WorldCom Finger-Pointing Begins
At WorldCom Inc. (Nasdaq: WCOM), the long process of figuring out what happened and who is to blame has just gotten started (see WorldCom Goes Boom).
Following the disclosure of $3.8 billion worth of false accounting at the telecom giant, the Securities and Exchange Commission (SEC) has announced that it is stepping up its investigation into the company’s accounting practices, and President Bush has indicated that a federal investigation is looming (see SEC Comments on WorldCom and Bush Outraged by WorldCom Fraud).
“Will there be a Congressional hearing? Absolutely,” says Daniel Sommers, a partner at Cohen Milstein Hausfeld & Toll PLLC. And, he says, if anything criminal is turned up, either the Federal Bureau of Investigation (FBI), the United States Department of Justice, or both will certainly launch their own investigations into WorldCom’s dealings. But no matter which institutions do the investigating, it’s likely to take a while before we know exactly what happened and all who were involved.
Though criminal charges have not yet been filed, today it was clear that the markets and many observers reacted with shock and dismay at the size of WorldCom's blunders. And many industry observers expressed anger and urged criminal proceedings.
"This wasn't a computer error. They had to have had malice aforethought," says Frank Dzubeck, president and CEO of Communications Network Architects, insisting that WorldCom consciously listed ongoing operational expenses on the capital spending side of the page, thus benefiting from 20-year depreciation. "This is fraud. This is hanging-offense stuff.”
The most obvious suspect has already been sacked. The company announced today that Scott Sullivan, the chief financial officer and secretary of WorldCom, has been fired. The company has also accepted the resignation of David Myers as senior vice president and comptroller.
The finger-pointing doesn't stop there, however. While new CEO John Sidgmore will probably be exempt from blame for the suspected fraud, the role of his predecessor, Bernard Ebbers, is likely to be examined closely, observers say. Sidgmore took over as head of the company on April 29 amidst growing dissatisfaction with Ebbers, who many say drove WorldCom into the ground with his aggressive acquisition strategy (see Sidgmore Takes Control at WorldCom). A personal $341 million company loan to Ebbers is currently being investigated by the SEC. Sidgmore has been put in charge of fixing WorldCom's mounting problems.
"The CEO had to know," Dzubeck says of Ebbers.
And then of course, there's accounting firm Arthur Andersen LLP, which has been turning up in several major accounting scandals, including Enron and Global Crossing, and which has already been convicted of criminal wrong-doing. Arthur Andersen was WorldCom's auditor until May of this year.
With Arthur Andersen in control, a scandal had to break, says Craig Johnson of the PITA Group. “Who was their auditor?” he says. “What’s so funny is that it’s taken people so long to find out.” In today's statement, WorldCom said that it recently brought in KPMG to undertake a comprehensive audit of its financial statements for 2001 and 2002.
In addition, blame is being placed on Wall Street analysts who have been accused of issuing false and misleading analyst reports on WorldCom, indicating that the company was doing better than it in fact was. One lawsuit targets Jack Grubman, an analyst at Salomon Smith Barney, who was one of Worldcom's biggest supporters on Wall Street.(see WCOM Buyers Sue Analysts).
On April 22, Grubman for the first time backed off his bullish stance on Worldcom, lowering his rating from Buy to Neutral. During the time Grubman had a Buy issued on Worldcom, it's shares fell more than 90%. On Monday, Grubman downgraded Worldcom's stock to Underperform from Neutral.
But Grubman wasn't the only analyst cheerleading Worldcom as its shares plummeted. Almost unbelievably, other sell-side analysts had Buy ratings on WorldCom stock as late as yesterday. Vik Grover, an analyst at Kaufman Bros. LP, for example, "reiterated" his Buy rating on WorldCom stock on Tuesday, as the stock price dipped below $1. Grover, scaling back some of his bullish feelings about the company's prospects, did have the sense to lower his price target from $10 to $6, though, as the stock plummeted into the pennies.
On Wednesday, Grover backtracked, downgrading WorldCom from a Buy to a Hold, after news of the accounting restatement surfaced. He also suspended his price target. "The newswires first indicated fraud, but takeaway from the situation indicate that Scott Sullivan believed he was properly capitalizing expenses under U.S. GAAP," he wrote in a report today. "This is impossible to confirm but seems plausible given his experience and respect in the industry. Our call on the stock was wrong, given that the information we were acting on appears to have been incorrect."
The bottom line is that the WorldCom developments, on top of the heap of scandals already plaguing the industry, have conspired to further erode investor confidence in the industry and in the sell-side Wall Street research firms that cover it, say observers.
“The analyst scandal coupled with Enron and WorldCom have led to a collapse in investor confidence," says Bart Schachter, a general partner with Blueprint Ventures. “The faith and trust in the stock market has been corrupted -- if not forever, for a long time.”
— Eugénie Larson, Reporter, Light Reading
http://www.lightreading.com Check 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.