WorldCom scandal
The WorldCom scandal is one of the most significant accounting frauds in United States history, involving the misstatement of approximately $11 billion in earnings. Founded in 1983 as Long Distance Discount Services and later led by CEO Bernard Ebbers, WorldCom became a major player in the telecommunications industry, notably merging with MCI in 1997. However, the company faced challenges in maintaining growth and stock prices, leading Ebbers to pressure accountants to manipulate financial statements. This fraudulent activity was ultimately exposed by whistleblowers, prompting a public revelation that led to the arrest of several executives, including Ebbers, who received a twenty-five-year prison sentence.
The fallout from the scandal resulted in over $180 billion in losses for investors and prompted the creation of the Sarbanes-Oxley Act of 2002, aimed at increasing corporate accountability and transparency in financial reporting. Following the scandal, WorldCom filed for Chapter 11 bankruptcy, the largest in U.S. history at the time, and later rebranded as MCI after emerging from bankruptcy in 2004. The company was eventually acquired by Verizon Communications in 2005. The WorldCom scandal not only marked a pivotal moment in corporate governance but also highlighted the need for stricter regulations against accounting fraud, a concern that remains relevant today.
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WorldCom scandal
On June 25, 2002, WorldCom, the second-largest telecommunications company in the United States, admitted that its accountants had overstated its 2001 and first quarter 2002 earnings by $3.8 billion. On July 21 of the same year, WorldCom filed for bankruptcy. On August 8, 2002, the company admitted that it had misclassified at least another $3.8 billion.
In the investigation that followed the initial revelations by WorldCom, it was revealed that the company had misstated earnings by approximately $11 billion. This remains one of the largest accounting scandals in United States history. The fall in the value of WorldCom stock after revelations about the massive accounting fraud led to over $180 billion in losses by WorldCom’s investors.
WorldCom, which began operating under the name Long Distance Discount Services in 1983, was led by one of its founders, CEO Bernard Ebbers, from 1985 to 2002. Under Ebbers’s leadership, the company engaged in a series of acquisitions, becoming one of the largest American telecommunications companies. In 1997, the company merged with MCI, making it the second largest telecom company after AT&T. In 1999, it attempted to merge with Sprint, which would have made it the largest in the industry. However, this merger was scrapped due to the intervention of the Department of Justice, which feared a WorldCom monopoly.
WorldCom stock, which rose more than 50 percent on rumors of this merger, began to fall. Ebbers then tried to grow his company through new customers rather than corporate mergers, but was unable to do so because the sector was saturated by 2000. He borrowed significantly so that WorldCom would have enough cash to cover anticipated margin calls, commonly used to prove that a company has funds to cover potential speculative losses. Desperate to keep his company’s stock prices high, Ebbers pressured company accountants to show robust growth on earnings statements.
The WorldCom accounting scandal was ultimately uncovered by a team of WorldCom whistleblowers led by accountantCynthia Cooper. Their secret investigation revealed evidence that ordinary business expenses were being counted as capital expenses, inflating the company’s record of assets. The whistleblowers informed the WorldCom board of directors, who then went public with the story. As a result, several WorldCom executives were arrested for orchestrating the fraud. In July 2002, WorldCom filed for Chapter 11 bankruptcy protection, the largest American bankruptcy filing to that time. On July 13, 2005, Ebbers was convicted of conspiracy, fraud, and filing false documents with the federal government and sentenced to twenty-five years in federal prison. Other former WorldCom executives, among them chief financial officer Scott Sullivan, comptroller David Myers, and accounting director Buford Yates, pleaded guilty to conspiracy and fraud charges and received lesser sentences.
Impact
When it broke, the WorldCom scandal was the largest instance of accounting fraud in American history. Moreover, it happened soon after a similar case involving the energy company Enron. As a result, the scandal created enormous public pressure to pass legislation targeting similar forms of fraud. This came in the form of the Sarbanes-Oxley Act of 2002. Among other things, the new law increased criminal penalties for executives involved with fraud, required companies to use external auditors, and called for more transparent asset disclosures. However, the law did not prevent even larger instances of accounting fraud revealed by the financial crisis of 2008. In 2008, WorldCom's financial fraud was eclipsed in size by the $64 billion Ponzi scheme orchestrated by financier Bernard Madoff.
In 2003, WorldCom changed its name to MCI, and the company emerged from bankruptcy in 2004. It was acquired in 2005 by Verizon Communications and has been known since 2006 as Verizon Enterprise Solutions.
Bibliography
Beresford, Dennis, Nicholas Katzenbach, and C. B. Rogers Jr. “Report of Investigation by the Special Investigative Committee of the Board of Directors of WorldCom, Inc.” US Securities and Exchange Commission. US SEC, 31 Mar. 2003. Web. 5 Dec. 2012.
Clikeman, Paul M. Called to Account: Financial Frauds that Shaped the Accounting Profession. 2nd ed. New York:Routledge. Print.
Cooper, Cynthia. Extraordinary Circumstances: The Journey of a Corporate Whistleblower. Hoboken: Wiley, 2008. Print.
Giroux, Gary. "What Went Wrong? Accounting Fraud and Lessons from the Recent Scandals." Social Research 75.4 (2008): 1205–38. Print.
Lyke, Bob, and Mark Jickling. “WorldCom: The Accounting Scandal.” CRS Report for Congress. Congressional Research Service, 29 Aug. 2002. Web. 5 Dec. 2012.