Question

Briefly describe the issues that led to the downfall of the following companies:

A. Enron

B. Global Crossing

C. Crazy Eddies

D. Worldcom

Answer 1

Enron Downfall

In the 1980s, Wall Street rejoiced as deregulation (especially surrounding energy) meant markets opened and became freer. This allowed for all kinds of new, innovative trading for those who saw the potential. By the 1990s, the "dot-com bubble" was growing wildly with share values commonly being padded to wow and woo investors.

If a company looked solid on paper, it performed well in the market, which was where Enron got its juice. It was CEO Jeff Skilling who decided to change Enron’s accounting approach from the traditional historical cost accounting method to the mark-to-market (MTM) method, and this changed everything, helping the company to reach its stratospheric heights of over $90 a share in August 2000 (and which would plunge to $0.26 a share by December 2001).

MTM accounting is legitimately used by many companies on a regular basis, but it’s easily misused by those looking for something to hide, like Enron. The method can be manipulated, since MTM is not based on 'actual' cost but on 'fair value,' which is harder to pin down. Some believe MTM was the beginning of the end for Enron as it essentially permitted the organization to log estimated profits as actual profits.” Basically, this method meant Enron could count projected long-term energy contract earnings as current income, thus cooking their books, which was one of the key Enron ethical issues.

Global Crossing downfall

Although the Bermuda-based company is complicated, the story of its failure is simple. Global Crossing sank too much money into an international network for high-speed Internet access. Sales growth failed to keep pace and prices for the company's products sank amid a worldwide economic slump and an industry glut in network capacity.

In the third quarter alone, Global Crossing lost $3.4 billion on revenue of just $793 million. When it filed for bankruptcy, Global Crossing was paying an estimated $600 million in annual interest.

Ironically, if Global Crossing survives it would likely herald the failure of other debt-ridden communications carriers. That's because the capacity glut would persist and maintain pressure on rivals to keep prices low. The result: tepid sales for everyone involved.

The painful if obvious lesson: debt matters. Just because you spend a lot of someone else's money to build it, customers won't necessarily come.

Crazy Eddies downfall

Crazy Eddie crime spree evolved in three phases:

(1) 1969-1979: Skimming and under-reporting income (tax fraud) prior to the big plan to go public.

(2) 1980-1984: Gradually reducing skimming to increase profit growth in preparation for the initial public offering, i.e., committing securities fraud by “going legit”

(3) 1984-1987: As a public company, Crazy Eddie overstated income to help insiders dump stock at inflated prices using a variety of fraudulent tricks:

• The “Panama Pump” Money Laundering Scheme — Cash skimmed from Crazy Eddie before its initial public offering was laundered back into the company after it went public to inflate revenues and reported profits.
• Fraudulent asset valuations — Overstated inventory assets to inflate reported profits.
• Understated Accounts Payable to Inflate Reported Profits (Accounts Payable Cut-off Fraud) — Inventory that was received by Crazy Eddie before the end of the accounting period was invoiced by suppliers and reflected as shipped to the company in the subsequent accounting period.
• Understated Accounts Payable to Inflate Reported Profits (Debit Memo Fraud) — Crazy Eddie claimed fictitious purchase discounts and trade allowances to understate accounts payable and inflate reported profits.
• Inflated Comparable Store Sales — Crazy Eddie reported bulk sales to non-end users (distributors and other retailers) that originated from its main offices as sales to end-user consumers in stores that existed in both the current and period year accounting periods (comparable stores).
• Premature Recognition of Sales to Inflate Revenues, Comparable Store Sales, and Earnings — Crazy Eddie invoiced certain distributors for merchandise and it simultaneously received checks dated before the end of the accounting period. The company shipped the merchandise to the distributors and cashed the checks in the subsequent accounting period.
• Covering up crimes — Subtle changes in accounting policies were used by Crazy Eddie to cover-up certain accounting frauds.

Worldcom downfall

WorldCom made major accounting misstatements that hid the increasingly perilous financial condition of the company. The Report described the accounting shenanigans as follows: " As enormous as the fraud was, it was accomplished in a relatively mundane way: more than $9 billion in false or unsupported accounting entries were made in WorldCom's financial systems in order to achieve desired reported financial results "

The driving factor behind this fraud was the business strategy of WorldCom's CEO, Bernie Ebbers. In the 1990s, Ebbers was clearly focused on achieving impressive growth through acquisitions.

How was he going to pay for this acquisition binge? By using the stock of WorldCom. To accomplish this buying spree, the stock had to continually increase in value.