WorldCom Fraud
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The document discusses the rise and fall of WorldCom, including its aggressive acquisition strategy, risky loans to executives, fraudulent accounting practices to inflate revenues and hide debts, and eventual bankruptcy. It analyzes WorldCom's financial ratios, z-score, and industry factors like the dot-com bubble burst that contributed to its decline. A whistleblower uncovered $3.8 billion in fraudulent line-cost accounting adjustments that hid expenses and misled investors.
WorldCom Fraud
- 1. Siddharth Mall Deepika Bajaj Rohit Mall Team ID : 630432 IIT Kharagpur Capital Edge || Kshitij 2012
- 2. The rise and Fall of WorldCom TIMELINE
- 3. Major aspects concerning the industry, their part in the growth and consequent fall COMPANY
- 4. STRATEGIES
- 5. CULTURE It was more than questionable whether WorldCom has effective, transparent process of application, evaluation, justified decision making, monitoring, risk assessment and follow up acquisition .
- 6. 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
- 7. 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
- 8. TECHNOLOGY Lower demand for Long Distance services in market . WorldCom was weak in wireless network and Technology 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.
- 9. LINE COSTS Increase in E/R ratio WorldCom outsourced some portions of its calls Paid the outside service providers for carrying WorldCom customers’ calls on their lines. Took majority of its lines on lease . Anticipated high demand in the industry. Increased their leased networks Decline in the growth of telecommunication industry reducing the demand Hefty fines for unutilized leased networks.
- 11. CAPITALIZATION AND OTHER ADJUSTMENTS CAPITALIZATION Reduction to Line Costs by capitalization and other adjustments (in % of the total line cost) Avoided recognizing standard operating expenses when they incurred, instead postponed them into future saying “work in progress ” Improperly shifted these expenditures from income statement to balance sheet, increasing current income and inflating assets. Reducing line costs and capitalizing entries significantly improved the line cost E/R ratio. OTHER ADJUSTMENTS Improperly booked of $312 million in revenue associated with Minimum Deficiency C harges . Accounted for over $215 million of credits that it had issued to Telecommunications Customers. Recognized $22.8 million in revenue from Early Termination Penalties.
- 12. REACTIONS The business unit managers were sceptical about the fraudulent accounting practices but some, because of their timid nature and the existence of the stringent hierarchy in WorldCom, were suppressed while others silenced by a disguised view of reality and lucrative incentives. “ Our goal is not to capture market share or be global. Our goal is to be the No. 1 stock on Wall Street” – Ebbers, CEO “ I guess the only way I am going to get this booked is to fly to D.C. and book it myself. Book it right now, I can‘t wait another minute” – Myers , director of General Accounting, to Schneeberger on his refusal of releasing accruals. One senior executive described the pressure as “ unbearable—greater than he had ever experienced in his fourteen years with the company” Senior staff described the target of maintaining 42% E/R ratio as “ wildly optimistic, pure fantasy and impossible” CFO Sullivan talked to Vinson and Normand about their resignation plans : “Think of us as an aircraft carrier. We have planes in the air. Let‘s get the planes landed. Once they are landed, if you still want to leave, then leave. But not while the planes are in the air”
- 14. FINANCIAL RATIOS Type of Ratios WorldCom S &P 500 Benchmark (2002) Valuation Ratios Price/Book 0.57 4.1 Price/ Earning 29 35.7 Price/ Sales 1.19 1.9 Price/Cash Flow 5.23 15.1 Income Statement Profitability Net Income/Sales 3.93% 4-8% Top-Line Growth -10.1% 5-15% Bottom-Line Growth -0.68% 5-15% Management Effectiveness Return on Assets 1.33% 8-12% Return on Equity 2.39% 9-16% Financial Strength Current Assets/Current Liabilities 0.99 1-2 Debt/Equity Ratio 0.52 0.5-1
- 15. FINANCIAL ANALYSIS Z SCORE ANALYSIS OF WORLDCOM Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5 RATIO DEFINITION 1999 2000 2001 X1 Working Capital/Total Asset (0.08) (0.08) (0.00) X2 Retained Earning/Total Assets (0.01) 0.03 0.02 X3 EBIT/Total Assets 0.08 0.08 0.04 X4 Market Value of equity/Book Value of Assets 3.58 1.13 0.54 X5 Sales/Total Assets 0.39 0.40 0.34 Z Z-Score 2.697 1.274 0.798
- 16. ACCOUNTING CONSULTANT Recommendations an accounting consultant would have given on being commissioned:
- 17. SWOT ANALYSIS
- 18. QUESTIONS ?
Editor's Notes
- #6: non-uniform accounting practices, prone to easy manipulations. Working according to Ebbers and Sullivan resulted in monetary incentives.
- #7: operational audits with the objective of uncovering potential cost savings rather than financial audits with the objective of safeguarding company assets In the large system, new risk-based evaluation methods, left gaps for intentional manipulations and frauds. Maintained good relations: Relied on reports provided by the financial dept of the company, without scrutiny. The board (Compensation Committee)approved ‘sweetheart loans’ (over $400 million) to Ebbers, without any collaterals or assurances or knowledge of use of those funds.which is totally unethical to the shareholders’ and employees’ interests.
- #10: Increase in E/R ratio
- #14: conducted her detective work was in secret, often late at night to avoid suspicion