The amount of accounting fraud at WorldCom Inc. is likely to exceed the $7 billion previously disclosed to investors, according to a broad report from a special company monitor who also found more than $1 billion in loans to the firm’s former chief executive.
Special examiner Richard Thornburgh, a former U.S. attorney general, released a report Monday sternly criticizing the telecommunication giant’s board of directors and top company executives.
Thornburgh said WorldCom took “extraordinary and illegal steps” to paint a rosy picture of its deteriorating finances.
WorldCom Inc.’s board never should have allowed former chief executive Bernard Ebbers to leverage his company stock for more than $1 billion in personal and business loans, a bankruptcy court-appointed monitor says. The extent of the fraud will likely exceed the $7.68 billion previously disclosed, the report says.
“Our investigation strongly suggests that WorldCom personnel responded to changing business conditions and earnings pressures by taking extraordinary and illegal steps to mask the discrepancy between the financial reality at the company and Wall Street’s expectations,” Thornburgh said in his report.
Thornburgh concluded that those responsible for the fraudulent practices include “the board of directors, the audit committee, the company’s system of internal controls and the independent auditors.”
“There were numerous failures, inadequacies and breakdowns in the multilayered system designed to protect the integrity of the financial reporting system at WorldCom,” the report said.
Thornburgh said the money the board allowed Ebbers to borrow greatly exceeds the $400 million in personal loans Ebbers was already disclosed to have been granted.
Thornburgh excluded details of accounting manipulations because the company is the subject of civil and criminal proceedings.
One corporate bankruptcy attorney said the report indicates WorldCom, the Clinton, Miss.-based parent of long-distance carrier MCI, may have to sell operating divisions to become viable again.
“What it means for the company is there will be more investigations, which will slow things down for reorganization,” said Richard Tilton, a Wall, N.J., bankruptcy attorney. “The report says it’s still a company without a strategic plan and without one, it will be very hard to exit Chapter 11.”
WorldCom, which filed for bankruptcy protection in July after revealing accounting irregularities, said in response to the report that it is doubling its internal audit department staff, creating two new operational chief financial officer positions and hiring a new corporate controller.
“WorldCom’s management and board are determined to ensure that what happened here in the past cannot recur,” said John Sidgmore, WorldCom’s president and chief executive.
One telecommunications industry analyst said the examiner’s report, with its hints of more fraud to be uncovered, deals another serious blow to WorldCom.
“It’s going to be hard for WorldCom to keep customers with these allegations and with the controversy continuing and the fraud apparently growing,” said Patrick Comack of Guzman & Co. in Miami.
Thornburgh said the huge loans to Ebbers put the interests of the company’s shareholders at risk, since if he had been forced to sell the stock he used as collateral, that “might have precipitated a rapid downward spiral in the company’s share price.”
Ebbers’ attorney, Reid Weingarten, said Monday that he could not comment on Thornburgh’s report because he had not reviewed it. Ebbers has an unlisted phone number and could not be reached.
Thornburgh said his findings were preliminary and no recommendations were made. For example, the report noted that further investigation is needed to determine why the pay of senior executives became significantly more lucrative in the two years before WorldCom declared bankruptcy.
Thornburgh’s report also said WorldCom auditor Arthur Andersen deemed WorldCom a maximum risk client but didn’t use appropriate audit procedures for such a company.
“It is virtually impossible for an auditor to detect purposeful fraud by company executives,” said Arthur Andersen spokesman Patrick Dorton. “There is clear evidence that Worldcom executives misled both the investing public and the Andersen auditors.”
The Thornburgh report also said the relationship between WorldCom and its primary investment banker, Salomon Smith Barney, was problematic. In particular, it cited evidence that a former Salomon analyst, Jack Grubman, told WorldCom in advance what questions he would ask in conference calls between securities analysts and WorldCom management.
Salomon said in a statement, “In light of ongoing discussions with the various regulators, we are declining to comment.”
Grubman, a telecommunications analyst whose recommendations helped send WorldCom stock soaring, was a close friend of Ebbers and attended at least four WorldCom board meetings as a “financial adviser,” according to the report.
The Justice Department and the Securities and Exchange Commission are investigating the accounting abuses, which have led to criminal charges against several former top executives.
The New York Times and the Wall Street Journal reported late Monday that the company is near a settlement with the SEC, which would ask a federal judge to dismiss the fraud case the agency filed in June in exchange for the payment of fines and a consent decree. The company and agency declined to comment.