WorldCom Hit With Federal Fraud Lawsuit
Amid shock waves from the WorldCom Inc. accounting scandal that rocked corporate America on Wednesday, federal investigators slapped the nation’s second-largest long-distance company with a civil fraud lawsuit to prevent it from disposing of assets, destroying documents and paying off senior officers.
In a measure of the scandal’s growing effect, the Securities and Exchange Commission said it has accelerated plans to force chief executives and financial officers to guarantee financial statements, making them potentially liable if the data are found to be fraudulent. The certifications would be required of the nation’s 1,000 largest corporations by Aug. 15, the agency said.
Shares of major banks and many telecommunications firms were hit hard Wednesday over concerns that the accounting and debt woes of the Clinton, Miss.-based WorldCom would cause broad economic harm. WorldCom’s bonds plummeted to as little as 11 cents on the dollar, and major New York banks saw their stocks skid over concerns that they stand to lose billions on shrinking WorldCom bonds.
Though the overall market dropped sharply in the morning, much of its loss was erased by the close of trading--a recovery explained by some market watchers as a result of the declining shock value of corporate scandals on Wall Street traders.
WorldCom disclosed Wednesday that it had improperly accounted for $3.9 billion in expenses over the last five quarters, showing that it was earning significant profit at a time it was losing hundreds of millions of dollars.
President Bush branded the news as “outrageous.” Lawmakers said it underscored a new urgency in Washington to strengthen federal oversight of corporate accounting and governance. Members of Congress said the WorldCom disclosures put pressure on them to produce legislation cracking down on corporate misdeeds.
Analysts said the WorldCom crisis creates a new crunch on the already besieged SEC, and pushes the Justice Department to bring more criminal cases against executives whose companies are accused of fraud.
WorldCom, meanwhile, appeared headed for a bankruptcy that could allow it to emerge as a healthier player in an industry of weak and damaged rivals.
But after a season of seemingly endless corporate corruption, the damage caused by WorldCom’s disclosure is not only a financial blow. Wall Street watchers said it has further solidified the public’s mistrust of the business world, and convinced many that the days of “ethical” Fortune 500 companies are long gone.
“WorldCom’s future depends on the faith that its creditors put into it,” said Michael Hodel, an analyst at Morningstar Inc. in Chicago. “This fraud wipes out the majority of faith that any creditor has in this company.”
WorldCom’s acknowledgment that it inflated profit could lend credence to the idea of systemic problems requiring more sweeping action. Bush told reporters Wednesday at an annual economic meeting that the federal government would begin taking a far more aggressive approach to companies engaging in such practices.
“There are some concerned about the validity of the balance sheets of corporate America, and I can understand why,” Bush said on the opening day of the Group of 8 economic summit in Canada.
Senate Majority Leader Tom Daschle (D-S.D.) promised, as the first order of business after the July 4 recess, to bring to the Senate floor legislation that would increase oversight of auditors and make corporate officers more accountable for the accuracy of their companies’ financial statements. He predicted that it would easily win Senate approval.
The House voted Wednesday to authorize nearly a doubling of the SEC budget, from $481 million in Bush’s proposed budget to $776 million for the fiscal year beginning Oct. 1.
Rep. W.J. “Billy” Tauzin (R-La.), chairman of the House Energy and Commerce Committee, launched an investigation into WorldCom’s restatement of earnings and losses, suggesting the case was “eerily similar to the accounting hocus-pocus that occurred at Enron.”
Hours after the vote, the SEC filed its civil suit against WorldCom in U.S. District Court for the Southern District of New York.
“By improperly transferring certain costs to its capital accounts, WorldCom falsely portrayed itself as a profitable business during 2001 and the first quarter of 2002,” according to the civil complaint. “This improper accounting action was intended to manipulate WorldCom’s earnings.... WorldCom violated the anti-fraud and reporting provisions of the federal securities laws and, unless restrained and enjoined by this Court, will continue to do so.”
The civil complaint filed against WorldCom points out that the firm reported its operating earnings were nearly $2.4 billion in 2001--when in reality it had “suffered a loss of approximately $662 million.” The suit later states that WorldCom reported in its federal filings for the first quarter of 2002 that the telecom company’s operating earnings were $240 million, rather than post the actual loss of about $557 million.
Just a few months ago, consumers were bombarded with a WorldCom advertising campaign that touted its hook into “Generation D,” the “digital generation” of business and life that was interconnected with technology.
The pitch was that WorldCom was hip and cool, and showed young workers zipping along corporate hallways with carefree joy as they pondered the ventures WorldCom was focusing on--Internet services, Web hosting and international business.
But industry watchers said the light-hearted tone of the ad campaign masked the very serious accounting maneuvers that hid WorldCom’s financial troubles, which paralleled the telecommunications industry slump.
Analysts expect telecommunication equipment companies to take another hit if WorldCom no longer is a customer. Though some vendors that supply equipment to the troubled telecom firm said the effect of WorldCom’s cutbacks would be minimal, many saw their shares fall in trading Wednesday, among them Lucent Technologies Inc., Nortel Networks Corp. and Juniper Networks Inc. Stock prices also slumped for some Baby Bell phone companies and even the advertising companies that handled WorldCom’s campaign.
“The WorldCom accounting scandal is pretty much the last thing the doctor could have ordered right now,” said John Wilson, an analyst at RBC Capital Markets.
Terrified of losing customers, WorldCom’s top executives spent much of Wednesday speaking to the large commercial clients of its WorldCom group operation, said spokesman Brad Burns. The unit caters to the voice and data needs of commercial customers, and the revenue generated last year accounted for two-thirds of the company’s sales.
Chief Executive John W. Sidgmore and Chief Operating Officer Ronald R. Beaumont personally handled calls to customers, Burns said. “They’ve received very good support,” he said. “That’s obviously positive for us.”
In addition, WorldCom’s MCI unit serves local and long-distance needs of up to 20 million consumers and small businesses.
Many of these smaller customers, as well as the vendors who supply WorldCom with the equipment that run its data networks, complained that WorldCom officials had kept them in the dark.
“You’d think that, given the news, someone in a glass office would have sent out an official memo or e-mail to everyone,” said an executive at a Silicon Valley high-tech firm that supplies equipment to WorldCom. “You’d think that they’d care about making us feel good about their future. Why is the only information we’re getting coming from rumor we’re hearing from the people who are handling our contract?”
Hoping to curb the potential for fraud, SEC officials said they would enact emergency powers to force chief executives and chief financial officers to “certify” that quarterly and annual reports are truthful and complete. The executives would have to sign a section of the reports attesting to the accuracy of the information and to their personal familiarity with it.
Securities law experts said current laws require executives to release accurate and thorough information. But the proposed rule would make it tougher for them to hide behind claims of ignorance, experts said. If they are held directly accountable for corporate reports, CEOs and CFOs could be exposed to heightened--and personal--legal liability should problems arise at their companies, legal experts said.
The SEC had been considering the rule earlier this month, but officials said they opted to bypass the remainder of the research and comment process in order “to give the public real confidence.”
*
(BEGIN TEXT OF INFOBOX)
*
WorldCom Meltdown
What’s at issue:
* WorldCom admitted late Tuesday that it used improper accounting techniques to classify $3.9 billion of routine expenses as capital expenditures over a 15-month period. That allowed the company to report profit when in fact it had been losing money.
*WorldCom’s board of directors fired the chief financial officer, Scott D. Sullivan. Another executive, Controller David Myers, resigned.
* Securities and Exchange Commission Chairman Harvey Pitt said Wednesday that his agency filed a fraud case against WorldCom, a move designed to prevent the company from disposing of assets or destroying potential evidence.
What’s next:
* The Justice Department, which is reviewing the WorldCom case, could file a criminal action against the company or its officers.
* Analysts expect the disclosures to force WorldCom into bankruptcy. The company says it has no plans for a bankruptcy filing.
* WorldCom customers may begin defecting from the carrier, which could doom its ability
to recover.
Researched by KAREN KAPLAN / Los Angeles Times
*
Times staff writers Walter Hamilton in New York, Richard Simon and Janet Hook in Washington, and Christine Frey and James S. Granelli in Los Angeles contributed to this report.
