Two former top executives of WorldCom Inc. were indicted Wednesday on securities fraud and other charges, widening the federal government’s efforts to prosecute alleged accounting fraud at the fallen telecommunications giant.
The move is seen as a key step as the government works to build a case against former WorldCom Chief Executive Bernard J. Ebbers, legal experts said, although Ebbers’ lawyers contend that he had no knowledge of the accounting scheme under which profit was allegedly inflated by billions of dollars.
Federal prosecutors accused Scott D. Sullivan, the 40-year-old former chief financial officer of WorldCom, and Buford Yates Jr., the company’s former director of general accounting, of directing a two-year scheme to conceal $3.9 billion in company expenses and boost profit.
The 24-page indictment also names two other WorldCom accounting executives, Betty Vinson and Troy Normand, as unindicted co-conspirators. However, court documents filed Wednesday indicate that Vinson and Normand—along with former WorldCom Controller David Myers—are prepared to plead guilty and cooperate with the government.
If fraud is proved, it would be the largest accounting scandal in U.S. history. WorldCom, the once-highflying telecommunications giant that carries nearly half of the country’s Internet traffic, owns MCI, the nation’s second-largest long-distance carrier.
Atty. Gen. John Ashcroft said he intended for the indictments to send a “clear message” to deter corporate lawbreakers.
“Today’s indictments … are the result of sustained law enforcement actions aimed at prosecuting corporate lawbreakers and protecting the savings and pensions of Americans,” Ashcroft said. “With each arrest, indictment and prosecution, we send this clear message: Corrupt corporate executives will be punished.”
Sullivan, who was arrested Aug. 1 along with Myers, allegedly conspired with Yates to instruct subordinates to hide WorldCom’s mushrooming expenses by capitalizing them—improperly shifting costs from operating to capital expenses—thus reducing reported expenses and artificially inflating profit.
In the seven-count indictment by a federal grand jury in New York, prosecutors allege that the scheme began taking shape about three years ago when WorldCom entered a large number of long-term lease agreements with other carriers to amass additional network capacity for an anticipated explosion in Internet traffic. That growth failed to materialize.
According to the indictment, many of the leases required WorldCom to make upfront payments to other carriers regardless of whether WorldCom actually used the additional capacity. Before the summer of 2000, WorldCom treated these payments as operating expenses.
But as the number of carrier leases climbed and became a significant expense, WorldCom did an about-face and began to capitalize the costs.
By ordering subordinates to carry out the change, the indictment says, Sullivan and Yates “engaged in an illegal scheme to … falsely and fraudulently” boost WorldCom’s reported earnings.
The moves allegedly allowed WorldCom to report to investors that its expenses were about 40% of company revenue from 1999 through 2001, even though the actual figure in the third year was closer to 50%.
“As Sullivan, Myers, Yates, Vinson and Normand well knew, there was no justification in fact or under generally accepted accounting principles for these entries,” the indictment says.
WorldCom’s accounting problems first surfaced in late June, when the company was forced to restate its earnings and admit that it wrongly listed $3.9 billion as capital expenses in 2001 and 2002.
A month later, WorldCom submitted the biggest bankruptcy filing in U.S. history. Since then, the company has disclosed an additional $3.3 billion in inflated profit.
Sullivan, Yates and their alleged co-conspirators “were able to assure that WorldCom’s reported earnings exceeded its actual earnings for the period from October 2000 through April 2002 by approximately $5 billion,” says the indictment, which does not mention Ebbers.
Sullivan, who is free on $10-million bail and is facing a prison sentence of up to 65 years if convicted on charges of securities fraud, conspiracy and filing false statements, could not be reached for comment. Sullivan’s attorney, Irv Nathan, has said his client was a victim of “a rush to judgment.”
David Schertler, a Washington lawyer who represents Yates, said he was surprised by the indictment of his client.
“It came totally out of left field,” said Schertler, who added that Yates worked two levels below Sullivan in the corporate hierarchy and reported to then-WorldCom Controller Myers, 44. Schertler declined to comment further.
The pursuit of top WorldCom executives has consumed law enforcement officials who have been looking to crack down on a wave of corporate financial scandals that began late last year when evidence surfaced that energy trader Enron Corp. used off-the-books partnerships to hide its deteriorating financial condition.
But the government’s complex case against Enron has produced only a single guilty plea and no criminal indictments of top executives.
The case against Sullivan and Yates also could prove difficult for prosecutors, some experts said. That’s because the accounting standards they are alleged to have violated are not clear cut.
“This is a gray area and it is not entirely clear that what they did was wrong,” said Joshua Ronen, an accounting professor at New York University who has served as an expert witness in a variety of securities litigation cases.
One source close to the Justice Department said the government has amassed considerable evidence, and noted that Yates and Sullivan would face trial in New York, where a jury would be likely to include at least some pensioners, investors or telecom employees angry about what has happened.
“This wasn’t a close call at all,” said Scott E. Cleland, a telecom expert and analyst at the Precursor Group, a Washington research firm, referring to the alleged wrongdoing. “This was way over the line.”
The indictment against Sullivan came after plea bargain talks apparently broke off. It is not known which side terminated the talks. But their end sets the stage for a criminal case that could have repercussions for corporate bookkeeping and the economy.
“The WorldCom scandal has [already] gotten Congress to pass the corporate reform bill,” Cleland said. The legislative reforms and legal case against Sullivan and Yates should serve as notice that “there is zero sympathy in Washington for the distant CEO who says, ‘I wasn’t aware of any fraud going on.’ ”
The indictments came amid disclosures that brokerage Salomon Smith Barney directed shares in hot initial public offerings in the late 1990s to former top WorldCom executives, including Ebbers. Congress is probing whether Salomon awarded those shares in an attempt to gain lucrative investment banking business.