Not long ago, Enron was in a class of its own, a corporate giant filing bankruptcy amidst a scandal that revealed the company was fraudently concealing $1 billion in debt. However, WorldCom, the nation’s second largest long distance company, is making a strong bid to eclipse Enron’s infamy via reports that it has fraudently misclassified at least $3.85 billion in debt, has allegedly practiced a variety of accounting improprieties, and ultimately, may become the largest U.S. company to file bankruptcy. And, that is only a few of WorldCom’s many problems.
On the surface, Mississippi-based, WorldCom entered 2002 strong. The company’s stock was trading at $15 a share and, according to its financial reports, it was meeting all of its profit goals. However, in the spring, WorldCom’s stock began to slip, and the SEC launched an investigation into the company’s accounting practices as well as the circumstances surrounding its decision to lend Bernard J. Ebbers, WorldCom’s founder and CEO, $366 million to cover his stock losses. The investigation was spawned by a lawsuit filed by shareholders and a separate class action lawsuit that claimed WorldCom violated SEC regulations by reporting inflated values in financial statements for other telecom firms the company bought.
In this same period, WorldCom’s credit rating was reduced to junk status and its 2002 revenue forecast was reduced by $1 billion. Ebbers was ousted in late April, and John W. Sidgmore, former head of UUNet and a WorldCom VP, assumed the role of CEO.
Sidgmore was quick to action, announcing a day into his new post that WorldCom would conduct a month long review of its operations, sell underperforming divisions, and cut jobs to help reduce its $28 billion of debt. WorldCom’s wireless-resale business, a market leader, was put up for sale in early June, with plans to also offload stakes in Latin American telecom companies Avantel of Mexico and Embratel of Brazil. WorldCom also planned to scrap its tracking stocks and dividend payments.
In mid-May, the company replaced its auditor, Aurther Andersen, the notorious auditing firm that has been at the center of more than a dozen corporate scandals and lawsuits including those tied to Enron, Global Crossing, Waste Management, Sunbeam, and Qwest. Andersen was recently convicted for obstruction of justice for shredding Enron’s documents. As a replacement, WorldCom appointed KPMG. At the same time, the company had Cynthia Cooper, an internal auditor, employed to investigate loans to Ebbers.
By mid June, the company’s stock had dropped below $1 a share and its debt had grown to $32 billion. Moody’s Investors Service cut the company’s credit rating two notches, the fourth downgrade for the year, after it deferred interest payments on some of its MCI Group securities. Regardless of growing woes, WorldCom was prepared for a turn-around, with the release of a restructuring plan that included a $5 billion loan and the elimination of 17,000 jobs.
Just as WorldCom was paving the way for a recovery, Cooper reported the discovery of accounting fraud to the company’s board of directors. The board fired its CFO, Scott Sullivan, accepted the resignation of its senior vice president and controller, David Myers, and then went public with the news on Tuesday, June 26. According to the company, WorldCom had overstated its EBIDTA (earnings before interest, taxes, depreciation, and amortization), a measure of cash flow, by $3.85 billion, over the past 5 quarters ($3.06 billion in 2001 and $797 million in 2002). The company wrongly booked ordinary expenditures as capital expenditures. As a result, a profit for the quarters were reported rather than a net loss of $1.22 billion.
The SEC responded quickly. The governing body immediately filed civil fraud charges against WorldCom and had a court order issued to prevent the company from destroying documents and gifting company executives with large payouts. U.S. District Judge Jed Rakoff said he would appoint an independent monitor to ensure the company complies with the order. Until the monitor arrives, WorldCom is barred from paying employees and directors more than $100,000 and from making extraordinary payments to people who hold titles at or above the level of vice president, and to workers in the accounting and financial units. Recently, Richard Breenan, former head of the SEC, was named as the watchdog.
The SEC also ordered WorldCom to submit, under oath, a detailed report explaining how the firm improperly accounted for billions of dollars, by Monday, July 1.
Nasdaq responded by temporarily halting trading of Worldcom stock on Wednesday, June 26.
The House Financial Services Committee responded by issuing subpoenas for a July 8 hearing. Initial Subpoenas were delivered to former CFO, Scott Sullivan; former CEO, Bernard Ebbers; CEO, John Sidgmore; Chairman, Bert Roberts; and Salomon Smith Barney analyst, Jack Grubman. Grubman is being investigated by New York State Attorney General Eliot Spitzer for his possible criminal involvement in the fiasco.
Shortly after issuing the first 4 subpoenas, the committee added others to the list including Cynthia Cooper, the internal auditor that discovered the fraud; David Myers, the controller; Max Bobbit, Chairman of the audit committee; and Melvin Dick, a former senior partner at Arthur Andersen.
Upon discovering conflicting stories regarding the audit committee’s response to Cooper’s findings, the committee has recently dismissed Cooper and Bobbit from testifying. Cooper claims that Bobbit sat on the news before reporting it to the company’s board of directors, while Bobbit claims to have acted immediately.
The House Energy and Commerce Committe responded by issuing a letter to Sidgmore requesting a collection of business and accounting documents including those related to the internal audit and minutes from the company’s board and audit committees.
President Bush demanded accountability, proposing in his pre-recorded weekly radio address that Congress pass a 10-point plan to improve corporate responsibility, by forcing executives to lose all money they gained by fraud and serving jail time, if found criminally negligent. The proposal was initially introduced in March, in response to the Enron scandal. Bush has been criticized for being soft on big corporate crime and is expected to take a hard line on WorldCom to improve his reputation in this area.
Members of Congress are taking action to distance themselves from acquiring a similar image by returning campaign donations from WorldCom or re-directing them to other organizations. WorldCom and its workers have contributed to more than half the House members and about 80% of the Senate in the past 13 years, according to the Center for Responsive Politics. In the 2000 cycle, they gave roughly $1.8 million – more than two thirds to the GOP, which then held the majority in both the House and the Senate. WorldCom and its employees donated around $916,000 this election, split almost evenly between Republicans and Democrats. Most recently, the company donated $100,000 to the National Republican Senatorial Committee. The committee is returning the money. Other political leaders are passing the bucks to charities and other non-profit efforts such as worker relief funds.
Arthur Andersen, responsible for auditing WorldCom’s financial statements for 2001 and the first quarter of 2002, claimed it had no knowledge of the accounting fraud and that its work was in compliance with the SEC. A firm spokesman placed the blame on WorldCom’s CFO, Scott Sullivan. Sidgmore has suggested that the firm is either lying or incompetent.
On Monday, July 1, WorldCom submitted a four page, 24-paragraph memo signed and sworned by WorldCom’s general counsel, to the SEC. The document was not received well by SEC Chairman, Harvey L. Pitt, who called the statement, wholly inadequate and incomplete. He further stated that the memo demonstrates a lack of commitment to full disclosure to investors and less than full cooperation with the SEC.
In addition to commenting on the $3.8 billion misappropriation, WorldCom revealed that it had identified significant changes in reserves against potential financial losses that might be deemed fraudulent. The accounting referenced goes back to documents from 1999.
Companies use reserve accounts to set aside revenue to be used against predictable future costs, such as unpaid bills or pending lawsuits. Companies are allowed to increase and reduce the reserves, but they are not supposed to do it for the purpose of making revenues look better.
In a case last month, the SEC alleged that Microsoft enhanced its financial results by setting aside artificially large reserves to reduce revenues, with a plan to strategically reverse that procedure to record the revenues in less profitable times. Microsoft agreed to refrain from the practice.
WorldCom continued with bad news on Monday, stating that it had defaulted on $4.25 billion in bank loans.
On the same day, Nasdaq allowed WorldCom shares to trade again. More than 250 million shares changed hands in the first 15 minutes of trading, and by noon, the stock had become the most heavily traded stock ever in a single day in U.S. history. During the day, 1.47 billion shares changed hands, at prices as high as 15 cents and as low as 5 cents. It closed the day at just above 6 cents.
Disenchanted by WorldCom’s news and Monday’s trading activity, Nasdaq announced that the company’s shares would be removed from trading on Friday, July 5. The company has challenged the delisting, which could delay the stock’s removal.
Sidgmore has recently apologized publicly for the company’s past transgressions and has committed to disclosing all of its misconduct and operating above the board from now on. He placed the company’s future in the hands of its banks. According to the CEO, WorldCom has $2 billion in available cash to keep operations alive. However, to stay afloat, the banks must not call for the balance of loans. Further, Sidgmore is seeking a $5 billion loan, which will pay off $4 billion in credit and give the company $750 million to $1 billion in additional cash. WorldCom is facing a $2 billion debt payment in January that it may not be able to meet if funding is not made available.
The CEO’s statement sparked some optimism among investors. The stock rose on Tuesday, July 2 to 12 cents and then doubled again on Wednesday to close at 24 cents. Analysts continue to warn investors, stating the company may eventually trade all of its equity for debt.
In the meantime, dozens of lawsuits have been filed against WorldCom by former employees, state comptrollers, shareholders, and bondholders.
IDT has offered to buy MCI for around $2 billion and its MFS and Brooks Fiber corporate local services for between $3 billion and $4 billion. WorldCom has hoped to get between $5 billion and $6 billion for MCI, which it bought for $37 billion in 1998. The company paid $12 billion to acquire MFS in 1996, and $2.9 billion for Brooks in 1998. Since its inception, WorldCom has based its growth on a series of more than 70 acquisitions and mergers.
Other offers are expected.
Sidgmore has stated that WorldCom does not expect any interruption in its services, even if the company has to file bankruptcy.
WorldCom will face security fraud charges in a trial to be held next March.