TOPICS > Economy

Wrong Numbers

June 26, 2002 at 12:00 AM EDT
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JIM LEHRER: WorldCom: Part one of our focus on corporate America and Wall Street is the WorldCom story. Here’s a report Gwen Ifill did before tonight’s SEC announcement it filed civil fraud charges against WorldCom.

GWEN IFILL: WorldCom was one the telecommunications industry’s biggest success stories. But the new revelations of apparently phony bookkeeping now threaten to make it the latest in a string of sudden and spectacular business collapses.

Founded in 1983 as a small long- distance provider, WorldCom surprised the communications world in 1998 with its $30 billion take over of MCI, a major player in the long distance market. At the time, the deal was the largest merger in history, and WorldCom became the nation’s number two long distance company behind AT&T. Another WorldCom blockbuster proposal for a $129 billion merger with Sprint fell through in July, 2000.

Like many other telecom companies in recent years, WorldCom was hit hard by over building, over investment, and declining revenues from dropping long distance rates. Then in March, the Securities and Exchange Commission launched an investigation into WorldCom’s finances. A month later, WorldCom President and CEO Bernard Ebbers announced his resignation. The news was coupled with reports that he owes the company more than $400 million in personal loans.

Once a stock market favorite with a peak price of $62 a share, today what appears to be a $3.8 billion accounting fraud sent global markets reeling from Tokyo to London. And on Wall Street, the NASDAQ stock market halted trading WorldCom stock as it plunged to nine cents a share. The disclosure also rocked the beleaguered firm Arthur Andersen, which was WorldCom’s auditor until last May.

GWEN IFILL: Now for a closer look at what happened at WorldCom, we’re joined by Scott Cleland, a telecommunications analyst and CEO of the precursor group, an investment research company. Mr. Cleland, how could something this massive have happened?

SCOTT CLELAND, The Precursor Group: Well, what really happened here was a momentum stock. This was an acquisition machine company. They acquired 60 companies. And when you acquire that many companies, you use pro forma accounting, which is accounting that is not necessarily standard, but it’s designed to explain how the company is performing as a newly-merged company. And what happened here is in the pro forma reporting, the real accounting got lost.

GWEN IFILL: There’s so much talk, the word "fraud" has been bandied about so much today. Is there anyway this could have been mere sloppiness rather than intentional behavior?

SCOTT CLELAND: Inconceivable. I mean, we’re talking about a $1.5 billion profit going to a $1.5 billion loss. And the allegation, if it is true, is a simple bookkeeping, you know, a first-year auditor wouldn’t make the mistake in their sleep.

GWEN IFILL: Break it down for us. How is this supposed to work, this kind of bookkeeping and how did it work in this case?

SCOTT CLELAND: Well, the question is, is what is an expense and what is a capital expense? At least the charge is that there was $3.8 billion worth of real costs, which they essentially mortgaged. They put into debt. And they represented to people that they were actually profitable when, in fact, they had borrowed those profits. Those weren’t real profits.

GWEN IFILL: Capital investment is supposed to be what?

SCOTT CLELAND: Well, capital investment, you know, they were spending for equipment. They were representing that they were reinvesting back into their company. And they weren’t. They were essentially using the books, if these charges are true, to make it appear that they were growing profits when all they were doing was growing debt.

GWEN IFILL: So they clearly had been doing this for some time– at least five quarters, as far as we know. How was it discovered?

SCOTT CLELAND: Well, how it was discovered is the SEC started investigating. And it’s amazing the power of a subpoena and the power of the federal government asking people under oath what’s going on. And I think also what happened is they had a new auditor. Somebody else came in, KPMG came in to look at Arthur Andersen and found something that was clearly obviously outrageously wrong and they came forward with it.

GWEN IFILL: We just heard about the departure of Bernard Ebbers in April. Was there a connection between his departure and the irregularities that surrounded that and what we’re hearing about today?

SCOTT CLELAND: I think it’s the same story, it’s just that one shoe fell then, and another shoe fell today.

GWEN IFILL: So $400 million in personal loans wasn’t precisely part of the $4 billions we’re talking about here, but the same kind of management, you say, contributed to this? Or mismanagement?

SCOTT CLELAND: The $3.8 billion was a huge mistake. The $400 million was another, you know, mistake. And I believe they will uncover more because if there was this egregious accounting from 2000- 2001, they’re going to have to go back and look at the books from ’96 to 2000.

GWEN IFILL: Who was supposed to know about this? Was this the chief financial officer’s job to report this sometime ago? Was it the auditor’s job to report it? I saw today there was some finger pointing going on on that front.

SCOTT CLELAND: This is another example like Enron and Global Crossing. There should have been dozens of people aware that something was seriously wrong. Dozens of people within WorldCom– the CFO and his subordinates– the lawyers that had to sign off on it, the executives above him, CEO, operating level, the board; the outside council, the investment bankers that did due diligence on this, and then the auditors who were supposed to be checking and giving us confidence that these numbers were actually accurate.

GWEN IFILL: As someone who keeps track of companies like this for a living are you surprised by the size, by the massive size of this loss?

SCOTT CLELAND: I am surprised that they were able to hide this amount of money from all of us. Shame on all of us that this type of number could be this off. We’ve known for a long time that WorldCom had serious problems and wasn’t being able to grow… outgrow its costs, but we didn’t even think that it was this bad.

GWEN IFILL: Now, is this Andersen’s fault? We’ve heard about so many irregularities, so far, with Andersen’s accounting procedures in other cases. Can we point to that as part of the reason?

SCOTT CLELAND: I think we can point it to at Enron, Global Crossing, WorldCom, Adelphia. All of these firms are expecting that shareholders are looking to auditors for a seal of approval. The only thing auditing is worth is giving us trust that somebody else, as a third party, honestly has looked at the books and said, "Yes, these are honest, true and a fair representation." And in these instances we couldn’t trust the auditors at all.

GWEN IFILL: A friend of mine said to me today, "you know, we didn’t know what Enron was, we didn’t know what Tyco was, but we know what MCI-WorldCom is." As a result of what people think their familiarity with the kind of business, can you anticipate it having greater reverberations, especially in the public mind?

SCOTT CLELAND: Well, I think what’s happening is the successive blows where people are seeing brand names– Enron, Global Crossing, Adelphia, Tyco, WorldCom, MCI is one of the most advertised brands– and why people are distrustful now in the markets is many brand names have had serious problems. So the average person could conclude that there are some patterns of problems developing.

GWEN IFILL: Does the average person also wonder whether they’re going to lose their phone service? What happens with this company? Is it on the brink of bankruptcy, restructuring? What has to happen?

SCOTT CLELAND: I think the average American shouldn’t be worried about losing their service. I think the nation should be worried that the quality of the Internet will deteriorate. One-third of all data traffic is covered — in the world is carried by WorldCom. If a company is going bankrupt, it does not have the money to reinvest in the network or to maintain quality standards. So, it should be expected that quality will be going down in the future.

GWEN IFILL: So how does a company like this restructure in a way that’s still… I mean, we’re talking 17,000 employees just so far. There’s going to be… there probably will be more jobs lost. There will be people who are going to directly feel the effect of what happens here. What does a company do to restructure to save itself at all or is it already too late?

SCOTT CLELAND: I think they should have restructured before they let the 17,000 people off. The 20 percent staff cut only saves 4 percent of the cost. And those 20 percent that are cut will drive revenues down way more than 4 percent. And so I think this company will eventually go bankrupt, and it probably could have restructured and saved thousands of jobs.

GWEN IFILL: The President talked today about a Justice Department investigation, an SEC investigation, as you alluded to, already is underway. What is the government’s role now?

SCOTT CLELAND: The government’s role is to be a very serious and diligent law enforcement cop. There are obviously a lot of people in the white-collar securities business and in corporations who have not had the integrity of following the law, not only the letter of the law or the spirit of the law. And so I think you will see a very aggressive federal government pursuit of justice in this area.

GWEN IFILL: Scott Cleland, thank you very much for joining us.

SCOTT CLELAND: Thank you.