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News
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WorldCom's financial bomb
From the president on down, officials worried about investor confidence weigh in.
June 26, 2002: 9:21 PM EDT
By Jake Ulick, CNN/Money Staff Writer

NEW YORK (CNN/Money) - Confidence in Corporate America hit new lows Wednesday as President Bush, Congress and other federal regulators vowed to investigate WorldCom while securities analysts forecast bankruptcy for the latest firm to fool investors with inflated profits.

WorldCom, which will downwardly restate financial results in one of the biggest accounting scandals in history, joins Enron, Global Crossing and Tyco International among the tarnished success stories of the 1990s.

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"No one blow is going to be terminal," said Pete Peterson, the chairman of Blackstone Group "But this is another very serious one. All this does is add to the increasing loss of confidence in our systems."

Peterson leads a group of investors that includes the heads of TIAA-CREF, the big pension fund and Vanguard, the mutual fund company, that are drawing up corporate governance recommendations.

Bush Wednesday promised a full investigation into WorldCom's accounting problems following word that the No 2 long-distance telephone provider improperly booked $3.8 billion over the past five quarters. The mis-accounting made earnings look better than they really were.

"We will fully investigate and hold all people accountable for misleading not only shareholders but employees as well," said Bush, who called the news "outrageous."

"Those entrusted with shareholders' money must strive for the highest of standards."

Hours later, the SEC filed a civil lawsuit against WorldCom, charging the company with fraud.

"We're seeking orders that will prevent any dissipation of assets or payouts to senior corporate officers past or present, and preventing any destruction of documents," SEC chairman Harvey Pitt said in New York.

The Federal Communications Commission is also taking some steps in the scandal. FCC Chairman Michael Powell said Wednesday that he was "deeply concerned" by the WorldCom developments and their impact on the telecom industry. Powell said he will travel to New York on Friday and meet with a variety of telephone industry officials, analysts and debt-rating agencies to assess the challenges facing industry.

"We are closely monitoring the situation and are doing everything possible to ensure and protect both the stability of the telecommunications network and the quality of service to consumers," Powell said in a statement.

Investors Wednesday could not trade WorldCom shares, which were halted after falling more than 98 percent from their all-time high through Tuesday. But the overall stock market ended little changed, recovering from an earlier tumble.

The Justice Department is also looking into WorldCom, a spokesman said at a midday briefing, joining a Congressional panel, which vowed an inquiry of its own.

Memories of Enron

The latest accounting misdeeds unnerved investors leery about the accuracy of corporate profits after the collapse of Enron Corp., which filed the biggest bankruptcy in the United States last December. Arthur Andersen LLP, found guilty earlier this month of obstructing justice in the Enron case, signed off on WorldCom's books.

"Our senior management team is shocked by these discoveries," WorldCom CEO John Sidgmore, who was appointed in April, said in a statement. "We are committed to operating WorldCom in accordance with the highest ethical standards."

The news late Tuesday from WorldCom prompted industry analysts to say the heavily indebted long-distance provider might file for bankruptcy protection from creditors.

WorldCom is looking for about $4 billion in financing but some of its main bank lenders, including Bank of America, J.P. Morgan and Citigroup, are refusing to loan them any more, banking sources told CNN/Money.

"They will have to file bankruptcy in a matter of days," a person familiar with the situation said.

But other bankers close to the situation said it was too early to say whether WorldCom will file for bankruptcy soon.

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In addition to describing improper accounting, WorldCom said it would cut 17,000 jobs, about a quarter of its work force, and fired Chief Financial Officer Scott Sullivan. David Myers, senior vice president and controller, resigned.

The company, based in Clinton, Miss., said an internal audit showed that expenses of $3.1 billion for 2001 and nearly $800 million for the first quarter of 2002 were improperly accounted for.

WorldCom said restating the expenses to account for their true costs would cut reported cash flow -- or earnings before interest, taxes, depreciation and other items -- for last year and the first quarter of 2002.

While CEO Sidgmore said the company remains "viable and committed to a long-term future,"Adam Quinton, who covers WorldCom for Merrill Lynch, said the developments bring the company closer to bankruptcy.

"This only adds to investor wariness," said Quinton, who advises investors to sell shares.

Nervous times

WorldCom's revelations may deter already reluctant customers from buying communications services. And its access to existing lines of credit may also dry up as banks demand repayment.

"The development brings into serious question the company's ability to close on a new bank deal and it raises the likelihood the company will file for Chapter 11 [bankruptcy protection]," Marc Crossman, who follows the company for J.P. Morgan, wrote in a note to clients Wednesday morning.

But one banker close to the situation said that WorldCom has $2 billion in cash that they have yet to burn through, making bankruptcy unlikely. "This is vastly different from Enron," the person said. "The $2 billion will last them several months."

The SEC said WorldCom had committed "accounting improprieties of unprecedented magnitude" -- proof, it said, of the need for reform in the regulation of corporate accounting.

To finance that reform, the House voted overwhelmingly Wednesday to authorize a 77 percent boost in the SEC's budget, raising it to $776 million for the fiscal year beginning Oct. 1.

Elsewhere, the chairman of the House Energy and Commerce Committee said he ordered a separate WorldCom probe. "Clearly, it was an orchestrated effort to mislead investors and regulators, and I am determined to get to the bottom of it," said committee chairman Billy Tauzin, R-La.

The accounting mishap comes during a tough time for WorldCom, which could face Nasdaq delisting if its share price remains below $1. The company's market value had tumbled to $2.7 billion at the close of trading Tuesday, from about $125 billion in mid-1999.

Salomon Smith Barney Telecom Analyst Jack Grubman -- who had been perhaps the most bullish analyst on WorldCom -- cut his rating to "underperform" just a day before the company's announcement Tuesday.

WorldCom said it asked its new auditors, KPMG LLP, to undertake a comprehensive audit of the company's financial statements for 2001 and 2002. The company will reissue unaudited financial statements for 2001 and for the first quarter of 2002 as soon as it can.

John Hodulik, who covers WorldCom for UBS Warburg, said the restatement should reduce WorldCom Inc.'s reported 2001 "cash flow" by 32.5 percent to $6.3 billion and first quarter results by 36.9 percent to $797 million.

"We are unable to provide a realistic price target until we have reliable financials," said Hodulik, who rates the company's stock a "hold."

Click here for a look at what other analysts are saying about WorldCom.

Selling assets

In addition to the 17,000 job cuts, the company said it is selling a series of non-core businesses, part of a plan to save $2 billion.

WorldCom stock began falling in late 1999 as businesses slashed spending on telecom services and equipment. A series of debt downgrades this year have raised borrowing costs for WorldCom, which is struggling with about $32 billion in debt. WorldCom said it has no debt maturing during the next two quarters.

Former WorldCom CEO Bernie Ebbers resigned in April amid questions about $366 million in personal loans from the company and a federal probe of its accounting practices.

WorldCom, whose shares once traded near $64 in 1999, tumbled to 21 cents in before-hours trading, down from Tuesday's regular-hours close of 83 cents.  Top of page


-- Staff Writer Luisa Beltran contributed to this report


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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.