The Mistake:
Committing fraudulent accounting practices, which led to a $9 billion misrepresentation of profits since 1999.

The Cause:
Corporate culture that was fixated on the "numbers," corporate greed, and high debt.

Background:
What began as a routine internal audit, transformed into the largest accounting manipulation of all time. Worldcom, a leading telecommunications company built from over 70 acquisitions,¹ found itself ranked at the top of its class for illegal and creative accounting practices. Worldcom leaders successfully managed to erode the company market value from $180 billion in 1999 to approximately $350 million today.²

In June of 2002, Cynthia Cooper, Vice President of internal audit, uncovered suspicious capitalizing of line costs that had been treated as expenses in prior years. Cooper brought the "accounting discrepancy" to the attention of Scott Sullivan, Chief Financial Officer at the time. Sullivan dismissed Cooper's concerns and attempted to convince her to postpone the audit. Unfortunately for Sullivan and Ebbers, Cooper continued her investigation and presented her findings to Max Bobbitt, Head of Worldcom's Audit Committee, who then informed the rest of the committee and KPMG.³ The Worldcom empire began to shake.

At first, the issue in question was approximately $4 billion of misallocated line costs⁴ in the financial statements beginning in 2001 to the first quarter of 2002.⁵ By capitalizing these expenses, Worldcom managed to "produce" profits for five quarters that would have otherwise shown loses.⁶ As if that were not bad enough, other fraudulent accounting practices were unveiled going back to 1999. An additional $2 billion reserved for bad debts was improperly used to boost operating income.⁷ Other accounting manipulations included inflating profit-margin figures by arbitrarily reducing line costs and maintaining fake accounts on the accounts receivables books. In total, Worldcom almost successfully misrepresented profits by approximately $7 billion⁸ with an additional $2 billion in question.

Warning Signs:
The Worldcom failure was a shock to many, but reality is, there were many "warning signs" that indicated trouble as early as 1999. Critically analyzing and leveraging these signs may have helped investors, board members, and executives prevent the fall of this major telecommunications company.

Worldcom leaders bred a culture of cutting corners to meet business needs. Customers, employees, and shareholders were all pawns in the game of making money. Worldcom was an "ethically challenged company."⁹ A mentality of cashing in and a Machiavellian approach to meeting numbers permeated Worldcom from executive management to customer service representatives. So, how can you spot the next Worldcom? Look below for major clues.

1. Management promoted a culture fixated on "the numbers"
   • During analyst meetings, Ebbers would only discuss the share price. He had been known to show a graph of an increasing share price of WorldCom and ask: "Any questions?"¹⁰
   • Going back as far as two years ago, employees were told to capitalize obvious expenses in order to meet aggressive targets. For example, one employee was told to capitalize plane tickets when visiting company sites.¹¹
   • In March 2001, revenue numbers weren't at a satisfactory level, therefore Sullivan, in hopes to improve current profit margins, provided David Myers, Worldcom Controller, with "alternative financial numbers along with an implicit command to substitute them for the company's actual financial data."¹²
   • Worldcom allocated significantly higher reserves for bad debt that would ultimately be used to boost operating income to meet income targets for that period.¹³
   • Since revenues were booked when the bill was issued as opposed to when the payment was received, Worldcom habitually overcharged and added undesired services to meet numbers. In total, billing errors had the potential of adding a significant amount to Worldcom's bottom line. For example, at one point, Infolink "owed" Worldcom $300,000 in billing errors.¹⁴
2. Customers, employees, and shareholders were an afterthought
   • Customer dissatisfaction was at an all time low. Several of Worldcom's business units were ranked among PlanetFeedBack's¹⁵ top ten worst companies in terms of customer service and billing errors.¹⁶ Worldcom received a significantly lower than industry average rating from customers. Worldcom ranked number one in "slamming complaints."¹⁷ The FCC found that since 1997, Worldcom has surpassed both AT&T and Sprint in terms of complaints.¹⁸ Customer service representative were told to "do whatever you had to do in order to get the sale" which included withholding information about monthly fees and minimums.¹⁹ Worldcom, who had fewer customers than other major carriers, had the most customer complaints logged against it.²⁰
   • It is believed that many of the billing errors did happen due to lack of training or knowledge from service reps of sales' deals/discounts, but when the service rep attempted to reverse the charge in the customer's favor—no superior would respond to the request.²¹ For two years a customer attempted to resolve a bill for $4 million.²²
   • Major problems with lawsuits.
     • Worldcom settles a California lawsuit by paying $8.5 million.²³ They also had problems in Florida and New York.
     • Worldcom settled class action suit for $88 million in 2001 for switching millions of customers to more expensive plans.²⁴
     • Lawsuit by two stockholders argues that the personal loans to Ebbers were inappropriate and a misuse of Worldcom dollars.²⁵
     • Another lawsuit supported by 100 former employees signaled trouble.²⁶ Accusations ranged from blatant double booking of sales to maintenance of receivables that were several years old to withholding payment to suppliers to avoid expense recognition.²⁷
   • Management showed little respect and confidence in employees. Junior accountants were sent in by Sullivan to double-check division managers' finance work.²⁸
3. Mentality of cashing in
   • Excessive loans to executives in order to protect stock price: The compensation committee agreed to loan Bernie Ebbers, Worldcom founder, approximately $400 million at 2% interest rate when his margin loans against Worldcom were called.²⁹ Although Ebbers owned 0.5% of the total shares outstanding, the compensation committee's logic for the loan approval was to prevent further decline of the stock price since he would have been required to sell his shares in order to cover the margin call.³⁰ Funny enough, the loans were secured on 27 million shares of Worldcom in addition to his other personal items.³¹ Interestingly, Stiles Kellett Jr., the compensation committee chairman and venture capitalist, received a $5 million investment for one of his start-ups from Ebbers in 2001;³² Kellert was also the beneficiary of a $1/month leasing arrangement for use of the corporate jet shortly after the loan was approved.³³
   • Ebbers approved major personal loans to board members, offered board positions to executives of newly acquired firms and allowed board members to heavily invest in competing companies.³⁴ In exchange, it appears board members lent their support to Ebbers. Board members who were not supportive were sometimes ridiculed in public.³⁵
   • Not only were customers being double billed for services, sales representatives were reaping the benefits by arbitrarily boosting their sales numbers to generate higher commissions. When Worldcom acquired MCI, Worldcom maintained both company's order-booking and billing systems,³⁶ which allowed sales representatives to book the same sale in two different systems. The result: inflated sales commissions. As one salesperson said, "It was the Wild, Wild West, with no sheriff and no rules."³⁷

Conclusion:
Not only did Worldcom create one of the largest telecommunications company, it also created a spectacular culture of cutting corners. Corrupt business practices took hold, driving leaders to make irrational business decisions and alienating customers and employees. WorldCom's management style and mentality, corporate strategy, and customer/employee relations all provided clues to the downfall. In the end, this was a story of corporate character, and what happens when it goes very wrong.

¹Backover, Andrew and Michelle Kessler. "Internal rifts threaten WorldCom." USA Today, August 27, 2002: Section: Money; Pg. 1B.

²Backover, Andrew and Michelle Kessler. "Internal rifts threaten WorldCom." August 27, 2002: Section: Money; Pg. 1B.

³Pulliam, Susan and Deborah Solomon. "How three unlikely sleuths exposed fraud at Worldcom." The Wall Street Journal, October 30, 2002: Section A; Pg. 1.

⁴Line Costs: Fees associated with using another companies network.

⁵Romero, Simon. "Turmoil at Worldcom: the overview; Worldcom facing charges of fraud; inquiries expand." The New York Times, June 27, 2002: Section A; Pg. 1.

⁶Sloan, Alan. "WorldCom's wrong numbers." Newsweek, July 8, 2002: Business; Pg. 44.

⁷Vieira, Paul. "Auditors find US$2B error at WorldCom: Total swells to US$5.9B: Magnitude of accounting fraud called 'staggering'." Financial Post, August 9, 2002: News; Pg. FP3.

⁸"Worldcom Errors hit $7.1 billion." St. Petersburg Times, August 9, 2002: National; Pg. 1A.

⁹Pender, Kathleen. "Corporate scandals; Worldcom's fraud was simple and blatant but hard to spot." The San Francisco Chronicle, June 30, 2002: Business; Pg. G1.

¹⁰Doward, Jaime. "Day the WorldCom world was turned upside down: The giant's fall." The Observer, June 30, 2002: Business Pages; Pg. 4.

¹¹Doward, Jaime. "Day the WorldCom world was turned upside down: The giant's fall." The Observer, June 30, 2002: Business Pages; Pg. 4.

¹²Dreazen, Yochi & Deborah Solomon. "WorldCom aide conceded flaws --- controller said company was forced to disguise expenses, ignore warnings." The Wall Street Journal, July 16, 2002: A3.

¹³Sloan, Alan. "WorldCom's wrong numbers." Newsweek, July 8, 2002: Business; Pg. 44.

¹⁴Porretto, John. "Overbilling may be the next issue to plague Worldcom." The Associated Press State & Local Wire, July 3, 2002.

¹⁵PlanetFeedBack is an online customer feedback service company that allows companies to gather and analyze customer feedback.

¹⁶PR Newswire. "PlanetFeedback releases consumer data findings on WorldCom; Thumbs down from consumers on billing practices, customer service and more." May 2, 2002: Financial News.

¹⁷Slamming: changing long-distance service without customer's permission

¹⁸Backover, Andrew. "Smaller WorldCom tops in complaints of slamming." USA Today, March 20, 2002 Link»

¹⁹Garcia, Beatrice. Worldcom's shareholder suit held key to problems but was dismissed." The Miami Herald, August 12, 2002.

²⁰Wallack, Todd. "Worldcom fares worst of all as complaints quadruple." The San Francisco Chronicle, April 14, 2002: Pg. G1.

²¹Porretto, John. "Overbilling may be the next issue to plague Worldcom." The Associated Press State & Local Wire, July 3, 2002.

²²Steffy, Loren. "The rise and fall of Worldcom: questionable accounting, neglect, disregard for customers and greed precipitated downfall." Montreal Gazette, August 23, 2002: Pg. B7.

²³Backover, Andrew. "Smaller WorldCom tops in complaints of slamming." USA Today, March 20, 2002 Link »

²⁴Wallack, Todd. "WorldCom to ante up $8.5 million; State lawsuit accused long-distance phone company of slamming, abusive billing." The San Francisco Chronicle, March 8, 2002: Business; Pg. B1.

²⁵The Associated Press. "2 Worldcom stockholders suing over $375 million in loans to CEO." The Commercial Appeal (Memphis, TN), April 1, 2002: Desoto Appeal; Pg. DS3.

²⁶Forbes, Neil Weinberg. "Worldcom warning was ignored." Business Review Weekly (Australia), August 1, 2002: News & Features; Pg. 90.

²⁷ Forbes, Neil Weinberg. "Worldcom warning was ignored." Business Review Weekly (Australia), August 1, 2002: News & Features; Pg. 90.

²⁸ Haddad, Charles and Dean Foust. "Worldcom's sorry legacy." Business Week, July 8, 2002: Number 3790; Pg. 38.

²⁹ Pender, Kathleen. "Corporate scandals; Worldcom's fraud was simple and blatant but hard to spot." The San Francisco Chronicle, June 30, 2002: Business; Pg. G1.

³⁰Pender, Kathleen. "Corporate scandals; Worldcom's fraud was simple and blatant but hard to spot." The San Francisco Chronicle, June 30, 2002: Business; Pg. G1.

³¹Economist.Com. "From bad to worse; Worldcom." July 1, 2002.

³²Pender, Kathleen. "Corporate scandals; Worldcom's fraud was simple and blatant but hard to spot." The San Francisco Chronicle, June 30, 2002: Business; Pg. G1.

³³Teegardin, Carrie. "Low-Key Atlanta Businessman Finds Himself in Worldcom Spotlight." Atlanta Journal and Constitution, September 29, 2002.

³⁴Haddad, Charles. "How Ebbers kept the board in his pocket." Business Week, October 14, 2002: Number 3803; Pg. 138.

³⁵Haddad, Charles. "How Ebbers kept the board in his pocket." Business Week, October 14, 2002: Number 3803; Pg. 138.

³⁶Pender, Kathleen. "Corporate scandals; Worldcom's fraud was simple and blatant but hard to spot." The San Francisco Chronicle, June 30, 2002: Business; Pg. G1.

³⁷Dreazen, Yochi. "Push for sales fostered abuses at WorldCom." The Wall Street Journal, May 16, 2002: B1.