Q&A: The WorldCom debacle

WorldCom Inc., the nation's second largest long-distance telephone carrier, admitted late Tuesday to disguising $3.8 billion in expenses last year and early in 2002 that resulted in fictitious profit earnings. Stocks tumbled upon opening Wednesday as investors absorbed the latest in a string of accounting scandals that have already rocked Enron Corp, Tyco International Ltd., Global Crossing, and Adelphia Communications. Both Enron and WorldCom had employed auditing firm Arthur Andersen. (Andersen claims it had no knowledge of the WorldCom irregularities.) WorldCom's 1998 merger with MCI was the largest in history at the time.

Monitor economics correspondent David Francis discusses the implications of this latest financial scandal with csmonitor.com producer Ben Arnoldy.

Can you briefly explain how WorldCom overstated its earnings?

At this point, it's a bit fuzzy. But apparently, WorldCom booked as capital expenses, rather than ordinary maintenance, some of its expenses on the company's telecom network. This enabled the costs to be capitalized and treated as an asset that can be written down on the books over time, rather than expensed immediately. The gimmick improperly boosted cash flow $3.8 billion over the past five years.

Beyond the market upset we see today, what will be the impact of these restatements?

Analysts expect that this mistaken – if not fraudulent – bookkeeping accelerates the need for WorldCom to reorganize and possibly shrink its $30 billion in debts. Some expect the company will need to file for protection under the bankruptcy law.

How will this affect the average investor with money in a 401(k) or mutual fund?

According to Morningstar, a Chicago mutual fund advisory group, the latest data shows that 539 mutual funds owned 400 million of the 3 billion in outstanding shares of WorldCom. Among those with the heaviest exposure were PIMCO Value Institutional and Oppenheimer Quest Balanced. Vanguard Windsor had the biggest holding. But most funds are heavily diversified in their holdings and this may not be a serious blow to fund shareholders. Many of those with 401(k) plans have that money in mutual funds.

Some pension funds may be hit, but not too visibly to those who expect to receive pensions from those funds.

Former WorldCom CEO Bernie Ebbers is alleged to have secretly borrowed $366 million from the company. How can something like this happen?

The board of directors would have had to approve such a deal. Mr. Ebbers had taken out bank loans for his private investments and put up his then-stellar WorldCom stock for collateral. When the market tumbled, he was faced in late 2001 with a margin call. That would have forced him to sell his WorldCom stock. Presumably, the board didn't think that was a good idea as it might have depressed the stock's value, and thus it let the company guarantee the investment loan.

What gave rise to this rash of bad bookkeeping?

In the atmosphere of the late 1990s when so many executives in the high-tech and telecommunications industry were getting rich on stock options, ethical standards slipped. Companies were able to easily sell new stock and were hyping that stock. Bad bookkeeping became contagious in the industry as executives figured rapid sales and rising stock prices would cover any sins. Accountants were also caught up in the excitement.

Do industry insiders believe these questionable accounting practices are widespread, or limited to a few bad actors?

A survey of top corporate ethics officers by The [N.Y.-based] Conference Board predicts at least a half dozen more "major" business ethics scandals will be revealed during the next 12 months. It seems likely bookkeeping standards have deteriorated. But not in every company, of course.

Has the accounting industry enacted the necessary reforms to prevent this in the future?

Many companies are scrambling to make sure their books are correctly stated. In addition, the Securities and Exchange Commission has proposed that chief executive officers should have to personally vouch for the veracity, timeliness, and fairness of their financial statements. It has also called for a regulartory board for accountants. And strong legislation is before Congress.

Is this yet another blow to the "new economy"? Will this slow the pace of investment, and therefore development, in high-tech fields?

Yes, it does raise new suspicions as to the value of the "new economy." But memories are often short on Wall Street and at some point capital and growth in the high-tech areas may well impress investors again.

What role, if any, did deregulation play in the meteoric rise and fall of WorldCom? Are telecommunications companies likely to return to more regulation now?

Deregulation opened the door for aggressive new companies like WorldCom to expand rapidly with acquisitions and mergers and borrow huge amounts of money. Talk of re-regulation of the industry has been rather scarce.

The savings and loan crisis eroded public trust in financial institutions. Could this year's bookkeeping crisis have a similar or greater impact?

The savings and loan crisis and a subsequent failure of numerous commercial banks hurt the recovery after the 1990-'91 recession. This current crisis isn't doing the present economy recovery any good. It may discourage some new investors in stocks and prompt some to leave the market. It is also damaging the reputation of capitalism, and thereby opens the door a little to Congress and regulatory agencies to impose some reforms on Wall Street and on corporations.