The WorldCom Fraud

2003, 2005 by the AICPA

This presentation is intended for use in higher education for instructional purposes only, and is not for application in practice. Permission is granted to classroom instructors to photocopy this document for classroom teaching purposes only. All other rights are reserved. Copyright 2003, 2005 by the American Institute of Certified Public Accountants, Inc., New York, New York.

WorldComs Background
Awoke the sleeping giant by leading the telecom industry into profitability in the 90s. Telecom industry faced low margins and Bernie Ebbers decided
growth=survival

During the 1990s, WorldCom was deeply involved in acquisitions and

completed several mega-deals

Purchased over 60 firms in 2nd half of the 90s WorldCom moved into Internet and data traffic
Handled 50% of US Internet traffic Handled 50% of e-mails worldwide
2003, 2005 by the AICPA

WorldComs Background (cont)

Purchased MCI for $37 billion in 1997
Not allowed to purchase Sprint in 2000 because of antitrust regulation.

In 1999 revenue growth halted; stock price dropped

By 2001 owned a third of the US data cables Was U.S. 2nd largest long-distance operator in 1998 and 2002

Had over 20 million customers in 2002

2003, 2005 by the AICPA

Bernard Ebbers, CEO

Borrowed $366 million to cover losses on stock which was not
repaid

Secured loans from WorldCom to fund personal investments Netted $140 million from stock sales

including a $100 million Canada ranch, $658 million in Mississippi timberlands and a $14 million Georgia shipyard

Facing dismissal, he resigned from WorldCom on April 30, 2002

Bernie Ebbers classic resignation statement: "I am confident that WorldCom will continue to lead the industry, setting the standards others will follow.

2003, 2005 by the AICPA

Scott Sullivan, CFO

Served as CFO, treasurer and secretary Directed staff to make false accounting
entries Personally made false and misleading public statements regarding finances Netted $45 million from stock sales

2003, 2005 by the AICPA

How the Fraud took place

From 1998-2000, WorldCom reduced reserve accounts
held to cover liabilities of acquired companies WorldCom added $2.8 billion to the revenue line from these reserves

Reserves didnt cut it; An e-mail was sent in December

2000 to a division in Texas directing misclassification of expenses.

CFO told key staff members to mark operating costs as

long-term investments. To the tune of $3.85 billion.
2003, 2005 by the AICPA

How the Fraud took place (cont)

Operating Expenses to Assets
-CFOs directions affected the income statement: Revenues xxx (no change) COGS xxx (no change) Operating Expenses:
Fees paid to lease other companies phone networks: Computer expenses: xxx (Huge Decrease) xxx (Huge Decrease)

NET INCOME
2003, 2005 by the AICPA

xxx (Huge Increase)

How the Fraud took place (cont)

Operating Expenses to Assets
-CFOs directions affected the balance sheet: Assets: Computer assets Leasing assets

xxx (Huge Increase) xxx (Huge Increase)

Liabilities Stockholders Equity:

Retained Earnings

xxx (no change)

xxx (Huge Increase) =HAPPY INVESTORS

2003, 2005 by the AICPA

How the Fraud took place (cont)

Operating Expenses into Assets
WorldComs journal entry for $500 million in computer expenses: Computer Assets Cash 500 million 500 million

The documents supporting the expenses were not found!

2003, 2005 by the AICPA

How the Fraud took place (cont)

Huge losses turned into enormous profits.
$1.38 billion in net income in 2001

Inflated the companys value in its assets

2003, 2005 by the AICPA

How the Fraud was discovered

1. Obscure tips were sent into the Internal audit
team

2. MCI audit and review of books uncovered

accounting irregularities

3. In March 2002, John Stupka complained to

Internal audit about $400 million he set aside that Sullivan wanted to use to boost WorldComs income.

2003, 2005 by the AICPA

How the Fraud was discovered (cont)

4.
March 7, 2002 - the SEC requests information from WorldCom How could WorldCom make so much when AT&T is losing money? The Internal audit started digging Found $2 billion company announced for capital expenditures (Internal Auditors found it was never authorized for capital expenditures.) Found the undocumented $500 million in computer expenses that were recorded as assets. Searching WorldComs computers, Mr. Morse found $2 billion in questionable entries

5.

2003, 2005 by the AICPA

How the Fraud was discovered (cont)

6. June 14, 2002 - The Internal audit team
contacted WorldComs audit committee

7. Internal auditor, Cindy Cooper, asked for

documents supporting numerous capital expenditures.
No supporting documents were found

8. The controller admits to internal auditors that

the accounting treatment is wrong
accounting

States no accounting standards support this

2003, 2005 by the AICPA

How the Fraud was discovered (cont)

9. June 20, 2002 - Internal audit explains irregularities to
the Audit committee.

10. June 25, 2002 - WorldCom announces it inflated profits

by $3.8 billion over the previous five quarters

11. June 26, 2002 - civil suit filed, stock trading halted

Ultimately, stock was delisted by Nasdaq

12. July 21, 2002 - WorldCom filed for bankruptcy

2003, 2005 by the AICPA

Post-Fraud Happenings
17,000 jobs cut to save $1 billion.
WorldCom may write off $50.6 billion in intangible
assets.

Added additional board members to serve on a special

investigative panel to review accounting practices:
Former US Attorney General Nicholas Katzenbach Dennis Beresford, Former Chairman of the FASB

WorldCom is trying to secure loans

2003, 2005 by the AICPA

Post-Fraud Happenings (cont)

John Sidgmore, the CEO replacing Ebbers, stated he wants to move forward:

We want the bad guys exposed. We want the bad guys punished. And we want to move on with our lives at WorldCom."

2003, 2005 by the AICPA

Post-Fraud Happenings (cont)

WorldCom was renamed MCI in 2004 when it
emerged from bankruptcy

Possible court-approved debt reductions Company could spin off several business units

2003, 2005 by the AICPA

Post-Fraud Happenings (cont) Scott Sullivan

In August 2002, Scott Sullivan, CFO, was indicted by a grand jury on one count of fraud and six counts of securities fraud and false filings involving almost $8 billion. He pleaded not guilty.

On March 2, 2004, in a superseded indictment, Sullivan pleaded guilty to 3 federal criminal charges for fraud and conspiracy.

Faces maximum 25 years in prison. Struck plea deal with government to testify against Bernie Ebbers. Sullivan to be sentenced after Ebbers trial.

2003, 2005 by the AICPA

Post-fraud happenings (cont) Bernie Ebbers

September 2003 pleaded not guilty to 15 felony counts of violating Oklahoma securities laws. Charges dropped. Oklahoma Attorney General to refile charges at a later date

January 19, 2005 - Federal jury trial on charges of fraud to begin in which Scott Sullivan is expected to testify against him
Possible sentence: 25+ years in prison

2003, 2005 by the AICPA

Post-fraud happenings (cont) Directors

January 2005 - 10 former directors agreed to pay $54 million to settle a shareholder class-action lawsuit
$18 million to be paid by the directors themselves $36 million paid by the liability insurance

February 28, 2005 Trial to begin against former auditors/directors who have not settled during class-action

2003, 2005 by the AICPA