What Was WorldCom?

WorldCom was an American telecom company. At its height, WorldCom was

one of the largest long-distance providers in the United States. The company
is best known for being embroiled in one of the largest accounting scandals
in the country, which came on the heels of the Enron and Tyco frauds. This
came after it was revealed the company cooked its books. WorldCom was
also involved in one of the largest bankruptcies of all time. The company
came out of bankruptcy, rebranded itself, and its network assets were sold to
Verizon.

Key Takeaways

 WorldCom was a telecommunications company that was established in

1983 by Murray Waldron, William Rector, and Bernard Ebbers.

 The company provided discount long-distance services to its customers

and pursued an aggressive acquisition strategy that propelled it to the
largest company of its kind in the United States.

 WorldCom was in financial trouble and used fraudulent accounting

techniques to hide its losses from investors and others.

 The company filed for bankruptcy because of the scandal, and several
key figures were punished, including its CEO and CFO.

 WorldCom emerged from bankruptcy, restructured, and was purchased

by Verizon.

Understanding WorldCom

WorldCom is now a byword for accounting fraud and a warning to investors

that when things seem too good to be true, they just might be. The company
was founded in 1983 as Long Distance Discount Service.1 It was established
after the breakup of AT&T by Murray Waldron, William Rector, early investor
Bernard Ebbers, and their business partners. The group secured a $650,000
loan, which allowed them to buy the technology to route long-distance
calls.23

Since courts ordered AT&T to lease its phone lines to new companies at
cheap rates, Ebbers, who was the company's chief executive officer (CEO),
could offer his customers very low rates. This allowed him to build the
company into one of America’s leading long-distance phone companies by
acquiring as many as 30 competing telecom companies. At the peak of
the dotcom bubble, WorldCom's market capitalization grew to $186 billion.4

When the tech boom turned to bust, and companies slashed spending on
telecom services and equipment, WorldCom resorted to accounting tricks to
maintain the appearance of ever-growing profitability. By then, many
investors became suspicious of Ebbers’ story—especially after
the Enron scandal broke in the summer of 2001.56

In 2002, it was revealed that Ebbers borrowed $408 million from WorldCom's
board of directors to cover margin calls on loans secured by company stock.
At the same time the company's accounting fraud and real financial situation
were coming to light as the SEC began to investigate. As a result Ebbers met
his downfall and resigned as CEO on April 30, 2002. In 2005 he was
convicted of securities fraud, conspiracy, and making false filings, and
sentenced to 25 years in prison.7

Ebbers was a larger-than-life figure whose trademark was a 10-gallon hat

and cowboy boots.

Cooking the Books

There were several factors that pushed WorldCom into a loss. The company
pursued acquisitions aggressively, buying up rival companies in an attempt
to gain market share. This, coupled with a major drop in revenue and rates,
pushed the company into further into the red. Executives needed a way to
prove WorldCom was still financially viable to its board and shareholders.

WorldCom used a series of questionable accounting techniques to hide its

financial position, which inflated its profits. This amounted to billions in
capital expenditures being improperly recorded on the books. But this was
hardly a sophisticated fraud.

In order to hide its falling profitability, WorldCom inflated net income and
cash flow by recording expenses as investments. By capitalizing expenses, it
exaggerated income by $3.8 billion, including $3.055 billion in 2001 and
$797 million in the first quarter of 2002, reporting a net profit of $1.38 billion
instead of a net loss.89

To hide its falling profitability, WorldCom inflated its net income and cash
flow by recording expenses as investments, reporting a profit of $1.38 billion
— instead of a net loss.8

The WhistleBlowers

Several individuals played a key role in exposing the fraud at WorldCom.

These people included Cynthia Cooper, who was vice president of
WorldCom's internal audit department, and Gene Morse, another auditor.
They became concerned about several inconsistencies in the company's
financial records, including:

 The use of reserves to boost the company's income

 The company's capital expenditures, which another employee

questioned and was fired over
  Complicated accounting terms (such as prepaid capacity), which were
used to hide the movement of capital

 The lack of evidence to substantiate certain financial transactions,

including a $500 million capital expenditure

Cooper and Morse conducted investigations on their own as well as an audit.

They were challenged by the company's chief financial officer (CFO), Scott
Sullivan, who requested that the process be delayed. They contacted KPMG,
the external auditor that replaced Arthur Andersen, as well as WorldCom's
audit committee.10

As a result of her diligence, Cooper was named a Person of the Year by Time
and was featured on the magazine's cover in 2002.11 She is now an author,
consultant, and internationally-recognized speaker.12

WorldCom Bankruptcy

The company could no longer keep up once things started to unravel. In fact,
WorldCom had to adjust its earnings for the 10-year period from 1999 to
2002 by $11 billion dollars and the fraud was estimated to be in the
neighborhood of $79.5 billion.

Bankruptcy was the only option. WorldCom filed for Chapter 11 bankruptcy
on July 21, 2002, only a month after its now former auditor Arthur Andersen
had been founded guilty in court and lost its license to practice
accounting.13 By this time, the company was indebted to its creditors by as
much as $7.7 billion. In its filing, the company noted $107 billion
in assets and $41 billion worth of debt.14

The filing allowed WorldCom to provide some restitution. Doing so allowed

existing customers to continue receiving services. WorldCom was also able to
pay its employees and keep its assets. It also provided some much-needed
time to restructure even though it lost its luster within the corporate
marketplace.

Fallout and Aftermath

Some of the key personnel involved in the firm's accounting scandal received
harsh punishment for their roles, including:

 Bernard Ebbers was convicted on one count of securities fraud, one

count of conspiracy, and seven counts fraud related to false SEC
filings. He was sentenced to 25 years in prison in 2005.15 Ebbers was
granted early release from prison on December 18, 2019, for health
reasons after serving about 13 years of his sentence.16

 Former CFO Scott Sullivan received a five-year jail sentence after

pleading guilty and testifying against Ebbers.6
Debtor-in-possession financing from Citigroup, J.P. Morgan, and G.E. Capital
allowed the company to survive.17 It emerged from bankruptcy in 2004 and
rebranded itself as MCI—a telecom company WorldCom acquired in
1997.18 Verizon purchased MCI and its assets in 2006.1 Worldcom's former
banks settled lawsuits with creditors for $6 billion without admitting liability.
Around $5 billion went to the bondholders, with the balance going to former
shareholders.19

In a settlement with the Securities and Exchange Commission (SEC), the

newly formed MCI agreed to pay shareholders and bondholders $500 million
in cash and 10 million shares of MCI.20

This spate of corporate crime led to the Sarbanes-Oxley Act in July 2002,
which strengthened disclosure requirements and the penalties for fraudulent
accounting.21 In the aftermath, WorldCom left a stain on the reputation of
accounting firms, investment banks, and credit rating agencies that had
never quite been removed.

Who Was to Blame?

Although no one actually admitted their part in the scandal, there were
several players who were at fault—some within the company and others who
weren't even employed by WorldCom.

Arthur Andersen, an accounting firm that audited WorldCom's 2001 financial

statements and reviewed WorldCom’s books for Q1-2002, was found to have
ignored memos from WorldCom executives informing them that the company
was inflating profits by improperly accounting for expenses.

Key management personnel, including WorldCom CEO Bernie Ebbers and

CFO Scott Sullivan, the company's board of directors, and its internal audit
team were also singled out for their lack of oversight, ignoring of accounting
principles, and committing fraud. Ebbers and his lawyer initially denied any
involvement or knowledge of the fraud. These claims were refuted by a Wall
Street Journal report, which cited internal communications to the contrary.

Wall Street analyst Jack Grubman gave the company consistently high
ratings even though the company (along with other telecoms) performed
poorly. Grubman was fired from his job at Salomon Smith Barney and was
fined $15 million by the SEC. He was also banned from any activity in
securities exchanges.22

What Happened to WorldCom?

WorldCom was a telecommunications company that provided discount long-

distance services to its customers. The company was embroiled in one of the
largest accounting scandals in the United States, which led to an equally
large bankruptcy filing. The company used fraudulent accounting practices
to cover up its losses by making itself look more profitable than it was.
Several individuals were concerned about fraudulent financial transactions
and reported the inconsistencies to authorities. Its bankruptcy helped the
company restructure, rebranding itself as MCI. This new entity was sold to
Verizon in 2006.1

Who Was Involved in the WorldCom Scandal?

Several key individuals and entities were involved in the WorldCom scandal.
Some of the most notable names include its CEO Bernie Ebbers, CFO Scott
Sullivan, and the company's auditing firm, Arthur Andersen. Wall Street
analyst Jack Grubman also played a role in providing the telecom company
with positive ratings.

Cynthia Cooper was a key player in bringing attention to the company's

financial inconsistencies. Together with auditor Gene Morse, Cooper
investigated and reported WorldCom's questionable accounting practices.
She was named a Person of the Year by Time in 2002.11

What Happened to Cynthia Cooper?

Cynthia Cooper was largely responsible for bringing attention to WorldCom's

questionable accounting practices. She discovered several inconsistencies in
the company's financial statements and reported them to auditors and the
company's board. In her book. Extraordinary Circumstances: The Journey of
a Corporate Whistle-Blower, Cooper said it was a difficult time in her
career.10 But she was awarded by Time by being named a Person of the Year
in 2002.11 She is now a speaker and consultant.

The Bottom Line

WorldCom was a telecommunications company that prided itself on providing

its customers with affordable long-distance services. But an aggressive
acquisition strategy and falling revenues led the company to a downward
spiral that would ultimately open the door to one of the largest accounting
frauds and bankruptcies in the United States. The company used fraudulent
accounting techniques to hide its losses while making itself look more
profitable than it was, which helped it retain its place as a darling among
investors. Although it managed to restructure and emerge from bankruptcy,
WorldCom's example helped corporate management teams and investors
learn a valuable lesson: If something looks too good to be true, it probably is.