The Rise and Fall of WorldCom

The Worlds Largest Accounting Fraud

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

Overview of WorldCom

WorldCom was the darling of Wall Street and the Telecom Industry of the 90s
Huge telecommunications company Largest in the U.S. Held responsible for waking up its somewhat sluggish industry in the early 90s Grew rapidly through acquisitions and from increased demand for telecom services Resorted to accounting fraud to meet financial targets

WorldComs 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.

How It Happened
Macro Business Environment The 90s has been labeled by many as the Perfect Storm

Resulted in a number of high profile business failures and wrongdoings

WorldCom Qwest Global Crossing Enron Tyco Boeing HealthSouth Adelphia 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.

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)

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 $24-34M to settle securities class action case

Impact of the Fraud

Board of Directors
12 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 JP Morgan B of A Other $2.6B 2.0B .5B .9B

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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Why It Happened
WorldCom Environment Substantial Problems with the Companys 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 companys 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.

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What Worldcom could have done better?

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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

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.

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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

References

At Center of Fraud, WorldCom Official Sees Life Unravel by Susan Pulliam WSJ (March 24, 2005) WorldComs 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

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