During 2001, Xeroxrestated its prior year earnings. The original earnings for the years 1997–2000 had been overstated by approximately $3 billion before-tax. According to Securities and Exchange Commission (SEC) allegations, earnings had been overstated to help the company meet internal earnings targets as well as financial analyst estimates. Furthermore, according to the SEC, the overstatements were allegedly performed with the knowledge of top management and included the cooperation of managers in the United States, Europe, and Brazil.

During 2003, the SEC charged six senior executives with securities fraud. These officers later reached a settlement with the SEC, without admitting or denying the allegations. According to SEC regulations, wrongdoers pay a civil penalty and are also required to “disgorge” or repay any ill-gotten gains. For the Xerox managers, these regulations meant they were required to repay the $14 million in bonuses and other benefits that were based on the overstated earnings. In addition, the SEC requires wrongdoers to pay interest on disgorgements to ensure that they do not benefit from an interest-free loan. Overall, the six officers were required to pay the following amounts:

Disgorgement .........$14 million

Interest on disgorgement .... 5

Civil penalties ........ 3

Total ...........$22million

However, the only cash actually paid by the six officers was for the civil penalties of $3 million.

Xerox paid $19 million for the disgorgement, interest, and officers’ legal fees. According to Note 15 (Litigation, Regulatory Matters, and Other Contingencies) in the 2003 Xerox annual report:

However, the only cash actually paid by the six officers was for the civil penalties of $3 million.

Xerox paid $19 million for the disgorgement, interest, and officers’ legal fees. According to Note 15 (Litigation, Regulatory Matters, and Other Contingencies) in the 2003 Xerox annual report:

“Our corporate by-laws require that, except to the extent expressly prohibited by law, we must indemnify Xerox Corporation’s officers and directors against judgments, fines, penalties and amounts paid in settlement, including legal fees and all appeals, incurred in connection with civil or criminal action or proceedings, as it relates to their services to Xerox Corporation and our subsidiaries.”

ANALYZE INFORMATION

The following questions will help you analyze the information for this problem. Do not turn in your answers to these questions unless your professor asks you to do so.

A. In this chapter, we learned about different types of agency costs. Do agency costs always involve an ethical problem? Why or why not?

B. Describe a hypothetical situation where a company officer incurs settlement and legal costs, but has done nothing wrong.

C. Discuss pros and cons of Xerox’s bylaw to indemnify officers and directors.

D. Does it matter whether the payments were made by an insurance company versus by Xerox? Why or why not? Clarify the values you use in drawing your conclusions.

REQUIRED

Turn in your answer to the following.

E. Use the information you learned from the preceding analyses to write an essay in response to the following question: Was it ethical for the officers to allow costs to be paid by Xerox and its insurance companies?