Worldcom’s Fraudulent Fallout

WorldCom’s Fraudulent Fallout

WorldCom got its start as a small discount long distance provider in Mississippi. Founded by Bernard Ebbers the idea for WorldCom was simple, buy long distance services from larger companies and then sell them off to small local ones. The idea worked and before long Long Distance Discount Services, later to be called WorldCom, was off and running. The company began acquiring small telecommunications firms and grew larger and larger. By 1995, WorldCom was one of the largest long distance providers in the world. As time progressed they acquired more then sixty companies, including MCI. The MCI take-over in 1997 cost over thirty-seven billion dollars, and at the time it was considered the largest merger in American history. After the MCI deal WorldCom became the second largest Telecommunications Company in the United States. They owned one-third of the data cables and were handling over fifty percent of all internet traffic in the United States. The growth of WorldCom was amazing, and they were the talk of Wall Street for many years. In fact, by the late 1990’s they were the fifth most widely held stock in America; a pretty big feat for a company founded out of a small Mississippi town. WorldCom rode the big wave of the telecommunications and internet boom of the mid to late 1990’s. Its shares were worth about $115 billion, more then double that of telecommunications giant AT&T. However, by the end of 1999, a huge slow down was occurring in the internet and telecommunications industries. This is when the trouble began for WorldCom.

Wall Street reacted to this sudden dip in these industries, and stock prices began to fall. In order to keep the faith of investors and to keep earnings from falling drastically, WorldCom began to commit fraudulent financial reporting. It was around this time, late 1999, when executives at WorldCom began to get involved in practices that were in violation to generally accepted accounting principles.

The accounting fraud at WorldCom was perpetrated by a number of high ranking executives, many of whom were in charge of accounting. At the forefront of the fraud was CEO and founder Bernard Ebbers. In addition to allegedly instructing others to make the financial situation look better then it was, he also borrowed almost $400 million from the company to pay the margin call on his stock. Another key figure was Scott Sullivan, the company’s chief financial officer, who spearheaded the accounting manipulations. Sullivan also instructed key accounting staff, including the controller, to follow along with his procedures.

By June of 2002, WorldCom could no longer cover up the massive manipulations to their financial reports. Their unethical and improper accounting practices had left the world’s second largest telecommunication company in ruins. The trading of WorldCom stock stopped trading in late June at an all time low. The news from the WorldCom scandal was so far reaching it set new post September 11th lows for the stock market. By July of the same year, the company claimed for bankruptcy protection of more then $41 billion in debt. By the end of the whole scandal investigations uncovered in total an estimated $11 billion in fraud over five consecutive quarters, the fraud remains the largest in United States history, even bigger then Enron.

The following is intended to highlight the actual accounting manipulations that took place at WorldCom, and the effects they had on the financial statements of the firm. The first offense was the disguising of $3.85 billion in expensing, which was done over an extensive period of time. During the first quarter of 2001, $771 million of expenses were hidden, followed by $610 million in the second quarter; $743 million in the third quarter; $931 million in the forth quarter. As opposed to some of the accounting frauds committed in recent years that used ingenious techniques or creative accounting, WorldCom’s expense cover-up was much more uncomplicated. Under the direction of Scott Sullivan, operating costs were put on the books as capital expenses. This meant that operating expenses were placed on the books as capital investments, which basically made them assets. Line costs were payments to other telecommunication companies for the privilege to use their lines. The problem with treating operating costs as capital expenses is that the costs are only being pushed into the future. Therefore, they would have to hope for more and more revenue in coming years, even though their earnings were decreasing in recent years. Putting the expenses into the capital account meant they would not be due right away, such as normal operating expenses would be. WorldCom was able to artificially lower current expenses which falsely showed higher earnings. This treatment of expenses has an affect on both