WorldCom Scandal: A Look Back at One of the Biggest Corporate Scandals in U.S.

History In 1998, the telecommunications industry began to slow down and WorldCom's stock was declining. CEO Bernard Ebbers came under increasing pressure from banks to cover margin calls on his WorldCom stock that was used to finance his other businesses endeavors (timber, yachting, etc.). The company's profitability took another hit when it was forced to abandon its proposed merger with Sprint in late 2000. During 2001, Ebbers persuaded WorldCom's board of directors to provide him corporate loans and guarantees totaling more than $400 million. Ebbers wanted to cover the margin calls, but this strategy ultimately failed and Ebbers was ousted as CEO in April 2002. Beginning in 1999 and continuing through May 2002, WorldCom (under the direction of Scott Sullivan (CFO), David Myers (Controller) and Buford Yates (Director of General Accounting)) used shady accounting methods to mask its declining financial condition by falsely professing financial growth and profitability to increase the price of WorldCom's stock. The fraud was accomplished in two main ways. First, WorldCom's accounting department underreported 'line costs' (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them. Second, the company inflated revenues with bogus accounting entries from 'corporate unallocated revenue accounts'. The first discovery of possible illegal activity was by WorldCom's own internal audit department who uncovered approximately $3.8 billion of the fraud in June 2002. The company's audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, Myers resigned, and the Securities and Exchange Commission (SEC) launched an investigation. By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion (WorldCom, 2005). On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection, the largest such filing in United States history. The company emerged from Chapter 11 bankruptcy in 2004 with about $5.7 billion in debt. At last count, WorldCom has yet to pay its creditors, many of whom have waited years for the money owed. On March 15, 2005 Bernard Ebbers was found guilty of all charges and convicted on fraud, conspiracy and filing false documents with regulators. 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), former controller David Myers (pleaded guilty to securities fraud, conspiracy to commit securities fraud, and filing false statements on September 27, 2002), former accounting director Buford Yates (pleaded guilty to conspiracy and fraud charges on October 7, 2002), and former accounting managers Betty Vinson and Troy Normand (both pleading guilty to conspiracy and securities fraud on October 10, 2002) (MCI, 2006). Ebbers reported to prison on September 26, 2006 to begin serving his sentence.

What did WorldCom say? The company said an internal audit had discovered that $3.3bn in profits were improperly recorded on its books from 1999 to the first quarter of 2002. That is on top of the $3.8bn in expenses the company said it had improperly reported as capital investments. WorldCom now says it must issue revised financial statements for 2000 and 1999 as well. The revision will reduce 2000 profits by more than $3.2bn, but this may not be the end of accounting horrors as the company warned it may find more problems. Is there a new twist to the latest disclosures? WorldCom said most of the $3.3bn irregularity involved the manipulation of reserves. Companies set aside reserves to cover estimated losses such as uncollected payments from customers and judgements in lawsuits and other expected costs. Are reserves normal business practice? It is a perfectly legitimate practice, like setting aside funds for a rainy day. But reserves can be abused to create the accounting equivalent of a slush fund. If a company wanted to massage profits to meet Wall Street expectations it can transfer the necessary sums from the reserve. The suspicion is that WorldCom deliberately inflated its reserves to be able to dip into them to boost profits in order to meet profit projections. Who is to blame? WorldCom's chief executive, John Sidgmore, blamed the company's former chief financial officer, Scott Sullivan, and the former controller, David Myers. The two were fired for claiming $3.8bn in regular expenses as capital investment in 2001. The pair were arrested in New York, handcuffed and paraded in front of TV cameras as part of the Bush's administration crackdown on corporate crime. Charged with securities fraud, conspiracy and other charges, they face 65 years in prison. WorldCom's founder and former chief executive, Bernie Ebbers, says he was unaware of the accounting problems, and has not been charged. What is wrong with filing expenses as investment? Operating expenses must be subtracted from revenue immediately, while the cost of capital expenses can be spread over time. Improperly spreading operating costs inflated WorldCom's profits. Why did WorldCom's accountants not spot the problem? WorldCom's accountants at the time were Arthur Andersen, the same people that looked after Enron's books as well as other companies hit by accounting issues - Tyco, Global Crossing and Adelphia. Andersen accused Mr Sullivan of withholding information from them. The deputy US attorney general, Larry Thompson, said: "We have to ask where the professionals were, the accountants and the lawyers." What is being done to get a proper accounting? WorldCom has new accountants, KPMG, who have been asked to scour the books back to 1999. It will be virtually impossible to get an accurate picture until a comprehensive audit for the past several years is done, a process expected to last months. The company is also under investigation by the department of justice and the securities and exchange commission, the US financial regulator. WorldCom, which has been charged with fraud for allegedly hiding $1.2bn in losses, is now under bankruptcy protection. Any other bad news? WorldCom said it may have to write off $50bn when it restates ifs finances. One of the largest write-offs in corporate history, that would amount to the 2001 gross domestic products of Hungary and the Czech Republic. Only Time Warner's $54bn write-off was bigger.