discovers massive apparent fraud
fired over accounting scandal; SEC notified
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
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
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
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.
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
Financial results for 2001 and first quarter 2002 will be
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.
||Murray Waldron and
William Rector sketch out a plan to create a discount
long distance provider called LDDS.
||Early investor Bernard
Ebbers becomes CEO of LDDS.
||LDDS merges with or
buys a series of other firms, in the process going
public and changing its name to WorldCom.
||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.
||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
|April 22-23, 2002
Poor’s, Moody’s and Fitch all cut WorldCom’s
|April 30, 2002
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
|May 13, 2002
||S&P 500 Index
|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.
DEFENDS ITS WORK
Because of its vast overstatement, WorldCom’s 43
percent profit margins were also allegedly a fiction, CNBC’s Faber
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
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 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
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.