1. FINA 503
DATE: 02/18/10
JOSE CINTRON,MBA

2. Enron & WorldCom will change the world
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. NET INCOME xxx (Huge Increase)
COGS xxx
(no change)
Revenues xxx (no change)
Computer expenses: xxx
(Huge Decrease)
Fees companies phone networks: xxx
(Huge Decrease)
HowtheFraudtook place
CFOs directions affected the income statement:
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 $11 billion.
8. 9. Largest Bankruptcy Filings
10. Z-score Analysis for WorldCom
The Z-score formula for predicting bankruptcy.
Ratio Definition1999 20002001
X1 Working capital/total assets (0.08) (0.08) (0.00)
X2 Retained earnings/total assets (0.01)0.03 0.04
X3 Earnings before interest and taxes/total assets0.080.08 0.02
X4 Market value of equity/book value of total liabilities3.58 1.130.54
X5 Sales/total assets 0.39 0.40 0.34
Z Z-score 2.6971.274 0.798
Z > 2.99 -Safe 1.8 < Z < 2.99 -Grey Z < 1.80 -Distress
Z-scores for WorldCom based on its annual 10-K reports .We found that the company indeed experienced a rapid deterioration in its
Z-score.
11. CONSOLIDATING BALANCE SHEET (10K SEC) (IN MILLIONS) AT DECEMBER 31, 2000
WORLDCOMMCI GROUP ELIMINATIONS WORLDCOM
Current assets......................................$ 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...................................... 11,6966,000 -- 17,696 Noncurrent liabilities.............................. 3,6481,087 -- 4,735Minority interests..................................2,592 -- --2,592 Company redeemable preferred securities...... 798----798
Shareholders' investment............................52,9462,463--55,409
Total liabilities and shareholders' investment....$85,893$14,635$(1,625)$98,903
======= ======= ======= =======
$ 9,755 / 17,673=(7,918) WORKING CAPITALOR .55 CURRENT RATIO
THE HIGHER THIS RATIO THE BETTER TO MEET THEIR CURRENT OBLIGATIONS.
12. WorldCom Statement of Cash flow
Cash flows from operating activities: 20002001
Net income Operating Activities$4,153 $1,501
OriginallyReportedRevised as of April 15, 2004
2000 20012002NNet loss$ -48,909-15,597 -9,173
13. I dont belief this happen to me .
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.
14. What do these dates have in common?
December 2, 2001
July 19, 2002
August 31, 2002
Enron declares
bankruptcy
MCI WorldCom declares
bankruptcy
Arthur Anderson agrees to
stop auditing public
companies
15. How did this happen?
Corporate Issues Audit Firm Issues
Earnings pressure
Lack of mandated disclosure of company reporting model
Minimal oversight into corporate business practices
No documented or enforced internal controls
Dependency on consulting fees
Assumed good intent of their client
Inability to continuously monitor a companys internal controls
Unable to identify violations of internal controls
16. How Did
Congress Respond?
Sarbanes Oxley Act
17. 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 companys 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.
18. Sarbanes Oxley Act
Highlights (continued)
Section 302:Your CEO and CFO must sign statements verifying the completeness and accuracy of financial reports.
Sections 404CEOs, CFOs 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.
19. SarbanesOxley Act
SarbanesOxley Law
20. Sarbanes - Oxley Impact on Information Systems
21. The 3 Cs of Sarbanes-Oxley
CEOs, CFOs and CIOs
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.'
22. System Control Examples
Financial Statement Generation
Report parameter changes are documented
Data that generates financial statements is accurate
Inventory Item Creation
Costing is accurately assigned
Purchasing
Approved suppliers are used
Approval limits cannot be easily manipulated
Customer Creation
Duplicate customers
Credit limits
23. Oversight of Financial Data Examples
Standard Data Entry is Enforced
Accurate reporting
Segregation of Duties
Separation of functions to minimize risk of fraud
Audit changes to sensitive data
Approval processes for creation of financial data
Oversight into Financial Processes
Ensure all month/year end activities are completed
24. Benefits of the NewOxley 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
25. 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.
26. The Enron Scandal
On October 22, 2001, the Securities and
Exchange Commission (SEC) begins an
inquiry into Enrons accounting practices.
On December 2, 2001, Enron files for bankruptcy, the largest bankruptcy in US history up to that time
27. 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.
28. 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.
29. How this happen.Continued
1993-2001: Enron senior management used.
Complex and foggy accounting schemes
to reduce Enrons tax payments;
to inflate Enrons income and profits;
to inflate Enrons 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 Enrons financial
condition in public reports.
30. Example of one scheme
Enrons creation of over 3000 (!) partnerships started about 1993 when it teamed with Calpers (Calif. Public Retirement System) to create JEDI (Joint Energy Development Investments) fund.
Why partnerships?According to GAAP , as long as Enron could find another partner to take at least a 3% stake, Enron was not required to report the partnerships financial condition in its own financial statements.
31. Example of one scheme Continued
Enron used partnerships to hide bad bets it made on speculative assets by selling these assets to the partnerships in return for IOUs backed by Enron stock as collateral! (over $1 billion by 2002)
In November 1997, Calpers wanted to cash out of JEDI.
To keep JEDI afloat, Enron needed a new 3%
partner.
It created another partnership Chewcoto buy
out Calpers stake in JEDI.
32. 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 Enrons share price started to
drop in Fall 2000.
33. 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