Business, Legal & Accounting Glossary
The WorldCom Scandal was an accounting scandal involving the telecommunications company WorldCom, which was at the time the second-largest long-distance phone company in the USA (2002).
As the scandal surfaced, it emerged that WorldCom had dishonestly enhanced its financial results by approximately $11 billion USD through:
The former meant that many current expenses failed to be displayed on the profit and loss account, thereby appearing to inflate the companies short-term profits; whilst also artificially boosting the value of the assets.
The latter likewise created illusory profits whilst diminishing liabilities.
The fraud identified by internal auditors at WorldCom was at the time the biggest scandal in US history – and led to the company subsequently filing for bankruptcy protection in 2002.
As a result of the scandal, several senior executives at WorldCom also faced criminal charges.
WorldCom was not just the biggest accounting scandal in the history of the United States—it was also one of the biggest bankruptcies of all time. The revelation that telecommunications giant WorldCom had cooked its books came on the heels of the Enron and Tyco frauds, which had rocked the financial markets. However, the scale of the WorldCom fraud put even them in the shade.
For a time, WorldCom (WCOM) was the United States’ second-largest long-distance phone company (AT&T is the largest). WorldCom grew largely by acquiring other telecommunications companies, most notably MCI. It also owned the Tier 1 ISP UUNET, a major part of the Internet backbone. It was based in Clinton, Mississippi.
WorldCom has become a symbol of accounting fraud and a caution to investors that when something appears to be too good to be true, it probably is. By acquiring other telecom firms, its CEO, Bernie Ebbers—a larger-than-life figure known for his cowboy boots and ten-gallon hat—had turned the company into one of America’s largest long-distance phone providers. Its market value had risen to $175 billion at the height of the dot-com bubble.
When the IT bubble burst and firms cut spending on telecom services and equipment, WorldCom used accounting gimmicks to keep the image of ever-increasing profitability. Many investors were sceptical of Ebbers’ storey by that time, especially after the Enron affair surfaced in the summer of 2001.
It was disclosed shortly after Ebbers’ forced resignation as CEO in April 2002 that he had borrowed $408 million from Bank of America in 2000 to cover margin calls, using his WorldCom shares as collateral. As a result, Ebbers’ riches were lost. He was found guilty of securities fraud in 2005 and was sentenced to 25 years in jail.
This was hardly a sophisticated deception. WorldCom overstated net income and cash flow by classifying expenses as investments in order to conceal its declining profitability. It overstated profits by $3.8 billion in 2001 and $797 million in Q1 2002 by capitalising expenses, reporting a profit of $1.4 billion instead of a net loss.
On July 21, 2002, WorldCom declared bankruptcy, just a month after its auditor, Arthur Andersen, was convicted of obstruction of justice for shredding documents connected to its audit of Enron. Arthur Andersen, which audited WorldCom’s 2001 financial results and evaluated the business’s books for the first quarter of 2002, was later revealed to have overlooked memoranda from WorldCom executives telling them that the company was inflating profits by incorrectly accounting for expenses.
This wave of corporate criminality prompted the passage of the Sarbanes-Oxley Act in July 2002, which reinforced disclosure standards and increased penalties for false accounting.
WorldCom’s demise left a stain on the reputations of accountancy companies, investment banks, and credit rating agencies that has yet to be completely cleansed.
Bernard Ebbers was sentenced to 25 years in prison in 2005 after being convicted of nine counts of securities fraud. After pleading guilty and testifying against Ebbers, former CFO Scott Sullivan was sentenced to five years in prison. After serving 14 years of his sentence, Ebbers was given early release for health reasons on Dec. 18, 2019.
When it emerged from bankruptcy in 2003 as MCI—a telecom business WorldCom had acquired in 1997—the company would continue as an ongoing concern thanks to debtor-in-possession financing from Citigroup, J.P. Morgan, and G.E. Capital.
However, tens of thousands of workers were laid off.
Without admitting blame, Worldcom’s banks, including Citigroup, Bank of America, and J.P. Morgan, agreed to pay $6 billion in settlements with creditors. Around $5 billion of the total went to bondholders, with the remainder going to former stockholders. MCI agreed to pay shareholders and bondholders $500 million in cash and $250 million in MCI stock as part of a settlement with the Securities and Exchange Commission. MCI was bought by Verizon Communications in January 2006.7
On November 10, 1997, WorldCom and MCI announced their US$37 billion merger to form MCI-WorldCom, making it the largest merger in US history.
In June 2002, an internal audit discovered that US$3.8 billion had been ‘mis-accounted.’ The US Securities and Exchange Commission launched an investigation into these matters on June 26, 2002.
On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection in the largest such filing in United States history. Its CEO and founder, Bernard Ebbers, came under fire for his failure to prevent the bankruptcy.
In August 2002, an additional $3.3 billion in improper accounting since 1999 was announced. By the end of 2003, it was estimated that the company’s assets had been inflated by around $12 billion.
In May 2003, the company was given a no-bid contract by the United States Department of Defense to build a cellular telephone network in Iraq. The deal has been criticized by competitors and others who cite the company’s lack of experience in the area.
The company emerged from Chapter 11 bankruptcy in 2004 with a new name, MCI, and about $5.7 billion in debt and $6 billion in cash. About half of the cash was intended to pay various claims and settlements. Previous bondholders ended up being paid 35.7 cents on the dollar, in bonds and stock in the new MCI company. The previous stockholders’ stock was valueless.
Under the bankruptcy reorganization agreement, the company paid $750 million to the SEC in cash and stock in the new MCI, which was intended to be paid to wronged investors.
WorldCom was not only the worst accounting fraud in US history, but it was also one of the largest bankruptcies in history. The news that telecommunications behemoth WorldCom had falsified its books came just days after the financial markets were rocked by the Enron and Tyco scandals. The size of the WorldCom deception, on the other hand, put them in the shade.
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This glossary post was last updated: 13th April, 2022 | 0 Views.