The Rise and Fall of WorldCom
The World’s Largest
Accounting Fraud
By John P. Meyer, 2-23-07
1
Agenda
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Overview of WorldCom
Nature of accounting fraud
Impact of the fraud
How it happened
Why ‘good’ managers make bad ethical
choices
Key take aways
Overview of WorldCom
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WorldCom was the darling of Wall Street and the
Telecom Industry of the 90’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
Resorted to accounting fraud to meet financial targets
Went bankrupt
Overview of WorldCom
Key Events
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1996: Acquired MFS (including 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
2005: Verizon agrees to acquire the company for $6.75B
(plus assumption of $6B of Debt)
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.
$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)
Source: Original SEC Filings , before restatements for accounting fraud.
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Nature of 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:
Understatement of operating expenses of $7B through improper release
of accruals and through improper capitalization of operating expenses
Overstatement of revenues of $1B.
Summary of Improper Income statement amounts ($ in millions)
1999
6
2000
Revenues
$
205
$
Line Costs
$
598
Other Expenses
$
Total
$
328
2001
Total
358
$
67
$ 2,870
$ 3,063
$
798
$ 7,329
135
$
$
177
$
(25)
$
938
$ 3,874
$ 3,598
$
840
$ 9,250
676
$
2002
$
958
428
Source: Report of Investigation by the Special Investigative Committee of Board of Directors of WorldCom, Inc.
Impact of the Fraud
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 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
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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
SEC Action:
Grubman an Soloman Brothers Securities Analyst fined $15M
and banned for life from practice.
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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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How It Happened
Macro Business Environment
The 90’s has been labeled by many as the “Perfect Storm”
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The whole system of checks and balances failed
Public Companies
- Management & Boards
Investment Banks
- Bankers and Analysts
- Institutional Investors
- Individual Investors
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Resulted in a number of high profile business failures and
wrongdoings
WorldCom
Qwest
Global Crossing
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Accounting Profession
-Standard Setters
-Independent Auditors
Legal Profession
Enron
Tyco
Boeing
HealthSouth
Adelphia
ImClone
Why ‘good’ managers make bad ethical
choices (Source: HBS 1986 – Saul W. Gellerman)
Four Rationalizations To Justify Questionable
Conduct
1) Believe that the activity is not “really” illegal
2) Believe that it is in the individual’s or
corporation’s best interest
3) Believe that it will never be found out
4) Believe 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 (HBS 1986 – 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
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