WorldCom’s cowboy bites the dust

Mar 17th 2005
From The Economist Global Agenda

Bernie Ebbers, the former boss of WorldCom, has been found guilty in a federal court in New York of a massive fraud, and faces up to 85 years in jail. Prosecutors will hope that this points the way to convictions in other big fraud cases, not least the upcoming Enron trials

WHILE on trial for fraud, Bernie Ebbers chose a more conservative wardrobe than the cowboy boots and ten-gallon hat that were his trademarks as boss of WorldCom. Despite this, he failed to convince a jury that he was no financial cowboy. On Tuesday March 15th he was found guilty of fraud, conspiracy and filing false documents with regulators in relation to the $11 billion accounting fraud that brought the telecoms giant crashing down in America’s biggest-ever bankruptcy. Mr Ebbers faces up to 85 years in prison when sentence is passed. Also set for sentencing is Scott Sullivan, WorldCom’s former chief financial officer, who pleaded guilty to fraud and gave the damning evidence against his former boss in the hope of securing a more lenient sentence.

Mr Ebbers had argued during the six-week trial that he was a salesman rather than a numbers man, but the jury clearly didn’t accept that a fraud of such magnitude could have happened without his connivance. Mr Ebbers built WorldCom from modest beginnings into a firm worth over $175 billion at the height of the stockmarket boom by relentlessly acquiring telecoms assets and eventually masterminding a $37 billion merger with MCI, one of America’s leading long-distance phone companies. At the height of the boom his firm’s internet-backbone business carried 40% of America’s web traffic. As the boom ran out of steam, WorldCom resorted to accounting tricks to maintain the appearance of ever-growing profitability. But the fraud failed to keep the company afloat.

In April 2002, Mr Ebbers was forced to step down as chief executive as WorldCom’s share price and revenue projections fell and the Securities and Exchange Commission (SEC) threatened a probe of the firm’s accounting practices. Revelations that he had borrowed hundreds of millions of dollars from WorldCom to cover losses from his purchase of company shares hastened his exit. By now, WorldCom’s market capitalisation had shrunk to $7 billion. Shortly afterwards, the firm admitted an accounting fraud and sought Chapter 11 bankruptcy protection.

The fraud bore the hallmarks of Mr Ebbers’s direct business style. Not for him the sophisticated financial shenanigans that brought down Enron. At WorldCom, costs were simply reclassified as capital expenses to boost cashflow and profits. The firm’s bankers and shareholders were fooled by this—or chose not to care—while the good times persisted. As the boom ended, WorldCom’s financial chicanery was thrown into the spotlight.

Ironically, the manner of WorldCom’s demise has allowed creditors and shareholders to recoup a little of their investments through the courts. Investors in other once-high-flying companies have been left to rue “lost” paper fortunes that evaporated with the tech bubble’s bursting. WorldCom was a little different. It had real assets, revenues and profits. Perhaps it was this as much as Mr Ebbers’s hubris that encouraged the firm to employ accounting tricks to keep an illusory promise alive.

Last May, Citigroup paid $2.6 billion to settle a class-action lawsuit by creditors relating to its part in helping WorldCom to issue bonds in 2000-01. Bank of America and four other banks agreed to pay $561m at the beginning of this month to settle similar charges. Last week some European banks involved agreed to pay $438m. And the day after Mr Ebbers was convicted, J.P. Morgan settled the case for $2 billion. Of the $6 billion that WorldCom's former banks have agreed to pay out, around $5 billion will go to the firm's bondholders, with the balance going to former shareholders. As is usual in this type of case, no bank has admitted liability.

Claimants say that the banks involved should have known that WorldCom was financially suspect. They also assert that the investment-banking arms of these financial institutions pressured their analysts to give favourable ratings to companies that provided lucrative business in the dotcom boom (WorldCom paid Citigroup some $100m for its services between 1996 and 2002).

Additionally, the SEC secured a settlement with MCI (as WorldCom has been known since emerging from bankruptcy in 2003), in which the reborn telecoms firm agreed to pay shareholders and bondholders $500m in cash and $250m in MCI shares. Shareholders complained that the award was too lenient, but the judge who made it was keen not to punish too severely a company that he considered had made great efforts to reform itself.

Actually, rather a lot remains of the firm Mr Ebbers built. America’s bankruptcy procedures are considered generous in comparison to those of other countries. Many of WorldCom’s pre-bankruptcy assets remain intact and it emerged from Chapter 11 with a strong balance sheet, a viable business and debts slashed to some $5.8 billion. The company still employs 41,000 people, compared with a 98,000-strong workforce in 2000.

This rebirth has caused alarm among competing telecoms firms. They complain that the bankruptcy proceedings left WorldCom in an unfairly strong position. But MCI has failed to capitalise. In 2004 revenues fell by 15% and the company suffered an operating loss of $3.2 billion after writing down the value of its telephone network by $3.5 billion. MCI may soon fall prey to a competitor: it is currently mulling an offer of $6.8 billion from Verizon Communications, one of America’s largest local phone companies, and a rival $8.5 billion offer from Qwest, a smaller local phone firm. (Fittingly, on the day Mr Ebbers was convicted, Joe Nacchio, Qwest's former chief executive, and six of his erstwhile colleagues were charged in connection with a “massive fraud” at the firm.)

As Mr Ebbers contemplates a lengthy prison sentence, he may take little comfort from the fact that the company he built and then all but ruined is still a going concern. But federal prosecutors will take much heart. Mr Ebbers is the biggest catch so far from the spate of corporate crime that was exposed as the tech boom turned to bust. Later this year, or early next, the bosses of Enron will take the stand to fight fraud charges relating to the demise of the Texan energy-trading company. As with WorldCom, the prosecution case will rely heavily on the testimony of former employees—and prosecutors will be praying for a similar result.

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