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The Rise and Fall of WorldCom

The World’s Largest Accounting Fraud

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Agenda

Introduction Overview of WorldCom Nature of accounting fraud How the Fraud Happened How was it Discovered Impact of the fraud Why ‘good’ managers make bad ethical

choices Key take aways

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Overview of WorldCom

WorldCom was the darling of Wall Street and the Telecom Industry of the 90’s

Huge telecommunications company Largest in the U.S. Held responsible for waking up it’s somewhat sluggish industry

in the early 90’s Grew rapidly through acquisitions and from increased demand

for telecom services Resorted to accounting fraud to meet financial targets

WorldCom’s Success Spree

WorldCom took the telecom industry by storm when it began a frenzy of acquisitions in the 1990s. The low margins that the industry was accustomed to weren't enough for Bernie Ebbers, CEO of WorldCom.

From 1995 until 2000, WorldCom purchased over sixty other telecom firms. In 1997 it bought MCI for $37 billion.

WorldCom moved into Internet and data communications, handling 50 percent of all United States Internet traffic and 50 percent of all e-mails worldwide.

By 2001, WorldCom owned one-third of all data cables in the United States. In addition, they were the second-largest long distance carrier in 1998 and 2002.

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How It Happened

Macro Business EnvironmentThe 90’s has been labeled by many as the “Perfect Storm”

Resulted in a number of high profile business failures and wrongdoings

WorldCom Enron HealthSouthQwest Tyco AdelphiaGlobal Crossing Boeing ImClone

In 1999, revenue growth slowed and the stock price began falling. WorldCom's expenses as a percentage of its total revenue increased because the growth rate of its earnings dropped.

In an effort to increase revenue, WorldCom reduced the amount of money it held in reserve (to cover liabilities for the companies it had acquired) by $2.8 billion and moved this money into the revenue line of its financial statements

These changes turned WorldCom's losses into profits to the tune of $1.38 billion in 2001. It also made WorldCom's assets appear more valuable.

How was it Discovered

An internal audit turned up the billions WorldCom had announced as capital expenditures as well as the $500 million in undocumented computer expenses.

There was also another $2 billion in questionable entries. WorldCom's audit committee was asked for documents supporting capital expenditures, but it could not produce them. The controller admitted to the internal auditors that they weren't following accounting standards.

WorldCom then admitted to inflating its profits by $3.8 billion over the previous five quarters.

A little over a month after the internal audit began, WorldCom filed

for bankruptcy.

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Impact of the Fraud

Overall investor distrust with companies undergoing similar problems.

National feeling that the stock market is not as safe as previously thought

Shareholders-$180B of shareholder value lost (based on peak stock price)

Debt & Preferred Stock holders-$37.5B of debt and preferred stock holder value lost

Company-$750M settlement paid to SEC Employees-57,000 employees lost jobs.All 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 Staff6 individuals convicted of fraud / conspiracy / false filings

Ebbers – CEO 25 years in prisonSullivan – CFO 5 years in prisonMyers – Controller 1 year in prisonYates – Dir of Acctg 1 year in prison Vinson – Acctg Dept 5 months in prison Manager 5 months house arrestNormand –Acctg Dept 3 years probation

ManagerAbove 6 individuals agreed to pay a total of $24-34M to

settle securities class action case

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Impact of the Fraud

Board of Directors12 Directors agreed to pay (out of pocket) a total of $25M to

settle securities class action case

Investment Bankers

Settlement of securities class action case with banks:Citi Group $2.6BJP Morgan 2.0BB of A .5BOther .9B

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Impact of the Fraud

Independent AuditorArthur Andersen agreed to pay $65M to settle securities class

action case

Insurance CompaniesAgreed to pay $36M to settle claims against WorldCom directors

and officers

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Why It Happened

WorldCom EnvironmentSubstantial 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 Government lack of keeping a check on the company’s

proceeding . 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

___________Source: Report of Investigation by the Special Investigative Committee of the Board of Directors of

WorldCom, Inc.

What Worldcom could have done better?

Worldcom could have began to change their business practices and attempted to right the wrongs.A plan to correct fraudulent practices should have taken care of those who were negatively affected.

They should never have stayed so far from common ethical practices from the beginning. A good framework for ethical decision making would have changed the course of the organization .

A good way to avoid management oversights is to subject the control mechanisms themselves to periodic surprise audit.

The point is to make sure that internal audits and controls are functioning as planned.

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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Conclusion

The year 2002 saw an unprecedented number of corporate scandals: Enron , Tyco , Global Crossing etc.

Worldcom was just another case of failed corporate governance , accounting abuses and outright greed.

It is correct to say that “No job is worth breaking the law or committing unethical acts for. Personal integrity is the most important asset – you own it and control it”

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References

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)

Settlements – WorldCom Securities Litigation – www.worldcomlitigation.com

http://prmia.org/pdf/Case_Studies/WorldCom_Case_Study_April_2009.pdf