World.com
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WorldCom began as a small long distance telephone provider and grew through acquisitions to become a large telecommunications company. However, in 2000-2002 fraudulent accounting practices were uncovered that inflated reported profits by $3.8 billion through improperly capitalizing regular operating costs. This led to WorldCom filing for the largest bankruptcy in US history at the time in 2002. Key executives were later charged and convicted for their role in the fraud scheme.
World.com
- 1. Presented By:- Sonu Kumar Prachee Pathak
- 2. • WorldCom Inc. began as a small Mississippi provider of long distance telephone service called LDDS. • 1996: Acquired MFS Communications (internet backbone) • 1998: Acquired MCI • 2000: Failed merger with Sprint • 2000: Dotcom Bubble Burst (rapid decline in telecom stock values) • 2002: Accounting Fraud uncovered • 2002: Filed for Bankruptcy Protection COMPANY OVERVIEW
- 3. Top Executives • Charles Cannada - CFO • Scott Sullivan -Vice President and assistant treasurer & Later CFO-David Myers - Controller • John W. Sidgmore- Chief Executive • Bernie Ebbers- CEO WorldCom • Jack Grubman- Analyst with Salmon Smith Barney • Whistle blower- Cynthia Cooper
- 4. • 75 mergers & acquisitions of other companies MCI acquisition • The largest merger in the US history • On November 1997, WorldCom and MCI Communication announced their $37 billion merger to form MCI WorldCom Proposed Sprint merger • On October 1999, Sprint and MCI WorldCom announced a $129 billion merger agreement • The deal did not go through due to concerns of it creating monopoly & anticompetitive environment. WorldCom’s Acquisitions
- 5. • The collapse of the organization • In July of 2002 WorldCom filed the biggest bankruptcy ever in the U.S history with a $41 billion debt load and more than $ 107 billion in assets Filing chapter 11 bankruptcy due to: • Fraud • Accounting mis-statements • Managerial issues after the mergers • Failure Board of Directors WorldCom’s Failure
- 6. The rise and Fall of WorldCom TIMELINE
- 7. 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
- 8. 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
- 9. 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 didn’t 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.
- 10. How the Fraud took place (con’t) • Operating Expenses to Assets -CFO’s 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)
- 11. How the Fraud took place (con’t) • Operating Expenses to Assets -CFO’s directions affected the balance sheet: Assets: Computer assets xxx (Huge Increase) Leasing assets xxx (Huge Increase) Liabilities xxx (no change) Stockholders Equity: Retained Earnings xxx (Huge Increase) =HAPPY INVESTORS
- 12. How the Fraud took place (con’t) • Operating Expenses into Assets • WorldCom’s journal entry for $500 million in computer expenses: Computer Assets 500 million Cash 500 million The documents supporting the expenses were not found!
- 13. How the Fraud took place (con’t) • Huge losses turned into enormous profits. • $1.38 billion in net income in 2001 • Inflated the company’s value in its assets
- 14. WHISTLE-BLOWER CYNTHIA COOPER Cooper‘s internal audit team, in the beginning of June 2002, discovered $2.3 billion in questionable expenses, including $500 million in undocumented computer expenses.
- 15. 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, it was complained to Internal audit about $400 million he set aside that Sullivan wanted to use to boost WorldCom’s income.
- 16. How the Fraud was discovered (con’t) 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 WorldCom’s computers, found $2 billion in questionable entries
- 17. How the Fraud was discovered (con’t) 6. June 14, 2002 - The Internal audit team contacted WorldCom’s audit committee 7. Internal auditor, Cynthia 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
- 18. How the Fraud was discovered (con’t) 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
- 19. 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
- 20. Post-Fraud Happenings (con’t) • WorldCom was renamed MCI in 2004 when it emerged from bankruptcy • Possible court-approved debt reductions • Company could spin off several business units
- 21. Post-fraud happenings (con’t) Directors January 2005 - 10 former directors agreed to pay $54 million to settle a shareholder class-action lawsuit. • February 28, 2005 – Trial to begin against former auditors/directors who • have not settled during class-action $18 million to be paid by the directors themselves $36 million paid by the liability insurance
- 22. Major aspects concerning the industry, their part in the growth and consequent fall Strategies Culture Corporate governance Technology Industry growth COMPANY
- 23. STRATEGIES RAPIDEXPANSION •Machiavellian approach •Became a full service telecommunication company •Boosted growth in primal years by eliminating competition •Driven by short term goals, securing deals was often overpriced •Over-expansion and ill judged acquisitions. The company personnel didn’t substantiate the ROI, group synergies and the mid-term effects. •Lack of both financial, management , technical and HR integration . FINANCIALGIMMICKRY •High revenue growth •Consolidated position in the stock market •Use of accounting measures like release of accruals and capitalization of expenditure were not in accordance with GAAP. •Negligence of long standing debt collection, only focus on building up revenue on books. EMPLOYEEINCENTIVES •Encouraged employees in the financial, accounts and investor relation departments •Affirmed employee relationships •Biasness against those in other departments viz. networks, technology, Public Relations, HR, etc. •Increased rivalry amongst departments. •Lead to reduced inter and intra departmental coordination and unity.
- 24. CULTURE •According to the CEO Ebbers, this was a “―colossal waste of time” •Little importance to the legal, internal audit, sales and marketing departments. Company Policies •Unhealthy, discouraging and non-cooperative working atmosphere for subordinates •Rendered internal audit powerless. Stringent hierarchy •Only focus on integrating physical networks, largely ignored sales, accounting and billing systems. •Clash of working culture, especially after MCI mergers Failure in integration after M&A •Senior officials favored those especially loyal, preferable from financial, accounting and Investor relations depts. •No vertical transparency, no horizontal synchronization. Bias between departments and employees It was more than questionable whether WorldCom has effective, transparent process of application, evaluation, justified decision making, monitoring, risk assessment and follow up acquisition.
- 25. CORPORATE GOVERNANCE •Habit of rubber stamping senior management’s decisions without scrutinising detailed performance indicators. •Never met outside board meetings. •No vent for employees for reporting malfunctioning even if they felt so.. •Not bothered to look into the accounts of the company Board of Directors Internal audit •Limited scope and power. •Perform mostly operational audits rather than financial audits. •Reported directly to the CFO External Audit: Arthur Anderson Firm •Limited its testing of account balancing relying on the adequacy of WorldCom's control environment. •Overlooked serious deficiency in the accounting ledgers, which were exploited. •Considered WorldCom as a “flagship client” and a “crown jewel” of its firm. Audit •Many senior executives, including the CEO Ebbers had private finances and debts taken on stocks of the company. •The board (Compensation Committee)approved ‘sweetheart loans’ (over $400 million) to Ebbers, without any collaterals or assurances or knowledge of use of those funds. Personal Finances
- 26. • Every stakeholder group other than top management was very poorly served by the WorldCom board of directors • Shareholders saw their shares become worthless • Lenders were forced to take losses on their loans • Employees lost jobs • This suggests support for the revisionist model of corporate governance – the board may reign (de jure) but the imperial CEO rules (de facto) Failures of Corporate Governance
- 27. TECHNOLOGY 2. Lower demand for Long Distance services in market. 1. WorldCom was weak in wireless network and Technology 3. •Attempted to achieve economies of scale by acquisitions •Refusal of merger with Sprint (Largest wireless network company then) by •US Justice Department to regulate the Telecommunications Industry.
- 28. DOT COM Bubble Burst Failure of Telecommunications Industry INDUSTRY GROWTH • Prices for long-distance communication services were falling • Local markets with high access charges were unprofitable Graph: Telecommunication Revenue Growth
- 29. • Unrealistic financial targets and inability to meet them • Recording of a/c entries without any evidences • Company was capitalizing its line costs. Line costs were operating expenses but classified as capital expenditure • False figures 3.055 Bn $ in 2001 & 797 Mn $ in 2002 • In 2000 and 2001, WC claimed pre tax revenue of 7.6 and 2.4 Bn $ respectively. Later discovered as loss of 49.9 and14.5 Bn $ for the respective years • Reserve accounts were manipulated to increase figures • Two versions of accounts the actual version and the Final version for investors Truth behind the scandal
- 30. • WorldCom is not only about “greed” • Corporate fraud is the result of how a corporation is led, how employees are motivated, the nature of the work, and the degree of individual autonomy • Ethics training and compliance programs don’t work in a culture that is exclusively materialistic and that devalues the dignity of work and workers • The basic assumptions about how corporations are organized and run need to be rethought • Corporate executives must re-learn how to lead • Leadership training must be holistic, emphasizing free will, personal responsibility and transparency i.e.: continuous, open, information-sharing Summary
- 31. Thank You