WorldCom Inc., now doing business as MCI, has legal grounds to sue its former chief executive officer, Bernie Ebbers, according to a bankruptcy court report filed on Monday. The company can also go after the accounting firms and investment bankers that provided advice and services to WorldCom as it committed accounting fraud of unprecedented proportions,
WorldCom is trying to complete its emergence from bankruptcy and distance itself from that historic book-cooking that was revealed in June, 2002 and which led it to bankruptcy a month later. Since then, the company moved its headquarters to Ashburn, Va., swapped out its chief executives and board of directors and changed its name. Four former WorldCom employees have pled guilty to criminal charges, and former Chief Financial Officer Scott Sullivan is fighting charges of fraud and conspiracy.
WorldCom maintained an improper relationship with investment bankers, handing million of dollars in deals to Salomon Brothers and Salomon Smith Barney (now succeeded by Citigroup Global Markets Inc.) because they provided personal financial benefits to Ebbers, according to a report filed with the U.S. Bankruptcy Court for the Southern District of New York on Monday.
In his final report to the bankruptcy judge, the court-appointed examiner, Dick Thornburgh, said that the investment bankers aided and abetted Ebbers breach of fiduciary duties by giving him extraordinary IPOs and secondary stock offerings. In 1996 and 1997, Salomon offered extraordinarily large allocations to Ebbers "under highly suspicious circumstances," according to the report. For an IPO for McLeod Inc., Ebbers allocation was more than four times that of any other individual even though Ebbers was not a retail client at Salomon.
"As of June 1996, Salomon had been seeking, without success, WorldCom investment banking engagements for almost two years. . . . [I]n the aftermath of the McLeod IPO allocation, Mr.Ebbers awarded the FMS merger engagement to Salomon, netting Salomon $7.5 million in fees," Thornburgh said.
Ebbers sold all of his shares from the McLeod IPO in about four months, making $2,155,000 in profit.
Salomon also provided Ebbers with unusually generous loan assistance beginning in 2000, which Thornburgh calls "an example of its willingness to award personal financial advantage to Mr. Ebbers in return for Mr. Ebbers award of WorldCom corporate business to SSB."
Ebbers acceptance of personal loans from WorldCom after he should have been aware of his precarious financial situation also constitutes a violation of his duties toward the company.
Apart from wide-ranging financial statement fraud—manipulating line costs, improperly classifying revenues, improperly capitalizing line costs—WorldCom also misled state taxing authorities in an effort to minimize state taxes, the report said. The company tried to reduce its taxes by hundreds of millions of dollars in part by licensing certain intangible assets, such as "management foresight," to subsidiaries and then charging them billions of dollars in royalty fees. By characterizing certain income as royalties, the company hoped for a tax break.
The problem is that applications to state tax authorities didnt give even a hint as to the real nature of the intangible assets, according to Thornburgh, who called the royalty program flawed. The examiner recommended that WorldCom could sue KPMG Peat Marwick LLP for negligence for its role in designing the program and providing advice on it.
However, WorldCom has no plans to pursue claims against KPMG, according to Stasia Kelly, MCI executive vice president and general counsel.
"Based upon [an] earlier review, the company concluded that the tax program recommended by KPMG in 1997 and 1998 was appropriate," Kelly said.
Members of the WorldCom audit committee "barely scratched beneath the surface" of the accounting issues they reviewed—failing to note the manipulation of financial statements from 1999 through the first quarter of 2002—but Thornburgh did not recommend that WorldCom pursue claims against the committee or the internal audit department.
"The company has put in place procedures and resources to ensure that the highest standards of business ethics are maintained," Kelly said. " We have worked together to build a culture at MCI where integrity and honesty are valued above all else. "