Scandal of Xerox

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Executive Summary
Xerox, the then world’s largest copier seller, was sued by the U.S. Security and Exchange Committee (SEC) in 2002 for its fraudulent accounting manipulations, which inflated $1.5 billion earnings from 1997 to 2000. Several parties got their hands dirty in the scandal, including the then senior Xerox management, the Board of Directors and external auditor KPMG LLP. The failure of those parties in discharging their duties induces the further thought of trust and accountability among them and shareholders. Furthermore, the external environment in 1990s, including economic bubble boom, irrational investors, fierce industrial competition and ineffective regulations on audit, provided a hotbed for the scandal. Lessons learnt from Xerox scandal indicate the necessity for changes in corporate governance system, regulations on accounting professions and analysts as well as regulators.

Around the Millennium, dozens of enterprises hit the iceberg of financial scandals, pulling back the global economy. Xerox, once world’s largest copier manufacturer and currently top document services provider, was also caught committing accounting fraud but has gradually recovered from the catastrophe. This report attempts to analyze the underlying causes of Xerox scandal by referring to its governance system and external audit as well as the then external environment and to figure out ways to mitigate the possibility of such scandal. Firstly, the basic knowledge of Xerox scandal will be given. Then, the paper will focus on the relevant internal and the external drivers. Finally, constructive recommendations will be proposed and evaluated. PART 1. CASE DESCRIPTION

To describe the Xerox scandal, Rezaee’s CRIME model which is short for cooks, recipes, incentives, monitoring and end-result, is used. Cooks represents those who are directly responsible for the scandal; recipes stand for accounting manipulation techniques; incentives refer to the reasons why recipes occur; monitoring explains how and why those manipulations are not detected earlier; and end-results are the consequences of the scandal (Rezaee, 2002). Firstly, six senior Xerox managers, shown in Table 1, acted as the major cooks in Xerox scandal. Table 1

Pressed by increasing industrial competition and fast technological innovation, Xerox actual earnings could hardly meet Wall Street’s expectation. Therefore, in order to ‘close the gap’, Xerox management used ‘one-offs actions’ (the recipes) to raise equipment revenues and adjust operational facts (GAO, 2002). According to SEC (2003), Xerox had fraudulently recorded $1.52 billion as the company of net income during four years (Figure 1) via variable accounting techniques that adjusted income in time and allocation. The Board and the external auditor are responsible to ensure the company is run in compliance with regulations. However, due to Xerox’s ineffective board structure and over-centralized power by the then dominant CEO Paul Allaire, the Board did not perform its functions appropriately (BusinessWeek, 2001). Additionally, its external auditor KPMG LLP (KPMG) failed to correct the deliberate accounting wrongdoings by Xerox management. Xerox scandal was first exposed in the disclosure of hidden provisions by its ex-employee in Mexican subsidiary, inducing further investigation by SEC later (Markham, 2005; GAO, 2002). The fraud was gradually uncovered during a series of investigations from 2000 to 2002. Consequently, three parties, top Xerox management, Xerox, and KPMG, were sued by SEC: Xerox was fined $10 million and forced to restate its financial reports for 1997-2000; the six directors were sued for fraud and fined $22 million in total; KPMG was accused of breach of duty (SEC, 2003). Furthermore, investors and Wall Street analysts got further struck by Xerox scandal after Enron and Worldcom, reflected by a ‘great depression’ in the stock market on the announcement day...
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