WorldCom discovers massive apparent fraud

CFO fired over accounting scandal; SEC notified

June 25, 2002

June 25 —  WorldCom has uncovered what people close to the company describe as a massive fraud, inflating a common measure of its earnings by more than $3.8 billion over the last five quarters. The company late Tuesday confirmed its intention to restate its earnings and said it had notified the Securities and Exchange Commission.

       “OUR SENIOR MANAGEMENT TEAM is shocked by these discoveries,” said recently-appointed WorldCom CEO John Sidgmore in a statement. “We are committed to operating WorldCom in accordance with the highest ethical standards.”

       WorldCom said its chief financial officer, Scott Sullivan, was dismissed by the board of directors. The company also accepted the resignation of David Myers as senior vice president and controller.

       WorldCom also said it would cut 17,000 jobs, or more than 20 percent of its work force, starting on Friday, a cost-cutting move expected to save $900 million on an annual basis. The company said the layoffs would be primarily composed of discontinued operations, attrition and contractor terminations.

       As first reported by CNBC’s David Faber, the broad outline of the fraud, as described by people familiar with it, transpired like this: Each quarter in 2001 and during the first quarter of 2002, Sullivan would allegedly transfer a similar amount of WorldCom’s ordinary costs and treat them as capital expenditure. The costs are believed to have been related to WorldCom’s network, but should not have been treated as capital expenditure.

When spending is listed as a capital expense, a company can delay applying it against earnings and spread its effect over many years, thus keeping its profits on paper higher. Standard accounting rules are relatively clear about what kind of purchases, for instance office equipment, can be listed as capital expenses and which must be listed as operating expenses and deducted immediately from profits.

       In its statement, WorldCom said that “as a result of an internal audit of the company’s capital expenditure accounting, it was determined that certain transfers from line cost expenses to capital accounts during this period were not made in accordance with generally accepted accounting principles.” WorldCom said the “amount of these transfers was $3.055 billion for 2001 and $797 million for first quarter 2002. Without these transfers, the company’s reported EBITDA (earnings before interest, taxes, depreciation and amortization) would be reduced to $6.339 billion for 2001 and $1.368 billion for first quarter 2002, and the company would have reported a net loss for 2001 and for the first quarter of 2002.”

       In a story posted on its Web site late Tuesday night, The Washington Post, citing unnamed sources, said the Justice Department had begun a criminal investigation.

• What just happened • Immediate impact on the firm • Key events in firm history

WorldCom, the No. 2 U.S. long distance carrier, announced Tuesday it had uncovered massive accounting irregularities totaling billions of dollars. Click on the topics above to find out more. Here are the highlights of the accounting problems: An internal audit found accounting for expenses not in accordance with generally accepted accounting principles. That involved $3.055 billion for 2001 and $797 million for the first quarter of 2002. Those amounts were improperly booked as capital investment, instead of expenses, artificially inflating earnings before interest, tax, depreciation and amortization, a common measure of operating profitability. Without the irregular accounting measures, WorldCom would have posted net losses in 2001 and the first quarter of 2002. Financial results for 2001 and first quarter 2002 will be restated. WorldCom is reviewing its financial guidance. Chief Financial Officer Scott Sullivan has been fired and Controller David Myers resigned. WorldCom will lay off 17,000 workers starting Friday, which will save about $900 million annually. WorldCom will sell off non-core businesses, including South American assets, and its wireless resale business, which will save $700 million annually; WorldCom sees $2 billion a year in cash savings. WorldCom will save about $375 million annually by paying some preferred dividends in common stock, not cash, deferring some dividends, and discontinuing the dividend on the its MCI tracking stock. WorldCom will also cut capital expenditures in 2002 and forecasts 2003 capital investment at $2.1 billion. 1983 Murray Waldron and William Rector sketch out a plan to create a discount long distance provider called LDDS. 1985 Early investor Bernard Ebbers becomes CEO of LDDS. 1989-1996 LDDS merges with or buys a series of other firms, in the process going public and changing its name to WorldCom. 1998 WorldCom merges with MCI Communications, Brooks Fiber Properties and CompuServe Corp. The $40 billion merger with MCI was the largest in history at that time. 2000 Regulators block a proposed merger with Sprint. March 11, 2002 The SEC asks WorldCom for information relating to accounting procedures and loans to officers, including Ebbers. April 3, 2002 WorldCom cuts 3,700 jobs. April 22-23, 2002 Standard & Poor’s, Moody’s and Fitch all cut WorldCom’s credit ratings. April 30, 2002 WorldCom Chief Executive Officer Bernard Ebbers resigns. Vice Chairman John Sidgmore becomes CEO. May 9-10, 2002 Moody’s and Standard & Poor’s both cut WorldCom’s rating to junk status. May 13, 2002 S&P 500 Index dumps WorldCom. May 15-June 5, 2002 While negotiating with lenders, WorldCom announces cost-cutting moves, including more job cuts. June 25, 2002 WorldCom fires its CFO after uncovering improper accounting of some $4 billion in expenses.

Source: Reuters

Printable version

ANDERSEN DEFENDS ITS WORK

       Because of its vast overstatement, WorldCom’s 43 percent profit margins were also allegedly a fiction, CNBC’s Faber reported.
       WorldCom said it “promptly notified its recently engaged external auditors, KPMG LLP, and has asked KPMG to undertake a comprehensive audit of the company’s financial statements for 2001 and 2002.” WorldCom also notified Arthur Andersen LLP, which had audited the company’s financial statements for 2001 and reviewed such statements for first quarter 2002.

       Andersen said Tuesday that its work for WorldCom complied with professional and SEC standards.
       “The WorldCom CFO did not tell Andersen about the line cost transfers nor did he consult with Andersen about the accounting treatment,” Andersen said in a statement. The auditing firm said that WorldCom’s financial statements for 2001 should not be relied upon.
       WorldCom said it will issue unaudited financial statements for 2001 and for the first quarter of 2002 as soon as practicable.
       It is unknown whether former CEO Bernie Ebbers, who resigned from the company at the end of April, was aware of the fraud, CNBC reported, quoting sources.
       The news could be a body blow to WorldCom, which is reeling from a low stock price, a crumbling telecoms market and an ongoing SEC investigation.

SHARES IN FREEFALL

       Shares of Clinton-based WorldCom dropped sharply in after hours trading, falling 57 cents to 26 cents a share, down 68 percent from its closing price of 83 cents. Shares of WorldCom this year traded as high as $15 in January but have free fallen since over concerns about the company’s $32 billion in debt, slowing revenues and the SEC investigation.

       In March, the SEC requested documents detailing pretax charges associated with domestic and international wholesale accounts that were no longer deemed collectible.
       The SEC investigation also focused on disputed customer bills and sales commissions, loans by WorldCom to officers and directors, customer service contracts and organizational charts and personnel records for former employees.
       Drawing scrutiny and investor displeasure were the $408 million in loans WorldCom gave to former chief executive Bernie Ebbers, who resigned in April.
       Bond ratings agencies Moody’s Investors Service, Standard & Poor’s and Fitch all cut their long-term credit ratings on WorldCom’s debt several times this year.
       Shares of WorldCom on Monday closed down 25 percent after Salomon Smith Barney analyst Jack Grubman, long seen as a WorldCom supporter, downgraded his outlook on the company.

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