CSR after the financial scandals

Transcription

1 CSR after the financial scandals Dr Udo C Braendle 1 Financial Scandals Make corporate governance / CSR so prominent today (Becht et al. 2002) Sign of weak corporate governance Accounting fraud Excessive executive compensation Number and size of financial statement frauds are increasing Many investors have lost confidence in credibility of financial statements and (CSR) reports Enron (2001) WorldCom (2002) European contribution Parmalat (2003) 2

2 Largest Bankruptcy Filings (1980 to 2002) from BankruptcyData.com Company 1. WorldCom 2. Enron 3. Conseco 4. Texaco 5. Financial Corp of America 6. Global Crossing 7. PG&E 8. UAL 9. Adelphia 10. MCorp Assets (Billions) $103.9 $63.4 $61.4 $35.9 $33.9 $30.2 $29.8 $25.2 $21.5 $20.2 When Filed July 2002 Dec Dec April 1987 Sept Jan April 2001 Dec June 2002 March Enron What we are looking at here is an example of superbly complex financial reports. They didn t have to lie. All they had to do was to obfuscate it with sheer complexity - although they probably lied too. Senator John Dingell 4

3 Enron s History I In 1985 after federal deregulation of natural gas pipelines, Enron was born from the merger of Houston Natural Gas and InterNorth, a Nebraska pipeline company Enron incurred massive debt and no longer had exclusive rights to its pipelines Needed new and innovative business strategy Kenneth Lay, CEO Assigned Jeffrey Skilling Background in banking and asset and liability management. His recommendation: that Enron create a Gas Bank to buy and sell gas 5 Enron s History II Enron Finance Corporation (1990) Skilling was hired to run it Enron soon had more contracts than any of its competitors Skilling hired the best and brightest traders and rewarded them handsomely Fastow was hired by Skilling CFO in 1998 Started Enron Online Trading in late 90s Created Performance Review Committee (PRC) employee ranking system 6

4 The Motivation Enron delivered smoothly growing earnings (but not cash flows) Wall Street took Enron on its word but didn t understand its financial statements It was all about the price of the stock Enron was a trading company In its last 5 years, Enron reported 20 straight quarters of increasing income Enron changed the business from hard assets to wholesale energy operations and services 7 Enron s Corporate Strategy Enron s core business was losing money shifted its focus from bricks-and-mortar energy business to trading of derivatives During 2000, Enron s derivatives-related assets increased from $2.2 billion to $12 billion and derivates-related liabilities increased from $1.8 billion to $10.5 billion Enron s top management gave its managers a blank order to just do it Deals in unrelated areas such as weather derivatives, water services, metals trading, broadband supply and power plant were all justified 8

5 The Events Jeff Skilling left on August 14 - gave no reason for his departure. By mid-august, the stock price began to fall Former CEO, Kenneth Lay, returned in August Oct 16: announced $618 million loss but not that it had written down equity by $1.2 billion Oct: Moodys downgraded Enron s debt Nov. 8: Told investors they were restating earnings for the past 4 and ¾ years Dec. 2: Filed bankruptcy according to chapter 11 9 Enron s SPEs To hide bad investments and poor-performing assets Declines in value of assets would not be recognized by Enron (Mark to Market) Quick execution of related-party transactions at desired prices (LJM1 and LJM2) To report over $1 billion of false income To hide debt (Borrowed money was not put on financial statements of Enron) To manipulate cash flows, especially in 4 th quarters Many SPE transactions were timed (or illegally back-dated) just near end of quarters so that income could be booked just in time and in amounts needed, to meet investor expectations 10

6 Special Purpose Entities Enron 100% HPL Kingfisher L.L.C. HPL Asset Holdings L.P. 0.01% GP ).1% LP 0.01% GP Egret L.L.C. Petegrime L.L.C. LP 99.89% LP Blue Heron L.L.C. 50% Whitewing Mangaement L.L.C. 50% GP interest 100% vote 0.01% of capital gains/ ENE Demand Note losses>$790m Preferred L.P. LP 99.99% LP interest 100% member Whitewing Associates L.P. 0.01% GP 99.99% LP SE Acquisition LP Natwest Bank Facility $125m LJM2 loan 38.5 m ENE Deman Note Osprey Trust Non-Enron Entity Condor Share Trust ENE PS $195 m Overfund $54m ENE Note $85m ENE Note $50 Share Settlement Agreement Third LP Raptor LP Pelican Bidder LP Heartland Yosemite 1 Sarlux m Trakya Shares Certificates (via Enron $104.7m $15 m ENE 35.6 m Dutch (via ET Power Demand Not Holdings BV) 3 LLC) Nowa Sarzyna $21.2m (Debt & Equity via Blackbird Sarl) Merlin Acquisition LP Promigas $137.2m (via ECT Col PL2) Raven LP BNACLO Notes $23.5m Consolidated Entities Unconsolidated Entities 11 Didn t Anyone See Enron s Problems? Enron grew to be the 7 th largest Fortune 100 company while media hype and the stock market euphoria reigned But in late 2000 negative reports began to originate from some skeptics Board of directors? => Enron s ride of broken dreams 12

7 Andersen Consulting Was paid $52 million in 2000, the majority for nonaudit related consulting services. Failed to spot many of Enron s losses Kept a whole floor of auditors assigned at Enron year around Enron was Andersen s second largest client Provided both external and internal audits CFOs and controllers were former Andersen executives Accused of document destruction - was criminally indicted Went out of business 13 The WorldCom Fraud Owned a third of the US data cables U.S. 2 nd largest long-distance operator Over 20 million customers During the 1990 s, WorldCom was deeply involved in acquisitions Completed several mega-deals in the hottest industry 14

8 Background Awoke the sleeping giant WorldCom led the telecom industry into profitability in the 90 s Telecom industry faced low margins Ebbers decided growth=survival Purchased over 60 firms in 2 nd half of the 90 s WorldCom moved into Internet and data traffic Handled 50% of US Internet traffic Handled 50% of s worldwide Purchased MCI for $37 billion in 1997 Disallowed to purchase Sprint in 2000 because of antitrust regulation 1999 revenue growth halted - stock dropped 15 Bernie Ebbers (WorldCom s former CEO) Resigned from WorldCom in April, 2002 Borrowed $400 million to cover losses on company shares Not repaid Secured loans from WorldCom to fund personal investments Bernie Ebbers classic resignation statement: "I am confident that WorldCom will continue to lead the industry, setting the standards others will follow. 16

9 Scott Sullivan, CFO Served as CFO, treasurer and secretary Directed staff to make false accounting entries Personally made false and misleading public statements regarding finances Netted $45 million from stock sales 17 How the fraud was discovered 2002 March 7 th, the SEC requests information from WorldCom How could WorldCom make so much profit whilst AT&T is losing money? The Internal Audit started digging Found $2 billion company announced for capital expenditures Found the undocumented $500 million in computer expenses that were recorded as assets. Searching WorldCom s computers, $2 billion in questionable entries were found 18

10 How the fraud was discovered 2002 June 20: the Internal audit explains irregularities to the audit committee June 25: WorldCom announces it inflated profits by $3.8 billion over the previous five quarters WorldCom filed for bankruptcy on July 21 st 19 Post-Fraud Happenings 17,000 jobs cut to save $1 billion WorldCom may write off $50.6 billion in intangible assets Added additional board members to serve on a special investigative panel to review accounting practices Former US Attorney General Nicholas Katzenbach Dennis Beresford, Former Chairman of the FASB WorldCom is trying to secure loans John Sidgmore (CEO replacing Ebbers) stated he wants to move forward: We want the bad guys exposed. We want the bad guys punished. And we want to move on with our lives at WorldCom. WorldCom was renamed MCI in 2004 when it emerged from bankruptcy In the meantime taken over 20

11 Post-Fraud Happenings Bernie Ebbers September 2003 pleaded not guilty to 15 felony counts of violating Oklahoma securities laws Jan 19, Federal jury trial on charges of fraud to began March 15, 2005: Found guilty of fraud, conspiracy and filing false document WorldCom s cowboy bites the dust (Economist March 17 th ) Faced up to 85 years in prison Verdict: 25 years 21 Parmalat Fraud Italy's biggest food company Italy s eighth largest industrial company One of the world s largest independent milk and dairy producer At age 22, Calisto Tanzi inherited the family business in 1961 By 2002, Parmalat had more than $8 billion a year in sales with 36,000 employees in 30 countries 22

12 Parmalat Fraud 2003 Dec. 24: Parmalat files for bankruptcy protection Dec. 27: An Italian court declares Parmalat insolvent. Calisto Tanzi is arrested Dec. 31: Italian prosecutors arrest seven people related to the investigation Jan. 26, 2004: A second opinion audit by PWC reported that Parmalat had net debt of $18 billion on Sept 30, including nearly $16 billion that it hadn t disclosed before Finance Minister, Giulio Tremonti, said the Parmalat affair could cost the state about 11bn 23 Some puzzling facts The Parmalat affair, investigators say, was astonishing in its simplicity and amateurishness. Dec. 19: Parmalat revealed that Bank of America Corp. wasn't holding about 3.95 billion of its funds, as the Italian company had reported in September Between 1990 and 2003, Parmalat raised a total of about $8 billion in debt globally. (Business Week, Jan. 26, 2004) Parmalat was audited by Grant Thornton and Deloitte & Touche As of November 2000, S&P gave Parmalat a corporate credit rating of triple-b-minus Re-listed in