© 2003, 2005 by the AICPA The WorldCom Fraud. This presentation is intended for use in higher education for instructional purposes only, and is not for

© 2003, 2005© 2003, 2005 by the AICPAby the AICPA

The WorldCom FraudThe WorldCom Fraud

This presentation is intended for use in higher education for instructional purposes only, and is not for This presentation is intended for use in higher education for instructional purposes only, and is not for application in practice. Permission is granted to classroom instructors to photocopy this document for application in practice. Permission is granted to classroom instructors to photocopy this document for classroom teaching purposes only. All other rights are reserved. Copyright © 2003, 2005 by the American classroom teaching purposes only. All other rights are reserved. Copyright © 2003, 2005 by the American Institute of Certified Public Accountants, Inc., New York, New York.Institute of Certified Public Accountants, Inc., New York, New York.

© 2003, 2005 by the AICPA© 2003, 2005 by the AICPA

WorldCom’s Background WorldCom’s Background

• Awoke the sleeping giant by leading the telecomAwoke the sleeping giant by leading the telecom industry industry into profitability in the 90’sinto profitability in the 90’s. .

• Telecom industry faced low margins and Bernie Ebbers Telecom industry faced low margins and Bernie Ebbers decided decided growth=survival growth=survival

• During the 1990’s, WorldCom was deeply involved in During the 1990’s, WorldCom was deeply involved in acquisitions and completed several “mega-deals”acquisitions and completed several “mega-deals”

• Purchased over 60 firms in 2Purchased over 60 firms in 2ndnd half of the 90’s half of the 90’s

• WorldCom moved into Internet and data trafficWorldCom moved into Internet and data traffic– Handled 50% of US Internet trafficHandled 50% of US Internet traffic– Handled 50% of e-mails worldwideHandled 50% of e-mails worldwide


WorldCom’s Background WorldCom’s Background (con’t)(con’t)

• Purchased MCI for $37 billion in 1997Purchased MCI for $37 billion in 1997– Not allowed to purchase Sprint in 2000 because of antitrust Not allowed to purchase Sprint in 2000 because of antitrust

regulation.regulation.

• In 1999 revenue growth halted; stock price droppedIn 1999 revenue growth halted; stock price dropped

• By 2001 owned a third of the US data cablesBy 2001 owned a third of the US data cables

• Was U.S.’ 2Was U.S.’ 2ndnd largest long-distance operator in 1998 and largest long-distance operator in 1998 and 20022002

• Had over 20 million customers in 2002Had over 20 million customers in 2002


Bernard Ebbers, CEOBernard Ebbers, CEO

• Borrowed $366 million to cover losses on stock which was not Borrowed $366 million to cover losses on stock which was not repaidrepaid

• Secured loans from WorldCom to fund personal investments Secured loans from WorldCom to fund personal investments including a $100 million Canada ranch, $658 million in including a $100 million Canada ranch, $658 million in Mississippi timberlands and a $14 million Georgia shipyardMississippi timberlands and a $14 million Georgia shipyard

• Netted $140 million from stock salesNetted $140 million from stock sales

• Facing dismissal, he resigned from WorldCom on April 30, 2002Facing dismissal, he resigned from WorldCom on April 30, 2002

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

Bernie Ebbers classic resignation statement:


Scott Sullivan, CFOScott Sullivan, CFO

• Served as CFO, treasurer and Served as CFO, treasurer and secretarysecretary

• Directed staff to make false Directed staff to make false accounting entries accounting entries

• Personally made false and misleading Personally made false and misleading public statements regarding financespublic statements regarding finances

• Netted $45 million from stock salesNetted $45 million from stock sales


How the Fraud took How the Fraud took placeplace

• From 1998-2000, WorldCom reduced reserve From 1998-2000, WorldCom reduced reserve accounts held to cover liabilities of acquired accounts held to cover liabilities of acquired companiescompanies– WorldCom added $2.8 billion to the revenue line WorldCom added $2.8 billion to the revenue line

from these reservesfrom these reserves

• Reserves didn’t cut it; An e-mail was sent in Reserves didn’t cut it; An e-mail was sent in December 2000 to a division in Texas directing December 2000 to a division in Texas directing misclassification of expenses. misclassification of expenses.

• CFO told key staff members to mark operating CFO told key staff members to mark operating costs as long-term investments.costs as long-term investments.– To the tune of $3.85 billion. To the tune of $3.85 billion.


How the Fraud took place How the Fraud took place (con’t)(con’t)

• Operating Expenses to AssetsOperating Expenses to Assets

-CFO’s directions affected the income statement:-CFO’s directions affected the income statement:

Revenues xxx (no change)Revenues xxx (no change)

COGS xxx (no change)COGS xxx (no change)

Operating Expenses:Operating Expenses: Fees paid to lease otherFees paid to lease other

companies phone networks: xxx (Huge Decrease)companies phone networks: xxx (Huge Decrease)

Computer expenses: Computer expenses: xxx (Huge Decrease)xxx (Huge Decrease)

NET INCOME xxx (Huge Increase)NET INCOME xxx (Huge Increase)

Removed From

Income

Statement

Removed From

Income

Statement


How the Fraud took place How the Fraud took place (con’t(con’t))

• Operating Expenses to AssetsOperating Expenses to Assets

-CFO’s directions affected the balance sheet:-CFO’s directions affected the balance sheet:

Assets:Assets:Computer assets xxx (Huge Increase)Computer assets xxx (Huge Increase)Leasing assets xxx (Huge Increase)Leasing assets xxx (Huge Increase)

Liabilities xxx (no change)Liabilities xxx (no change)Stockholders Equity:Stockholders Equity:Retained Earnings xxx (Huge Increase)Retained Earnings xxx (Huge Increase)

Added to

Balance Sheet

Added to

Balance Sheet

=HAPPY INVESTORS



• Operating Expenses into AssetsOperating Expenses into Assets

– WorldCom’s journal entry for $500 million in WorldCom’s journal entry for $500 million in computer expenses:computer expenses:

Computer Assets 500 millionComputer Assets 500 million

Cash 500 millionCash 500 million

The documents supporting the expenses were not found!



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

• Inflated the company’s value in its assetsInflated the company’s value in its assets


How the Fraud was How the Fraud was discovereddiscovered

1.1. Obscure tips were sent into the Internal Obscure tips were sent into the Internal audit teamaudit team

2.2. MCI audit and review of books uncovered MCI audit and review of books uncovered accounting irregularitiesaccounting irregularities

3.3. In March 2002, John Stupka complained In March 2002, John Stupka complained to Internal audit about $400 million he to Internal audit about $400 million he set aside that Sullivan wanted to use to set aside that Sullivan wanted to use to boost WorldCom’s income.boost WorldCom’s income.


How the Fraud was discovered How the Fraud was discovered (con’t)(con’t)

4.4. March 7, 2002March 7, 2002 - - the SEC requests information from the SEC requests information from WorldComWorldCom

– How could WorldCom make so much when AT&T is How could WorldCom make so much when AT&T is losing money?losing money?

5.5. The Internal audit started diggingThe Internal audit started digging– Found $2 billion company announced for capital Found $2 billion company announced for capital

expendituresexpenditures

(Internal Auditors found it was never authorized for (Internal Auditors found it was never authorized for capital expenditures.)capital expenditures.)

– Found the undocumented $500 million in computer Found the undocumented $500 million in computer expenses that were recorded as assets.expenses that were recorded as assets.

– Searching WorldCom’s computers, Mr. Morse found $2 Searching WorldCom’s computers, Mr. Morse found $2 billion in questionable entriesbillion in questionable entries



6.6. June 14, 2002 - The Internal audit team June 14, 2002 - The Internal audit team contacted WorldCom’s audit contacted WorldCom’s audit committeecommittee

7.7. Internal auditor, Cindy Cooper, asked for Internal auditor, Cindy Cooper, asked for documents supporting numerous capital documents supporting numerous capital expenditures.expenditures.

– No supporting documents were foundNo supporting documents were found

8.8. The controller admits to internal auditors The controller admits to internal auditors that the accounting treatment is wrongthat the accounting treatment is wrong

– States no accounting standards support this States no accounting standards support this accounting accounting



9.9. June 20, 2002 - Internal audit explains irregularities June 20, 2002 - Internal audit explains irregularities to the Audit committee.to the Audit committee.

10.10. June 25, 2002 - WorldCom announces it inflated June 25, 2002 - WorldCom announces it inflated profits by $3.8 billion over the previous five profits by $3.8 billion over the previous five quartersquarters

11.11. June 26, 2002 - civil suit filed, stock trading haltedJune 26, 2002 - civil suit filed, stock trading halted– Ultimately, stock was delisted by NasdaqUltimately, stock was delisted by Nasdaq

12.12. July 21, 2002 - WorldCom filed for bankruptcyJuly 21, 2002 - WorldCom filed for bankruptcy


Post-Fraud HappeningsPost-Fraud Happenings

• 17,000 jobs cut to save $1 billion. 17,000 jobs cut to save $1 billion.

• WorldCom may write off $50.6 billion in intangible WorldCom may write off $50.6 billion in intangible assets.assets.

• Added additional board members to serve on a Added additional board members to serve on a special investigative panel to review accounting special investigative panel to review accounting practices:practices:– Former US Attorney General Nicholas KatzenbachFormer US Attorney General Nicholas Katzenbach– Dennis Beresford, Former Chairman of the FASBDennis Beresford, Former Chairman of the FASB

• WorldCom is trying to secure loansWorldCom is trying to secure loans


Post-Fraud Happenings Post-Fraud Happenings (con’t)(con’t)

John Sidgmore, the CEO replacing Ebbers, John Sidgmore, the CEO replacing Ebbers, stated he wants to move forward:stated he wants to move forward:

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


Post-Fraud Happenings Post-Fraud Happenings (con’t)(con’t)

• WorldCom was renamed MCI in 2004 when it WorldCom was renamed MCI in 2004 when it emerged from bankruptcyemerged from bankruptcy

• Possible court-approved debt reductionsPossible court-approved debt reductions

• Company could spin off several business unitsCompany could spin off several business units


Post-Fraud Happenings (con’t)Post-Fraud Happenings (con’t) Scott Sullivan Scott Sullivan

In August 2002, Scott Sullivan, CFO, was indicted by a grand jury on In August 2002, Scott Sullivan, CFO, was indicted by a grand jury on one count of fraud and six counts of securities fraud and false one count of fraud and six counts of securities fraud and false

filings involving almost $8 billion. He pleaded not guilty.filings involving almost $8 billion. He pleaded not guilty.

On March 2, 2004, in a superseded indictment, Sullivan pleaded guilty to 3 federal criminal charges for fraud and conspiracy.

Faces maximum 25 years in prison. Struck plea deal with government to testify against Bernie Ebbers. Sullivan to be

sentenced after Ebbers trial.


Post-fraud happenings (con’t)Post-fraud happenings (con’t)Bernie EbbersBernie Ebbers

January 19, 2005 - Federal jury trial on charges of fraud to begin in which Scott Sullivan is expected to

testify against him

Possible sentence: 25+ years in prison

September 2003 – pleaded not guilty to 15 felony counts of violating

Oklahoma securities laws. Charges dropped. Oklahoma Attorney General to refile charges at a later date


Post-fraud happenings (con’t)Post-fraud happenings (con’t)DirectorsDirectors

January 2005 - 10 former directors January 2005 - 10 former directors agreed to pay $54 million to settle a agreed to pay $54 million to settle a shareholder class-action lawsuitshareholder class-action lawsuit

$18 million to be paid by the directors themselves $36 million paid by the liability insurance

February 28, 2005 – Trial to begin against former auditors/directors who have not settled during class-action

Documents

© 2003, 2005 by the AICPA The WorldCom Fraud. This presentation is intended for use in higher education for instructional purposes only, and is not for