WorldCom's Grubby Secrets

Salomon analyst explains how he rated the stock from the company's boardroom, as WorldCom execs plead the Fifth

July 9, 2002

5 Min Read
WorldCom's Grubby Secrets

WASHINGTON -- If one thing stood out in yesterday’s opening session of the investigation into the WorldCom Inc. (Nasdaq: WCOME) scandal by the Financial Services Committee in the U.S. House of Representatives, it was the testimony of Jack Grubman, an analyst at investment bank SalomonSmith Barney.

Specifically, congressmen were troubled by the fact that Grubman, who had made about $20 million per year for four years during boom times, had rated the company’s stock so highly for so long, as the stock plummeted to new lows. They also questioned the timing of his last downgrade, which was issued just days before the company publicly revealed the alleged fraud. Grubman defended himself by explaining that he had consistently been downgrading the company since March of this year as the company revealed its financial problems. But he also emphasized that he always considered WorldCom a long-term winner.

“I certainly have made mistakes,” he said. “In retrospect, I regret staying with my point of view for too long. For most of the last decade, I was right and I was roundly praised, and now I’ve been wrong and am roundly criticized.”

It was Grubman’s close ties with the company and to his firm’s investment banking arm that troubled committee members most. By Grubman’s own admission, WorldCom generated nearly $80 million in fees to Salomon Smith Barney’s investment banking division from 1998 to 2001.

Grubman also admitted that his compensation was indirectly influenced by investment banking deals that his company won. He referred to his “close working relationship” with WorldCom founder and former CEO Bernard J. Ebbers and admitted that he had attended three WorldCom board meetings, in which he served as an advisor for deals between Salomon's investment banking arm and WorldCom. Despite all these connections, Grubman continued to assert his independence and objectivity.

“I still believe that you can be objective and still be part of a full-service firm,” he said. “I’m not saying it’s easy. There are conflicts that you have to navigate through.” He mentioned that Salomon Smith Barney has now adopted a policy instituted first by Merrill Lynch & Co. Inc., which prohibits the investment banking division of the company to influence analyst compensation.

Another example of the failure of self-regulation was seized on during the testimony of the former Arthur Andersen LLP partner who oversaw the WorldCom account, Melvin Dick [ed. note: pardon the expression]. Member after member of the committee expressed outrage at the fact that the company had shifted $3.8 billion worth of capital expenses to the operational expenses category.

When questioned as to how Andersen auditors could have missed such a big mistake, Dick repeatedly stated that his firm had performed the WorldCom audit according to standard accounting practices. He asserted many times throughout his testimony that as an auditor he relied on figures presented to him by the company’s management and that the information his firm received was not complete. It was clear from his evasive answers that Arthur Andersen, which is being prosecuted for shredding documents in the Enron scandal, did little additional digging and relied almost entirely on the company’s word that its stated figures and documents were valid.

Even WorldCom's current CEO, John Sidgmore, blamed the auditors. In his testimony late on Monday, he blasted Andersen for missing such an egregious mistake. “I am puzzled by the fact that the wrongdoing was not uncovered by our outside auditor,” he said.

As he had done in previous public statements, Sidgmore acted the part of cheerleader, trying to convince committee members that WorldCom has changed its ways under new management (see Sidgmore's Last Stand). But as members listened to testimony from Sidgmore and chairman of the board Bert Roberts, regarding Ebbers's $400 million loan, they questioned the company’s current moral fabric. Even though Sidgmore only became CEO in March, he had worked for WorldCom for many years, coming to the company via the UUNet acquisition. Up until his appointment as CEO, he served as vice chairman of the board of directors.

“I’m at a loss to see where the new management team is,” said Rep. Sue W. Kelly (R-NY). “What’s new? Tell me.”

Sidgmore and Roberts said that in retrospect, they should not have given the go-ahead for the loan.

“At the time it seemed like a good idea, but looking back, we shouldn’t have done that,” said Roberts.

“The simplicity and audacity of the deception at WorldCom provides ample evidence of a profound change in culture within our largest corporations,” said Rep. John J. LaFalce (D-NY). “The safeguards we have relied on to protect investors failed at every level... There is an urgent need for strong and reasoned legislation to restore the market confidence that has been squandered by greed, incompetence, fraud, and weak regulation.”

As has been reported elsewhere, Bernard J. Ebbers, founder and former CEO of the company, denied complicity in the scandal while invoking his Fifth Amendment rights in refusing to testify.

“I do not believe I have anything to hide in these or any other proceedings," he said. "No one will conclude that I engaged in any criminal conduct or fraud." Even when asked to verify his previous statement, he cited the Fifth Amendment in refusing to answer.

His reluctance to answer questions after declaring his innocence enraged some committee members, who called for Ebbers to be held in contempt of the committee.

“By giving a statement, he waived his right under the Fifth Amendment,” said Rep. Max A. Standlin (D-TX) in an interview after the hearing. “You can’t selectively plead the Fifth Amendment. I think it’s a slap in the face to this committee and the Constitution to show up, say you haven’t done anything wrong, and then refuse to answer questions.”

Committee Chairman Michael G. Oxley (R-OH), ruled that the committee should review the legality of Standlin’s claim and recall Ebbers at a later date if necessary to answer questions.

Former WorldCom chief financial officer Scott D. Sullivan, who was fired on June 25th, the day the scandal was made public, nervously invoked his Fifth Amendment right without making any public statements.

— Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.comCheck out Light Reading's July Research Poll on this topic to find out what others think about who's to blame for Worldcom's woes, and whether there are other skeletons in its closet.

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