complied," the SEC complaint says. After the first
quarter of 2000, KPMG reassigned the Xerox account from Mr. Safm to senior
KPMG partner Michael Conway. KPMG declined to make Mr. Safi-an available
for comment.
One matter that has especially rankled t1^e SEC, say people familiar with the case,
is that KPMG ultimately signed off on the 2000 annual report, or 10K, after
Xerox made only minor restatements of its past financials. KPMG did this, say
these people, knowing that the SEC already suspected the massive overstatement
of profit from 1997 to 2000 that it detailed in its consent decree with Xerox. The
SEC staff, this person says, "couldn't believe, to say the least, that" Xerox "filed
the 10K with a minimal restatement and came out with a press release saying they
had cleaned everything up, knowing full well that the staff still had serious
problems."
316.
After the SEC Complaint was filed, both Conway and KPMG were sent Wells
Notices by the SEC, even though KPMG had publicly admitted it had already urged upon the
SEC its view that it had acted appropriately in purportedly standing up to Xerox
317.
In March 2001, KPMG and its attorneys confronted Xerox officials with some of
the "smoking guns" shown to KPMG by the SEC. The May 6, 2002 Wall Street Journal
reported:
The first document brought up by the KPMG team was an anonymous note to
Messrs. Romeril and Allaire, alleging "fak transactions" and "illegal revenue
recognition." It was signed "Xerox China 3, yal employees."
Mr. Romeril's reply : "I suspect we get one or two of these per week," says a
ill
Right away, this person says, "the
MG interpreted Mr. Romeril's response
ln't recognize it was not a good thing to
" says Mr. [KPMG Outside attorney]
:king comment.
participant who took notes at the meeti
meeting wasn't going well for Xerox."
as a signal that "this was a culture that
be getting anonymous letters aboutfra
Young. Mr. Romeril didn't return calls
318.
it was exonerated by PwC's review of the
While KPMG publicly claims
PwC actually replaced KPMG-as Xerox's
accounting issues preceding the First
auditor and required the massive Second
VIII.
and Misleading Earnings Releases,
e Results and Audit Reports
Defendants' Additional Materially
Financial Statements , Guidance of
A.
KPMG's False and Misleading
319.
GAAS provide that an audit
Opinions
must state whether a company's financial
statements are presented in conformity with G
. AU § 110.01. The audit reports issued and
signed by defendant KPMG for fiscal 1997
2000 during the Class Period falsely
represented that Xerox's financial statements for
reported periods were presented in
conformity with GAAP,yhen, as noted above, s
financial statements violated GAAP in a
myriad of ways. Had these financial statements
prepared in accordance with GAAP,
Xerox's net income, earnings per share, total
and stockholder's equity (among other
financial statement items) would have been
320.
y and materially reduced.
The following KPMG report,
enclosed with the Company's 1997
Annual Report to Shareholders, was annexed to
Report of Independent Auditors
To the Board of Directors and S
1997 Form 10-K:
of Xerox Corporation
We have audited the consolidated balance sheets of Xerox Corporation and
consolidated subsidiaries as of December 1, 1997 and 1996, and the related'
consolidated statements of income and c
flows for each ofthe years in the
three-year period ended December 31, 19 7. These consolidated financial
112
)mpany's management- Our
statements are the responsibility of the
responsibility is to express an opinion
based on our audits.
these consolidated financial statements
We conducted our audits in accordance 'th generally accepted auditing
standards. Those standards require that e plan and perform the audit to obtain
reasonable assurance about whether the nsolidated financial statements are free
of material misstatement. An audit inch as examining, on a test basis, evidence
supporting the amounts and disclosures the consolidated financial statements.
An audit also includes assessing the aco rating principles used and significant
evaluating the overall consolidated
estimates made by management, as well
financial statement presentation. We be^ we that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated- Inane statements appearing on pages 30, 38,
42 and 46-65 presentfairly, in all mate ri respects, the financial position of
Xerox Corporation and consolidated si, ddiaries as ofDecember 31, 1997 and
1996, and the results oftheir operation ,ad their cashflowsfor each ofthe years
in the three-year period ended Decemb, 31, 1997, inconformity with generally
accepted accounting principles.
Isl KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
Stamford, Connecticut
January 23, 1998 (emphasis a
321.
Additionally, the following
report, supplied as part of the Company's 1998
Annual Report to Shareholders, was included in
1998 Form T O-K:
Report of Independent Auditors
To the Board of Directors and S
of Xerox Corporation
We have audited the consolidated
Corporation and consolidated sub:
1998 and 1997, and the related coi
cash flows and shareholders' equit
three-year period ended Decembei
financial statements are the respor
management. Our responsibility i
consolidated financial statements I
sheets of Xerox
as of December 31,
.d statements of income,
r for each of the years in the
31, 1998. These consolidated
of the Company's
to express an opinion on these
ased on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
113
assurance about whether the
perform the audit to obtain rea
consolidated financial statemer are free of material misstatement.
An audit includes examining, c a test basis, evidence supporting
the amounts and disclosures in c consolidated financial
statements. An audit also inch -s assessing the accounting
principles used and significant timates made by management, as
financial statement
well as evaluating the overall c
audits provide a reasonable basis
presentation. We believe that i
for our opinion.
In our opinion, the consolidated nancial statements appearing on
pages 23, 33, 36 and 40-61 Ares itfairly, in all material respects,
the financial position ofXerox C rporation and consolidated
subsidiaries as ofDecember 31, 998 and 1997, and the results of
their operations and their cashflowsfor each ofthe years in the
three-year period ended December 31, 1998, inconformity with
generally accepted accounting principles.
KPMG LLP
Stamford, Connecticut
January 25, 1999 (emphasis added).
322.
1
Moreover, the following Report from KPMG supplied as part of the Company's
1999 Annual Report to Shareholders was inciudcd in the 1999 Form 1 Q-K:
Report-6f 4idependent Auditors
To the Board of Directors and Shareholders of Xerox Corporation:
We have audited the consolidated balance sheets of Xerox
Corporation and consolidated su1
as of December 31,
1999 and 1998, and the related ct solidated statements of income,
cash flows and shareholders' equi for each of the years in the
three-year period ended Decembc 31, 1999. These consolidated
financial statements are the respo sibility of the Company's
management. Our responsibility i to express an opinion on these
consolidated financial statements ased on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the consolidatedfinancial stateme^zts arefree ofmaterial
misstatement. An audit includes e^arnining, on a test basis,
114
evidence supporting the amounts and disclosures in the
consolidated financial statement. An audit also includes assessing
the accounting principles used aid significant estimates made by
management, as well as evaluating the overall consolidated
finances statement presentation. i We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the consolidatedfinancial statements appearing on
pages 42 through 65 presentfairly, in all material respects, the
financial position ofXerax Corporation and consolidated
subsidiaries as ofDecember 31, 1999 and 1998, and the results of
their operations and their cash Bows for each ofthe years in the
three-year period ended DecembL-r 31, 1999, in conformity with
generally accepted accountingprinciples_
Isl KPMG LLP
KPMG LLP
Stamford, Connecticut
January 25, 2Q00 (emphasis added).
323
The following Report from KPMG supplied as part of the Company's 2000
Annual Report to Shareholders was included in the 2000 Form 10-K:
Report of Independent Auditors Ieport of Independent Auditors
To the Board of Directors and Shareholders of Xerox Corporation.
We have audited the consolidated balance sheets of Xerox
Corporation and consolidated sub idiaries as of December 31,
2000 and 1999, and the related co solidated statements of
operations, cash flows, and shareholders' equity for each of the
three years in the three year period ended December 31, 2000.
These consolidated financial statements are the responsibility of
the Company's management. Our'esponsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United Mates of America. Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial
statements are free of material mi$tatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
115
disclosures in the consolidated fi:
includes assessing the accountin€
estimates made by management,
consolidated financial statement
audits provide a reasonable basis
ancial statements. An audit also
principles used and significant
s well as evaluating the overall
resentation. We believe that our
for our opinion.
In our opinion, the consolidated financial statements appearing on
pages 16 through 47 present fairli, in all material respects, the
financial position of Xerox Corporation and consolidated
subsidiaries as of December 31, 2400 and 1999, and the results of
their operations and their cash flows for each of the three years in
the three year period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of
America.
As discussed in Note 2 to the consolidated financial statements, the
accompanying consolidated balance sheet as of December 31,
1999, and the related consolidated statements of operations, cash
flows, and shareholders' equity for the years ended December 31,
1999 and December 31, 1998 have been restated.
The supplementary quarterly fina ici.ai information on page 48 of
the Company's Annual Report contains information that we did not
audit, and accordingly, we do not express an opinion on that
information. We did not have an adequate basis to complete
reviews of the quarterly information in accordance with standards
establishes y the American Institute of Certified Public
Accountants, due to the matters related to the restatement issues as
described in Note 2 to the consolidated financial statements.
Is! KPMG LLP
KPMG LLP
Stamford , Connecticut
May 30, 2001
324.
The foregoing audit reports issued by KPMG were materially false and
misleading because the financial statements referred to therein were not in conformity with
GAAP. The audit reports were also materially false and misleading because the audits referred
to therein were not conducted in accordance with GAAS.
116
B.
The Xerox Defendants ' False and Misleading Statements
325.
On January 23, 1998, Xerox ann unced its results for the fourth quarter and year
ended December 31, 1997. Net income was reported to have increased 23% to $525 million, and
diluted earnings increased 24°/o to $1.46 per share. The announcement noted that "[f]ourth
quarter income also benefitted from the June 1997 acquisition of the Rank Group's remaining
interest in Rank Xerox .... r,
326.
On March 23, 1995, the Company filed its 1997 Form 10-K (the "1997 Form 10-
K"), signed by Thoman, Allaire, Romezii, and Fishbach. As set forth in the 1997 Form 10-K, the
Company reported $18.166 billion in revenue, $2.14 billion in pre-tax income and net income of
$1.452 billion. Basic earnings per share were reported to be $4.31, while diluted earnings per
share were reported to be $4.04.
327.
The 1997 Form 10-K contained
following "Report of Management" attesting
to the adequacy of Xerox's accounting controls:
Report of Mana.gE rent
Xerox Corporation management is responsible for the integrity and objectivity of
the financial data presented in this annualI report. The consolidatedfinancial
statements were prepared in conformity th generally accepted accounting
principles and include amounts based on management !s, best estimates and
judgments.
The Company maintains an internal control structure designed to provide
reasonable assurance that assets are safeguarded against loss or unauthorized
use and thatfinancial records are adequate and can be relied upon to produce
financial statements in accordance with generally accepted accounting principles.
This structure includes the hiring and training of qualified people, written
accounting and control policies and procedures, clearly drawn lines ofaccountability and delegations ofauthority. In a b
ethics policy that is communisu^ess
cated annually to all employees, the Cola any
has established its intent to adhere
to the highest standards ofethical conduct in all of its business activities.
117
I structure with direct management
internal audits. In addition. KPMG
have audited the consolidated financial
control structure to the extent they
The Company monitors its internal car,
reviews and a comprehensive program
Peat Marwick LLP, independent auditc
statements and have reviewed the inter.
considered necessary to support their n
328.
rt, which follows. (emphasis added).
reported that revenue in its "Other Areas,"
In its 1997 Form IO-K, the
principally comprised of Mexico, Latin
Canada, and China, grew 8% pre-currency
adjustment, or more than any other
region. The Company stated:
Other Areas 1997 revenue reflects good growth in Brazil and China, modest
growth in Canada, and excellent growth in Mexico. Revenues in Brazil were $1.8
billion in 1997, $1.6 billion in 1996 and $L3 billion in 1995. (emphasis added).
329.
Also in the 1997 Form 10-K, un er the heading "Revenue Recognition," the
Company described the manner in which it recognized revenues pursuant to its installment
contracts and sales-type leases:
Revenues from the sale of equipment unt
sales-type leases are recognized at the tir
respectively. Associated finance income
effective annual yield method. Revenues
accounted for b^ e operating lease met]
term. Service revenues are derivedprim
equipment sold to customers and are rea
(emphasis added).
330.
er the installment contracts and from
e of sale or at the inception of the lease,
is earned on an accrual basis under an
from equipment under other leases are
od and are recognized over the lease
rily from maintenance contracts on our
gnized over the term ofthe contracts.
Additionally, the Company
its accounting policies for determining
provisions for losses on uncollectible
"provisions for losses on uncollectible trade
and finance receivables are determined
331.
on the basis of past collection experience."
In the 1997 Form I O-K, the
also reported on its Rank acquisition:
In June 1997, the company completed the cquisition of The Rank Group's
remaining 20 percent financial interest in erox Limited and related companies
for (pound)940 million, or approximately 1.5 billion.
118
332.
Additionally, in the 1997 Form 10-K, the Company described its hedging
transactions pertaining to foreign currency fluctuations:
In order to manage the risk of foreign ci
hedge a significant portion of all transac
invested) denominated in a currency ott
to each of our legal entities. From time
derivatives are used to hedge internatioi
:ncy exchange rate fluctuations, we
ns (except for amounts "permanently"
than the functional currency applicable
time, when cost-effective, currency
equity investments.
Consistent with the nature of the econo 'c hedge of such foreign currency
exchange contracts, associated unrealize gains or losses would be offset by
corresponding decreases or increases in the value of the underlying asset or
liability being hedged.
333.
the statements identified in paragraphs 325 to 332 were materially false and
misleading when made and/or omitted to disclose material facts due to, inter alia:
a.
Xerox's financial statements were not prepared in accordance with GAAP;
b.
The internal controls at X
C.
The Xerox Defendants kn w or recklessly disregarded that the Company's
x were deficient or non-existent;
reported financial results were materially inflated by the improper accounting identified above;
d.
The Company's purported.growth in Mexico and Brazil was, in significant
part, the product of the accounting machinations set forth above;
e.
The Company was
f
Service revenues were not
hedged against currency fluctuations;
contracts, but were in many cases, improperly
g.
over the terms of Xerox's equipment
on an accelerated basis;
The Xerox Defendants knew or recklessly disregarded that Xerox Mexico
recorded revenues from inflated and/or fictitious invoices which resulted in uncollectible
receivables for which inadequate reserves were e
119
fished; and
h.
The 1997 financial results improperly included a $100 million reserve
which was improperly established in connectio1 with the Rank acquisition.
334.
On April 22, 1998, Xerox announced its results for the first quarter of 1998.
Income and earnings were reported to have increased 12% to $301 million, or 84 cents per
diluted share, before a previously announced after-tax charge of $190 million in connection with
the Company's discontinued financial services operations. The Company claimed "strong
revenue growth for the second quarter," and further stated that "Latin American operations
continued their strong performance. ..." (emphasis added).
335.
Two days later, on April 24, 1998, Xerox issued a release entitled "Xerox Briefs
Investors on `98 Growth Plans." This release stated:
Xerox Corporation's senior management today outlined aggressive plans for
double-digit revenue and earnings growth through a variety of major initiatives...
Barry D. Romeril, executive vice president and chief financial officer,
underscored the importance of consistent earning s performance as an element of
the total XeroxIi
pgy. He said that "Xerox has delivered 15 percent operational
earnings-per-share growth in 11 of the last 12 quarters -- better than other
leadership companies."
336.
On April 24, 1998 , Dow Jones News reported that:
Xerox spokesman Judd Everhart told Dow Jones the company anticipates annual
earnings-per-share percentage growth in the mid- to high-teens. He also said
Xerox believes it can maintain the 10°/v revenue growth achieved in the last two
quarters. (emphasis added).
337.
Based on the Xerox Defendants' guidance, Morgan Stanley issued a report on
May 12, 1998, stating that, given the Company's reported results, it was "confident that Xerox
remains on its strategic growth track We expect,Xerox can consistently deliver on its double-
120
digit top-line and EPSgrowth-objectives..."
338.
On May 13, 1998, the Company filed its Form 10-Q for the first quarter ended
March 31, 1998. This Form 14-Q reported:
Income from continuing operations increased 12 percent to $301 million in the
1998 first quarter from $270 million in the 1997 first quarter. Including a
previously announced after-tax charge of $190 million in connection with the
final exit of the Company's discounted financial services operations, income was
$111 million in the quarter.
Revenues of $4.3 billion in the quarter represented 10 percent growth on a precurrency basis, the second consecutive quarter of double-digit revenue growth.
After the adverse effect of currency, revenue growth was 7 percent. The precurrency revenue growth was driven by 17 percent growth in equipment sales
(excluding OEM sales).
Diluted earnings per share from continuing operations increased 12 percent to
$0.84 in the first quarter.
339.
Attesting to the propriety of the Company's accounting, the First Quarter 1998
Form 1 0-Q stated:
The unaudited consolidated interim financial statements presented herein have
been prepared by_ arox Corporation ("the Company') in accordance with the
accounting policies described in its 1997 Annual Report to Shareholders [in
which defendants claimed the Company had complied with GAAP] and should be
read in conjunction with the notes thereto.
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) which are necessary for a fair statement of operating
results for the interim periods presented have been made. (emphasis added).
340.
The First Quarter 1998 Form 10-Q described its operations in "Other Areas" for
the quarter as follows:
Other Areas include operations principally in Latin America, Canada and China.
Growth in Other Areas was driven by strdn g equipment sales and excellent
document outsourcing growth. Revenue rowth in Brazil was strong in the first
quarter with excellent equipment sales of low volume products to smaller
121
customers . Mexico and a number ofthe: smaller Latin American affiliates,
including Argentina and Chile, had strong growth in the first quarter while
revenue in Canada grew modestly. (emphasis added).
341.
The statements identified in paragraphs 334-340 were materially false and
misleading when made and/or omitted to disclose material facts for the reasons set forth above in
¶ 333 a-c and for the following reasons:
a.
The Company's purported growth in Latin America was, in significant
part, the product of the accounting machinations set forth above; and
b.
The-Xerox Defendants' projections of future growth in revenues and
earnings were provided on the continuation of the improper accounting practices and financial
improprieties and therefore lacked any reasonable basis.
342.
On July 23, 1998, the Company issued a release disclosing its second quarter
1998 results. According to the release, diluted ehrnings per share increased 16% to $1.09 and
income increased 17% to $395 million, before an after-tax charge of $1.1 07 billion in connection
with the Company's prej psly announced worldwide restructurin g program . Pre-currency
revenues reportedly grew 10°/a. The Company's release stated:
The Company achieved double-digit revenue growth in the United States, Europe,
and all other major geographic areas in the quarter, except for Brazil where
revenue declined as a result of that country's weaker economic environment.
... "However, our technologically superior family of digital products and
solutions, and the worldwide restructuring we initiated during the quarter will
underpin the consistent delivery ofdouble-digit revenue growth and mid- to high
teens earnings-per-share growth over the next several years" [remarked Xerox
President and Chief Operating Officer G. Richard Thomani. (emphasis added).
343.
On August 13, 1998, the Company filed its Form 10-Q for the quarter ended June
30, 1998. This Form I O-Q, signed by defendant Fishbach,,.reported:
122
Income from continuing operations, before restructuring charges, increased 17
percent to $395 million in the 1998 second quarter from $337 million in the 1997
second quarter. Including a $1,107 mill on after-tax charge in connection with the
previously announced worldwide restructuring program, the second quarter net
loss was $712 million.
Revenues of $4.7 billion in the quarter 4resented 10 percent growth on a precurrency basis, the third consecutive quarter ofdouble-digit revenue growth. The
pre-currency revenue growth was driven by 19 percent growth in equipment sales
(excluding OEM sales). After the adverse effect of currency, revenue growth was
9 percent.
Diluted earnings per share from continuing operations increased 16 percent to
$1.09 in the second quarter excluding the restructuring charge. (emphasis added).
344.
Attesting to the propriety of the Company's accounting, the Second Quarter 1998
Form I O-Q stated:
The unaudited consolidated interim financial statements presented herein have
been prepared by Xerox Corporation ("the Company") in accordance with the
accounting policies described in its 1997 Annual Report to Shareholders [in
which defendants claimed the Company had complied with GAAPJ and should be
read in conjunction with the notes thereto.
In the opinion of management, all adjustments (consisting only of normal
recurring adjustrii ts) which are necessary for a fair statement of operating
results for the interim periods presented have been made.
345.
The Company's Second Quarter I 99S Form. I O-Q also stated:
Other Areas include operations principally in Latin America, Canada and China
Growth in Other Areas during the 1998 second quarter was driven by good
equipment sales and strong document ouIourcing growth.... Brazil' s profits
declined for the second quarter and first half of 1998 , however, we are
anticipating modest economic growth in Brazil and on that basis, expect modest
profit growth in our Brazilian affiliate in the second halfof1998. Canada,
Mexico and a number of'the smaller Latin American affiliates including
Argentina and Chile had excellent growth in the second quarter. (emphasis
added).
346.
The statements identified in parag I phs 342-345 were materially false and
123
misleading when made and/or omitted to disclose material facts for the reasons set forth above in
paragraphs 333 a-c and for the following
a.
The Company's
growth in Latin America and Mexico was, in
set forth above;
significant part, the product of the accounting
b.
All adjustments
necessary for a fair statement of operating
c.
for the financial statements which were
had not been made; and
The Company's projections of future growth and revenues and earnings
were premised upon the continuation of the improper accounting practices described above. The
Xerox Defendants, therefore, lacked any reasonable basis for such guidance.
347.
On September 24, 1998, Merrill Lynch issued a report summarizing
management's comments issued during a conference call, which were predicated upon the
Company's recently reported revenue base:
We hosted a Virtual Visit Conference Call with Xerox (XRX, $83 1116, B-2-1-7)
CFO Barry Romeril yesterday. Mr. Romeril did not back offfrom
from the company's
long-term expecii tkms ofdouble-digit pre-currency revenue growth and mid-tohigh teens earnings gains. (emphasis added).
348.
On October 22, 1998, the Company announced its results for the third quarter of
1998. The Company's release stated that diluted .earnings per share increased 19% to $1.05
billion and income increased 19% to $381 million, "primarily as a result of outstanding growth in
digital product revenues and improved operating margins, including the initial benefits from the
worldwide restructuring program." Commenting on the results, Defendant Auaire stated:
We delivered another quarter of strong dquble-digit earnings growth consistent
with our objectives, even though pre-currency revenue growth - at 6 percent - was
clearly affected by weaker global economic conditions.
124
We are committed to delivering consistent mid- to high teens earnings-per-share
growth over the next several years. (emphasis added).
349.
On November 10, 1998, the Company filed its Form 10-Q for the quarter ended
September 30, 1998, signed by Fishbach. This document stated:
Income from continuing operations increased 19 percent to $381 million in the
1998 third quarter from $320 million in the 1997 third quarter, primarily as a
result of outstanding growth in digital product revenues and improved operating
profit margins, including the initial benefits from the worldwide restructuring
program.
Third quarter 1998-revenues of $4.6 billion were affected by weaker global
economic conditions, growing 6 percent on a pre-currency basis. Weakness in
Brazil and Russia alone reduced pre-currency revenue growth by 2 percentage
points in the quarter.
Diluted earnings per share from continuing operations increased 18 percent to
$1.05 in the third quarter.
350.
Attesting to the propriety of the Company's accounting, the Third Quarter 1998
Form 10-Q stated:
The unaudited cotalidated interim financial statements presented herein have
been prepared by Xerox Corporation ("the Company") in accordance with the
accounting policies described in its 1997 Annual. Report to Shareholders [in which
defendants claimed the Company had complied with GAAP] and should be read
in conjunction with the notes thereto.
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) which are necessary for a fair statement of operating
results for the interim periods presented have been made.
351.
In describing its business in "Other Areas," the Company stated:
Other Areas include operations principally in Latin America, Canada, China and
Russia. Revenue in Brazil declined by 1 0 percent in the 1998 third quarter as
customers deferred purchases due to the leak economic environment, although
there was modest growth in digital product revenues. . . . Canada and a number of
the smaller Latin American affiliates, including Argentina and Colombia, had
125
good revenue growth in the third quarter. Revenue in Other Areas grew 4 percent
during the first nine months of 1998. Revenue growth in Canada and Mexico was
strong while revenue in Brazil dedinedirnodestly. (emphasis added).
352.
The statements identified in paragraphs 348-351 were materially false and
misleading when made and/or omitted to disclose material facts for the reasons stated above at
paragraph 333 a-c and for the following reasons:
a.
The Company's purported results in Latin America and Brazil were
materially overstated as a result of the accounting machinations set forth above;
b.
11e.Xerox Defendants' projections of future growth in revenues and
earnings were premised upon the continuation of Xerox`s improper accounting practices and thus
lacked any reasonable basis; and
All adjustments necessary for a fair statement of Xerox's results for the
third quarter 1998 had not been made.
353.
In discussing management's conference call held with analysts on or about
December 2, 1998, Mar 2a% Stanley stated:
The company reiterated its goal of delivering double-digit top-line growth in a
stable economic environment, and mid-to-high teens growth over the next five
years.....In light of this information, we are raising our price target to $120, from
$110,
i
354.
In January 1999, Brazil devalued its currency , the Real, by 33%. Brazil , in 1998,
contributed $1.7 billion to Xerox's $3.5 billion operations in Latin America. Due to the lack of
sufficient hedging, Xerox's revenue, in Brazil, would thereafter be off 45% in the first quarter of
1999 and 32% in the second quarter of 1999. A ordingiy, this drop in revenue, which resulted
from the insufficiency of Xerox's hedging activities, was not disclosed until following the
126
Company's issuance of its 1998 Form 10-K, which contained materially false and misleading
statements concerning the Company's hedging activities, as alleged below.
355.
On January 26, 1999, the Company announced its results for the fourth quarter
and year ended December 31, 1998. Diluted earnings per share were reported to have increased
16% to $ 1.69 and income was said to have increased 17% to $615 million. Operating profit
purportedly improved by 1.6 percentage points in the quarter, while total gross margin improved
by 1.1 percentage points to 48.1 %. Allaire was quoted in the Company's January 26, 1999
release as stating: "We delivered another record quarter, reflecting strong double-digit earnings
growth consistent with our objectives, even though currency revenue growth - at 7 percent - was
clearly affected by some weaker economies" The Company's release also stated:
"YYe remain committed to delivering consistent mid-to high teens earnings-pershare growth over the next several years, despite some weakness in the Pacific
Rim and uncertainty in Brazil," Allaire and Thoman added.
"The overall strength of Xerox and our excellent prospects for continuing
consistent growth prompted our board to increase the dividend and split the stock,
underscoring our bjnmitment to shareholder value," Allaire and Thoman added.
(emphasis added)_
356.
On January 27, 1999, The Orange County Register similarly reported that,
notwithstanding the uncertainty in Brazil, Rorneril stated that "the company remains `confident'
in its projections per-share growth in 1999.... The troubled economy in Brazil might even be
giving Xerox an edge over competitors."
357.
As reported in the February 1, 1999 issue of Barron's, Allaire and Thoman "said
that Xerox remains committed to delivering consistent mid- to high-teens earning s-per-share
growth over the next several years."
127
358.
On March 22, 1999, the Company filed its Annual Report on Form 10-K for the
year ended December 31, 1998 (the "1998 Fozxn 10-K"). This document, signed by Allaire,
Romeril, Fishbach, and Thoman, reported the following:
Document Processing revenues, which grew 8 percent on a pre-currency basis to
$ 19.4 billion in 1998, were affected by some weaker economies. Excluding
Brazil and Russia, pre-currency revenues grew 10 percent. Total pre-currency
revenue growth was driven by 12 percent growth in equipment sales and 25
percent growth in document outsourcing (excluding equipment accounted for as
sales).... Revenues increased 7 percent on a pre-currency basis to $18.1 billion
in 1997 and 6 percent on a pre-currency basis to $17.4 billion in 1996.
Income from continuing operations increased 17 percent in 1998, excluding the
impact of a $1,107 million after-tax restructuring charge, and 20 percent in 1997.
Diluted earnings per share from continuing operations increased 16 percent in
1998, excluding the restructuring charge, and 22 percent in 1997. Earnings per
share have been adjusted to reflect the 2-for-I stock split to shareholders of record
on February 4, 1999.
359.
In describing the geographical distribution of its revenues, the Company's 1998
Form 10-K disclosed:
Other Areas 19$k: venue reflected a 7 percent decline in Brazil due to the
difficult economic environment. Revenues in Brazil were $1.6 billion in 1998,
$1.8 billion in 1997, and $1.6 billion in 1996.... Growth in Canada and Mexico
was strong in 1998. 1997 revenue growth. reflects good growth in Brazil and
China, modest growth in Canada, and excellent growth in Mexico. (emphasis
added).
360.
The Report of Management contained in the 1998 Form 10-K attested to the
adequacy of the Company's internal accounting controls:
Report of Management
Xerox Corporation management is responsible for the integrity and objectivity of
the financial data presented in this annual report. The consolidatedfinancial
statements were prepared in conformity ith generally accepted accounting
principles and include amounts based on management's best estimates and
128
judgments.
The Company maintains an internal co ' of structure designed to provide
reasonable assurance that assets are sa eguardecl against loss or unauthorized
use and thatfnancial records are adeq a and can be relied upon to produce
financial statements in accordance with generally accepted accounting principles.
i g of qualified people, written
This structure includes the hiring and
accounting and control policies and procedures, clearly drawn lines of accountability and delegations of authority. In a business ethics policy that is communicated annually to all employees, the Company has established its intent to adhere
to the highest standards ofethical conduct in all ofits business activities.
The Company monitors its internal structure with direct management reviews and
a comprehensive program of internal audits. In addition, KPMG LLP, independent auditors, have audited the consolidated financial statements and have
reviewed the internal control structure toI the extent they considered necessary to
support their report which follows. (em basis added).
361.
The Company also portrayed affiImatively its financing activities:
In 1998, good growth in the financing of equipment sales in the U.S. and Latin
America has been partially offset by lower average interest rates. In 1997, good
financing growth in the U.S., Europe, and Latin America was partially offset by
lower average interest rates.
362.
Concealing its accounts receivables problem, the Company stated the following:
Inventories and receivables grew by $1571 million in 1998, or $866 million more
than in 1997. The higher level of inventory investment was driven by accelerated
digital product sales growth. Accounts relleivable growth reflects strong
equipment sales in 1998 and some increase in days sales outstanding due to
temporary effects from the reorgan ization and consolidation of U.S. customer
administrative centers.
i
363.
The Notes to the Consolidated Financial Statements contained in the 1998 Form.
1 d-K stated: "[t]he provisions for losses on uncollectible trade and finance receivables are
determined principally on the basis of past collection experience."
364.
The Notes to the Company's Cons lidated Financial Statements also revealed the
following under the caption "Revenue Recognition":
129
Revenues from the sale of equipment under installment contracts and from salestype leases are recognized at the time of sale or at the inception of the lease,
respectively. Associated finance income is earned on an accrual basis under an
effective annual yield method. Revenues from equipment under other leases are
accounted for by the operating lease method and are recognized over the lease
term- Service revenues are derived primarilyfrom maintenance contracts on our
equipment sold to customers and are re ograiaed over the term ofthe contracts.
(emphasis added).
7
1
365. The Company described its Rana acquisition as follows: In June 1997, we
acquired the remaining 20 percent of Xerox Limited from The Rank Group Plc (Rank) in a
I
transaction valued at (pound) 940 million, or approximately $1.5 billion."
366.
The Company's "hedging" activities were described as follows:
Certain financial instruments with off-balance-sheet risk have been entered into
by us to manage our interest rate and foreign currency exposures. These
instruments are held solely for hedging purposes and include interest rate swap
agreements, forward exchange contracts ;and foreign currency swap agreements.
We do not enter into derivative instrurne it transactions for trading or other
speculative purposes.
We employ the use of hedges to reduce the risks that rapidly changing market
conditions may have on the underlying transactions. Typically, our currency and
interest rate hecdgi*tk,activities are not affected by changes in market conditions, as
forward contracts and swaps are arranged and normally held to maturity in order
to lock in currency rates and interest rate spreads related to underlying
transactions.
367.
The statements identified above in paragraphs 353-366 were materially false and
misleading when made, and/or omitted to disclo a material facts for the reasons identified above
in paragraph 333 a-c and for the following reasons:
a.
The Xerox Defendants knew or recklessly disregarded that the Company's
financial statements overstated net income by $100 million as a result of the improper Rank
reserve used to mask expenses from European operations;
L)
b.
The statements regarding Xerox being adequately hedged against foreign
currency exchange rate fluctuations were materially false and misleading. In 1998, Bingham
advised Romeril to increase Xerox's foreign currency hedges. According to Bingham, Romeril
refused because it would cost the Company $80 million. In 1999, Brazil devalued its currency
by approximately 40%, resulting in a write-down in equity of approximately $1 billion as Xerox
was forced to reduce the value of its Brazilian assets as it was not properly hedged against
foreign currency exchange rate fluctuations;
c.
The Xerox Defendants' projections of future earnings per share growth were
premised upon the continuation of Xerox's improper accounting practices and thus lacked any
reasonable basis;
d.
Growth in Mexico was not "excellent,," but rather was the product of the
accounting fraud alleged; and
e.
Service revenues on equipment contracts were not recognized over the term of
such contracts, but were;ail many instances, improperly recognized on an accelerated basis.
368.
On April 22, 1999, Xerox issued a release discussing its first quarter results.
Income and earnings per share were reported to have increased 1 4% to $343 million, or 48 cents
per diluted share. While acknowledging turmoil in Brazil, Romeril falsely stated: "we
recognized early and acted upon the fact that the economic turmoil in Brazil could otherwise
have significantly impacted our earnings."
369.
As to the Company's future prospects, based upon the Company's purported
revenue success, Thoman assured investors that'
e are very confident that revenue growth will
improve as the year progresses." Additionally, the Company stated:
131
..t
substantial and our sales force is
market our broad and technologically
industry solutions," said CEO Thoman,
ce growth and delivering mid- to high
f 1999 and beyond."
a the remainder of
"Our global growth opportunities rein
energized and motivated to aggressiv+
innovative line of products, services s
We are committed to accelerating rev
teens earnings-per-share growth thro
(emphasis added).
370.
filed its Form 1 C}-Q for the quarter ended March
On May 14, 1999, the
Xerox's quarterly results as follows:
31,1999. The First Quarter 1999 Form 10-Q
Income from continuing operations increased 14 percent to $343 million in the
1999 first quarter from $301 million in the 1998 first quarter. The increase was
primarily due to improved operating margins that reflected ongoing benefits from
the company's worldwide restructuring program and a heightened focus on
productivity and expense controls. The productivity and expense control actions
included significant cost reductions in o^zr Brazilian operations, encompassing
branch consolidations and centralization of administrative support functions, as
well as additional worldwide cost
Pre-currency revenues, excluding Brazil
growth of 4 percent in the United States
European revenue growth was depresses
impact of the implementation of initiati-,
industry-oriented global document solut
Brazil and the effects of currency, reven
with the first ggiar. 'ryof 1998.
grew 3 percent, reflecting revenue
m d 2 percent in Europe. U.S. and
in the 1999 first quarter, reflecting the
:s announced in January 1999 to provide
for major customers .... Including
of $4.3 billion were flat compared
Diluted earnings per share from contin
$0.48 in the 1999 first quarter from $0
371.
g operations increased 14 percent to
in the 1998 first quarter.
Attesting to the propriety of the qompany 's accounting, the First Quarter 1999
Form 1 d-Q stated:
The unaudited consolidated interim
statements presented herein have
prepared
by
been
Xerox Corporation ("the Company") in accordance with the
accounting policies described in its 1998 Annual Report to Shareholders [in
which defendants claimed the Company lead complied with GAAP] and should be
read in conjunction with the notes thereto[
In the opinion of management, all adj
eats (consisting only of normal
recurring adjustments) which are necessarry for a fair statement of operating
132
i
results for the interim periods presented have been made.
372.
In describing its geographical distribution of revenues, the Company' s First
Quarter 1999 Form 1 O-Q stated:
Other Areas include operations principally in Latin America, Canada, China,
Russia, the Middle East and Africa. Revenue in Brazil declined by 45 percent in
the 1999 first quarter reflecting primarily the very significant currency
devaluation and also the Brazilian recession- Brazilian revenues represented
approximately 4 percent of Xerox revenues in the 1999 first quarter compared
with 8 percent in the 1998 first quarter. Excluding Brazil, revenue in Other Areas
had modest growth. China, the Middle East and Africa had strong revenue growth
in the first quarter, Canada and Mexico had good revenue growth, while revenue
declined in Argentina, Venezuela and Russia due to economic weakness.
(emphasis added).
373.
The statements identified in paragraphs 368-372 were materially false and
misleading when made and/or omitted to disclose material facts because of the reasons identified
above in paragraph 333 a-c for the following reasons:
a.
The Xerox Defendants' projections of future growth in revenues and
earnings were premised upon the continuation of Xerox's improper accounting practices and thus
lacked any reasonable basis;
b.
Romeril's April 22, 1999 statement concerning Xerox's "early" action in
dealing with the "economic turmoil in Brazil" was knowingly false as described above;
c.
The Company's purported;results in the DMC, Latin America, Mexico and
Brazil were materially overstated as a result of tt
d.
accounting machinations set forth above;
The Company did not recognize service revenues over the term of the
contract, but, in many instances, improperly accelerated the recognition of such revenues; and
e.
All adjustments necessary or a fair presentation of operating results for
133
the first quarter 1999 had not been made.
374.
Business News reported on an analyst meeting
On May 14, 1999, the Dow
of 5% revenue growth for the current .
held by the Xerox Defendants that morning,
that its goal remained to consistently deliver
quarter was repeated and the Company rei
earnings growth in the mid- to high-teens.
375-
On May 17, 1999, Merrill Lynchi,published & report reiterating management's
comments made at the recently-held 1999 Invesior Conference. This report stated, in pertinent
part:
The company reiterated its key objectives and long-term forecast of double-digit
revenue growth, slight gross margin erosion, SG&A-to-revenue in the low 20s,
and mid-to-upper teens EPS growth.
376.
On May 22,1999, the Company i, sued a release discussing occurrences at its
Annual Meeting of Shareholders held on the same day. The release stated:
Xerox Corporation's new chief executive ,officer, Rick Thoman, told shareholders
at the company' s Annual. Meeting today that Xerox is "poised on the threshold of
another period of great success " -- a period he said would produce profitable
revenue growth and significantly improved shareholder value.
377.
On July 22, 1999, the Company i sued its second quarter results . Diluted
earnings per share were reported to have increase 15% to 62 cents and income was reported to
have increased 13% to $448 million, before the prior year's restructuring charge. The release
stated:
The earnings increase reflects improved revenue growth, particularly in the United
States and Europe, and ongoing benefits fom the company's worldwide restructuring program and the continuing focus on productivity and expense controls.
"We delivered another quarter of strong
and Chief Executive Officer Rick Thom
ings growth," said Xerox President
. " We are pleased with the rebound in
134
revenue growth in the U.S_ and Europe ^whi.ch we expect to improve further in the
second half of the year.
"While we remain focused on improvin pre-currency revenue growth and
achieving mid-to high teens earnings-per-share growth, any continuation of the
current weak European exchange rates together with ongoing weakness in Brazil
and Japan, make this earnings growth a ouch more challenging objective for the
remainder of the year," he said.
378.
On August 11, 1999, the Compoy fled its Form 10-Q for the quarter ended June
30, 1999. This Form 1 Q-Q, signed by
Income increased 13 percent to $448 million in the 1999 second quarter from
$395 million in the 1998 second quarter, before the 1998 worldwide restructuring
program charge of $1,107 million. The increase reflects improved revenue
growth, particularly in the United States and Europe, and ongoing benefits from
the company's worldwide restructuring program and the continuing focus on
productivity and expense controls.
Pre-currency revenues, excluding Brazil, grew 7 percent, reflecting revenue
growth of 9 percent in the United States ind 6 percent in Europe. Including Brazil
where revenues declined substantially dt.e to the January currency devaluation
and economic weakness, pre-currency revenues grew 4 percent. Total 1999
second quarter revenues, including the
ect of adverse European currency
translation, grew 3 percent to $4.9 billi
compared with $4.7 billion in the 1998
second quarter'.. `ffeVenues in the 1999 1
half were $9.2 billion compared with
$9_0 billion a year ago.
Diluted earnings per share increased 15
quarter from $0.54 in the 1998 second
charge.
379.
.it to $0.62 in the 1999 second
, before the 1998 restructuring
Attesting to the propriety of the
accounting, the Second Quarter 1999
Form 1O-Q stated:
The unaudited consolidated interim financial statements presented herein have
been prepared by Xerox Corporation ("thh Company") in accordance with the
accounting policies described in its 19598 4 .nnual Report to Shareholders [in
which defendants claimed the Company had complied with GAAP} and should be
read in conjunction with the notes thereto
135
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) which are necessary for a fair statement of operating
results for the interim periods presented have been made.
380.
In describing the Company's geographical distribution of revenues, the Company's
Second Quarter 1999 Form 10-Q stated:
Other Areas include operations principally in Latin America, Canada, China,
Russia, India, the Middle East and Africa. Revenue in Brazil declined by 32
percent in the 1999 second quarter and 38 percent in the 1999 first half reflecting
primarily the very significant currency devaluation as well as the Brazilian
recession. Brazilian revenues represented approximately 6 percent of Xerox
revenues in the 1999 second quarter compared with 9 percent in the 1998 second
quarter. Excluding Brazil, revenue growth in Other Areas was modest, including
strong growth in Mexico and flat revenues in Canada-
381.
The statements identified in p
hs 368-380 were materially false and
misleading when made and/or omitted to disclose material facts for the reasons identified in
paragraph 333 a-c and for the following reasons;
a.
Thoman's statements at the Annual Meeting and in the July 22, 1999 press
release lacked any reasonable basis in fact because, as Thoman knew or recklessly disregarded,
they were based on the continuation of the improper accounting practices and financial
improprieties described above;
b.
The Xerox Defendants'
}ections of future growth in revenue and
earnings were premised upon the continuation of Xerox's improper accounting practices and thus
lacked any reasonable basis;
c.
The Company's purported results in Brazil, Mexico and Venezuela were
materially overstated as a result of the accounting machinations set forth above; and
d.
All adjustments necessary for a fair statement of operating results for the
136
second quarter 1999 had not been made.
382.
call with management which had taken place
Xerox management was far more upbi
2Q 1999 earnings call. CFO Barry R
had recently lowered guidance for the
company maintains its goal for 8-9% ^
currency and Brazil).
383_
noted the occurrences during a conference
On September 23, 1999, Paine
day earlier:
in yesterday's call than it was during its
;ril addressed erroneous reports that he
,ond half of 1999, reiterating that the
-currency growth for 3Q 1999 (excluding
On October 18, 1999, the Company announced its 1999 third quarter results.
According to the Company's Press release, diluted earnings per share decreased 11% to 47 cents
and income decreased 11 % to $339 million. The Company further stated:
For the quarter, pre-currency revenues, excluding Brazil, grew 6 percent.
Including Brazil, where results continued to be depressed due to the devaluation
and economic weakness, pre-currency re' enues grew 2 percent. Total 1999 third
quarter revenues were flat at $4.6 billioncompared to the 1998 third quarter.
"While realizing the benefit of our strategic direction is taking longer than
anticipated, the positive effects of these changes should be reflected in stronger
results towards the end ofnext year," Thoman said. (emphasis added).
384.
On November 12, 1999, the Company filed its Form I4-Q for the quarter ended
September 30, 1999. This Form. 1O-Q, signed b I Fishbach, reported:
Pre-currency revenues, excluding Brazil, ew 6 percent, reflecting revenue
growth of 6 percent in the United States, 3 percent in Europe, and 13 percent in
the rest of the world. Including Brazil wh6re revenues declined substantially due
to the continuing effects of the January currency devaluation and the subsequent
economic weakness, pre-currency revenu s grew 2 percent. Including the effect of
adverse European currency translation, tota11999 third quarter revenues of $4.6
billion were equal to the 1998 third quarter.
Income declined I I percent to $339 million in the 1999 third quarter from $381
million in the 1998 third quarter. The inc me decline reflects significant gross
margin deterioration almost offset by low selling, administrative and general
expenses and lower research and develop ent spending. The 1999 third quarter
137
income decline also reflects deteriorati in equity income, predominantly Fuji
Xerox and increased non-financing inteest expense. Operating income benefitted
from significantly lower provisions for overall incentive compensation expense.
Diluted earnings per share declined 11 percent to $0.47 in the 1999 third quarter
from $0.53 in the 1998 third quarter.
385.
Attesting to the propriety of the Company's accounting, the Third Quarter 1999
Form 10-Q stated:
The unaudited consolidated interim fin ancial statements presented herein have
been prepared by Xerox Corporation ("the Company") in accordance with the
accounting policies described in its 1991 Annual. Report to Shareholders [in
which defendants claimed the Company', had complied with GAAF] and should be
read in conjunction with the notes thereto.
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) which are necessary for a fair statement of operating
results for the interim periods presented have been made.
386.
The Company reported the following regarding its results in "Other Areas"
Other Areas include operations principally in Latin America, Canada, China,
Russia, India, the Middle East and Afi is . . Revenue in Brazil declined by 41
percent in the 1999 third quarter and 39 percent in the first nine months of 1999,
primarily reflecfih 'the very significant currency devaluation as well as the
economic weakness. Brazilian revenues x'eepresented approximately 5 percent of
Xerox revenues in the 1999 third quarter compared with 9 percent in the 1998
third quarter. Excluding Brazil, revenue in Other Areas grew 13 percent in the
third quarter, including excellent growth in Mexico, good growth in Canada and a
resumption of growth in developing markets. (emphasis added).
387.
The statements identified in paragraphs 382-386 were materially false and
misleading when made and/or omitted to disclos material facts because of the reasons set forth
above in paragraph 333 a-c and for the following reasons:
a.
The Company's purported results in Latin America, Mexico, Brazil and
Venezuela were materially overstated due to the accounting machinations set forth above;
138
b.
jections of future earnings per share growth in
The Xerox Defendants'
of Xerox's improper accounting
revenues and earnings were premised upon the
practices and thus lacked any reasonable basis;
c.
for a fair statement of operating results for the
All adjustments
made.
quarter ended September 30,1999 had not
388.
On December 10, 1999, the Company issued a release stating that it expected
fourth quarter earnings per share to be approximately 40% lower than analysts' consensus
estimate . Nonetheless , in the same release, the Xerox Defendants informed investors that the
Company's results would improve:
we expect some recovery in Brazil and our sales force reorganization will have
been implemented . To ensure that our cast base is aligned with the increasingly
competitive environment, we are in the midst of a comprehensive review of our
costs and key business processes to idennify opportunities for substantial
additional savings . All ofthese support my confidence that our earnings will show
meaningNl growth in the second halfof ` ext year." (emphasis added).
389.
The market placed great emphasis on defendant Thoman's assurances of a 2000
turn around for the Company. The December 131, 1999 The Wall Street Journal reported:
"'[the December 10, 1999 announcement that fourth quarter net income will be 40% less
than analysts' consensus estimate] represents everyone's worst fears coming to light,' said
Credit Suisse First Boston analyst Cribbo.ey Huske. However, if the company's
explanations can be taken at face value, most of the problems are temporary . 'Xerox is a
pretty compelling buy at $20 share,' Ms. Huske said."
390.
Similarly, on December 13, 1999, AFX News in San Francisco reported:
In a conference call with analysts on Friday, Xerox president and chief executive
Rick Thoman said the earnings disappointments in the third and fourth quarters
did not reflect fundamental shortcon:
Referring to the profit warnings, he said:
third-quarter (issues) ... many of which
139
ey`re related to intensification of the
be moderated or will go away next
year."
391.
Additionally, on December 13, 1 999, The Dow Jones Business News reported
that:
call on Friday, Xerox characterized
its control.
in its press release and subsequent con
its problems as largely short-term and
"If you take the view that a lot of their p obiems are temporary, there's bound to
be a rebound," said Steve Milunovich, ap analyst with Merrill Lynch & Co.
(emphasis added).
392.
On December 21, 1999, the Company filed an S-8 Registration Statement with the
SEC. Pursuant to this Registration Statement, Allaire registered for the sale of 3,126,198 shares
of Xerox stock; Romeril 652,329 shares; and Thoman 2,463,565 shares of Xerox stock. This
document, signed by Thoman, incorporated, inter alma, the following documents by reference:
(i) Annual Report on Form 10-K for the fiscal year ended December 31, 1998;
(ii) Quarterly Reports on Form. 1 O-Q for the fiscal quarters ended March 31, 1999,
June 30, 1999 and September 30, 1999; and
(iii) Current Reports on Form 8-K dated December 18, 1998 (filed January 29,
1999), January 25, 1999, March 26, 1999, May 13, 1999, June 24, 1999,
September 22, 1999, December 9, 1999 end December 10, 1999.
393.
Additionally, the December 2I, 1999 Form S-$ incorporated by reference
[tihe consolidated financial statements and schedule of Xerox Corporation and
consolidated subsidiaries as of December, 31, 1998 and 1997, and for each of the
years in the three-year period ended December 31, 1998... in reliance upon the
reports set forth therein of KPMG LLP, independent certified accountants,
incorporated by reference herein, and upo6 the authority of said firm as experts in
accounting and auditing.
Also, attached to the Form S-8, was KPMG's
ember 21, 1999 consent for the use of its
140
reports incorporated by reference. As a result of the filing of the December 21, 1999 Form S-S,
in these documents as set forth above
the materially false and misleading statements
were republished as of December 21, 1999.
394.
on January 18, 2000, defendant
As reported by Newshyte News
informed investors, consumers, and
Thoman, at the January 2000 Lyra Imaging
on what happened in 1999, particularly in the
analysts that he: "wanted to set the record
third and fourth quarters." Newsbytes reported.
Thoman acknowledged that Xerox has i
six percent a year for some time, but growth numbers increase to double digi
in digital publishing, high-end printing,
number two-after Hewlett-Packard-in v
395.
perienced a revenue growth of five to
the company was now poised to see its
as a result of Xerox being number one
ad copiers (worldwide), as well as
ridwide printing.
On January 25, 2000, the
issued a release announcing its results for the
1999 fourth quarter and year ended December 31, 1999. The Company reported earnings of 41
cents per share for the fourth quarter. For the
$1.96 per share, and in&5
the Company reported diluted earnings of
represented a decrease of 16% from $2.33 and
of $1.4 billion.
$1.7 billion, respectively, in 1998, before a
charge. Revenues in 1999 were $19.2
billion, compared with $19.4 billion in 1998.
Company headlined its fourth quarter 2000
earnings release in bold faced type with the
quotation: "There are encouraging reasons
for renewed confidence." The release continued:
Xerox Corporation (NYSE: XRX) today
:ed fourth quarter earnings per
share of 41 cents. The company also annt
that it will take a substantial
restructuring charge, most likely in the fir quarterWe believe the Y2K effect is largely 1
improved and there are signs of some
that these positive developments will
us, results from Fuji Xerox have
hening in Brazil . We fully expect
e significant, especially during the
141
second half of 2000.
with expectations disclosed last
fourth
quarter were flat year over year,
9
e revenues declined substantially due to
fourth quarter revenues declined 3
Fourth quarter results were generally c
month. Pre-currency revenues in the 1
excluding Brazil. Including Brazil, wk
the devaluation and economic weakne,
percent from the 1998 fourth quarter.
396.
Company's January 25 , 2000
The market reacted favorably to
reported that:
pronouncements . Thus, AFX News, in San
Xerox up 2 at 21-15/16 after the
and predicted it will soon see a s
1p y beat fourth-quarter earnings forecasts
fic
improvements in profits...
of 41 cents, down from 84 a year earlier
ons of 40.
Xerox earlier reported earnings per
but I penny better than analysts' ex
-quarter EPS could be up to 40 pet
Hate of 66 due to a Y2K-related
sales, higher-than-expected costs in its
eakness in Brazil.
Xerox had said in December that its fou
lower than analysts' earlier consensus e
slowdown in highend printing equipme
sales force reorganization and economic
after the company management said
Analysts held their estimates for 2000 s
the full year Wall Street consensus EPOS'
of L 95 used is reasonable, even
after cost savings from its restructuring- emphasis added).
397.
Additionally, Dow Jones Pusine,
News reported on January 25, 2004 that:
Now, the company said, the impact of
at Fuji Xerox have improved and there
Those positive developments will becc
second half of 2000, the company said.
398.
concerns is largely behind it; results
signs of some strengthening in Brazilsignificant, especially during the
announced that:
On February 14, 2000, the
Xerox Corp.'s Mexican subsidiary had on
with 420 million dollars sales on the dom
worth. At the same time the companies pi
dollars, said Antonio Robles, the director
Robles added that Xerox has little or no c
60 percent of the photocopier market, 80
market, and 80 percent of the color prints,
ofthe best years ofits history in 1999,
rtic market and 200 million dollar
fits rose 30 percent to 127 million
eneral ofthe company in Mexico.
npetition in Mexico. Xerox controls
ercent of the intensive use printers
market.,. (emphasis added).
142
399.
On February 23, 2000, the
Company announced that it was releasing its
investment community and was posting them
filed a Form 8 -K with the SEC in which the
1999 financial statements to the
its Internet website in advance of the
publication of its 1999 Annual Report to
A copy of the financial statements was
attached as an Exhibit to the Form 8-K. These
statements, which also reiterated the
materially false and misleading results
published for years 1997 and 1998, reported
the following for 1999: total revenues of $19.23 billion, net income of $1.42 billion, basic
earnings per share of $2.09, and diluted
400.
On March 27, 2000, the
per share of $1.96.
filed with the SEC its Annual Report on Form
10-K for the year ended December 31, 1999. Ws document, signed by Romeril, Thoman,
Fishbach, and Allaire, reported:
Document Processing revenues of $19.2
currency basis with 1998. Excluding Br
substantially due to the currency devalue
pre-currency revenues grew by 4 percent
currency basis to` 9.4 billion in 1998 a
$18.1 billion in 1997.
401.
In the 1999 Form 10-K, net
per diluted share was reported to be $1.96. The
rillion in 1999 were flat on a preil, where revenues declined very
on and subsequent economic weakness.
Revenues increased 8 percent on a pre1. 7 percent on a pre-currency basis to
was reported to be $ 1.424 billion and income
Form I a-K further noted:
Excluding the 1998 restructuring charge, income from continuing operations
decreased 16 percent in 1999 and increas6d
percent in 1998.
Excluding the 1998 restructuring charge,
continuing operations decreased 16 percc
1998.
402.
The Report of Management
adequacy of the Company' s internal accounting
uted earnings per share from
in 1999 and increased 16 percent in
in the 1999 Form 14-K attested to the
Report of Management
Xerox Corporation management is re,
the financial data presented in this ani
statements were prepared in conforms
principles and include amounts based
judgments.
rnsible for the integrity and objectivity of
il report. The consolidatedfinancial
with generally accepted accounting
management's best estimates and
The Company maintains an internal cor
reasonable assurance that assets are sa
use and thatfinancial records are adeq2
financial statements in accordance with
This structure includes the hiring and tr,
accounting and control policies and pros
bility and delegations ofauthority. In a'
cated annually to all employees, the Coy
to the highest standards ofethical condo
)l structure designed to provide
,carded against loss or unauthorized
'e and can be relied upon to produce
werally accepted accountingprinciples.
ing of qualified people, written
lures, clearly drawn lines ofaccountass ethics policy that is communihas established its intent to adhere
in all ofits business activities.
The Company monitors its internal coy
reviews and a comprehensive program
independent auditors, have audited the
reviewed the internal control structure
support their report, which follows. (e
71 structure with direct management
'internal audits. In addition , KPMG LLP,
nsolidated financial statements and have
the extent they considered necessary to
)hasis added).
403.
In describing the geographical
of its revenues during 1999, the 1999
Form I0-K stated:
Revenues in the United States were 54 I
of total revenues in 1999 compared
with 52 percent of revenues in 1998 and I percent in 1997. European revenues
represented 28 percent of total revenues i 1999, compared with 27 percent in
1998 and 1997. Other Areas, which inch u as operations in Latin America,
Canada, China, Russia, India, the Middle East and Africa, contributed 18 percent
of total revenues in 1999 compared with
I percent in 1998 and 22 percent in
1997.
Excluding Brazil, revenue in Other Areas grew 8 percent in 1999, reflecting
excellent growth in Mexico and Central America and modest growth in Canada.
In 1998, revenues in Brazil declined 7 pe ent due to the difficult economic
environment, and although our operation in Russia are relatively small, with
revenue of less than $100 million, revenu s declined very significantly due to the
weak economy in that country. Growth in Canada and Mexico was strong in
1998. 1997 revenue growth reflects good krowth in Brazil and China, modest
growth in Canada and excellent growth ^n Mexico. (emphasis added).
404.
lathe 1999 Form 10-K, the Xerox Defendants further emphasized the importance
of revenues derived from operations outside the U.S., stating that Xerox "derives half its
revenues from operations outside the United Stites."
405.
„ the Company's 1999 Form i Q-K
Under the heading " Revenue
stated:
Revenues from the sale of equipment to
type leases are recognized at the time of
respectively. Associated finance income
effective annual yield method. Revenue
accounted for by the operating lease me
term. Service revenues are derived prim
equipment sold to customers and are reo
Sales of equipment subject to the Comp
finance companies are recorded as sales
the third party. (emphasis added).
406.
ler installment contracts and from salesWe or at the inception of the lease,
is earned on an accrual basis under an
from equipment under other leases are
kod and are recognized over the lease
rilyfrom maintenance contracts on our
ggnized over the term ofthe contracts.
ny's operating leases to third-party lease
it the time the equipment is accepted by
The Notes to the Company's
ial statements revealed "[t]he provisions for
losses on uncollectible trade and finance
are determined principally on the basis of
past collection experience."
407.
The Company described its Rank
: "In rune 1997, we acquired the
remaining 20 percent of Xerox Limited from Th Rank Group Pie (Rank) in a transaction valued
at (pound)940 million, or approximately $1.5 bil ion."
408.
388-407 were materially false and
The statements identified in
misleading when made and/or omitted to
material facts because of the reasons stated
above in paragraph 333 a-c for the following
a.
The Xerox Defendants` pr ections of future growth revenues and earnings
1.45
e Xerox Defendants knew or recklessly
lacked any reasonable basis in fact because, as
disregarded, they were based on the continuatio of the improper accounting practices and
described above;
b.
acterization of the Company's problems as
The Xerox Defendants' c
ause, as the Xerox Defendants knew or
temporary lacked any reasonable basis in fact
recklessly disregarded, they were based on the continuation of the improper accounting practices
and financial improprieties described above;
c.
The -Company's purporte( results in Latin America, Mexico, Brazil and
Venezuela were materially inflated due to the ac counting machinations set forth above;
d.
The Company's revenues from outside the United States were materially
overstated as a result of the accounting mac '
e.
ons set forth above;
The financial statements - chided in or incorporated into the December 21,
1999 and February 23, 2000 Registration Stat
eras were misleading for the reasons set forth
above;
f
The Company's financialstatements overstated net income by $100
million as a result of the improper Rank reserve
ich was improperly used to mask expenses
from European operations;
g.
The Company's provision for losses on uncollectible, trade and finance
receivables was materially understated; and
h.
Service revenues were not recognized over the term of the Company's
equipment contracts but were, in many instances improperly accelerated into revenues.
409.
On April 25, 2000, the Company
146
ounced its results for the quarter ended
March 31, 2000. The Company stated:
Xerox Corporation today announced ea
previously announced charges. First qua
percent, or 3 percent excluding the Tek7
quarter post-currency revenue was $4.4
billion in the first quarter of 1999.
410.
gs of 30 cents per share before two
,r pre-currency revenue increased 6
ix printer division acquisition. First
ion, all inclusive, compared to $4.3
The Company further stated:
Several of the issues affecting perform ce in the second half of 1999 improved
in the first quarter, including better bus' iess results from Brazil and Fuji Xerox.
Revenue grew 15 percent in Developin
includes Latin America, China, Russia,
currency revenue was flat across Indust
the direct sales force in North America
Market Operations (DMD), which
ndia, the Middle East and Africa. Prey Solutions Operations (ISO), primarily
nd Europe.
Thoman reiterated his belief that 2000
be a year of two distinct halves.
"We continue to expect a significant yer
earnings due to the impacts of the sales
our customer administration turnaround
said . " However, we believe we are on tt
growth in the second halfoft ie year- T
momentum in the second halfofthe yew
announced resii-uc i ring program posit
growth in 2001." (emphasis added).
411.
On April 26, 2000, The Wall
..over-year decline in second quarter
3rce turnaround, increased competition,
and adverse currency translation," he
wk to achieve meaningful earnings
e combination ofthis increased
and benefits from our recently
rns us for mid-to high-teens earnings
Journal reported on Xerox's first quarter 2000
results . While the Journal noted that earning s for the quarter had fallen 36% (excluding
charges), the paper noted that "
revenue indicated that the copier company
may have halted a lengthy slump ." The Journal
reported that "[t}he improved revenue
figure cheered investors, who boosted Xerox
nearly 1 I %" on the news. Xerox's first
quarter results of earnings per share of 30 cents
analysts consensus estimates of earnings per
share by 5 cents.
I
412.
Romeril was reported in The W411 Street Journal on April 26, 2000, as stating that
he expected revenue to rise 7% to 8% for
413.
The market was taken in by
reported results as evidenced by the
comments of analyst Benjamin. Reitzes
.Webber, Inc., who was reported in The Wall
Street Journal on April 26, 2000, as stating
the numbers "were pretty good" and that
"[r]evenues were better than anticipated."
414.
Similarly, on April 26, 2000, C
issued a report on Xerox, terming the stock a
"Buy." In this report, CSFB informed i
Revenue Surprise Points to Inflection
Xerox reported first quarter sales of $4.
$4.3 billion, despite a negative 3% imp,
second consecutive upside surprise, we
reduced by 80%. Our DCF valuation fi
upside.... With significantly reduced ris
term catalysts, we would be buyers at tl
415.
billion that surpassed our estimate of
t from foreign exchange ... With the
^lieve the risk associate with the stock is
Xerox is about $40, providing 50%
substantial upside to fair value and near
current levels.
After the close of the market on ]
Thornan had resigned from his position as CEO
Xerox's Board of Directors. Upon Thonian's
11, 2000, the Company announced that
the Company and from his membership on
Allaire became Xerox's CEO and
Mulcahy became its President.
416.
On May 12, 2000, the Company
31, 2000 (the "First Quarter 2000 Form 10-Q").
its Form I O-Q for the quarter ended March
this document, signed by Defendant Tayler,
the Company reported:
First quarter 2000 pre-currency revenues grew 6 percent including the beneficial
impact of the January 1, 2000 acquisition of the Tektronix, Inc. Color Printing and
Imaging Division (CPI)}. Excluding CP 13 the Color and Printing Imaging
Division, Inc., acquired by Xerox and Fu i Xerox on January 1, 2000], pre-
148.
flat revenues in Industry Solutions
Markets operations and 15 percent
currency revenues grew 3 percent
Operations, growth of 6 percent in
growth in Developing Markets.
Income in the 2000 first quarter deelin
million in the 1999 Est quarter before
(including our $18 million share of a s
connection with the company's previol
program and a previously announced I
in-process research and development a
136 percent to $220 million from $343
n after-tax charge of $444 million
)arate Fuji Xerox restructuring charge) in
ly announced worldwide restructuring
7 million before-tax charge for acquired
,ociated with the CPID acquisition.
Diluted earnings per share declined 38
from $0.48 in the 1999 first quarter, e
the acquired CPID in-process R&D ch
included an unfavorable year-over-yea
cents. Including both charges, the first
,nt to $0.30 in the 2000 first quarter
ng the 2000 restructuring charge and
First quarter 2000 earnings per share
ency impact of approximately five
417.
er 2000 loss was $0.38.
Attesting to the propriety of the
accounting , the First Quarter 2000
Form I4-Q stated:
The unaudited consolidated interim fins
statements presented herein have
been prepared by Xerox Corporation (Mt e Company") in accordance with the
accounting policies described in its 1991. Annual Report to Shareholders [in which
defendants claimed the Company had c< nplied with GAAP] and should be read
in conjunction with the notes thereto.
In the opinion of management, all adjus
recurring adjustments) which are necess
results for the interim periods presented
418.
rats (consisting only of normal
for a fair statement of operating
e been made.
The First Quarter 2000 Fornn i
stated the following about its Developing
Market Operations:
Developing Market Operations includes
Russia, India, the Middle East and Afric
strong in Brazil reflecting an improving
and activity growth. First quarter 2000 n
strong growth was evident in several oth
419.
aerations in Latin America, China,
First quarter 2000 revenue growth was
onomie environment, a stable currency
enue growth was excellent in China and
countries.
The First Quarter 2000 Form 10-Q also -reported a dramatic increase in Xerox's
149
net accounts receivable during the quarter, rising from $2.622 billion at December 31., 1999 to
$2994 billion at March 31, 2000.
420.
409-419 were materially false and
The statements identified in
material facts because of the reasons stated
misleading when made and/or omitted to
above at paragraph 333 a-c and for the
reasons:
The Company's
results in the DMQ, Latin America, Mexico,
Brazil and Venezuela were materially
due to the accounting machinations set forth
a.
above;
b.
The Xerox Defendants'
jections of future growth in revenues and
earnings were premised upon the continuation
improper accounting practices and thus
lacked any reasonable basis; and
c.
All adjustments
for a fair statement of operating results for the
Company's first quarter ended March 31, 2000
not been made.
C.
The Xei iii efendants Begin t Selectively Disclose the Existence of Their
Accounting Machinations
421.
On June 16, 2000, the Company $led a Form 8-K cryptically revealing:
Registrant (or Xerox or the company) to y announced that second quarter
underlying earnings per share would be low market expectations and likely in
line with the company's first quarter lev
Xerox said its earnings would be
further reduced by significant unexpectprovisions
in its Mexico business.
i
422.
Nonetheless, the Company's June 116, 2000 Form 8-K assured investors that the
Company would soon report better results:
I am confident of improvements during th second half of the year, but they will
be developing later and to a lesser degree than previously anticipated. Momentum
will accelerate as we enter 2001," Allaire ;
150
at they are largely within our control and
aggressively on our productivity
technology, products and solutions are
and will - improve," he said.
`It will take time to resolve our issues,
will be fixed. We will continue to foc
initiatives and improving cash flow. C
world-class. Now our execution must
423.
The Xerox Defendants informed analysts that the Mexico problems would lead to
the quarter.
a 5 to 6 cent reduction in earnings per share
424.
of Xerox to tumble 18.5% on a volume of
the June 16 warning caused
daily volume of 2.4 million) and
17.5 million shares (compared with a previous
credibility problems at Xerox. Analyst
prompted Wall Street analysts to voice concern
James Corridore with Standard & Poor's
Group was reported as stating : "It's definitely
disturbing that the company has not been able to forecast the extent of the problem, and also to
to come to an end."
let us know rightfully when the problem is
425.
A June 19, 2000 CSFB report,
maintaining a "Buy" rating on the
that Mexico was an isolated incident,
Company's stock based on management's
questions Xerox's internal accounting controls:
Mexico receivables issue. Management
have to be written off and that this item v
$0.06 in the second quarter and possibly :
the receivables would be around $60 mill
considering that sales in Mexico are only
Although this would appear to be a one ti
about the company's financial controls. 7
the end of the quarter.
426.
On rune 19, 2000, Ryan, Beck
ed that receivables in Mexico would
Id potentially lower EPS by $0.05 e. At this level, the total amount of
, which is very significant
aected to be $400 million for the year.
charge, it does raise some questions
companyw4.I provide more detail at
issued a report discussing the impact of
the Mexico accounting issue on the Company's
ity stating:
Management also said that the situation in Mexico could reduce EPS by $0.05$0. 06 per share or more. Although the p blem is under investigation, Xerox
apparently may have to write off accounts eceivable of $60470 million or more
151
in this quarter. That is a huge amount n a revenue base in Mexico of about $400
million annually and indicates a possi e writeoffabout equal to the total normal
level ofreceivables, We believe the cc any is looking at the possibility offraud,
and management says the problem do+ not extend beyond. Mexico.
wise credibility issues, which will take
nan resigned as CEO a little more than a
had been no further deterioration in its
surfacing of the Mexico receivables
ivy's financial controls, in our opinion.
The recent developments will certai
some time to alleviate . When Rick
month ago, the company stated that
outlook. That statement and the suc
problem raise questions about the o
(emphasis added).
427.
The statements identified in
36-37; 421-23; 425-26 were materially
to disclose material facts for the reasons set forth
false and misleading when made and/or omi
above paragraph 333 a-c and for the following
a.
The Xerox Defendants' projecti
of future growth in revenues and earnings
were premised upon the continuation of Xerox' improper accounting practices and thus lacked
any reasonable basis;
b.
Defendants grossly understated
charges necessary even as to Mexico , let alone
those necessary on a company-vide basis;
c.
The Xerox Defendants' June 16,
discovery of bad debts in Mexico were
statements regarding the "unexpected"
false and misleading because, as the Xerox
Defendants knew or recklessly disregarded, the l adividual. Defendants had been directing a
corporate-wide program of accounting
in order to meet the market's expectations;
and
d.
The Xerox Defendants' June 16,
statements to analysts that the Company's
problems did not extend beyond Mexico were
false and misleading because, as the
152
`s
the improper accounting practices and
Xerox Defendants knew or recklessly
in2 on a worldwide basis.
financial improprieties that had occurred were
428.
that the SEC had begun an investigation of
On. June 29, 2000, Xerox
business. Defendants misrepresented that
accounting issues relating to the Company's
"twie are fully cooperating with the
in and may be in a position to provide more
We have no more information from the
information when we release second-quarter
a further private inquiry, but they have not
SEC and clearly they believe the issue
reached any conclusions."
429.
On July 26, 2000, Xerox
earnings of 30 cents per share for its second
quarter ended June 2000, "before an 11 cent pei share charge associated with its Mexican
subsidiary." The Company's charge equaled $ I115 million, pre-tax, and $78 million after taxes or
twice the amount the Company had estimated jist weeks earlier (5-6 cents/share). Defendant
Allaire was quoted as stating:
"We have no real to believe that the
Mexico are replicated in any other cow
episode, but we have dealt swiftly with.
430.
^cial circumstances that existed in
y .... We regret this unfortunate
and are cooperating fully with the SEC."
In a conference call to discuss
for the second quarter of 2000, held on July
27, 2000, Romeril admitted the pre-existing
of Xerox's accounting fraud:
A recent internal review discovered that, Ever a period ofyears, several but by no
means all, senior management managers in Mexico had collaborated to
circumvent Xerox accounting policies an t administrative procedures. Thecharge
relates to provisionsfor uncollectible lop g-term receivables, the recording of
liabilities for amounts due to concession Tres, and, to a lesser extent, for
contracts with customers that did notfull meet the requirements to he recorded
as sales type leases. The charge represer. is the Company's best estimate of the
impact of nonevents. Management, with the assistance of outside advisors,
continues to investigate our Mexican ope
ons. Until the investigation is
1
Complete, the need; if any, for further
not practical to estimate what, if any
time..
i.^+E^3 ^4^1i'3^ -i't^xi !J° kn own.
A
,,]
r'1.l^1L1 "'0 1it3
ionai VTO'6sioas may be needed a t this
We believe the issues are confined to Pv
local management who participated wa
structures and operational alignments tl
Company. Sef-contained units had res
including order taking, record keeping,
This unique lack ofseparation ofduties
Lion . A few key managers at the Mexic
complicate and/or weak, and therefore i
undetected.
exieo. Collusion amongst the several top
helped by certain organizational
at were somewhat unique to the Mexican
aonsibilityfor allfacets ofthe business,
credit approval, billing and collection.
contributed to the issues under investigain Company' s headquarters were
We've dealt swiftly with this
the SEC. Certain senior managers inch
and Finance Director were held account
The audit committee of the Board of Di
accounting firms to conduct an indepen
report back to the Audit Committee. 'W
with the addition of several senior staff
control and marketing-
episode, and are cooperating €u ly with
ing the former Mexico General Manager
3Ie and removed from the Company.
etors has engaged outside law and
is issues grew over time and remained
;nt investigation and report ... and
strengthened the Mexican organization
ith experience in operations, financial
And elsewhere in the world actions hav3 been taken to further underpin our belief
that our controls are not only adequate i other Xerox operations but that the
Mexican provision is an isolated occurr+ rice. (emphasis added).
431.
39-40; 53; 54; 428-430 were materially
The statements identified in Dar,
false and misleading when made and/or
above in paragraph 333 a-c and for the
disclose material facts for the reasons set forth
in reasons:
a.
The charge necessary for
b.
Defendants misrepresented that
remained understated;
circumstances in Mexico were not replicated
in any other country;
c.
The improper accounting
were not the product of collusion by a few
local managers in Mexico. The improper accouig practices, as well as the other financial
154
improi5riet ies, were done with the
and/or at the direction of the Company's senior
managemen t at Xerox's corporate
d.
Defendants misrepresented
in order to
"belief" that Xerox's controls were adequate in
other Xerox operations and that the Mexican
432.
ost quarterly revenues; and
was an isolated o ccun-p-mc .
In addition to the accounting
that plagued the Company's second
quarter, A Uaire announced on July 25, 2040
the Company's earnings would fall short of the
38 cents per share that analysts expected for
s second half, stating that investors should
make a "significant downward adjustment to
433.
In response to Xerox's
second-half expectations."
its common stock price fell to as low as $14
3/4 per share on July 27, 2000, its lowest prick since 1994 and down over 7011/9 from the stock's
52-week high. In addition, Standard'& Poor'o lowered its credit ratings for Xerox and reported
that it remained on its CreditWatch "with ne
live implicationa ." Xerox`s senior debt was
lowered from single-A to single-A-minus and its subordinated debt was reduced from single+-Aminus to triple-Bplus.
434.
On August 3, 2000 Merrill, Lys Report O wed:
X's managemet i credibility has beep i called into question . previously, both
S&P and Moody's were willing to give management the benefit of the doubt and
give them the time needed to improve, )perating performance enough so as to
return credit measures back to siu e-J
I5
s IIW7 anyaowign
's* ram-r-, one i-io-iffi to l3aal,
S&P is also Rely to downgrade
(emphasis added)-
aim a 2-3 week intense credit review i
the credit yet another notch from A. to
435.
filed its Form 10-Q for the quarter ended June
On August 14, 2000, the
30, 2000. This Form I O-Q, signed by Tayler,
During the second quarter of 2000, the Company recorded a pre-tax provision of
155
$115 million ($78 million after taxe
Mexico . The provision relates to csl
xweivablcs; recording liabilities for
lesser extent, for contracts that did i
as sales-type leases. The charge rep
Impact ofcurrently known exerts. ll
advisors , continues to investigate of
is complete, the need, i f any, for f
ingly, it is not practical to estimate
may be needed.
related to its previously announced issues in
blishing reserves for uncollectibie long-term
mounts due to concessionaires and, to a
t fully meet the requirements to be recorded
sets tie Company's best estimate ofthe
nagementa with the assistance of outside
Mexican operations. Until the investigalion
Ler provisions will not be known, Accordthis time, what, if any, additional provisions
In response to these issues, the Cam
number of senior local managers in-D.
from the Company; a new general =
strong financial background; the And
launched an independent investigatie
extensive review of the Company's v
ensure that the issues identified in Mi
The Company was recently advised
(SEC) had entered an order of a fon
accounting and financial reporting I
subpoenas for the production of cerl
the SEC. (emphasis added).
436.
Attesting to the propri
ay has taken the following actions - a
mica were held accountable and removed
alter was appointed in Mexico with a
Committee of the Board of Directors has
into the Mexican operation and as
ridwide internal controls was initiated to
;ico are not present elsewhere.
t the Securities and Exchange Commission
non-public investigation into our
:ices in Mexico. The SEC has also issued
documents. We are cooperating fully with
of th^ Compares accounting, the Scce nd Quarter 2000
Farm T 0-Q stated:
The unaudited consolidated interim fi
been prepared by Xerox Corporation I
accounting policies described in its I. {
defendants claimed the Company had
in conjunction with the notes thereto.
cial statements presented herein have
e Company") in accordance with the
Annual. Report to Shareholders [in which
npIied with (MAP] and should be read
In the opinion of management, all
recurring adjustments) which are z
results for the interim pe iods pre,
have been made.
437.
1 O-Q reported the following results=
The Second Quarter 2000
nts (consisting only of normal
for a .fair statement of operating
Total second quarter 2000 revenues
with $4.9 billion in the 1999 second
3 4 percent to $4.7 billion compared
. Excluding adverse currency
356
translation, pre-curre= y revenues
impact of the January 1, 2000 acgi
Imaging Division (CPID), pre-cur
lined 1 percent. Excluding the beneficial
ion of the Tektrord , Inc. Color Printing and
y revenues declined 4 percent
l uding a $115 million pro-tax prc
company's previously announced is:
quarter was $145 million. over ape
Mexico had collaborated to circumv
adminis trative procedures, resulting
receivables and uwecorded liabilitie
declined 50 percent to $223 million
sivn-($78 million after taxes) related to the
:s iri Mexico, income in the 2000 second
rd ofyears, several senior managers in
t Xerox accounting policies and
. a charge primarily for unt4b=dble
1 xcluding the Mexico provision, income
438.
Additionally, be Second
in $448 million in the 1999 second quarter.
2000 Form 10-Q stated:
Income Wore income taxes was $15 million in the 2000 second quarter
including the Mexico provision. Exo] ding the Mexico provision, income before
income taxes declined 57 percent to 74 million in the 2000 second quarter from
$633 million in the 1999 second cuai
439.
The Second Quarter Form I
also presented the following results with respect
to the DMO:
Developing Market Operations (DMO
China, Russia., Mia, the Middle East g
second quarter improved sequentially I
increase and the economic enviromatn
1999 send quarter, revenue in Brazil
1999 to subsequently sustain the price
devaluation. China, Russia, the Middle
growth in the second quarter but revcix
440.
includes opera ions in Latin Armerica.
rid Africa. Revenue in Brazil. in the 2000
s activity and momentum contim to
improves. However, compared with the
temporarily declined due to an inability in
nc,reases implemented following the maxiEast and Africa h ad excellent revenue
Ee declined in Mexico and Argentina.
The statements identified in
1 nislfiqWhen mde
s9ttmdi
39-40; 432-39 were materi ally false and
`ezRail facs , rElie reasons setfvrt. above in
paragraph 333 a-c and for the following
a. -
.. The Company's
results in the DMO, Latin America, Mexico,
Brazil and Venezuela were materially
due to the accounting improprieties set Earth
above;
57
b.
projections of growth in revenues and earnings
The Xerox
improper accounting practices and thus lacked
were premised upon the continuation of
any reasonable basis;
c.
to earnings due to Mexico did not represent the
The second quarter
Company's "lost estimate of the impact of
known events." Defendants knew that
Xerox's accounting issues went well beyond
d.
Xerox was not
e.
All adjustments
fully with the SEC; and
for a fair statement of opmmflng results for the
second quarter of 2000 had not been made.
441,
On October 2, 2000, the
also Bled a Form 8-K su4ug that:
[i]t would likely report a tbiird quarter oss of 15- 20 cents per share. Revenue was
much weaker than anticipated in Nvr# America and Europe, particularly in
September . The expected improvenzei in high-end sales did not occur,
Additiona.Ily, increased competitive pr assures across all businesses and European
cy deterioration are expected to. lave a further negative effect on gross
e
margins . These factors are compounde I by higher bad-debt provisions and
increased investments required to reso eve customer administration issues .... The
investigation related to accounting isst es in Mexico is continuing and the
company will provide an update at the time it reports third quarter earrings. The
company will also address its plans to restore shareholder value in more detail
when it announces third quarter carom is later this month.
442.
The following day, Allaire told linvestors that Xerox had an "unsustainable
money
id annpraveits ---ance sheet, This
^. _
warning -- the fourth in the past five quarters - prompted. Xerox shares to plunge 28% declining
$4.31 per share to$11 per share.
443.
I-
nded
-----------• - -
that it had been forced to draw down on its
On October 1 1,, 2000, Xerox
banking facility after investors d
-..__ ....__..._. -_...
r intent rates on the Cornpany's'short term.
158
securities instead of its commercial paper
A bond analyst at BNP Pazi .as Inc. stud
on the line for that reason:,'
"there is a cash flow shortage - they had to
444.
Xerox's senior debt rating, to EBB- from
On October 13, 2000, Fitch
A- and the Company's U.S. co ui
program to F3 from. P2 due to the Company's
ial
decreasing fine xcial performance,
surrounding the Compare 's business model and
for reduced liquidity. Firtch.'s rating meant
operating strategy moving forward, and the
of speculative or "junk" gxide. Fitch also placed
that the Company's debt stood at the
the debt an Negative Watch far even farther
445.
On October 24; 2000, the
announced a quarterly loss of 20 cents per
share, before an "incremental 6 cent charge
to its Mexican subsidiary.". The Company
Thrther stated:
Including a $55 million pre-tax provi on associated with the companys
previously announced issues in Mexic , the third quarter net loss was $167
million. No additional provisions re
d to Mexico are anticipated.
446.
An October 25, 2000
report reiterated the defendants' statements:
Xerox also recorded another charge in
$0.06 after-tax charge ($55 million prrt
$115 million pie-tax provision. The S
situation, but Xerox stated that it did n
that the problems were isolated.
7
[ation to the `Mexican receivable issue.' a
Lx). This is a follow-up to last quarter's
is still investigating the Mexico
anticipate any further related charges and
r T,I-e TFarm. $
-211 las'
itsconsoLa ^=
financial statements in advance of the filing oflits Form 10-Q for the third quarter of 2000. The
financial statements refiec ted^t t ^^ $
Ilan 'Mexico provision," bringing the total
provision during the nine months ended September 3D, 2400 to $170 million. The Company
reported a net loss of $ 167 mullion, or $(0 .26) Oer share.
159
--
448.
On No^
filed its Form 1 a-Q for the quarter ended
ber 14, 2000, the
September 2000, which contained the same
state ents previously filed with, the
Company's November 3, 2000 Form $-K.
to the propriety of the Company's
accounting, this Form l0-Q stated:
The unaudited consolidated interim f
been prepared by Xerox Corporation
accounting policies described in its i
which defendants claimed the Corip
read in conjunction with the notes tho
acial statements presented herein have
re Company") in accordance with the
Annual Report to Shareholders (in
had complied with CAI'] and should be
In the opinion of management, all
recurring adjustments) which are i
results for the interim periods pre!
Lments (consisting only ofnonrni
cry for a fair statement of operating
have been made-
449.
The Third Quarter 2000 Form ].O-Q reported the Company's purported results:
Income (Loss). before income taxes
quarter including the Mexico provit
before income taxes was $141 milli
income of $505 million in the 1999
450.
a a loss of $196 million in the 2000 third
1- Excluding the Mexico provision, the loss
in the 2000 third quarwr compared with
rd quarter.
As -to the "Mexico Provision,"
Third Quarter 2000 Form I O-Q stud:
For the nine months ended September
provision of $170 million ($120 milli(
announced issues in Mexico. A portio:
which Would ordinarily represent a ch
be included in selling, administrative,
presently not determinable.
0, 2000, the Company recorded a pre-tax
i after taxes) related to its previously
of this provision includes an amount
Se for uncollectible accounts that would
rid general expenses. This amount is
_----- rves cr unco ec z 1e ong-terra ' ,
receivables, recording liabilities for an runts due to concessi onaires and, to a
lesser extent, for adjustments related t[ contracts that did not fully meet the
requirements to be recorded as sales-ty )c leases. No farther provisions are
expected . The investigation of Ng mat er
heiAd1t _C&=mittce.of our. Board oof_
Directors, with the assistance of outsid advisors , is presently being finalized.
Including an additional $55 million
related to the company's previously
provision ($41 million after taxes)
red issues in Mexico, the net loss was
160
-
-- - -
$167 million in the 2 000 third goarterl No further provisions for this issue are
expected. Excluding the Mexico p ov^sion, the third quarter 2000 net l oss was
$ 126 mMon compared with net income of $339 imillion in the 1999 third quarter.
Including the 6 cent provision wising
m the independent investigation of our
Mexico operations, our loss pc share was $0.26 in the 2000 third quarterExcluding this provision , the third qur 2000 loss per share was $0.20
compared with $0.47 earnings per share in the 1999 third quarter. (emphasis
added).
451.
The Compaay's Form 10-Q also stated:
Over a period of years, several senior managers in Mexico had collaborated to
circumvent Xerox accounting policies I d administrative procedures. The
long-teun receivables, the recording
charges related to provisions for uncoi.lectible
an
of liabilities for amounts due to cone ianaires and to a lesser extent for contracts
that did not fully meet the requir en to be recorded as sales-type leases. No
further provisions are expected. The i vestigation ofthis matter by the A Wit
Committee of out Board of Directors, with the assistance of outside advisors, is
presently being finalized.
In response to these issues, the Company has taken the following actions -- a
number of senior local mar aagers in Me dco were held accountable and removed
from the Company, a new general manager was appointed is Mexico with a
strong financial background; the Audit ?Cor rnittee of the Board of (Directors has
launched an independent investigation into the Mexican operation and an
extensive review of the Company's worldwide internal controls was initiated to
ensure that the issues identified in Mexico are not present elsewhere452.
On November 17, 2000, the CoIpany filed a report with the SEC, which revealed
the dimensions of the Company's credit woes p ompted by its debt rags. As rated by
Bloomberg,
I
-
-
Xerox, which is depending on a credit ]n.c to fund operations, may be Forced to
repurchase derivatives contracts worth s much as $240 million if its credit ratings
fall below investment grade.
The wodd's largest copier company said a non-investment grade rating from
either Moody's Investors Service or StaA-daird & P ciz's l ayoblige it to piircbas
derivative agreements worth $110 millia^n. Junk grades from both would trigger a
further $130 million of repayments, the mpany said in a quarterly filing with
r
161
the U.S. Securities and Exchange Cornmission.
Xerox warned in the filing that "there is no assurance that the company's credit
ratings will be maintained." '
co pany's "ability to access capital markets and
uncommitted bank lines of credit" 1 been curtailed since the beginning of
October, and those funding sores 'I "largely unavailable."
Moody's rates Xerox "Baal ," or two otches away front non-investment grade,
and has had that assessment on revi
for downgrade since Oct 19. S&P rates
the company "BBB-," the l owest inv anent-grade level, though it has a stable
outlook. Xerox had $ 17.2 billion in total debt as of Sept.. 30.
A downgrade to junk bond status would also require Xerox to refinance the $315
million in asset-backed securities its 'Xd in the third quarter, after packaging some
of its customers' unpaid bills into securities . A rating below investment grade
would prevent Xerox from selling more of this type of security.
4537-
On December I, 2000, Moody's Investor Services lowered its long-term senior
unsecured credit rating of Xerox and its subsidiaries to Bal from Baal and its short-term rating
to Not Prime from Prime-2_ This rating is bellow investment grade. Xerox spokesman Bill
McKee said that Xerox would have to repurclase $425 million in derivative contracts and asset
backed securities because of the downgrade. toady's rating outlook was "negative," citing
concerns about liquidity and "earnings and operating cash flow deteraiora£i on." Shares of Xerox
declined another 9.9% to $6.25 per share. A spokesperson for T. Rowe Price Assoc., which hold
8.1 million Xerox sus in Tune 2000, stated'1 [i]fyou believe Xerox can't sell the assets, they
have a problem; i f you believe Xerox can't sacuritize finance receivables, they have a problern,'^
454
On January 29, 2001,
rox aI•ounced a 3 cents per share loss for the fourth
quarter ended December 31, 2000. For the fiscal year, the Company reported a $117 million
profit, or 12 cents per share before special itcmL Including these special items, Xerox reported a
loss of t53 cents per share, or $384 million for fiscal 2000. Revenues were reported to be $18.6
1
162
billion, down from $19.5 billion in 1999.
455.
On January 30, 2001,
Company's increase in its provision for
Smith Barztey confirmed that $29 million of the
ectible receivables was attributable to Mexico:
SG&A grew 8%, year over year, to 43.1 `Yo as a percentage of revenues. Bad debt
expense increased substantialy, due n part to unsettled business and economic
conditions, predominantly in Latin I erican countries. It in4luded a $29 million
increase in Mexico due in part to a higher provision fur current receivables.
456.
The January 30, 2001, UBS W,arburg also commented on the Company's actions
in establishing a reserve in other Latin Arnmican countries:
The SEC is continuing its investigation into Mexican accounting ism as well as
other accouaft mat's. Although erox believes the issues are still exclusive
to lexica, the company increased its receivables reserve in other Latin American
countries. In 2000, Xerox recorded a $4.18 charge to account for the Mexican
accounts receivable issues.
457_
The statements identified in
false and misleading when made and/or
above in paragraph 333 a-c and for the
a.
Defendants
47; 50; 441-43; 445-54 were materially
to disclose material facts for the reasons set forth
set forth below:
that Xerox did not anticipate any further
related changes and that the problems were
Defendants knew the accounting activities
extended well beyond Mexico;
b.
Xerox had not
I an "iildeDendent'T inyesd
operations. roth Akin Gump and
c.
The Company's
'pcoliaboxat[ion]" ofseveml managers in
Mexican accounting improprieties were
f -u of sS,,,Mmiean..
had con icts of interest in the investigation;
accounting practices were not the mere
to circumvent accounting policies. Inst
, the
by the home office and were symptomatic of
163
Xerox`s corporate culture of using aacountmI improprieties to meet financial goals;
not "exclusive" to Mexico;
d.
The accounting issues1
e.
The Conipar^s finan al results in Latin America, Mexico, Brazil, and
'Venezuela were materially inflated due to the accounting improprieties set forth above;
f.
Ilie Company's also
a-
All adjustments necess
t es for bad debts in Mexico were iuadcq at ;
for a fir statement of optating results for the
quarter ended September 30, 2000 had not
h.
The Company's allo
made;
ce for uncollectible receivables- was materially
understated, concurrently overstating the Com ,any's reportod revenues; and
1.
The Xerox Defendants`
jections of fat= growth in revenues and
earnings were Premised upon the continuation f erox's improper accounting pre bees and thus
lacked any reasonable basis.
D.
The Xerox Defmdani&' Ma
ally False And Misleading Statements
Regarding The F011 Extent of The Results of Its Investigation Into The
Mexican Accounting xx-reguIai'ties
458.
On February 1, 2001, the Com p I
announced the results of its "independent
investigation of its Mexican subsidiary." In the release, the Company continued to Misrepresent
that the accounting issues were the product of a ions by thirteen rogue Mexican ofcials;
-
°= s Apr s^r^
i #hat the fY^terial- o, ZIW
review
er
's in
n au-If-Cniiiral's -c&fimed that
the issues identi5ed in Mexico were not found i any other major unit; concealed the Xerox
Defendants' prior knowledge of these issues; an falsely assured investors that the Company had
acted appropriately once it became aware oftthe, ccouating irregularities in mid-2000- The
release stated:
164
The investigation commissioned by )
accounting firms determined that the
convergence of several disparate fact,
styles of certain Xerox Mexico execu
growl) at any cost, and inxpleruentati
practices. The investigation also con
and ascertaining and verifying the exi
plan of corrective action was timely e
459.
rs including the dominating management
Ives, the desire of those managers to drive
n of questionable business decisions and
]tided that upon learning of the problem,
ant of the issue, the company's response and
id proper ts' denial of wrongdoing, they were forced to
Notwithstanding the Xerox
admit to various accounting irregularities in
The investigation revealed irregulariti.+
inappropriate re-aging of past-due ace
debt reserves; improper transaction cli
rental of equipment; failure to adhere
corporate policies and procedures; anc
appropriate segregation of duties. Tht
controls and processes, many of whicl
being implemented with the oversight
460.
erox and conducted by external legal and
mpropzieties were caused by the
Tayler acknowledged that
Company's February 1, 2001 release:
s including, ineffective collection and
tints; billing inaccuracies; insufficient bad
ssification pertaining to the sale, lease or
a Xerox's well-developed and extensive
inadequate internal controls including
report made recommendations to enhance
were already under way- These are all
of the Audit Committee of the Board.
of the fourth quarter bad-debt increase of $77
million resulted from provisions for its
Moreover, Aomeri l admitted that the SEC
461.
in Mexico and other parts of Latin America.
widened its probe beyond Mexico.
As reported in The Wall Street
Xerox Controller Greg Tayler declinec
led to [Xerox's $120 million in the fin1
that the main problem stemmed from t
write off bad debts when customers fe.
on February 2,2001:
to provide a breakdown of the items that
zcial statement) charges- However, he said
le failure of Xerox officials in Mexico to
behind in their payments.
Instead, they relabeled the debts as cu 'ent, and failed to set aside enough money
for bad-debt reserves. And to a lesser xtent, the executives improperly booked
revenue from rental income up front as if it were a sale, Mr. Taylor said.
Xerox blamed its Mexican problems in part on the "dominating management"
styles of certain managers there, as we c on t npropeuly segregated dutier
among ern],7loy.,ees.
165
(3ibboney Huske, an analyst at Credi Suisse First Boston, says one problem was
that Mexican sales managers doubled as billing staffers, raking it easier to cover
up irteguIarities. (emphasis added).
462.
That same Wall Street Journ64 article also reported:
The Xerox announcement [a Credit S usse First Boston analyst] said, "raises the
question, `How good are the controls this company?`" The analyst] called it
nsuspicfous" that Xerox in its fourth quarter inmased its bad-debt provisions
nearly 5% of revenue, while they historically had been only 2% to 3% of revenueIn its fourth-quarter results released tact week, Xerox boosted its bad-debt
provisi to $230 rnilliorl from $1 53 loon in the year-earlier quarter.
463.
On February 9, 2001, in ane
st iiggling to mairntain credibility with
ew York Tunes article noting that Xerox was
and customers, given that it had failed to
adequately address accusations of faulty
practices,, Defendant Allaire falsely assumed
investors that Xerox's self-examiration bad
thorough and that its board had bezn diligent,
stating that "[w]e are mvare ofTim Bingham.'s
we investigated them, we found there
was no basis, and I see no need for an
464.
investigation now,"
The statements identified in paragraphs 458-fit ; 46:3; 253-59; 26Iwere materially
false and misleading when made and/or on tte to disclose material Faces for the reasons set forth
above in paragraph 333 a-c and for the iollo
a.
Defendants misrepresented that
Ihc depIuza
`[SIii" cniei
an-
reasons:
a Mexican accounting problems were caused by
ci .tg _. _Cr tki rt' I Pj
ii`ecfieci day
x c^rrpdia
_
..- _.
headquarters;
b.
Defendants painted the misperception that Xerox had resolved its accounting
improprieties by terming ing the "Mexi as executives";
C,
Defendants misrepresented that the issues identified in Mexico were not present
1
166
elsewhere;
d.
Defendants misrepresented that ex's response and plan of corrective action,
was timely and proper;
e.
Defendants understatement
Company's deviations from proper internal
account controls;
Defendants misrepresented
L
"worldwide." Both Akin Gump and PwC
investigation to M
g.
465.
tMr investigation was "independcr t" and
conflicts of interest and were directed to limit the
co; and
Defendants misrepresented
there was no basis for the Bingham allegations.
On April 2, 2001,.Xerox
that the filing of its year 2000 10-K report
would be delayed.
This delay relates to an internal review
Committee, en cooperation with the col
a fuller audit resew than previously cc
company's 2000 financial statements.
last week by the compmYs Audit
s auditors, KPMG. This will permit
laced and a sign-off on the
The con pany and its Audit Committee
accounting policies and procedures arc
accepted accounting principles.
that they believe that the company's
rriate and consistent with generally
466.
As a result of the disclosure, Xerox shares fell 18 percent or $I . )5, the biggest
drop in four months . " Considcring the other ail^ations of financ W roi mana,Vement, i t is
difficult
to give the company the benefit of ft . ubt," Gibboncy Huske, an analyst at Credit ^_
Suisse First Boston, wrote in a report,
467.
According to The Wall Street Journal, on or about the time ofthe April 2
announcement, Allaire and Mulcahy told emplo ces in an internal memo regarding KFMG,
167
- --
b
"This action is both disappointing and suipri.s txg,,, and that Xerox's accounting policies and
procedures are "approp riate and consistent" with. GAAP.- "Until recently, we had no indication
that KPMO would delay our filing.' Xerox
rked diligently throughout last week to conic to a
satisfactory resolution, but to no avail ," they said. "KPMG (Xerox's auditor) hasn't raised any
specific issues, nor have they alleged any
that this review will not lead to any issues
468.
" said the company. "We are convinced
will raise a problem for the company."
On or about the same time,
Theobald , man ofthe Xerox audit
committee, issued a release stating that the
"believes the company's accounting
policies and procedures are appropriate, and inj compliance with generally accepted accounting
principles ." He said K?MC had not advised
committee of "any specific transactions or
accounting matters of concern."
469.
le
On April 19, 2001, Allai.re and
appeared on The Nightly Business
it, offering false assurances to investors
Xerox's problems had been sufficiently
disclosed:
Susie CJHIARTS: Paul[Ailaire], when I v
one of the concerns, I mean every quest
to do that 10-K filing? Is it a matter ofji
auditors or they're wondering is another
more problems at Xervx?
_
----=
talking to Waft Street analysts today,
that came up was when is Xerox going
super cautiousness on the part of your
another shoe going to drop? Ire there
EA^ft := ell, ve c i a e
ayert^^ e problems but early
situation we had in Mexico and with th e ^SI1C Investigation, KPMQ, our auditors,
have asked for more time and they're gong trough all the additional steps that
they need to do to ensure that they have comfort with us. (emphasis -added),
470.
On April 20, 2001, Allaire and 1 ulcahy Awffi.er reassured investors by issuing a
letter to shareholders again misrepresenting that
ero)es accounting issues were limited to
168
Mexico:
An independent inve, ti ; ion concluded that our response in ascertaining the
extent of the problem and then taking action, including the termination of several
executives in Mexico, was timely an roper. (ernphasisadAed).
471.
on May 2?, 2001, The Wall &reel Journal
In contrast to these
regarding future reveaun stream
reported that the SEC was widening its probe
transactions in Brazil. Xerox's
,lChrista Carone vehemently denied any
"completely legitimate and were accounted for
impropriety, insisting that the transactions
appropriately in co
472.
m.
ce with generally
accounting principles."
On May 31, 2001, Xerox
statements for the three years ended
that KPMG had certified. its financial
31, 2040. The related financial statements
over the three year period. Claire touted that:
reduced net pre-tax income by just $140
"After rigorous reviews ofXerox's
fictitious transactions were faund and the
company's liquidity is not impacted."
473.
Investors were pleased with
pushing Xerox shares up $1.26, or 14
percent, to $14-29 in trading. Indeed, analysts
fell victim to Allaire's assurances and were
satisfied that Xerox's troubles were behind it:
"I think they came out with a relatively clean bill of health," said Pete Enderlin, a
Xerox analyst with Ryan Beck in New ork. "This removes that fear of the
Jack L. Kelly. managing director of Clolcr an Sachs & Co. in. New York, also said
the completion of the audit lifts a cloud
of uncertainty hanging over Xerox.
474.
The statements set forth above in
104; 465-, 467-72 were materially false and
69-70; 72; 74; 78; 81; 84-88; 93;
ink when made and/or omitted to disclose
169
material facts for the reasons set forth above in paragraph 333 ac and for the reasons set forth
below
a.
Xerox's accounting policies and procedures were not "appropriate and consistent"
with QAAP;
b.
KPMG had advised Xerox of "specific transactions or accounting matters of
concern;"
C,
'tional problems and that these problems went
Altai knew that there were
beyond Mexico;
d.
Defendants' actions regarding
a Company's accounting irregularities w= not
timely nor proper;
e.
Xerox's transactions with
F
"Whether or not Xerox' s transacti'
were not recorded in compliance with GAA?;
and
were "fictitious", its accounting for such
transacti ons w as fictitious.
475.
On June 7, 2001, Xerox filed its
I O-K for 2000 with the SEC, disclosing
the following:
We have restated our Consolidated Pi
eial Statements for the fiscal years ended
December 31, 1999 and 1999 as a result of two separate invesligado ns conducted
i -adifRtF th-b
a znvcs ,a 'ois moo ve - - _
D
previously disclosed i ssues in our Mexico operations and a review of our
accounting policies and procedures and application thereof. As a result ofthese
inv
gations, it was determined that ceai" n accounting practices and the
application thereof misappIied generally accepted accounting principles (( AP)
and certain accounting errors and irregul 'ties were identified. The Company has
corrected the accounting errors and irre
arWes. (emphasis added).
476-
On July 26, 2 001, Xerox anno
that the Board of Directors appointed
I
-= -
__
.
.1
Mulcaiiy as president and chief executive
477.
,cffective August 1, 2001.
On August 28, 2001, Xerox
its annual meeting. As reported in AP Online,
putting our opera#ions on a sound and
Mulcahy comforted investors by stating: "W
disciplined footing- And were doing all this
478,
^u: mortgaging ourfuture." (emphasis added).
d that PwC had. been named the Contpany's new
On Oct 5, 2001, Xerox anna
auditors for the fiscal year ending Decermber 31, 2001, replacing KPMO.
479.
On October 12, 2001, Xerox announced its preliminary third-quarter results that
included an estimated $3.8 billion to $4 billion n revenue and a loss in the range of22 to 25
cents per share, before net restructuring charges of 5 cents.
480.
On member 3, 2001, Xerox a zounced that the Board of Directors elected
president and chief executive officer Mulcahy t the additional post of chairman, effective
January 1, 2002.
481.
On January 29, 240 2, Mulcahy falsely assured investors that Xerox "continue[d]
to believe that [its) accounting is is accordance
482.
'th GAAP."
The statements set forth above in paragraphs 106; 109; 475-8I were materially
false and misleading when made and/or omitted
disclose material facts for the reasons set forth
above in paragraph 333 a-c and for the reasons
forth beIow:
e
ornnanvIra , 0
61
itsai~cvuntrrzg errors
b.
The Company was mortgaging is
483.
On April 1, 2002, Xerox annouxic
-ii-re
axitfFE an
to report current results.
that it had reached an agreement in principle
with the Division of Enforcement of the SEC con
matters that had be= under
investigation since June 2000. The settlement
a required restatement of Xerox's
171
financials for the years 1997 through 2000 as
ell as an adjustment of previously announced
2001 results. Xerox's release stated:
The restatement will primarily reflect s
lease revenue recognition and could ixr
revenue in excess of $2 billion from 15
will be no impact on the cash thaf has I
received from these leases ... The re;
could be in excess of $300 million due
reserves prior to 2001 and other misce]
484.
iatments in the timing and allocation of
ve a reallocation of equipment sales
through 2000... In any event, there
n received or is contras may due to be
ement will also include adjustments that
the establishment and release of certain
Leous items.
On April 11, 2002, Xerox
that it had concluded its settlement with the
SEC, stating that:
As a result, the Commission filed today a complaint and a consent order in federal
district court for injunctive relief and a civil penalty of $10 million. Xerox neither
admits nor denies the allegations of the complaint
lively resolves Xerox's outstanding
xy, Xerox chairman and chief
now behind us, we are better
sss through operational improvements
enhanced value for our customers and
'"rhe settlement with the Commission
issues with the SEC;, said Anne M. ?v
executive officer ... With the SEC m
positioned to continue fortifying our I:
and future growth opportunities -- ere
shareholders."
485.
The statements set forth above
s 111-14; 116-20; 125.26; 128-29;
483-84 were materially false and misleading when made and/or omitted to disclose material facts
for the reasons set forth in paragraph 333 a-c
a.
Defendants materially
b.
The required restatement would
and as set forth below:
the magnitude of the required statement ;
a negative effect on the Company's cash
position; and
G.
The restatement would not resolve Xeroxes issues with the SEC.
486.
Finally, at the end of the Class Pei od, Defendants revealed what appears to be the
172
true magnitude of Xerox's accounting fiau . Thus, on June 2$, 2402, Xerox announced that it
expected to file the Company's 2001 Form 10-
which included a testament for the years 1997
tluougi 2000 as well as adjustments to previously announced 2001 results. The restatement,
required under the Companys previously anno .nced settlement agreement with the SEC,
prirrxariIy reflected changes to Xerox's lease accounting under SFAS No. 13.
As a result, adjustments have been ma,
equipment, service, rental and finance
billion of revenue that was recognized
be recognized in the company's future
value of customers' contracts has not c
that has been received or is co
cual
to the timing and allocation of
.ue streams. Approximately $1.9
rer past years bs been-reversed and will
xults, beginning in 2002. The monetary
aged and there is no impact on t cash
due to be received.
For 1997 through 2001, the c
any revemed $5.4 billion ofprevi rly recorded
equipment sale revenue offset by $5.1 billion ofrevenue that has been recognized
and reported during the same period as service, remrtat, document outsourcing and
fnancfn, revenues. Revenues for 1997-2001 have been reduced by 2 percent to
$91 billion.
The reversal of equipment sale revenue
primarily due to a change in the comnpau
from equipment sales to rental.
larger than initially expected
lease accounting in Latin America
In addition to the reallocation ofrevei
reduction in pre-tax income primarily
release of certain reserves, ineludin8 I
recognition of interest income on tax ;
the restatement includes a $368 million
to the timing ofthe establishment and
icturing reserves and the timing of
In total, pre-tax income over this five -year period declined by X1.4 billion romp
previously reported amount . Shareholders equity was reduced by $1.3 billion ar
M .
Additional Applicable Accounting Principles and Rides
4$7.
4AAP are those principles recognized by the accounting professk n as the
conventions , rules, and procedures necessa ry to d
nc accepted - accounting practice at a
particular time. As set forth in Financial Aceoun ing Standards Board Statement of Concepts
In
("Concepts Statement") No. 1, one of the
objectives of financial reporting is to
provide accurate and reliable information
an entity's financial performa nce during the
period being presented. Concepts Statement 1;1 42, states:
Financial reporting should provide inf nation about an enterprise's financial
performance during a period . Investorr and creditors often use infbnnation about
the past to help in assessing the prospects of an enterprise. Thus, although
investment and credit decisions reflect Investors' and creditors' expectations about
future enterprise perfo inanrc, those expectations are commonly based at least
partly on evaluations of past enterprise gerfbnnance.
488.
Asset forth in SEC Rule 4-01(a) of SEC Regulation S-X, "(f]inan ciai statements
filed with the [SEC] which are not prepared in
misleading or inaccurate." 17 C.F.R. § 21
with f(MAP] will be presumed to be
I(a)(1). Ma aagement is responsible for preparing
financial statements that conform with GAAP.
financial statements are management's i
responsible for adopting sound account
maintaining internal control that v614 zi
summarim and report transactions (as,
with management's assertions embodied
transactions and the related assets, 3iabi
knowledge and control ofmanagement
financial statements in conformity with
Principles is an implicit and integral pau
489.
noted by the AICPA professional standards:
sponsibWty . - - : Management is
ig policies and for establishing and
tong other things, record, process,
Felt as events and conditions) consistent
in the fir ancial statements. The entity's
ties and equity are within the direct
... Tbus, the fair presentation of
3encrally Accepted Accounting
of management's responsibility.
As a result of the accounting
deseriibed., the Xerox Defendants
caused Xerox's reported financial results to
among other things, the fol
of GAAP for which each of-the Xerox
a.
is necessarily responsible-
The principle that financial reporting should provide information
that is useful to present aAd potential investors and creditors and
other users in making rat nal investment, credit and similar
decisions- (Statement oft inancial Concepts No. 1, Objectives of
Financial Reporting byB^rsfners Enterprises, CANT 134);
174
490.
b.
The principle that ina
about how manag eme7
stewardship responsib
enterprise resources ex
offers securities of the
accepts Crider responsi
investors and to the vu
ial repo ing should provide information
of an enterprise bas discharged its
ty to owners (stockholders) for the use of
usted to it. To the extent that management
5terprise to the public, it voluntarily
Jities for acs' untabi lity to prospective
fie in general.. (CONI ISO);
c.
The principle that fun
about an enterprise's
Investors and creditors r
in assessing the prospoc
investment and credit d+
about future enterprise I
commonly based at leas
performance. (CONI ¶
ial reporting should provide information
ncial performance during a'period-
(ten use information about the past to help
s of an enterprise. Thus, although
oAs reflect investors' expectations
=fonnance, those expectations are
partly on evaluations of past enterprise
d.
The principle that finandial reporting should be reliable in that it
represents what it piupoits to represent The notion that
inibrmakion should be reliable as well as relevant is central to
accounting, (Statement I flFinancial Concepts Na 2, Qualitative
Characleristtcs ofAcco tin$1nfo matron; "CON2 ¶ 5$-59);
e.
The principle of compl
which means that nothing is left out
of the information that ay be necessary to enure that it validly
represents underlying cv nts and conditions. (CON2 I SO); and
f.
The principle that con
ttsm be used as a prudent reaction to
uncertainty to try to ensure that uncertainties arid risks inherent in
business situations are adequately considered. The best way to
avoid injury to investors s to try to ensure that w^ is reported.
represents what it purpo , to represent. (CC)N2, 1J 95,. 97).
Xerox was required to restate
financial statements for years 1997, 1999, 1 999,
and 2000 and to adjust its 2001 results, as set fa
Restatement, because those financial statements
in the First Restatement and iti the Second
not been prepared in conformity with (MAP
and SEC accounting requirements when they we
issued. In view of "the potential dilution of
public co
from restating the financial statements ofprior
de in financial stat cents resuld
175
periods," according to GAAP, a rctroaetivc
statement of financial statements is reserved for
material accounting errors that existed at the ^ime the financial statements were prepared. See
APB Opinion No. 20, Accounting Changes, f 18,27 , 34-38, Since GAAP only allows for
correction of errors that are "material," by
its financial statements, Xerox admitted the
financial statements for years 1997, 1998, 1999,
materiality of the errors in its previously
and 2000, and all interim quarks.
491.
GAAP also requires that
statements disclose contingencies when it is at
least rcascnably possible, (e.g., a greater than
chance) t at.4 loss may have been incurred.
SFAS 5 The disclosure shall indicate the natu* e ofthe contingency and shall give an estimate of
the possible loss, a range of loss, or state that
cli an estimate cannot be made. Id. The SEC
considers #
be so important to an informed investment
disclosure of loss contingencies
decision that it promulgated Regulation S X,
'th provides that disclosurres in interim period
not
financial statements may be abbreviated and
duplicate the disclosure contained in the
most recent audited
statements,
that, "where material contingencies exist,
disclosure of such matters shall be provided
though a significant change since year end may
not have occurred ." 17 C.F.R. 210. 10-01.
X.
Y PMG's Violations of GAAS
for auditors in performing and reporting on
engagements. Statements on Auditing
Standards ('SAS") are recognized by the AICP4 as the authoritative interpretation of GAAS.
KPMCI failed to comply with GARS in
its audit work and in certifying Xerox's
financial statements.
I
r
493.
I
GAAS requires an auditor to d i termine three initial risk factors in order to obtain
an understanding of intmal control suf1cient to plan the audit. An auditor must evaluate (i)
"control risk" or whether a misstatement will be prevented or ducted on a timely basis by the
entity's internal control; (ii) "inherent risk," or whether the possibility exists that there -Al be a
misstatement due to lack of internal controls; and (iii) "detection risk,," or whether the auditor
will detect the material misstatement AU § 3 19A6.
494.
GARS also requires an auditor
assess risk factors relating to misstatements
arising from fraudulcnt financial reporting. AU § 316.16-316.17. GARS provides a list of
procedures that an auditor must consider in assessing audit risk factors, which include: (a)
whether management compensation creates a
vation to engage in fraudulent financial
pup; (c) actions which are not supported
reporting; (b) domination ofmanagement by a
by Proper documentation or are not
should be, but a
authorized; (d) mporting records or files that -
not, readily available and are not promptly produced when requested; and (e)
lack of timely appropriate doCurx entation for transactions. AU §§ 316.16-316.25. The risk
associated with an audit determines the nature and extent of the evidentiary matter that must be
obtained to assure the auditor that the financial statements are free from material error.
495.
GAAS and KPMQ's audit ap oal required KPMG to study Xerox's internal
GAAS requires that:
I
AU § 319, Consideration ofInternal
in a Financial Statements edit
In all audits, the auditor should obtain an .i,nderstanding of internal control sufficient to
plan the audit by performing procedures to understand the design of controls relevant to
an audit of f ncial statements, and whether they have been placed in operation.
177
[319.02]
In all audits , the auditor should obtain an understanding of each of the five components of
internal control suflie : ern to plan the auit by performing procedures to understaud the
design of controls relevant to an audit of financial statements, and whether they have
been placed in operation. In planning the audit, such knowledge should be used torIdentify types of potential misstatement,
Consider factors that acct the risk of material miss
Design substantive tests. [319.1 j
-nt.
The auditor should obtain sufficient kuq vledge of the control environment to understand
management's and the board of directors' attitude, awareness, and actions concerning the
control environment, considering both tie substance of controls and their collective
effect The auditor should concentrate 4 the substance ofcontrols rather than their form,
because controls may be established but;not acted upon. For example, merge rent may
establish a formal code of conduct but aet in a manner that condones violations of that
code. [319.26]
1
Tim auditor should obtain sufficient knowledge of the entitys risk assessment process to
understand how management considers risks relevant to financial reporting objectives and
decides about actions to address those risks. This knowledge might include
understanding how management identifies risks, estimates the significance of the risks,
assesses the likelihood of their
and relates them to financial reporting.
occ'1rren8c,
13l9.3O]
The auditor should obtain sufficient kno ledge of the information system relevant to
financial reporting to understandThe classes oftransactions in the entity's operations that are significant to
the financial statements.
--.-
'=a'=-
ansaetsens
cintti
The accounting records, supporting infonvAtion, and specific accounts in
•
the financial statements involved in the processing and reporting of transactions.
a
Tice accounting processing involved from the initiation of a transaction to
its inclusion in the f ncial statements, i chording electronic means (such as
computers and electronic data interchange) used to transmit, process, maintain,
and access information.
178
The financial reporting process used to prepare the eatity's financial
•
statements, including signifie t accounting estates and disclosures ...
(319.36j
In obtaining an understanding of corit
auditor should perform procedures to
of the relevant controls ping to e
and whether they have been placed in
obtained through previous experience
inquiries of appropriate manage ment,
of entity documents and records; and
operations.... [319.411
AU §150 .02, Generally Ace
that are relevant to audit planning, the
side sufficient knowledge of the design
of the five internal control components
ion. This knowledge is ordinarily
h the ci .ty and procedures such as
arvisory, and staff personnel; inspection
:z-vation of entity activities and
dAud1tj
UdLft Standards
The generally accepted auditing stand;
membership of the American Institute
follows:
s as approved and adopted by the
Certified Public Accountants are as
Standards ofField Work
A sufficient understanding of internal cd tr( is to be obtained to plan the audit
and to determine the nature, timing, and
t of tests to be perfor med .
496.
KPM( refers to its audit
"BMP." According to in1onnation available at
... helps [KPMG) analyze your busiines
environment and industry to determine I
results . BMP provides a framework for
information flows that impact the financ
service team to work 'with you to ideaatii
financial performance,
as "Business Measurement Process" or
`s website, this BMP methodology:
in the context of your market
your key risks affect your financial
xamining financial and non-tnanaial
d statements, and it enables our client
opportunities for improving your
Indus try Focused
At the heart of the EMP audit is our prof
models. These models provide our audit
key industry trends and issues that could
identi fy the areas that pose the highest ri:
Technology1:nabled
taffy industry segment business
ems with up4o-date information on
1pact your business. They enable us to
to your financial dents.
XPMG audit teams are wmod with pri
quality audit. KPMC's technology tot
focused workflow that puts industry is
team collaboration. These state-off-the
workpapers; they help teams focus on
concise analysis that is fundamental tt
prietary applications designed to ensure a
is provide our teams with a structured, risk.formation at their fingertips, and enables
-art tools are more than simple electronic
the key risks of your business and drive
the financial statement audit.
Our IBMP3 audit methodology takes I ito ac count a Companyls strategy, its related
risks and controls, and their impact an financial. results. Through this advanced
audit process, KPMG is able to pzc'vid information to clients that helps them
better understand the risks that exist w Lthin key business processes and the effect
those risks can have on their financial
I<IPMG has published a document title "Auditing Organizations Through a
Strategic-Systems Leis, " available on
Internet, which provides details of the
Fig.'s audit approach (the "Audit App aach Summary"). The Amt Approach
Summary states, in pertinent part, the :
BMP has a very clear strategy focus. I
approach that focuses the auditor=s asse
systems lens - - a lens that directs the a
dynamics: its business strategy and the
the strengths of its connections to outsi
suppliers, investors, and regulators; any
threaten the viability of its chosen rich
Id at 2.
is a riskbased strategic-systems audit
sment ofrisk through a broader strategic
editor's attention to the client's system
:commie niches it has chosen to occupy;
it economic agents, including enstomers,
^te external and internal forces that
and the achievement of its objectives* 0
Today's auditor should place more we S t on knowledge about the client's
business and industry, and its interacts 3, s with its environment, when forming an
opinion about the validity of financial statement assertions. Id at 13.
*I
497.
Using the BMP, KPMG
analogs) and integrates these analyses with
"whole-system„ decision frame for the assess
assertions- The five system levels are; (I) bu
controls embedded in business processes, (4)
management process . id at 17-18.
analyzes five system levels (business
analyses of the client's environment, to form its
of the validity of fuancial-statement
processes, (2) information systems, (3)
management process, and. (5) strategic
498.
titled "Auditing Organizations' cough a
KPMG has published a
Strategic-Systems Lens," available on the
which provides details of the Firm's audit
approach (the "Audit Approach Suxnmaiy").
Audit Approach Summary states, in pertinent
part, the following:
Under BMP, the auditor's work process
assessment focus from a transactions ri:
risk orientation ....
tinned upside down, shifting the risk
orientation to a stiategc client business
BMP m based on live principles of
The methods and procedures
business monitoring and measurement: trategic analysis, business process
analysis, risk assessment, business mea iremeut, and continuous improvement.
ld at 33.
-ocesses ofthe client organization as a
9 ofthe flow of activities comprising
with one another and with individuals
those competencies and competitive
these interrelationships. During
r identifies significant process risks and
The EMP auditor analyzes key business
means of developing a broad and tand
each process, how the processes it rrc1
and organizations outside of the entity, s
advantages that determine the strengths ,
business process analysis, the BMP audi
comes to understand how they are being
ntrou.ed. Mat 35.
The 13MP auditor gains an understandini of the client's own risk management
processes and the extent to v hich the clip at is monitoring externs.l and internal
risks that threaten the achievement of its )verall business objections and its
business process objectives.
Particular attention is paid to the adequa
includes considerations such as whether
management are complete; business risk
existing controls reduce these risks to ac
y of the risk management process, and
Yesc business risks identified by
have been prioritized appropriately;
rptable levels; and accounting choices
During the business measurement phase the BMp audit, the auditor measures
the processes and variables that have the eatest impact on the business and
analyzes interrelated perfonnance measti > (financial and nonfinancial) both over
time and relative to those of similar orgy
**I*
Additional audit test work is performed
interrelated financial and
nonfinancial performance measures are
7istent, and when key financial18
statement assertions are not consistcat
ith the auditafs understanding of the
organizatio's strategic-systems dynan
process performance. Id at 36.
:s, including its strategy and measures of
#I*
BUT $uisiness Process Analysis
Specifically, each key core business prv ss is studied in depth to discern
risks relatcd to these objectives, the
signiUcant process objectives, the busin
controls established to mitigate the risks and the financial-statement implications
of the risks and controls . Id at 43
that threaten achievement of the process
The UMP auditor next considers the ii
objectives, and the controls that have ben implemented to r&tigate such risks.
Id at 47.
J3MP Risk Assessment
Clearly, a major business risk is ma;
misleading financial statements and
employe. Id at 49.
Y
art's preparation and d ribut n of
ion to investors, creditors, and
infor
Because auditors are recognized for their
unique position to influence control polio
recognizing the control paradigm shift. IN
thinking about control must evolve - e.g.,
lines of a aority and increasingl y flat art
opportunities for segregation of duties. A
segregation of duties and functions, prop(
controlled access to assets, proper records
proceduxal checks and balances that safes
must be recognized as only one aspect of
mosaic. la at 50.
During reviews o f elient's risk
reasonableness of the assumptions that un
potential impacts of these risks- Id at 5 1.
Rowledge of controls, they an in a
as it evolves in organ7ations
ire importantly, however, auditors'
mpowennent will increasingly blur
ni.zations will provide fewer
ditors' traditional notions ofcontrol as
authorization for expenditure-,,!
of transactions, etc., that `define the
and assets and assure integrity of data'
contemporary organization's control
process, the BMP auditor develops an
is management's assents of the
l3MP Business Measurement
fT]hc BMI' auditor assesses the client's re'
quality of the client's reported eamii gs, in
the related financial-statement assertions.
recognition practices, and the
of their impact on the validity of
measurements and assessments
i
are combined with the BMP auditor's
documented in the client business ma
wledge about residual business risks and
id at 52,
EMP Continuous improvement
The in.-depth knowledge the Bhe audit
process indicators he collects, equip the
independent feedback to the organiyatio
and business process owners as a bypre
acquires ... combined with the key
MP auditor to provide valuable,
board of directors, tipper management,
act of the BW audit. rd at 60.
Managers
cr's can benefit from independ(
the eat auditor, The BW auditor
managers, and process ovmers that refl,
entity-level performance, b) structural
process strengths and weaknesses, and
possible vu,Inerabilities related to emer
feedback and assurances provided by
equipped to paint a picture for directors,
s an independent image of aspects of a)
:ngt s and Weaknesses, c) business
499.
According to the auditing
conducted by K'PMG pursuant to its proprietary
disregarded the lapse in Xerox's internal
risk that financial statements are materially
factors to be considered in connection with the
its current strategic positioning and
tg tnmds. -.Id at 62.
set forth above, as well as the procedures
process, KPMG knew or recklessly
GAAS atsn requires the auditor to assess the
and provides the auditor with specific
s assessment . During the annual audit,
K.PMG noted or deliberately turned a blind eye t the existence of at least the following specific
factors:
(a)
Xerox management failed to displ y and communicate appropriate attitude
regarding internal control and the financial reporting process;
by a small group without o
board of directors or Audit
(c)
(d)
Xemx inadequately monitored
Xerox Mexico and at its Latin.
Xerox management failed to
basis; and
ing controls such as effective oversight by the
t controls, particularly those in place in
subsidiaries;
known reportable conditions on a timely
I
(e)
Xerox's nonfinancial. managTe t had excessive participation in, or preoccupation
with, the selection of accounting
ciples or the determination of significant
estimates.
500.
KPMO' s falure to qualify,
Xerox's fiscal 1997, 1OK8i, 1999, and 2000
turned a blind eye to numerous facts that
or abstain from issuing its audit opinions on
statements when it knew or deliberately
that those financial statements were materially
false and misl eading caused KPMG to violate at] least the following provisions of C3AAS:
(a)
KPMG violated the second gR
ent, an
relating to the assi
by the auditor or auditors, "
standard , which provides that "[i]n all matters
ndence in mental attitude is to be maintained
(b)
1CPMG violated the third general btandard, which provides that "[d]ue
professional care is to be
in the performance ofthe audit and the
preparation of the report."MM,
(c)
KFMG violated the second stand
d of field work, which provides that "la)
sufficient understanding of intertu
to determine the nature, timing, ai
standard requires the auditor to m,
including accounting, financial an
reliance thereon was justified, anc
E control is to be obtained to plan the audit and
I extent of tests to be performed." This
ke a proper study of existing internal controls,
I managerial controls, to determine. whether
if such controls are not reliable, to expand the
nature and scope of the auditing p acedures to be applied. In the course of
auditing Xerox's financial stateTuc its, i<PMG either knew or xcklcssly
disregarded farts that evidenced t] A it failed to sufficiently undeistand Xerox's
internal control structure and/or it isregarded weaknesses and deficiencies in
Xerox's internal control structure, end failed to adequately plan its audit or expand
its auditing procedures.
(d)
KPMG violated the third standard of field v
which provides that "[s]ufficient
inquiries, and confirmations to afford a reasonable basis for an opinion r
the financial statements under audit."
rding
(e)
KPMO violated the first standard of reporting, which provides that "jt)he report
shall state whether the financial
tements are presented in accordance with
generally accepted accounting pri ciples."
(i}
KPMG violated the second standa,d of reporting, which provides "[t]he report
7
sball identify those circumsi
consistently observed in the
KPMG violated the third Stan
disclosures in the financial. s
unless otherwise stated in the
in wluci such principles have not been
it period in relation to the preceding period,"
of reporting, which provides that "[i]nformative
sets are to be regarded as reasonably adequate
rrd of reporting, which provides that "[tlhe report
of opinion regarding the financial statements,
to the effect that an opinion cannot be expressed.
be expressed, the reasons therefore should be
1tor's name is associated v ith fieancisl
stain a clear-cut indication of the character of the
agree of responsibility the auditor is taking." This
pinion on the financial statements taken as a
easons therefore must be stated. KPMG should
be issued by it on Xerox's fiscal 1997, 1998, and
ied an adverse opinion stating that those financial
(h)
KPMG violated the fourth stanc
shall either contain an expresso
taken as a whole, or an assertio:
When an overall opinion canna
stated. In all cases where an au
statements, the report should cc
auditor's work, if any, and the a
standard requires that when an +
whole cannot be expressed, the
have stated that no opinion con
1999 financial statements or iss
statements were not fairly pxese
(1)
KPMG violated AU §f 316.16-3 16.25, wbch provides that an auditor must
consider the following factors in assessing .audit risk: (a) whether management
compensation creates a motivadi Mn to engage in fraudulent financial reporting; (b)
domination of management by a small group; (c) one's actions which are not
supported by proper docnmentat on or are not appropriately authorized; (d)
reporting records or files that sh( Auld be, but are not, readily available and am not
promptly produced when reques ^d; and (e) lack of timely inappropriate
documentati on for transactions.
G}
KPMG violated AU § 316.27,
material misstatement due to f
Cl)
Rh provides that "fjludgments about the risk of
may affect the audit" in the fallowing ways:
Professional skepticism,
exercise professional ski
professional care requires the auditor to
an -- that is, an attitude that includes a
through.09). Same exam ales demonstrating the application of
professional skepticism in response to the auditor's assessment of the risk
of material misstatement c ue to fraud include (a) increased sensitivity in
the selection of the nature and extent of documentation to be examined in
support of material transaw tions, and (b) increased recognition of the need
to corroborate manageme, it explanations or representations concerning
material matters -- such a; further analytical procedures, examination of
documentation, or discuss on with others within or outside the entity.
185
1
'!
(ii)
Accounting principles d po ivies. The auditor may decide to consider
finrther management's Iection and application of significant accounting
policies, particuh rly
se related to revenue recognition, asset valuation,
or capitalizing versus pcnsing. In this respect, the auditor may have a
ther the accounting principles selected and
greater concern about
policies adopted are be' applied in an inappropriate i nner to create a
material misstatement o thae financial. statements.
(iii)
Controls. When a risk a mate iii misstatement due to fraud relates to risk
factors that have control implications, the auditofs ability to assess control
risk below the maximum may be reduced. However, this does not
auditor to obtain an understanding ofthe
eliminate the need for
components of the enti 's internal control sufficient to plan. the audit (see
319). In fact, such an derstan,ding may be of particular importance in
further understanding an considering any controls (or lack thereof) the
the identified ud risk factors. However,
entity has in place to ad
this consideration also
td need to include an added sensitivity to
management's ability to Override such controls.
(iv)
KPMG violated AU § 31
management: incentives
material misstatement of
activities may be reduce
(v)
KPMG violated AU § 319.22, which provides that "[t]he auditor's
understanding of internal control may sometimes raise doubts about the
auditability of an entity's 1nancial statements." Indeed, "[ejoncerns about
the integrity of the entity' management may be so serious as to cause the
1
auditor to conclude that
risk of management r .isrepresentation in the
financial statements is
h that an audit cannot be conducted." Moreover,
"[c]oncerns about the
and extent of an entity's records may cause
the auditor to conclude t t it is unlikely that sufficient competent
evidential matter will be ailable to support an opinion on the financial
(vi)
KPMCI violated AU § 384.09, which states that "[t]he auditor should
inform the audit commit
about adjustments arising from the audit that
his
could , in
judgment, ei er individually or in the aggregate, have a
significant effect on the tity's financial reporting process." For purposes
of this section, "an audit a justment; whether or not recorded by the entity,
is a proposed correction o the financial statements that, in the auditor's
judgment, may not have , detected except through the auditing
18, which provides that "when the presence of
an environment that could result in
ia1 statements, the effectiveness of control
procedures performed." Indeed; "[m]atters underlying adjustments
proposed by the auditor t not worded by the entity could potentially
cause future financial sta
eats to be materially misstated, even though
the auditor has conclud- that the adjustments are not material to the
curreni financial statem .ts."
501.
either failed to identify these blatantly
Duiiug its Class Period audits,
(L e. failure of controls to prevent or detect
apparent material weaknesses in internal cons
the existence of such conditions in violation
misstatements of revenue), or identified and i;
of GARS.
XL
Plaintiffs' Class Actian Allegations
502_
Plaintiffs bring this action as a
action pursuant to Federal Rudy of Civil
Procedure 23(a) and (b) (3) on behalf of the
consisting of all persons and/or entities who
purchased Xemi common stock and/or bonds c
the period from Fchruary 17, 1998 through
June 28, 2002 and who were damaged th
ided from the Class are Defendants, the
by.
officers and directors of the Company, members
immediate families, their agents, and
affiliates
503.
The members of the Class are so Aumerous that joinder ofan members is
impracticable . Throughout the Class Period, x£
x common shares were actively traded on the
NYSE. As of December 13, 2001, there were ap roxitnately 719 988,021 shams of Xerox
exceeded two million shares per day during the
ass Period. While the exact number of Class
members is unknown to Plaintiffs at this time a
can only be ascertained through appropriate
discovery, Plaintiff's believe that there are
ds of members in the proposed Glass, Record
owners and other members of the Class may be
.lnti%ied from records maintained by Xerox or
1
its tracer agent and may be notified of the p Ldency ofthis action by mail, and public notice
using the form of notice similar to that custo
504.
rily used in securities class actions.
Plaintiffs' claims are typical of ie other members of the Class as all members of
the Class are similarly affected by Defendants' wrongful conduct in violation offederal law
complained of herein.
505_
Plaintiffs will fairly and adequal ;Iy protect the interests of the members of the
Class and have retained counsel competent and experienced in class action and securities
litigation.
Common questions of law and f
as to all members of the Class predominate
over any questions solely affecting individual x
7bers of the Class. Among the questions of
505..
law and fract common to the Class are whether:
507,
were violated by Defendants' acts as alleged
a.
the federal securities la'
herein;
b.
statements made by Def
Period misrepresented n
financial statements or c
ants to the investing public during the Class
:rim faces about the business, operations, and
iition of Xerox; and
c.
members of the Class he
such damages.
sustained damages and the proper measure of
A class action is superior to all o her available methods for the fair and efficient
`in`nhi
a ,Ira ieaf`
^s=^n^p a
care
rs---
the damages suffered by individual Class xncmb rs may be relatively small, the expense and
burden of individua l litigation make it impossibi for members of the Class to individually
redress the wrongs done to them . There will be
as a class action.
18
difficulty in the management ofthis actions
X1I.
and The Fraud-on-the-Market Doctrine
Applicability of Presumption of
508.
At all relevant times hereto, the market for Xemx`s Stock was an efficient rnaz±ct
for the fall owing reasons:
quantitative requirements for listing, and
efficient and automated market;
Xero s stock met the t
EL
was listed and actively traded on the NYSFL, a
b-
filed periodic public reports with the SEC and
as a regulated issuer,
the NYSE;
C.
Xerox regularly comet ' 'cated with public investors via established
market communication mechanisms, including through regular disseminations of press releases
on major newswire services and through other ide-ranging public discl osures, such as
communications with the financial press and o er similar reporting services; and
d.
Xerox was followed by veral securities analysts employed by major
brokerage firms whose written. reports were die 'buffed to the sales force and certain customers of
their respective brokerage firms. Each ofthese
orts was publicly available and entered the
public marketplace,
•
509.
As a result ofthe foregoing, the
for Xeroies stock promptly digested
current information regarding Xerox from all
icly available sources and reflected such
information in Xerox's stock price. Under
circumstances, all purchasers ofXerox's
common stock and bonds during the Class
suffered similar injury through their p
of Xerox's common stock and bonds at artilici
inflated prices and a presumption of reliance
base
applies.
510.
for fbrwerd-looking statements under certain
The statutory safe harbor provi
pleaded in this Complaint that are alleged
circumstances does not apply to any of the
to be false and misleading. Many of the
pleaded herein were not identified as
"forward-looking statements " when made. Moreiver, the statements pleaded heroin related to
1
coudiuoris existing at the time the statements "re made. To the a tent the Court deems any
statement to be forward-look`
fined cautionary statements identifying the
the r were no
factors set forth herein which the Xerox Defew
knew would cause actual results to differ
materially from those in the purportedly forwai
statements, once the subject matters of
the Xerox Defendants' non.-disclosures became
known. Alternatively, to the extent that
pleaded herein, the Xerox Defendants are
the statutory safe harbor does apply to any staJ
liable for those false statements hec-muse at the
each statement was ma&, the particular
speaker knew that the particular statement was
and/or the statement was authored and/or
statements were false when made.
approved by an officer ofXerox who knew
XV.
Counts
Violation of Section 10(b)of The Exchange ct and Rule 1 0b--5 Promulgated Thereunder
Against All I)efendh its
511.
Plaintiffs repeat and reallege ee^ and ever y al1P_gation contained above as if fully
set forth herein.
512.
During the Class Period,
;s, and each of then, carried out a plan, scberuc
and course of conduct which was intended to
throughout the Class Period, did: (a) deceive
the investing public, including Plaintiffs and the ther Class members, as alleged herein; (b)
cause Plaintiffs and other members of the Class io purchase X=Vs common stock and bonds at
artificially inflated prices. In furtherance of this
forth hein.
Defendants, and each of them, took the actions
513.
schern; plan and course of conduct,
schemes, and artifices to defraud; (b) made
Defendants: (a) employed devic
1
untrue statements of material fact and/or
to state material facts necessary to make the
statements not misleading; and (c) engaged in
prices, and a course of business which
opened as a fraud and deceit upon the
of the Company's securities in an effort to
maintain artificially high market prices for
securities it, violation of Section 10(b) of the
either as primary participants in the
Exchange Act and Rule I Ob-5. Defendants are
wrvngfuil and illegal conduct charged herein or 0 controlling persons as alleged below.
514.
their of
sty imposed on Defendants as a result of
In addition to the duties of full
ve statements and reports, or
in the making of affirmative statements
and reports to the investing public, Defendants
a duty to promptly disseminate truthful
information that would be material to investors
compliance with the integrated disclosure
provisions of the SEC as embodied in SEC
S-X 017 C.F.R. Sections 210.41 et seq.)
and Regulations S-K (17 C.F.R. Sections 229.10 let seq.) and other SEC reg lations, including
making accurate and truthful infon nation with
to the Company's operations , financial
condition and earnings so that the market price
the Company's securities would be based on
truthful, complete and accurate information.
515.
directly and indirectly, by the use, means
Defendants, individually and in
or instrumentalities of interstate commerce
ofthe mails, engaged and participated in a
operations and future prospects of Xerox as
516.
ham.
Each of the Individual
primary liability, and controlling person
liability, arises from the following facts: (a) each Of these Individual Defendants were high-level
executives and/by directors at the Company during the Class period and members of the
19
Company's management team or had control
of; (b) each of these Individual Defendants, by
virtue of his or her responsibilities and activities as a senior officer and/or director ofthe
Company was privy to and participated in the creation, development and reporting ofthe
Company's internal budgets, plans, projections and/or reports; (c) each of these Individual
Defendants enjoyed significant personal contact and familiarity with the other Individual
Defendants and was advised of and had access to other members of the Company's management
fry internal reports and aver data and info
tiion about the
and sales at all relevant times; and (d) each oft
mpany's finances, operations,
o Individual Defendants was aware of the
Company's dissemination ofinformation to the Ivesting public, which he or she knew or
recklessly disregarded was materially false and misl eading .
517.
of the misrepres entations and omissions of
Defendants had actual
material facts set forth herein, or acted with
disregard for the truth in that they failed to
ascertain and to disclose such facts, even
such facts were available to them. Such
material misrepresentations andfor omissions
e done knowingly or recklessly and for the
purpose and effect of concealing Xerox's
ig condition and future business prospects from
the investing public and supporting t
r inflated price of its securities. As
demonstrated by Defendants' overstatements
misstatements ofthe Company's business,
knowledge of the misrepresentations and
alleged, were reckless in Ming to obtain
such knowledge by deliberately retra ining from
those steps necessary to discover whether
those statements were false or misleading.
518.
As a result of the dis=ninafloa
materially false and misleading infbrmation
192
and failure to disclose material facts, as set fo
above, the market prices of Xerox's common
stock and bonds were artificially inflated during the Class Period. In ignorance of the fact that
market prices of Xerox's pubficlytraded securities WeTe artificially inflated, and relying directly
or m directly an the ffalse and mislead ing statements made by th e t
ndants, or upon the
integrity ofthe market in which the securities trade, and/or in the absence ofmaterial adverse
information that was known to the Defendants, Plaintiff and the Clays purchascd Xerox
common stock and/or bonds at artificially inflated prices and vmre damaged themby.
Claims
e Act Against The Individual Defendants
Violation of Sermon 20(a) of The
519.
Plaintiffs hereby incorporate by
each of the preceding allegations as
though filly set forth herein.
520.
As officers and directors of croI the Individual Defendants were "controlling
persons" of the Company because they had the power to cause Xerox to engage in the unlawful.
conduct complained of herein and because they
have prvei ted the unlawful conduct that
Plaintiffs allege.
521.
demonstrate. that they acted in good faith in
The Individual Defendants
connection with the misconduct committed by
that Plaintiffs allege. 1
Defendants di rectly or indirectly induced Xerox
522.
Individual
commit the unlawful acts alleged herein.
Because the Individual Defendants were "controlling persons" ofthe Company,
which is a person primarily liable to plaintiffs and the Class under § i 0(b) of tbjp,- Exchange Act,
the Individual Defendants are secondarily liable for those primary violations pursuant to § 20(a)
of the Exchange Act.
193
WHF I3FORE, ?Wmtiffs request relief as follows:
a.
Determining that this action is a; proper clays action, certifying Plaindffs as class
representatives under bide 23 of the Federal Ries of Civil Procedure and cuing the
counsel as Class Counsel;
b_
Awarding compensatory damages in favor of Plaintiffs and the other Class
members against all Defendants, jointly and severally, for all damages sustained as a result of
Defendants' wrongdoing, in an amount to be proven at trial, including interest thereon;
C.
Awarding Plaintiffs and the of ier members ofthe Class their reasonable costs and
expenses incurred in, this action, including counsel fees and expert fees; and
d.
XV.
Such other and further relief as the Court may deemjust and proper.
Jury Trial Demanded
Plaintiffs hereby demand a trial by jury.
194
.
A"
DATED: August 9. 2W2
-a
RcspectfuIly submitted.:
THE 1LA NTIJ 1?S
Dennis I Johnson(,) (,-.j
Jacob B. Perkinson
Joluson & Perldnson
1690 Wiilistau Road
South Burlington, Vermont 05403
(802) 862-0030
Keith M. fleischmati al 0469
Francis?. Karam d21194
Elizabeth A. Barney
Cary L. Talbot a21193
NDIberg Weiss Bershad Hynes & Tench LLB'
One Pennsylvania Plaza 49th Floor
New York, New'York 10119-0165
{212) 594-5300
c„f c C. Block
tChae1 T. Matrala
.esiie R. stem
Sara B , Davis
Berman DeValerio Pease Tabaccv
Burt & Puoillo
^rle Liberty Square
oston, Massachusetts 02109
(I7) 542-8300
Counsel
195
5 ^
•
•
f-I
I l
^I
Andrew M. Schatz C't00603
i
e'y S. Nobel Gt04855
Patrick A. Yiingmau ct17813
Schatz & Nobel, F.C.
330 Mann Street 2nd Floor
Dartford, Connecticut 06106-1851
(S60) 493-6292
J. Daniel Sagarin ctO4289
Margaret E. Haering ctI0818
Hurtwitz & S garin, LLC
147 N. Broad Street
Milford, Connecticut 06460
(203) 977-SDD4
Co-Li* ison Counsel