"Some of my management decisions turned wrong, but fraud? Never, never, never,"[1] stated the former CEO of Vivendi Universal, Jean-Marie Messier, as he took the stand in November 20th of 2009 for a civil class-action lawsuit brought against himself, Vivendi Universal, and the former CFO, Guillaume Hannezo, accusing the company of hiding Vivendi's true financial condition before a $46 billion three-way merger with Seagram Co and Canal Plus. The case was brought against Vivendi, Messier, and Hannezo after it was discovered that the firm was in a liquidity crisis and would have problems repaying its outstanding debt and operating expenses (contrary to the press releases by Messier, Hannezo, and other senior executives that the firm had “excellent” and “strong” liquidity), that it participated in earnings management to achieve earnings goals, and failure to disclose debt obligations regarding two of the company’s subsidiaries[1]. The stock price of the firm dropped 89 percent from €84.70 on Oct. 31, 2000, to €9.30 on Aug. 16, 2002, over the period of fraudulent reporting and press releases to the media[1].

Vivendi is a French water and waste-management into an international media giant rivaling Time Warner Inc. and spending $77 billion on acquisitions that included the world’s largest music company, Universal Music Group. Messier took the firm to new heights, which of course was going to come along with a large amount of debt through all these mergers and acquisitions, but maybe he and the senior executive staff were committing fraud and being deceitful in order to buy time for these new acquisitions to return profit and cash flow.

The Vivendi Universal case raises a few ethical issues. For example, was it wrong for Vivendi to make improper adjustments to its EBITDA (earnings before interest, taxes, depreciation and amortization) to meet ambitious earnings targets in 2001? Then, was Messier correct in stating that he made some decisions that just turned out poorly and was not participating in an extensive fraud scandal?

Vivendi dates back to around 1853, being known primarily for providing environmental management services. In December 2000, however, Vivendi acquired Seagram and Canal+, and during 2001 and 2002 acquired all or a portion of the outstanding shares or assets of various other media and telecommunications companies, such as Houghton Mifflin Company, MP3.com, USA Networks, Inc., and Maroc Telecom[1]. At the time, it was one of Europe’s largest companies in terms of assets and revenues, with holdings in the United States that included Universal Studios Group, Universal Music Group, and USA Networks Inc. These acquisitions cost Vivendi cash, stock, and assumed debt of over $60 billion and increased the debt associated with Vivendi's "Media & Communications" division from approximately €3 billion at the beginning of 2000 to over €21 billion in 2002.

In July of 2002, Messier and Hannezo resigned from their positions as CEO and CFO, respectively, and new management disclosed that the company was experiencing a liquidity crisis which was a very different picture than the previous management had painted about the financial condition of Vivendi Universal. This was due to senior executives using four different methods to conceal Vivendi Universal’s financial problems: issue false press releases stating that the liquidity of the company was “strong” and “excellent” after the release of the 2001 financial statements to the public, using aggressive accounting principles and adjustments to increase EBITDA and meet ambitious earnings targets, failing to disclose the existence of various commitments and contingencies, and failing to disclose part of its investment in a transaction to acquire shares of Telco, a Polish telecommunications holding company.

On March 5 ^th , 2002, Vivendi issued earnings releases for 2001, which were approved by Messier, Hannezo, and other senior executives, that their Media & Communications business had produced €5.03 billion in EBITDA and just over €2 billion in Operating Free Cash Flow. These earnings were materially misleading and falsely represented Vivendi’s financial situation because due to legal restrictions, Vivendi was unable unilaterally to access the earnings and cash flow of two of its most profitable subsidiaries, Cegetel and Maroc Telecom, which accounted for 30% of Vivendi's EBITDA and almost half of its cash flow. This attributed to Vivendi’s cash flow actually being “zero or negative”, making it difficult for Vivendi to meet its debt and cash obligations[1]. Furthermore, Vivendi declared a €1 per share dividend because of its excellent operations for the pass year, but Vivendi borrowed against credit facilities to pay the dividend, which cost more than €1.3 billion after French corporate taxes on dividends. Throughout the following months until Messier and Hannezo’s resignations, senior executives continued to lie to the public about the strength of Vivendi as a company

In December 2000, Vivendi and Messier predicted a 35% EBITDA growth for 2001 and 2002 and in order to reach that target, Vivendi used earnings management and aggressive accounting practices to overstate its EBITDA. In June 2001, Vivendi made improper adjustments to increase EBITDA by almost €59 million, or 5% of the total EBITDA of €1.12 billion that Vivendi reported. Senior executives did this mainly by restructuring Cegetel’s, a Vivendi subsidiary whose financial statements were consolidated with Vivendi’s, allowance for bad debts. Cegetel took a lower provision for bad debts in the period and caused the bad debts expense to be €45 million less than it would have been under historical methodology, which in turn increased earnings by the same amount. Furthermore, after the third quarter of 2001, Vivendi adjusted earnings of UMG, its music, by at least €10.125 million or approximately 4% of UMG's total EBITDA of €250 million for that quarter. They did this by prematurely recognizing revenue of €3 million and temporarily reducing the corporate overhead charges by €7 million.

Vivendi failed to disclose in their financial statements commitments regarding Cegetel and Maroc Telecom that would have shown Vivendi’s potential inability to meet its cash needs and obligations. They were also worried that if they disclosed this information, companies that publish independent credit opinions would have declined to maintain their credit rating of Vivendi. In August of 2001, Vivendi entered into an undisclosed current account with Cegetel, one of its subsidiaries, for €520 million and continued to grow to over €1 billion at certain periods of time. Vivendi maintained cash pooling agreements with most of its subsidiaries, but the current account with Cegetel operated much like a loan, with a due date of the balance at December 31, 2001 (which was later pushed back to July 31, 2002) and there was clause in the agreement that provided Cegetel with the ability to demand immediate reimbursement at any time during the loan period. If this information would have been disclosed, it would have shown that Vivendi would have trouble repaying its obligations.

Regarding Maroc Telecom, in December of 2000, Vivendi purchased 35% of the Moroccan government owned telecommunications operator of fixed line and mobile telephony and Internet services for €2.35 billion. In February 2001, Vivendi and the Moroccan government entered into a side agreement that required Vivendi to purchase an additional 16% of Maroc Telecom's shares in February 2002 for approximately €1.1 billion[1]. Vivendi then did this in order to gain control of Maroc Telecom and consolidate its financial statements with their own because Maroc carried little debt and generated substantial EBITDA. By not disclosing this information on their financial statements, Vivendi’s financial information for 2001 was materially false and misleading.

The major stakeholders in the Vivendi case include: (1) The investors, creditors, and shareholders of the company and its subsidiaries. By not providing reliable financial information, Vivendi mislead these groups into lending credit, cash, and investing in a company that was not as strong as it seemed; (2) The subsidiaries of Vivendi and their customers. By struggling with debt and liquidity, Vivendi borrowed cash from the numerous subsidiaries all over the globe, jeopardizing their operations; and (3) The governments of these countries are also stakeholders because some of Vivendi’s companies were government owned (such as the Moroccan company Maroc Telecom), and these governments have to regulate the fraud and crimes that Vivendi committed; and (4) Vivendi, Messier, Hannezo, and other senior management and employees are major stakeholders. Messier was putting his future, the employees of Vivendi, and the company itself in jeopardy by making loose and risky decisions involving the sanctity of the firm.

Questions:

The case opens with a quote by former Vivendi CEO Jean-Marie Messier. “Some of my management decisions turned wrong, but fraud? Never, never, never.” Can you explain from an ethical perspective Vivendi management’s obliviousness to what was going on around them?

Why do financial analysts look at measures such as EBITDA and operating free cash flow? How do these measures differ from accrual earnings measurements?

An important issue in the case is the extent of disclosures about the transactions undertaken by Vivendi that affected its liquidity. The company was very concerned about its potential inability to meet its cash needs and obligations. Use stakeholder analysis to identify the ethical questions raised by the facts of the case.

[1] As of December 31, 2009, €1 = $1.4406, or $1 = €0.694155.