FINA 503<br />DATE: 02/18/10<br />JOSE CINTRON,MBA<br />
Enron & WorldCom will change the world<br />
WORLDCOM: <br />    In 1998, the telecommunications industry began to slow down and WorldCom's stock was declining. CEO ca...
HOW THIS HAPPEN<br />    The fraud was accomplished in two main ways. First, WorldCom's accounting department underreporte...
NET INCOME                   xxx (Huge Increase)<br />COGS xxx <br />(no change) <br />Revenues xxx                       ...
Overstating Asset Frauds (WorldCom)<br />Overstatement of current assets(marketable securities)<br />Overstating pension a...
HOW WAS DISCOVER<br />    The first discovery of illegal activity was by WorldCom's own internal audit department who unco...
Largest Bankruptcy Filings <br />
Z-score Analysis for WorldCom<br />The Z-score formula for predicting bankruptcy.<br />Ratio Definition  1999     2000    ...
                         CONSOLIDATING BALANCE SHEET (10K SEC)                           (IN MILLIONS) AT DECEMBER 31, 200...
WorldCom Statement of Cash flow<br />Cash flows from operating activities:       20002001<br />Net income Operating Activi...
I don’t belief this happen to me . <br />HOW ENDED<br />On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protect...
What do these dates have in common?<br />December 2, 2001<br />July 19, 2002<br />August 31, 2002	<br />Enron declares <br...
How did this happen?<br />Corporate Issues       Audit Firm Issues      <br />Earnings pressure<br />Lack of mandated disc...
How Did <br />Congress Respond?<br />Sarbanes – Oxley Act<br />
Sarbanes – Oxley Act<br />Highlights<br />Section 103:Your auditor (and therefore, you should) maintain all audit related ...
Sarbanes – Oxley Act<br />Highlights (continued)<br />Section 302:Your CEO and CFO must sign statements verifying the comp...
Sarbanes–Oxley Act<br />Sarbanes–Oxley Law<br />
Sarbanes - Oxley Impact on Information Systems<br />
The 3 Cs of Sarbanes-Oxley<br />CEO’s, CFO’s and CIO’s<br />The jobs of the CEO, CFO & CIO got tougher on July 30, 2002 --...
System Control Examples<br />Financial Statement Generation<br />Report parameter changes are documented <br />Data that g...
Oversight of Financial Data Examples<br />Standard Data Entry is Enforced<br />Accurate reporting<br />Segregation of Duti...
Benefits of the New  Oxley Act<br />1. Increased confidence of CEO/CFO in meeting requirements<br />2. Improved coordinati...
The Enron Scandal<br />The Enron scandal was a corporate scandal involving the American energy Enron Corporation, the worl...
The Enron Scandal<br />On October 22, 2001, the Securities and<br />    Exchange Commission (SEC) begins an<br />    inqui...
   Consequences<br />Thousands of employees lost their jobs and even their life savings in 401(k) plans tied to the energy...
How this happen<br />The company used shortcomings of Rule-Based US GAAP , special purpose entities, and poor financial re...
How this happen….Continued<br />  1993-2001: Enron senior management used.<br />  Complex and foggy accounting schemes<br ...
Example of one scheme<br />  Enron’s creation of over 3000 (!) partnerships started about 1993 when it teamed with Calpers...
Example of one scheme…… Continued<br /> Enron used partnerships to hide bad bets it made on speculative assets by selling ...
Profit to Enron from all this?<br />$10 million in guarantee fee + fee based on   loan balance to JEDI. A total of $25.7 m...
Generally Accepted Accounting Principles prior to 2002.<br />Auditing companies often consult for the<br />   companies th...
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Worldcom,Enron.Fraud,Bankruptcy,SOA,GAAP,SEC

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Worldcom,Enron.Fraud,Bankruptcy,SOA,GAAP,SEC

  1. 1. FINA 503<br />DATE: 02/18/10<br />JOSE CINTRON,MBA<br />
  2. 2. Enron & WorldCom will change the world<br />
  3. 3. WORLDCOM: <br /> 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. <br />
  4. 4. HOW THIS HAPPEN<br /> 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. <br />
  5. 5. NET INCOME xxx (Huge Increase)<br />COGS xxx <br />(no change) <br />Revenues xxx (no change)<br /> Computer expenses: xxx <br />(Huge Decrease)<br /> Fees companies phone networks: xxx <br />(Huge Decrease)<br />HowtheFraudtook place<br />CFO’s directions affected the income statement:<br />
  6. 6. Overstating Asset Frauds (WorldCom)<br />Overstatement of current assets(marketable securities)<br />Overstating pension assets<br />Capitalizing as assets amounts that should be expensed<br />Failing to record depreciation/amortization expense<br />Overstating assets through mergers and acquisitions<br />Overstating inventory and receivables <br />
  7. 7. HOW WAS DISCOVER<br /> 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. <br /> 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. <br />
  8. 8.
  9. 9. Largest Bankruptcy Filings <br />
  10. 10. Z-score Analysis for WorldCom<br />The Z-score formula for predicting bankruptcy.<br />Ratio Definition 1999 2000 2001<br />X1 Working capital/total assets (0.08) (0.08) (0.00)<br />X2 Retained earnings/total assets (0.01) 0.03 0.04<br />X3 Earnings before interest and taxes/total assets 0.08 0.08 0.02<br />X4 Market value of equity/book value of total liabilities 3.58 1.13 0.54<br />X5 Sales/total assets 0.39 0.40 0.34<br />Z Z-score 2.6971.274 0.798<br />Z > 2.99 -“Safe” 1.8 < Z < 2.99 -“Grey” Z < 1.80 -“Distress” <br />Z-scores for WorldCom based on its annual 10-K reports .We found that the company indeed experienced a rapid deterioration in its<br /> Z-score.<br />
  11. 11. CONSOLIDATING BALANCE SHEET (10K SEC) (IN MILLIONS) AT DECEMBER 31, 2000 <br /> WORLDCOM MCI GROUP ELIMINATIONS WORLDCOM <br />Current assets...................................... $ 9,068 $ 2,312 $(1,625) $ 9,755 <br />Property and equipment, net......................... 35,177 2,246 -- 37,423 <br />Goodwill and other intangibles...................... 36,685 9,909 -- 46,594 <br />Other assets........................................ 4,963 168 -- 5,131 <br />Total assets...................................... $85,893$14,635$(1,625) $98,903 <br />Current liabilities................................. $14,213 $ 5,085 $(1,625) $17,673 <br />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<br /> Shareholders' investment............................ 52,9462,463 -- 55,409<br />Total liabilities and shareholders' investment.... $85,893 $14,635 $(1,625) $98,903 <br /> ======= ======= ======= =======<br />$ 9,755 / 17,673=(7,918) WORKING CAPITAL OR .55 CURRENT RATIO<br />THE HIGHER THIS RATIO THE BETTER TO MEET THEIR CURRENT OBLIGATIONS.<br />
  12. 12. WorldCom Statement of Cash flow<br />Cash flows from operating activities: 20002001<br />Net income Operating Activities $4,153 $1,501 <br />OriginallyReportedRevised as of April 15, 2004<br />2000 20012002NNet loss $ -48,909 -15,597 -9,173 <br />
  13. 13. I don’t belief this happen to me . <br />HOW ENDED<br />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.<br />
  14. 14. What do these dates have in common?<br />December 2, 2001<br />July 19, 2002<br />August 31, 2002 <br />Enron declares <br />bankruptcy<br />MCI WorldCom declares <br />bankruptcy<br />Arthur Anderson agrees to <br />stop auditing public <br />companies<br />
  15. 15. How did this happen?<br />Corporate Issues Audit Firm Issues <br />Earnings pressure<br />Lack of mandated disclosure of company reporting model<br />Minimal oversight into corporate business practices<br />No documented or enforced internal controls<br />Dependency on consulting fees <br />Assumed good intent of their client<br />Inability to continuously monitor a company’s internal controls<br />Unable to identify violations of internal controls<br />
  16. 16. How Did <br />Congress Respond?<br />Sarbanes – Oxley Act<br />
  17. 17. Sarbanes – Oxley Act<br />Highlights<br />Section 103:Your auditor (and therefore, you should) maintain all audit related records, including electronic ones, for seven years.<br />Section 201:Firms that audit your company’s books can no longer provide you with IT related services.<br />Section 301:You must provide systems or procedures that allow employees to communicate effectively with the audit committee.<br />
  18. 18. Sarbanes – Oxley Act<br />Highlights (continued)<br />Section 302:Your CEO and CFO must sign statements verifying the completeness and accuracy of financial reports.<br />Sections 404CEO’s, CFO’s and outside auditors must attest to the effectiveness and accuracy of financial reports.<br />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.<br />
  19. 19. Sarbanes–Oxley Act<br />Sarbanes–Oxley Law<br />
  20. 20. Sarbanes - Oxley Impact on Information Systems<br />
  21. 21. The 3 Cs of Sarbanes-Oxley<br />CEO’s, CFO’s and CIO’s<br />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.' <br />
  22. 22. System Control Examples<br />Financial Statement Generation<br />Report parameter changes are documented <br />Data that generates financial statements is accurate<br />Inventory Item Creation <br />Costing is accurately assigned<br />Purchasing<br />Approved suppliers are used<br />Approval limits cannot be easily manipulated<br />Customer Creation<br />Duplicate customers<br />Credit limits<br />
  23. 23. Oversight of Financial Data Examples<br />Standard Data Entry is Enforced<br />Accurate reporting<br />Segregation of Duties<br />Separation of functions to minimize risk of fraud<br />Audit changes to sensitive data<br />Approval processes for creation of financial data<br />Oversight into Financial Processes<br />Ensure all month/year end activities are completed<br />
  24. 24. Benefits of the New Oxley Act<br />1. Increased confidence of CEO/CFO in meeting requirements<br />2. Improved coordination of Company Management Team<br />3. Improved and clarified Corporate Governance process<br />4. Systematized process for early identification of business risks/ whistle blowing issues/incident management<br />5. Systematized approach to dealing with change (i.e., transactions, personnel, accounting principles, internal controls and operating procedures) <br />6. Increased operational effectiveness <br />
  25. 25. The Enron Scandal<br />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.<br />On October 16, 2001, in the first major<br /> public sign of trouble, Enron announces a huge third-quarter loss of $618 million.<br />
  26. 26. The Enron Scandal<br />On October 22, 2001, the Securities and<br /> Exchange Commission (SEC) begins an<br /> inquiry into Enron’s accounting practices.<br /> On December 2, 2001, Enron files for bankruptcy, the largest bankruptcy in US history up to that time<br />
  27. 27. Consequences<br />Thousands of employees lost their jobs and even their life savings in 401(k) plans tied to the energy company's stock. <br />Disastrous falling down on the whole stock market during the following months, especially in the financial service industry.<br />Arthur Andersen, which at the time was one of the five largest accounting firms in the world, was dissolved.<br />
  28. 28. How this happen<br />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. <br />Enron's audit committee failed to follow up on high-risk accounting issues <br />Andersen was pressured by the company to ignore accounting practices.<br />
  29. 29. How this happen….Continued<br /> 1993-2001: Enron senior management used.<br /> Complex and foggy accounting schemes<br />to reduce Enron’s tax payments;<br />to inflate Enron’s income and profits;<br />to inflate Enron’s stock price and credit rating;<br />to hide losses in off-balance-sheet subsidiaries;<br />to engineer off-balance-sheet schemes to direct<br /> money to themselves, friends, and family;<br />to fraudulently misrepresent Enron’s financial<br /> condition in public reports.<br />
  30. 30. Example of one scheme<br /> Enron’s 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.<br /> 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.<br />
  31. 31. Example of one scheme…… Continued<br /> 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) <br />In November 1997, Calpers wanted to cash out of JEDI.<br /> To keep JEDI afloat, Enron needed a new 3%<br /> partner.<br /> It created another partnership Chewco to buy<br /> out Calpers’ stake in JEDI.<br />
  32. 32. Profit to Enron from all this?<br />$10 million in guarantee fee + fee based on loan balance to JEDI. A total of $25.7 million revenues from this source.<br /> Increase in price of Enron stock held by<br /> JEDI. Enron recognized $126 million in<br /> the first quarter of 2000 from this.<br />But everything began to fall apart<br /> when Enron’s share price started to<br /> drop in Fall 2000.<br />
  33. 33. Generally Accepted Accounting Principles prior to 2002.<br />Auditing companies often consult for the<br /> companies they audit (conflict of interest).<br />Audit company partners often later accept <br /> jobs from their client companies.<br />Companies often retain the same auditing<br /> company for long periods of time.<br />Auditing companies have been allowed to police themselves.<br />Appointment of auditor company is in theory by shareholders but in practice by senior management<br />

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