Study and Analysis of the Scandal from Worldcom Finance Essay

WorldCom (WCOM) was United States' second largest long distance phone company. WorldCom grew largely by acquiring other telecommunications companies. It owned Tier 1 ISP UUNET, major part of Internet backbone. It was in Mississippi. On November 10, 1997, WorldCom and MCI announced their US$37 billion merger to form MCI-WorldCom, making it largest merger in US $37 BILLION merger to form MCI-WorldCom, making it largest merger in U.S. history. MCI, Inc. was American telecommunications subsidiary of Verizon Communications that is headquartered in Ashburn, unincorporatedLoudounCounty,Virginia.Thecorporationwasoriginally formed as result of the merger of WorldCom and MCI Communications, and used the name MCI WorldCom followed by WorldCom before taking final name on April 12, 2003 as part of the corporation's emergence from bankruptcy. The company formerly traded on NASDAQ under the symbols "WCOM" pre-bankruptcy and "MCIP" post-bankruptcy. Corporation was purchased by Verizon Communications with deal closing on July 7, 2006, and now identified as that company's Verizon Business division with local residential divisions slowly integrated into local Verizon subsidiaries.

CORPORATE FOUNDING

Long Distance Discount Services, Inc. (LDDS) began in Hattiesburg, Mississippi 1983. In 1985 LDDS selected Bernard Ebbers to be its CEO. The company went public in the1989 through a merger with Advantage Companies Inc. Company name was changed to LDDS WorldCom in the1995, and later WorldCom. Company's growth under WorldCom was fueled primarily through acquisitions during the 1990s and reached its apex with acquisition of MCI in the 1998. Major companies acquired Advanced communication corp.(1992) Metromedia communication corp.(1993) Resurgens communication group(1993) IDB communication group,inc(1994) Compuserve from its parent company HNR block Digex (DIGX)in june 2001 on november 10,1997

MCI acquisition

IN November 10, 1997, WorldCom and MCI Communications announced their US$37 billion merger to form the MCI WorldCom, making it largest merger in the US history. On September 15, 1998 the new company, MCI WorldCom, opened for the business.

Sprint Merger

In October 5, 1999 A Sprint Corporation and MCI WorldCom announced the $129 billion merger agreement between two companies. The deal did not go because of the pressure from the US Department of the Justice and EU on concerns of creating a monopoly. In July 13, 2000,Board of Directors of both the companies acted to terminate merger. Later, in 2000, MCI WorldCom renamed itself "WorldCom" without the Sprint being part of a company.

Accounting scandals

CONDITION OF AMERICAN CORPORATE FIRM IN THE 90S In early 1990 s the us economy went trough the phase of consolidation, of which many major companies acquired or merged with weaker companies to strengthens their own position in the market The share price of the companies play a vital role during mergers and acquisitions,and the companies try to maintain the prices of their shares. If they fail to do they can easily become target for the takeover or acquisition Moreover the company wish to raise capital from a market, its performance in the stock exchange is considered to be important .The companies are generally valued on a basis of cashflows they could generate in the future. As the financial performance of the company is important factors affecting the share price,companies were under constant pressure to show the positive revenue Downturn of the telecom industry

BRAINS BEHIND THE FRAUD OF $11bn

ACEO Bernard Ebbers A CFO Scott Sullivan A Former controller David Myers The Accounting director Buford Yates The Accounting managers betty Vinson and troy Normand Arthur Andersons auditing firm s Ebbers' angle borrowed $1billion for personal purposes from the various banks. He pledged the WorldCom stock as the collateral. Bernard Ebbers became wealthy from the rising price of the holdings in WorldCom's stock.However, after the MCI acquisition in 1998,the telecommunications industry entered the downturn and the WorldCom's growth strategy suffered a serious blow when it forced to abandon their proposed merger with sprint in the late 2000.At that time ,WorldCom's stock is declining and Ebbers came under increasing pressure from the banks to cover a margin calls on his WorldCom stock that was used to finance the other businesses (timber,yatching,etc) In 2001, Ebbers persuaded the WorldCom's board of directors to provide corporate loans and guarantees in the excess of $400 million to cover margin calls. The board hope that loans would avert the need for Ebbers to sell the substantial amounts of worldcom stock.His doing would put further downward pressure in stocks price .This strategy failed and Ebbers was as ousted as CEO in April 2002 and replaced by the John Sidgmore,former CEOof NET TECHNOLOGIES INC. In1999 and continuing May 2002, Company under direction of A Scott Sullivan (CFO),David Myers(Controller)and Bufford (Director of general accounting)used the fraudulent accounting methods to mask the declining earnings by painting the false picture of the financial growth and the profitability to prop up a price of WorldCom's stock. HOW FRAUD TOOK PLACE IN 1998-2000, WorldCom reduced the reserve accounts held to cover the liabilities of the acquired companies WorldCom added $2.8 billion to revenue line from reserves. An e-mail was sent in December 2000, to the division in Texas directing misclassification of the expenses. CFO ordered key staff members to the mark operating costs as the long-term investments. To a tune of $3.85 billion. Operating Expenses to Assets -CFO's direction affects a income statement: Revenues xxx (no change) COGS xxx (no change) Operating Expense: Fees paid to the lease other thecompanies phone networks: xxx(large Decrease) The Computer expenses xxx(large Decrease) NET INCOME xxx (large Increase) Operating Expenses to Assets -CFO's direction affects the balance sheet: Assets: Computer asset xxx (LargeIncrease) Leasing asset xxx (Large Increase) Liabilities xxx (no change) Stockholders Equity: Retained Earnings xxx (large Increase) Operating Expenses into Assets A WorldCom's journal entry for $500 million in the computer expenses: Computer Assets 500 million Cash 500 million A Huge losses turned into the enormous profits. $1.38 billion in net income in 2001 Inflated a company's value in the assets HOW FRAUD WAS DISCOVERED AObscure tips were sent to the Internal audit team MCI audit and review of the books uncovered the accounting irregularities During March 2002, John Stupka complained to the Internal audit about $400 million he set aside the Sullivan wanted to use to boost theWorldCom's income. In March 7, 2002 - the SEC requests the information from the WorldCom WorldCom make much when the AT&T is the losing money. Internal audit started the digging. Found $2 billion the company announced for capital expenditures. Found the undocumented $500 million in the computer expenses that recorded as assets. Searching the WorldCom's computers, Mr. Morse found $2 billion in the questionable entries During June 14, 2002 - Internal audit team contacted the WorldCom's audit committee Internal auditor, Cindy Cooper, asked for the documents supporting the numerous capital expenditures. No supporting documents was found Controller admits to the internal auditors that the accounting treatment was wrong No accounting standards support the accounting 9.during June 20, 2002 -A Internal audit explains the irregularities to the Audit committee. 10.during June 25, 2002 - WorldCom announces the inflated profits by $3.8 billion over a previous five quarters 11.During June 26, 2002 - the civil suit filed, a stock trading halted Ultimately, stock is delisted by Nasdaq During July 21, 2002 - WorldCom filed for the bankruptcy

METHODS

Underreporting the 'line costs' by capitalizing the costs on balance sheet rather than the properly expensing them in the balancesheet. Inflating revenues with the bogus accounting entries from the 'corporate unallocated revenue accounts'. During 1998-2000, worldcom reduced a reserve accounts held to coverthe liabilities of acquired the companies. Worldcom has added $2.8 billion to revenue line from the reserves.

FINAL COUNTDOWN

The media, legal and investor unrest intensified against the WorldCom, there was a little hope left for a company. Company was required to pay the $172 million in the interest and the debt in 2002, was to increase further to $1.7 billion and $2.6billion as a part of the repayment schedule in 2003 and 2004. Negative cash flow of $871 million in the 2001. Generated only $564 million in the free cash in 2002 and $1 billion in 2003. The company admitted that it had resorted to the fraudulent accounting practices for five quarters .

IMPACT OF WORLDCOM FALL DOWN

CEO Ebber was sentenced 25yrs imprisonment. The Standard and the poors reduced WorldCom's credit rating to a junk status and worldcom was removed from prestigious S&P500 index. Share price fell over by 80%. On june 26, SEC filed a suit alleging "securities fraud "against worldcom in the district court in a Newyork. 17000 employees lost their jobs. Ordinary in vestors were put into the several loss. Worldcom changed its name to MCI,and moved the corporate headquarters from clinton to dulles,virginia,on april14,2003. Under bankruptcy reorganisation agreement,the company paid $750 million to the SEC in cash and stock in a new MCI,which is intended to be paid to the wronged investors. AT&T is seen as the potential gainer in a aftermath of worldcom's inevitable collapse.

Bankruptcy

During July 21, 2002, WorldCom filed Chapter 11 bankruptcy protection in a largest such filing in a United States history . None of criminal proceedings against WorldCom and their officers and agents were originated by referral from Gonzalez or Department of Justice lawyers. WorldCom change its name to MCI, and moved its corporate headquarters on Clinton, Mississippi, to Dulles, Virginia, on the April 14, 2003. Under a bankruptcy reorganization agreement, a company paid $750 million to SEC in cash and stock in the new MCI, which was intended to be paid to the wronged investors. During May 2003, Company was given the no-bid contract by a United States Department of Defense to build the cellular telephone network in the Iraq. A deal has been criticized by the competitors and others who cite a company's lack of experience in area.

Post-bankruptcy

The company emerged from the Chapter 11 bankruptcy in 2004 with $5.7 billion in the debt and $6 billion in the cash. It had to pay many of the creditors, who had waited for the two years for the portion of the money owed. Many of a small creditors included former employees, primarily those who was laid off in the June 2002 . About half of the cash were intended to pay the various claims and settlements. The Previous bondholders ended up the being paid 35.7 cents on dollar, in bonds and stock in a new MCI company. previous stockholders' stock was valueless severance and the benefits were withheld when WCOM filed for the bankruptcy. During August 7 2002, the exWorldCom 5100 group is launched. It is composed of former WorldCom employees with the common goal of seeking the full payment ofa severance pay and benefits based on a WorldCom Severance Plan. The '5100' stands for number of WorldCom employees laid off on June 28, 2002 before WorldCom filed for the bankruptcy. During February 14, 2005, Verizon Communications agreed to acquire the MCI for $7.6 billion. During March 15, 2005 Bernard Ebbers is found guilty of all the charges and convicted of the fraud, conspiracy and filing false documents with a regulators - all related to a $11 billion accounting scandal at telecommunications company . He is sentenced to 25 years in prison. Other former WorldCom officials was charged with criminal penalties in relation to company's financial misstatements include former CFO Scott Sullivan , controller David Myers, accounting director Buford Yates and accounting managers Betty Vinson and Troy Normand. During July 13, 2005 Bernard Ebbers received sentence that would keep imprisoned for 25 years. During March 2005, 16 of WorldCom's 17 former underwriters reach settlements with investors. During December 2005, Microsoft corporation announce that MCI will joined it by providing Windows Live Messenger customers "Voice Over Internet Protocol" (VOIP) services to make telephone calls. This is MCI's last new product - "MCI Web Calling". After a merger, this product is renamed "Verizon Web Calling". RESULTS FROM WORLDCOM SCANDALS First , A negative perception of corporate America has been reinforced. Investors have developed the destructive sentiment corporate management, a accounting firms, the lawyers and the investment banks. CEO no longer stands for the Chief Executive Officer, but the Chief Embezzlement Officer and that EBITDA now means Earnings Before I Tricked Dumb Auditors. Banks, which lent the money to all of the companies, are under scrutiny by the nervous investors. Second result of WorldCom scandal is that government is moving to re-regulate the economy. It is the Republican administration that is moving to the tighten controls over accounting, corporate governance and the transparency and a disclosure. To reduce chances of a corporate wrongdoing, it will also the add layers of regulations on a businesses that will be more costly in terms of time and money. The WorldCom scandal is likely to become election issue in upcoming fall 2002 congressional races, with Democrats seeking to paint the Republicans as friends of big sleazy business. The third result was WorldCom's customers was likely to leave it in the large numbers. AT&T is the most likely first choice for the most enterprise customers seeking a relatively sophisticated network. After AT&T, the mostly likely candidates are the Sprint and the Qwest . The fourth result will be the reexamination of the U.S. telecom policy. The Securities Exchange Commission take WorldCom as the worst accounting scandals in the history and will take the enforcement action of a considerable harshness. The Federal Communications Commission was to be the more open to letting the company be sold to the rival, including one of the former Baby Bells. It remove WorldCom as the ongoing crisis. The Department of Justice is involved because of anti-trust issue. Several Bells at buying WorldCom, largely for the position in a Internet backbone and enterprise markets. In bankruptcy proceeding, those assets be attractively priced for the Bell. Other long distance companies are in no condition to buy the WorldCom, leaving the Bells as the only real possibility. The fifth result is WorldCom and the other scandals are weakening dollar. One, foreign investors, with an eye to the slumping value of the dollar, could demand the premium to hold U.S. securities. Two, they could demand the premium for credit risk. Both the trends would accelerate the dollar's declining value in the international markets. Foreign funds flow into the United States is not to be the casually dismissed considering that the U.S. needs to it help finance its current account balance of payments deficit, which is the expected to be around of 5% of GDP. The sixth factor is the impact of WorldCom beyond U.S. shores. Firstly, the sleaze element is giving impetus to the greater regulation and a better corporate governance in the countries such as the Canada and the United Kingdom. Second, WorldCom as well as Enron scandal, are hurting the attractiveness of the so-called Anglo-American model of de-regulated capitalism and giving greater credence to a capitalism modified by a larger state role in the economy . Third, the WorldCom weakens foreign investor sentiment on the U.S. securities, this feeds into weaker dollar.

ARTICLE WITH INTERPRETATION

WorldCom Scandal: A Look Back at One of the Biggest Corporate Scandals in U.S. History

INTERPRETATION During I998 telecommunications industry slow down and WorldCom's stock is declining. CEO Bernard Ebbers is under increasing pressure from banks to cover margin calls on WorldCom stock is used to finance his other businesses endeavors (timber, yachting, etc.).A Company's profitability took another hit when it is forced to abandon their proposed merger with Sprint late 2000. Im 2001, Ebbers persuade the WorldCom's board of directors to provide him the corporate loans and theguarantees totaling more than $400 million. Ebbers wanted to cover the margin calls, but strategy ultimately failed and Ebbers is ousted as CEO in April 2002. In 1999 and through May 2002, The WorldCom used accounting methods to mask its declining financial condition with falsely professing financial growth and profitability to increase the price of WorldCom's stock. The fraud is accomplished in two main ways. First, WorldCom's accounting department underreported ' theline costs' by capitalizing the costs on the balance sheet rather than a properly expensing . Second, company inflated revenues with the bogus accounting entries from the 'corporate unallocated revenue accounts'. The discovery of possible illegal activity is by WorldCom's internal audit department who uncovered approximately $3.8 billion of a fraud in June 2002. Company's audit committee and the board of directors was notified of the fraud and was acted swiftly: Sullivan is fired, Myers resign, and Securities and Exchange Commission launch investigation. By end of 2003, it was estimated that company's total assets had been inflated with around $11 billion . CONCLUSION The company's share- and bond-holders were left holding practically worthless assets. With assets below the company's debt of $30 billion, creditors were unlikely to get money back. WorldCom's 80,000 employees were likely to pay with the jobs. According to athe mutual fund advisory group, 539 mutual funds own 400 million of the three billion in the outstanding shares of WorldCom. Ordinary investors in the funds were likely to suffer heavy losses. There are 401(k) plans of ordinary workers in the mutual funds. In contrast to the losses that were immediate for the ordinary people hooked to the shares and investments in mutual and pension funds, corporate laws provide the far better cushion to the top executives. On July 8, Ebbers and former Chief Financial Officer Scott Sullivan refuse to testify before congressional Financial Services Committee inquiring into a WorldCom scandal. The Committee is keen to investigate links between the the company and an investment analyst who is believed to have had prior knowledge about the dubious accounting methods employed by the WorldCom. The telecom major AT&T is seen as the potential gainer in aftermath of WorldCom's inevitable collapse.

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