False accounting and fictitious sales at Fuji Xerox Australia, NZ

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False accounting and fictitious sales at Fuji Xerox Australia, NZ

Fuji Xerox's Australian and New Zealand business were spinning out of control as warnings of fraudulent behaviour went unheeded, major accounting irregularities were covered up and bad behaviour was not simply ignored, but promoted.

Those are some of the takeaways from a newly published translation of the investigation report by its Japanese parent company, Fujifilm, which has combed through 360,000 files and emails on servers and PCs used by 58 individuals as part of the investigation.

The problems, which began in Fuji Xerox New Zealand (FXNZ) and spread to Fuji Xerox Australia (FXA), have had global ramifications for Fujifilm, a technology giant that turns over A$26 billion (¥2,322.2 billion) in revenue.

The company has been forced to delay its annual report due to the "inappropriate accounting" at its regional subsidiaries. Several Fuji Xerox top brass in Japan have been shown the door and others have seen wages and bonuses cut by 20-50 percent.

FXA, which has its head office in North Ryde, is primarily a direct sales operation and is distinct from Fuji Xerox Printers, a largely separate company based in Frenchs Forest that sells via resellers.

The latest translation of the investigation report contains new details that were absent from the initial translation, published on 21 June. The company has revealed it would knock ¥37.5 billion (A$451 million) off six years' worth of net profits and has been frozen out of New Zealand government contracts.

The investigation report provides painstaking detail on how top executives at FXA and FXNZ regularly brought revenue forward to hit targets, repeatedly avoided recognising losses so red ink would not reach the bottom line and simply fabricated monthly accounting numbers then chalked up asset sales as revenue to cover up the missing millions.

The report is damning of key individuals in the leadership team. It blames the company's "sales at any cost" culture under former FXA and FXNZ managing director Neil Whittaker, which led to commissions and bonus payments of "massive amounts" from 2011 onwards.

The report alleges that management overcompensated favoured workers, who included family members, with six-figure salaries that were more than three times the market rate, as well as gifting bonuses and using corporate expenses for lavish meals and pocket money.

The root cause of the problems stemmed from a practice of overstating revenue on managed service agreements (MSAs), which typically had variable pricing based on usage, sometimes with no minimum value, yet were accounted as upfront revenue.

The abuse of MSAs started at the New Zealand business and became so commonplace that "inappropriately recognised revenue" was close to 30 percent of total sales of FXNZ in 2015.

"Furthermore, these inappropriate transactions may have included completely fictitious transactions, not just transactions that recorded revenue in advance," according to the report.

"The cumulative amount… of sales inappropriately recorded early using the aforementioned methods was NZ$90 million as of January 2016."

Of that NZ$90 million, "NZ$35 million was fictitious sales, and the remaining NZ$55 million was not fictitiously recorded, but comprises revenue inappropriately recorded early", the report explained.

This practice of inappropriately recognising revenue became "constant practice" at Fuji Xerox NZ and occurred in about 70 percent of contracts over a six-year period.

The litany of accounting abuses went beyond the practice of recognising revenue early.

FXNZ rolled clients into new contracts in the beginning or middle phases of the initial contract term in order to recognise new equipment revenue.

There were cases of double recording of advance sales, and the recording of "fictitious sales" to achieve monthly performance targets. Free products and promotional giveaways to schools were chalked up as sales.

Lax credit policies helped greenlight orders from risky clients. In fact, credit screenings were only carried out in about 10 percent of total transactions.

FXNZ ignored numerous warning signs that its largest customer was in trouble, including a report in 2013 that the customer was "essentially bankrupt", and continued to supply. Accounts receivable for that one customer skyrocketed from NZ$2 million in 2013 to NZ$29m in 2017, and "the vast majority of those receivables are now unlikely to be recovered".

When incorrect financial figures were identified in the monthly accounts, they were often simply fudged.

Scrambling to clean up the mess and avoid detection, in 2015 the company recorded asset sales and other non-operating transactions as revenue "to reduce the risk that inappropriate accounting... would become a problem in an accounting audit at the end of the period".

"This created the external appearance that FXNZ’s financial activities and financial condition had improved in that fiscal year, and that FXNZ had revenue higher than its actual revenue."

The disastrous culture was entrenched, with the report claiming "some of FX’s officers and employees have lacked a sense of ethics and honesty when preparing the financial statements".

Next: The problem of "Mr A"

The report anonymises the names of executives, though "Mr A" can clearly be identified as Neil Whittaker, the former MD of Fuji Xerox New Zealand who then led Australia before he was shuffled out in May 2016 with a "resignation upon agreement" and a $1 million golden parachute to avoid any potential legal dispute.

CRN attempted to contact Whittaker.   

A number of senior Fuji Xerox Australia executives have exited the company in the past year, including chief financial officer Devlin Bell and chief people officer Beth Winchester.

The company's auditors, Ernst & Young, were sacked in July 2016 and replaced by KPMG.

That million-dollar payout to the managing director came despite numerous allegations of impropriety by "Mr A", who "applied pressure to dissenters and created an atmosphere where opposition was impossible".

An examination of a corporate credit card found that Mr A "and other members originally from the FXNZ office may have repeatedly used their corporate credit cards to pay for dining at high-end establishments".

Over the span of 10 months, three executives spent more than $50,000 on 41 dinners – an average cost per dinner of $1233.

It is alleged that during corporate trips, Mr A withdrew nearly $10,000 in cash in local currency on his corporate credit card but did not submit receipts to support the withdrawals. The report claimed that the company paid $43,704 for private trips for Mr A and his family members between June 2015 to April 2016.

The report also highlights how certain FXA sales employees "that Mr A brought with him from New Zealand were being extremely well compensated".

Five of the nine employees transferred from New Zealand were on salaries that exceeded pay scale benchmarks.

The $1.1 million annual salary of "business development manager E"  – $800,000 of which  was incentives-based remuneration – was 3 to 3.4 times the benchmark level, according to the report, while Mr A's son was paid an annual salary of $740,000, including $420,000 of bonuses.

The investigative report claimed that FXNZ "centralised authority with Mr A by centralising all internal reporting lines with Mr A".

This minimised oversight by the board and allowed the mounting problems to go unnoticed.

"Control functions were not effective and transparency was lacking because the reporting lines to the parent company and others in the group were all limited to Mr A, centralising the flow of information," the report stated.

"In such a situation, and given the lack of effective supervision of Mr A by [Fuji Xerox's Asia Pacific sales headquarters], it was easy for the execution of business by Mr A to run out of control."

Next: Swept under the rug

The Japanese company's most senior leaders could scarcely argue they didn't hear alarm bells ringing.

An internal audit in 2009 raised concerns with the standard contract templates for managed service agreements, which could lead to revenue being recorded inappropriately. This was just one warning brushed under the rug by company executives in Australia, New Zealand and the global HQ.

The pressure ratcheted up in July 2015 following a whistleblower email from a New Zealand employee, which brought the problems of overstated revenue at the NZ subsidiary to the doorstep of the Japanese parent.

Amid the warning signs of inflated revenues, the leadership team met in Shanghai in August 2015 and made an attempt to "conceal the accounting irregularities".

"Deputy president Y" – thought to be deputy president Haruhiko Yoshida – instructed that they respond internally "that there are no problems" following the whistleblower email.

An internal audit report to Fuji Xerox's president said there were "no accounting irregularities or cases of overstated revenue such as had been indicated in the whistleblower email”.

While denying the problems, they took the decision to forbid the use of MSAs in Australia and New Zealand. The decision was poorly received because it would lead to revenue declines of NZ$27 million and AU$27 million in the second half of 2015.

Getting the books in order would be no small effort, and moves to write down bad debts and recognise losses from the MSAs were also stymied by senior leaders' unwillingness to take the hit. Fuji Xerox's executive vice president dubbed attempts to impair losses as “overly conservative”.

The problem of overstated revenue in managed service agreements was discovered in a July 2015 audit and reported to the deputy president and executive vice president at the Fuji Xerox head office but they did not report those issues to the company president.

A year later, around July or August 2016, the deputy president and executive vice president were told future losses from MSAs would be NZ$70 million. This bad news was removed from the report materials given to the president of Fuji Xerox.

Deputy president Haruhiko Yoshida and executive vice president Katsuhiko Yanagawa have both stepped down in the wake of the scandal, and president Hiroshi Kurihara has come out strongly in favour of reforming the company culture.

In September 2016, more than a year after the whistleblower email and barely three months after managing director Neil Whittaker's departure, the New Zealand corporate regulator contacted FXNZ in response to a reports in the National Business Review about innappropriate revenue recognition dating back years.

FXNZ responded that "there had been no inappropriate recognition of revenue in advance".

In October, the deputy president and executive vice president agreed on a response – they would say that media reports indicating accounting irregularities were not factual. They even considered suing the publisher for damages.

These years of cover-ups and unheeded alarms have come back to bite the company. It's something the Fuji Xerox president warned of in October 2016, comparing the situation to another Japanese company embroiled in an accounting scandal.

"Toshiba also said at the outset that there were no problems because they had gone through an audit firm, but once they were investigated thoroughly all manner of things came out. Everyone… is trying to put a lid on this by saying that there’s no problem."

Fujifilm has now made it a priority to clean up Fuji Xerox by clamping down on excessive incentives, eradicating the "sales at any cost" culture and beefing up the internal systems to allow better oversight.

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