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Xerox Corporation is a global document management company which manufactures

and sells a range of color and black-and-white printers, multifunction systems, photo
copiers, digital production printing presses, and related consulting services and supplies.

Xerox is headquartered in Norwalk, Connecticut, though its largest population of

employees is based in and around Rochester, New York, the area in which the company
was founded.

The Founders«

The KPMG network was formed in 1987 when Peat Marwick International and Klynveld
Main Goerdeler merged along with their respective member firms.

There were four key figures in the formation of KPMG. They are the founding members
of the present organization.

Piet 
 founded the accounting firm Klynveld Kraayenhof & Co in Amsterdam in
1917. William Barclay 

founded the accounting firm Peat & Co in London. James
  established the accounting firm Marwick, Mitchell & Co in New York City in 1897.
Dr. Reinhard 


 was the first president of the International Federation of
Accountants and a chairman of KPMG. He is credited with laying the foundations of the
Klynveld Main Goerdeler merger


KPMG firms are some of the world¶s leading providers of audit, tax and advisory
services. They have 135,000 people operating in over 140 countries. KPMG was
established in India in September 1993, and has rapidly built a significant competitive
presence in the country. The firm operates from its offices in Mumbai, Pune, Delhi, Kolkata,
Chennai, Bangalore and Hyderabad, and offers its clients a full range of services, including
financial and business advisory, tax and regulatory, and risk advisory services. The firm's
global approach to service delivery help provide value-added services to clients. The firm
serves leading information technology companies and has a strong presence in the
financial services sector in India while serving a number of market leaders in other industry
segments. Their practice is organized around our Audit, Tax and Advisory practices.

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In one of the latest scandals involving a prominent American corporation, Xerox

revealed in 2002 that over the five years prior to 2002 it had improperly classified over $6
billion in revenue, leading to an overstatement of earnings by nearly $2 billion.

The announcement of Xerox is not entirely new. The Securities and Exchange
Commission (SEC) began an investigation that ended in April of that year. The SEC had
charged the producer of copiers and related services with accounting manipulations. It was
estimated at the time, however, that the amount involved was about half that which is now
stated, or about $3 billion. A settlement was eventually reached that included a $10 million
fine, as well as an agreement to conduct a further audit. It was this audit that produced the
$6 billion figure.

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The first was the so-called '
 ( ) "

. This involved improperly storing
revenue off the balance sheet and then releasing the stored funds at strategic times in
order to boost lagging earnings for a particular quarter. This is a widely used manipulation..

The second method²and what accounted for the larger part of the fraudulent
earnings²was the acceleration of revenue from short-term equipment rentals, which were
improperly classified as long-term leases. The difference was significant because according
to the Generally Accepted Accounting Principles (GAAP)²the standards by which a
company¶s books are supposed to be measured²the entire value of a long-term lease can
be included as revenue in the first year of the agreement. The value of a rental, on the
other hand, is spread out over the duration of the contract.

The effect of the manipulation was that Xerox could count as earnings what was
essentially future revenue. This boosted short-term profits and allowed the company to
meet profit expectations in 1997, 1998 and 1999, though it had the effect of reducing
earnings during the past two years. In 1998 Xerox reported a pretax income of $579 million,
while it should have reported a loss of $13 million. On the other hand, the $137 million loss
for 2001 will become a $365 million gain after the manipulation is reversed. The $1.9 billion
total that will now be subtracted from revenue reported from 1997-2001 will be added to
future reports.

Thus, unlike some of the other scandals that have emerged over the past several
months, Xerox has not been accused of falsely creating unearned income. Rather it spread
its income out in a fraudulent manner. To the same end, WorldCom improperly capitalized
about $4 billion in ordinary expenses in order to allow the company to deduct the expense
over a period of decades rather than writing it off all at once. Both these methods serve to
boost short-term profits.

Why carry out these manipulations when the extra money earned in one year would
have to be subtracted from future years?

This was necessary because corporations are under enormous pressure from Wall
Street investors to keep up short-term earnings. Otherwise, their share values will drop,
which not only threatens companies heavily reliant on share values to finance debt, but
also has financial consequences for top executives, whose astronomical incomes are
bound up with stock options.

The SEC investigation noted that ³compensation of Xerox senior management

depended significantly on their ability to meet [earnings] targets.´ Because of the
accounting manipulations, top Xerox executives were able to cash in on stock options
valued at an estimated $35 million.

Xerox stock rose to a peak of $60 a share in mid-1999, when the company was carrying
out the accounting fraud. It has since declined sharply and is now trading at about $7.

Confronted with declining revenue during the late 1990s that should have led to lower
than expected earnings reports²thereby reflecting the true nature of the company¶s
deepening problems²Xerox decided to cook the books. This was done quite
methodically. Internal documents have recorded discussions among top officials at
Xerox concerning ways to manipulate accounting to allow the company to meet Wall
Street expectations. Executives apparently calculated the exact amount that would have
to be altered in order to allow the company to just meet or slightly exceed ³first call
consensus´ expectations on Wall Street, which are determined prior to a company¶s
release of earnings data.

In 1997, for example, expected earnings were at $1.99 a share, while reported earnings
were $2.02. Actual earnings, correcting for the accounting manipulations, were at $1.65.
Using its earlier underestimate of $3 billion in improperly classified revenue, the SEC
calculated these actual earnings. In 1998, expected and reported earnings were both at
$2.33 while actual earnings were only $1.72 a share. In 1999, reported earnings beat
expected earnings by one cent, while actual earnings fell short by almost 50 cents.

This is a striking example of a company fitting earnings to expectations in order to

prevent a run on stock. It is, however, a fairly common practice. Many companies, like
General Electric for example, always seem to come out just barely ahead of
expectations. Indeed, recent studies have found the distribution of reported earnings of
major companies around expectations was skewed to the positive side. That is, it is
more likely for a company to beat than to fall short of expectations, suggesting that
there are many companies that have been following the same accounting practices as
Xerox.

Like the WorldCom fraud, Xerox¶s manipulation should have been easy to detect if
there was anyone interested in looking. As former SEC chief accountant Lynn Turner
noted, ³These numbers have gotten so large that it¶s akin to auditors driving past Mt.
Everest and saying they never saw it.... Corporate America has somehow gotten into
the mindset that this is OK.´ Xerox¶s auditor during the period in question was KPMG,
one of the ³big four´ accounting firms that dominate the profession. KPMG was fired in
October and replaced by PricewaterhouseCoopers.

KPMG was also part of the SEC investigation that began last year. The evidence
suggests that the auditing firm knew what was going on and decided to allow it to
continue. An internal document obtained by the SEC contained a statement by a KPMG
official acknowledging that Xerox¶s schemes constituted ³half-baked revenue
recognition.´ When the KPMG auditor in charge of the Xerox account began to
raise some concerns about the company¶s improper techniques, he was replaced
with someone else.

Earlier this year, the SEC considered filing civil charges against top executives at both
KPMG and Xerox. The accounting firm is currently facing lawsuits from shareholders
charging the company with failing to audit Xerox properly. KPMG is also under scrutiny
for its role in approving the books of the drug store chain Rite Aid, which recently
acknowledged that it inflated its income by more than $1 billion over a two-year period.
It also approved the books of the collapsed Belgian software company Lernout &
Hauspie Speech Products NV, which has admitted to fabricating 70 percent of sales at
its largest unit.

The Xerox case has focused attention on the role of the SEC and its chairman, Harvey
Pitt. Pitt, a former lawyer for the big accounting firms including KPMG, met with KPMG¶s
new chairman, Gene O¶Kelly, in April. O¶Kelly issued a statement declaring he told Pitt
at this meeting that any SEC action against KPMG would be ³unfounded´ and ³would
pose serious disruption ... in the capital markets.´ Pitt denied that the two discussed
Xerox at all during the meeting. Such a discussion, if it took place, would be a serious
violation of norms of independence. The SEC, having failed to raise any flags while the
fraud was being carried out, appears complicit in the scandal.

Because of its protracted crisis, Xerox has been forced to sell off some of its assets. It
managed to renegotiate its credit earlier this month, but at higher interest rates. If the
company had failed to renegotiate its credit line, it may have been unable to meet its
obligations, forcing it into bankruptcy. This almost happened once before, in late 2000.

In an attempt to cut back on costs, Xerox has laid off thousands of workers in the past
two years and may well make further retrenchments in the future. On the other hand, as
Xerox¶s troubles grew more severe, the company¶s CEO Anne Mulchay received a pay
package in 2001 that could be worth as much as $25 million.

According to SEC¶s complaint, the accounting violations committed by Xerox are

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Xerox allegedly repeatedly changed the way it accounted for lease revenue but failed to
disclose that the associated gains were the result of accounting changes rather than
improved operating performance. Moreover, many of the practices used failed to comply
with GAAP. For example, Xerox used a return on equity allocation method that involved
calculating the estimated fair value of the equipment as the portion of the lease
payments remaining after subtracting the estimated fair value of the services and
financing components. As the estimated fair value of services and financing declined,
the equipment sales revenue that was recognized immediately increased. Xerox was
also accused of accelerating the recognition of revenues by immediately recognizing as
the revenue price increases and extensions of existing lease rather than recognizing the
increases over the remaining life of the lease.
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Xerox allegedly adjusted the estimated residual value of leased equipment (that is, its
remaining value at the end of the lease term) after the inception of the lease in violation
of GAAP. SEC alleges that this write-up in the residual value of equipment was used to
credit the cost of sales, were recorded close to the end of quarterly reporting periods as
³a gap-closing measure to help Xerox meet or exceed internal and external earnings
and revenue expectations.´

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Selling investors the revenue streams from portfolios of its leases that otherwise would
not have allowed for immediate revenue recognition. SEC alleges that Xerox used these
transactions to recognize revenue that would have otherwise been recognized in future
periods and failed to disclose this practice.

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Xerox allegedly increased its earnings by releasing excess reserves that were originally
established for some other purpose into income in violation of GAAP. Xerox also
allegedly systematically released a gain associated with the successful resolution of a
dispute with the Internal Revenue Service to improperly increase earnings from 1997
through 2000. Although GAAP required that the entire gain be recognized upon the
completion of all legal contingencies in 1995 and 1996, Xerox used most of it to meet its
earnings targets.

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Xerox allegedly failed to disclose factoring transactions that allowed it to report a

positive year end cash balance, instead of a negative one. This factoring involved Xerox
selling its receivables at a discount in order to realize instant cash instead of a future
stream of cash. According to SEC complaint, analysts looked to Xerox to increase its
liquidity and called for stronger end-of year cash balances in 1999. Unable to generate
cash, Xerox management instructed its largest operating units to explore the possibility
of engaging in factoring transactions with local banks. These transactions materially
affected Xerox¶s 1999 operating cash flows but these transactions were not disclosed in
its 1999 financial statements. In some of the factoring transactions involved buy-back
agreements in which Xerox would reacquire the receivables after the end of the year.
By accounting for these transactions as true sales, Xerox violated GAAP. Not only did
Xerox fail to disclose the agreements, it failed to reverse them in the next year.

Without admitting or denying the allegations of the complaint, Xerox consented to a final
judgment that includes a permanent injunction 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
Exchange Act and Rules 10b-5, 13a-1. 13a-13, 12b-20 and 13b2-1 promulgated there
under. In addition, Xerox agreed to restate its financials for the years 1997 through 2000
and pay a $10 million civil penalty. As part of this agreement, Xerox also agreed to have
its board of directors review the company¶s material internal accounting controls and
policies.

The Consequences that followed Xerox Corp. agreed to pay $670 million while KPMG
LLP had to pay $80 million, to settle an eight-year-old securities lawsuit filed on behalf
of Xerox investors who claimed Xerox committed accounting fraud to meet Wall Street
earnings expectations.

The case of Carlson v. Xerox Corp., filed on behalf of purchasers of Xerox

common stock and bonds from between February 1998 and June 27, was
something of a high profile one for the pre-Enron era.

In April 2002, Xerox had already agreed to a $10 million fine as part of a
settlement with the Securities and Exchange Commission. The fine was the
largest ever paid by a company to settle with the SEC at that time.

The SEC charged that the copier company schemed to defraud investors during a
four-year period by using what it called \"accounting actions\" and \"accounting
opportunities\" to meet or exceed Wall Street expectations and disguise its true
operating performance. The commission stated at the time that most of the
actions violated generally accepted accounting principles, and thus accelerated
the company's recognition of equipment revenue by more than $3 billion and
increasing its pretax earnings by approximately $1.5 billion.

In 2005, KPMG agreed to pay $22.5 million to settle SEC charges related to its
audits of Xerox from 1997 through 2000. Under that arrangement, the firm agreed
to relinquish the $9.8 million in fees it received for auditing Xerox's books during
that time, and pay $2.7 million in interest and a $10 million civil penalty. The total
package was the largest payment ever made to the SEC by an audit firm.

The Securities and Exchange Commission also charged six former senior
executives of Xerox Corporation, including its former chief executive officers, Paul
A. Allaire and G. Richard Thoman, and its former chief financial officer, Barry D.
Romeril, with securities fraud and aiding and abetting Xerox's violations of the
reporting, books and records and internal control provisions of the federal
securities laws.

The six defendants agreed to pay over $22 million in penalties, disgorgement and
interest without admitting or denying the SEC's allegations. The SEC intended to
have these funds paid into a court account pursuant to the Fair Fund provisions of
Section 308(a) of the Sarbanes-Oxley Act of 2002 for ultimate distribution to
victims of the alleged fraud.
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32. Use of these topside accounting devices distorted

Xerox's public financial reports, which were supposed to
fairly reflect the results of Xerox's business operations.
Investors were not informed that a material component
of Xerox's business results was new and untested
improper accounting devices highly subject to
manipulation. The defendants did not require Xerox to
disclose it had changed its methods of accounting in
material respects from prior years, and they falsely
represented that Xerox was recording earnings and
revenues in a manner consistent with GAAP, which fairly
reflected the results of company operations. Further,
despite Xerox's claimed inability to reasonably estimate
the fair value of its products without resort to unreliable
topside estimates, the defendants failed to identify
material internal control weaknesses.Ê