"THE WORLDCOM CON"
Response to the Proposed Accounting Fraud Settlement

By Charlie Cray

U.S. District Judge Jed S. Rakoff held off giving his final approval to the $500 million fine announced this week by WorldCom (now renamed MCI), its creditors and the SEC to settle the largest accounting fraud in history, because he still has questions about what internal controls and corporate governance changes the company has made while in bankruptcy.

You can bet that WorldCom’s defrauded shareholders, the tens of thousands of innocent employees who were laid off (some without the severance payments that others received), and unwitting U.S. taxpayers would ask an additional set of questions if they were ever given their own day in court.

Questions like: Why did the federal government give WorldCom/MCI a contract to rebuild Iraq’s wireless network the same day that it announced the largest penalty yet assessed on any single company involved in the recent corporate crime wave? For that matter, why is a company that committed the biggest accounting fraud in history not simply barred from receiving government contracts and FCC licenses?

This isn’t the first time the SEC and other government agencies seem to be crossing wires. In fact, just one day after the U.S. Securities and Exchange Commission (SEC) announced that it was expanding its WorldCom investigation (after the company’s auditors discovered a few more billion dollars in fraudulent earnings), across town, another branch of the federal government -- the Veterans Administration – was entering into a new contract with the telecommunications firm.

Shareholder activists including the Gray Panthers (who have been one of the most aggressive critics of the federal government’s response to WorldCom) have asked the General Services Administration (the federal agency that oversees government contracting) to use its hundreds of billions of dollars of annual government purchasing power to deter corporate misdeeds by barring law-breaking firms like WorldCom from bidding on federal contracts. After all, the GSA suspended Enron and Arthur Andersen from bidding on federal contracts as a result of similar misdeeds. Why hasn’t the GSA also suspended WorldCom, given that its accounting fraud – which amounted to $11 billion in total – far surpassed Enron’s?

Another question that should be asked is why is the company able to pay most of the fine out of a $300 million tax rebate that it received as a result of claiming it overpaid its taxes when overstating its earnings? "This is really a closed issue for us," MCI spokeswoman Julie Moore told reporters when asked to comment on attempts to close this loophole with an amendment to the tax bill now moving through Congress. In other words, they can close the loophole if they want, but WorldCom (or is it MCI?) already cashed the check.

In years past, the SEC didn’t usually seek fines in accounting fraud cases involving public companies because they figured a monetary punishment would simply inflict more damage on shareholders victimized by the fraud in the first place. But the new Sarbanes-Oxley accounting law requires that some attempt be made to help injured shareholders. And certainly the SEC wants to make it appear that it has done something about the largest accounting fraud in history. But shareholders must be asking themselves who the SEC is kidding: The $500 million – reduced by a third from the $1.5 billion fine originally proposed because, like other unsecured creditors in the bankruptcy process, investors are only paid a third – amounts to less than a penny on the dollar of the well over $150 billion that shareholder activists estimate was lost. And like the recent SEC settlement with Citigroup and the other Wall Street banks, ongoing shareholder lawsuits are not helped much by the fact that WorldCom is allowed to settle the case without having to admit any guilt.

When President Bush signed Sarbanes-Oxley he said there would be “no more easy money for corporate criminals, just hard time.” If that’s true, then why the contracts, and why have no WorldCom executives yet been sent to jail?

In truth, the WorldCom con goes far beyond the issue of accounting fraud and the coddling of corporate criminals. No matter how complicated the numbers, the simple truth is that WorldCom illustrates how reckless the ideological push for deregulation can be.

Between 1996, when the Telecommunications Act deregulated the industry, and 2001 when the bubble popped, the industry spent nearly half a trillion dollars building a monumental high-tech network with huge overcapacity. A Los Angeles Times analysis of SEC filings by 116 telecommunications companies found that the companies’ total debt ballooned from $9 billion in 1996 to $127 billion in 1997, expanding to $306 billion in 2000.

WorldCom rode the crest of this wave, growing through a rapid succession of deals that increasingly saddled the company with huge debts. Like other telecom executives, CEO Bernie Ebbers -- the quintessential deal-maker – spread wild projections about the how rapidly the industry would grow. And he was egged on by bankers and analysts like Citigroup’s Jack Grubman, who waited until the day before the company first admitted the fraud to cut the company’s rating to “underperform.”

At some point the game could not be sustained. The hype about exponential fiber-optic usage growth was revealed to be false. Ebbers couldn’t seal his career-making attempt to buy out Sprint, he got out of the game. At some point the accounting fraud began – an attempt to postpone the inevitable crash as past debts were coming due. (It remains to be seen if Ebbers himself will be charged with fraud.)

Like Enron, WorldCom was no anomaly, but rather emblematic of how an entire industrial sector could become a giant Ponzi scheme once it was deregulated. Similar stories are told about other telecom companies like Global Crossing, whose founder and chairman Gary Winnick sold $577.9 million in shares before the company filed for bankruptcy. Only half a dozen of the 116 companies studied by the L.A. Times reporters generated a positive return on the massive investments made in the telecommunications sector over the six-year post-deregulation period. Some companies had negative returns of over 1000 percent. And most of the spending was financed by debt.

Yet there’s one difference between WorldCom and other telecom firms that have had to file for bankruptcy: it will survive. The fact that its fiber-optic cables handle half of the nation’s business communications and a third of all residential long-distance accounts probably explains why it isn’t being barred from government contracts and licenses. By climbing to the top, it has reached a position where it is given the same consideration as other poorly managed giant corporations whose best insurance has been the fact that they are treated as “too big to fail.”

Last Updated May 20, 2003