Accounting Fraud at WorldCom

Group - 9 MACR, Section C

Chanchal Raj Deepak Prasad Kumari Sonia Mukesh Meena Nishant Negi Preethi R S 208 210 214 219 222 228

WorldCom
1983 Long Distance Discount Services, Inc. (LDDS) began in Hattiesburg, Mississippi 1985 LDDS selected Bernard Ebbers to be its CEO 1989 Merged with Advantage Companies Inc Became a Public Company 1993 LDDS became the fourth-largest long-distance carrier in USA 1995 Company name was changed to LDDS WorldCom Became WorldCom in May 1998 Became a full-service telecommunications company

Top Executives,2002
Bernard Ebbers, CEO Scott Sullivan, CFO Ronald Beaumont, COO David Myers, Controller Cynthia Cooper, Director Internal Audit Thomas Bosley, SVP US Operations

Merger & Acquisitions

Company s growth under WorldCom was fuelled primarily through acquisitions during the 1990s 1992-Merged with Advanced Communications Corp Acquisitions
1993-Metromedia Communication Corp 1993-Reurgens Communications Group 1994-IDB Communications Group, Inc 1995-Williams Technology Group, Inc 1996-MFS Communications Company Included UUNet Technologies, Inc 1997- MCI Communications 1998-CompuServe Retained the CompuServe Network Services Division Sold its online service to America Online 2001-Digex

Corporate Culture
Acquisition led to a hodgepodge of people and cultures Headquarters for Network Operations in Texas Human resources department in Florida Legal department in Washington,D.C. No written policies Each department had its own rules and management style Encouraged a systematic attitude conveyed from the top down Compensation to Ebbers and Sullivan beyond the company s approved salary and bonus guidelines Employees had no platform for expressing concerns about company policies or behavior

Corporate Culture
Board of Directors
Between 1999-2002 50% non-executive Former owners, officers or directors of companies acquired by WorldCom Board meeting 6 times a year Prior April 2002, outside meeting directors never met by themselves Always got manipulated wrong information from management Distant and detached from the working of the Company

CEO Ebbers had acquired and was managing several unrelated businesses
Acquisitions through commercial bank loans secured by his personal WorldCom stock WorldCom did not receive any collateral from Ebbers or his business interests to secure these loans By April 29, 2002 the loans and guarantees to Ebbers exceeded $400 mn

Changing Scenario
1990s-Focused on building revenues and acquiring capacity sufficient to handle expected growth Revenue growth was a key to increasing the company s market value Encouraged managers to spend whatever was necessary to bring revenue in the door Long-term costs of a project outweighed short-term gain Entered into long-term fixed rate leases for network capacity 2000-Industry conditions began to deteriorate due to Heightened competition Overcapacity Reduced demand at the onset of economic recession and the aftermath of dot-com bubble collapse Struggled to maintain Expense-to-Revenue Ratio @42%

Accounting Tactics
1999- 00-Accrual Releases Release accruals that were too high relative to future cash payments Released $3.3 billion worth of accruals Several business units were left with accruals for future cash payments that were well below the actual amounts they would have to pay when bills arrived in the next period 2001- 02-Expense Capitalization Stop recognizing expenses for unused network capacity 2001Capitalize $771 mn of non-revenue-generating line expenses into an asset account Construction in Progress Account Reverse $227 mn of the capitalized amount and to make a $227 mn accrual release from ocean-cable liability 2002Capitalize $818 mn line costs

Effect of CFO s Directions

On income Statement Directions Removing Fees paid to lease other companies phone networks Removing Computer Expenses This led to huge decrease in operating expenses Hence huge increase in Net Income On balance sheet Directions Added Computer assets and Leasing assets to balance sheet on Asset side Adding Retained Earnings to liabilities side

Accounting and Audit

TO BE FILLED

Accounting and Audit

WorldCom repeatedly refused to Andersen s request to access the computerized general ledger

Myers, Stephanie Scott, and Mark Willson instructed WorldCom staff about what information could and could not be shared with Anderson

Withheld information, altered documents, omitted information from requested materials and transferred millions of dollars in account balances to mislead Anderson

Still Andersen rated WorldCom s compliance with requests for information as fair

The Endgame
June-2002 Cooper s internal audit team discovered $3bn in questionable expenses Including $500 mn in undocumented computer expenses June 20-Met in Washington D.C. with the audit committee and disclosed their findings of inappropriate capitalized expenses Board told Sullivan and Myers to resign immediately Myers resigned June 25-WorldCom announced that its profit had been inflated by $3.8bn over the previous five quarters Nasdaq immediately halted trading of WorldCom s stock S&P lowered its long-term corporate credit rating on WorldCom bonds from B+ to CCCJune 26-SEC initiated a civil suit of fraud against WorldCom U.S. Justice Department launched criminal investigations into the actions of Bernie Ebbers, Scott Sullivan, David Myers, Buford Yates, Betty Vinson and Troy Normand July 21, 2002 - WorldCom filed for Chapter 11 bankruptcy

What is Chapter 11 Bankruptcy?

Reorganization
A legal way to salvage a company rather than liquidate it

The company is temporarily protected from its creditors Creditors are encouraged to negotiate new terms with the company Acceptance of a reorganization plan requires approval of:
2/3 of the $ amount and more than 1/2 of the creditors who cast votes 2/3 of each class of stockholders who cast votes

Confirmation by the court Cram Down-Court also has the authority to force acceptance of a plan that was voted down As a final alternative, the court can convert a Chapter 11 Bankruptcy to a Chapter 7 Liquidation at any time

The Endgame
August-2002 August 28-David Myers pleaded guilty to three felony charges Securities Fraud Conspiracy to commit fraud Making false fillings with the SEC October 2002 Yates, Vinson and Normand each pleaded guilty to Securities Fraud Conspiracy to commit fraud Making false fillings with the SEC WorldCom was renamed MCI in 2004 when it emerged from bankruptcy

17,000 jobs cut to save $1 billion

The Endgame
March 2004 Sullivan pleaded guilty to federal fraud and conspiracy charges U.S. Justice Department indicted Bernie Ebbers January 2005 10 former directors agreed to pay $54 million to settle a shareholder class-action lawsuit March 2005 Ebbers was sentenced to 25 years in prison August 2005 Betty Vinson was sentenced to 5 months in prison and 5 months of home detention David Myers and Bufford Yates received jail sentences of a year and a day September 2006 Bennie Ebbers entered prison

Thank You
References:
http://en.wikipedia.org Casebook