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July 1, 2003

4 Min Read
Carrier Channel: SEC: WorldCom Execs Concealed Glut, Investigators Say

Posted: 7/2003

WorldCom Execs Concealed Glut, Investigators
Say

By Josh Long
WorldComs Bernie EbbersIt is a familiar story. In
2000, ailing carriers sought to topple their rivals by undercutting them on
price because most of the worlds network capacity was underutilized. WorldCom
Inc. was not immune to the pressure: Line costs, which represented about half of
all its expenses, were swelling.

An investigative report released in June reveals
WorldCom senior executives exerted immense pressure on many groups responsible
for its network to cut line costs, and manipulated the results to help post
quarterly profits in one of corporate Americas most notorious scandals (see
chart).

In a July 2000 e-mail submitted to two former
WorldCom executives who have been charged with fraud by the U.S. Justice
Department, an underling suggested that the company capitalize the excess
capacity to slash its costs, according to a report released by the Special
Investigative Committee of the board of directors of WorldCom.

I have been making some phone calls trying to
find out why our cost[s] are increasing this quarter and from what I am
gathering it sounds like we are starting to get a network out there that has a
lot of extra capacity, wrote Tony Minert, then general accountings manager
of telco reporting, to David Myers and Buford Yates, the former controller and
director of general accounting. If we could somehow take that
…underutilized network … into an inventory or prepaid account and only
booked it as expense when we have the revenue to match it, then this might help
with our e/r [ratio of line cost expense to revenue] numbers.

Myers and Yates, the report says, rejected the
proposal as unsupportable under generally accepted accounting principles. Minert
suggested the idea several more times in July, but Yates informed him his
idea had no accounting support, according to the report.

Minert left the company shortly afterwards, but
his idea apparently stuck with his superiors.

Based on the evidence we have seen, it appears
the decision to capitalize operating line costs in 2001 was made by [former CFO
Scott] Sullivan with the involvement, or at least cooperation, of Myers and
Yates, the report states. Because we have been unable to talk to these
three people there are important questions we cannot answer, including how they
settled on capitalization as to the solution of the excess capacity problem and
whether [former CEO Bernie] Ebbers was aware of the decision or its effect on
WorldComs reported results.

The investigation, led by William McLucas of the
law firm of Wilmer, Cutler & Pickering, describes how WorldComs brass
ruled the phone giant as lords who concealed the fraud from their auditor,
bullied employees who questioned their tactics and approved multibillion-dollar
acquisitions in a matter of hours or minutes without a shred of paper presented
to the board of directors.

As of early June, the SEC and Justice Department
had not filed charges against Ebbers. Ebbers was aware, at a minimum, that
WorldCom was meeting revenue expectations through financial gimmickry, stated
the report, which was issued after investigators examined millions of pages of
accounting records and other documents and electronic files.

The report describes how former top brass
concealed questionable accounting practices from employees while scolding and
intimidating others. After one employee approached Yates for an explanation
of a large [accounting] discrepancy, Yates reportedly berated him and said, Show
the numbers to the damn auditors and Ill throw you out of the [expletive]
window.

The former board of directors, according to a
separate investigative report bankruptcy court examiner Dick Thornburgh issued,
functioned as puppets, rather than as watchdogs.

Several multibillion-dollar acquisitions were
approved by the board of directors following discussions that lasted for 30
minutes or less without the directors receiving a single piece of paper
regarding the terms or implications of the transactions, the report states.

For example, WorldCom acquired Web hosting
provider Digex Inc. for $6 billion based on about 90 minutes of due diligence
and a 35-minute telephone board meeting, according to the report. The board also
approved the $2 billion acquisition of SkyTel Communications Inc. in 1999 after
a 15-minute presentation and again without a single piece of paper being
provided to the board, according to the report.

 

By the Numbers

The WorldCom fraud principally took
two forms: the reduction of reported line costs and the inflation of
reported revenue, according to an investigative report released in June.
Here is a summary of income statements in particular areas shown in
millions of dollars.   
 

1999

2000

2001

2002

Total

Revenue

$205

$328

$358

$67

$958

Line costs

598

2,870

3,063

798

7,329

SG&A

46

283

181

25

535

Other

89

393

(4)

(50)

428

Total

938

3,874

3,598

840

9,250

Source:
Special Investigative Committee of the board of directors of WorldCom Inc.

 

Links

Digex Inc. www.digex.com

U.S. Department of Justice www.usdoj.gov

U.S. Securities & Exchange Commission www.sec.gov

Wilmer, Cutler & Pickering www.wilmer.com

WorldCom Inc. www.mci.com

 

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