S.E.C. v. Kpmg Llp.
| Decision Date | 13 January 2006 |
| Docket Number | No. 03 Civ. 671(DLC).,03 Civ. 671(DLC). |
| Citation | 412 F.Supp.2d 349 |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. KPMG LLP, Joseph T. Boyle, Michael A. Conway, Anthony P. Dolanski, Ronald A. Safran, and Thomas J. Yoho, Defendants. |
| Court | U.S. District Court — Southern District of New York |
Gary F. Bendinger, Rebecca S. Parr, Bendinger, Crockett, Peterson, Greenwood & Casey, PC, Salt Lake City, Utah, for Michael A. Conway.
Scott B. Schreiber, Andrew T. Karron, Leslie Wharton, Arnold & Porter LLP, Washington, D.C., New York, New York, for Anthony P. Dolanski.
Martin L. Perschetz, Marc E. Elovitz, Yocheved Cohen, Dana M. Roth, Schulte Roth & Zabel LLP, New York, New York, for Ronald A. Safran.
Frank H. Wohl, Charles T. Spada, Joseph A. Patrice, Jennifer R. Ridha, Lankler Siffert & Wohl LLP, New York, New York, for Thomas J. Yoho.
In this action, the Securities and Exchange Commission ("SEC") alleges that KPMG LLP ("KPMG") and several KPMG audit partners participated in a massive accounting fraud at Xerox Corporation ("Xerox") from 1997 through 2000. This Opinion concerns the summary judgment motions filed by Michael A. Conway ("Conway"), Anthony P. Dolanski ("Dolanski"), Ronald A. Safran ("Safran"), and Thomas J. Yoho ("Yoho"), the remaining defendants in the action. For the reasons stated below, the motions are granted in part.
On January 29, 2003, the SEC filed a complaint against KPMG, Xerox's auditor during the years in question, and four KPMG partners, Joseph T. Boyle ("Boyle"), Conway, Dolanski, and Safran. The complaint alleges that these defendants permitted Xerox to manipulate its accounting practices in order to fill a $3 billion gap between its actual operating results and the results it reported to the investing public. In 2001, Xerox released a $312 million restatement of 1998 and 1999 pretax earnings (the "First Restatement"). In 2002, after the scope of the alleged fraud was exposed, and with the assistance of a new auditor, Xerox issued a $6.1 billion restatement of its equipment revenues and a $1.9 billion restatement of its pre-tax earnings for the years 1997 through 2000 (the "Second Restatement"). The Second Restatement was the largest financial restatement in American history up to that time. The nature of the alleged fraud and the involvement of the various defendants are discussed in detail below, as drawn principally from the evidence presented by the SEC in opposition to these motions.
On April 9, 2003, the defendants' motion to transfer venue to the District of Connecticut, where privately filed civil actions were pending, was denied. SEC v. KPMG LLP, et al., No. 03 Civ. 671(DLC), 2003 WL 1842871, at *5 (S.D.N.Y. Apr.9, 2003). In an August 20, 2003 Opinion, the SEC's motion to strike four defendants' affirmative defenses of laches, undue delay, estoppel, waiver, unclean hands, and statutes of limitations was granted. SEC v. KPMG LLP et al., No. 03 Civ. 671(DLC), 2003 WL 21976733, at *4 (S.D.N.Y. Aug.20, 2003). An August 22, 2003 Opinion denied Boyle's motion to dismiss. SEC v. KPMG LLP et al., No. 03 Civ. 671(DLC), 2003 WL 21998052, at *6 (S.D.N.Y. Aug.22, 2003). On November 5, 2003, the SEC filed an amended complaint that included Yoho, a fifth KPMG partner, as a defendant. A Second Amended Complaint (the "Complaint") was filed on May 5, 2004.
In November 2004, KPMG reached a settlement with the SEC. KPMG consented to a finding that it violated Section 10A of the Securities Exchange Act of 1934 (the "Exchange Act"); to pay disgorgement of $9,800,000, plus prejudgment interest; to pay a civil penalty of $10 million; and to implement a number of internal reforms. A final judgment against KPMG was issued on April 20, 2005. In June 2005, defendant Boyle settled with the SEC. The settlement was renewed in October 2005 after an initial rejection by the Commissioners. Pursuant to the settlement, Boyle paid a civil penalty of $100,000 and was permanently enjoined from violating Exchange Act Section 10A. The final judgment against Boyle was issued on October 11, 2005.
Five claims remain against Conway, Dolanski, Safran, and Yoho (the "KPMG Partners"): (1) violations of Section 17(a) of the Securities Act of 1933 (the "Securities Act") and Section 10(b) of the Exchange Act; (2) aiding and abetting violations of Exchange Act Section 10(b); (3) violation of Exchange Act Section 10A; (4) aiding and abetting violations of Section 13(a) of the Exchange Act; and (5) aiding and abetting violations of Section 13(b) of the Exchange Act. The SEC seeks permanent injunctions and civil penalties against the KPMG Partners.
In June 2005, the KPMG Partners filed the summary judgment motions that are the subject of this Opinion. All four defendants contend that they did not make false or misleading statements on which primary liability under Exchange Act Section 10(b) and Rule 10b-5 could be predicated, and that they face, at most, aiding and abetting liability under Exchange Act Section 20(e). Dolanski and Safran also move on the basis that they made no actionable misstatements that would support Securities Act Section 17(a) liability. All defendants also argue that actual knowledge is necessary to support liability under Section 20(e). Dolanski, Conway, and Yoho argue that the evidence is insufficient to establish that they possessed actual knowledge of the alleged violations.
Conway, Dolanski, and Yoho also argue that they should not be held liable under Exchange Act Section 10A, claiming that the provision does not apply to individual accountants. Conway contends that he should not incur Section 10A liability because he performed an extensive investigation of potential illegal acts by Xerox, reported those acts to the Xerox Audit Committee, and insisted upon appropriate remedial action. Yoho argues that he should not be held liable under Section 10A because there is no reason to believe that he failed to notify the Audit Committee as required under the statute.1
Conway and Dolanski argue that, even if they made misstatements sufficient to support Section 10(b) liability, the evidence is not sufficient to support an inference that they had scienter. Dolanski argues additionally that the claims against him under Sections 10A and 20(e) are barred by the statute of limitations, and that he should receive judgment as a matter of law on claims premised on "price increases and extensions to existing leases" because such claims are not asserted against him in the complaint.
Conway has filed a motion to strike certain portions of plaintiffs Response to Mr. Conway's Statement of Material Facts Pursuant to Local Rule 56.1 and the Statement of Facts in plaintiff's opposition brief. That motion is considered at the end of this Opinion.
The following facts are taken from the parties' evidentiary submissions and are either undisputed or stated in the light most favorable to the SEC, unless otherwise noted. The various accounting treatments at issue, including lease accounting methodologies and accounting for reserves, and Dolanski's, Safran's, and Yoho's involvement in them, are described in subsection B. Conway's involvement, and the events that led up to the Second Restatement in 2001, are described in subsection C.
Financial statements must be reported in accordance with Generally Accepted Accounting Principles, or "GAAP." The meaning of GAAP was explored in detail in this Court's January 18, 2005 Opinion deciding the summary judgment motion of Arthur Andersen LLP in In re WorldCom, Inc. Securities Litigation, 352 F.Supp.2d 472, 478-79 (S.D.N.Y.2005), and this Opinion draws heavily from that discussion.
The goal of financial reporting is to "provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions." Financial Accounting Standards Board ("FASB"), Statement of Financial Accounting Concepts No. 1 (1978). The purpose of GAAP is "to increase investor confidence by ensuring transparency and accuracy in financial reporting." In re Global Crossing, Ltd. Sec. Litig., 322 F.Supp.2d 319, 339 (S.D.N.Y.2004).
There are "19 different GAAP sources." Shalala v. Guernsey Mem'l Hosp., 514 U.S. 87, 101, 115 S.Ct. 1232, 131 L.Ed.2d 106 (1995). When a conflict among these sources arises, "the accountant is directed to consult an elaborate hierarchy of GAAP sources to determine which treatment to follow." Id. Standards issued by FASB sit at the top of this hierarchy and are used as reference points by all parties to the summary judgment motions considered in this Opinion. FASB, an independent private sector organization, is the "designated organization in the private sector for establishing standards of financial accounting and reporting." FASB, Facts About FASB, available at http://www.fasb.org/facts/index.html. FASB's standards have been recognized by the SEC as authoritative. See Statement of Policy on the Establishment and Improvement of Accounting Principles and Standards, SEC Release No. AS-150, 1973 WL 149263, at *1 (Dec. 20, 1973).
The SEC offers evidence that Xerox used several improper accounting treatments to distort its reported financial results in the years 1997 through 2000. One of its accounting experts contends that the accounting treatments violated GAAP, and it has presented evidence to show that the purpose and effect of these treatments was artificially to inflate Xerox's reported quarterly earnings to meet the earnings targets that the company had...
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