Ethics and Corporate Responsibility: Accounting Fraud

The key issued described in the suit against Xerox Corporation is that Xerox had overstated its revenues during the past four years by almost $2 billion. The fraudulent scheme had misled investors about Xerox’s earnings to polish its reputation on Wall Street and to boost the company’s stock price.

These accounting fraud cases show us that ethics is a real issue, a very current issue and it is one that needs to be addressed. Unethical behaviour is common and reasons exist for such behaviour. Recent accounting scandals involving high-profile companies such as Xerox Corp have called into question accounting practices and undermined public confidence in the profession. These ethical scandals in the ‘real world’ suggested a market economy being out of control and raised demands for more stringent and effective government regulation. Such deception by management hampers the ability of the users of financial statements from gaining accurate business information for decision-making and leaves their interests unprotected.

2.CASE DISCUSSION

a)What are the ethical issues confronted in these cases?

The term ethics refer to a system or code of conduct based on moral duties and obligation that indicate how we should behave; it deals with the ability to distinguish right from wrong and the commitment to do what is right. Unethical behaviour in the corporate world is political and business scandals, which arise with the disclosure of misdeeds by trusted executives of large public corporations. Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets or underreporting the existence of liabilities, sometimes with the cooperation of officials in other corporations or affiliates.

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For Xerox Corp. it has been defrauding investors since 1997 till 2000. In a scheme directed and approved by its senior management, Xerox falsely portrayed itself as a business meeting its competitive challenges and increasing its earnings every quarter. Xerox knowingly or recklessly increased revenues and earnings by accelerating the recognition of revenues through mostly non-GAAP accounting actions, overstated its earnings by using so called “cookie jar” reserves and interest income from tax refunds, disguised loans as asset sales and manipulated its accounting in violation of generally accepted accounting principles (GAAP). All of them should have been disclosed to investors in a timely manner because, singly and collectively, they constituted a significant departure from Xerox’s past accounting practices and misled investors about the quality of the earnings being reported.

Besides that, senior Xerox management reaped over $5 billion in performance-based compensation and over $30 million in profits from the sale of stock.

The practices summarized above constitute an unlawful scheme by Xerox to defraud investors through undisclosed accounting practices and other material transactions, some of which the company knew or should have known violated GAAP. Xerox failed to tell investors that these actions were the reason Xerox met or exceeded consensus earnings estimates quarter after quarter.

b) The possible reasons or factors that may cause the unethical actions in the cases.

The ethical issues faced by Xerox corp can be explained from a personal, organizational and systematic level and it possible reasons why they commit unethical actions.

Personal Level

Possible reasons: Individual moral failures and greed

Personal level calls for the character evaluation of the main individuals that participated in the various fraud as for Xerox Corp Former Chairman and CEO, Paul Allaire, Former Chief

Financial Officer, Barry Romeril and KPMG partner, Michael Conway, in a statement

reported that they are the main person whom in charged by the SEC way back year’s of

1999. The values and ethical behaviours of these individuals have continuously been called

into question. Many of the charges directed towards these individuals are a clear indication

of acquiring personal interest.

It is not that the senior executives did not receive any ethics training earlier on but it is their own individual moral failures and greed that led to the distortion of financial statements. They did not consider the social implications of their unscrupulous decision on their company and also all parties with interests in the company. What concern these executives are their own individualized interests especially in wealth maximization.

Organizational Level

Possible reasons: The need to follow orders from bosses and pressure from top

management on their accountants to make the numbers add up.

An unethical practices by the Top management to ensure that the accountant of the

Corporation to make up the financial statement reporting to reflect the corporation financial

position was on a good position no matter what it cost as long as they can manipulate the

treatment of accounting practices.

This might be the reasons for the accountant in that organizational tied up( unable to

perform as an independent parties) with the mislead accounting practices in order to follow

the command of the superior management.

As in Nicor Energy’s overstated unbilled revenue by approximately $4.5 million for 2001

was a collusion between Johnson (senior-most financial officer) and Stoffer (NE’s

President & CEO) in inflating the unbilled revenue number.

Stoffer also directed a reversal of a portion of the incurred expense of 2001 into 2002

to meet year-end earnings targets.

Besides that, Johnson who was responsible for setting the level of the bad debt reserve

was under pressured by Stoffer to purposely understate the bad debts reserve.

Systematic Level

Possible Reasons: Cosy relationship the firms have with their corporate clients

and Enormous pressure from Wall Street investors to keep up

short term earnings.

As been spell out, many external factors have contributed to the confront of this unethical

issues. Such possible factors from the external forces are Corporations often hire accountants and other personnel from their auditor and accountants and much of the pressure brought to bear on accountants; stems from the cosy relationships the firms have with corporate clients.

As for Xerox’s auditors, KPMG kept silent when it found out about the accounting discrepancies in Xerox so that they can maintain their relationship and businesses with Xerox.

There was no watchdog ( legal and structure) at Xerox. KPMG’s bark sounded no warning to investors; its bite was toothless.

Beside the possible causes that might led them to commit in these unethical actions possibly

might be due to the investment climate of 1990s added insults to injuries. Cited back, year

of 1990s, Companies that failed to meet Wall Street’s earnings estimates by even a penny

often were punished by significant declines in stock price. In addition, compensation of

Xerox senior management team depended significantly on their ability to meet increasing

revenue and earning target.

c).Who were the stakeholders (individual or groups) that are affected by the unethical

actions? How are they affected by the fraud or unethical actions?

Stakeholders are those groups “who can affect or [are] affected by the achievement of the firm’s objectives.” Stakeholders in a company may include shareholders, directors, management, suppliers, government, employees and also the community. The unethical actions in Xerox Corp have affected the stakeholders in a way or so.

Shareholders

Shareholders are invariably the first victims of top management fraud. When news of fraud by a firm becomes public knowledge, it immediately reduces the stock market value of the companies involved. Bondholders and other creditors of the firm can also end up bearing the negative effects of management fraud.

After news of the financial fraud at Xerox Corp. is released, Xerox’s stock has been declining sharply and is now trading at about $7. Shareholders can no longer assume that management is acting within the law or with their best interests in mind. Shareholders now require greater openness on the part of their senior managers.

Society

Fraud also depresses the overall moral climate in a society. It can lead to a general lack of faith in the integrity of senior managers, erosion in the confidence in the free market system, including its political institutions, processes, and leaders, and a general growth of cynicism in a society. The failure of accounting firms to detect managerial fraud has also led to less faith in audited financial statements. Worse still, many believe that the accounting firms have compromised their own integrity because of the lure of lucrative consulting contracts from firms they were auditing. In Xerox’s case, their auditor, KPMG complied with management at Xerox to allow the accounting irregularities to continue.

Employees

Employees of companies whose top managers engage in fraud often are hit the hardest, even when they are unaware of their executives’ illegal activities. Fraud can cause employees to lose their jobs, their retirement savings (which often are tied up in company stock) and their reputations. Frequently, the very fact that employees have worked for a fraudulent company taints their resumes to the point that some find it difficult to find jobs elsewhere. The negative impact of Xerox’s fraud was that Xerox has laid off thousand of workers in the past two years and may make further retrenchments in the future.

d) Discussion on the governance and control issues arising from the companies’

experienced.

The highly visible accounting scandal in Xerox Corp showed us one significant matter; the corporate governance and internal controls is failed in the corporations. The worst incidences of fraud are usually committed by insiders, among whom those executives figure prominently who are assigned to manage and control their organizations. Corporations are now looking at how they can make their respective boards of directors more effective. Xerox Corp, has made a good progress on corporate governance and control issues arising from the company’s experience.

They have adopted strict new guidelines on what constitutes director independence. Applying this definition, 75% of their directors are independent.

Proactively integrated Sarbanes-Oxley Act and proposed NYSE rules into their governance processes.

Revised and strengthened the charters for their Board of Directors’ committees.

Hold regular executive sessions of outside directors without Xerox management present.

Launched a massive effort to strengthen internal controls, train their people and promulgate a clear and strong Code of Conduct.

Established an Ethics Help line for their employees and have taken other measures all aimed at making Xerox a role model in ethical behaviour.

Bear in mind that, no laws or policies will ever be sufficient to end all corporate misbehaviour. We are confident, however, that truly independent and inquisitive boards of directors will provide the best safeguard against corporate wrongdoings. such Audit Committees must be autonomous and vigorous, Financial Information is inherently judgmental ,give Sarbanes-Oxley a chance to work, excessive executive compensation can be tamed by the Compensation Committee and directors must be selected and appraised by Independent Nominating Committee.

3.Conclusion

Fraud had damages the reputations of the individuals and firms involved. Revelations of top management fraud have caused the public to question the ability of boards of directors to monitor senior executives and protect shareholders’ wealth. As for Xerox Corp, in order too minimize the harm caused by the unethical actions by the executives, firstly Law and regulations are, and will remain, the most influential external drivers of corporate ethics, but legislation is no substitute for the presence of leaders who support and model ethical behaviour. The single most important ethical leadership behaviour is keeping promise, followed by encouraging open communication, keeping employees informed and supporting employees who uphold ethical standards. Corporate leaders need to communicate ethical values throughout the organization, but they must do more than talk the talk in order to establish and sustain an ethical culture. As for specific programs and practices, a corporate code of conduct is viewed as being most important to prevent or minimize accounting frauds. Such a code must reflect and reinforce the values and principles of an organization. Besides that, ethics training for all members of the organization, corporate social responsibility programs, ombudsman services and help lines can be done to combat unethical behaviour. In summary, employees need to have a code to set the ethics foundation, training to help people truly understand it, and programs that permit them to inquire about and report ethical violations. A comprehensive Whistleblowers Act to provide wide-ranging protection for whistleblowers in all sectors too can help encourage whistle blowing.