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 years. At the time of the sentence Ebbers was 63 years old. He may potentially be let out of prison at the age of 83 on terms of good behavior. Ebbers reported to prison on Tuesday, Sept 26th, 2006 to begin fulfilling his sentence. In March of 2005, 16 of WorldCom's 17 former underwriters reached settlements with the investors ([7]). Citigroup settled for $2.65 billion on May 10, 2004 ([8]). http://en.wikipedia.org/wiki/Worldcom#Bankruptcy

2. Has a plan been established to reorganize or liquidate? Describe the plan in general terms.

Under WorldCom's plan of reorganization, the shareholders got a hefty settlement. For example, on July 7, 2003, United States District Judge Jed Rakoff, of the Southern District of New York, approved a settlement between the SEC and WorldCom to make WorldCom pay a record-breaking $750,000,000 to investors who allege they lost $200,000,000,000 as a consequence of WorldCom's accounting shenanigans. In approving the settlement, Judge Rakoff issued a groundbreaking opinion. See SEC v WorldCom (SD NY, July. 7, 2003, No. 4693) available at the Southern District's website. http://www.nysd.uscourts.gov/rulings/02cv4963_070703.pdf

The investors are the common shareholders of WorldCom. As mentioned above, WorldCom is in Chapter 11 bankruptcy and balance-sheet insolvent. The absolute-priority rule is a fundamental of United States bankruptcy law. See 11 USC §1129; Norwest Bank Worthington v Ahlers, (1998) 485 US 197, 108 S Ct 963, 99 LEd 2d 169; Case v Los Angeles Lumber Products Co., Ltd., (1939) 308 US 106, 60 S Ct 1, 84 LEd 110.

Under the absolute priority rule, a senior class of creditors must receive full payment before a junior class may receive anything at all. In addition, no class of equity securities (such as common shareholders) may receive any payment until all creditors and senior equity security holders, if any, have been paid in full. The shareholders of a corporation that is balance-sheet insolvent are supposed to receive nothing at all. There have been limited ways that shareholders may circumvent the absolute priority rule. See Thomas Henry Coleman and David E. Woodruff, Looking Out for Shareholders: The Role of the Equity Committee in Chapter 11 Reorganization Cases of Large, Publicly Held Companies, 68 American Bankruptcy Law Journal 295 (Summer 1994). Generally speaking, such circumvention of the bankruptcy laws has been difficult. Moreover, Section 510(b) of the Bankruptcy Code explicitly subordinates the rescission or damages claims of defrauded shareholders, rendering such claims otiose.

In 2002, along came Section 308(a) of the Sarbanes-Oxley Act, entitled "Fair Funds for Investors," that has enabled the SEC to add civil penalties to disgorgement funds for the relief of the victims of stock swindles. Under Section 308(a), the SEC has negotiated a large - nay, a VERY large - penalty with the Debtor-in-Possession management of WorldCom, totaling $2,250,000,000, with $750,000,000 of the penalty allocated for distribution to the pre-bankruptcy shareholders of WorldCom. Of the latter sum, $500,000,000 will be distributed in cash, plus $250,000,000 worth of new common stock. This distribution is about 75 times the amount of the next largest civil penalty distribution to shareholders.

The Debtor-in-Possession must fund this civil penalty, and as a result $750,000,000 in value will be leaving the bankrupt WorldCom and paid via the SEC to the old WorldCom shareholders. The SEC, as the recipient of the civil penalty, could utilize the $2,250,000,000 in any constitutional way it sees fit. A donation to victims of frauds of every kind; a donation to educate the masses on virtue; a donation to flood victims; or a minuscule reduction of the National Debt. By the same token, any creditor in a bankruptcy case may decide to donate the distributions resulting from its allowed claim to anyone, including the members of a junior class in the same bankruptcy case. So, for example, a secured creditor in a bankruptcy case may lawfully donate the proceeds of its claim in a specified amount to the unsecured creditors, or to the equity security holders. Does this transfer of wealth violate the absolute priority rule? Of course not, because it is the joint, voluntary act of the Debtor-in-Possession, and a senior claimant, the SEC.

In the WorldCom situation, there was no circumvention of the absolute priority rule, because the Debtor-in-Possession management entered into a monetary compromise settlement of a controversy, approved by the Official Unsecured Creditors' Committee.

(Source: http://ceb.com/newsletterv6/Bus_Law.htm).

3. Do you think the firm will succeed in getting out of bankruptcy and why?

The company emerged from Chapter 11 bankruptcy in 2004 with about $5.7 billion in debt and $6 billion in cash. About half of the cash was intended to pay various claims and settlements. Previous bondholders ended up being paid 35.7 cents on the dollar, in bonds and stock in the new MCI company. The previous stockholders' stock was valueless. It has yet to pay many of its creditors, who have waited for two years for a portion of the money owed. Many of the small creditors include former employees, primarily those who were laid off in June 2002 and whose severance and benefits were withheld when WCOM filed for bankruptcy. On August 7, 2002, the exWorldCom 5100 group was launched. It was composed from former WorldCom employees with a common seeking full payment of severance pay and benefits based on the WorldCom Severance Plan. The '5100' stands for the number of WorldCom employees laid off on June 28, 2002 before WorldCom filed for bankruptcy.[2] http://ceb.com/newsletterv6/Bus_Law.htm

However, on February 14, 2005, Verizon Communications agreed to acquire MCI for $7.6 billion.

4. Who will be adversely affected if the firm shuts down for good? Will anyone benefit? Should the Federal Government bail them out?

As mentioned above, the employees and major shareholders are adversely affected. Since, Verizon Communications agreed to acquired MCI, perhaps we could conclude that they benefited.

Now let's look at Kmart.

Company 2: Kmart Holdings Corporation

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?

On January 22, 2002, Kmart filed for Chapter 11 bankruptcy protection; led into the bankruptcy by its then chairman Chuck Conaway and president Mark Schwartz.

How and why? Conaway, who had success building up the CVS Corporation, had accepted an offer to take the helm at Kmart, along with a loan of some $5 million. Similar to the Enron scandal, Conway and Schwartz were accused of misleading shareholders and other company officials of the company's financial crisis, while they were allegedly making millions and allegedly spending the company's money on airplanes, houses, boats and other luxuries. At a conference for Kmart employees January 22, Conaway accepted "full blame" for the financial disaster. As Kmart emerged from bankruptcy, Conaway was forced to step down and was asked to pay back all the loans he had taken. http://en.wikipedia.org/wiki/Kmart

2. Has a plan been established to reorganize or liquidate? Describe the plan in general terms.

Like WorldCom, Kmart wound up in Chapter 11. Like WorldCom, Kmart went into Chapter 11 balance-sheet insolvent. But unlike WorldCom's shareholders, and despite the presence of an equity security holders committee that was supposed to represent Kmart shareholders, the pre-bankruptcy Kmart shareholders got nothing under Kmart's plan of reorganization, recently confirmed by the Bankruptcy Court. Outraged Kmart shareholders, including thousands of former employees, are looking for justice, and they believe the law and the system have mistreated them. The problem for Kmart shareholders is that the bankruptcy laws were administered as required, and the shareholders therefore received nothing. http://ceb.com/newsletterv6/Bus_Law.htm

3. Do you think the firm will succeed in getting out of bankruptcy and why?

After dismissing Conaway and Schwartz, Kmart closed more than 300 stores in the United States and laid off around 34,000 workers as part of a restructuring. On May 6, 2003, Kmart officially emerged from bankruptcy protection as the Kmart Holdings Corporation and on June 10, 2003, it began trading on the NASDAQ as "KMRT." Kmart introduced five prototype stores with a new logo, layout and color scheme (lime green and gray) with one in White Lake, Michigan, and four in Peoria, Illinois. The new layout was touted as having wider aisles, improved selection and lighting. However, Kmart could not afford a full-scale rollout. The lime green prototype was abandoned for the new Kmart "orange" concept that rolled out at nine test stores nationwide. Kmart was also once a major presence in Canada. However, as a result of Kmart's ongoing financial difficulties, the Canadian division was sold to competitor Zellers of the Hudson's Bay Company in 1998, after which the stores were either closed or converted to the Zellers brand. Like Target stores, Kmart-branded stores in Australia belong to Coles Myer; Coles Myer also holds the rights to the Kmart brand in New Zealand. Kmart stores in Australia will be renamed in line with the Coles brand in late 2007, however the precise name has not been decided. http://ceb.com/newsletterv6/Bus_Law.htm

Merger

On November 17, 2004, Kmart announced its intention to purchase Sears, Roebuck and Company. As a part of the merger, the Kmart Holdings Corporation would change its name to Sears Holdings Corporation. The new corporation announced that it would continue to operate stores under both the Sears and Kmart brands. http://en.wikipedia.org/wiki/Sears_Holdings_Corporation

4. Who will be adversely affected if the firm shuts down for good? Will anyone benefit? Should the Federal Government bail them out?

Re-organization did not result in Kmart shutting its doors. Where did the Federal Government fit in, though, when the stakeholders lost their money? And, what of the SEC? What of Section 308 of Sarbanes-Oxley and "Fair Funds for Investors?" To be sure, the SEC, the FBI, the US Attorney's Office and the US Congress House of Representatives Energy and Commerce Committee have all devoted considerable study to Kmart's slide into insolvency and ruin. However, the key to "Fair Funds for Investors" is a civil penalty from the SEC. After spending more than a year reviewing Kmart's books, the SEC recently decided that it would not seek a civil penalty or seek to obtain disgorgement of ill-gotten gains. http://ceb.com/newsletterv6/Bus_Law.htm

This is not exhaustive, but seems to touch on the main points asked for in the above questions.