Background

 Huge telecommunication company, provided:

 Internet services
 Long Distance and various other phone services for a
cheaper price than competitors
 2nd Largest in the US
 MCI, Inc. became its name in April 12, 2003
Overview
 Global communications company offering Internet access,
voice and data services, IT Solution and Hosting and VoIP
sfor business
 MCI: WorldCom’s business and residential communication service
division. MCI is the nation's second-largest long-distance provider and
serves 20 million consumers and thousands of corporate customers.

 Market Capitalization of $120 billion in Summer 1999

 Current examples of $120 billion companies: Coca-Cola, Altria,
Merck, and Bank of America
Overview
 WorldCom Inc. began as a small provider of long
distance telephone service called LDDS in Jackson,
Mississipi
 1996 – acquired MFS Communications (internet
backbone)
 1997 – acquired MCI
 2000 – failed merger with Sprint
 2000 – Dotcom bubble burst (rapid decline in telecom
stock values)
 2002 – accounting fraud uncovered
 2002 – filed to bankruptcy protection
Facts
 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 didn’t 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.
 Huge losses turned into enormous profits.
 $1.38 billion in net income in 2001
 Inflated the company’s value in its assets
Facts
 They classified over $3.8 billion in the payments for
line costs as capital expenditures rather than
current expenses.
 SEC claims that the total for fraudulent accounting
comes to $9 billion.
 Ebber also takes out a separate $43 million loan to
finance the purchase of a 500,000-acre ranch-
backed by Ebber’s WorldCom stock.
Facts
 Reduced the amount of money held in reserve by
$2.8 billion and moved this money into the revenue
line of its FS.
 In 2000, classified operating expenses as long-term
capital investment amounted to $3.85 billion
 Tin 2001, these changes turned WorldCom’s losses
into profits to the tune of $1.38 billion. Its assets
appear more valuable
Facts
 They also added a journal entry for $500 million in
computer expenses, but supporting documents for
the expenses were never found
 Scott Sullivan misallocated capital expenditure as
normal expenses, thus turning profits into losses ($9
billion) – not discovered by internal auditor Cynthia
Cooper until June 2002.
 Fraud #1: Inflating Revenues with bogus accounting entries
from corporate unallocated revenue accounts
 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
 How WorldCom manipulated the process of adjusting reserves
 First , in some cases accruals were released without any apparent analysis of whether the
Company actually had an excess accrual in the account. Thus, reported line costs were reduced
(and pre-tax income increased) without any proper basis.
 Second , even when WorldCom had excess accruals, the Company often did not release them in
the period in which they were identified. Instead, certain line cost accruals were kept as rainy
day funds and released to improve reported results when managers felt this was needed.
 Third , WorldCom reduced reported line costs by releasing accruals that had been established for
other purposes. This reduction of line costs was inappropriate because such accruals, to the
extent determined to be in excess of requirements, should have been released against the
relevant expense when such excess arose, not recharacterized as a reduction of line costs.
 In 1999 and 2000, WorldCom reduced its reported line costs by approximately $3.3
billion through this fraud.

Sources: WorldCom’s 6/9/03 8K report to the SEC and Report of Investigation by the Special
Investigative Committee of the Board of Directors of WorldCom, Inc., March 31, 2003
 Fraud #2: Line Costs as Capital Expenditures instead of expenses

 Line Costs: Fees WorldCom paid, under long-term contracts, to third-party

telecommunication carriers for the right to access their network in order to
service their customers.
 WorldCom’s largest operating expense and 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.

Sources: WorldCom’s 6/9/03 8K report to the SEC and Report of Investigation by the Special Investigative Committee of the Board
of Directors of WorldCom, Inc., March 31, 2003
WorldCom’s FALSE Statement in Filings with SEC

WorldCom's False Statements in Filings With SEC

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 -$578 million
Source: SECURITIES AND EXCHANGE COMMISSION v. WORLDCOM, INC., Civ No. 02-CV-4963 (JSR)
The stock price had fallen from around 60$
in 1999 to $1 in 2002
7
KEY PLAYERS
Bernard Ebbers
 one of the firm’s founders in 1983.
 In 1985 he took the position of chief executive officer in
the company.
 He held the position until his resignation in April of 2002.
It was his financial woes could have been the motivation
that sparked the fuel for the accounting scandal that
occurred under his supervision.
 He had an excess of $400 million dollars in personal
loans using his WorldCom stock as collateral at the time of
his resignation. (U.S. Telecommunications Company
WorldCom Says It Hid $3.8 Billion in Expenses; Write-
down Is Largest in U.S. History; Other Developments,
2002)
 was convicted and sentenced to 25 years in prison for his
role in the scandal.
 His appeal was eventually denied and he is currently
serving his time. (AccountancyAge.com, 2006)
Scott Sullivan
 the chief financial officer and secretary of
WorldCom.
 fired in June of 2002 for his blatant roll in
the improper accounting.
 a close ally of Bernard Ebbers. (U.S.
Telecommunications Company WorldCom
Says It Hid $3.8 Billion in Expenses; Write-
down Is Largest in U.S. History; Other
Developments, 2002)
 the star witness for the prosecution in the
trail against Bernard Ebbers.
 receive 5 years in prison for his own role in
the scandal. (AccountancyAge.com, 2005)
David Myers

 the controller and senior vice president of

WorldCom.
 resigned in June 2002, the same day as
the firing of Sullivan, because of his
alleged involvement in the improper
accounting. (U.S. Telecommunications
Company WorldCom Says It Hid $3.8
Billion in Expenses; Write-down Is Largest
in U.S. History; Other Developments, 2002)
 He was sentenced to 1 year and 1 day in
prison for his role in the scandal.
Buford “Buddy” Yates

 the former director of accounting at

WorldCom.
 charged and sentenced to 1 year and 1
day in prison for his role in the scandal.
(Bennett, 2005)
Betty Vinson

 former director of corporate accounting

at WorldCom.
 sentenced to five months in prison for
her role in the scandal. (Bennett, 2005)
Jack Grubman
 analyst on Wall Street at the time of the
scandal.
 had a very intimate relationship with key
members of many top organizations that he
was giving financial advice about to
customers.
 urged people to buy WorldCom securities and
then urged them sell.
 maintains that he was unaware of the scandal
until it was made publicly known.
 has been banned for life from the securities
business and ordered to pay a 15 million
dollar fine. He was not being charged
criminally. (Frontline, 2003)
Troy Normand

 former accountant for WorldCom.

 sentenced to 3 years probation for his

role in the scandal.
Arthur Anderson LLP

 Kenneth M. Avery and Melvin Dick were

the primary auditors representing their
firm in the WorldCom scandal.
 They were accused of not exercising
due care and skepticism in their 2001
audits of the company.
 Dick was barred from practicing
accounting for 4 years and Avery was
barred for 3 years. (Hawkes, 2008)
John Sidgmore
 vice chairman of the board until 2002
when Ebbers resigned.
 WorldCom’s new CEO.
 He was never charged in the accounting
scandal and maintains that he was not
involved in the finances of the company in
many years.
 He did publicly apologize on behalf of
WorldCom for its behavior and vowed to
see that those involved are punished.
(Obituary, 2003)
Cynthia Cooper

 Chief Internal Auditor of WorldCom.

 She brought the accounting discrepancies that
she and her team found to the attention of
Sullivan, Arthur Anderson LLP, Myers and many
more throughout the company.
 She was told to ignore the issue. She
conducted her own audit of the company in
comparison to the Arthur Anderson audit.
With the help of her team, she “blew the
whistle” on the scandal at WorldCom to their
audit committee in Washington D.C. (Carozza,
2008)
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)
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

 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
 How Was Fraud Uncovered?
 On May 21, 2002, a WorldCom employee sent a featured article to an internal auditor,
indicating that the issues raised in the article might warrant investigation
 Article was from the May 16 edition of Fort Worth Weekly Online and was based upon
interviews with a former WorldCom employee who was allegedly fired for whistle blowing.
 WorldCom’s Internal Audit Department began an investigation concerning the capitalization of
line costs.
 On June 12, 2002, the Internal Audit team contacted Max Bobbitt, the Chairman of the
Audit Committee of the Board of Directors.
 $2.5 billion in line costs that had been capitalized.
 Mr. Bobbitt requested that these issues be discussed with KPMG prior to a meeting of the
Audit Committee on June 14, 2002.
 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.
 Effect of Fraud
 WorldCom/MCI has acknowledged that it committed more fraud
than it original reported, raising the estimate from $3.8 billion
(June 25, 2002) to $7.2 billion (August 9, 2002) to $9 billion
(September 19, 2002).
 WorldCom/MCI overpaid taxes and sought to recover $300 million in federal
tax payments that it made to cover up its fraudulent activity.
 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/MCI lost an estimated $176B in
value in WorldCom stock, laid off 25,000 employees and caused
another 73,000 job losses in the industry.
Violations
 Violated the revenue recognition principle because
they recorded revenue entries that had no valid
economic activity underlying the entries.
 Defrauding investors on multiple occasions
 Improperly transferring certain cost to its capital
accounts
 Conflicts of interest
Suggestions to strengthen IC
 An active and independent Board of Directors and Committees;
 A corporate culture of candor, in which ethical conduct is encouraged
and expected, as exemplified by the ethics pledge that the
Company and the Corporate Monitor have developed and that
senior management has signed;
 A corporate culture in which the advice of lawyers is sought and
respected;
 Formalized and well-documented policies and procedures, including
a clear and effective channel through which employees can raise
concerns or report acts of misconduct;
 Conference for the whole company in order to be address the
concerns; and
 Increase the transparency of records to the public.
…

What will it profit a man if

he gains the world but
loose his own soul (Mark
8:36)