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Regulation

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 Salomon Smith 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.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.

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erbiumfiber 12/4/2012 | 10:08:23 PM
re: WorldCom's Grubby Secrets Easily the most stupid thing he could have done. Invoke the 5th AND THEN SHUT UP, like Sullivan did. There are some serious issues of waiver here, and the House counsel is working on them. The best part is where HE HAS THE AUDACITY TO CHALLENGE CONGRESS NOT TO ASK INFLAMMATORY QUESTIONS THAT HE WILL NOT ANSWER!!

Bernie, you fool, Congress is filled with people whose egoes are even bigger than yours! Man, you really pissed them off by saying this. I saw almost the entire testimony of both sets of witnesses and it was better than most movies I have recently seen- watching them all get pistol-whipped by Congressman and even invoking the 5th in response to questions whether Ebbers and Sullivan slept well at night (lol). Watch the re-runs on C-SPAN or set your VCR. Must-see TV!!

Anyway, the full text of Bernie's idiotic statement:

>>Good afternoon Mr. Chairman and members of the committee.

I served as CEO of WorldCom for 17 years. During that time, I helped a small company rise to one of America's largest corporations. I am proud of the work that I did at WorldCom, and I believe that, despite its recent problems, WorldCom continues to be a valuable company that provides important services to many Americans and to the United States government.

Within the last two weeks, following the restatement of earnings by WorldCom, officials at the Department of Justice, the SEC, various congressional committees and other law enforcement agencies have launched a number of investigations and proceedings relating to WorldCom.

Countless reports in the media have suggested that my conduct as a WorldCom CEO may be examined in these inquiries. During the last week, I retained counsel to represent me in connection with these proceedings. Although I would like, more than you know, to answer the questions that you and your colleagues have about WorldCom, I've been instructed by my counsel not to testify based on my Fifth Amendment Constitutional rights.

After careful consideration, I have decided to follow my counsel's instruction, even though I do not believe I have anything to hide in these or any other proceedings.

I have reached this decision because, one, the investigations appear to be open-ended examinations of a variety of activities at WorldCom, the details of which have not been provided to me. Second, I have not been advised of the specific conduct of mine that is being called into question. And third, I understand that preliminary statements can be taken out of context as inquiries such as these become focused over time.

I hope the committee will not draw a negative inference based on my assertion of these constitutional protections on the instruction of my counsel, or attempt to subject me to ridicule by asking inflammatory questions, knowing that I will not answer them.

I do not believe that I should be subject to legal harm as a result of my exercise of a basic constitutional protection found in the Bill of Rights.

When all of the activities at WorldCom are fully aired and when I get the opportunity -- and I'm very much looking forward to it -- to explain my actions in a setting that will not compromise my ability to defend myself in the legal proceedings arising out of the recent events, I believe that no one will conclude that I engaged in any criminal or fraudulent conduct during my tenure at WorldCom.

Until that time, however, I must respectfully decline to answer the questions of this committee on the basis of my Fifth Amendment privilege.<<

Don't even get me started on Jack Grubman=Uriah Heep from Charles Dickens. "Grub" is absolutely what comes to mind when listening to this unctious, obsequious, slimy larva...

BobbyMax 12/4/2012 | 10:08:22 PM
re: WorldCom's Grubby Secrets It must be mentioned that the coruption is built in the system. All one has todo is to invoke it. SEC and Deparrtment of Justice are not going to take any real action. In fact, these institutions have largely ignored crimes involving finance in business settings. The US Government has rendered shareholders ineffective.

THe employees of a company cannot raise objections or report wrongdoings on the part of their companies for the fear of getting fired. Thanks to employment at will. It is such a barbaric concept that the rest of the world shakes it head that the US Goverment would make employment at will as a corner stone of its justice system.

Misreporting of profit and loss, and loans to executives to be later forgiven is promoted by a majority of businesses. It is not just a few bad apples, it is really a majority of bad apples.

To be very blunt, a vast majority of businesses are very deceitful because of the governmen's inability to enforce the law. We are going to be good just by proclaiming good things.
Vesting 12/4/2012 | 10:08:21 PM
re: WorldCom's Grubby Secrets I think the two questions I would like to see answered is, why does a guy with millions in the bank need to borrow $400 Million in the first place?

Then the next obvious question is, what did he do with it?

I wonder if he has the number to his Swiss bank account tattooed on him somewhere under that beard.
maryhadalambda 12/4/2012 | 10:08:21 PM
re: WorldCom's Grubby Secrets Who owned stock in RBAK and continually touted it to the press?

switchrus 12/4/2012 | 10:08:21 PM
re: WorldCom's Grubby Secrets Bernie, Bernie, BernieGǪYou ignorant slut!

DonGÇÖt you listen to rock and roll?

In the immortal words of Jim Croce

And they say, `You don't on Supermans' cape
You don't spit into the wind
You don't pull the mask off the old Lone Ranger

Added: You donGÇÖt piss off a already pissed off Congress
billy_fold 12/4/2012 | 10:08:19 PM
re: WorldCom's Grubby Secrets Balto,

I am going to have to grudging agree with you on this one. I think that how Bernie and Scott Sullivan "sleep at night" is a moot point. I'll take the fifth on how I sleep at night also.


billy
rjmcmahon 12/4/2012 | 10:08:19 PM
re: WorldCom's Grubby Secrets why does a guy with millions in the bank need to borrow $400 Million in the first place?
_____________

My understanding, which comes second hand, was that he used the money to buy WCOM stock. If correct, it begs the question why would an executive choose this mechanism to increase his equity holdings in his own company. Why not issue stock options and let the company have a buyback on the stock?

Considering the outcome, this decision turned out to be a very bad deal for the executive. The WCOM bondholders seem to be getting a deal of a lifetime on the backs of equity holders. Anybody who borrowed to buy equity seems to be on the wrong side of the deal.

Maybe somebody more knowledgable could explain this to me. Thanks in advance.
steve 12/4/2012 | 10:08:19 PM
re: WorldCom's Grubby Secrets While the witnesses did not cloak themselves in glory, the most painful and disturbing part of the hearings yesterday was the enormous ignorance, ego and just plain old stupidity demonstrated by virtually all of the congressmen/women. My favorite senior moment was by the inimitable Maxine Waters, of our own California, who referred to Grubman's firm as "Salomon Smith Barney Frank".

With a few exceptions (the gentleman from North Carolina) all were interested in generating the most scintillating sound bite filled with righteous indignation vs. finding out how we can prevent these abuses from occuring again.

In discussing conflicts of interest, I wish one of the witnesses would have had the balls to ask those morally decaying dinosaurs how they manage conflicts of interest when they line their own pockets with campaign contributions from the very firms they are now trying to destroy.
lilgatsby 12/4/2012 | 10:08:18 PM
re: WorldCom's Grubby Secrets Good discussion point, RJ.

My second-hand information says that this "loan" was used to prevent Bernie from cashing out his many shares and sinking the stock value. I would be interested in hearing of any other rumors floating around regarding this trasnaction.

lg
erbiumfiber 12/4/2012 | 10:08:17 PM
re: WorldCom's Grubby Secrets Quotes Sidgmore's testimony from last night that I referred to in my last post:

http://biz.yahoo.com/djus/0207...

Cheers!
erbium
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