Transcript The Rise and Fall of WorldCom

The Rise and Fall of WorldCom
(Now owned by Verizon)
One (of many) Accounting
Frauds Leading to the
Sarbanes-Oxley Act
By John P. Meyer (JFZ edited)
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Overview of WorldCom
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WorldCom was the darling of Wall Street and the
Telecom Industry of the 1990’s
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WorldCom was a casualty of the Dotcom Bubble
Burst of 2000
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Grew rapidly through acquisitions and from increased
demand for telecom services
High stock price was a powerful currency to make
acquisitions
Mgmt resorted to acct fraud to meet financial targets
 Mgmt Motive to Manipulate Earnings (see text – pg 19)
Overview of WorldCom
Key Events
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1996: Acquired MFS Communications (internet backbone)
1998: Acquired MCI (more than twice it’s size)
2000: Failed merger with Sprint (would have been the
largest merger in history)
2000: Dotcom Bubble Burst (rapid decline in telecom
stock values)
2000-02: WorldCom loans $400M to CEO (Ebbers)
2002: Accounting Fraud uncovered
2002: Filed for Bankruptcy Protection
2004: Emerged from Bankruptcy as MCI (changed name)
2005: Verizon agrees to acquire the company for $6.75B
(plus assumption of $6B of Debt)
Financial Overview of WorldCom
Financial Highlights
1994
1999
2001
2004
Revenues
$2.2
$37.1
$35.2
$20.7
Total Assets
$3.4
$91.1
$103.9
$17.1
Employees (in 000's)
7.5
97.6
87.8
40.4
Market Cap (total shs
* market price)
$3.3
$150.5
$42.8
$ 6.4
Debt
$0.8
$ 13.1
$30.0
$ 5.9
Total Capitalization
$4.1
$163.6
$72.8
$12.3
($ in billions)
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Source: Original SEC Filings, before restatements for accounting fraud.
Nature of the Accounting Fraud
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$11 Billion Accounting Fraud over 3 year period (1999 - 2002)
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Accounting Fraud occurred in two main forms:
1) Understatement of operating expenses through improper
accruals and through improper capitalization of operating expenses.
2) Overstatement of revenues of $1B.
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Impact of the Fraud
Shareholders
$180 Billion of shareholder value lost (based on peak
stock price)
Debt & Preferred Stock holders
$37.5 Billion of debt and preferred stockholder value lost
Company
$750 Million settlement paid to SEC
Employees
57,000 employees lost jobs
* Also, current and former employees lost most of their
retirement savings (invested in WorldCom stock)
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Impact of the Fraud
Executives and Accounting Staff
6 individuals convicted of fraud / conspiracy / false filings
Ebbers – CEO
25 years in prison
Sullivan – CFO
5 years in prison
Myers – Controller
1 year in prison
Yates – Dir of Acctg
1 year in prison
Vinson – Acctg Dept
5 months in prison
Manager
5 months house arrest
Normand –Acctg Dept
3 years probation
Manager
Above 6 individuals agreed to pay a total of $34M to settle
securities class action case.
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Impact of the Fraud
Independent Auditor
Arthur Andersen agreed to pay $65M to settle securities class
action case.
Insurance Companies
Agreed to pay $36M to settle claims against WorldCom directors
and officers.
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How It Happened
WorldCom Environment:
Substantial Problems with the Company’s Internal Controls
 WorldCom was dominated by Ebbers and Sullivan, with
virtually no checks and constraints placed on their actions.
 Significant pressure to “meet the numbers”.
 Lack of courage of employees to communicate the
fraudulent activates – believed it would have cost them
their jobs.
 A financial system in which controls were extremely
deficient.
 The BOD and Audit Committee did not appear to have had
an adequate understanding of the company and culture.
 Inadequate audits by independent auditors.
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Source: Report of Investigation by the Special Investigative Committee of the Board of Directors of
WorldCom, Inc.
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Why ‘good’ managers make bad
ethical choices (Source: Saul W. Gellerman)
Rationalizations To Justify Questionable Conduct
(One part of the “Fraud Triangle”)
1) Belief that the activity is not “really” illegal.
2) Belief that it is in the individual’s or
corporation’s best interest.
3) Belief that it will never be found out or it will
correct itself in the future.
4) Belief that the company will condone actions
that are taken in its interest and will even
protect the managers responsible.
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Why ‘good’ managers make bad
ethical choices (Saul W. Gellerman)
Conclusion
A good way to avoid management oversights is to
subject the control mechanisms themselves to
periodic surprise audits…
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The point is to make sure that internal audits and controls
are functioning as planned.
It is a case of “inspecting the inspectors” and taking the
necessary steps to keep the controls working efficiently.
It is up to Top Management to send a clear &
pragmatic message to all employees that good
ethics is still the foundation of good business
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Key Take Aways
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History repeats itself.
Be aware of your environment.
If it seems too good to be true, it probably is.
No job is worth breaking the law or committing
unethical acts for.
Your personal integrity is your most important
asset – you own it and control it.
“Trust, but Verify”.
References
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First Interim Report of Dick Thornburgh, Bankruptcy Court Examiner – United States
Bankruptcy Court Southern District of New York – re. WorldCom, Inc. (November 4, 2002)
Report of Investigation by the Special Investigative Committee of the Board of Directors of
WorldCom, Inc. (March 31, 2003)
Second Interim Report of Dick Thornburg, Bankruptcy Court Examiner (June 9, 2003
Why ‘good’ managers make bad ethical choices by Saul W. Gellerman– Harvard Business
Review (July – August 1986)
Order to Commit Fraud, A Staffer Balked, Then Caved by Susan Pulliam – Wall Street
Journal (June 23, 2003)
Ebbers Is Convicted in Massive Fraud by Almar Latour, Shawn Young and Li Yuan – WSJ
(March 16, 2005)
At Center of Fraud, WorldCom Official Sees Life Unravel by Susan Pulliam – WSJ (March
24, 2005)
WorldCom’s Myers Gets One-Year Prison Term by Shawn Young – WSJ (August 10,
2005)
WorldCom’s Sullivan Gets Five Years in Jail by Dionne Searcey and Shawn Young – WSJ
(August 11,2005)
Settlements – WorldCom Securities Litigation – www.worldcomlitigation.com