WorldCom: The Fraud That Topped Enron

WorldCom corporate fraud was simpler than Enron’s — and larger. The company filed for bankruptcy on July 21, 2002, with $107 billion in assets, surpassing Enron’s record. The mechanism was a few spreadsheets and a handful of accountants reclassifying $11 billion in operating expenses as capital investments. What it destroyed took a lot longer to count: 17,000 jobs, $180 billion in shareholder value, and a telecommunications network that one-third of American internet traffic ran through.

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How Bernard Ebbers Built an Empire on Acquisitions

CEO Bernard Ebbers, a former high school basketball coach from Mississippi, turned a small long-distance carrier called LDDS Communications into one of the largest telecommunications companies in the world through more than 60 acquisitions in less than two decades.^1^ By 1999, WorldCom controlled roughly one-third of all internet traffic routed through the United States. The company owned MCI, the second-largest long-distance carrier in the country, and had tried — unsuccessfully, blocked by the Justice Department — to acquire Sprint in a deal worth $115 billion.

The telecom boom of the late 1990s inflated WorldCom’s stock and the ambitions of everyone inside it. When the boom ended and revenue fell, WorldCom’s business model — premised on endless growth through acquisition — had nowhere to go.

How Did WorldCom Hide $11 Billion in Losses?

CFO Scott Sullivan and Director of General Accounting Buford Yates directed the fraud that kept WorldCom’s earnings numbers healthy on paper. Telecom companies pay “line costs” — fees to other carriers for leasing network capacity. These are operating expenses, deducted from revenue in the period they’re incurred. Sullivan’s team reclassified billions in line costs as capital expenditures, which under accounting rules get spread out — depreciated — over multiple years. The manipulation made quarterly profits look far better than they were.^2^

Between 1999 and 2002, WorldCom improperly capitalized approximately $3.8 billion in line costs in the period internal auditors first uncovered. Later investigations revealed an additional $7.2 billion in fraudulent entries, bringing the total to approximately $11 billion. The fraud also involved improper reserve releases: WorldCom had accumulated roughly $3.3 billion in reserves during its acquisitions and released them into earnings when needed to hit Wall Street’s quarterly targets.

Arthur Andersen — the same accounting firm that audited Enron — audited WorldCom’s financial statements and missed it all, or at least claimed to have missed it. Andersen was already facing criminal charges related to Enron when the WorldCom fraud became public, and the firm collapsed before the full picture was understood.

The Internal Auditors Who Found It Themselves

The fraud wasn’t uncovered by the SEC, external auditors, or Wall Street analysts. Cynthia Cooper’s internal audit team found it. In the spring of 2002, Cooper’s team — working at night to avoid detection by executives who knew what they might find — traced the suspicious journal entries and reported them to the audit committee of the board in June 2002.^2^ The board immediately contacted the SEC.

Cooper later described receiving hostile responses from Sullivan when she began asking questions about the line cost capitalization. She pressed forward anyway. Time magazine named her, along with Sherron Watkins of Enron and Coleen Rowley of the FBI, as Persons of the Year for 2002.

What the Collapse Actually Cost

WorldCom’s 17,000 laid-off employees were the most immediately visible casualties. The bankruptcy wiped out retirement savings for thousands of workers who held company stock. WorldCom had approximately 20 million long-distance customers in the United States, and the uncertainty about the company’s survival disrupted businesses that depended on its network infrastructure.

MCI, which WorldCom had acquired in 1998 for $37 billion, emerged from bankruptcy in 2004 and was subsequently acquired by Verizon in 2006 for $8.44 billion — a fraction of what WorldCom had paid.^3^ The destruction of shareholder value across the fraud period exceeded $180 billion. Investors who had trusted WorldCom’s reported numbers — pension funds, mutual funds, individual investors — absorbed losses directly attributable to decisions made in a few accounting offices in Clinton, Mississippi.

Why Ebbers Got 25 Years When Enron’s Skilling Got 24

Bernard Ebbers was convicted of fraud, conspiracy, and filing false documents with regulators in March 2005 and sentenced to 25 years in federal prison.^3^ He was 63 years old. Ebbers maintained throughout his trial that Sullivan had run the books and he had trusted him. Prosecutors argued he had every incentive to support a fraud that was keeping his own stock-leveraged loans from being called.

Scott Sullivan pleaded guilty to fraud in March 2004 and cooperated with prosecutors against Ebbers, receiving a five-year sentence. Buford Yates and several other accounting department employees also pleaded guilty. Ebbers was released from prison in December 2019 due to deteriorating health and died in February 2020.

WorldCom’s fraud, like Enron’s, generated legislation. The Sarbanes-Oxley Act signed in July 2002 was drafted against the backdrop of both scandals running concurrently. But the structural question both scandals posed — whether executive compensation tied to stock price creates systematic incentives to commit accounting fraud — was never resolved. Stock options and equity grants remained the primary vehicle for executive compensation. The pressure to hit quarterly earnings estimates that drove WorldCom’s manipulations didn’t disappear from corporate culture. It adapted.

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Sources:

1. Jeter, Lynne W. Disconnected: Deceit and Betrayal at WorldCom. Wiley, 2003.
2. Cooper, Cynthia. Extraordinary Circumstances: The Journey of a Corporate Whistleblower. Wiley, 2008.
3. United States House Committee on Financial Services. The WorldCom Fraud. U.S. Government Printing Office, 2002.
4. Securities and Exchange Commission. In the Matter of WorldCom, Inc. SEC Litigation Release No. 17753, 2002.