AVOIDING INVESTMENTS IN FRAUDULENT COMPANIES:
THE WORLDCOM FRAUD
The purpose of this report is to investigate and discuss the accounting fraud that occurred at WorldCom in order to recommend improved strategies to Berkshire Hathaway’s management for avoiding investments in companies with fraudulent financials. Accounting fraud is a crime committed by high level employees at an organization to manipulate the organization’s financial statements and intentionally disguise company performance. The fraud is committed without the knowledge of owners (shareholders and investors) to benefit the individuals perpetrating or committing the fraud and results in a negative impact ...view middle of the document...
In 1984, AT&T was broken down and opportunity for competition gave rise to companies such as Sprint, MCI, and eventually WorldCom; the new competition led to the complete deregulation of long-distance telecommunications in 1995 (p.49). From January 1996 to March 2001, the industry grew 36% (Carbone, 2006, p. 27). Currently, the industry is even more complicated with all the advancements in technology and the switch to digital information, so although there is still regulation in some areas, there is a great deal of services in telecommunications that remain deregulated (Economides, 2005, p. 54).
WorldCom originated in Clinton, Mississippi as a reseller of long-distance services in the early 1980’s after the deregulation of the telephone industry under the name of Long Distance Discount Company (LDDC). Bernie Ebbers was named CEO in 1985 and took LDDC public with the acquisition of Advantage Cos. in 1989. In 1995, LDDC became known as WorldCom, and started trading under the ticker symbol WCOM. In June of 1999, WorldCom shares were trading at $61.99 a share. WorldCom acquired over 60 firms in the late 1990’s and handled 50% of U.S. internet traffic, as well as 50% of emails worldwide. Their largest purchase was of MCI for $37 billion in 1997. By the turn of the century, growth had significantly decreased due to overexpansion in the industry; however, from 1998 to 2001, WorldCom was the second largest long-distance operator in the U.S and had over 20 million customers (O’Reilly, 2005).
The WorldCom Fraud
The massive fraud conducted by CFO, Scott Sullivan and CEO, Bernie Ebbers was revealed on June 25, 2002. WorldCom increased revenues by transferring money from their reserve accounts; the reserves were liabilities representing estimated costs expected to be paid in order to use equipment controlled by outside parties. In addition, Sullivan directed staff members to misclassify operating expenses as long-term investments, inflating assets and net income at the same time. From the second quarter of 1999 through the first quarter of 2002, WorldCom fraudulently reduced its line costs by over $7 billion. From the second quarter in 2001 through the first quarter of 2002, WorldCom improperly capitalized line expenses as long-term assets in the amount of over $2 billion. After all investigations were concluded, over $11 billion worth of accounting fraud had been discovered (Beresford, Katzenbach, Rogers, 2003, p. 9) (WorldCom, 1999-2002, Financial Information).
Table 1. Amount of WorldCom Misstated Expenses 1999-2002 |
Year | Reported Expenses According to WorldCom's Records | Actual Expenses According to Security and Exchange Commission | Difference (Amount of Improper Expense Recognition) | Improper Expense Recognition Percentage |
1999 | $24,878 | $24,145 | $733 | 2.95% |
2000 | $26,059 | $22,513 | $3,546 | 13.61% |
2001 | $25,785 | $22,545 | $3,240 | 12.57% |
2002 | $9,179 | $8,406 | $773 | 8.42% |