When WorldCom's share price started to slip and its mangers began to suffer, how did they try to prop it up? By fiddling the books.
Coming hard on the heels of major misdeeds by Enron Corporation and its accountant Arthur Andersen in 2001, in July 2002 WorldCom further shocked the business world by admitting to a massive accounting fraud.
It was enough to shock the Bank of England, even as long ago as 2002, into fearing a possible credit crunch, amidst worries that such accountancy scandals might cause lenders to turn away from higher-risk investments. It's such a shame the BoE failed to spot the real credit crunch risk that was around the corner, but that's hindsight for you.
What was WorldCom?
Through the 1990s and into the telecoms boom at the start of the 21st century, WorldCom (formerly LDDS WorldCom), with CEO Bernard Ebbers at the helm, became one of America's largest long-distance telecommunications companies.
WorldCom's growth was achieved through acquisitions, with the list of takeovers, re-organisations, mergers etc being mind-boggling on its own, without even looking at any financial details. Deals included the takeover of Advanced Communications in 1992 and MFS Communications in 1996 (which netted UUNet Technologies, only just acquired by NFS). In 1998, WorldCom bought up CompuServe, kept CompuServe's network division, and sold its pioneering online services to America Online in exchange for AOL's network division.
The peak of WorldCom's acquisition spree also came in 1998 when it bought MCI, and for a brief period traded as MCI WorldCom. But even this event would have been eclipsed had WorldCom succeeded in its most audacious plan to date, the attempted $129b merger with Sprint -- now Nextel Sprint -- in 2000, which would have created the largest telecoms company in the USA, ahead of even AT&T Inc. That deal was blocked by the US Department of Justice and the European Union due to monopoly concerns.
Fraud uncovered
During these years, the value of CEO Ebbers' holding in WorldCom has been inflating nicely, and he used much of it as collateral for other business ventures. As the telecoms industry started to slow down at the end of the century, and with WorldCom sitting on debts of around $40b, its share price, along with the value of Ebbers' slice of the company, started to slip. Ebbers faced increasing margin calls from his banks. After the Sprint failure further damaged expectations for the company, Ebbers turned to the board and persuaded them to give him loans and guarantees worth more than $400m to finance his, ultimately unsuccessful, personal bail-out.
But that was just the tip of the dodgy-accounting iceberg, and in June 2002 WorldCom's own audit department uncovered accounting fraud to the tune of $3.8b. A Securities and Exchange Commission investigation followed, and when the full details emerged it was found that the company's assets had been fraudulently inflated by around $11b in order to prop up the share price.
It turned out that WorldCom has been under-reporting its costs of connecting with other telecoms companies (its 'line costs'), capitalizing them on the balance sheet instead of recording them as expenses. It had also been fabricating some accounting entries to inflate its revenues.
Bankruptcy and criminal charges
After making the largest ever Chapter 11 bankruptcy protection filing, WorldCom eventually emerged in 2004 with over $5b in debt. Many of its creditors (including laid-off former employees) are still unpaid.
CEO Ebbers faced trial and was convicted of all charges (including fraud, conspiracy, and filing false documents), and was banged up for 25 years. CFO Scott Sullivan and various other company officers pleaded guilty to a number of similar charges.
How could it happen?
The WorldCom scandal was probably just a larger instance of the affliction that hit so many investors around that time -- the bubble mentality. When all we hear around us is "growth, growth, growth", it can become so easy to switch off our critical faculties and jump on a bandwagon. The officers of WorldCom just couldn't see failure as a possibility, and with bubble mania all around, prudence went out of the window. And when economic reality started to set in, they were too deeply entrenched in the "High stock price at all costs" mentality to rein back.
What about private investors? Over those few years of non-stop acquisition mania and no focus on actual organic growth, WorldCom's accounts would have been near-impossible for most accountants to sensibly evaluate, never mind private investors. And when you can't follow a company's accounts, you definitely shouldn't be buying the shares.
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