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Worldcom ny { June 26 2002 } Original Source Link: (May no longer be active)
http://nytimes.com/2002/06/26/business/26CND-TELE.htmlhttp://nytimes.com/2002/06/26/business/26CND-TELE.html
June 26, 2002
WorldCom Says It Hid Expenses, Inflating Cash Flow $3.8 Billion
By SIMON ROMERO and ALEX BERENSON
After falling as low as 9 cents in pre-market trading on Instinet today, trading in shares of WorldCom, the nation's second-largest long-distance carrier, was halted this morning on the Nasdaq Stock Market. The developments came after the company revealed last night that it had overstated its cash flow by more than $3.8 billion during the last five quarters.
On Tuesday, WorldCom fell 8 cents, or 8.8 percent, to 83 cents and plunged as low as 26 cents in after-hours trading. The problems at WorldCom weighed heavily on the stock market today, dragging each of the major indexes down.
By early afternoon major market averages had recovered slightly from their morning lows, but were still down on the day.
Shortly before 1 p.m. the Dow Jones industrial average was down 94.01, or 1 percent, to 9,030.25. The Standard & Poors 500 index was off 10.98, or 1.1 percent, to 965.05. And the Nasdaq composite index had lost 16.55, or 1.2 percent, to 1407.57.
Trading in Worldcom Inc. shares remained suspended on the Nasdaq stock market.
WorldCom, which had a peak value of $115.3 billion in June 1999 when its shares reached a high of $62, is now worth less than $1 billion.
Analysts cited the Worldcom accounting scandal and its related financial fallout as another reason why policymakers at the Federal Reserve Board are not likely to alter its monetary policy stance at a meeting that concludes this afternoon. An announcement from the Fed is expected around 2:15 p.m. today.
President Bush, speaking with reporters in Kananaskis, Alberta, Canada, on the opening day of a summit of wealthy nations, called the reported problems at WorldCom outrageous and said that the federal government "will fully investigate and hold people accountable."
"There is some concern about the validity of the balance sheet of corporate America and I can understand why," the president said during a photo opportunity with British Prime Minister Tony Blair.
"We've had too many cases of people abusing their responsibilities and people just need to know that the SEC is on it, our government is on it, and Arthur Andersen has been prosecuted. We will pursue, within our laws, those who are irresponsible."
The problems at WorldCom, discovered during an internal audit, throws into doubt the survival of WorldCom and MCI, the long-distance company it acquired in 1998. The company, which was already the subject of a federal investigation into its accounting practices, has been struggling to refinance $30 billion in debt. Its credit was relegated to junk-bond status last month, and even before last night's announcement, the stock price was down more than 94 percent so far this year.
Some analysts now see a bankruptcy filing as a strong possibility, which would follow the pattern of Enron, Global Crossing and other companies laid low by accounting scandals since last fall. In an effort to avoid that fate, WorldCom said last night that it would cut 17,000 employees, or one-fifth of its work force. Analysts had been expecting a job cut of that magnitude for several weeks.
Instead of the profit of $1.4 billion the company reported in 2001 and $130 million in this year's first quarter, WorldCom now says it lost money during those periods, although it did not say how much.
In disclosing the bookkeeping problem, WorldCom said it had fired its chief financial officer, Scott D. Sullivan, the executive widely credited with helping orchestrate the financial strategy during the mid-to-late 1990's that enabled WorldCom to rise from a second-tier telecommunications company to a world giant through a series of acquisitions that included the $30 billion purchase of MCI in 1998.
Mr. Sullivan had been the executive closest to Bernard J. Ebbers, the company's longtime chief executive, who abruptly resigned in April, owing WorldCom more than $366 million for loans and loan guarantees the company had made to him.
WorldCom's board said it had fired Mr. Sullivan after discovering a strategy in which operating costs like basic network maintenance had been booked as capital investments, an accounting gimmick that enabled WorldCom to hide expenses, inflate its cash flow and report profits instead of losses. Until last month, WorldCom's auditor had been Arthur Andersen, the accounting firm that also audited the books of Enron and Global Crossing.
Arthur Andersen issued a statement last night saying that WorldCom's chief financial officer had not told the firm about the accounting techniques now being called into question. "Our work for WorldCom complied with S.E.C. and professional standards at all times," the statement said.
WorldCom replaced Arthur Andersen with KPMG last month and said last night that it had asked KPMG to undertake a comprehensive audit of the company's financial statements for 2001 and 2002.
"Our senior management team is shocked by these discoveries," said John W. Sidgmore, who became WorldCom's chief executive after Mr. Ebbers left in April. "I want to assure our customers and employees that the company remains viable and committed to a long-term future."
But it remains to be seen how WorldCom's customers will react to the disclosure of the massive accounting irregularities. In addition to providing millions of consumers with long-distance service through its MCI unit, WorldCom sells sophisticated data communications services to many of the world's largest companies.
In addition to dismissing Mr. Sullivan, WorldCom's board said it had accepted the resignation of David Myers as senior vice president and financial controller. The company said it had notified the Securities and Exchange Commission, which had already been investigating the company's accounting. WorldCom also said it was hiring William R. McLucas, the former chief of the enforcement division of the S.E.C., to conduct an independent investigation.
Mr. Sullivan was unavailable for comment.
The S.E.C. said in a statement released early today that the disclosures confirmed "accounting improprieties of unprecedented magnitude."
The statement, by Christi Harlan, director of public affairs, said the commission was ordering the company to file, under oath, "a detailed report of the circumstances and specifics of these matters."
The agency also said the events "further demonstrate the need for comprehensive market regulatory reforms that the administration, the Congress and the S.E.C. have been advocating and implementing."
The company said last night that it had informed its main bank lenders of the bookkeeping problems. It is currently in tense negotiations with its banks, a group led by Citigroup, Bank of America and J. P. Morgan Chase, about restructuring lines of credit worth about $5 billion.
Last night's disclosure is expected to add to the problems of telecommunications companies to arrange financing as the industry's long slump continues.
"This is horrible for the industry," said Susan Kalla, senior telecommunications analyst at Friedman, Billings & Ramsey. "If we can't hang our hat on historical numbers, why should we believe in the present figures?"
The size of Worldcom's restatement surprised even hardened short-sellers — investors who profit when stocks fall and generally view corporate America with skepticism. "I'm kind of shaken by that," said James Chanos, a short-seller who played a major role in unearthing Enron's overstated profits and hidden debt. "I'm about as cynical as they come. It's pretty amazing."
Particularly disturbing, Mr. Chanos said, is that WorldCom had manipulated its cash flow statements, not just its reported earnings. Investors used to believe that cash flow was a more reliable indicator of a company's financial health because the number could not be manipulated as easily as earnings, but that assumption now appears to be wrong. WorldCom now joins a list that includes Dynegy, Adelphia Communications and Tyco International as companies that have apparently used financial gimmicks to inflate their cash flow.
"The one touchstone that investors had was that you couldn't fudge cash flow numbers, but apparently you can," Mr. Chanos said. "Like any system, it can be gamed if enough people are looking at something, an unscrupulous management will find a way to game it."
WorldCom's news rattled investors in other companies. In after-hours trading, technology and telecom stocks and broad market indexes plunged after word of the accounting problem, first reported by the financial news cable network CNBC. Stocks had already fallen in regular trading yesterday. The Nasdaq 100 index, composed mainly of big technology stocks, fell almost 3 percent in after-hours trading, while the Standard & Poor's 500 index of major companies dropped more than 1.5 percent.
David Tice, another short-seller, said WorldCom's rise and fall was emblematic of larger problems in Wall Street and corporate America.
When WorldCom's stock was rising, Mr. Tice said, investors cheered its acquisition binge and paid little attention to how the company generated its profits. That attitude, he said, encouraged the company to stretch accounting rules and take ever-bigger risks in an effort to keep its stock rising.
During the late 1990's, "the executives, the money managers, the auditors, the C.F.O.'s, the C.E.O.'s, the ones that got ahead were the most reckless, the least ethical," Mr. Tice said.
"The most reckless guys were the ones that ended up having the most power and the highest market valuations," he said.
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