Accounting
Scandal Updates on
September 30,
2002
Bob
Jensen at Trinity
University
Bob Jensen's main document on the
Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm
CBS MarketWatch Scandal Sheet --- http://cbs.marketwatch.com/news/features/scandal_sheet.asp?siteid=mktw
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September
20, 2002 message from FinanceProfessor
[FinanceProfessor@lb.bcentral.com]
Enron:
Merrill Lynch fired two
executives (a Vice
Chairman and a managing
director) for their role
in the Enron scandal. The
two had taken their fifth
amendment rights and not
testified in front of
congress, but Merrill (and
others) saw this as an
admission of guilt and let
them go. http://money.cnn.com/2002/09/18/news/merrill_firing/index.htm
As
officials turn their
attention to Enron’s
Broadband unit, the
Houston Chronicle suggests
that Ken Lay and Jeff
Skilling may be next on
Fed’s hit list. This is
in part because the
evidence will be easier to
understand and is more
like other insider trading
cases.
http://www.chron.com/cs/CDA/story.hts/page1/1578061
It
can no longer be said that
all Enron employees kept
their figures hidden. Ok,
so I am not a comedian.
Some former employees have
decided to not hide
anymore and posed for
PlayGirl magazine. http://money.cnn.com/2002/09/18/news/enron_playgirl.reut/index.htm
http://story.news.yahoo.com/news?tmpl=story2&u=/020918/161/29sw9.html&e=11
Worldcom:
Worldcom’s problems just
never seem to end. More
accounting errors have
been found that are
expected to swell losses
by another $2 billion.
This will make nearly $9
billion in losses that had
been accounted for
incorrectly.
http://www.msnbc.com/news/809991.asp
A
sad part of all of the
corporate fraud scandals
is that there are many
innocent victims. For
example, we know all about
the employees who have
lost their jobs at Enron.
Now WorldCom Inc. has
announced they will be
cutting 25 percent of its
overseas staff in an
attempt to return to
profitability.
http://www.nytimes.com/reuters/technology/tech-telecoms-worldcom.html
http://biz.yahoo.com/ft/020916/1031119346071_5.html
Tyco:
It seems Tyco had more
problems than originally
thought. Not only did
Dennis Kozlowski get many
unreported perks from the
firm, now reports indicate
that others at the firm
also partook in the
excess. Some had loans
forgiven and some rather
extravagant (and
unreported at the time)
perks including $15,000
for dog umbrellas and
$2900 for hangers! (Can
you imagine the size of
the closet?!) One theory
behind this lavish
spending is that Kozlowski
was trying to “buy off”
those who knew what he was
doing. All told over $170
million may have been
taken from the firm.
(Since
I know you want to find
out what it looks like:
here is a link to dog
umbrellas. I could not
find anything in the
$15,000 price range, but
if you can please let me
know.) http://shop.store.yahoo.com/bsnstore/100904-1.html
And
yet another problem at
Tyco. Now it seems that
all may not have been on
the “up and up” with
respect to Tycos’s
takeover of CIT. If you
remember that was the case
where Frank E. Walsh a
then Board member of Tyco
who just happened to own a
large stake in CIT. He
received $10 million for
bringing the companies
together. Plus a donation
in his name of another $10
million. The company is
suing him for the return
of the money. http://www.msnbc.com/news/809994.asp
As
a result of the problems
and the steep drop in
stock price 9 of the 11
board members will not be
renominated in what has
been termed a “board
shuffle”.
Currently
Kozlowski and other top
executives Tyco have had
their assets seized and as
a result had a difficult
time coming up with bail
money. In the end
Kozlowski’s ex-wife came
up with enough money to
keep Mr. K and former CFO
Mark H. Swartz out of
jail. Prosecutors however
are protesting that the
house, which was pledged
as collateral, was
obtained with “tainted”
funds. Stay tuned. http://www.nytimes.com/2002/09/13/business/13NORR.html
http://www.nytimes.com/2002/09/16/business/16TYCO.html
http://biz.yahoo.com/ft/020916/1031119357872_2.html
http://news.bbc.co.uk/1/hi/business/2264822.stm
http://biz.yahoo.com/tsp/020916/10042359_1.html
http://story.news.yahoo.com/news?tmpl=story&u=/nm/20020917/ts_nm/manufacturing_tyco_investigation_dc_5
http://money.cnn.com/2002/09/18/news/kozlowski_jail.reut/index.htm
http://www.msnbc.com/news/810084.asp
http://www.cfo.com/article/1,5309,7676,00.html
Adelphia:
Not unexpectedly, Adelphia
has chosen to not pay the
Rigases the severance pay
that was originally agreed
upon. The payments have
been stopped as a result
of the many cases of
self-dealing and probable
fraud that have surfaced
since the original deal
was struck back in may.
http://story.news.yahoo.com/news?tmpl=story&u=/nm/20020911/media_nm/adelphia_2
http://www.washingtonpost.com/wp-dyn/articles/A5471-2002Sep11.html
Federal
officials are expected to
expand the charges against
the former Adelphia
officials. Reportedly, one
new charge will be
obstruction of justice. http://story.news.yahoo.com/news?tmpl=story&u=/dowjones/20020918/bs_dowjones/200209180106000025
http://www.msnbc.com/news/809475.asp
On
the plus side, for the
first time in a long time,
Adelphia reported
operating results. Ok, so
they were only for June
and July. They had to
start somewhere. http://www.nytimes.com/2002/09/16/business/16ADEL.html
Slate
has decided to look ahead
and see what will happen
to these fallen leaders.
It predicts some (such as
Ken Lay) can bounce back
ala Michael Milken.
Others, like Dennis
Kozlowski probably can
not.
http://slate.msn.com/?id=2071203
Teaching
ethics? Thinking about
incorporating it more in
your class? The economist
provides some useful (and
interesting!) resources. http://www.economist.com/globalExecutive/education/executive/
FBI agents and federal
prosecutors are
investigating the
possibility that Enron and
other companies conducted
fraudulent electricity
trades from 1999 to 2001
which resulted in the
manipulation of power prices
in California, Oregon, and
Washington. http://www.accountingweb.com/item/90940
"NASD
Plans to File Charges
Against Salomon Grubman
Citicorp Administrative
Securities-Fraud Charges
Stem From Analyst's Touting
of Winstar," by Charles
Gasparino, The Wall
Street Journal,
September 20, 2002.
The
National Association of
Securities Dealers is
preparing to file
administrative charges of
securities fraud against
Salomon Smith Barney and
its former
telecommunications analyst
Jack Grubman, according to
people familiar with the
matter. The charges would
stem from the firm's
positive research reports
on Winstar Communications
Inc., a telecommunications
company that filed for
bankruptcy-law protection
last year, these people
said. The NASD's
enforcement arm has
notified lawyers for the
big securities firm and
Mr. Grubman that it could
file an administrative
case as early as Monday,
though negotiations are
continuing and the
situation could change,
these people say. Salomon
may be able to persuade
the NASD to settle on
lesser charges amid the
continuing negotiations.
The
NASD has focused on
whether Mr. Grubman misled
investors by touting
shares of Winstar, one of
Salomon's
investment-banking
clients, amid evidence
that the company was in
deep financial trouble,
people familiar with the
matter say. Mr. Grubman
had been a vociferous bull
on the stock for several
years, and he continued to
support the company in his
research even as evidence
began to emerge in early
2001 about Winstar's
financial problems. Any
NASD civil action would
mark the first major case
by federal securities
regulators investigating
whether big securities
firms obtained
investment-banking
business by making overly
optimistic stock picks.
Charles Prince, Salomon
Smith Barney's new chief
executive, met Thursday
with Mary Schapiro, head
of the NASD's regulatory
division, to discuss the
Winstar case, people
familiar with the meeting
say. Mr. Prince is intent
on settling the matter as
soon as possible, these
people say.
Continued
in the article.
Bob
Jensen's threads on
"Rotten to the
Core" are at http://www.trinity.edu/rjensen/fraud.htm#Cleland
Bankrupt
retailer Kmart explained the
impact of accounting
irregularities and said
employees involved in
questionable accounting
practices are no longer with
the company. http://www.accountingweb.com/item/90935
Kmart's
CFO Steps up to
Accounting Questions
|
| AccountingWEB
US - Sep-19-2002 -
Bankrupt retailer
Kmart explained the
impact of accounting
irregularities in a
Form 10-Q filed with
the U.S. Securities
and Exchange
Commission (SEC)
this week. Chief
Financial Officer Al
Koch said
several employees
involved in
questionable
accounting practices
are no longer with
the company.
Speaking
to the concerns
about vendor
allowances recently
raised in anonymous
letters from
in-house
accountants, Mr.
Koch said, "It
was not hugely
widespread, but
neither was it one
or two people."
The
Kmart whistleblowers
who wrote the
letters said they
were being asked to
record transactions
in obvious violation
of generally
accepted accounting
principles. They
also said
"resident
auditors from
PricewaterhouseCoopers
are hesitant to
pursue these issues
or even question
obvious changes in
revenue and expense
patterns."
In
response to the
letters, the company
admitted it had
erroneously
accounted for
certain vendor
transactions as
up-front
consideration,
instead of deferring
appropriate amounts
and recognizing them
over the life of the
contract. It also
said it decided to
change its
accounting method.
Starting with fourth
quarter 2001,
Kmart's policy is to
recognize a cost
recovery from
vendors only when a
formal agreement has
been obtained and
the underlying
activity has been
performed.
According
to this week's Form
10-Q, early
recognition of
vendor allowances
resulted in
understatement of
the company's fiscal
year 2000 net loss
by approximately $26
million and
overstatement of its
fiscal year 2001 net
loss by
approximately $78
million, both net of
taxes. The 10-Q also
said the company has
been looking at
historical patterns
of markdowns and
markdown reserves
and their relation
to earnings.
Kmart
is under
investigation by the
SEC and the Justice
Department. The
Federal Bureau of
Investigation, which
is handling the
investigation for
the U.S. Attorney,
said its
investigation could
result in criminal
charges. In the
months before
Kmart's bankruptcy
filing, top
executives took home
approximately $29
million in retention
loans and severance
packages. A
spokesperson for PwC
said the firm is
cooperating with the
investigations.
|
From
SmartPros on September 13,
2002
Despite
pressures on auditors to
question financial
statement numbers,
companies can successfully
negotiate during the audit
process, according to a
new CFO magazine survey.
Given
the scrutiny audit firms
have faced in the wake of
recent accounting
scandals, companies have
braced for more rigorous
audits. But according to a
new survey conducted by
CFO magazine, companies
still generally prevail in
the audit process.
Thirty-eight
percent of CFOs reported
being challenged during an
audit in the past year.
But of those whose
financials were
questioned, only 43
percent changed their
practices to secure their
auditor's approval.
"Some 57 percent of
companies that have been
challenged did not alter
their statements,"
says Julia Homer,
editor-in-chief of CFO
magazine.
"Twenty-five percent
got the auditor to agree
to the practice in
question, while 32 percent
convinced the auditor that
the results were
immaterial."
A
full 69 percent of the
questioned results
involved reserve amounts,
and 36 percent involved
revenue recognition.
Meanwhile,
despite all the calls for
overhauling the accounting
industry, most CFOs voiced
opposition to specific
reforms. Some 52 percent,
in fact, did not believe
audit firms should be
banned from providing
consulting services to
clients; 65 percent did
not think auditors should
be barred from going to
work for clients for a
specified period; and 52
percent did not think it
wise to rotate auditors on
a regular basis. "For
CFOs, says Homer,
"all of these
proposals are just going
to make their jobs more
time-consuming and
expensive."
The
survey was based on the
responses of 170 CFOs, 51
percent of whom worked at
public companies. Featured
in the September issue of
CFO, it is the second of a
four-part series
documenting finance
executives' response to
the recent financial
scandals. The first survey
on financial disclosure
was published in August.
Follow-up surveys will
examine the changing
relationship between
finance executives and the
investment banking
community, and changing
pressures on the audit
committee.
CFO
is published monthly by
CFO Publishing Corp., a
division of The Economist
Group.
"In Corporate
America It's Cleanup Time
Under pressure, a slew of
companies are now changing
the way they do business.
Will it last?," by
Jerry Useem, Fortune,
September 16, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209348
Even
at a time when hunting for
the "next Enron"
has become a national
sport, Krispy Kreme
Doughnuts would seem a
highly unlikely target.
The North Carolina-based
purveyor of crullers and
Hot Original Glazed has
long enjoyed a sweet
reputation with customers
and investors. But early
this year some shareholder
questions turned sour. In
particular, why was Krispy
Kreme using a
"synthetic
lease" to finance a
mixing factory--an
off-balance-sheet practice
that carried a whiff of
Enron-style finance? CEO
Scott Livengood felt the
criticism was undeserved,
and that his company was
already a model of
transparency. "It was
guilt by
association," he
says. "But in this
new environment, it was
shoot first and ask
questions later."
So
Livengood formed a
governance committee of
independent board members,
which recommended a hasty
overhaul of governance and
accounting practices.
Krispy Kreme's synthetic
lease is toast. All inside
board members, save
Livengood, will eventually
be replaced with
outsiders. Corporate loans
to executives have been
banned. And the top five
executives can now sell
their stock only in
preplanned, immediately
disclosed blocks.
To
avoid even a passing
resemblance to Enron's
notorious partnerships,
furthermore, the company
has terminated a mutual
fund that let executives
invest directly in Krispy
Kreme franchises--and it
returned only the initial,
unappreciated sums the
executives had invested.
"I really regret the
things that have put us in
this position," says
Livengood. "But
there's been a tremendous
amount of damage done to
the credibility of honest
people."
It's
cleanup time in corporate
America, and a new set of
rules is in force. Some of
those rules are, of
course, literal, such as
those proposed by the New
York Stock Exchange or
contained in Congress's
Sarbanes-Oxley Act. But
some are taking hold as a
result of fear--fear of
disgusted, distrustful
investors and their
various avengers,
including SEC
investigators and New York
State attorney general
Eliot Spitzer (see Eliot
Spitzer: The Enforcer).
"You've got a totally
disaffected individual
investor community, and
they're angry," says
former Securities and
Exchange Commission
chairman Arthur Levitt.
"They're going to
differentiate between
companies that stand with
them and companies that
don't."
This
is a huge change of heart
that has come remarkably
fast. Between 1992 and
1999, the number of
companies beating First
Call estimates by exactly
one penny quadrupled--and
investors rewarded those
companies for what was
seen as great reliability.
Now, says Baruch Lev, an
accounting professor at
New York University,
"there will be
suspicion of exactly
meeting estimates, or
beating them by a
penny"--the
presumption being that
those companies could be
accused of cooking their
books. Corporate
executives feel the heat.
In a poll taken by Kennedy
Information, publisher of
Shareholder Value
magazine, 46% said the
wave of scandals had
harmed the way investors
viewed their companies,
while 43% were changing
the way they did business.
The
most visible change has
been a stampede to expense
stock options; as of press
time, 81 companies had
announced they would treat
stock options as a cost of
doing business. But the
cleanup has extended to
insider selling, financial
disclosure, even CEO
pay--all issues that fed
the image of corporate
corruption.
"Hopefully, this will
convince my mother that
companies are serious and
that the numbers can be
trusted," says Peggy
Foran, vice president for
corporate governance at
Pfizer.
At
Citigroup, under fire for
its financing of Enron and
WorldCom, CEO Sandy Weill
is adopting what
Prudential analyst Mike
Mayo sarcastically calls
"just-in-time
corporate
governance." Besides
doing an about-face on the
issue of expensing all
stock options, Weill has
set up a special
governance committee,
pledged to avoid any deals
involving hidden
off-balance-sheet
transactions, and
reaffirmed a "blood
oath" never to sell
more than 25% of his
Citigroup stock.
Coca-Cola
CFO Gary Fayard has had a
road-to-Damascus
conversion on stock
options. "When Enron
hit, I said, 'It's an
anomaly,' " he
recalls. "When the
scandals came flooding
out, I was floored. I
couldn't believe it was
that endemic."
Foreseeing increased
scrutiny of corporate
accounting--and prodded by
board member Warren
Buffett--he and CEO Doug
Daft decided to bite the
bullet and expense
options. Even Cendant, a
company whose excessive
pay packages have long
been ridiculed, is trying
to ride the reform train:
It slashed CEO Henry
Silverman's pay in
half--to a mere $15
million--by getting rid of
his annual options
package.
Among
corporate governance
activists, long used to
measuring their gains in
inches, there's a giddy
sense of suddenly having
run the field. "I've
never seen a debate end
this quickly,"
bubbles Charles Elson, a
governance expert at the
University of Delaware.
"The era of the
dominant CEO died a very
quick and painful death.
It will be a long time
before it comes
back."
Indeed,
both the Sarbanes law and
the NYSE proposals would
turn the corporation into
a less imperial, more
constitutional place.
Boards will need a
majority of independent
directors; a more powerful
audit committee led by a
"financial
expert"; and the
chance to meet without
management present.
"The old ceiling is
the new floor," says
Patrick McGurn, vice
president at Institutional
Shareholder Services.
Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209348
Bob Jensen's threads on
proposed reforms are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm
"Conseco's
Colorful Crash It may not
have the buzz of Enron, but
this fiasco still scores on
the shame scale," by
Andy Serwer, Fortune,
September 16, 2002 ---
http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209384
Picture
the scene: Conseco CEO
Steve Hilbert and his CFO,
sitting down to lunch at
the Four Seasons in New
York with Salomon Smith
Barney analysts Colin
Devine and Bill Ryan.
Devine and Ryan know this
isn't going to be a
picnic. They just blasted
the major insurance and
consumer-lending company
in a high-profile research
report. But they never
expected what happened
next. "How the fuck
could you do this to
me?" Hilbert
bellowed, as startled
diners turned to stare.
"Don't you know I
spent $20 fucking million
in fees at your firm last
year?!" Wow!
That
tete-a-tete took place in
the spring of 1999, Devine
says, when CEOs could yell
things like that and
analysts in said
situations would usually
fold. Hilbert doesn't
acknowledge swearing; he
concedes only that he was
angry. But Devine didn't
fold (Ryan left Salomon),
and of course he was
right. Conseco was rotten
to the core. Now it's on
the edge of bankruptcy.
Conseco
is overshadowed by
mega-disasters like Enron
and WorldCom, but it's
still a doozy. (If Conseco
sounds familiar to
faithful Street Life
readers, it's because I
wrote about it in June of
last year--
Two Titans Play Conseco in
the Middle. More on
that in a minute.)
Consider that Conseco's
recent earnings
restatement of $368
million for the year 1999
was the ninth largest in
U.S. history, according to
a New York University
study. That Conseco is now
the subject of a formal
SEC investigation. That
the company is not making
interest payments on its
$6.5 billion in debt.
As
if that weren't enough,
there's an incredible cast
of characters here,
including Steve Hilbert,
who built Conseco brick by
brick. Legend has it that
Hilbert met his sixth
wife, Tomisue, when she
popped topless out of a
cake at his stepson's
bachelor party. Hilbert
has previously denied this
but acknowledges that
Tomisue did work as an
exotic dancer.
The
beginning of the end for
Conseco came when Hilbert
bought Green Tree
Financial--a mobile-home
lender--for $6.7 billion
in 1998. By spring 2000
the company had begun to
flag. Exit Hilbert and
enter Gary Wendt, the big,
swinging GE exec who
pledged to put the company
in order. The stock jumped
on the news. And then
began a remarkably public
battle between veteran
raiders Carl Icahn, who
was shorting the stock,
and Irwin Jacobs, who was
long (the subject of my
article last year). All
the while Devine, who was
savaged by Jacobs and
Wendt for not buying the
turnaround story, stuck by
his guns. "There were
three things
happening," says
Devine. "Subpar
earnings for the insurance
business. Deteriorating
credit quality at the old
Green Tree business. And
too much debt."
Devine says that the
company wasn't merely a
victim of a weak economy
during Wendt's tenure. The
ex-head of GE Capital
actually made matters
worse. "The worst
loans ever made by Conseco
were within the past two
years," he says. (The
company denies that.)
Meanwhile, Devine
estimates that Wendt will
end up taking more than
$75 million out of Conseco
for his trouble. The
company says it's some $10
million less.
Continued
at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209384
Bob
Jensen's "Rotten to the
Core" threads are at http://www.trinity.edu/rjensen/fraud.htm#Cleland
CANADA
"Accountants
propose tougher
standards," by John
Saunders, Globe and Mail,
September 5, 2002 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=90067
Canada's
chartered accountants, who
have so far avoided
embarrassment on the scale
of the Enron-Arthur
Andersen scandal, are
considering new
professional standards
designed to keep auditors
from sliding too far into
bed with companies whose
books they check.
A
68-page draft issued
Thursday by the Canadian
Institute of Chartered
Accountants proposes rules
mimicking some of those
announced recently in the
United States, including a
five-year rotation of
audit partners on public
company audits.
It
would also require
auditors to apply broad
principles in guarding
their independence where
specific rules do not
exist. They would be
instructed to watch for
five types of threat:
•Self-interest
threats, such as when an
auditor owns shares in the
client company or hopes to
land a job with it, or
when the auditor's firm
depends too heavily on
fees from the company and
fears losing the work.
•Self-review
threats, such as when an
auditor previously worked
for the company and would
be checking his or her own
work, or when the
auditor's firm provided
separate services relating
to preparation of the
financial statements.
•Advocacy
threats, such as when an
auditor sheds objectivity
by acting on the client's
behalf in a legal dispute
or a stock promotion.
•Familiarity
threats, such as when an
auditor has a close
relative in the client
company's management or
accepts significant
hospitality from the
company or simply has been
involved with the company
too long.
•Intimidation
threats, such as when a
client company hints it
will change auditing firms
over a disagreement on
accounting or puts
pressure on the auditor to
cut fees and do less work
than is needed.
Donald
Wray, chairman of the
CICA's public interest and
integrity committee, said
auditors facing such
threats would not
necessarily quit if
adequate safeguards were
created, in some cases
merely by making full
disclosure to the audit
committee of the client
company's board of
directors.
"It
takes a long time for
rules to catch up to
what's going on out there,
and rules also encourage
loophole hunting and
finding ways to get around
them," Mr. Wray, a
retired
PricewaterhouseCoopers LLP
partner, said in an
interview. "With the
principles, you know where
you have to get to with
regard to independence in
any situation you're in."
Continued
at http://www.accountingweb.com/cgi-bin/item.cgi?id=90067
Xerox
Settles SEC Enforcement
Action Charging Company with
Fraud, Agrees to Pay $10
Million Fine, Restate Its
Financial Results and
Conduct Special Review of
Its Accounting Controls --- http://www.sec.gov/litigation/litreleases/lr17465.htm
On
April 11, 2002, the
Securities and Exchange
Commission filed a civil
fraud injunctive action in
the United States District
Court for the Southern
District of New York,
alleging that from at
least 1997 through 2000,
Xerox Corporation, a
Stamford,
Connecticut-based public
company, employed a
variety of undisclosed
accounting actions to meet
or exceed Wall Street
expectations and disguise
its true operating
performance from
investors. These actions,
most of which violated
generally accepted
accounting principles (GAAP),
accelerated Xerox's
recognition of equipment
revenue by over $3 billion
and increased its pre-tax
earnings by approximately
$1.5 billion over the
four-year period from 1997
through 2000.
The
complaint alleges that
these accounting actions,
which often were approved,
implemented and tracked by
senior Xerox management,
had a substantial impact
on Xerox's reported
performance. For example,
in the fourth quarters of
both 1998 and 1999,
accounting actions
generated 37% of Xerox's
reported pre-tax profit.
The Commission's complaint
further alleges that by
1998, nearly $3 of every
$10 of Xerox's annual
reported pre-tax earnings
resulted from undisclosed
accounting actions.
Without these accounting
actions, the complaint
alleges, Xerox would have
fallen short of market
earnings expectations in
virtually every reporting
period from 1997 through
1999.
The
allegations in the
complaint center around
seven different accounting
actions that Xerox used to
help meet or exceed market
expectations from 1997 to
2000. Many of these
actions accelerated
Xerox's recognition of
revenue into current
periods at the expense of
future periods. According
to the complaint, Xerox
fraudulently disguised
these actions so that
investors remained unaware
that the company was
meeting earnings
expectations only by using
accounting maneuvers that
could compromise future
results.
The
complaint alleges that
several of the accounting
actions related to Xerox's
leasing arrangements.
Under these arrangements,
the revenue stream from
Xerox's customer leases
typically had three
components: the
value of the
"box," a term
Xerox used to refer to the
equipment; revenue that
Xerox received for
servicing the equipment
over the life of the
lease; and financing
revenue that Xerox
received on loans to its
lessees. Under GAAP,
Xerox was required to book
revenue from the
"box" at the
beginning of the lease,
but was required to book
revenue from servicing and
financing over the course
of the entire lease.
According to the
complaint, Xerox relied on
accounting actions to
justify shifting more
lease revenue to the
"box," so that a
greater portion of that
revenue could be
recognized immediately.
The
complaint alleges that the
two accounting actions
with the largest impact on
Xerox's financial
statements were
methodologies that Xerox
called "return on
equity" and
"margin
normalization." Xerox
used the return on equity
method to shift revenue to
equipment that the company
historically had allocated
to financing. Margin
normalization shifted
revenue to equipment that
historically had been
allocated to servicing.
These two methodologies,
which did not comply with
GAAP, increased Xerox's
equipment revenues by $2.8
billion and its pre-tax
earnings by $660 million
from 1997 to 2000. The
complaint alleges that
Xerox fraudulently failed
to disclose to investors
its use of and changes to
these methodologies —
which were changes in
accounting methods and
changes in accounting
estimates.
The
complaint also alleges
that Xerox used
approximately $1 billion
of additional accounting
actions to artificially
improve its operating
results. By using these
accounting actions and
failing to disclose their
use, Xerox violated GAAP
as well as disclosure
requirements. These
additional actions
included the improper use
of "cushion" or
"cookie jar"
reserves, the improper
recognition of the gain
from a one-time event, and
miscellaneous lease
accounting related
actions.
In
addition, the complaint
alleges that Xerox misled
investors by failing to
disclose the impact that
approximately $400 million
in sales of leases had on
its 1999 operating
results. The effect of
these undisclosed sales
was to immediately
recognize income that
otherwise would have been
recognized in future
periods. Although the
company earlier had
entered into similar
transactions in small
amounts, none compared in
size or scope to the 1999
sales, which added $182
million in pre-tax profits
to Xerox's 1999 results.
As
alleged in the complaint,
Xerox's fraudulent failure
to disclose these
accounting actions, most
of which violated GAAP,
resulted in Xerox filing
periodic reports with the
Commission that contained
materially false and
misleading statements and
omissions, including 12
quarterly and four annual
reports covering the
period 1997-2000, and
seven registration
statements that were filed
or in effect during this
period which included four
offerings that registered
nearly $9 billion dollars
worth of debt securities.
Without
admitting or denying the
allegations of the
complaint, Xerox consented
to the entry of a Final
Judgment that permanently
enjoins the company from
violating the antifraud,
reporting and
recordkeeping provisions
of the federal securities
laws, specifically Section
17(a) of the Securities
Act of 1933 and Sections
10(b), 13(a), 13(b)(2)(A)
and 13(b)(2)(B) of the
Securities Exchange Act of
1934 ("Exchange
Act") and Rules
10b-5, 13a-1, 13a-13,
12b-20 and 13b2-1
promulgated thereunder. In
addition, Xerox agreed to
pay a $10 million civil
penalty and to restate its
financial results for the
years 1997 through 2000.
Xerox also agreed to have
its board of directors
appoint a committee
composed entirely of
outside directors to
review the company's
material internal
accounting controls and
policies. Finally, as part
of the settlement of this
action, the Commission
entered an Order exempting
Xerox from certain filing
requirements of the
Exchange Act to extend,
until June 30, 2002, the
date by which Xerox and
its finance subsidiary,
Xerox Credit Corporation,
may file annual reports on
Forms 10-K for the fiscal
year ended December 31,
2001, and quarterly
reports on Forms 10-Q for
the quarter ended March
31, 2002. (See
Securities Exchange Act Release
No. 45730 (April 11,
2002).)
The
SEC is continuing its
investigation of this
matter as it relates to
other parties.
"Sweeping Charges Expected for Tyco's Ex-Chief and 2 Others," by
Andrew Ross Sorkin, The New York Times, September 12, 2002
The Manhattan district attorney and the Securities
and Exchange Commission plan to bring new and wide-ranging criminal and civil
charges today against Tyco International's former chief executive and two
other former executives, people briefed on the plan said last night.
Tyco is also planning to file its own lawsuit as
early as today against the former chief executive, L. Dennis Kozlowski. Tyco
will seek the return of his income and benefits since 1997, an amount that is
at least $250 million, and the forfeiture of all his severance pay, these
people said.
The Manhattan district attorney, Robert M. Morgenthau,
plans to indict Mr. Kozlowski as well as Tyco's former chief financial
officer, Mark H. Swartz, and the company's former general counsel, Mark A.
Belnick, on charges that include conspiracy to commit fraud, larceny and
enterprise corruption, these people said. The S.E.C. is expected to accuse the
men of securities fraud and plans to seek millions of dollars in penalties,
these people said.