The WorldCom Scandal
While Enron was complex (Derivatives, SPEs), WorldCom was simple, old-school accounting fraud. It was simply: "Let's lie about our expenses." It remains one of the largest bankruptcies in US history.
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Timeline of Deception
- 1999: Revenue Slowdown - The Telecom bubble bursts. WorldCom's revenue growth slows down.
- 2000: The Fraud Begins - CFO Scott Sullivan instructs accountants to move 'Line Costs' from Expense acts to Capex accounts.
- Jun 2002: Discovery - Internal Auditor Cynthia Cooper finds the $3.8 Billion hole working secretly at night.
- Jul 2002: Bankruptcy - WorldCom files for Chapter 11 bankruptcy.
- 2005: Conviction - Ebbers convicted of fraud, conspiracy, and filing false documents.
The Accounting Trick (Detailed Analysis)
1. Capitalizing "Line Costs"
WorldCom paid Verizon/AT&T to use their network lines. This is a standard Operating Expense (like rent).
- The Correct Way:
- Expense: $1 Billion.
- Action: Deduct from Revenue immediately.
- Profit: Lower by $1 Billion.
- The WorldCom Way:
- Sullivan said: "These lines are assets for the future."
- Action: Move $1 Billion to the Balance Sheet (Asset).
- Profit: Unchanged (The expense vanished!).
- Asset: Inflated by $1 Billion.
They did this quarter after quarter, accumulating over $3.8 Billion in fake assets.
2. "Cookie Jar" Reserves
In good years, WorldCom set aside extra money in "Reserves" (for bad debts, etc.). In bad years, they released these reserves back into income to make the numbers look good. This is illegal earnings management.
The Hero: Cynthia Cooper
Cynthia Cooper, the VP of Internal Audit, is a legend in the audit world.
- Suspicion: She noticed some weird entries in the Capex ledgers.
- Obstruction: Her boss (CFO Sullivan) told her to back off and stop looking.
- Investigation: She and her team worked secretly at night to avoid detection, pulling data from the servers.
- Discovery: She found the undeniable proof of the entries moving expenses to assets. She went directly to the Audit Committee, bypassing the CFO.
Bernie Ebbers' Defense: In court, Ebbers claimed the "Idiocy Defense". He said he was just a gym teacher turned salesman and didn't know anything about complex accounting. The jury didn't buy it. He got 25 years.
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