Worldcom and Enron both engaged in accounting fraud in the late 1990s and early 2000s. Worldcom fraudulently reported $3.8 billion in line costs as capital expenditures instead of operating expenses. An internal audit uncovered the fraud, and Worldcom later filed for the largest bankruptcy in US history at that time. Enron used accounting loopholes and off-balance sheet entities to hide billions in debt and losses. When its stock price declined, Enron's true financial situation was revealed and it filed for bankruptcy in 2001. In response, Congress passed the Sarbanes-Oxley Act to increase accounting oversight and impose harsher penalties for corporate and accounting fraud.
3. WORLDCOM:
In 1998, the telecommunications industry began to slow
down and WorldCom's stock was declining. CEO came under
increasing pressure from banks to cover margin calls on his
WorldCom. Beginning in 1999 and continuing through May
2002, WorldCom used shady accounting methods to mask its
declining financial condition by falsely professing financial
growth and profitability to increase the price of WorldCom's
stock.
4. HOW THIS HAPPEN
The fraud was accomplished in two main ways. First,
WorldCom's accounting department underreported
'line costs' (expenses with other telecommunication
companies) by capitalizing these costs on the balance
sheet rather than properly expensing them. Second,
the company inflated revenues with bogus accounting
entries from corporate unallocated revenue accounts.
5. How the Fraud took place
NET INCOME
xxx (Huge Increase)
Revenues xxx COGS xxx
(no change)
(no change)
CFO’s directions
affected the income
statement:
Fees companies phone
Computer expenses:
networks: xxx xxx
(Huge Decrease) (Huge Decrease)
6. Overstating Asset Frauds (WorldCom)
Overstatement of current assets(marketable securities)
Overstating pension assets
Capitalizing as assets amounts that should be expensed
Failing to record depreciation/amortization expense
Overstating assets through mergers and acquisitions
Overstating inventory and receivables
7. HOW WAS DISCOVER
The first discovery of illegal activity was by WorldCom's
own internal audit department who uncovered $3.8 b. of
the fraud in June 2002. The company's audit committee
and board of directors were notified of the fraud.
The Securities and Exchange Commission (SEC)
launched an investigation. By the end of 2003, it was
estimated that the company's total assets had been
inflated by around $11 billion.
8.
9. Largest Bankruptcy Filings
Company Assets (Billions) When Filed
1. WorldCom $103.9 July 2002
2. Enron $63.4 Dec. 2001
3. Conseco $61.4 Dec. 2002
4. Texaco $35.9 April 1987
5. Financial Corp of America $33.9 Sept. 1988
6. Global Crossing $30.2 Jan. 2002
7. PG&E $29.8 April 2001
8. UAL $25.2 Dec. 2002
9. Adelphia $21.5 June 2002
10. MCorp $20.2 March 1989
10. CONSOLIDATING BALANCE SHEET (10K SEC)
(IN MILLIONS) AT DECEMBER 31, 2000
WORLDCOM MCI GROUP ELIMINATIONS WORLDCOM
Current assets...................................... $ 9,068 $ 2,312 $(1,625) $ 9,755
Property and equipment, net......................... 35,177 2,246 -- 37,423
Goodwill and other intangibles...................... 36,685 9,909 -- 46,594
Other assets........................................ 4,963 168 -- 5,131
Total assets...................................... $85,893 $14,635 $(1,625) $98,903
Current liabilities................................. $14,213 $ 5,085 $(1,625) $17,673
Long-term debt...................................... 11,696 6,000 -- 17,696
Noncurrent liabilities.............................. 3,648 1,087 -- 4,735
Minority interests.................................. 2,592 -- -- 2,592
Company redeemable preferred securities...... 798 -- -- 798
Shareholders' investment............................ 52,946 2,463 -- 55,409
Total liabilities and shareholders' investment.... $85,893 $14,635 $(1,625) $98,903
======= ======= ======= =======
$ 9,755 / 17,673=(7,918) WORKING CAPITAL OR .55 CURRENT RATIO
THE HIGHER THIS RATIO THE BETTER TO MEET THEIR CURRENT OBLIGATIONS.
11. WorldCom Statement of Cash flow
Cash flows from operating activities: 2000 2001
Net income Operating Activities $4,153 $1,501
Originally Reported Revised as of April 15, 2004
2000 2001 2002
N Net loss $ -48,909 -15,597 -9,173
12. HOW ENDED
On July 21, 2002, WorldCom filed for Chapter 11
bankruptcy protection, the largest such filing in United
States history. The company emerged from Chapter 11
bankruptcy in 2004 becoming MCI. On March 15, 2005
Bernard Ebbers (CEO) was found guilty of all charges and
convicted on fraud, conspiracy and filing false documents
with regulators. He was sentenced to 25 years in prison.
I don’t belief this
happen to me .
13. What do these dates have in
common?
December 2, 2001 Enron declares
bankruptcy
July 19, 2002 MCI WorldCom declares
bankruptcy
August 31, 2002 Arthur Anderson agrees to
stop auditing public
companies
14. How did this happen?
Corporate Issues Audit Firm Issues
Earnings pressure Dependency on consulting fees
Lack of mandated disclosure Assumed good intent of their
of company reporting model client
Minimal oversight into Inability to continuously monitor
corporate business practices a company’s internal controls
No documented or enforced Unable to identify violations of
internal controls internal controls
15. How Did
Government
Respond?
Sarbanes – Oxley Act
16. Sarbanes – Oxley Act
Highlights
Section 103: Your auditor (and therefore, you should)
maintain all audit related records, including electronic
ones, for seven years.
Section 201: Firms that audit your company’s books
can no longer provide you with IT related services.
Section 301: You must provide systems or procedures
that allow employees to communicate effectively with
the audit committee.
17. Sarbanes – Oxley Act
Highlights (continued)
Section 302: Your CEO and CFO must sign
statements verifying the completeness and accuracy of
financial reports.
Sections 404 CEO’s, CFO’s and outside auditors must
attest to the effectiveness and accuracy of financial
reports.
Section 409: Companies must report material
changes in their financial conditions “on a rapid and
current basis.” The act calls it “real-time” disclosure but
is unclear on what it means.
18. Sarbanes–Oxley Act
Sarbanes–Oxley Law
Behavior Consequence
Any CEO or CFO who “recklessly” violates his Fine of up to $1,000,000 and/or up to 10 years
or her certification of the company’s financial imprisonment.
statements.
Fine of up to $5 million and/or up to 20 years
If “willfully” violates.
imprisonment.
Any person who “corruptly” alters, destroys,
conceals, etc., any records or documents with Fine and/or up to 20 years imprisonment.
the intent of impairing the integrity of the record
or document or use in an official proceeding.
20. The 3 Cs of Sarbanes-Oxley
CEO’s, CFO’s and CIO’s
The jobs of the CEO, CFO & CIO got tougher on
July 30, 2002 -- the day the Sarbanes-Oxley Act
was signed. The legislation requires significant
changes to financial practices and corporate
governance, and touches all corporate areas --
including technology. For the first time ever, the
CFO and CEO can look a CIO in the eye and say,
'Guess what, you're on the hook with us.'
21. Benefits of the New Oxley Act
1. Increased confidence of CEO/CFO in meeting requirements
2. Improved coordination of Company Management Team
3. Improved and clarified Corporate Governance process
4. Systematized process for early identification of business
risks/ whistle blowing issues/incident management
5. Systematized approach to dealing with change (i.e.,
transactions, personnel, accounting principles, internal
controls and operating procedures)
6. Increased operational effectiveness
23. The Enron Scandal
The Enron scandal was a corporate scandal involving
the American energy Enron Corporation, the world's
leading energy company and the accounting, auditing,
and consultancy firm Arthur Andersen.
On October 16, 2001, in the first major
public sign of trouble, Enron announces a huge third-
quarter loss of $618 million.
24. The Enron Scandal
On October 22, 2001, the Securities and
Exchange Commission (SEC) begins an
inquiry into Enron’s accounting practices.
On December 2, 2001, Enron files for bankruptcy,
the largest bankruptcy in US history up to that time
25. Consequences
Thousands of employees lost their jobs and even their
life savings in 401(k) plans tied to the energy company's
stock.
Disastrous falling down on the whole stock market
during the following months, especially in the financial
service industry.
Arthur Andersen, which at the time was one of the five
largest accounting firms in the world, was dissolved.
26. How this happen
The company used shortcomings of Rule-Based US
GAAP , special purpose entities, and poor financial
reporting to hide billions in debt from failed deals
and projects.
Enron's audit committee failed to follow up on
high-risk accounting issues
Andersen was pressured by the company to ignore
accounting practices.
27. How this happen….Continued
1993-2001: Enron senior management used.
Complex and foggy accounting schemes
to reduce Enron’s tax payments;
to inflate Enron’s income and profits;
to inflate Enron’s stock price and credit rating;
to hide losses in off-balance-sheet subsidiaries;
to engineer off-balance-sheet schemes to direct
money to themselves, friends, and family;
to fraudulently misrepresent Enron’s financial
condition in public reports.
28. Profit to Enron from all this?
$10 million in guarantee fee + fee based on loan
balance to JEDI. A total of $25.7 million revenues from
this source.
Increase in price of Enron stock held by
JEDI. Enron recognized $126 million in
the first quarter of 2000 from this.
But everything began to fall apart
when Enron’s share price started to
drop in Fall 2000.
29. Generally Accepted Accounting
Principles prior to 2002.
Auditing companies often consult for the
companies they audit (conflict of interest).
Audit company partners often later accept
jobs from their client companies.
Companies often retain the same auditing
company for long periods of time.
Auditing companies have been allowed to police
themselves.
Appointment of auditor company is in theory by
shareholders but in practice by senior management
