WORLDCOM SCAM

SYMBIOSIS INSTITUTE OF BUSINESS MANAGEMENT, BENGALURU

Proposed By

Vishal 19020841219
Tanmay Jaiswal 19020841151
Naresh Jani 19020841134
Dhruvi Manasta 19020841130
Andrew .P. Nongrum 19020841105

Under the guidance of

Prof. Shweta Bhargav

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 Abstract
The economic prosperity of the late 1990s was characterized by
a perceived expansive growth that increased the expectations of
a company’s performance. WorldCom, a telecommunications
company, was a victim of these expectations that led to the
evolution of a fraud designed to deceive the public until the
economic outlook improved. Through understanding what led to
the fraud, how the fraud grew, and what its effects were, lessons
can be derived to gain a better understanding of the reasons
behind a fraud and to prevent future frauds from occurring or
growing as big as the WorldCom fraud did.

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 CONTENT

S. No. Topic

1 Overview

2 Details of Scam

3 Financial Analysis
 Releasing Accruals
 Capitalizing Line Costs
 Revenue
 Ratio Comparison

4 Window Dressing

5 Punitive Actions
 Bankruptcy filings
 consequences

6 Violations and Standards

7 Remedial Measures

8 Suggestions

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Overview:

Worldcom was the provider of phone services to businesses and residents. It started as
“Long Distance Discount Services” (LDDS) that grew to become the third largest
telecommunications company in the US due to the management of CEO “Bernie Ebbers”.
Worldcom took the telecommunication industry by storm when it began a period of
acquisitions in the 90s. The low margins that the industry was accustomed to weren’t enough
for CEO of Worldcom. From 1995 until 2000, Worldcom purchased over 60 other
telecommunication firms. In 1997, WorldCom and MCI Communications announced their
merger of US$37 billion to form MCI WorldCom, making it the largest corporate merger in
U.S. In 1998, MCI WorldCom, opened for business, after MCI divested itself of its successful
"internet MCI" business to get approved from the U.S. Department of Justice. By 2001,
Worldcom owned one-third of all the data cables in the US. In 1999, Sprint Corporation and
MCI WorldCom announced a US$129 billion merger agreement between the two companies.
If the deal was completed, it would have been the largest corporate merger. The merged
company would have surpassed AT&T as the largest communications company in the U.S.
However, the deal failed due to opposition from the U.S. Department of Justice and the EU on
concerns that it would create a monopoly. In 2000, the boards of directors of both companies
terminated the merger. Later that year, MCI WorldCom renamed itself "WorldCom".

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Details of the Scam:
In 1999, growth in revenue slowed and the stock price started falling. WorldCom's expenses
in percentage of its total revenue increased because the growth rate of its earnings started
decreasing. This also meant WorldCom's income might not meet Wall Street analysts’
expectations. In an effort to increase revenue, WorldCom reduced the amount of money it
held in reserve by $2.79 billion and moved this money into its financial statements.
That wasn't enough to increase the earnings that Bernard wanted. In 2000, WorldCom
started classifying operating expenses as long-term investments. Hiding all these expenses
in this way gave them another $3.84 billion. These classified assets were expenses that
WorldCom paid to lease phone network lines from other companies to access their networks.
They also added entry for $500 million in computer expenses, but documents for the
expenses were never found. These changes turned WorldCom's losses into profits to the tune
of $1.37 billion in 2001.
On June 25, 2002, WorldCom announced that it intended to restate its financial statements
for 2001 and the first quarter of 2001. It was determined that certain transfers totalling
$3.85 billion during that period from “line cost” expenses to asset accounts were not made
in accordance with GAAP (generally accepted accounting principles).
Less than one month later, WorldCom and substantially all of its active US subsidiaries filed
voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code. WorldCom
announced that it discovered an additional $3.83 billion in improperly reported earnings
before taxes for the year 1999, 2000, 2001 and the first quarter of 2002. It has also written
off approximately $80 billion of the stated book value of the assets on the company’s balance
sheet at the same time fraud was announced. On June 26, 2002, the US Securities and
Exchange Commission filed a lawsuit.

Key Players Involved in WorldCom Scandal:

1. Bernard Ebbers - CEO in the Company
2. Scott Sullivan - CFO and Secretary of WorldCom
3. Cynthia Cooper - Chief Internal Auditor of WorldCom

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People who were affected:
1. Shareholders
2. Management
3. Employees
4. Creditors
5. Customers
6. Government

Financial Analysis:
The fraud committed by WorldCom was characterized mainly by the improper reduction of
line costs and false adjustments to report revenue growth. Line cost is the cost that
WorldCom had to pay to other telecommunication companies due to using their phone
calls. If WorldCom customer made a phone call from New York to London, then the call
would first go through the local telephone company’s line in New York to WorldCom’s long
distance and finally to London’s local telephone companies. This process was very costly
for WorldCom; in fact this was half of the cost that they had incurred in a particular time
period. WorldCom had to reduce those costs to make them profitable. Especially after 2000
it became crucial for them to manage those costs in a way that would help them to show
shareholders that WorldCom was profitable. WorldCom’s competitors such as Sprint and
AT&T had line costs that were 52% of revenues. WorldCom reported line costs of about
42% of revenues, in reality these costs were 50%-52% of revenues. WorldCom had made
inappropriate accrual releases both in the domestic and international divisions that
amounted to about $3.3 billion (Beresford, Katzenbach, & Rogers, 2003).

These are some of the ways through which they committed fraud:

Releasing Accruals:

According to Breeden (2003), the end of each month, during the fraud period at WorldCom,
was characterized by the estimation of costs that were associated with using the phone

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lines of other companies. The actual bill for the services was usually not received for
several months (Breeden, 3 Ahnaf & Others 2003).This meant that some of the entries they
had made to the payables were overestimated or underestimated. As result liability was
overestimated, and when the actual bill was received it would have had a surplus in
liability. Here is the journal entry to show the adjustment for WorldCom

Accounts Payable 1,000,000

Cash Paid to Suppliers 900,000

Line Cost Expense “release” 100,000

WorldCom adjusted its accruals in three ways; some accruals were released without even
confirming any accruals. Secondly, they didn’t release the accruals in proper time; instead
they kept them as “rainy days” future fund. Lastly, some of the accruals were released not
establishing any accruals.

Capitalizing Line Costs:

 WorldCom committed major fraud in capitalizing leased property as well.

 They paid 4% utilization periodically of fiber optics cable which didn’t generate any
revenue.
 WorldCom had leased fiber optics line for 2-5 years agreement that could not be
canceled. Then they showed it as a capital lease in the records with an estimated life
of 20 -30years. This increased the amount of fixed asset, which wasn’t authentic
according to GAAP.
 By the time the fraud was discovered, Sullivan had managed to improperly reduce
the line costs by approximately $3.883 billion (Beresford, Katzenbach, & Rogers
2003).
 WorldCom’s April 26, 2001 press release and subsequent 10-Q quaterly report filed
with the US Securities and Exchange Commission (SEC) reported $4.1 billion of line
costs and capital expenditure that included $544 million of capitalized line costs.

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 With $9.8 billion in reported revenues, WorldCom’s line-cost E/R ratio was
announced at 42% rather than the 50% it would have been without the
reclassification and accrual release.

Revenue:

 WorldCom initiated a process called ‘close the gap’ to falsify the information in
company records.
 There were meetings after every accounting period between top management who
helped to change the records of the company. They would receive a report called
‘MonRev’ report which showed the actual image of the company. 4 Ahnaf & Others.
 These records were heavily guarded by the company’s securities.
 Top executives would then make up and correct the gaps between the major journal
entries and financial statements. This way they prepared the company’s records for
public presentation.
 A total of approximately $958 million in revenue was improperly recorded by
WorldCom during 1999 – 2002 (Beresford, Katzenbach, & Rogers (2003).

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Ratio comparison:

In 2002, WorldCom showed disastrous market ratios even though S&P 500 promised quite
good benchmarks for the year. Considering the company’s financial situation, this was not
actually a surprise. With a crushing debt of $41 billion and $3.8 billion expenses
improperly booked, the company had to file for a bankruptcy. Later this led to a shocking
ROA of 1.33% and ROE of 2.39%, when S&P 500 benchmark showed an average 10% for
both ratios. Top-line growth was at negative 10% but surprisingly they managed to keep
their CA ratio at 0.99. Through comparing the market performance the disaster within the
company was pretty obvious.

WINDOW DRESSING:
Worldcom case is one of the most infamous examples of window dressing which was done
by inflating earnings through improper capitalization of expenses. WorldCom declared
bankruptcy in July 2002. Chief accounting and finance executives charged with securities
fraud. There are the following reasons which states, why they involve such type of
unethical exercise

 Shareholders and Potential shareholders will be interested to invest in the company if

the financial look is good.
 It is useful to seek funds from investors or to obtain any loan.
 The stock price of the company will shoot up if the financial performance is good. To
show a stable profit and results for the company.
 It is done to reassure the financial stability of the company to money lenders.
 It is done to achieve targeted financial results.
 It is done to showcase a good return on investment.
 To cover up the actual state of business in case the business is nearing insolvency.

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PUNITIVE ACTIONS:
Bankruptcy filings:

On July 21, 2002, WorldCom and substantially all of its direct and indirect domestic
subsidiaries filed voluntary petitions for relief in the United States Bankruptcy Court for the
Southern District of New York under chapter 11 of Title 11 of the United States Code. On
November 8, 2002, the company filed additional chapter 11 petitions for 43 of its
subsidiaries, collectively with the Initial Filers, the “Debtors”, most of which were effectively
inactive and none of which had significant debt. The Debtors continue to operate their
businesses and manage their properties as debtors-in-possession pursuant to sections
1107(a) and 1108 of the Bankruptcy Code. By orders dated July 22, 2002 and November 12,
2002, the Debtors’ chapter 11 cases were declared to be jointly administered. Accordingly,
pursuant to section 362 of the Bankruptcy Code, most of the litigation against the company
has been stayed.

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 By orders dated, May 28, 2003, July 11, 2003, August 2, 2003, and September 12, 2003,
the Bankruptcy Court approved the Debtors’ proposed disclosure statement for their
proposed joint plan of reorganization and the proposed modifications thereto. Pursuant to
the Disclosure Statement, the Debtors solicited votes on their proposed plan of
reorganization.

By order dated October 31, 2003, after due notice and a hearing, the Bankruptcy Court
confirmed the Debtor’s Modified Second Amended Joint Plan of Reorganization dated
October 21, 2003, which provides for, among other things, certain settlements, the
substantive consolidation of the Intermedia debtors (collectively, the Intermedia parent
company and subsidiaries), and the separate substantive consolidation of the WorldCom
debtors (collectively, all debtors other than the Intermedia debtors). The confirmation order
determined that the Plan complied with all of the requirements of the Bankruptcy Code. On
February 24, 2004, on a motion made by the Debtors, the Bankruptcy Court extended the
period of time for us to emerge from bankruptcy to April 30, 2004.

The New York federal district judge presiding over the securities cases, Denise L. Cote, has
wound up playing ringmaster as she tries to keep as many of them as possible consolidated
in her court through the pretrial stage. In doing so, she has issued scads of opinions and
orders that are both sternly worded and legally bold.
The class action trial is scheduled for Jan. 10 against the remaining defendants. Besides the
deep-pocketed investment banks, those defendants include the auditing and accounting firm
Arthur Andersen and 16 former officers and directors, including former CEO Bernard J.
Ebbers. WorldCom itself was not named as a defendant because the bankruptcy filing
entitled it to an automatic stay. Plaintiffs wanting to use other courts will have to wait in line
behind the class.

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CONSEQUENCES:

 The seven women and five men in the jury reached a verdict after deliberating for
about 40 hours over eight days. Mr. Ebbers was convicted of securities fraud,
conspiracy and seven counts of filing false reports with regulators. Each count
carries a sentence of 5 or 10 years.

 He was sentenced to 25 years in prison for his role in orchestrating the biggest
corporate fraud in the United States history. It’s in 2005, he was convicted of
securities fraud, conspiracy, and filing false documents. It resulted in a $180 billion
loss to investors and the biggest bankruptcy the U.S had ever seen, leaving 30,000
people unemployed. He even had to surrender $40 million of his assets including his
Mississippi home. Currently he is serving a 25 year sentence in a correctional
institution in Louisiana with projected release date of july 2028 at the age of 87.

 Scott Sullivan, the CFO( Chief Finance Officer) of the company was indicted on
several counts of accounting fraud related to Worldcom. He rose to CFO of
WorldCom through a close relationship with Bernie Ebbers by helping with
acquisitions and mergers. He was a leading executive, who was more than $19
millions in earning in 1998. He was fired after the discovery of accounting fraud in
2002. He was considered one of the masterminds behind the WorldCom scheme by
manipulating numbers.

 He was sentenced to 5 years in prison for his role of whole WorldCom financial
scam. However he was released from prison after 3 years confinement in jail and he
was sentenced for 5 years of home confinement.

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Violations and Standards:

In order to understand the violations, we have to know what the actual standards are, in
accounting books of any company expenses are treated in two ways i.e. either as capital
investment or current expenses. The capital investment are the expenses made in a
particular year which will have its effect for a long period of time. For example, installing a
new equipment or upgradation of an existing network etc. these expenses have an impact
over a very long period of time, in simple words the benefit of these expanse can’t be
measured in the return in that particular year only. And therefore these expenses are not
taken in the profit and loss statement but goes in the asset and liabilities section. Now
coming on to the current expenses, these can be considered as day to day expenses which
have impact for only short period of time, such as salary of employees, utilities rent, etc.
thus these expenses are booked in the profit and loss statement.
After the initial telecom boom of 1990’s the competition of telecom service provider
increased and this led to decline in profits earned by Worldcom. In order to maintain the
profit high in the books they started to transfer some of their current expenses in to the
capital investment category. In addition of this they also moved the capital held in reserve
into the revenue line. By doing this they were inflating their revenue and decreasing their
expenses. The result of this was, the profit shown in the books was higher than what actual
profit earned.
This practice was supposed to reported to the board by the audit committee as soon as
they found it and board was supposed to act on it immediately. But they failed to do so, and
this made the situation worse. The irregularities in the account book was found in 2001 by
the internal auditor, and the visible action taken can be considered as the sacking of then
CFO Scott Sullivan which was in 2002. It was stated that the cash flow was overstated by
more than 3 billion USD over a period of about 1 year.
Other than accounting violation the other violation can be observed in the loan of Bernie
Ebbers then CEO of Worldcom taken from the company. It was learned in 2002 that
worldcom had given loans of amounting to 341 million USD at a very nominal rate of
2.16%. this rate was even lower than the cost of capital for Worldcom. It was speculated

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that the main reason behind this can be the huge stakes held by Ebbers in Worldcom. And
that he might have to sell his shares in order to meet his financial needs. If Ebbers decides
to sell his stake, then it will be huge blow to the share value of Worldcom.
By using such strategies just to keep their market value high Worldcom started the
beginning to its end.

Remedial Measures:
 WorldCom, which registered the biggest bankruptcy after discovering a massive
accounting fraud, had slipped into the corporate history books.
 The business emerged from bankruptcy by taking the new name MCI, a brand it had
been using unofficially for the past year and in which shares in the stock market had
resume trading on the Nasdaq stock market in 2 week time.
 Under a court-supervised reorganisation, It had cut down its workforce from 70,000
to 50,000 and reshaped senior management. The company’s debts have been
reduced from $41 billion to $6 billion, to the chagrin of competitors, which argued
that it should simply be forced into liquidation.
 There should be strict Organisation policies as the Worldcom did not have any
control on top management.
 WorldCom had hired new accountants, KPMG, who have been asked to scour the
books back to 1999.
 In December 2005, Microsoft Corporation announced that MCI will join it by
providing Windows Live Messenger customers "Voice over Internet Protocol"
(VoIP) service to make telephone calls. This was MCI's last new product - called
"MCI Web Calling". After the merger, this product was renamed "Verizon Web
Calling".

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Suggestions:
 We can analyse specific area of weakness. The best way to do this is by viewing
Worldcom through the COSO framework such as control environment as there was
no whistle blowing function and risk assessment as there was no risk assessment
function either as there was only profit sharing and no loss sharing.
 There should be realistic financial goals and those goals should focus on the core
business operations rather than mergers and other investments.
 The real performance of the company should be measured by benchmarking the
industry and not by benchmarking from past performances.
 There should be strengthening of internal Audit Function where the proper amount
of resources are allocated properly.
 There should also be a very specify goal of that Audit department where they are
focusing not only on business segment reporting but also on the overall financial
reporting of the company
 Internal auditors should have access to all financial records and documentation
required for all journal entries. There should not be a lack of required authorisation.
 There should not be misdirecting for the employees and auditors and there should
not be any misallocation of resources in the departments.
 The compulsory rotation of a company’s auditors every five or six years.

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