Introduction
The paper discusses the accounting frauds in the light of corporate governance committed by the leading US telecommunications giant, WorldCom during the 1990s that led to its eventual bankruptcy. The paper provides a detailed description of the growth of WorldCom over the years through its policy of mergers and acquisitions. The paper explains the nature of the US telecommunications market, highlighting the circumstances that put immense pressure on companies to project a healthy financial position at all times. The paper provides an insight into the ways by which WorldCom manipulated its financial statements. The role of the company's top management in the scandal has also been discussed. Finally, From being one of the world's most valuable companies (valued over $ 100 billion at its peak), WorldCom came to be known as one of the biggest instances of the 'fraud wave' sweeping the global corporate world since the late 1990s. The company's downfall from WorldCom to 'WorldCon' is a story of a corporate feeding its greed through financial and accounting manipulations.
Background of WorldCom
WorldCom was started by Bill Fields in Hattiesburg, Mississippi, in 1983 under the name 'Long Distance Discount Services' (LDDS), providing long distance telecommunication (telecom) services. The venture was profitable right from the start. In 1985, Bernie Ebbers became the company's CEO.
Ebbers reportedly played a major role in the success of LDDS in the following years. The company went public in 1989 when it acquired Advantage Companies Inc., a publicly traded long distance telecom services company. Throughout the 1990s, the company continued to grow by acquiring various companies and expanding its operations across the world (Refer Table I for the major acquisitions).
WorldCom took the telecom industry by storm when it began a frenzy of acquisitions in the 1990s. The low margins that the industry was accustomed to weren't enough for Bernie Ebbers, CEO of WorldCom. From 1995 until 2000, WorldCom purchased over sixty other telecom firms. In 1997 it bought MCI for $37 billion. WorldCom moved into Internet and data communications, handling 50 percent of all United States Internet traffic and 50 percent of all e-mails worldwide. By 2001, WorldCom owned one-third of all data cables in the United States. In addition, they were the second-largest long distance carrier in 1998 and 2002
Corporate Governance
Corporate governance is the process of supervision and control intended to ensure that the company's management act in accordance with the interests of shareholders. (Parkinson, 1994) Corporate governance is concerned with issues such as effectiveness and efficiency of operations, reliability of financial reporting, compliance with the law and regulations, and safeguarding of assets.
Accounting Fraud
In 1999, revenue growth slowed and the stock price began falling. WorldCom's expenses as a percentage of its total revenue increased because the growth rate of its earnings dropped. This also meant WorldCom's earnings might not meet Wall Street analysts' expectations. In an effort to increase revenue, WorldCom reduced the amount of money it held in reserve (to cover liabilities for the companies it had acquired) by $2.8 billion and moved this money into the revenue line of its financial statements.
That wasn't enough to boost the earnings that Ebbers wanted. In 2000, WorldCom began classifying operating expenses as long-term capital investments. Hiding these expenses in this way gave them another $3.85 billion. These newly classified assets were expenses that WorldCom paid to lease phone network lines from other companies to access their networks. They also added a journal entry for $500 million in computer expenses, but supporting documents for the expenses were never found. These changes turned WorldCom's losses into profits to the tune of $1.38 billion in 2001. It also made WorldCom's assets appear more valuable.
Early in 2002, an internal audit found operating expenses charged as capital expenditures, double counting of revenues and undisclosed debt. New auditor KPMG reviewed the books; old auditor
Arthur Andersen was fired. Ebbers resigned in April. On June 25, 2002, WorldCom announced $3.8 billion in accounting errors ($3.1 billion for 2001 and $800 million for first quarter 2002), mainly by capitalizing "line costs," which are fees to other telecom companies for network access rights. These are operating expenses. With the required restatements, net losses were now reported for both 2001 and first quarter 2002. CFO Scott Sullivan was fired on the same day.
Further review found over $10 billion in operating expenses that were fraudulently capitalized. WorldCom filed for bankruptcy in July 2002. CFO Sullivan pleaded guilty of securities fraud and agreed to cooperate with prosecutors. Ebbers was indicted on securities fraud and making false statements to the SEC and convicted. WorldCom emerged from bankruptcy in 2004 as MCI, with debt reduced to less than $6 billion and about that much cash. Debtors ultimately received about
35 cents on the dollar in new bonds and stock; the original stockholders received nothing. MCI agreed to pay the SEC some $750 million to repay investors wiped out by the scandal.
Sarbanes-Oxley Act - USA
After, following high profile scandal WorldCom - the US Congress working with the New York Stock Exchange (NYSE) agreed reforms to address potential conflicts of interest and the close working relationship between companies and their auditors. The result was The Accounting Industry Reform Act 2002, widely known as the Sarbanes-Oxley Act (2002). The purpose of the act is to enforce the independence of external auditors, reinforcing the duties of chief executive officers (CEOs) and chief financial officers (CFOs) by imposing strict penalties for misrepresenting the financial position of their companies in quarterly and annual reports. Penalties of personal fines up to USD 1 million or imprisonment of up to 10 years, or both, are available for mis-declaration. Sarbanes-Oxley has had a profound effect on corporate governance strategies within the US and further afield. The NYSE listing requirements proscribe additional requirements including that listed companies must have a majority of independent directors and must adopt and disclose a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers.
Impact of Failure of WorldCom
The failure impact of WorldCom was worse than expected. The company's share- and bond-holders are left holding practically worthless assets. With assets well below the company's debt of over $30 billion, creditors were unlikely to get their money back. WorldCom's 80,000 employees were likely to pay with their jobs. According to a mutual fund advisory group, 539 mutual funds own 400 million of the three billion in outstanding shares of WorldCom. Ordinary investors in these funds were likely to suffered severe losses. Moreover, there were also the 401(k) plans of ordinary workers in these mutual funds. In contrast to the losses that were immediate for ordinary people hooked to shares and investments in mutual and pension funds, corporate laws provide a far better cushion to top executives. On July 8, Ebbers and former Chief Financial Officer Scott Sullivan refused to testify before the congressional Financial Services Committee inquiring into the WorldCom scandal. The Committee is particularly keen to investigate links between the company and an investment analyst who were believed to have had prior knowledge about the dubious accounting methods employed by WorldCom. The telecom major AT&T was seen as a potential gainer in the aftermath of WorldCom's inevitable collapse.
Effect on Employee
17,000 of the WorldCom employees who lost jobs and retirement funds during bankruptcy. Severance was typically paid in a lump sum. WorldCom has elected to spread it out into multiple payments. If the company filed bankruptcy before paying severance packages, employees could have bumped to the back of the line with other low-ranking creditors and could have possibly see their severance capped. The company was delaying these payments to conserve cash.
Effect on Consumer
Consumers could also expect a noticeable difference in customer with longer customer service call times and slower complaint resolution. Over the years, aggressive competition has driven down long distance rates; however, the remaining large carriers probably took the opportunity to increased consumer rates and fees. Consumers looking to switch carriers would have to shop around for low long distance rates.
Effect on Corporate Account
WorldCom's 20 million customers include many Wall Street powerhouses, large manufacturers and government agencies. It was likely that many companies suffered one way or another from WorldCom's problems. A full-scale switch could have taken months, depending on the complexity of a system.
Many corporate clients were locked into lengthy contracts with WorldCom that contain large penalties for switching, even if WorldCom filed for bankruptcy reorganization. Many companies would have forced to choose between paying a steep fee for breaking the contract or let their vital communication networks deteriorate
Effect on Investor
There was no much hope for stockholders looking to recoup lost investments. Stockholders legally had the right to some money, but in most situations they were at the bottom of the list and got nothing.
After WorldCom declared bankruptcy, bondholders did not receive interest and principal payments and shareholders did not receive dividends. Bondholders could have received new stock in exchange for bonds, new bonds, or a combination of stocks and bonds. The majority of bondholders were banks' investment departments, insurance companies and pension funds.
Effect on Auditors
As MCI prepared to cross the finish line in its massive corporate restructuring by the end of April, a new set of hurdles were thrown up involving its auditor-KPMG. Massachusetts, Alabama, Arkansas, Connecticut, Florida, Georgia, Iowa, Kentucky, Mary l a n d, Michigan, Missouri, New
Jersey, Pennsylvania and Wisconsin filed in bankruptcy court seeking the disqualification of KPMG as MCI's auditor and demanding KPMG give up approximately $140 million fees.
KPMG is WorldCom's auditor and tax adviser. The states contend that the firm should be disqualified as the company's auditor because the different hats it wears allow it to certify the propriety of its own work in reducing WorldCom's state tax liabilities.
CONCLUUSION:
This paper described the major twenty-first-century business scandal, World com. WorldCom was a big company with a case of simple fraud (capitalizing operating expenses), with the same result: bankruptcy. Combined with other corporate scandals, the result was the Sarbanes-Oxley Act of 2002 to improve regulation and oversight, a quick and broad-based federal response to these problems
The early twenty-first century has proved that the business cycle still exists and corporate scandals are not a thing of the past. Greed and hubris are recurring themes in these as in earlier scandals. There are obvious differences. Considerable oversight and regulations exist they just were not effective when not adequately enforced. Somewhat unusual were the scandals at really big companies and the fraudulent schemes coming from the executive offices. Most frauds are at smaller companies and at lower levels in big companies
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