pravin pandey (m5-25)

8/6/2019 pravin pandey (m5-25)

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ASSIGNMENT OF CORPORATE

GOVERNANCE

SUBMITTED TO: - Prof. P. Lakshmi Prasanna

SUBMITTED BY: - Pravin Kumar Pandey (M5-25)


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ENRON CASE

Facts:-

The Enron-private action was characterized by Judge Harmon, the presiding judge, as probablythe largest and most complex [litigation] of its kind in the history of this country.

This case focuses on the international market environment and political behaviorparticularly,

the dynamic and conflictual co-existence of Corporations and Stateswithin national regulation

of the impacts of Multinational Enterprises (MNEs).

The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron

Corporation, an American energy company based in Houston, Texas, and the dissolution of

Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the

world. In addition to being the largest bankruptcy reorganization in American history at that

time, Enron was attributed as the biggest audit failure.

The Enron failure demonstrated a failure of corporate governance, in which internal control

mechanisms were short-circuited by conflicts of interest that enriched certain managers at the

expense of the shareholders. Although derivatives made appearances in the course of the

governance failures, they played no essential role.

Enrons actions appear to have been undertaken to mislead the market by creating the appearance

of greater creditworthiness and financial stability than was in fact the case. The market in the end

exercised the ultimate sanction over the firm.

Even after Enron failed, the market for swaps and other derivatives worked as expected and

experienced no apparent disruption. There is no evidence that the market failed to function in the

Enron episode. On the contrary, the market did exactly what it is supposed to do, which is to use

reputation as a means of monitoring market participants

There is no evidence that existing regulation is inadequate to solve the problems that did occur.

Had Enron complied with existing market practices, not to mention existing accounting and

disclosure requirements, it could not have built the house of cards that eventually led to its

downfall.


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Shareholders lost nearly $11 billion when Enron's stock price, which hit a high of US$90 per

share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S. Securities

and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy

offered to purchase the company at a fire sale price. The deal fell through, and on December 2,

2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code.

Enron's $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until

WorldCom's bankruptcy the following year.

Lessons from the Enron Scandal

The Enron scandal is the most significant corporate collapse in the United States since the failure

of many savings and loan banks during the 1980s. This scandal demonstrates the need forsignificant reforms in accounting and corporate governance in the United States, as well as for a

close look at the ethical quality of the culture of business generally and of business corporations

in the United States.

There are many causes of the Enron collapse. Among them are the conflict of interest between

the two roles played by Arthur Andersen, as auditor but also as consultant to Enron; the lack of

attention shown by members of the Enron board of directors to the off-books financial entities

with which Enron did business; and the lack of truthfulness by management about the health of

the company and its business operations. In some ways, the culture of Enron was the primary

cause of the collapse. The senior executives believed Enron had to be the best at everything it did

and that they had to protect their reputations and their compensation as the most successful

executives in the U.S. When some of their business and trading ventures began to perform

poorly, they tried to cover up their own failures.

The board of directors was not attentive to the nature of the off-books entities created by Enron,

nor to their own obligations to monitor those entities once they were approved. The board did not

pay attention to the employees because most directors in the United States do not consider this

their responsibility. They consider themselves representatives of the shareholders only, and not

of the employees. However, in this case they did not even represent the shareholders well-and

particularly not the employees who were shareholders.

Enron company started running its business by focusing on oil product. But finally, the company

could not make any money. Then, the company changed into natural gas. But, the company

could not make money. They lost a lot of money for the second time. They started their game by

doing bandwidth. But, they failed the game. They started to lose money, but they do not show it


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to people. In order not to get shame, the CEO tried to broadcast the company. Unluckily, they

could not bring their money back.

As we know from the case above, Enron had lost a lot of money at beginning. But, they tried to

put a lot of ideas into their company not in the right way. Actually, the people at Enron were

very smart. Kenneth Lay, the big boss, a man with big ideas, hired some people to do the

business such as Jeffrey Skilling, Andrew Faslow, and Lu Pai. But, these guys just wanted to get

money into their pockets. They get profits to their personal accounts, not for the company

accounts.

Actually, there are a lot of lessons we can get from this case. First, when we do a business, do

not ever cheat customers. If we do this, they may go and never feel trust on our company and

products. Second, if we have a lot of ideas, just use them in the right way and manner. Good

ideas, of course, will have positive effects and be useful to our companies if they are used in

proper ways. Third, we need to obey all the rules in the company or in the market, otherwise, we

will get problems and troubles in future from many people.

There are many lessons that can be learned from the collapse of Enron. Any organization has an

obligation to all of its stakeholders, not just its shareholders, and those obligations were not met

in this case. Executives at Enron made decisions that were wrong. Some of their decisions may

have involved illegal activities. Many people also are beginning to question the professional

conduct of auditors Arthur Andersen. Did their interest in preserving their income cloud their

judgment? We will leave those discussions for others and focus instead on the key management

failure - curbing dissent.

It starts at the top

It is the leader's job to provide the vision for the group. A good executive must have a dream and

the ability to get the company to support that dream. But it is not enough to merely have the

dream. The leader must also provide the framework by which the people in the organization can

help achieve the dream. This is called company culture.

When your company culture allows people to challenge ideas, suggestions, and plans, you create

an organization of thinking, committed people capable of producing the kind of innovation and

productivity required to succeed today. However, if your company culture does not allowed

dissent, if people who suggest alternatives are castigated for not being "team players", you

produce an environment of fear, stagnation, and antipathy. Not allowing appropriate dissent will

kill your company.

Discuss and debate - up to a point


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Every manager has a boss. It is our responsibility to our bosses to be honest with them, to tell

them what we really think, even if we disagree. Especially if we disagree. You, and every one of

your peers, need to discuss issues openly, frankly, and with the best interests of your area clearly

visible. You need to give the boss as much information and as many options as possible. Don't be

afraid to fight hard for what you believe to be right. Be professional about it, but be candid too.

But the lesson we need to draw in this country is more to do with the aftermath of the entire

affair in the US. Throughout the post-collapse saga, the American legal system has worked

overtime to ensure that not only the facts came out but also that justice was seen to be done. That

the dramatis personae were powerful people Lay was on first name basis with George W

Bush and had access to the finest lawyers made no difference to the public prosecutors or the

investigating agencies.

Contrast that with what often happens in India, if powerful people are involved. After the initial

burst of publicity, the case either dies a quiet death or gets bogged down in the labyrinthine legal

system. If India has to become truly globalised, this state of affairs cannot continue.

CEOs will have to understand that increasingly, investors will not stand for malfeasance of any

kind. Foreign investors, and in time Indian ones too, will demand accountability and ethics. All

the stakeholders companies, executives, shareholders and the government need to

understand the implications of the Enron saga.

Reasons for the sudden collapse of Enron.

Enron's nontransparent financial statements did not clearly depict its operations and finances

with shareholders and analysts. In addition, its complex business model and unethical practices

required that the company use accounting limitations to misrepresent earnings and modify the

balance sheet to portray a favorable depiction of its performance. The Enron scandal grew out of

a steady accumulation of habits and values and actions that began years before and finally

spiraled out of control. In an article by James Bodurtha, Jr., he argues that from 1997 until its

demise, the primary motivations for Enron's accounting and financial transactions seem to have

been to keep reported income and reported cash flow up, asset values inflated, and liabilities off

the books.


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The combination of these issues later led to the bankruptcy of the company, and the majority of

them were perpetuated by the indirect knowledge or direct actions of Lay, Jeffrey Skilling,

Andrew Fastow, and other executives. Lay served as the chairman of the company in its last few

years, and approved of the actions of Skilling and Fastow although he did not always inquire

about the details. Skilling, constantly focused on meeting Wall Street expectations, pushed for

the use of mark-to-market accounting and pressured Enron executives to find new ways to hide

its debt. Fastow and other executives "...created off-balance-sheet vehicles, complex financing

structures, and deals so bewildering that few people can understand them even now

Revenue recognition

Enron and other energy suppliers earned profits by providing services such as wholesale trading

and risk management in addition to building and maintaining electric power plants, natural gas

pipelines, storage, and processing facilities. When taking on the risk of buying and selling

products, merchants are allowed to report the selling price as revenues and the products' costs as

cost of goods sold. In contrast, an "agent" provides a service to the customer, but does not take

on the same risks as merchants for buying and selling. Service providers, when classified as

agents, are able to report trading and brokerage fees as revenue, although not for the full value of

the transaction.

Although trading firms such as Goldman Sachs and Merrill Lynch used the conventional "agent

model" for reporting revenue (where only the trading or brokerage fee would be reported as

revenue), Enron instead elected to report the entire value of each of its trades as revenue. This

"merchant model" approach was considered much more aggressive in the accounting

interpretation than the agent model. Enron's method of reporting inflated trading revenue was

later adopted by other companies in the energy trading industry in an attempt to stay competitive

with the company's large increase in revenue. Other energy companies such as Duke Energy,

Reliant Energy, and Dynegy joined Enron in the top 50 of the Fortune 500 mainly due to their

adoption of the same trading revenue accounting approach as Enron.

Between 1996 to 2000, Enron's revenues increased by more than 750%, rising from $13.3 billion

in 1996 to $100.8 billion in 2000. This extensive expansion of 65% per year was unprecedented

in any industry, including the energy industry which typically considered growth of 23% peryear to be respectable. For just the first nine months of 2001, Enron reported $138.7 billion in

revenues, which placed the company at the sixth position on the Fortune Global 500.

Special purpose entities


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Enron used special purpose entitieslimited partnerships or companies created to fulfill a

temporary or specific purposeto fund or manage risks associated with specific assets. The

company elected to disclose minimal details on its use of special purpose entities. These shell

firms were created by a sponsor, but funded by independent equity investors and debt financing.

For financial reporting purposes, a series of rules dictates whether a special purpose entity is a

separate entity from the sponsor. In total, by 2001, Enron had used hundreds of special purpose

entities to hide its debt.

The special purpose entities were used for more than just circumventing accounting conventions.

As a result of one violation, Enron's balance sheet understated its liabilities and overstated its

equity, and its earnings were overstated. Enron disclosed to its shareholders that it had hedged

downside risk in its own illiquid investments using special purpose entities. However, the

investors were oblivious to the fact that the special purpose entities were actually using the

company's own stock and financial guarantees to finance these hedges. This setup prevented

Enron from being protected from the downside risk.

Mark-to-market accounting

Enron's natural gas business, the accounting had been fairly straightforward: in each time

period, the company listed actual costs of supplying the gas and actual revenues received from

selling it. However, when Skilling joined the company, he demanded that the trading business

adopt mark-to-market accounting, citing that it would reflect "... true economic value." Enron

became the first non-financial company to use the method to account for its complex long-term

contracts. Mark-to-market accounting requires that once a long-term contract was signed, income

was estimated as the present value of net future cash flows. Often, the viability of these contractsand their related costs were difficult to judge. Due to the large discrepancies of attempting to

match profits and cash, investors were typically given false or misleading reports. While using

the method, income from projects could be recorded, which increased financial earnings.

However, in future years, the profits could not be included, so new and additional income had to

be included from more projects to develop additional growth to appease investors. As one Enron

competitor pointed out, "If you accelerate your income, then you have to keep doing more and

more deals to show the same or rising income." Despite potential pitfalls, the U.S. Securities and

Exchange Commission (SEC) approved the accounting method for Enron in its trading of natural

gas futures contracts on January 30, 1992. However, Enron later expanded its use to other areas

in the company to help it meet Wall Street projections.

For one contract, in July 2000, Enron and Blockbuster Video signed a 20-year agreement to

introduce on-demand entertainment to various U.S. cities by year-end. After several pilot

projects, Enron recognized estimated profits of more than $110 million from the deal, even

though analysts questioned the technical viability and market demand of the service. When the


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network failed to work, Blockbuster pulled out of the contract. Enron continued to recognize

future profits, even though the deal resulted in a loss

JEDI and Chewco

In 1993, Enron set up a joint venture in energy investments with CalPERS, the California state

pension fund, called the Joint Energy Development Investments (JEDI). In 1997, Skilling,

serving as Chief Operating Officer (COO), asked CalPERS to join Enron in a separate

investment. CalPERS were interested in the idea, but only if they could be removed as a partner

in JEDI. However, Enron did not want to show any debt from taking over CalPERS' stake in

JEDI on its balance sheet. Chief Financial Officer (CFO) Fastow developed the special purpose

entity Chewco Investments L.P. which raised debt guaranteed by Enron and was used to acquireCalPER's joint venture stake for $383 million. Because of Fastow's organization of Chewco,

JEDI's losses were kept off of Enron's balance sheet.

Whitewing

The White-winged Dove is native to Texas, and was also the name of a special purpose entity

used as financing vehicle by Enron. In December 1997, with funding of $579 million provided

by Enron and $500 million by an outside investor, Whitewing Associates L.P. was formed. Two

years later, the entity's arrangement was changed so that it would no longer be consolidated with

Enron and be counted on the company's balance sheet. Whitewing was used to purchase Enronassets, including stakes in power plants, pipelines, stocks, and other investments. Between 1999

and 2001, Whitewing bought assets from Enron worth $2 billion, using Enron stock as collateral.

Although the transactions were approved by the Enron board, the assets transfers were not true

sales and should have been treated instead as loans

Investors' confidence declines

By the end of August 2001, his company's stock still falling, Lay named Greg Whalley, president

and COO of Enron Wholesale Services and Mark Frevert, to positions in the chairman's office.

Some observers suggested that Enron's investors were in significant need of reassurance, notonly because the company's business was difficult to understand (even "indecipherable") but also

because it was difficult to properly describe the company in financial statements. One analyst

stated "it's really hard for analysts to determine where [Enron] are making money in a given

quarter and where they are losing money. Lay accepted that Enron's business was very complex,

but asserted that analysts would "never get all the information they want" to satisfy their

curiosity. He also explained that the complexity of the business was due largely to tax strategies


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and position-hedging. Lays efforts seemed to meet with limited success; by September 9, one

prominent hedge fund manager noted that [Enron] stock is trading under a cloud. The sudden

departure of Skilling combined with the opacity of Enron's accounting books made proper

assessment difficult for Wall Street. In addition, the company admitted to repeatedly using

"related-party transactions," which some feared could be too-easily used to transfer losses that

might otherwise appear on Enron's own balance sheet. A particularly troubling aspect of this

technique was that several of the "related-party" entities had been or were being controlled by

CFO Fastow.

After the September 11, 2001 attacks, media attention shifted away from the company and its

troubles; a little less than a month later Enron announced its intention to begin the process of

shearing its lower-margin assets in favor of its core businesses of gas and electricity trading. This

move included selling Portland General Electric to another Oregon utility, Northwest Natural

Gas, for about $1.9 billion in cash and stock, and possibly selling its 65% stake in the Dabhol

project in India

Was Eron having Proper Corporate Governance in place? If not

what precisely lacking?

The role of a companys board of directors is to oversee corporate management to protect the

interests of shareholders. However, in Enrons board waived conflict of interest rules to allow

chief financial officer Andrew Fastow to create private partnerships to do business with the firm.

Transactions involving these partnerships concealed debts and losses that would have had a

significant impact on Enrons reported profits. Enrons collapse raises the issue of how to

reinforce directors capability and will to challenge questionable dealings by corporate managers.

Specific questions involve independent, or outside directors. (Stock exchange rules require that

a certain percentage of board members be unaffiliated with the firm and its management.) Should

the way outside directors are selected be changed or regulated? Directors are elected by

shareholders, but except in very unusual circumstances these are Soviet-style elections, where

managements slate of candidates receives nearly unanimous approval. Should there be

restrictions on indirect compensation in the form of, say, consulting contracts or donations tocharities where independent board members serve? Should the personal liability of directors in

cases of corporate fraud be increased? Do the rules requiring members of the boards audit

committee to be financially literate ensure that the board will grasp the innovative and

complex financial and accounting strategies employed by companies like Enron.


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Healy and Palepu write that a well-functioning capital market "creates appropriate linkages of

information, incentives, and governance between managers and investors. This process is

supposed to be carried out through a network of intermediaries that include assurance

professionals such as external auditors; and internal governance agents such as corporate boards.

On paper, Enron had a model board of directors comprising predominantly outsiders with

significant ownership stakes and a talented audit committee. In its 2000 review of best corporate

boards, Chief Executive included Enron among its top five boards. Even with its complex

corporate governance and network of intermediaries, Enron was still able to "attract large sums

of capital to fund a questionable business model, conceal its true performance through a series of

accounting and financing maneuvers, and hype its stock to unsustainable levels

Executive compensation

Although Enron's compensation and performance management system was designed to retain

and reward its most valuable employees, the setup of the system contributed to a dysfunctional

corporate culture that became obsessed with a focus only on short-term earnings to maximize

bonuses. Employees constantly looked to start high-volume deals, often disregarding the quality

of cash flow or profits, in order to get a higher rating for their performance review. In addition,

accounting results were recorded as soon as possible to keep up with the company's stock price.

This practice helped ensure deal-makers and executives received large cash bonuses and stock

options.

The company was constantly focusing on its stock price. Management was extensively

compensated using stock options, similar to other U.S. companies. This setup of stock option

awards caused management to create expectations of rapid growth in efforts to give the

appearance of reported earnings to meet Wall Street's expectations. The stock ticker was located

in lobbies, elevators, and on company computers. At budget meetings, Skilling would develop

target earnings by asking "What earnings do you need to keep our stock price up?" and that

number would be used, even if it was not feasible. At December 31, 2000, Enron had 96 million

shares outstanding under stock option plans (approximately 13% of common shares outstanding).

Enron's proxy statement stated that, within three years, these awards were expected to be

exercised. Using Enron's January 2001 stock price of $83.13 and the directors beneficial

ownership reported in the 2001 proxy, the value of director stock ownership was $659 million

for Lay, and $174 million for Skilling.

Skilling believed that if employees were constantly cost-centered, it would hinder original

thinking. As a result, extravagant spending was rampant throughout the company, especially

among the executives. Employees had large expense accounts and many executives were paid

sometimes twice as much as competitors. In 1998, the top 200 highest-paid employees earned


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$193 million from salaries, bonuses, and stock. Two years later, the figure jumped to $1.4

billion.

Risk management

Before its fall, Enron was lauded for its sophisticated financial risk management tools. Riskmanagement was crucial to Enron not only because of its regulatory environment, but also

because of its business plan. Enron established long-term fixed commitments which needed to be

hedged to prepare for the inevitable fluctuation of future energy prices. Enron's bankruptcy

downfall was attributed to its reckless use of derivatives and special purpose entities. By hedging

its risks with special purpose entities which it owned, Enron retained the risks associated with the

transactions. This setup had Enron implementing hedges with itself.

Enron's aggressive accounting practices were not hidden from the board of directors, as later

learned by a Senate subcommittee. The board was informed on the rationale for using the

Whitewing, LJM, and Raptor transactions, and after approving them, received status updates on

the entities' operations. Although not all of Enron's widespread improper accounting practices

were revealed to the board, the practices were dependent on board decisions. Even though Enron

extensively relied on derivatives for its business, the company's Finance Committee and board

did not have comprehensive backgrounds in derivatives to grasp what they were being told. The

Senate subcommittee argued that had there been a detailed understanding of how the derivatives

were organized, the board would have prevented their use.

Financial audit

Enron's auditor firm, Arthur Andersen, was accused of applying reckless standards in their audits

because of a conflict of interest over the significant consulting fees generated by Enron. In 2000,

Arthur Andersen earned $25 million in audit fees and $27 million in consulting fees (this amount

accounted for roughly 27% of the audit fees of public clients for Arthur Andersen's Houston

office). The auditors' methods were questioned as either being completed solely to receive its

annual fees or for their lack of expertise in properly reviewing Enron's revenue recognition,

special entities, derivatives, and other accounting practices.

Enron hired numerous Certified Public Accountants (CPA) as well as accountants who had

worked on developing accounting rules with the Financial Accounting Standards Board (FASB).The accountants looked for new ways to save the company money, including capitalizing on

loopholes found in Generally Accepted Accounting Principles (GAAP), the accounting industry's

standards. One Enron accountant revealed we tried to aggressively use the literature [GAAP] to

our advantage. All the rules create all these opportunities. We got to where we did because we

exploited that weakness.


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Andersen's auditors were pressured by Enron's management to defer recognizing the charges

from the special purpose entities as their credit risks became clear. Since the entities would never

return a profit, accounting guidelines required that Enron should take a write-off, where the value

of the entity was removed from the balance sheet at a loss. To pressure Andersen into meeting

Enron's earnings expectations, Enron would occasionally allow accounting firms Ernst & Young

or PricewaterhouseCoopers to complete accounting tasks to create the illusion of hiring a new

firm to replace Andersen. Although Andersen was equipped with internal controls to protect

against conflicted incentives of local partners, they failed to prevent conflict of interest. In one

case, Andersen's Houston office, which performed the Enron audit, was able to overrule any

critical reviews of Enron's accounting decisions by Andersen's Chicago partner. In addition,

when news of SEC investigations of Enron were made public, Andersen attempted to cover up

any negligence in its audit by shredding several tons of supporting documents and deleting

nearly 30,000 e-mails and computer files.

Revelations concerning Andersen's overall performance led to the break-up of the firm, and tothe following assessment by the Powers Committee (appointed by Enron's board to look into the

firm's accounting in October 2001): "The evidence available to us suggests that Andersen did not

fulfill its professional responsibilities in connection with its audits of Enron's financial

statements, or its obligation to bring to the attention of Enron's Board (or the Audit and

Compliance Committee) concerns about Enron's internal contracts over the related-party

transactions

Other accounting issues

Enron made a habit of booking costs of cancelled projects as assets, with the rationale that noofficial letter had stated that the project was cancelled. This method was known as "the

snowball", and although it was initially dictated that snowballs stay under $90 million, it was

later extended to $200 million.

In 1998, when analysts were given a tour of the Enron Energy Services office, they were

impressed with how the employees were working so vigorously. In reality, Skilling had moved

other employees to the office from other departments (instructing them to pretend to work hard)

to create the appearance that the division was bigger than it was. This ruse was used several

times to fool analysts about the progress of different areas of Enron to help improve the stock

price.


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WORLD COM CASE

Facts of the case.

In 1998, the telecommunications industry began to slow down and WorldCom's stock was

declining. CEO Bernard Ebbers came under increasing pressure from banks to cover margin calls

on his WorldCom stock that was used to finance his other businesses endeavors (timber,

yachting, etc.). The company's profitability took another hit when it was forced to abandon its

proposed merger with Sprint in late 2000. During 2001, Ebbers persuaded WorldCom's board of

directors to provide him corporate loans and guarantees totaling more than $400 million. Ebberswanted to cover the margin calls, but this strategy ultimately failed and Ebbers was ousted as

CEO in April 2002.

Beginning in 1999 and continuing through May 2002, WorldCom (under the direction of Scott

Sullivan (CFO), David Myers (Controller) and Buford Yates (Director of General Accounting))

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.

The fraud was accomplished in two main ways. First, WorldCom's accounting department

underreported 'line costs' (interconnection 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'.

The first discovery of possible illegal activity was by WorldCom's own internal audit department

who uncovered approximately $3.8 billion of the fraud in June 2002. The company's audit

committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired,

Myers resigned, and 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 (WorldCom, 2005).

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 with about

$5.7 billion in debt. At last count, WorldCom has yet to pay its creditors, many of whom have

waited years for the money owed.


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On March 15, 2005 Bernard Ebbers 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.

Other former WorldCom officials charged with criminal penalties in relation to the company's

financial misstatements include former CFO Scott Sullivan (entered a guilty plea on March 2,

2004 to one count each of securities fraud, conspiracy to commit securities fraud, and filing false

statements), former controller David Myers (pleaded guilty to securities fraud, conspiracy to

commit securities fraud, and filing false statements on September 27, 2002), former accounting

director Buford Yates (pleaded guilty to conspiracy and fraud charges on October 7, 2002), and

former accounting managers Betty Vinson and Troy Normand (both pleading guilty to

conspiracy and securities fraud on October 10, 2002) (MCI, 2006). Ebbers reported to prison on

September 26, 2006 to begin serving his sentence.

The Mistake:Committing fraudulent accounting practices, which led to a $9 billion misrepresentation of profits since

1999.

The Cause:Corporate culture that was fixated on the "numbers," corporate greed, and high debt.

What are the advantages and disadvantages of aggressive merger policyof WorldCom?

The advantages of the aggressive merger policy were:

Provided mission-critical communications services for tens of thousands ofBusinesses around the world

Carried more international voice traffic than any other company Carried a

significant amount of the world's Internet traffic

Owned and operated a global IP (Internet Protocol) backbone that providedConnectivity in more than 2,600 cities and in more than 100 countries

Owned and operated 75 data centers on five continents. Data centers provide

hosting and allocation services to businesses for their mission-critical business

computer applications.

All this would be just another story of a successful growth strategy if it weren't for one

significant business reality-mergers and acquisitions, especially large ones, present significant

managerial challenges in at least two areas. First, management must deal with the challenge of

integrating new and old organizations into a single smoothly functioning business.


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The disadvantages of the strategy were:

For all its talent in buying competitors, the company was not up to the task of merging them.Dozens of conflicting computer systems remained, local systems were repetitive and failed towork together properly, and billing systems were not coordinated.

Poor integration of acquired companies also resulted in numerous organizational problems.

Among them were:

Senior management made little effort to develop a cooperative mindset among the various

units of WorldCom.

Inter-unit struggles were allowed to undermine the development of a unified service delivery

network.

WorldCom closed three important MCI technical service centers that contributed to network

maintenance only to open twelve different centers that, in the words of one engineer, were

duplicate and inefficient.

Competitive local exchange carriers (Clerics) were another managerial nightmare. WorldCom purchased a large number of these to provide local service. According to one executive, "the

WorldCom model was a vast wasteland of Clerics, and all capacity was expensive and much

underutilized. There was far too much redundancy, and we paid far too much to get it.

In July 2002, WorldCom filed for bankruptcy protection after several disclosures regarding

accounting irregularities. Among them was the admission of improperly accounting for operating

expenses as capital expenses in violation of generally accepted accounting practices (GAAP).

WorldCom has admitted to a $9 billion adjustment for the period from 1999 through the firstquarter of 2002.

What motivations would explain the fraudulent account of world com?The fraud was accomplished primarily in two ways:

1. Underreporting line costs (interconnection expenses with other telecommunicationcompanies) by capitalizing these costs on the balance sheet rather than properly

expensing them.2. Inflating revenues with bogus accounting entries from "corporate unallocated revenueaccounts".

In 2002, a small team of internal auditors at WorldCom worked together, often at night and in

secret, to investigate and unearth $3.8 billion in fraud. Shortly thereafter, the companys audit

committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired,


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Myers resigned, Arthur Andersen withdrew its audit opinion for 2001, and the U.S. Securities

and Exchange Commission (SEC) launched an investigation into these matters on June 26, 2002.

Salomon v Salomon & Co Ltd (1897)

Principle of the case: Separate Legal Entity Concept

A organization is a separate legal entity from its owners.

Facts

The company is independent and separate from any other entities who are related to

it(company).

Mr. salmon had his own business of boot manufacturing . its not the main issue here . since his

children wanted to be part of his business as owners ,Mr. salmon sold sold his business to new

company for a certain amt. of money (40000pound).

-He was selling his business to the new company as he knew that the company is seprate legal

entity. He needed 7 members to form that company. So, he had 5 children.7 members found-: 5

children, wife and salmon him self .

So , he gave himself 20000 shares (1 pound each). 1 share to each child and 1 share for wife.

-He elected his 2 children together himself with him to be the Director of the company.

So, the company gives him debentures of 10000 pounds and rest 10000 pounds were paid in

cash. Now he is a share holder of company and debenture holder and also Director.

He was ordinary shareholder who would be paid after all the creditors are paid if there is

liquidation of company. but he was debenture holder too.


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After 1 year ,the company went in to liquidation (because the liabilities were more than asset by

certain amount) and the creditors needed to paid.

The liquidator asked Mr. salmon to pay all creditors since Mr. salmon was owner of the

company.

Salmon did not agree with that . because he was supported to paid for his debentures. But the

liquidator asked him to pay to other creditors . but he rejected it.

So, the shareholder appealed to court of appeal so,that he did not have to pay the debts owed to

creditors by the company court of appeal said that salmon just found 6 people to form a company

.those 6 people also asked Mr. salmon to pay.

Judgement

The House of Lords held that the company was a different legal person from the shareholders,

and thus Mr Salomon, as a shareholder and creditor, was totally separate in law from the

company Salomon & Co Ltd. The result was that Mr Salomon was entitled to be repaid the debt

as the first secured creditor.

Ashbury Railway Carriage and Iron Co Ltd V Riche

Principle:

Any transaction which is outside the scope of the powers specified in the objects clause of the

Memorandum of Association and is not reasonable incidentally or necessary to the attainment of

the objects is ultra vires or beyond the powers of the company and therefore null and void.

Facts:

The construction of a railway, as distinct from rolling stock, was ultra vires. Therefore Riche's

action for breach of the alleged contract failed as it was void.

"To make and sell, or lend on hire, railway carriages and wagons, and all kinds of railway plant,

fittings, machinery and rolling stock; to carry on the business of mechanical engineers and


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general contractors; to purchase, lease, work and sell mines, minerals, land and buildings; to

purchase and sell as merchants, timber, coal, metals, or other materials, and to buy any such

materials on commission or as agents."

The law has since changed through Section 108 of the Companies Act 1989, substituting a new

section 35 of the Companies Act 1985.

The directors purchased a concession for making a railway in Belgium and contracted with

Riche to construct the line.

This would have been the case even if every shareholder of the company had given approval - it

was an act which the company had no lawful power to do.

Thus by applying the modern law to the Ashbury case, the directors committed a breach of duty

by making the contract and might have been restrained by action by a member; but once the

contract was made its validity could not be questioned provided that the making of the contract

was "an act done by the company."

Under that new section it remains the duty of the directors to observe any limitations on their

powers flowing from the company's memorandum (section 35(3)) and a member of a company

may bring proceedings to restrain the doing of an act in excess of those powers (section 35(2));

but, by section 35(1): "The validity of an act done by a company shall not be called into question

on the ground of lack of capacity by reason of anything in the company's memorandum."

Judgement:

"In favour of a person dealing with a company in good faith, the power of the board of directors

to bind the company, or authorize others to do so, shall be deemed to be free of any limitation

under the company's constitution."

pravin pandey (m5-25)

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