WorldCom Scandal 2002

Case Study

Business Accountancy
•Jaspreet
•Krish
•Raghav
•Lakhshit
•Naga
 • About Bernie Ebbers
• Building of WorldCom
 Worldcom’s History
 About WorldCom
Table Of • WorldCom Peak 1999 (The Fraud)
Contents • Unravelling Of The Fraud
• Aftermath
• Consequences
• Key Events
 • Bernard John Ebbers (August 27, 1941 – February 2, 2020) was a
Canadian businessman, the co-founder and CEO of WorldCom and a
convicted fraudster. Under his management, WorldCom grew rapidly
but collapsed in 2002 amid revelations of accounting irregularities,
making it at the time one of the largest accounting scandals in the
United States
• After high school, Ebbers briefly attended the University of Alberta
About and Calvin College before enrolling at Mississippi College on a
basketball scholarship. Between schools, he worked as a milkman and

Bernie bouncer. An injury before his senior season prevented him from
playing his final year and he was instead assigned to coach the junior
varsity team. In 1967, he received a Bachelor's degree in physical
Ebbers education, with an academic minor in secondary education, from
Mississippi College.
• Ebbers began his business career operating a chain of motels in
Mississippi .In 1983, in a coffee shop in Hattiesburg, Mississippi, he
and 3 other investors formed Long Distance Discount Services, Inc.
and in 1985, he was named chief executive officer. The company
acquired over 60 telecommunications firms and in 1995, it changed
its name to WorldCom
  WorldCom’s History
• LDDS began operations in January 1984 with 200 customers. At first
LDDS had neither sufficient technical expertise nor the right
technical equipment (such as switching facilities) to win over larger
and more profitable companies.

Building • In order to grow the company, LDDS needed to invest in equipment

and properly trained technical staff, but this was expensive and the
WorldCom company was soon struggling financially. By the end of 1984 LDDS
had accumulated debts of about $1.5 million.

• Ebbers had proved himself as a shrewd business man in running his

motel chain, it was decided by the board of LDDs that it would be
useful to ask him to take charge and in 1985 Ebbers became CEO.
Within a few months Ebbers was able to turn the company round
and turn it into a profitable business.
• In a relatively short time LDDS, with Ebbers as CEO, had grown very
quickly and by 1988 sales were $95 million. In order to maintain this
rate of growth and the strategy of expansion, Ebbers realized that the
company would have to get a stock market quotation to gain access
to the necessary finance. A suitable opportunity presented itself
when a NASDAQ listed company, Advantage Companies Inc. (ACI) was
facing bankruptcy and LDDS acquired it in 1989.
• In 1995, LDDS took over one of its major suppliers, WilTel, leading to
cost savings and synergy gains. In May 1995, LDDS was renamed
WorldCom, which underlined the ambitious global intentions of both
the company and Ebbers.
• WorldCom’s entry into the Internet market was considerably helped
by the purchase of UUNET Technologies, which was headed by John
Sidgmore when it was taken over in 1996 by MFS Communications
Company. Within weeks, WorldCom took over MFS and Sidgmore
joined WorldCom to head its Internet division. In 1996, the Wall
Street Journal ranked WorldCom as number one in terms of
shareholder return over the previous decade.
 • MCI, Inc. (previously Worldcom and MCI WorldCom) was a
telecommunications company. For a time, it was the second largest
long-distance telephone company in the United States, after AT&T.
Worldcom grew largely by acquiring other telecommunications
companies, including MCI Communications in 1998, and filed
About bankruptcy in 2002 after an accounting scandal, in which several
executives, including CEO Bernard Ebbers, were convicted of a

WorldCom
scheme to inflate the company's assets. In January 2006, the
company, by then renamed MCI, was acquired by Verizon
Communications and was later integrated into Verizon Business.

• Worldcom was originally headquartered in Clinton, Mississippi before

relocating to Ashburn, Virginia when it changed its name to MCI
 •In 1999, revenue growth slowed and the stock price began falling.
WorldCom's expenses as a percentage of its total revenue increased
because the growth rate of its earnings dropped. This also meant
WorldCom's earnings might not meet Wall Street analysts' expectations.
In an effort to increase revenue, WorldCom reduced the amount of
money it held in reserve (to cover liabilities for the companies it had
WorldCom acquired) by $2.8 billion and moved this money into the revenue line of
its financial statements.

Peak 1999 •Thus the members of senior management engaged in a continuing

series of improper accounting manipulations to try and achieve market

( The Fraud)
expectations on growth and making the financial reports more
appealing. The initial fraudulent methods included
• changes to financial estimates,
• early revenue recognition,
• erroneous capitalization of the long term assets
• alteration of the reserves in order to improve the earnings
picture.
 • The above frauds were not enough to boost the earnings that Ebbers
wanted. In 2000, WorldCom began classifying operating expenses as
long-term capital investments. Hiding these expenses in this way gave
them another $3.85 billion. These newly classified assets were

WorldCom expenses that WorldCom paid to lease phone network lines from
other companies to access their networks. They also added a journal
entry for $500 million in computer expenses, but supporting
Peak 2000 documents for the expenses were never found.

( The Fraud) • These changes turned WorldCom's losses into profits to the tune of
$1.38 billion in 2001. It also made WorldCom's assets appear more
valuable.
 •In 2001, the internal audit team noticed accounting irregularities
spotted in MCI's books, the SEC requested that WorldCom provide more
information. The SEC was suspicious because while WorldCom was
making so much profit, AT&T (another telecom giant) was losing money.
• An internal audit turned up the billions that the WorldCom had
announced as capital expenditures as well as the $500 million in
Unravelling undocumented computer expenses. There was also another $2 billion in
questionable entries. WorldCom's audit committee was asked for

Of The
documents supporting capital expenditures, but it could not produce
them. The controller admitted to the internal auditors that they weren't
following accounting standards. WorldCom then admitted to inflating its
Fraud profits by $3.8 billion over the previous five quarters. A little over a
month after the internal audit began, WorldCom filed for bankruptcy.
•Cynthia Cooper, VP of Internal audit, questioned external auditors
about some dubious accounting transactions. The accountants who had
made the entries, and the auditors called these “pre-paid capacity” –
but no one could explain what this meant. These related to apparently
ordinary operating expenses which had been treated as capital
investment which is a fraud.
• This questioning by the internal audit team became a crucial issue at
WorldCom and an important contributor to its decline in share price.
If the audit committee and the board had acted more quickly, then
confidence in WorldCom’s accounts might have been maintained.

• Sullivan was sacked as CFO on 24 June 2002. Two days later it was
reported that WorldCom had overstated its cash flow by more than
$3.8 billion during the previous five quarters, which was referred to as
‘one of the largest cases of false corporate book keeping yet
 •While the debtors of WorldCom were protected from some losses,
Within days, the stock of not so long ago major player in the
telecommunication industry fell well under $1.
•The consequences of the bankruptcy were severe for shareholders,
who lost virtually all their investments, and many employees lost their
jobs. Creditors also lost out.
• At the time of the bankruptcy, substantial numbers of employees were
Consequences laid off and it was predicted that the shareholders would receive
nothing for their shares. For employees who also held WorldCom’s
shares, the bankruptcy was a double blow.
•By the same token, 17,000 WorldCom employees lost their jobs
together with insurance and pensions, which have collapsed along with
the share price. Three years after the fraud was revealed, Bernard
Ebbers, who had already left the company’s CEO position, was found
guilty and sentenced to 25 years of prison for the charges of fraud,
conspiracy and filing false documents.
• WorldCom’s fraudulent activities gradually took its toll on the entire
U.S. telecommunications industry. Equipment manufacturers such as
Lucent Technologies, Nortell Networks, and Corning which had
initially been benefitting from WorldCom’s fictitious profitability and
projections ultimately suffered with depressed stock prices and were
forced to lay off work forces, too.
• WorldCom’s then larger rival, the telecommunication company AT&T
(American Telephone & Telegraph) had been laying off tens of
thousands in the late 90’s as it was trying to match WorldCom’s
phantom profits
• The Sarbanes-Oxley Act (SOX) was enacted in July 2002 was shortly
passed after this scandal to restore investors' confidence in the
financial markets and close loopholes that allowed public companies
to defraud investors. By the end of 2003, it was estimated that the
company’s total assets had been inflated by about $11 billion; making
the WorldCom Fraud the largest accounting fraud in American history
at that time.
 • 1983 – LDDS (Long Distance Discount Services) created
• 1985 – Bernie Ebbers appointed chief executive officer of LDDS
• 1992-Scott Sullivan joins LDDS
• 1994 – Scott Sullivan promoted to chief financial officer
• 1995 – LDDS changes name to WorldCom
• 1998- WorldCom completed takeover of MCI

Key Events • 1999- WorldCom begins to reclassify some operating expenses as

capital expenditure
• 2000 – WorldCom shareholders approve takeover of Sprint, but
regulators block deal
• 2001 – Internal auditors find overpayments on sales
• 2000 – WorldCom shareholders approve takeover of Sprint, but
regulators block deal
• 2001 – Internal auditors find overpayments on sales commissions
• 2002:
1. March – Public learns that WorldCom has loaned Ebbers $341
million.
2. April – Ebbers resigns as CEO; Sidgmore takes over.
3. June – Cynthia Cooper reports to WorldCom audit committee on
capital expenditure accounting (13 June); Sullivan is dismissed as CFO
(24 June); WorldCom reports cash flows overstated by $3.8 billion (26
June)
4. July – WorldCom Files for bankruptcy (21 July); Sarbanes-Oxley Act
becomes law (30 July)
5. August – WorldCom reports additional $3.3 billion in accounting
irregularities
6. September – Sidgmore resigns as CEO
7. December – Federal judges approve compensation package for new
CEO, Michael Capellas
 2004:
1.March – Sullivan pleads guilty to fraud and conspiracy and agrees
to testify against Ebbers, who faces similar charges
2.May – WorldCom emerges from bankruptcy and is renamed MC I