WorldCom Inc. and the Securities and Exchange Commission may have agreed on a broad outline for a $500 million settlement to resolve civil fraud charges, but now comes the hard part deciding who will share in the payout.
Under the proposed agreement, the SEC would use the $500 million to create, in effect, a victim’s fund to benefit shareholders and bondholders harmed by WorldCom’s record accounting fraud.
There are an enormous number of potential beneficiaries. One industry source said the benefit would be open to all individuals who traded in WorldCom’s stock and bonds during the three-year period when the fraud took place and can prove harm. A government source with knowledge of the settlement said it would be limited to those who owned stock as of June 26, the day WorldCom filed for bankruptcy protection. The criteria for proving harm is one of many details that must be hammered out before the SEC and WorldCom seek final approval for the deal next month.
The only shareholders that have already been blocked from participating in the deal are company executives who have been linked to the fraud, said one source familiar with the settlement. The company itself also is barred from filing a claim.
While the $500 million penalty would be the largest ever paid by a non-Wall Street company in a securities fraud case, analysts say it adds up to a fraction of the total losses suffered by investors.
“There were so many shareholders that were harmed by WorldCom that it is hard to hold out hope that they will get any significant benefit,” said Drake Johnstone, a telecommunications analyst with Davenport & Co.
The actual process for filing a claim and distributing the money has yet to be finalized, which is one reason U.S. District Judge Jed Rakoff said Monday that he needed more details before he approved the plan. Rakoff is presiding over the SEC’s case against WorldCom. In addition, the plan must be approved by U.S. Bankruptcy Court Judge Arthur Gonzalez.
Another key detail that has to be determined is whether the $500 million payment would be tax-deductible for WorldCom.
WorldCom filed for bankruptcy last July after disclosing a massive accounting scandal. The company has confirmed that it improperly accounted for $9 billion, but sources say the final tally may be closer to $11 billion.
According to the outline submitted to the court, the SEC would file a bankruptcy court claim for $1.51 billion and receive 33.1 cents on the dollar like other unsecured creditors. In the past, courts have appointed receivers who review claims and mail out checks. It will be up to the receiver, using guidelines approved by the court, to decide which claims are legitimate.
In many ways, the SEC is breaking new ground with its proposal to pay defrauded investors from the proceeds of WorldCom’s penalty. The new approach is made possible by a provision of the Sarbanes-Oxley legislation that Congress passed last year in response to a wave of corporate scandals.
If approved, the deal would remove another major hurdle to the company emerging from bankruptcy by October. But it has also attracted criticism from rivals who say the penalty would be paltry compared with the fraud.
“We think it is amazing how lenient the government has treated WorldCom given the billions of dollars in economic harm it has caused consumers and pension funds,” said Paul Mancini, senior vice president and assistant general counsel for SBC Communications Inc. “This is just a slap on the wrist.”
WorldCom has charged that the critics are trying to interfere with its efforts to emerge from bankruptcy. “It’s clear that our competitors’ opposition to us is based on nothing but our competitive threat to them,” said WorldCom spokesman Brad Burns.
Some experts on corporate governance criticized the deal, but not because it is too lenient. Instead, they say it is unfair to penalize the company $500 million for the misdeeds of a few executives.
“I don’t believe it was the company (that committed fraud), I think it was the people who were running the company who should be punished,” said Charles Elson, director of the John Weinberg Center for Corporate Governance at the University of Delaware.
The SEC has charged four former WorldCom officials with civil fraud, but a source familiar with the situation said the former executives’ collective assets are insignificant compared with the $500 million the company has agreed to pay. Separately, five former WorldCom officials have been charged with criminal fraud.