The WorldCom Accounting Scandal

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Case Details:

Case Code : FINC022
Case Length : 19 Pages
Period : 1990 - 2002
Pub. Date : 2002
Teaching Note :Not Available
Organization : WorldCom, Arthur Anderson
Industry : Telecom, Financial Services
Countries : USA

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This case study was compiled from published sources, and is intended to be used as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of a management situation. Nor is it a primary information source.

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"Corrupt corporate executives are no better than common thieves when they betray their employees and steal from their investors."

- John Ashcroft (US Attorney General), in August 2002.

"WorldCom put extraordinary pressure on itself to meet the expectations of securities analysts."¹

- A report filed with the bankruptcy court, November 2002.

Worldcom 2002: Yet Another Corporate Scam

On June 26, 2002, the US-based telecommunications major WorldCom received unprecedented media coverage all over the world. Not for good reasons though. The company had earned the dubious distinction of being involved in the largest accounting scandal ever to hit the US corporate history. WorldCom had reportedly misrepresented its financial statements to an extent of around $ 4 billion.

The company admitted that it had resorted to fraudulent accounting practices for five quarters (four quarters of 2001 and the first quarter of 2002). Soon after, WorldCom terminated the services of some of its top executives including Scott Sullivan (Sullivan), the Chief Financial Officer and David Myers, the Senior Vice President and Controller.

The company's auditors held Sullivan responsible for the accounting mess and Sullivan was soon arrested on charges of fraud and misrepresentation. Adding fuel to the fire was the fact that Arthur Anderson was WorldCom's auditor while the inappropriate accounting was taking place.²

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However, Arthur Andersen tried to wash its hands off the crisis stating that it was not aware of the accounting discrepancies. They accused Sullivan for withholding crucial information about book-keeping practices followed at WorldCom.

With the sudden appearance of a $ 4 billion hole in its balance sheet, WorldCom was in an acute financial crisis. A severe cash crunch forced the company to layoff 17000 workers, which constituted 20% of its global workforce. Eventually, the financial crisis forced WorldCom to file for reorganization under chapter 11³ of the Bankruptcy Code in July 2002., In August 2002, WorldCom shocked company observers and stakeholders yet again by reporting an additional improper reporting in its financial statements. This time around, the amount involved was $ 3.3 billion, carried out by manipulating the EBITDA⁴ during 1999-2001, and the first quarter of 2002. By late 2002, the extent of misappropriation by WorldCom was estimated to be well over $ 9 billion...

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1] www.guardian.co.uk.

2] Arthur Anderson was also found guilty on charges of 'Obstruction of Justice' in the government investigation of another infamous client, Enron, which was embroiled in a major financial scandal as well.

3] Chapter 11 of the U.S. Bankruptcy Code provides debtors a vehicle for operating their business under protection from the creditors while developing a plan for resolving their financial problems. The debtors can then develop a 'plan of reorganization' that enables them to operate successfully in the future, free from the burdens that precipitated the Chapter 11 filing in the first place.

4] Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) refer to a company's reported profit before the charges of depreciation and amortization (non-cash) interest and taxes (cash). It is calculated by deducting total expenses from the revenues in the period under consideration excluding the four expenses mentioned. Often used as a measure of a company's financial performance, EBITDA has many critics as well who state that unlike cash flows, it can be very easily manipulated to please investors.