WorldCom Case Study

From Benchmark to Bankrupt

(Updated 2006)

Between July 2002 when WorldCom declared bankruptcy and April 2004 when it emerged from bankruptcy as MC ! company officials worked fe"erishly to restate the financials and reorgani#e the company$ %he new C&' Michael Capellas (formerly C&' of Compa) Computer* and the newly appointed C+' ,obert Blakely faced the daunting task of settling the company-s outstanding debt of around ./0 billion and performing a rigorous financial audit of the company$ %his was a monumental task! at one point utili#ing an army of o"er 000 WorldCom employees! o"er 200 employees of the company-s outside auditor! 12M3! and a supplemental workforce of almost 400 people from 5eloitte 6 %ouch$ As Joseph McCafferty notes! 7(a*t the peak of the audit! in late 200/! WorldCom had about 8!000 people working on the restatement! under the combined management of Blakely and fi"e controllers9(the t* otal cost to complete it: a mind;blowing ./40 million7(McCafferty! 2004*$ n addition to re"ealing sloppy and fraudulent bookkeeping! the post;bankruptcy audit found two important new pieces of information that only ser"ed to increase the amount of fraud at WorldCom$ +irst! 7WorldCom had o"er"alued se"eral ac)uisitions by a total of .0$< billion7(McCafferty! 2004*$ n addition! =ulli"an and &bbers! 7had claimed a preta> profit for 2000 of .?$4 billion7 (McCafferty! 2004*$ n reality! WorldCom lost 7.4<$@ billion (including a .4? billion write;down of impaired assets*$7 Conse)uently! instead of a .80 billion profit for the years 2000 and 2008! WorldCom had a combined loss for the years 2000 through 2002 (the year it declared bankruptcy* of .?/$? billion$ f the .0$< billion of o"er"alued assets is added to this figure! the total fraud at WorldCom amounted to a staggering .?@$0 billion$ Although the newly audited financial statements e>posed the impact of the WorldCom fraud on the company-s shareholders! creditors! and other stakeholders! other information made public since 2002 re"ealed the effects of the fraud on the company-s competitors and the telecommunications industry as a whole$ %hese show that the fall of WorldCom altered the fortunes of a number of telecommunications industry participants! none more so than A%6% Corporation$ %he CABC news show! 7%he Big Bie: nside the ,ise and +raud of WorldCom!7 e>posed the e>tent of the WorldCom fraud on se"eral key participants! including the then;chairmen of A%6% and =print (+aber! 200/*$ %he so;called 7big lie7 was promoted through a spreadsheet de"eloped by %om =tluka! a capacity planner at WorldCom! that modeled in &>cel format the amount of traffic WorldCom could e>pect in a best;case scenario of nternet growth$ n essence! 7=tluka-s model suggested that in the best of all possible worlds nternet traffic would double e"ery 800 days7 (+aber! 200/*$ n working with the model! =tluka simply assigned "ariables with "arious parameters to 7whate"er we think is appropriate7(+aber! 200/*$ %his was innocent enough! had it remained an e>ercise$ A problem emerged when the e>ercise was e>tended and integrated into corporate strategy! when it was adopted and implemented by WorldCom and then by the telecommunications industry$ Within a year! 7other companies were touting it7 and the model was gi"en credibility it should not ha"e been accorded (+aber! 200/*$ As =tluka e>plains! 7there were a lot of people who were saying 80C growth! doubling e"ery three to four months! doubling e"ery 800 days! 8!000 percent! that kind of thing7 (+aber! 200/*$ But it wasn-t true$ 7 don-t recall traffic $$$ in fact growing at that rate 9 still! WorldCom-s lie had become an immutable law$7 'ptimistic scenarios with little foundation in reality began to spread and per"ade the industry$ %hey became emblematic of the 7smoke and mirrors7 beha"ior not only at WorldCom prior to its collapse! but the industry as a whole$ +ictitious numbers dro"e not Dust WorldCom! but also other companies as they reacted to WorldCom-s optimistic proDections$ According to Michael Armstrong! then chairman and C&' of A%6%! 7+or some period of time! can recall that we were back;filling that e>pectation with laying cable! something like 2!200 miles of cable an hour7 (+aber! 200/*$ Ee adds: 7%hink of all the companies that went out of business that assumed that that was real$7 %he fallout from the WorldCom debacle was significant$ Feri#on obtained the freshly minted MC for .?$4 billion! but not the ./0 billion of debt MC had when it declared bankruptcy (Ale>ander! 2000*$ Although WorldCom was

one of the largest telecommunications companies with nearly .840 billion in assets! shareholder suits obtained .4$8 billion from a "ariety of sources including in"estment banks! former board members and auditors of WorldCom (Belson! 2000*$ f this sum were e"enly distributed among the firms 2$@4< billion common shares! the payoff would (ha"e been* well under .8 a share for a stock that peaked at .4@$@8 on Jan$ 20007 (Ale>ander! 2000! /*$ %here are more losers in the aftermath of the WorldCom wreck$ %he reemerged MC was left with about 00!000 employees! down from <<!000 at its peak$ =ince March 2008! howe"er! 7about /00!000 telecommunications workers ha"e lost their Dobs$ %he sector-s total employment;8$0/2 million;is at an eight year low7 (Ale>ander! 2000! /*$ %he carnage does not stop there$ %elecommunications e)uipment manufacturers such as Bucent %echnologies! Aortell Aetworks! and Corning! while benefiting initially from WorldCom-s groundless predictions! suffered in the end with layoffs and depressed share prices$ 2erhaps most significant! in 5ecember 2000! the "enerable A%6% Corporation ceased to e>ist as an independent company$

__________________________________________________

2002 saw an unprecedented number of corporate scandals: &nron! %yco! 3lobal Crossing$ n many ways! WorldCom is Dust another case of failed corporate go"ernance! accounting abuses! and outright greed$ But none of these other companies had senior e>ecuti"es as colorful and likable as Bernie &bbers$ A Canadian by birth! the 4 foot! / inch former basketball coach and =unday =chool teacher emerged from the collapse of WorldCom not only broke but with a personal net worth as a negati"e nine;digit number$ Ao palace in a gated community! no stable of racehorses or multi;million dollar yacht to show for the telecommunications giant he createdG only debts and red ink;;results some consider ine"itable gi"en his unflagging enthusiasm and entrepreneurial flair$ %here is no )uestion that he did some pretty bad stuff! but he really wasn-t like the corporate "illains of his day: Andy +astow of &nron! 5ennis 1oslowski of %yco! or 3ary Winnick of 3lobal Crossing$ 2ersonally! Bernie is a hard guy not to like$ n 8@@< when Bernie was in the midst of ac)uiring the telecommunications firm MC ! ,e"erend Jesse Jackson! speaking at an all;black college near WorldCom-s Mississippi head)uarters! asked how &bbers could afford ./0 billion for MC but hadn-t donated funds to local black students$ Businessman Be,oy Walker Jr$! was in the audience at Jackson-s speech! and afterwards set him straight$ &bbers had gi"en o"er .8 million plus loads of information technology to that black college$ 7Bernie &bbers!7 Walker reportedly told Jackson! 7is my mentor$7 ,e"$ Jackson was won o"er! but who wouldn-t be by this erstwhile milkman and bar bouncer who ser"es meals to the homeless at +rank-s +amous Biscuits in downtown Jackson! Mississippi! and wears Deans! cowboy boots! and a funky tur)uoise watch to work$ t was 8@</ in a coffee shop in Eattiesburg! Mississippi that Mr$ &bbers first helped create the business concept that would become WorldCom$ 7Who could ha"e thought that a small business in itty bitty Mississippi would one day ri"al A%6%H7 asked an editorial in Jackson! Mississippi-s Clarion;Bedger newspaper$ Bernie-s fall I and the company-s ; was abrupt$ n June 8@@@ with WorldCom-s shares trading at .44! he was a billionaire! and WorldCom was the darling of the Aew &conomy$ By early May of 2002! &bbers resigned his post as C&'! declaring that he was 78!000 percent con"inced in my heart that this is a temporary thing$7 %wo months later! in spite of Bernie-s unflagging optimism! WorldCom declared itself the largest bankruptcy in American history$ %his case describes three maDor issues in the fall of WorldCom: the corporate strategy of growth through ac)uisition! the use of loans to senior e>ecuti"es! and threats to corporate go"ernance created by chumminess and lack of arm-s;length dealing$ %he case concludes with a brief description of the hero of the case ; whistle blower Cynthia Cooper$ The Growth through Acquisition Merr !Go!"ound +rom its humble beginnings as an obscure long distance telephone company WorldCom! through the e>ecution of an aggressi"e ac)uisition strategy! e"ol"ed into the second;largest long distance telephone company in the Jnited =tates and one of the largest companies handling worldwide nternet data traffic$ According to the WorldCom Web site! at its high point! the company! K 2ro"ided mission;critical communications ser"ices for tens of thousands of businesses around the world K Carried more international "oice traffic than any other company K Carried a significant amount of the world-s nternet traffic

K 'wned and operated a global 2 ( nternet 2rotocol* backbone that pro"ided connecti"ity in more than 2!400 cities and in more than 800 countries K 'wned and operated ?0 data centers on fi"e continents$ L5ata centers pro"ide hosting and allocation ser"ices to businesses for their mission;critical business computer applications$M WorldCom achie"ed its position as a significant player in the telecommunications industry through the successful completion of 40 ac)uisitions$ Between 8@@8 and 8@@?! WorldCom spent almost .40 billion in the ac)uisition of many of these companies and accumulated .48 billion in debt$ %wo of these ac)uisitions were particularly significant$ %he M+= Communications ac)uisition enabled WorldCom to obtain JJAet! a maDor supplier of nternet ser"ices to business! and MC Communications ga"e WorldCom one of the largest pro"iders of business and consumer telephone ser"ice$ By 8@@?! WorldCom-s stock had risen from pennies per share to o"er .40 a share$ %hrough what appeared to be a prescient and successful business strategy at the height of the nternet boom! WorldCom became a darling of Wall =treet$ n the heady days of the technology bubble Wall =treet took notice of WorldCom and its then "isionary C&'! Bernie &bbers$ %his was a company 7on the mo"e!7 and Wall =treet in"estment banks! analysts and brokers began to disco"er WorldCom-s "alue and make 7strong buy recommendations7 to in"estors$ As this process began to unfold! the analysts- recommendations! coupled with the continued rise of the stock market! made WorldCom stock desirable! and the market-s "iew of the stock was that it could only go up$ As the stock "alue went up! it was easier for WorldCom to use stock as the "ehicle to continue to purchase additional companies$ %he ac)uisition of M+= Communications and MC Communications were! perhaps! the most significant in the long list of WorldCom ac)uisitions$ With the ac)uisition of M+= Communications and its JJAet unit! 7WorldCom suddenly had an in"estment story to offer about the "alue of combining long distance! local ser"ice and data communications$7 n late 8@@?! British %elecommunications Corporation made a .8@ billion bid for MC $ Fery )uickly! &bbers made a counter offer of ./0 billion in WorldCom stock$ n addition! &bbers agreed to assume .0 billion in MC debt! making the deal ./0 billion or 8$< times the "alue of the British %elecom offer$ MC took WorldCom-s offer! making WorldCom a truly significant global telecommunications company$ All this would be Dust another story of a successful growth strategy if it weren-t for one significant business reality! mergers and ac)uisitions! especially large ones! present significant managerial challenges in at least two areas$ +irst! management must deal with the challenge of integrating new and old organi#ations into a single smoothly functioning business$ %his is a time;consuming process that in"ol"es thoughtful planning and considerable senior managerial attention if the ac)uisition process is to increase the "alue of the firm to both shareholders and stakeholders$ With 40 ac)uisitions in si> years and se"eral of them large ones! WorldCom management had a great deal on their plate$ %he second challenge is the re)uirement to account for the financial aspects of the ac)uisition$ %he complete financial integration of the ac)uired company must be accomplished! including an accounting of assets! debts! goodwill and a host of other financially important factors$ %his must be accomplished through the application of generally accepted accounting practices (3AA2*$ WorldCom-s efforts to integrate MC illustrate se"eral areas senior management did not address well$ n the first place! &bbers appeared to be an indifferent e>ecuti"e who 7paid scant attention to the details of operations$7 +or e>ample! customer ser"ice deteriorated$ 'ne business customer-s ser"ice was discontinued incorrectly! and when the customer contacted customer ser"ice! he was told he was not a customer$ Jltimately! the WorldCom representati"e told him that if he was a customer! he had called the wrong office because the office he called only handled MC accounts$ %his poor customer stumbled 7across a problem stemming from WorldCom-s ac)uisition binge: +or all its talent in buying competitors! the company was not up to the task of merging them$ 5o#ens of conflicting computer systems remained! local systems were repetiti"e and failed to work together properly! and billing systems were not coordinated$7 2oor integration of ac)uired companies also resulted in numerous organi#ational problems$ Among them were: K =enior management made little effort to de"elop a cooperati"e mindset among the "arious units of WorldCom$ K nter;unit struggles were allowed to undermine the de"elopment of a unified ser"ice deli"ery network$ K WorldCom closed three important MC technical ser"ice centers that contributed to network maintenance only to open twel"e different centers that! in the words of one engineer! were duplicate and inefficient$ K Competiti"e local e>change carriers (Clercs* were another managerial nightmare$

WorldCom purchased a large number of these to pro"ide local ser"ice$ According to one e>ecuti"e! 7the WorldCom model was a "ast wasteland of Clercs! and all capacity was e>pensi"e and "ery underutili#ed$ %here was far too much redundancy! and we paid far too much to get it$7 ,egarding financial reporting! WorldCom used a liberal interpretation of accounting rules when preparing financial statements$ n an effort to make it appear that profits were increasing! WorldCom would write down in one )uarter millions of dollars in assets it ac)uired while! at the same time! it 7included in this charge against earnings the cost of company e>penses e>pected in the future$ %he result was bigger losses in the current )uarter but smaller ones in future )uarters! so that its profit picture would seem to be impro"ing$7 %he ac)uisition of MC ga"e WorldCom another accounting opportunity$ While reducing the book "alue of some MC assets by se"eral billion dollars! the company increased the "alue of 7good will!7 that is! intangible assets! a brand name! for e>ample! by the same amount$ %his enabled WorldCom each year to charge a smaller amount against earnings by spreading these large e>penses o"er decades rather than years$ %he net result was WorldCom-s ability to cut annual e>penses! acknowledge all MC re"enue and boost profits from the ac)uisition$ WorldCom managers also tweaked their assumptions about accounts recei"ables! the amount of money customers owe the company$ +or a considerable time period! management chose to ignore credit department lists of customers who had not paid their bills and were unlikely to do so$ n this area! managerial assumptions play two important roles in recei"ables accounting$ n the first place! they contribute to the amount of funds reser"ed to co"er bad debts$ %he lower the assumption of non;collectable bills! the smaller the reser"e fund re)uired$ %he result is higher earnings$ =econdly! if a company sells recei"ables to a third party! which WorldCom did! then the assumptions contributed to the amount or recei"ables a"ailable for sale$ =o long as there were ac)uisition targets a"ailable! the merry;go;round kept turning! and WorldCom could continue these practices$ %he stock price was high! and accounting practices allowed the company to ma>imi#e the financial ad"antages of the ac)uisitions while minimi#ing the negati"e aspects$ WorldCom and Wall =treet could ignore the consolidation issues because the new ac)uisitions allowed management to focus on the beha"ior so welcome by e"eryone! the continued rise in the share price$ All this was put in Deopardy when! in 2000! the go"ernment refused to allow WorldCom-s ac)uisition of =print$ %he denial stopped the carousel! put an end to WorldCom-s ac)uisition;without;consolidation strategy and left management a stark choice between focusing on creating "alue from the pre"ious ac)uisitions with the possible loss of share "alue or trying to find other creati"e ways to sustain and increase the share price$ n July 2002! WorldCom filed for bankruptcy protection after se"eral disclosures regarding accounting irregularities$ Among them was the admission of improperly accounting for operating e>penses as capital e>penses in "iolation of generally accepted accounting practices (3AA2*$ WorldCom has admitted to a .@ billion adDustment for the period from 8@@@ through the first )uarter of 2002$ #weetheart $oans to #enior %&ecuti'es Bernie &bbers- passion for his corporate creation loaded him up on common stock$ %hrough generous stock options and purchases! &bbers- WorldCom holdings grew and grew! and he typically financed these purchases with his e>isting holdings as collateral$ %his was not a problem until the "alue of WorldCom stock declined! and Bernie faced margin calls (a demand to put up more collateral for outstanding loans* on some of his purchases$ At that point he faced a difficult dilemma$ Because his personal assets were insufficient to meet the call! he could either sell some of his common shares to finance the margin calls or re)uest a loan from the company to co"er the calls$ Net! when the board learned of his problem! it refused to let him sell his shares on the grounds that it would depress the stock price and signal a lack of confidence about WorldCom-s future$ Ead he pressed the matter and sold his stock! he would ha"e escaped the bankruptcy financially whole! but &bbers honestly thought WorldCom would reco"er$ %hus! it was enthusiasm and not greed that trapped Mr$ &bbers$ %he e>ecuti"es associated with other corporate scandals sold at the top$ n fact! other WorldCom e>ecuti"es did much! much better than &bbers did$ Bernie borrowed against his stock$ %hat course of action makes sense if you belie"e the stock will go up! but it-s the road to ruin if the stock goes down$ Jnlike the others! he intended to make himself rich taking the rest of the shareholders with him$ n his entire career! Mr$ &bbers sold company shares only half a do#en times$ 5etractors may find him irascible and arrogant! but defenders describe him as a principled man$

%he policy of boards of directors authori#ing loans for senior e>ecuti"es raises eyebrows$ %he sheer magnitude of the loans to &bbers was breathtaking$ %he ./48 million loan the board granted Mr$ &bbers is the largest amount any publicly traded company has lent to one of its officers in recent memory$ Beyond that! some )uestion whether such loans are ethical$ 7A large loan to a senior e>ecuti"e epitomi#es concerns about conflict of interest and breach of fiduciary duty!7 said former =&C enforcement official =eth %aube$ Ae"ertheless! 2? percent of maDor publicly traded companies had loans outstanding for e>ecuti"e officers in 2000 up from 8?percent in 8@@< (most commonly for stock purchase but also home buying and relocation*$ Moreo"er! there is the claim that e>ecuti"e loans are commonly sweetheart deals in"ol"ing interest rates that constitute a poor return on company assets$ WorldCom charged &bbers slightly more than 2 percent interest! a rate considerably below that a"ailable to 7a"erage7 borrowers and also below the company-s marginal rate of return$ Considering such factors! one compensation analyst claims that such lending 7should not be part of the general pay scheme of perks for e>ecuti"es$ Dust think it-s the wrong thing to do$7 (hat)s a *od or (ink Among Friends+ n the autumn of 8@@<! =ecurities and &>change Commission Chairman Arthur Be"itt Jr$ uttered the prescient criticism! 7Auditors and analysts are participants in a game of nods and winks$7 t should come as no surprise that it was Arthur Andersen that endorsed many of the accounting irregularities that contributed to WorldCom-s demise$ Beyond that! howe"er! was a host of incredibly chummy relationships between WorldCom-s management and Wall =treet analysts$ =ince the 3lass;=teagall Act was repealed in 8@@@! financial institutions ha"e been free to offer an almost limitless range of financial ser"ices to their commercial and in"estment clients$ Citigroup! the result of the merger of Citibank and %ra"elers nsurance Company! which owned the in"estment bank and brokerage firm =olomon =mith Barney! was an early beneficiary of in"estment deregulation$ Citibank regularly dispensed cheap loans and lines of credit as a means of attracting and rewarding corporate clients for highly lucrati"e work in mergers and ac)uisitions$ =ince WorldCom was so acti"e in that mode! their senior managers were the targets of a great deal of influence peddling by their banker! Citibank$ +or e>ample! %ra"elers nsurance! a Citigroup unit! lent .8/4 million to a timber company Bernie &bbers was hea"ily in"ested in$ &ight months later ! WorldCom chose =alomon =mith Barney! Citigroup-s brokerage unit! to be the lead underwriter of .0 billion of its bond issue$ But the entanglements went both ways$ =ince the loan to &bbers was collaterali#ed by his e)uity holdings! Citigroup had reason to prop up WorldCom stock$ And no one was better at that than Jack 3rubman! =alomon =mith Barney-s telecommunication analyst$ 3rubman first met Bernie &bbers in the early 8@@0s when he was heading up the precursor to WorldCom! B55= Communications$ %he two hit it off socially! and 3rubman started hyping the company$ n"estors were handsomely rewarded for following 3rubman-s buy recommendations until stock reached its high! and 3rubman rose financially and by reputation$ n fact! Institutional Investing maga#ine ga"e Jack a Aumber 8 ranking in 8@@@! and Business Week labeled him 7one of the most powerful players on Wall =treet$ %he in"estor community has always been ambi"alent about the relationship between analysts and the companies they analy#e$ As long as analyst recommendations are correct! close relations ha"e a positi"e insider )uality! but when their recommendations turn sour! corruption is suspected$ Certainly 3rubman did e"erything he could to tout his personal relationship with Bernie &bbers$ Ee bragged about attending Bernie-s wedding in 8@@@$ Ee attended board meeting at WorldCom-s head)uarters$ Analysts at competing firms were annoyed with this chumminess$ While the other analysts strained to glimpse any tidbit of information from the company-s conference call! 3rubman would monopoli#e the con"ersation with comments about 7dinner last night$7 t is not known who picked up the tab for such dinners! but 3rubman certainly rewarded e>ecuti"es for their close relationship with him$ Both &bbers and WorldCom C+' =cott =ulli"an were granted pri"ileged allocations in 2' ( nitial 2ublic 'ffering* auctions$ While the =ecurities and &>change Commission allows underwriters like =alomon =mith Barney to distribute their allotment of new securities as they see fit among their customers! this sort of fa"oritism has angered many small in"estors$ Banks defend this practice by contending that pro"iding high net;worth indi"iduals with fa"ored access to hot 2's is Dust good business$ Alternati"ely! they allege that greasing the palms of distinguished in"estors creates a marketing 7bu##7 around an 2'! helping deser"ing small companies trying to go public get the market attention they deser"e$ +or the record! Mr$ &bbers personally made .88 million in trading profits o"er a four;year period on

shares from initial public offerings he recei"ed from =alomon =mith Barney$ from 2's! indicating that they were apparently not 7sure things$7

n contrast! Mr$ =ulli"an lost .8/!000

%here is little )uestion but that friendly relations between 3rubman and WorldCom helped in"estors from 8@@0 to 8@@@$ Many trusted 3rubman-s insider status and followed his rosy recommendations to financial success$ n a 2000 profile in Business Week! he seemed to mock the ethical norm against conflict of interest: 7What used to be a conflict is now a synergy!7 he said at the time$ 7=omeone like me would ha"e been looked at disdainfully by the buy side 80 years ago$ Aow they know that -m in the flow of what-s going on$7 Net! when the stock started cratering later that year! 3rubman-s enthusiasm for WorldCom persisted$ ndeed! he maintained the highest rating on WorldCom until March 8<! 2002! when he finally raised its risk rating$ At that time! the stock had fallen almost @0 percent from its high two years before$ 3rubman-s mea culpa to clients on April 22 read! 7 n retrospect the depth and length of the decline in enterprise spending has been stronger and more damaging to WorldCom than we e"en anticipated$7 An official statement from =alomon =mith Barney two weeks later seemed to contradict the notion that 3rubman-s analysis was conflicted: 7Mr$ 3rubman was not alone in his enthusiasm for the future prospects of the company$ Eis co"erage was based purely on information yielded during his analysis and was not based on personal relationships$7 ,ight$ 'n August 80! 2002! Jack 3rubman resigned from =alomon where he had made as much as .20 millionOyear$ Eis resignation letter read in part! 7 understand the disappointment and anger felt by in"estors as a result of the company-s collapse! am ne"ertheless proud of the work and the analysts who work with me did$7 'n 5ecember 8@! 2002! Jack 3rubman was fined .80 million and was banned from securities transactions for life by the =ecurities and &>change Commission for such conflicts of interest$ %he media "ilification that accompanies one-s fall from power unearthed one interesting detail about 3rubman-s character;he repeated lied about his personal background$ A graduate of Boston Jni"ersity! Mr$ 3rubman claimed a degree from M %$ Moreo"er! he claimed to ha"e grown up in colorful =outh Boston! while his roots were actually in Boston-s comparati"ely bland '>ford Circle neighborhood$ What makes a person fib about his personal history is an open )uestion$ As it turns out! this is probably the least of Jack 3rubman-s present worries$ Aew Nork =tate Controller E$ Carl McCall sued Citicorp! Arthur Andersen! Jack 3rubman! and others for conflict of interest$ According to Mr$ McCall! 7%his is another case of corporate co#iness costing in"estors billions of dollars and raising troubling )uestions about the integrity of the information in"estors$ The ,ero o- the .ase Ao integrity )uestions can be raised about Cynthia Cooper whose careful detecti"e work as an internal auditor at WorldCom e>posed some of the accounting irregularities apparently intended to decei"e in"estors$ 'riginally assigned responsibilities in operational auditing! Cynthia and her colleagues grew suspicious of a number of peculiar financial transactions and went outside their assigned responsibilities to in"estigate$ What they found was a series of cle"er manipulations intended to bury almost .4 billion in misallocated e>penses and phony accounting entries$ A nati"e of Clinton! Mississippi! where WorldCom-s head)uarters was located! Ms$ Cooper conducted her detecti"e work was in secret! often late at night to a"oid suspicion$ %he thing that first aroused her curiosity came in March 2002 when a senior line manager complained to her that her boss! C+' =cott =ulli"an! had usurped a .400 million reser"e account he had set aside as a hedge against anticipated re"enue losses$ %hat didn-t seem kosher! so Cooper in)uired of WorldCom-s accounting firm! Arthur Andersen$ %hey brushed her off! and Ms$ Cooper decided to press the matter with the board-s audit committee$ %hat put her in direct conflict with her boss! =ulli"an! who ultimately backed down$ %he ne>t day! howe"er! he warned her to stay out of such matters$ Jndeterred and emboldened by the knowledge that Andersen had been discredited by the &nron case and that the =&C was in"estigating WorldCom! Cynthia decided to continue her in"estigation$ Along the way! she learned of a WorldCom financial analyst who was fired a year earlier for failing to go along with accounting chicanery$ Jltimately! she and her team unco"ered a .2 billion accounting entry for capital e>penditures that had ne"er been authori#ed$ t appeared that the company was attempting to represent operating costs as capital e>penditures in order to make the company look more profitable$ %o gather further e"idence! Cynthia-s team began an unauthori#ed search through WorldCom-s computeri#ed accounting information system$ What they found was e"idence that fraud was being committed$ When =ulli"an heard of the ongoing audit! he asked Cooper to delay her work until the third

)uarter$ =he bra"ely declined$ =he went to the board-s audit committee and in June! =cott =ulli"an and two others were terminated$ What Ms$ Cooper had disco"ered was the largest accounting fraud in J$=$ history$ As single;minded as Cynthia Cooper appeared during this entire affair! it was an incredibly trying ordeal$ Eer parents and friends noticed that she was under considerable stress and was losing weight$ According to the Wall =treet Journal! she and her colleagues worried 7that their findings would be de"astating to the company and whether their re"elations would result in layoffs and obsessed about whether they were Dumping to unwarranted conclusions that their colleagues at WorldCom were committing fraud$ 2lus! they feared that they would somehow end up being blamed for the mess$7 PPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPP The Impact on Individuals The WorldCom fiasco had a permanent effect on the lives of its key players as well. Cynthia Cooper, who spearheaded the uncovering of the fraud, went on to become one of Time Maga ine!s "##" $ersons of the %ear. &he also received a number of awards, including the "##' (ccounting )*emplar (ward, given to an individual who has made notable contributions to professionalism and ethics in accounting practice or education. (t present, she travels e*tensively, speaking to students and professionals about the importance of strong ethical and moral leadership in business +,ationwide &peakers Bureau, "##-.. )ven so, as /ennis Moberg points out, 0(fter )bbers and &ullivan left the company, 0...Cooper was treated less positively than her virtuous acts warranted. In an interview with her on 11 May "##2, she indicated that, for two years following their departure, her salary was fro en, her auditing position authority was circumscribed, and her budget was cut00+Moberg, "##3, -13.. (s far as the protagonists are concerned, in (pril "##", C)4 Bernie )bbers resigned and two months later, C54 &cott &ullivan was fired. &hortly thereafter, in (ugust "##", &ullivan and former Controller /avid Myers were arrested and charged with securities fraud. In ,ovember "##", former Compa6 chief Michael Capellas was named C)4 of WorldCom and in (pril "##', 7obert Blakely was named the company!s C54. In March "##-, &ullivan pleaded guilty to criminal charges +McCafferty, "##-.. (t that time, too, )bbers was formally charged with one count of conspiracy to commit securities fraud, one count of securities fraud, and seven counts of fraud related to false filings with the &ecurity and )*change Commission +8nited &tates /istrict Court 9 &outhern /istrict of ,ew %ork, "##-.. Two months later, in May of "##-, Citigroup settled class action litigation for :1.3- billion after9ta* brought on behalf of purchasers of WorldCom securities +Citigroup Inc., "##-.. In like manner, ;$Morgan Chase < Co., agreed to pay :" billion to settle claims by investors that it should have known WorldCom!s books were fraudulent when it helped sell :2 billion in company bonds +7ovella, "##2.. 4n March 12, "##2, )bbers was found guilty of all charges and on ;uly 1'th of that year, sentenced to twenty9five years in prison, which was possibly a life sentence for the 3'9year9old. =e was e*pected to report to a federal prison on 4ctober 1"th, but remained free while his lawyers appealed his conviction +$appalardo, "##2.. (t the time of his conviction, )bbers! lawyers claimed the >udge in the case gave the >ury inappropriate instructions about )bbers! knowledge of WorldCom!s accounting fraud +$appalardo, "##2.. By ;anuary of "##3, 7eid Weingarten, )bber!s lawyer, was claiming that the previous trial was manipulated against )bbers because three high level WorldCom e*ecutives were barred from testifying on )bbers! behalf. (t that time, too, ;udge ;ose Cabranes of the 8& &econd Circuit Court of (ppeals commented, 0There are many violent criminals who don!t get "2 years in prison. Twenty years does seem an awfully long time0 +MacIntyre, "##3.. Weingarten went on to assert that the government 0should have charged the three former WorldCom employees that could have helped e*onerate )bbers or let them go0 +7eporter, "##3.. =e charged, too, that 0the >ury was wrongly instructed that it could convict )bbers on the basis of so9called 0conscious avoidance0 of knowledge of the fraud at WorldCom0 +7eporter, "##3.. $erhaps most compellingly, Weingarten called into 6uestion the fairness of )bbers! sentence that was five times as long as that given to e*9WorldCom financial chief &cott &ullivan +7eporter, "##3..

Weingarten!s claims are not without merit. In (ugust "##2, former C54 &ullivan was sentenced to five years in prison for his role in engineering the :11 billion accounting fraud. =is relatively light sentence was part of a bargain wherein he agreed to plead guilty to the charges filed against him and to cooperate with prosecutors as they built a case against )bbers. In doing so, &ullivan became the prosecution!s main witness against )bbers and the only person to testify that he discussed the WorldCom fraud directly with )bbers +5erranti, "##2.. 4thers involved in the scandal were also treated less harshly than )bbers. In &eptember "##2, >udgments were rendered approving settlement and dismissing action against /avid Myers and a number of others associated with WorldCom +8nited &tates /istrict Court 9 &outhern /istrict of ,ew %ork, ;udgment (pproving &ettlement and /ismissing (ction (gainst Buford %ates and /avid Myers, "##2, ;udgment (pproving &ettlement and /ismissing (ction (gainst ;ames C. (llen, ;udith (reen, Carl ;. (ycock, Ma* ). Bobbitt, Clifford ?. (le*ander, ;r., 5rancesco @alesi, &tiles (. Aellett, ;r., @ordon &. Macklin, ;ohn (. $orter, Bert C. 7oberts, ;r., The )state of ;ohn W. &idgmore, and ?awrence C. Tucker, "##2.. (t the time of this update, )bbers has been convicted by a court of law, but remains free on bail while he pursues an appeal. (lthough the e*tent of his punishment is under contention, one thing remains clear 9 that )bbers and the other officers at WorldCom are guilty of presiding over what is to date, the largest corporate fraud in history.

Answer all Questions 8$ &>plain the terms Qcreative accountingB and Cearnings managementB.(/ marks) 2$ %hree maDor issues ha"e been linked to the fall of WorldCom: i$ the corporate strategy of growth through ac)uisition! ii$ the use of loans to senior e>ecuti"es! and iii$ threats to corporate go"ernance created by chumminess and lack of arm-s;length dealing$ n your own words! summarise how each of the abo"e factors contributed to the collapse of the company$ (0/ marks) /$ 5iscuss how WorldCom used creati"e accounting to portray that the companyRs profit were increasing when it fact it was making huge losses during the period of 2000 I 2002$ (20 marks) 4$ &>plain the conse)uences of the scandal to the "arious stakeholders such as shareholders! employees and others$ (00 marks)