Companies Declaring Bankruptcy

Solution Preview

Please see response attached (also below).

RESPONSE;

Two titanic Chapter 11 shipwrecks - WorldCom and Kmart - have had quite disparate results for investors. How did the shareholders fare in these two Chapter 11 bankruptcies?

Company 1: WORLDCOM

1. Why did the firm declare or is declaring bankruptcy? -- Is the firm declaring under Chapter 7 or Chapter 11 of the Federal Bankruptcy Reform Act?

WorldCom declared Chapter 11 bankruptcy and balance-sheet insolvent because of WorldCom's $11 billion accounting shenanigans. The fraud was accomplished primarily in two ways:

1. Underreporting 'line costs' (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them.

2. Inflating revenues with bogus accounting entries from 'corporate unallocated revenue accounts'.
Specifically, WorldCom's internal audit department uncovered approximately $3.8 billion of the fraud in June 2002 during a routine examination of capital expenditures and alerted the company's new auditors, KPMG (who had replaced Arthur Andersen, WorldCom's external auditors during the fraud). Shortly thereafter, the company's audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, 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 (see accounting scandals). By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion.

Bernard Ebbers became very wealthy from the rising price of his holdings in WorldCom's stock. However, shortly after the MCI acquisition in 1998, the telecommunications industry entered a downturn and WorldCom's growth strategy suffered a serious blow when it was forced to abandon its proposed merger with Sprint in late 2000. By that time, WorldCom's stock was declining and Ebbers came under increasing pressure from banks to cover margin calls on his WorldCom stock that was used to finance his other businesses (timber and yachting, among others). During 2001, Ebbers persuaded WorldCom's board of directors to provide him corporate loans and guarantees in excess of $400 million to cover his margin calls, but this strategy ultimately failed and Ebbers was ousted as CEO in April 2002 and replaced by John Sidgmore, former executive of UUNet Technologies, Inc.

On March 15, 2005 Bernard Ebbers was found guilty of all charges and convicted on fraud, conspiracy and filing false documents with regulators ? all related to the $11 billion accounting scandal at the telecommunications company he founded. 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 [3]), former controller David Myers (pleaded guilty to securities fraud, conspiracy to commit securities fraud, and filing false statements on September 27, 2002 [4]), former accounting director Buford Yates (pleaded guilty to conspiracy and fraud charges on October 7, 2002 [5]), and former accounting managers Betty Vinson and Troy Normand (both pleading guilty to conspiracy and securities fraud on October 10, 2002 [6]). On July 13, 2005 Bernard Ebbers received a sentence that would keep him in prison (potentially Yazoo City in Mississippi) for 25 ...