WorldCom Scandal (2002)

Company: Telecommunications company; now MCI, Inc.

What happened: Inflated assets by as much as $11 billion, leading to 30,000
lost jobs and $180 billion in losses for investors.
Main player: CEO Bernie Ebbers
How he did it: Underreported line costs by capitalizing rather than expensing
and inflated revenues with fake accounting entries.
How he got caught: WorldCom's internal auditing department uncovered $3.8
billion of fraud.
Penalties: CFO was fired, controller resigned, and the company filed for
bankruptcy. Ebbers sentenced to 25 years for fraud, conspiracy and filing false
documents with regulators.
Fun fact: Within weeks of the scandal, Congress passed the Sarbanes-Oxley
Act, introducing the most sweeping set of new business regulations since the
1930s.

WorldCom's Failure: Why Did It

Happen?
PrintEmail

By Theodore F. di Stefano
Aug 19, 2005 7:00 AM PT

When WorldCom, the telecommunications giant, failed and was put into
bankruptcy, the U.S. witnessed one of the largest accounting frauds in
history. Former CEO, Bernie Ebbers, 63, was convicted of orchestrating this
US$11 billion accounting fraud and was sentenced to 25 years in prison on
July 13, 2005.
 How could a loss of this magnitude have occured? Where were the checks
and balances? The watchdogs? Specifically, whatever happened to
WorldCom's board of directors, the custodians of this once mighty
corporation? Were they "asleep at the switch?"

While examining this colossal failure in corporate governance and what could
have been done to avoid it, I came across a fascinating document entitled
"Report of Investigation" dated March 31, 2003. This Report was prepared
for, among others, the Federal Bankruptcy Court overseeing WorldCom. A
great deal of my research was obtained from the Report and all of the
quotes below can be directly attributed to the Report.

Accounting Misstatements

WorldCom made major accounting misstatements that hid the increasingly

perilous financial condition of the company. The Report described the
accounting shenanigans as follows: "... As enormous as the fraud was, it was
accomplished in a relatively mundane way: more than $9 billion in false or
unsupported accounting entries were made in WorldCom's financial systems
in order to achieve desired reported financial results ..."

What Drove the Fraud?

The driving factor behind this fraud was the business strategy of WorldCom's CEO,
Bernie Ebbers. In the 1990s, Ebbers was clearly focused on achieving impressive
growth through acquisitions.

How was he going to pay for this acquisition binge? By using the stock of
WorldCom. To accomplish this buying spree, the stock had to continually
increase in value.

Here's a bit of how the Report describes this scenario:

"... WorldCom pursued scores of increasingly large acquisitions. The strategy

reached its apex with WorldCom's acquisition in 1998 of MCI
Communications, a company with more than two-and-a-half times the
revenue of WorldCom. Ebbers' acquisition strategy largely came to an end
 by early 2000 when WorldCom was forced to abandon a proposed merger
with Sprint because of antitrust objections ..."

Ebbers felt the need to show ever-increasing revenue and income. His only
recourse to achieve this end was financial gimmickry. The problem is that
the more one resorts to this sort of deception, the more complicated it
becomes to continue it. Deception is just not sustainable in the long run.

Complicating Ebbers' situation was an industry-wide downturn in

telecommunications. During this time, Wall Street had continuing
expectations of double-digit growth for WorldCom. After all, they had
achieved so much in such a relatively short period of time.

However, WorldCom needed time for its management to catch up to its

newly acquired companies and learn how to run and manage them.
Unfortunately, Ebbers did not have the courage to tell Wall Street that
WorldCom needed time for the consolidation and digestion of its acquisitions.
In order to satisfy Wall Street's expectations, Ebbers had to doctor his
company's books.

If he had had the courage to tell them what was really needed, WorldCom
would be alive today and Ebbers wouldn't be facing the prospect of spending
the rest of his life in prison.

Another major factor driving this fraud was Ebbers' very apparent desire to
build and protect his personal financial condition. For this reason, he had to
show continually growing net worth in order to avoid margin calls on his own
WorldCom stock that he had pledged to secure loans.

This Debacle Could Have Been Stopped

It is obvious that the Board of Directors that was in place when WorldCom
was planting the seeds of its destruction could have stepped in and stopped
this financial death spiral.

Although the Report clearly puts a great deal of the blame on Ebbers saying,
"... The fraud was the consequence of the way WorldCom's Chief Executive
Officer, Bernard J. Ebbers, ran the Company ... he was the source of the
culture, as well as much of the pressure, that gave birth to this fraud," the
Board of Directors certainly shares this blame. As the Report states, "... The
setting in which it occurred was marked by a serious corporate governance
failure ..."

The Court-Ordered Fix

The Bankruptcy Court directed the newly constituted Board of Directors and
the newly appointed Corporate Monitor to fix this horrible example of
corporate malfeasance. The Report of Investigation includes
recommendations meant to "... cure the principal failing that gave rise to the
fraud: a lack of effective checks and balances on the power of senior
management ..." Here are a few:

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;

and

Formalized and well-documented policies and procedures, including a clear

and effective channel through which employees can raise concerns or report
acts of misconduct.

Make Your Company Transparent

You can avoid the pitfalls that plagued WorldCom by choosing a corporate culture
which would insure that a similar situation doesn't happen to your company. Two
sources of information on how to do this include the articles entitled "Your
Corporate Culture: A Boon or a Bane?" and "Choosing Your Board of Directors."

You should never have to fear what regulators or other government officials
would uncover if they were to take a good look at the workings of your
company. Transparency can bring you safety. It's a great way to get a good
night's sleep!

Good luck!