On This Day In Finance: July 7, 2003 - WorldCom Pays $750 Million

By Peter Cherewyk | July 07, 2009 AAA
On This Day In Finance: July 7, 2003 - WorldCom Pays $750 Million

WorldCom was ordered to pay $750 million by a federal judge to settle a lawsuit by the Securities and Exchange Commission (SEC). This was just a drop in the bucket which held the giant WorldCom scandal.

CEO Bernard Ebbers and CFO Scott Sullivan, among others, decided to record regular operating expenses as investments between 1999-2002. The difference between the two accounting categories is the year in which they are registered as an expense. (Where there is money, there are swindlers. Protect yourself by learning how investors have been betrayed in the past in The Biggest Stock Scams Of All Time.)

Investment: Recorded as expense (capitalized) over a number of years.
Operating Expense: Recorded as an expense in the year they were incurred.

So WorldCom decided to take $3.8 billion expense and spread it over several years by calling it a capital expense. At the time it reported profits of $1.3 billion, so if the expenses were not spread out, the company would actually be reporting a loss. Not very favorable to shareholders or management. It was later found that the company actually had additional improperly stated funds, bringing the total accounting fraud to $11 billion (2003 SEC News Release).

Spiraling out of Control
So lets say, as a manager, you find out that your company has lost $1 billion this year but you need to show profit to get your bonus, or not lose your job. You decide to cook the books a little, to eek out a profit of $100 million. You get your bonus and think you will never do it again. Now the company will need to have a legitimate profit of $1.1 billion just to break even. (To spot the signs of earnings manipulation, you need to know the different ways companies can inflate their figures, see Cooking The Books 101.)

On July 21, 2002 WorldCom filed for Chapter 11 bankruptcy, and re-emerged in 2004 as the MCI company. In 2005, Ebbers was sentenced to 25 years in prison and Sullivan was sentenced to five years for his role.

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