International FinanceExecutive Development Program

05 Oct 2014Deveena Balasundaram

Nadeeshan WadugeAbdul Rahim Rumi

Introduction

The Rise and Fall of WorldCom

What Went Wrong and How?

Recommendations

Conclusion

The last couple of decades saw the fall of many organizations• Eg: Enron, Parmalat, Adelphia Communications Corp and

Global Crossing Ltd

Main Reasons for their fall:• Recessions• Accounting Fraud• Criminal Activities• Corruption• Mismanagement of Assets and Operations

Some Companies ended up bankrupt while some were able to recover and continue operations

Established in 1983 by Murray Waldron and William Rector.

First named Long-Distance Discount Service (LDDS). The company provided long distance telephone calls at a discount.

Investor Bernard Ebbers joined the company and was appointed as CEO.

Ebbers strategy was to grow through Mergers and Acquisitions and was involved in close to 64 mergers and acquisitions over the years

Was the second largest telecommunication provider in the US and largest Internet Provider

The company grew mainly through its M&A strategies

The company's first acquisition was Advantage Companies in 1989 through which the company went public

Other Major Mergers and Acquisitions

• 1992 Acquired Advanced Telecommunications Corp USD 850 Mn (Stock to Stock)

• 1993 Acquired Resurgens Communications Group Inc and

Metromedia Communications Corp Long Distance Service Providers USD 1.25 Bn (Stock to Stock and Cash)

Other Major Mergers and Acquisitions (cont’d)

• 1994 Acquired IDB Communications Group Domestic and International Network Provider including data

connections, TV, Radio and Mobile Satellite Communication capabilities

USD 936 Mn (Stock to Stock)

• 1995 Acquired Williams Telecommunications Group Voice and Data Transmission Company USD 2.5 Bn (Cash) Changed name to WorldCom

• 1996 Mergers with MFS Communications Company and UUNet

Technologies MFS was into communication for business and governments in US and

Europe. UUNet was a internet service provider USD 12 Bn (Stock to Stock)

Other Major Mergers and Acquisitions (cont’d)

• 1998 Merged with MCI Long distance service provider USD 40 Bn (Stock and Cash) The largest deal at that time and led to increase in

shareholder value and exceptional customer service

Merged with Brooks Fiber Properties USD 1.2 billion

Merged with CompuServe Internet provider for business and personal use USD1.3 billion

Other Major Mergers and Acquisitions (cont’d)

• 1999 In talks with Sprint for a merger Estimated value USD 129 Bn Share Price reached a high of USD 65. 00 per share Merger was blocked by the US Department of Justice

and European Regulators fearing the violation of Celler-Kefauver Antimerger Act

Both parties decided to terminate their merger agreement

• 2001 Merged with Intermedia Internet service provider

In 2002, the Securities and Exchange Commission started their investigation on accounting policies and loans to executives

Consequences of the Investigation• Lost Value with share price falling to pennies• Around 20,000 Job Cuts• Exited certain business sectors• CEO Ebbers resigned• CFO Sulivan was sacked• Was listed as “Junk” status• Filed for Bankruptcy

Over expansion strategies & industry recession

• WorldCom outsourced some portions of its calls

• Paid the outside service providers for carrying WorldCom customers’ calls on their lines.

• Took majority of its lines on lease. Anticipated high demand in the

industry. Increased their leased networks

Decline in the growth of telecommunication industry reducing the demand

Hefty fines for unutilized leased networks.

Increase in E/R ratio

• Prices for long-distance communication services were falling

DOT COM Bubble Burst

Refusal of merger with Sprint (Largest wireless network company then) by US Justice Department to regulate the Telecommunications Industry.

Accounting fraud

EXPENSE VS CAPITAL EXPENSE VS CAPITAL EXPENDITUREEXPENDITURE

WorldCom’s CEO Ebbers and CFO Sullivan

Cooper‘s internal audit team discovered $2.3 billion fraud including $500 million in undocumented computer expenses

• Did not make any attempt to control organization’s debt levels - WorldCom is accounted for over 250 million dollar credit issued to Telecommunications Customers.

• approved billions of dollars without any management information and without even considering the terms and conditions or implications of the deal.

-WorldCom has paid 22.8 million dollars in revenue for Early Termination Penalties.

Board of Directors

Internal audit

•The internal auditing operation within the company was purposely diverted away from auditing responsibilities and concentrated upon increased efficiencies and cost-cutting instead of searching on internal affairs.•understaffed, underpaid and under-qualified to carry out a responsible internal audit function.

External audit•Arthur Andersen the external auditing team identified WorldCom as a “maximum risk” client, but failed to act consistently and overlooked serious deficiency in the accounting ledgers

.

Audit

• Many senior executives, including the CEO Ebbers had private finances and debts taken on stocks of the company. The board approved over 400 million dollar loans to Ebbers, without any assurances or knowledge of use of those funds

Personal Finances

Lack of corporate Lack of corporate governancegovernance

Corporate CultureCorporate Culture

autocratic style of management and followed a top down approach

no outlet for employees to express their concerns.

Senior officials favored those especially loyal, preferable from financial, accounting and Investor relations departments leading to bias between departments and employees

Top hierarchy granted compensation and bonus beyond the company guidelines to a select group of individuals based on their loyalty to them

SummarySummary

-The domination of Ebbers and no checks and constraints placed

on his actions.

-For personal gains under pressure to meet numbers.

-Lack of corporate governance.

-Employees failure to communicate fraudulent activities

-A financial system with no control mechanism

-Audit company’s failure of the company and its culture

understanding

-Inadequate audit by independent auditors

Legal and Ethics Programs The Risk Management Committee The Audit Committee The Board of Directors Executive Compensation Communication and Trainings Secure Organization Preventing Accounting Frauds

Legal and Ethics ProgramsThe best way to establish Ethics and Legal standards is to communicate the Code of conducts which will lead the employees in the direct path.

Ethics office Legal Department Ethics Programs Diversity Issues

The Risk Management Committee

A committee to identify the major risk factors of company and the strategies to mitigate such risks with a minimum of three independent directors with good experience.

The committee must disclosure company's risks in all documents. These risks would include all processors of the company from Technology, Networks, Finance and many. The risk management meetings can be set in certain time duration but not less than six times in an year.

The Audit Committee

• Leadership Rotation

• Use of Corporate Aircraft and Other Corporate Assets

• Required Resources for Audit Committee

• External Audit Oversight

• Internal Audit

• Disclosure Review

The Board of Directors

• Meetings and Commitment

• Director Training and Retaining

• Qualification Standards for the Board:A Director should not have any personal or financial

links with the CEOA Director should not have any conflict of interest

with the companySkills with regards to Ethics, Financial, senior

management expectance planning and control

Executive Compensation

Control over Severance Programs

Severance Programs are protection tool for an employee if case of loss of employment where the employee will be getting an income till they finds another Job. Ebbers was paid exceptionally long term Severance package.

Implement Strict Controls on Executive Loans

The company should ensure that there is a limit to the executive loan scheme and should accounted to repay in due time.

Communication and Trainings

Communication within an organization will help to prevent fraud activities. An effective training programmes will meet the below criteria:It must fully cover the job roles and risks involved in

them.Regular training programmesCase studies of real world examples and necessary

actionsClear and simple to understand

Whistle blowing and Open CommunicationEmployees should be given communication channels to freely communicate any misconduct..Confidentiality Anonymity Organization - wide Availability Classifications and financial reporting Concerns

Secure Organization

• Set clear standards - Set clear standards objectives and lead the organization towards the mission which will help employees to work in line with company's expectations.

• Check employee references - This will provide an understanding of the employees background when hiring. Human Resources will be able to identify if anyone has come from credit, licensing and criminal history.

• Information Security - Setting standards and protocols in information retention policy. Also keeping a track on employees who view sensitive information very often.

Preventing Accounting Frauds

• Minimize Cash transactions :Policy that authorized person will be able to sign off cash transactions.

• Periodical reconciliation with parties: The payables and the receivables should be tallied regularly.

• Protect your paperwork:  All transactions no matter how

small they are should be documented and all such paperwork should be well filed and stored in a safe place with only authorized personal to have access.

• Reconcile bank accounts and review statements: Bank statements must be review against the cash statements with deposits and payments.

• External Audit and surprise Internal Checks: Regularly external audits should be arranged and conducted to ensure that no deviations or frauds are taking place. In addition checks should be carried out randomly by the internal audit team to ensure that standards are being followed.

To Implement the Sarbanes–Oxley Act

• It provides a comprehensive and clear structure of the way of financial statement should be presented.

• The purpose of this act to provide confidence to investors and accountability, reliability and transparent of financial statements.

• Promotes penalties like fines and jail time etc if rules are no met. As a part of this act it allows the top executive of an organization to certify that the presented financial statements are fair and accurate.

What the company thought of as good for them, ended up being a reason for their failure.

Proper controls along with strict internal and accounting policies need to be in place.

Employee needs to be educated on ethical and legal aspects.