Professionalism/Cynthia Cooper and Worldcom

The WorldCom accounting scandal is an important case in ethics.

WorldCom Background

WorldCom started as a small long distance telephone service provider in a small in Mississippi. During this time period in the early 90’s, their business model was the resale of long-distance telephone service from larger telephone companies like AT&T to individual consumers and businesses. It later transitioned into a wholesale long distance service provider through the acquisition of various companies and network facilities during the mid to late 80’s. From 1990 to 2001, WorldCom boosted its reported revenues from $154 million to 39.2 billion. It evolved into the second-largest long distance telephone company in United States and one of the largest companies handling Internet data traffic. It was truly a global telecommunications company that boasted 22 million customers and an international presence in more than 100 countries.

Business Strategy

WorldCom’s main growth strategy was mergers and acquisitions, and employed little focus on the organic development and growth of its own network facilities, instead opting to buy another companies assets. Between 1991 and 1998, WorldCom successfully completed 65 acquisitions and spent 60 billion dollars and accumulated 41 billion dollars in debt. Every acquisition successfully completed further increased WorldCom profit and revenue, and eventually WorldCom became the darling of Wall Street, where numerous Investment banks, stock analysts, and brokers made strong buy recommendations to investors. By 1997, WorldCom’s stock had risen from less than a dime to over $60 dollars, giving them ample capital to pursue bigger and bolder acquisitions to expand their revenue and profit.

MCI Acquisition

MCI communications had received a lot of interest in 1994 from British Telecom, who acquired a 20% minority ownership stake in MCI communications. In late 1997, British telecom made a 19 billion dollar bid for MCI communications, which was later trumped by WorldCom’s 30 billion dollar offer in stock. In 1998, WorldCom acquired MCI Communications in a deal worth 35 billions dollars. This this was composed of 30 billion dollars in WorldCom stock and 5 billion dollars in assumed MCI communications debt.

WorldCom’s acquisition of MCI Communication was met with some opposition from US and European regulation due to concerns on its effect on the telecommunications market. One concern was the fact that the merger would develop an excessive amount of market power over the Internet, which would lead to higher prices for consumers. This would undermine the Telecommunications Act of 1996, which was created for the intention of promoting competition within the telecommunications sector. Also, It was feared the merger of WorldCom and MCI communications could impose serious social costs by reducing the amount of resources and capital needed to adequately modernize the shared telecommunications network. Despite these concerns, the WorldCom acquisition of MCI communication was approved. This acquisition was WorldCom’s most significant acquisition and made them into a salient global telecommunications company.

Subsequently to the merger with MCI communications, WorldCom encountered numerous difficulties in the integration of MCI communications billing systems and network infrastructure. WorldCom’s management was responsible for properly integrating the old and new businesses of WorldCom and MCI communications into a cohesive company. WorldCom was also responsible for the financial integration of the company’s assets, revenue, goodwill, and debt. WorldCom’s inability to adequately execute the WorldCom and MCI Communications integration resulted in an increase in costs and the erosion of profits. WorldCom failed to develop a unified corporate culture among their business units and board of directors. Also the inefficient management of MCI communications’ technical service centers led to the development of duplicate centers that further exacerbated WorldCom’s costs.

Sprint Merger

After the successful completion of the MCI merger, WorldCom sought an even bigger merger to further bolster their revenues, profits, and network facilities. In 1999, WorldCom proposed a $129 billion merger with Sprint Corp to form one of the largest corporate unions in history. IT was met it immense scrutiny from US and European Regulators who were concerned the newly formed company would be dominant and topple Internet competition in the USA and Europe. In 2000, European and US regulators blocked the proposed merger of WorldCom and Sprint, putting WorldCom under intense pressure to increase revenue and profits in order to appease Wall Street and shareholders.

Fraud

Motivation

WorldCom had embarked on a path of non-sustainable growth by acquisition of new companies. The integration of the newly acquired companies was difficult and made efficient management of the entire corporate entity practically impossible. The telecom industry faced a decrease in demand at the end of the dot-com boom, which was when the economy entered a recession WorldCom was affected by the recession and was unable to generate the sales they had projected. WorldCom had an oversupply of telecom capacity that it could not sell due to the decline in customer demand. WorldCom paid third party providers for long-distance telecom lines that were being underutilized. The high cost of line capacity, combined with declining customer demand led to a fall in net revenue, hence putting pressure on WorldCom to generate better results.

The Scandal

The increased pressure on WorldCom to deliver results resulted in the employment of “creative accounting” that made WorldCom’s profit look much larger than it actually was. This entailed reporting over $3.8 billion in line costs as capital expenditures rather than current expenses. Classifying line costs as capital expenditure meant that it was considered an asset; this would have permitted the company to spread its expenses on the telecom line into the future, since capitalized assets were depreciated annually, and were not reported on the income statement of the company. In the short term, costs fell, and revenue remained stable, implying an increase in profit (profit = revenue – cost). This made the company look like it was performing significantly better than it actually was, and in turn lied to shareholders and investors.

Exposing the Scandal

During an internal audit led by Cynthia Cooper, the auditors observed rather unusual accounting entries in the capital expenditure account in the WorldCom wireless division. Cynthia Cooper reported this to the external audit firm, which was Arthur Anderson. Internal auditors report to external auditors, who have the responsibility of reporting to investors and shareholders. Author Anderson told the internal auditors that all “aggressive” accounting entries were balanced out on a companywide basis. Soon after, Cynthia Cooper received a phone call from the chief financial officer of WorldCom Scott Sullivan, who asked her to delay the capital expenditure audit. This made the internal auditors more suspicious, Cynthia and her team delved deeper into this investigation and eventually got the WorldCom controller David Meyers to confess.

The Aftermath

On June 25th 2002, WorldCom admitted that the company had classified $3.4 billion in payments for line cost as capital expenditure rather than current expenses. WorldCom could no longer manage their debt and in July 2002 filed for Chapter 11 bankruptcy. The company had over $104 billion in assets, making it the largest bankruptcy in the United States at the time. The CEO Bernard Ebbers, CFO and other executives involved in the scandal were prosecuted and went to prison. The internal audit team moved on to new jobs and Cynthia Cooper was revered for her role in uncovering this scandal.

Major Players

There are three major players in the WorldCom accounting scandal: Cynthia Cooper, Bernard Ebbers, and Scott Sullivan. The actions of Ebbers and Sullivan pushed the company into bankruptcy and later found guilty of securities fraud. Cooper, the whistle blower, helped bring the scandal to light.

Cynthia Cooper

Cynthia Cooper is thought of as a prime example of a whistleblower for her role in uncovering the WorldCom accounting scandal. She was among Time Magazine’s persons of the year in 2002. Cynthia, a native of Mississippi, was an accountant that worked as the vice president of internal audit at WorldCom. She quit her job after the scandal and founded her own consulting firm. She also gives talks to students, professionals and companies on professionalism and whistleblowing, and shares her personal experiences. She also published a book in 2008 called “Extraordinary Circumstances: The Journey of a Corporate Whistleblower” that talked about her life, WorldCom and her lessons learned.

Bernard Ebbers

Bernard Ebbers was the founder and Chief Executive Officer of WorldCom at the time the scandal broke out. He acquired much of his wealth through the acquisitions of telecom companies in the late 1990s. In 1999, Ebbers' net worth was about $1.4 billion. Much of his stock holdings were used to invest in real estate and other property.

When WorldCom's stock price dropped significantly in the early 2000s, Ebbers was pressured to provide more collateral for loans backed by his shares in the company. To prevent him from selling his shares, WorldCom's board of directors granted him several loans to prevent him from selling the stock. By 2002 these loans amounted to $408 billion, including interest.

Ebbers resigned as CEO in April 2002, under pressure by the board of directors and amidst a Securities and Exchange Commission investigation into $400 million in loans issued to him.

In March 2004 Ebbers was indicted on 3 charges of conspiracy and securities fraud. . In May the number of charges was increased to nine, with seven consisting of filing false statements to investigators. He was found guilty on all counts in March 2005, with a 25 year sentence imposed in July. Though he was allowed to remain free upon appeal, the sentence was upheld in July 2006.

Scott Sullivan

Scott Sullivan was the Chief Financial Officer and treasurer for WorldCom, and was responsible for the fraudulent accounting practices of the company. Under the direction of Ebbers, Sullivan oversaw the making of accounting entries that were not in line with generally accepted accounting principles to give WorldCom a false image of profitability.

As Cynthia Cooper began investigating suspicious accounting entries with Arthur Andersen, WorldCom's accounting firm, Sullivan initially did not resist the motion. He later asked her to stay out of such matters. As Cooper's investigation continued, more evidence of fraud was found, prompting Sullivan to ask her to hold off on the investigation until the third quarter 2002. She refused, and in June 2002 Sullivan was fired.

In August 2002 Sullivan was indicted on two charges of securities fraud and five charges of false reports. These charges are a result not only of improper accounting entries and for using the incorrect numbers in false statements in the 10-K and 10-Q filings for 2001 and first quarter 2002. He pled guilty to these charges, and was sentenced to five years in jail. His cooperation with prosecutors helped him get a reduced sentence, as he also testified against Ebbers at trial.