Agenda

1) OVERVIEW OF WORLDCOM

2) NATURE OF ACCOUNTING FRAUD

3) IMPACT OF THE FRAUD

4) HOW IT HAPPENED

5) WHY ‘GOOD’ MANAGERS MAKE BAD ETHICAL

CHOICES

6) KEY TAKE AWAYS

 Overview of WorldCom

 WorldCom was the darling of Wall Street and the

Telecom Industry of the 90’s
 Grew rapidly through acquisitions and from increased demand for
telecom services
 High stock price was a powerful currency to make acquisitions
 WorldCom was a casualty of the Dotcom Bubble
Burst of 2000
 Resorted to accounting fraud to meet financial targets
 Went bankrupt
 Overview of WorldCom

Key Events
 1996: Acquired MFS (including internet backbone)
 1998: Acquired MCI (more than twice it’s size)
 2000: Failed merger with Sprint (would have been the largest
merger in history)
 2000: Dotcom Bubble Burst (rapid decline in telecom stock
values)
 2000-02: WorldCom loans $400M to CEO (Ebbers)
 2002: Accounting Fraud uncovered

Extra information gathered

 2002: Filed for Bankruptcy Protection

 2004: Emerged from Bankruptcy as MCI
 2005: Verizon agrees to acquire the company for $6.75B
(plus assumption of $6B of Debt)
 Overview of WorldCom

Financial 1994 1999 2001 2004

highlights
(in billions)
Revenues $2.2 $37.1 $35.2 $20.7
Total Assets $3.4 $91.1 $103.9 $17.1
Employees 7.5 97.6 87.8 40.4
(000’s)
Market Cap $3.3 $150.6 $42.8 $6.4
Debt $0.8 $13.1 $30.0 $5.9
Total $4.1 $163.6 $72.8 $12.3
Capitalization
 Nature of Accounting Fraud

 $11 Billion Accounting Fraud over 3 year period (1999 - 2002)

 Accounting Fraud occurred in two main forms:

 Understatement of operating expenses of $7B through improper release

of accruals and through improper capitalization of operating expenses

 Overstatement of revenues of $1B.

 Impact of the Fraud

Shareholders
$180B of shareholder value lost (based on peak stock price)
Debt & Preferred Stock holders
$37.5B of debt and preferred stock holder value lost
Company
$750M settlement paid to SEC
Employees
57,000 employees lost jobs
All current and former employees lost most of their
retirement savings (invested in WorldCom stock)
 Impact of the Fraud

Executives and Accounting Staff

6 individuals convicted of fraud / conspiracy / false filings
Ebbers – CEO 25 years in prison
Sullivan – CFO 5 years in prison
Myers – Controller 1 year in prison
Yates – Dir of Acctg 1 year in prison
Vinson – Acctg Dept 5 months in prison
Manager 5 months house arrest
Normand –Acctg Dept 3 years probation
Manager
Above 6 individuals agreed to pay a total of $24-34M to settle
securities class action case
 Impact of the Fraud

Independent Auditor
Arthur Andersen agreed to pay $65M to settle securities class action
case

Insurance Companies
Agreed to pay $36M to settle claims against WorldCom directors and
officers
 Unethical Environment

WorldCom Environment

Substantial Problems with the Company’s Internal Controls

 WorldCom was dominated by Ebbers and Sullivan, with virtually no checks and constraints placed
on their actions

 Significant pressure to “meet the numbers”

 Lack of courage of employees to communicate the fraudulent activates – believed it would have cost
them their jobs

 A financial system in which controls were extremely deficient

 The BOD and Audit Committee did not appear to have had an adequate understanding of the
company and culture

 Inadequate audits by independent auditors

 Why ‘good’ managers make bad ethical choices

Four Rationalizations To Justify Questionable

Conduct
1) Believe that the activity is not “really” illegal
2) Believe that it is in the individual’s or
corporation’s best interest
3) Believe that it will never be found out
4) Believe that the company will condone actions
that are taken in its interest and will even protect
the managers responsible
 Why ‘good’ managers make bad ethical choices

Conclusion
A good way to avoid management oversights is to
subject the control mechanisms themselves to
periodic surprise audits…

 The point is to make sure that internal audits and controls are
functioning as planned
 It is a case of inspecting the inspectors and taking the necessary steps
to keep the controls working efficiently

It is up to Top Management to send a clear &

pragmatic message to all employees that good
ethics is still the foundation of good business
 Key Take Aways

History repeats itself

Be aware of your environment
If it seems too good to be true, it probably is
No job is worth breaking the law or committing
unethical acts for
Your personal integrity is your most important
asset – you own it and control it
The 5 Largest Business Bankruptcies in U.S. History

Company Bankruptcy Date Total Assets Pre-

Bankruptcy

Worldcom, Inc. 7/21/02 $103,914,000,000

Enron Corp. 12/2/01 $63,392,000,000
Texaco, Inc. 4/12/87 $35,892,000,000
Financial Corp. 9/9/88 $33,864,000,000
of America
Global Crossing 1/28/02 $25,511,000,000
Ltd.