Accounting Fraud At WorldCom a big bubble burst

1. Accounting Fraud At WorldCom
By : Nadeem Shafi

2. WorldCom: Overview
 Global communications company offering Internet, voice,
and data services for business
 Started operations in 1983 in southern states of United States
with a capital of $650,000 by providing long distance calls at
discount rates
 Initially named as LDDS (Long Distance Discount Service)
 By the end of 1993 LDDS was fourth long distance carrier in
United States
 In 1995 the company became Officially known as WorldCom

3.  Bernie Ebbers (CEO)
 Scott Sullivan (CFO)
 David Myers (Vice President)
 Cynthia Cooper (Director Internal Audit)
 Buford Yates, Jr. (Director General Accounting)
Key Executives :

4. WorldCom’s Growth
▀ 75 mergers and acquisitions of smaller companies.
▀ Bought competitor MCI in 1997 for 42 billion Dollars which
was 2nd
largest long distance Company
▀ Attempted to buy sprint in 2000, but the U.S justice
department refused to allow the merger .

5. Line
Costs ?
WorldCom
customer in Chicago
WorldCom
customer in London
Local network
in Chicago
WorldCom’
s network
British
network
Line Costs: Fees WorldCom paid, to third-party telecommunication
carriers for the right to access their network in order to service their
customers

6. How it started
 With failure of sprint merger WorldCom faced a severe setback as Ebbers
(CEO) lacked technology experience and strategic sense of direction . He
relied mostly on mergers for the expansion of business
 WorldCom encouraged “a systemic attitude conveyed from the top down
that employees should not question their superiors, but simply do what
they were told
 Ebbers was obsessed to maintain an E/R ratio of 42% which was
impossible to maintain because line costs were high and business was
declining
 CFO Sullivan decided to fraud accounting entries to achieve targeted
performance

7. Accounting Fraud #1: Improperly Releasing Reserves Held
Against Operating Expenses (1999 - 2000)
 WorldCom has set reserves to pay anticipated bills, reflecting estimates of
(unpaid) costs associated with the used of lines and other facilities of
outside vendors
 In the third quarter of 2000, WorldCom starts to manipulate true line cost
expenses by releasing reserves (reduced 3Q line costs by $828 million,
and 4Q line costs by $407 million).
 In 1999 and 2000, WorldCom reduced its reported line costs by
approximately $3.3 billion through this fraud.

8. Accounting Fraud #2: Re-characterizing Certain Expenses as
Capital Assets (2001 – 2002)
Line costs (WorldCom’s largest operating expense) typically reached
50% of revenue.
By booking line costs as capital assets instead of as an operating
expense, WorldCom.
1. reduced their operating expenses (and increased pre-tax income)
2. increased the value of their capital assets (and total assets)
3. increased the value of the company’s net worth
In April 2001, WorldCom starts making false general ledger entries
which transfer a significant portion of line cost expenses to a variety
of capital asset accounts. Violates GAAP.
In 2001 and 2002, WorldCom improperly capitalized $3.5 billion of
line costs.

9. A Bunch of Dirty Liars
Form Filed Reported Line Reported Income Actual Line Actual Income
With the Cost Expenses (before Taxes Cost Expenses (before Taxes
Commission and Minority and Minority
Interests) Interests)
10-Q, 3rd Q. 2000 $3.867 billion $1.736 billion $4.695 billion $908 million
10-K, 2000 $15.462 billion $7.568 billion $16.70 billion $6.33 billion
10-Q, 1st Q. 2001 $4.108 billion $988 million $4.879 billion $217 million
10-Q, 2nd Q. 2001 $3.73 billion $159 million $4.290 billion -$401 million
10-Q, 3rd Q. 2001 $3.745 billion $845 million $4.488 billion $102 million
10-K, 2001 $14.739 billion $2.393 billion $17.754 billion -$622 million
10-Q, 1st Q. 2002 $3.479 billion $240 million $4.297 billion -$578 million
Source: SECURITIES AND EXCHANGE COMMISSION v. WORLDCOM, INC., Civ No. 02-CV-4963 (JSR)
WorldCom's False Statements in Filings With SEC

10. How Was Fraud Uncovered?
 Cooper’s internal audit team, by the beginning of June 2002, had discovered $3
billion in questionable expenses
 On June 11, Cooper met with Sullivan, who asked her to delay audit until after the
third quarter which Cooper refused
 Vinson (Dir. Management reporting) admitted that she had made many of the entries
but did not have any support for them
 On June 20, Cooper and her internal audit team met in Washington, D.C. with
the audit committee and disclosed their findings of inappropriate capitalized
expenses.
 $2.5 billion in line costs that had been capitalized.
 On June 25, 2002, the Board determined that WorldCom would restate its
financial statements for 2001 and the first quarter of 2002.
 KPMG would reaudit the Company’s financial statements for 2001
 It decided to terminate Mr. Sullivan without severance and to accept the resignation of
Mr. Myers without severance.

11. Effect of Fraud
 WorldCom has acknowledged that it committed more fraud than it
original reported, raising the estimate from $3.8 billion.
 Nasdaq immediately halted trading of WorldCom’s stock.
 corporate credit rating on WorldCom bonds lowered from B+ to CCC-.
 Misrepresented cash position to analysts as “solid” while facing cash
crunch. Made loan to Ebbers constituting 30% of WorldCom’s cash.
 WorldCom continued to issue securities using fraudulent and materially
false financial statements and information.
 American investors in WorldCom lost an estimated $176B in value in
WorldCom stock, laid off 25,000 employees and caused another 73,000
job losses in the industry.

12. WorldCom Files for Bankruptcy on July 21, 2002
 On July 21, 2002, WorldCom Group, a telecommunications
company with more than $30 billion in revenues, $104 billion in
assets, and 60,000 employees, filed for bankruptcy
 WorldCom’s stock, once valued at $180 billion, became nearly
worthless
 Seventeen thousand employees lost their jobs; many left the
company with worthless retirement accounts
 The company’s bankruptcy also jeopardized service to
WorldCom’s 20 million retail customers ,

13. WorldCom: The Poster Child For Corporate Governance Failures
 WorldCom was dominated by Ebbers (CEO) and Sullivan (CFO) with virtually no
checks or restraints placed on their actions by the Board of Directors or other
Management.
 WorldCom Management provided the Company’s Directors with extremely
limited information regarding many acquisition transactions. Several multi-billion
dollar acquisitions were approved by the Board of Directors following discussions
that lasted for 30 minutes or less and without the Directors receiving a single
piece of paper regarding the terms or implications of the transactions (e.g.
Intermedia -$6B acquisition, 60 –90 min )
 No evidence of meaningful debt planning. The ability to borrow was facilitated by
massive accounting fraud. In 4 years issued more than $25 billion in debt
securities at complete discretion of Ebbers and Sullivan. Board rubber-stamped
Pricing Committee decisions.
 The Compensation and Stock Option Committee approved Company loans of
more than $400million to Mr. Ebbers without initially informing the full Board or
taking appropriate steps to protect the
 The Board never questioned non-WorldCom business activities of CEO and
effectively funded those with the company money.

14.  Audit committee had little power, was under funded and understaffed;
concentrated only on operational audit. Also improper oversight by external audit
– Arthur Andersen.
 Screwed up compensation structure. Decisions single-handedly taken by CEO.
Most Board members also had stock-based compensation.
 WorldCom was a company that grew tremendously in both size and complexity in
a relatively short period of time. Its management, systems, internal controls and
other personnel did not keep pace with that growth. WorldCom grew in large part
because the value of its stock rose dramatically.
 Board members had poor oversight on corporate strategy. Very little meaningful
or coherent strategic planning at WorldCom. Absence of proper corporate
governance protocols. The Company’s approach to acquisitions and significant
outsourcing transactions was ad hoc and opportunistic.
 Loyalty of Board was ensured by members whose companies had been acquired
by WorldCom (6 out of 10) and whose personal fortunes through ownership of the
Company’s stock had, for a long period of time, been greatly enhanced during
Ebbers’ leadership of WorldCom.
WorldCom: The Poster Child For Corporate Governance Failures
(cont.)

15. Actual Steps Taken Following SEC Investigation:
 On April 30, 2002, the Company announced that Mr. Ebbers had resigned as
President, CEO and Director.
 KPMG became the Company’s independent auditor and accountants effective
May 14, 2002, replacing Arthur Andersen.
 In May 2002, the Company’s Internal Audit Department began an investigation
concerning the capitalization of line costs.
 The Board has terminated jobs of CFO Sullivan and Chief Controller Myers.
 Appointed 3 independent directors – professionals in financial fraud
investigations.

16. NAME POST SENTENCE
Bernard Ebbers CEO 25 Years in prison
Scott Sullivan CFO 5 years in prison
David Myers Vice President 1 Year and 1 Day
Buford Yates
Former Director of
Accounting
1 Year and 1 Day
Betty Vinson
Former Director of
Corporate
Accounting
5 months
LEGAL TRIALS

17. Thank You
Any Questions???