The WorldCom Fraud

2003, 2005
by the AICPA

This presentation is intended for use in higher education for instructional purposes only, and is not for
application in practice. Permission is granted to classroom instructors to photocopy this document for
classroom teaching purposes only. All other rights are reserved. Copyright 2003, 2005 by the
American Institute of Certified Public Accountants, Inc., New York, New York.

WorldComs Background
Awoke the sleeping giant by leading the telecom industry into
profitability in the 90s.
Telecom industry faced low margins and Bernie Ebbers decided
growth=survival

During the 1990s, WorldCom was deeply involved in acquisitions and

completed several mega-deals

Purchased over 60 firms in 2nd half of the 90s

WorldCom moved into Internet and data traffic
Handled 50% of US Internet traffic
Handled 50% of e-mails worldwide
2003, 2005 by the AICPA

WorldComs Background (cont)

Purchased MCI for $37 billion in 1997

Not allowed to purchase Sprint in 2000 because of antitrust regulation.

In 1999 revenue growth halted; stock price dropped

By 2001 owned a third of the US data cables

Was U.S. 2nd largest long-distance operator in 1998 and 2002

Had over 20 million customers in 2002

2003, 2005 by the AICPA

Bernard Ebbers, CEO

Borrowed $366 million to cover losses on stock which was not
repaid

Secured loans from WorldCom to fund personal investments

including a $100 million Canada ranch, $658 million in Mississippi

timberlands and a $14 million Georgia shipyard

Netted $140 million from stock sales

Facing dismissal, he resigned from WorldCom on April 30, 2002
Bernie Ebbers classic resignation statement:
"I am confident that WorldCom will continue to lead the
industry, setting the standards others will follow.

2003, 2005 by the AICPA

Scott Sullivan, CFO

Served as CFO, treasurer and secretary
Directed staff to make false accounting
entries
Personally made false and misleading
public statements regarding finances
Netted $45 million from stock sales

2003, 2005 by the AICPA

How the Fraud took place

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

Reserves didnt cut it; An e-mail was sent in December

2000 to a division in Texas directing misclassification of

expenses.

CFO told key staff members to mark operating costs as

long-term investments.
To the tune of $3.85 billion.

2003, 2005 by the AICPA

How the Fraud took place (cont)

Operating Expenses to Assets
-CFOs directions affected the income statement:
Revenues
xxx (no change)
COGS
xxx (no change)
Operating Expenses:
Fees paid to lease other
companies phone networks:

xxx (Huge Decrease)

Computer expenses:

xxx (Huge Decrease)

NET INCOME

xxx (Huge Increase)

2003, 2005 by the AICPA

How the Fraud took place (cont)

Operating Expenses to Assets
-CFOs directions affected the balance sheet:
Assets:
Computer assets
Leasing assets

xxx (Huge Increase)

xxx (Huge Increase)

Liabilities
Stockholders Equity:

xxx (no change)

Retained Earnings

xxx (Huge Increase)

=HAPPY INVESTORS

2003, 2005 by the AICPA

How the Fraud took place (cont)

Operating Expenses into Assets
WorldComs journal entry for $500 million in computer
expenses:
Computer Assets
Cash

500 million
500 million

The documents supporting the expenses were not found!

2003, 2005 by the AICPA

How the Fraud took place (cont)

Huge losses turned into enormous profits.
$1.38 billion in net income in 2001

Inflated the companys value in its assets

2003, 2005 by the AICPA

How the Fraud was discovered

1. Obscure tips were sent into the Internal audit
team

2. MCI audit and review of books uncovered

accounting irregularities

3. In March 2002, John Stupka complained to

Internal audit about $400 million he set aside

that Sullivan wanted to use to boost
WorldComs income.

2003, 2005 by the AICPA

How the Fraud was discovered (cont)

4.

March 7, 2002 - the SEC requests information from WorldCom

How could WorldCom make so much when AT&T is losing
money?

5.

The Internal audit started digging

Found $2 billion company announced for capital expenditures
(Internal Auditors found it was never authorized for capital
expenditures.)
Found the undocumented $500 million in computer expenses
that were recorded as assets.
Searching WorldComs computers, Mr. Morse found $2 billion in
questionable entries

2003, 2005 by the AICPA

How the Fraud was discovered (cont)

6. June 14, 2002 - The Internal audit team
contacted WorldComs audit committee

7. Internal auditor, Cindy Cooper, asked for

documents supporting numerous capital
expenditures.
No supporting documents were found

8. The controller admits to internal auditors that

the accounting treatment is wrong

States no accounting standards support this

accounting

2003, 2005 by the AICPA

How the Fraud was discovered (cont)

9. June 20, 2002 - Internal audit explains irregularities to
the Audit committee.

10. June 25, 2002 - WorldCom announces it inflated profits

by $3.8 billion over the previous five quarters

11. June 26, 2002 - civil suit filed, stock trading halted

Ultimately, stock was delisted by Nasdaq

12. July 21, 2002 - WorldCom filed for bankruptcy

2003, 2005 by the AICPA

Post-Fraud Happenings
17,000 jobs cut to save $1 billion.
WorldCom may write off $50.6 billion in intangible
assets.

Added additional board members to serve on a special

investigative panel to review accounting practices:
Former US Attorney General Nicholas Katzenbach
Dennis Beresford, Former Chairman of the FASB

WorldCom is trying to secure loans

2003, 2005 by the AICPA

Post-Fraud Happenings (cont)

John Sidgmore, the CEO replacing Ebbers,
stated he wants to move forward:

We want the bad guys exposed. We want the

bad guys punished. And we want to move on
with our lives at WorldCom."

2003, 2005 by the AICPA

Post-Fraud Happenings (cont)

WorldCom was renamed MCI in 2004 when it
emerged from bankruptcy

Possible court-approved debt reductions

Company could spin off several business units

2003, 2005 by the AICPA

Post-Fraud Happenings (cont)

Scott Sullivan
In August 2002, Scott Sullivan, CFO, was indicted by a grand jury on one
count of fraud and six counts of securities fraud and false filings involving
almost $8 billion. He pleaded not guilty.

On March 2, 2004, in a superseded indictment, Sullivan pleaded guilty to 3

federal criminal charges for fraud and conspiracy.

Faces maximum 25 years in prison. Struck plea deal with government

to testify against Bernie Ebbers. Sullivan to be sentenced after Ebbers
trial.

2003, 2005 by the AICPA

Post-fraud happenings (cont)

Bernie Ebbers
September 2003 pleaded not guilty to 15 felony counts of violating
Oklahoma securities laws. Charges dropped. Oklahoma Attorney
General to refile charges at a later date

January 19, 2005 - Federal jury trial on charges of fraud to

begin in which Scott Sullivan is expected to testify against
him
Possible sentence: 25+ years in prison

2003, 2005 by the AICPA

Post-fraud happenings (cont)

Directors
January 2005 - 10 former directors agreed
to pay $54 million to settle a shareholder
class-action lawsuit
$18 million to be paid by the directors themselves
$36 million paid by the liability insurance

February 28, 2005 Trial to begin against former auditors/directors who

have not settled during class-action

2003, 2005 by the AICPA