WorldCom Internal Probe Uncovers Massive Fraud
Expenses of $3.8 Billion Were Improperly Booked,
Boosting Cash Flow and Profits; CFO Is Dismissed
By REBECCA BLUMENSTEIN, JARED SANDBERG and SHAWN YOUNG
Staff Reporters of THE WALL STREET JOURNAL
WorldCom Inc.'s audit committee has uncovered what could be one of the largest accounting frauds in history with the discovery of $3.8 billion in expenses that were improperly booked as capital expenditures, a financial gimmick that boosted the company's cash flow and profit over the past five quarters, according to people familiar with the situation.
WorldCom, Clinton, Miss., said the discovery will result in a restatement of earnings for 2001 and the first quarter of 2002. Without the improperly booked expenses, which the company said weren't in accordance with generally accepted accounting principles, the company's reported earnings before interest, taxes, depreciation and amortization, or Ebitda, would be reduced to $6.339 billion for full-year 2001 and $1.368 billion for the first quarter of 2002 and would have resulted in a loss for those periods. The company is planning to issue new audited financial statements for all required periods after it completes an audit.
Go to Called to Account
WorldCom has fired its longtime chief financial officer, Scott Sullivan, and has accepted the resignation of its controller and senior vice president, David Myers, the company said in a statement.
WorldCom spokesman Brad Burns said the company is working to address the situation as quickly as possible. "We are obviously very shocked. We identified the problem, took it to the SEC and will work with them closely throughout this process," said Mr. Burns.
Neither Mr. Sullivan nor Mr. Myers could be reached to comment.
The discovery was made during an internal investigation launched by the board after the ouster of WorldCom's chief executive, Bernard J. Ebbers, in April. John Sidgmore, who took over as WorldCom's chief executive in late April, declined to comment.
"The whole thing is just unbelievable," said one person familiar with the matter.
The restatement alone could deliver the final blow to WorldCom, which was one of the biggest stock-market stars of the 1990s. The telecommunications firm has already been hobbled by a collapsing market, an investigation by the Securities and Exchange Commission and $30 billion in debt.
WorldCom has been in difficult negotiations with its banks for a $5 billion line of credit and the latest development could increase the likelihood that WorldCom will be forced to draw down $5.4 billion in existing credit lines, one of which expires June 30. Investors have been speculating that the company would draw down the lines.
Mr. Sidgmore, however, said in a statement that WorldCom remains "viable and committed to our long-term future. Our services are in no way affected by this matter and our dedication to meeting customer needs remains unwavering."
WorldCom said it notified its lead bank lenders of the audit results.
Sanford C. Bernstein analyst Jeff Halpern said he expected swift action from WorldCom's banks. "I would think the banks will foreclose on them immediately," said Mr. Halpern, who said that a Chapter 11 filing is quite possible. "This send them into a spiral of customer defections."
WorldCom initially discovered the problems during an internal audit as the company's audit committee initiated its own investigation, according to people familiar with the situation. Last week, one of WorldCom's internal auditors discovered that starting in early 2001, huge amounts of expenses related to building out their telecom system weren't being treated as a regular cost but were being capitalized, these people said. That resulted in a significant boosting of the company's Ebitda, which WorldCom used as a critical gauge of its growth, the same people said.
Based on a preliminary investigation, WorldCom believes that its Ebitda was inflated to the tune of $3.6 billion. The committee turned its findings over to its new auditors at KPMG LLC, which WorldCom hired after firing Arthur Andersen LLC earlier this year. The board forced Mr. Sullivan to resign and informed the SEC late Tuesday, according to people familiar with the situation.
Mr. Sullivan, who until recently was viewed as a financial wunderkind on Wall Street, came to WorldCom through an acquisition of his phone company and was extremely close to Mr. Ebbers. Mr. Sullivan served as a WorldCom director since 1996 and as chief financial officer, treasurer and secretary of the company since 1994. He became an executive vice president at WorldCom when Mr. Ebbers resigned April 30 amid criticism over a $366 million personal loan from the company.
In 4 p.m. Nasdaq Stock Market trading Tuesday, WorldCom's stock was at 83 cents, down 8.8% for the day and a far stretch from its high of $64.50 in June 1999.
WorldCom since March has been embroiled in an SEC investigation into its finances and the double-digit revenue growth. The SEC also is investigating how the company accounted for its biggest acquisitions, a sensitive point since the company is the legacy of more than 70 businesses that Mr. Ebbers acquired since founding the company in Mississippi as a long-distance reseller.
Monday, WorldCom's shares slipped below $1 for the first time, a situation that could trigger a delisting by the Nasdaq Stock Market if it persists for 30 consecutive days. The decline was in response to a negative report from Salomon Smith Barney analyst Jack Grubman, once the company's biggest supporter on Wall Street.
WorldCom has 20 million consumer customers and 80,000 employees. The core of its business is phone and data service to large corporate clients.
Write to Rebecca Blumenstein at rebecca.blumenstein@wsj.com, Jared Sandberg at jared.sandberg@wsj.com and Shawn Young at shawn.young@wsj.com
Updated June 25, 2002 9:11 p.m. EDT |
