HISTORY & EVOLUTION

 Long Distance Discount Services, Inc. (LDDS) began in

Hattiesburg, Mississippi in 1983.

 In 1985 LDDS selected Bernard Ebbers to be its CEO.

 The company name was changed to LDDS WorldCom in

1995, and later just WorldCom.

 The company’s growth under WorldCom was fueled primarily

through acquisitions during the 1990s and reached its apex
with the acquisition of MCI in 1998.
 Telecom industry faced low margins; Ebbers
decided growth=survival
Ebbers purchased over 60 firms in 2nd half of the
90’s.

 WorldCom moved into Internet and data traffic

 Handles 50% of US Internet traffic

 Handles 50% of e-mails worldwide

 1999 revenue growth halted; stock dropped

 Major Companies
acquired
 Advanced Communications Corp. (1992)

 Metromedia Communication Corp.(1993)

 Resurgens Communications Group(1993)

 IDB Communications Group, Inc (1994)

 CompuServe from its parent company H&R

Block

 Digex (DIGX) in June 2001 On November 10,

1997
 On November 10, 1997, WorldCom and MCI
Communications announced their US$37 billion
merger to form MCI WorldCom, making it the
largest merger in US history. On September 15,
1998 the new company, MCI WorldCom, opened
for business.

 On October 5, 1999 Sprint Corporation and MCI

WorldCom announced a $129 billion merger
agreement between the two companies. Had the
deal been completed, it would have been the
largest corporate merger in history, ultimately
putting WorldCom ahead of AT&T as the largest
communications company in the United States.

 However the deal did not go through because of

 Condition of American
Corporate firms in 90’s
 In the early 1990s, the US economy went
through a phase of consolidation, in which many
major companies acquired or merged with
weaker companies to strengthen their own
position in the market (as seen earlier,
WorldCom happened to be one of the key
acquirers in this phase).

 The share prices of companies play a vital role

during mergers and acquisitions. Therefore
companies try to 'maintain' the prices of their
shares (that is, keep them sufficiently high). If
they fail to do so, they can easily become
targets for takeover/acquisition.
 Moreover, if a company wishes to raise capital
from the market, its performance on the stock
exchange is considered to be very important. The
companies are generally valued on the basis of
cash flows they could generate in future. As the
financial performance of a company is one of the
most important (and direct) factors affecting its
share price, companies were under constant
pressure to show positive revenue streams...
 Down turn of “TELECOM INDUSTRY”.
 Brains behind the fraud of
$11bn

 CEO Bernard Ebbers

 CFO Scott Sullivan
 Former controller David Myers
 Former accounting director Buford Yates
 Former accounting managers Betty Vinson and
Troy Normand
 Arthur Anderson auditing firm
 Ebbers Angle (borrowed more than $ 1 billion
for personal purposes from various banks. He
pledged his WorldCom stock as collateral. )
 Bernard Ebbers became very wealthy from the rising
price of his holdings in WorldCom’s stock. However,
shortly after the MCI acquisition in 1998, the
telecommunications industry entered a downturn and
WorldCom’s growth strategy suffered a serious blow
when it was forced to abandon its proposed merger
with Sprint in late 2000. By that time, WorldCom’s stock
was declining and Ebbers came under increasing
pressure from banks to cover margin calls on his
WorldCom stock that was used to finance his other
businesses (timber and yachting, among others).

 During 2001, Ebbers persuaded WorldCom’s board of

directors to provide him corporate loans and
guarantees in excess of $400 million to cover his
margin calls. The board hoped that the loans would
avert the need for Ebbers to sell substantial amounts of
his WorldCom stock, as his doing so would put further
downward pressure in the stock's price. However, this
strategy ultimately failed and Ebbers was ousted as
CEO in April 2002 and replaced by John Sidgmore,
 Beginning in 1999 and continuing through May
2002, the company (under the direction of Scott
Sullivan (CFO), David Myers (Controller) and
Buford “Buddy” Yates (Director of General
Accounting) used fraudulent accounting methods
to mask its declining earnings by painting a false
picture of financial growth and profitability to
prop up the price of WorldCom’s stock.
 Method used
The fraud was accomplished primarily in two ways:

 Underreporting ‘line costs’ (interconnection

expenses with other telecommunication companies)
by capitalizing these costs on the balance sheet
rather than properly expensing them.

 Inflating revenues with bogus accounting entries

from ‘corporate unallocated revenue accounts’.

 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
 How the Fraud took
place?
 Operating Expenses to Assets?

-Mr. Sullivan’s directions affected the income

statement:
Revenues xxx (no change)
COGS xxx (no change)
rom Operating Expenses:
e dF
mov me Fees paid to lease other
Re Inco ent companies phone networks: xxx (Huge Decrease)
t e m
Sta
F rom
d
o ve e Computer expenses: xxx (Huge Decrease)
m m
Re Inco ent
t e m NET INCOME xxx (Huge Increase)
Sta
 How the Fraud took
place?
 Operating Expenses to Assets?

-Mr. Sullivan’s directions affected the balance sheet:

Assets:
t o Computer assets xxx (Huge Increase)
d
Adde SheetLeasing assets xxx (Huge Increase)
ce
n
Bala

Liabilities xxx (no change)

Stockholders Equity:
e d to Retained Earnings xxx (Huge Increase)
Add Sheet
a la nce
B
=HAPPY INVESTORS
 Final Countdown
 As media, legal and investor unrest intensified
against WorldCom, there was little hope left for
the company. The company was required to pay $
172 million in interest and debt in 2002, which
was to increase further to $ 1.7 billion and $ 2.6
billion as a part of the repayment schedule in
2003 and 2004.
 Negative cash flow of $ 871 million in 2001
 Generated only $ 564 million in free cash flow in
2002 and $ 1 billion in 2003.
 The company admitted that it had resorted to
fraudulent accounting practices for five quarters
(four quarters of 2001 and the first quarter of
2002)
 Bankruptcy
 On July 21, 2002, WorldCom filed for Chapter 11
bankruptcy protection in the largest such filing
in United States history at the time (since
overtaken by the collapse of Lehman Brothers
in September 2008). The WorldCom bankruptcy
proceedings were held before U.S. Federal
Bankruptcy Judge Arthur J. Gonzalez who
simultaneously heard the Enron bankruptcy
proceedings which were the second largest
bankruptcy case resulting from one of the largest
corporate fraud scandals. None of the criminal
proceedings against WorldCom and its officers
and agents were originated by referral from
Gonzalez or Department of Justice lawyers.
 Impact of WorldCom fall
down
 Ebber was sentenced 25yrs imprisonment
 Standard & Poor's reduced WorldCom's credit
rating to junk status and WorldCom was removed
from the prestigious S&P 500 Index
 The share price fell by over 80%
 On June 26, the SEC filed a suit alleging
"securities fraud" against WorldCom in a district
court in New York.
 17000 employees lost there jobs
 Ordinary investors were put into severe loss
 WorldCom changed its name to MCI, and moved
the corporate headquarters from
Clinton, Mississippi to Dulles, Virginia, on April 14,
2003.
 Under the bankruptcy reorganization agreement,
the company paid $750 million to the SEC in cash
and stock in the new MCI, which was intended to
be paid to wronged investors.
 AT&T is seen as a potential gainer in the
aftermath of WorldCom's inevitable collapse.