Fiasco Report WorldCom The team members do not have any relationship with WorldCom Overview of WorldCom (WC) WC started its journey as a small company known as Long Distance Discount Services (“LDDS”) in 1983, based in Clinton, Mississippi. In 1985 LDDS selected Bernard Ebbers, one of the major investors of the company, to be its CEO. The company went public as a corporation in 1989 after merging with Advantage Companies Inc. The company name was changed to LDDS WorldCom in 1995 and MCI WorldCom in 1998. During the 1990s, the firm acquired a number of telecommunications firms that helped it to grow from $154 million in 1990 to $39.2 billion in 2001, placing it 42nd among Fortune 500 companies[i]. Significant acquisitions included the 1998 takeover of MCI, which made it the second largest U.S. long distance carrier, and the purchases of UUNet, CompuServe, and America Online’s data network, which put WC among the leading operators of Internet infrastructure. In 2001 the company had an employee base of 85,000 workers with a presence in more than 70 countries. From the outside, WC appeared to be a strong leader of growth. In reality, the appearance was nothing more than a perception. On June 25, 2002, the company revealed that it had been involved in fraudulent reporting of its numbers by stating a $3 billion profit when in fact it was a half-a-billion dollar loss. After an investigation was conducted, a total of $11 billion in misstatements was revealed[ii]. As a result investors in WC have suffered major losses: the market value of the company’s common stock plunged from about $150 billion in January 2000 to less than $150 million as of July 1, 2002[iii]. WorldCom’s Product Market Focus Initially, it was a provider of long distance phone services to businesses and residents. Later the company diversified its business to internet service and solution, Data and IP Services, IT Solutions and Hosting, Networks management, Premises Equipment (PE), Security, Voice, VoIP, and Wireless network to reach a customer base of 20 million. However, increase in the number of services and the products are mainly attributed to the new acquisitions and mergers with new companies. During the pick of the business, WC provided mission-critical communications services for thousands of businesses around the world, owned and operated a global IP (Internet Protocol) backbone that provided connectivity in more than 2,600 cities and in more than 100 countries. In 2001 it carried a significant amount of the world’s Internet traffic, specifically 50% of total worldwide e-mails and 50% of US Internet traffic. It also owned and operated 75 data centers on five different continents. Merger and Strategy was the key for WorldCom growth strategy Throughout its journey since the inception WC choose merger and acquisition strategy for its growth. The company evolved into the second largest long distance telephone company in the United States and one of the largest companies handling worldwide Internet data traffic through the successful completion of 65 acquisitions. [iv] Between 1991 and 1997, WC spent almost $60 billion in the acquisition of many of these companies and accumulated $41 billion in debt[v]. Two of these acquisitions were particularly significant. The MFS Communications acquisition enabled WC to obtain UUNet, a major supplier of Internet services to business, and MCI Communications, thus providing them one of the largest providers of business and consumer telephone service. By 1997, WC’s stock price grew from pennies per share to over $60 a share[vi]. During those days of the internet boom, WC’s strategy seemed to be perfect to everyone and investment banks, analysts and brokers recommended WC as a “strong buy” to investors. The analysts’ recommendations, coupled with the continued rise of the stock market, made WC a very demanding and desirable stock to the investors. The top management explored this advantage (high stock price) to use WC stock as the vehicle to continue to purchase additional companies. The acquisition of MFS Communications and MCI Communications were, perhaps, the most significant in the long list of WC acquisitions. With the acquisition of MFS Communications and its UUNet unit, “WC suddenly had an investment story to offer about the value of combining long distance, local service and data communications.”[vii] In late 1997, WC’s offer of $35 billion for the acquisition of MCI was 1.8 times more than the nearest offer made by British Telecommunications Corporation ($19 billion). MCI took WC’s deal making WC a truly significant global telecommunications company[viii]. Issues affecting WordCom’s Growth Strategy WC growth strategy was solely focused on mergers and acquisitions, not product development, innovation and customer satisfaction. It engaged in nearly 70 merger and acquisition deals in less than five years but did not focus on integrating organizational culture, structure and appropriate management control mechanisms. As a result, it was observed that by the early 2000s, the revenue of the company was diminishing. Furthermore, it was facing an emerging problem in 1990s of oversupply in telecommunications as the industry rushed to build fibre optic networks and other infrastructure based on overly optimistic Internet growth projections. WC and other telecommunications firms had experienced reduced demand as the internet boom ended and the economy entered recession. Their revenues had fallen short of expectations, while debt taken on to finance mergers and infrastructure investment remained. In this circumstance, the desire to conceal the bad news on company earning from the stock market investors created a powerful incentive for the top management to engage in fraudulent accounting reporting[ix]. The Management Controls Failure Fraud began at WC’s corporate headquarters, in the late 1990’s[x]. Several employees were involved, including: Bernard Ebbers – CEO, Scott Sullivan – CFO, David Myers – Senior VP & Controller, Buford Yates, Director of General Accounting, Betty Vinson – employee under Yates, and Troy Normand – employee under Yates[xi]. WC paid various fees to use or lease facilities belonging to third parties. Normally, these fees were reported as an expense on the income statement, which were filed with the other financial statements on a quarterly and annual basis. The financial statements also included commentary and guidance from WC’s senior management regarding future earnings. Typically this guidance pointed toward continued positive growth in earnings. In July 2000, WC’s expenses as a percentage of total revenue had begun to increase above historic averages[xii]. The fees paid for leasing were the primary drivers of this increase. This resulted in a decline in the rate of growth of WC’s earnings. The risk of missing investor analysts’ forecasts had increased, and with that the possibility of stock declines also increased. By October 2000, Sullivan believed that expenses as a percentage of revenue were too high to meet analysts’ expectations, and that expenses were higher than previous guidance statements suggested they would be[xiii]. With Ebber’s approval, Sullivan instructed Myers, and those working under him to make entries in WC’s general ledger that credited (and therefore reduced) expenses, and debited reserve and capital accounts (increasing these accounts)[xiv]. This series of transactions had the effect of increasing net income. This activity continued until June 2002[xv]. During this time, WC did not disclose these transactions to their external auditing firm, Arthur Anderson. The transactions were also not reported in SEC filings[xvi]. The fraud committed at WC was uncovered by a team of internal auditors in 2002[xvii]. The discovery was brought forward to the internal audit committee and board of directors. Once the board knew, several executives at WC were either fired by the board, or resigned, and the SEC began their investigation. Research Plan Outline To efficiently and effectively conduct our research on WC’s corporate scandal, we split the research into two areas: The WC’s fiasco itself, and an academic understanding of the control systems in place (and the ones that were missing). The first stage of the research component involves becoming familiar with the WC scandal from archives of reputable newspapers and business magazines. Secondly, we will examine the allegations brought upon WC by the SEC. We will also seek peer-reviewed academic journals for more details and insights into the incident allowing us to conduct an analysis of the role management controls played in the fiasco. In order to best understand WC’s corporate scandal, we have to be familiar with well-known frameworks to analyze fraud, corporate governance, managerial controls, and compliance. As the purpose of this research is to seek for academic standard or frameworks in the above mentioned areas, we should rely on information or publications from regulators, or generally accepted principals, such as US-GAAP. We may obtain information from academic, peer- reviewed journals. This research will be conducted concurrently with the studying of the WC fiasco as it does not require any sequence and therefore, can be conducted independently. End Notes
[i] Lyke, Bob & Jickling, Mark, WorldCom: The Accounting Scandal CRS Report for Congress,P-2, Updated August 29,2002 [ii] Ashraf, Javiriyah, The accounting fraud at WorldCom: The causes, the Characteristics, the consequences, and the lessons learned [iii] Ibid,p-2 [iv] Eichenwald, Kurt (2002). For WorldCom, Acquisitions Were Behind its Rise and Fall, New York Times (August 8), A-1 [v] Romero, Simon, & Atlas, Rava D. (2002). WorldCom’s Collapse: The Overview. New York Times (July 22), A-1 [vi] Browning, E. S. (1997). Is the Praise for WorldCom Too Much? Wall Street Journal (October 8), p. C-24. [vii] Eichenwald, Op. cit., p. A-3 [viii] Ibid [ix] Lyke, Op Cit. P-2 [x] “MCI Inc.” Wikipedia, The Free Encyclopedia. Wikimedia Foundation, Inc. 10 January 2014. Web. 2 February 2014. ‘https://en.wikipedia.org/wiki/MCI_Inc.” [xi] “Sullivan” United States Department of Justice, Office of Public Affairs. 2 March 2004. Web. 2 February 2014.