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The WorldCom Fraud

WorldComs Background
Owns a third of the US data cables
U.S. 2nd largest long-distance operator

Over 20 million customers


During the 1990s, WorldCom was
deeply involved in acquisitions
Completed several mega-deals in the hottest industry

WorldComs Background
Awoke the sleeping giant
WorldCom led the telecom industry into profitability in the 90s. Bernie Ebbers purchased over 60 firms in 2nd half of the 90s. Handles 50% of US Internet traffic Handles 50% of e-mails worldwide

Telecom industry faced low margins; Ebbers decided growth=survival

WorldCom moved into Internet and data traffic

Purchased MCI for $37 billion in 1997

Disallowed to purchase Sprint in 2000 because of antitrust regulation.

1999 revenue growth halted; stock dropped

Bernie Ebbers (WorldCom CEO)


Resigned from Worldcom in
April, 2002

Borrowed $400 million to


cover losses on company shares
Not repaid
Bernie Ebbers classic resignation statement:

Milkman and night-club


bouncer in college

"I am confident that WorldCom will continue to lead the industry, setting the standards others will follow.

How the Fraud took place?


From 1998-2000, WorldCom reduced reserve accounts
held to cover liabilities of acquired companies WorldCom added $2.8 billion to the revenue line from these reserves

Reserves didnt cut it; An e-mail was sent in December

2000 to a division in Texas directing misclassification of expenses.

Mr. Sullivan told key staff members to mark operating


costs as long-term investments. To the tune of $3.85 billion.

How the Fraud took place?


Operating Expenses to Assets?
-Mr. Sullivans directions affected the income statement: Revenues xxx (no change) COGS xxx (no change) Operating Expenses:
Fees paid to lease other companies phone networks: Computer expenses: xxx (Huge Decrease) xxx (Huge Decrease)

NET INCOME

xxx (Huge Increase)

How the Fraud took place?


Operating Expenses to Assets?
-Mr. Sullivans directions affected the balance sheet: Assets: Computer assets Leasing assets

xxx (Huge Increase) xxx (Huge Increase)

Liabilities Stockholders Equity:


Retained Earnings

xxx (no change)


xxx (Huge Increase)

=HAPPY INVESTORS

How the Fraud took place?


Operating Expenses into Assets?
WorldComs journal entry for $500 million in computer expenses: Computer Assets Cash 500 million 500 million

The documents supporting the expenses were not found!

How the Fraud took place?


Huge losses turned into
enormous profits. $1.38 billion in net income in 2001

Inflated the companys value in

its assets Essentially, they were buying paper clips and recording them as buildings

How the Fraud was discovered?


1. Obscure tips were sent into the internal audit team
2. The fraud-finding team consisted of:
Cynthia Cooper, Manager of Internal Audit, reports to Scott Sullivan Gene Morse, Internal Audit, technology expert Glyn Smith, Internal Audit, Senior Manager

3. In March 2002, John Stupka complained to Internal


audit about $400 million he set aside that Sullivan wanted to use to boost WorldComs income.

How the Fraud was discovered?


4.
March 7th, the SEC requests information from WorldCom How could WorldCom make so much when AT&T is losing money?

5.

The Internal Audit started digging Found $2 billion company announced for capital expenditures (Internal Auditors found it was never authorized for capital expenditures.) Found the undocumented $500 million in computer expenses that were recorded as assets. Searching WorldComs computers, Mr. Morse found $2 billion in questionable entries

How the Fraud was discovered?


6. The Internal audit team contacted the WorldComs audit
committee (June 14th)

7. Mrs. Cooper asked for documents supporting numerous


capital expenditures.

No supporting documents were found

8. Mr. Myers, the controller, admits to internal auditors


that the accounting treatment is wrong

States no accounting standards support this accounting

How the Fraud was discovered?


9. June 20th, the Internal audit explains irregularities to the
audit committee.

10. June 25th, WorldCom announces it inflated profits by


$3.8 billion over the previous five quarters

11. June 26th, civil suit filed, stock trading halted

Ultimately, stock was delisted by Nasdaq

12. WorldCom filed for bankruptcy on July 21st

Post-Fraud Happenings
17,000 jobs cut to save $1 billion.
Not directly related to the fraud

WorldCom may write off $50.6 billion in intangible


assets.

Added the following additional board members:


Former US Attorney General Nicholas Katzenbach Dennis Beresford, Former Chairman of the FASB

WorldCom is trying to secure loans

Post-Fraud Happenings
Some werent surprised by the fraud
announcement:

"When you look at the history of WorldCom, and their acquisition trail, you have a classic wheeler-dealer. This is the age where wheelerdealers get called for who they are," said Frank Dzubeck, president of the Communications Network Architects consultancy.

Post-Fraud Happenings
New WorldCom CEO, John Sidgmore
wants to move forward:

We want the bad guys exposed. We want the bad guys punished. And we want to move on with our lives at WorldCom." Ebbers

Myers

Post-Fraud Happenings
WorldCom soon to be
renamed MCI

Possible courtapproved debt reductions

Company could spin


off several business units

Post-Fraud Happenings

Mr. Sullivans maximum possible punishment:


$2.5 million in fines and
65 Years in Prison

Post-Fraud Happenings
Stock price topped out @ $64 in 1999

The company filed bankruptcy on July 21, 2002, and its stock price bottomed after it was delisted from the Nasdaq

WorldCom & Enron Comparison


WorldCom The Auditor: Andersen Enron The Auditor: Andersen

The Officers:
CEO: Fired CFO: Committed the fraud

The Officers:
CEO: Fired CFO: Committed the fraud

Fraudulent Amount:
At Least $9 billion

Fraudulent Amount:
$600 million

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