Directions: Below is a news article about WorldCom. Answer the five questions below related to the article. Responses should be limited to two pages.

WorldCom Discloses $3.8 Billion Accounting Scandal, Global Markets Reel

Published June 26, 2002

FoxNews.com

JACKSON, Miss. Markets worldwide reeled on Wednesday after U.S. long-distance carrier WorldCom Inc. (WCOM) revealed Tuesday night it had disguised nearly $3.8 billion in expenses, in what appears to be one of the biggest accounting frauds in U.S. history.

WorldCom, the second-biggest U.S. long-distance telecoms group, Tuesday night fired its Chief Financial Officer Scott Sullivan and said it would restate its results for the last five quarters, erasing all profits from the beginning of 2001. In addition, the company said it would lay off 17,000 workers beginning Friday.

"This is just another nail in the coffin of confidence," said Paul Marsch, a London-based Morgan Stanley telecoms analyst.

Stock markets reeled from Asia to Europe to the U.S., with already beleaguered telecoms stocks touching new, historic lows.

"You walk into the kitchen, and you see a cockroach -- you are pretty confident that it is not the only one around," said John Hendricks, vice president, trading and strategy group at State Street Global Markets.

In mid-afternoon trading Wednesday, the blue-chip Dow Jones industrial average was down 165 points at 8,960 while the technology-packed Nasdaq Composite Index was down 26 points at 1,397. The index plunged as low as 1,375.53, an intraday trough unseen since Oct. 8, 1998. If the index closes below 1,419.12, its Oct. 8 close, it will end at a 5-year low.

The broader Standard & Poor's 500 Index was down 18 points at 958, a level unseen since late September after the devastating Sept. 11 attacks on the United States.

Trading in WorldCom shares, which peaked at more than $64 in 1999, was halted after they lost nearly all of their remaining value in pre-market trade, plunging to 9 cents a share. By 7:10 a.m. EDT Wednesday 13.6 million shares had changed hands.

Tokyo's Nikkei stock average tumbled 4 percent to close at a four-month low, and the pan-European FTSE Eurotop 300 index was off by a similar amount about 1-1/2 hours ahead of Wall Street's opening bell.

President George W. Bush on Wednesday said the accounting irregularities at WorldCom were "outrageous", and promised to hold accountable those who were responsible for the scandal.

"I am deeply concerned about some of the accounting practices that took place in America," Bush, in Kananaskis for the Group of Eight summit of industrialized nations' leaders, told reporters ahead of a bilateral meeting with British Prime Minister Tony Blair.

Tuesday's disclosure could be the final blow to WorldCom, which is already suffering from a crumbling telecommunications market and an ongoing Securities and Exchange Commission investigation.

"Clearly, it means ... that the company has made a few giant leaps toward bankruptcy," said John C. Hodulik, an analyst for UBS Warburg.

"Our senior management team is shocked by these discoveries," John Sidgmore, who was appointed WorldCom CEO on April 29, said. "We are committed to operating WorldCom in accordance with the highest ethical standards."

More than $3 billion of expenses in 2001 and $797 million for the first quarter of 2002 were wrongly listed on company books as capital expenses, the company said, and thus not reflected in its earnings results. It will restate earnings for all of 2001 and the first quarter of 2002.

"If you can't trust the accountants or the companies then the whole thing falls down like a pack of a cards," said Henk Potts, investment analyst at Barclays Private Clients.

When spending is listed as a capital expense, a company can delay applying it against earnings and spread its effect over many years, thus keeping its profits on paper higher. Standard accounting rules are relatively clear about what kind of purchases, for instance office equipment, can be listed as capital expenses and which must be listed as operating expenses and deducted immediately from profits.

WorldCom, which already was under investigation by the U.S. Securities and Exchange Commission (SEC), said it discovered the accounting problem during a routine internal audit. The news could derail its efforts to secure $5 billion in financing, without which it may face a cash-crunch next year, or even bankruptcy, analysts said.

The Clinton, Mississippi-based company, which switched auditors from Andersen to KPMG this year, said it booked operating expenses such as routine network maintenance as capital investments, which allowed it to hide expenses, inflate cash flow and artificially post profits.

The SEC ordered a detailed report from the company, while The Washington Post newspaper said the Justice Department had begun a criminal probe.

"The WorldCom disclosures confirm that accounting improprieties of unprecedented magnitude have been committed in the public markets," the SEC said in a brief statement.

WorldCom promptly announced plans to axe 17,000 jobs, or more than 20 percent of its work force, starting Friday. The move will save about $900 million a year.

WorldCom, with colorful, cowboy-boot wearing former chief executive and co-founder Bernie Ebbers at its helm, burst on to the world stage in 1997 when the upstart made a unsolicited offer to buy larger peer MCI and wrest it away from Britain's BT Group Plc.

WorldCom grew from a small long-distance company into a telecommunications force through more than 60 acquisitions in the past 15 years. The rapid-fire growth was stopped dead in its tracks in 2000 when federal and European regulators blocked WorldCom's proposed $129 billion merger with Sprint Corp., citing competition concerns.

Ebbers resigned in April, owning the company more than $408 million for personal loans.

"When you look at the history of WorldCom, and their acquisition trail, you have a classic wheeler-dealer. And now this is the age were wheeler-dealers get called for what they are," said Frank Dzubeck, president of consulting firm Communications Network Architects.

"Our senior management team is shocked by these discoveries," said John Sidgmore, WorldCom's CEO of less than two months. He previously served as WorldCom's vice chairman.

Rick Black, analyst for Blaylock & Partners, L.P. in New York, said he wants to know if former CEO Ebbers knew about the accounting practice.

"The people who were running the company prior to this should know what's going on. That's the most logical assumption," Black said. "If the CFO knows, the next question people are going to ask is 'What did Bernie Ebbers know?,' and of course they're going to ask 'What did the board know?'"

Much of the company's future depends on whether WorldCom's secures $5 billion in financing. The company has $30 billion in total debt, but no debt payments are due in the next two quarters.

The scandal may affect more than just the telecom industry -- it could have grand implications for the Internet and cyber-commerce.

One division within WorldCom is UUNet, which operates one of the world's biggest "backbone" networks for Internet traffic and electronic commerce, providing tech services to businesses. According to WorldCom, UUNet has a network spanning 3,800 points of presence with more than 2 million modem ports.

WorldCom is the latest company linked to auditing firm Andersen, which was convicted two weeks ago of obstructing a probe into Enron's collapse. Andersen audited WorldCom's financial statements for 2001.

But in a statement, Andersen said that WorldCom had withheld key information and not consulted its auditors about the accounting treatment of the expenses.

The revelation adds WorldCom to a growing list of companies struck by accounting scandals, led by Enron Corp., Tyco International Ltd. (TYC) and Adelphia Communications (ADLAE), that have shaken public faith in business and Wall Street and created a flood of shareholder lawsuits.

Bond ratings agencies Moody's Investors Service, Standard & Poor's and Fitch all cut their long-term credit ratings on WorldCom's debt several times this year.

Shares of WorldCom on Monday closed down 25 percent after Salomon Smith Barney analyst Jack Grubman, long seen as a WorldCom supporter, downgraded his outlook on the company.

Questions

1. What is the ethical issue in this article?
2. What accounting rule did WorldCom violate?
3. What reasons would WorldCom have to misstate their earnings? List at least 3 reasons with explanations.
4. Who is affected by this inappropriate reporting?
5. Why did the auditor not catch this issue?