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S T U D E N T S O F M A S T E R S I N B U S I N E S S A D M I N I S T R AT I O NI Q R A U N I V E R S I T Y, Q U E T TA C A M P U S

D AT E D D E C E M B E R , 2 0 1 0

SECURITY ANALYSISCorporate Frauds

Corporate Frauds???

which arise with the disclosure of misdeeds by trusted executives of large public corporations.

Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets or underreporting the existence of liabilities.

Sometimes with the cooperation of officials in other corporations or affiliates.

Top Ten Corporate Frauds!

1. Enron (USA) – 2001 – Lose of more than $11 billion to shareholders

2. Worldcom (USA) – Profits inflated by $3.8 Billions

3. Bank of Credit and Commerce International (UK) - £5.6bn deficit (at closure)

4. Subprime Mortgage (USA) – 2008 – Merged with JP Bank with $3 Billions

5. Bernard L. Madoff Investment Securities (USA) - $50 billion

6. American International Group (AIG) (USA) - Inflated its net worth by up to $1.7 billion

7. Barlow Clowes (United Kingdom) – 1990s -  £150m to compensate

8. Fannie Mae and Freddie Mac (USA) – 2006 - fined $400 million

9. Daewoo Group (South Korea) – 2005- $54.20 Billions

10. Satyam Computers (India) – 2009 - Rs. 7,100 crores 

Just Ten… No!

Company Year Company Year Company Year Company Year

Nugan Hand Bank 1980 MicroStrategy 2000El Paso Corporation

2002 Reliant Energy 2002

ZZZZ Best 1986 Unify Corporation 2000 Freddie Mac 2002 Sunbeam 2002

Barlow Clowes 1988Computer Associates

2000 Global Crossing 2002 Tyco International 2002

MiniScribe 1989 Xerox 2000 Halliburton 2002 WorldCom 2002

Polly Peck 1990 One.Tel 2001 Homestore.com 2002 Royal Ahold 2003

Bank of Credit and Commerce International

1991 Enron 2001 ImClone Systems 2002 Parmalat 2003

Northern Rock Adelphia 2002 Kmart 2002 HealthSouth Corporation 2003

Clearstream AOL 2002 Merck & Co. 2002 Chiquita Brands International 2004

Phar-Mor 1992Bristol-Myers Squibb

2002 Merrill Lynch 2002 AIG 2004

Informix 1996 CMS Energy 2002 Mirant 2002Bernard L. Madoff Investment Securities LLC

2008

Cendant 1998 Duke Energy 2002 Nicor 2002 Anglo Irish Bank 2008

Waste Management, Inc. 1999 Dynegy 2002Peregrine Systems

2002

We will Discuss…

Enron (USA)

Worldcom (USA)

Parmalat (Italy)

ENRON

Overview (1985 – 2000s)

Enron Corporation is an energy trading, natural gas, and electric utilities company based in Houston, Texas.

Employed around 21,000 people more than 40 Countries by mid-2001, before it went bankrupt.

Fraudulent accounting techniques allowed it to be listed as the seventh largest company in the US.

ENRON (Contd)

Tactics used by Enron…EARNINGS/(EPS) MANIPULATION

From at least 1998 through late 2001, Enron's executives and senior managers engaged in wide-ranging (Diversification) schemes to deceive the investing public about the true nature and profitability.

By manipulating Enron's publicly reported financial results (FS) and making false and misleading public representations.

ENRON (Contd)

Tactics used by Enron…The scheme's objectives were: -

To produce that reported earnings steadily grew by approximately 15-20% Per Annum.

To meet or exceed, without fail, the expectations of investment analysts about Enron's EPS.

To persuade the investing public that Enron's future profitability would continue to grow.

ENRON (Contd)

EARNING MANIPULATIONHow?

Quarterly earnings targets were imposed on each of the company's business units based on EPS goals and not on true forecasts.

When the budget targets could not be met, through results from business operations, they were achieved through the use of fraudulent devices.

The primary purpose was to increase the share price which increased from $30 per share in 1998 to $80 in 2001 even after a stock split.

ENRON (Contd)

EARNING MANIPULATIONHow?

The rising stock prices enriched Enron's senior managers in the form of: -Salary, Bonuses, Grants of Artificially

Appreciating Stock Options, Restricted Stock, and Phantom stock, and Prestige within their professions and communities.

ENRON (Contd)

EARNING MANIPULATION Other Methods…

Manipulating reserve accounts to maintain the appearance of continual earnings, growth and to mask volatility in earnings by concealing earnings during highly profitable periods and releasing them for use during less profitable periods.

Concealing losses in individual "business segments" through fraudulent manipulation of "segment reporting," and deceptive use of reserved earnings to cover losses in one segment with earnings in another.

Manufacturing earnings through fraudulent inflation of asset values and avoiding losses through the use of fraudulent devices designed to "hedge," or lock-in, inflated asset values.

Structuring of financial transactions using improper accounting techniques in order to achieve earnings objectives.

ENRON (Contd)

CONCEALMENT OF UNCOLLECTIBLE RECEIVABLES How?

Conceal huge receivables (valued in the hundreds of millions of dollars), accumulated during the California energy crisis.

That California public utilities owed to Enron and believed it would not be collected.

The California utilities were refusing to pay these amount, and they likely were headed for bankruptcy.

Enron concluded that it should book a large reserve for these unrecoverable receivables.

ENRON (Contd)

CONCEALMENT OF EES FAILURES BY MANIPULATING REPORTINGHow?

In the first quarter of 2001, new EES managers discovered and quantified hundreds of millions of dollars in inflated valuations of EES contracts that would have to be recorded as losses. This would wipe out EES's modest reported profits and reveal it was a badly mismanaged business that was losing large amounts of money.

EES “Enron Energy Services”

ENRON (Contd)

CONCEALMENT OF EES FAILURES BY MANIPULATING REPORTING

Senior management decided to conceal these EES losses from investors by offsetting them with Enron Wholesale trading profits earned in that quarter.

As well as Profits improperly reserved in prior periods.

This was accomplished through a "reorganization" of Enron's business segments that was made effective for the first quarter of 2001, enabling Enron to avoid reporting the losses in the EES segment.

ENRON (Contd)

Other Tactics used by Enron…FRAUDULENT VALUATION OF

"MERCHANT" ASSETS.MANIPULATIVE DEVICES USED IN

ENRON WHOLESALE.and so on…

ENRON (Contd)

At the end!

Enron filed for Chapter 11 bankruptcy, allowing it to reorganise while protected from creditors.

Enron has sought to salvage its business by spinning off various assets.

Enron's core business, the energy trading arm, has been tied up in a complex deal with UBS Warburg. The bank has not paid for the trading unit, but will share some of the profits with Enron.

Centrica, part of the former British Gas, has bought Enron's European retail arm for £96.4m.

Dynegy, a smaller rival, has won a key pipeline in the US after merger talks fell through. The pipeline was then resold to Warren Buffet.

WorldCom

Overview (1983 – 2000s)

WorldCom was one of the big success stories of the 1990s. It was a symbol of aggressive capitalism.

Founded by Bernie Ebbers, one of the most aggressive acquirer during the US mergers and acquisitions boom of the 1990s.

WorldCom's asset value had soared to $180bn before the US capital market started witnessing a downtrend.

WorldCom

Admitted in March 2002 that it will have to restate its

financial results to account for: -

Billions of dollars in improper bookkeeping after an

internal audit.

Showed transfers of about $3.06 billion for 2001 and

$797 million for the first quarter of 2002.

There transactions were not made in accordance with

generally accepted accounting principles.

WorldCom

In August 2002, An internal audit has revealed an additional

$3.3bn of improperly reported earnings.

Taking the total to more than $7bn, double the level previously

reported.

$3.3bn was money from the company's reserves, which was

misrepresented as operating income.

As a result of the discovery, WorldCom said that its financial

statements for the year 2000 will have to be reissued.

Also said it may now write off $50.6bn in intangible assets.

WorldCom

The company filed for Chapter 11 bankruptcy

protection on 22 July.

Chapter 11 is a process that protects it from its

creditors while it tries to restructure.

It became the largest bankruptcy in US history, listing

$107bn in total assets and $41bn in debts.

In May 2003, WorldCom agreed to pay a record

amount to the US financial watchdog.

WorldCom

MCI (formerly WorldCom), while neither admitting nor denying

any wrongdoing, came to a settlement over its massive

accountancy scandal.

It will pay $500m to the Securities and Exchange Commission,

the highest fine ever imposed by the regulator.

The original figure of $1.5bn was scaled down as MCI declared

itself bankrupt and so received favorable treatment.

The settlement sorts out the civil lawsuits that have been filed.

But the criminal cases relating primarily to the actions of former

employees at the company are still pending.

WorldCom

Summary…Scandal Discovered in March 2002.

Changes Overstated cash flow by booking $3.8 billion in

operating expenses as capital expenses. Gave founder Bernard Ebbers $400 million in off-the-

books loans. The company found another $3.3 billion in improperly

booked funds, taking the total misstatement to $7.2 billion, and it may have to take a goodwill charge of $50 billion.

WorldCom

Finally…

Former CFO Scott Sullivan and ex-controller David

Myers have been arrested and criminally charged.

On 9th March 2005, four foreign banks agreed to pay

$428.4 millions for settling the class action law suit by

investors accusing them of hiding risks at WorldCom

before its collapse.

Parmalat

Overview (1961 – 2000s)

An Italian dairy and food company and Europe's biggest dairy company.

Declared bankrupt in late 2003.

36,000 workers around the world and 5,000 Italian dairy farms dependent on the company.

At the end of 2003, one of the biggest corporate accounting scandals in history came to light as a 8 billion euro.

Parmalat

In 1999, Parmalat set up a subsidiary in the Cayman Islands called “Bonlat”.

The first indication of financial problems came in early 2003.

As the company tried to sell 500 million euro in bonds.

After this CFO Fausto Tonna resigned in March replaced by Alberto Ferraris.

Parmalat

The crisis became public in November as the Parmalat Scandal.

Questions were raised about transactions with mutual fund Epicurum, (Another company linked to Parmalat)

Ferraris resigned less than a week later replaced by Luciano Del Soldato.

In December, Del Soldato resigned, unable to get cash from Epicurum fund, needed to pay debts and make bond payments.

Parmalat

Tanzi himself resigned as chairman and CEO.

Parmalat's bank, Bank of America, then released a document showing 3.95 billion Euros in Bonlat's bank account as a forgery.

Prime Minister Silvio Berlusconi initiated a Fraud investigation and appointed Bondi to administer the company's rescue.

Parmalat

Calisto Tanzi, once a symbol of unlimited success, was detained hours after the firm was declared officially insolvent and eventually charged with financial fraud and money laundering.

Italians were shocked that such a vast and established empire could crumble so quickly.

Tanzi reportedly admitted during questioning in prison, that he diverted funds from Parmalat into Parmatour and elsewhere.

Thanking You For Patience!

REGARDS

Mati ur Rehman

Arshad Hussain

Javed GulabSecurity Analysis (Specialization-IV)Masters in Business Administation,Iqra University,Quetta Campus