WorldCon
Nailed for the biggest bookkeeping deception in history, a fallen giant gives investors another reason to doubt corporate integrity

Soon after Worldcom CEO John Sidgmore revealed the most sweeping bookkeeping deception in history, a copy of his internal memo on the scandal was e-mailed to folks around the telecom industry. Under his predecessor, Sidgmore announced, WorldCom had overstated a key measure of earnings by more than $3.8 billion over five quarters, dating back to January 2001. The company's reported profits, it turned out, were really losses.

As WorldCom—once big and rich enough to swallow No. 2 long-distance carrier MCI—struggles to survive, it is laying off 17,000 workers. Its stock, which peaked at $64.50 three years ago, stopped trading last Tuesday at 83¢, having all but wiped out employee retirement accounts. The plunge in WorldCom shares has cost investors upwards of $175 billion—nearly three times what was lost in the implosion of Enron. WorldCom is not yet financially bankrupt, but it's clear that it—like a fat slice of corporate America—has been ethically bankrupt for years. We're only now getting a look at the red ink on the moral balance sheets, and new revelations of malfeasance in one company after another are sending shocks around the globe.

The dollar is falling. Stocks are in a swoon. Foreigners are calling home capital. Corporate insiders are dumping shares by the bucketful. Individuals are redeeming mutual-fund shares. Pension funds are getting socked. Banks are taking loan-portfolio hits. This is all a direct result of the spreading collapse of confidence in U.S. companies and the executives and board members who run them—a crisis that threatens to untrack a fragile economic recovery. Speaking at an economic summit in Canada, President Bush said he was "concerned about the economic impact of the fact that there are some corporate leaders who have not upheld their responsibility." The Federal Reserve seems concerned as well. At a meeting last week, it left interest rates unchanged—signaling that the recovery isn't firmly rooted. Some economists speculate that the Fed will soon cut rates to guard against a "double-dip" recession.

In the context of recent developments, President Bush's musings on CEO responsibility are as understated as the expenses in WorldCom's financial statements, the flashpoint for new worries of widespread accounting abuse. WorldCom said that an internal review uncovered huge hidden expenses—mostly line charges that it pays to other telecom carriers—that were characterized as capital investments, a gimmick that boosted its profits.

The company fired its longtime chief financial officer, Scott Sullivan, 40, and is turning over its findings to the Securities and Exchange Commission. The sec has filed fraud charges and is launching an investigation—as is the Justice Department, at least two congressional committees and the state of Mississippi, where WorldCom is based. All current and former employees, along with WorldCom's ex-accounting firm, Arthur Andersen, have been ordered to refrain from Enron-like paper shredding. Investigators are especially eager to hear from WorldCom founder Bernie Ebbers, who resigned as ceo in April, not long after it was revealed that he owed the company $366 million in low-interest loans.

In the same week that the veil was lifted from WorldCom's books, Xerox restated $6.4 billion in revenues dating to 1997. The amount turned out to be more than triple what investors had expected and sparked a 13% sell-off of Xerox's stock.

Martha Stewart, meanwhile, faced fresh doubts about her explanation of why, after buying stock in a drug company run by a close friend, she sold her shares just ahead of bad news about the company's cancer drug. Stewart, recently appointed a director of the New York Stock Exchange, denies wrongdoing, but shares in her Martha Stewart Omnimedia have declined 40% in the past month over fears of damage to her image.

Yet this scandal sharply raises the stakes. When Enron filed for bankruptcy in December, it employed 28,000, of whom 12,600 have been let go. WorldCom employs 80,000 and will eliminate a fifth of those jobs almost immediately. The Enron-stock meltdown wiped out $67 billion of shareholder wealth—less than half what WorldCom investors have lost.

The losers include pension funds and mutual-fund investors across the country. And, as at Enron, WorldCom's 401(k) plan was full of company stock, socking employees with greatly diminished savings just when they are likely to need them the most. Says John Alexander, 31, a former WorldCom benefits manager: "Everything they ever told us was, 'We're making money hand over fist.'" Alexander lost $180,000, a large chunk of his life's savings.

The developments at WorldCom suggest that accounting games may be more pervasive than we had thought. With Enron, the tricks involved complicated partnerships, off-the-books debt and hedging techniques that made the firm's financial results difficult to assess even for pros. It seemed unlikely that anything so complex could be widespread. But with WorldCom, as House Financial Services Committee chairman Mike Oxley says, it looks like "good old-fashioned fraud."

How, exactly, did WorldCom cook its books? By treating routine expenses as capital investments. Normal operating expenses must be subtracted from a company's revenues in the year they occur. But capital expenditures can be subtracted from revenues a little at a time over many years. In the short term, that lets money flow to the bottom line and boosts financial results. It's the oldest trick in the book, and mind-numbingly simple. Dennis Beresford teaches Accounting 101 at the University of Georgia and says what happened at WorldCom is "plain vanilla" trickery that he covers on the second day of class.

Yet WorldCom's auditor—Arthur Andersen, the firm convicted of obstructing justice in the Enron case—somehow missed it. Andersen, which was paid $4.4 million a year to certify that WorldCom's books were honest, says WorldCom cfo Sullivan never handed over the material Andersen asked for. Scoffs analyst Patrick Comack of the brokerage Guzman & Co.: "That's like a police officer saying the criminal didn't turn himself in." —TIME, July 8, 2002

Questions

1. How does the WorldCom scandal compare to the Enron meltdown?

2. How did WorldCom "cook its books"?