Case 7-10
Vivendi Universal
“Some of my management decisions turned wrong, but fraud? Never, never, never.” This statement was
made by the former CEO of Vivendi Universal, Jean-Marie Messier, as he took the stand in November 20,
2009, for a civil class action lawsuit brought against him, Vivendi Universal, and the former CFO,
Guillaume Hannezo, that accused the company of hiding Vivendi’s true financial condition before a $46
billion three-way merger with Seagram Company 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 that it had failed to disclose debt
obligations regarding two of the company’s subsidiaries. The jury decided not to hold either Messier of
Hannezo legally liable because “scienter” could not be proven. In other words, the court decided it could
not be shown that the two officers acted with the intent to deceive other parties.
The stock price of the firm dropped 89 percent from €84.70 on October 31, 2000, to €9.30 on August 16,
2002, over the period of fraudulent reporting and press releases to the media.
Vivendi is a French international media giant rivaling Time Warner Inc. that spent $77 billion on
acquisitions including the world’s largest music company, Universal Music Group (UMG). Messier took
the firm to new heights that came with a large amount of debt through mergers and acquisitions.
The Vivendi Universal case raises a few ethical issues. For example, was it wrong for Vivendi to make
improper adjustments to its earnings before interest, taxes, depreciation, and amortization (EBITDA) to
meet ambitious earnings targets in 2001? Was Messier correct in stating that he made some decisions that
just turned out poorly and that he was not participating in an extensive fraud scandal?
In December 2000, Vivendi acquired Canal Plus and Seagram, which included Universal Studios and its
related companies, and became known as Vivendi Universal. 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, UMG, 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 ($4.32 billion) at the beginning of 2000 to over €21 billion ($30.25
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 that 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: issuing 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, 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 ($7.25 billion) in EBITDA and just over €2 billion ($2.88 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 percent 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. Furthermore, Vivendi declared a €1
($1.44) 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 ($1.87 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 percent 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 ($85 million), or 5 percent of the total EBITDA of €1.12 billion ($1.61 billion) that Vivendi
reported. Senior executives did this mainly by restructuring Cegetel’s allowance for bad debts. Cegetel, a
Vivendi subsidiary whose financial statements were consolidated with Vivendi’s, took a lower provision for
bad debts in the period and caused the bad debts expense to be €45 million ($64.83 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 by at least €10.125 million
($14.77 million) or approximately 4 percent of UMG’s total EBITDA of €250 million ($360.15 million) for
that quarter. At that level, UMG would have been able to show EBITDA growth of approximately 6 percent
versus the same period in 2000, and to outperform its rivals in the music business. They did this by
prematurely recognizing revenue of €3 million ($4.32 million) and temporarily reducing the corporate
overhead charges by €7 million ($10.08 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 borrowing with Cegetel, one of its subsidiaries, for €520 million
($749.11 million) and continued to grow to over €1 billion ($1.44 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 a 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 2000 Vivendi purchased 35 percent of the Moroccan
government–owned telecommunications operator of fixed line and mobile telephony and Internet services
for €2.35 billion ($3.39 billion). In February 2001, Vivendi and the Moroccan government entered into a
side agreement that required Vivendi to purchase an additional 16 percent of Maroc Telecom’s shares in
February 2002 for approximately €1.1 billion ($1.58 billion). Vivendi 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 the 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; (3) the governments of
these countries—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—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.
On August 11, 2008, the SEC announced the distribution of more than $48 million to more than 12,000
investors who were victims of fraudulent financial reporting by Vivendi Universal. Investors receiving
checks reside in the U.S. and in 15 other countries. More than half bought their Vivendi stock on foreign
exchanges and are receiving their Fair Fund distribution in euros.
In the Fair Funds provisions of the Sarbanes-Oxley Act of 2002, Congress gave the Commission
increased authority to distribute ill-gotten gains and civil money penalties to harmed investors. These
distributions reflect the continued efforts and increased capacity of the Commission to repay injured
investors, regardless of their physical location and their currency of choice.
Questions
1. Why do financial analysts look at measures such as EBITDA and operating free cash flow to
evaluate financial results? How do these measures differ from accrual earnings? Do you believe
auditors should be held responsible for auditing such information?
At the end of the day, cash is still king. If the accrual numbers on the financial statements do not convert
into cash, the company will be out of business. Financial analysts look at measures as EBITDA and
operating free cash flow to indicate the cash position of the company. Then this cash position is used to test
EBITDA means: earnings before interest, taxes, depreciation, and amortization. This metric has both
some advantages and some disadvantages. These are identified in an article by Catanach, Jr. and Ketz in
their column Grumpy Old Accountants as follows:
Advantages
The construct is well defined inasmuch as the number equals operating income plus interest
expense, depreciation, depletion, and amortization charges.
Its components are GAAP-based, and thus are audited numbers.
Disadvantages
Nobody knows what EBITDA is really measuring. EBITDA clearly is not earnings, as it pretends
that some very real costs are fictional.
Trumpeting EBITDA is a particularly pernicious practice. Doing so implies that depreciation is not
truly an expense, given that it is a “non-cash” charge.
EBITDA is not a cash flow. It does not proxy for cash flow because it ignores working capital
changes, adjustments for changes in deferred income taxes, as well as the effects of other long-
term adjustments.
The authors conclude that EBITDA is neither earnings nor cash flow. “Indeed, we have no idea what it
really is measuring.” [http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/542]
Free cash flow is measure of financial performance calculated as operating cash flow minus capital
expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out
the money required to maintain or expand its asset base. Free cash flow is important because it allows a
company to pursue opportunities that enhance shareholder value. Without cash, it’s tough to develop new
products, make acquisitions, pay dividends and reduce debt. FCF is calculated as:
EBIT(1-Tax Rate) + Depreciation & Amortization – Change in Net Working Capital – Capital Expenditure
It can also be calculated by taking operating cash flow and subtracting capital expenditures.
Currently, calculations such as EBITDA and operating cash flow are numbers used to report to investors
how the company is doing but they are not GAAP-recognized amounts. Moreover, there are no specific
standards as to how these amounts should be recorded. In such an environment, auditing these numbers
creates all sorts of consistency and comparability issues.
Adjustments made to reported EBITDA from the financial statements can have a dramatic effect, significantly
increasing or decreasing the ultimate EBITDA figure. The following are a three examples of these adjustments:
One-time expenses for professional fees, severance expenses, inventory write-downs, acquisition and
restructuring costs
Non-cash stock compensation expense
Discretionary expenses
2. Given the major stakeholders mentioned in the Vivendi case, evaluate the ethics of actions taken
by Messier and Hannezo as it affected stakeholder interests. Consider in your answer the
fiduciary obligations of these managers.
Messier and Hannezo had a fiduciary duty to the corporation and its shareholders. The officers owe ethical
and legal duties of care and loyalty and to use good business judgment. The standard of due care provides
that the officer act in good faith, exercise the care that an ordinarily prudent person would exercise in
Messier and Hannezo incurred too much debt. They then hid the seriousness of the liquidity crisis and the
possible inability to meet the debt obligations. The hiding of the liquidity crisis included reducing the
allowance for bad debt of a subsidiary that was consolidated and it masked the liquidity crisis of the
company. The situation was made worse when the officer borrowed to pay dividends which then increased
3. Evaluate the accounting issues discussed in the case from the perspective of Schilit’s financial
shenanigans. Which of the various accounting decisions made by Vivendi through Messier and
Hannezo can be categorized as one of the shenanigans?
The company engaged in financial shenanigans by prematurely recognizing revenue of subsidiary UMG