Source: CWA v.061603
Crime Must Not Pay
It’s Time to Punish WorldCom/MCI
For the Largest Corporate Fraud in U.S. History
WorldCom/MCI: The Largest Perpetrator of Corporate Fraud in U.S. History
WorldCom/MCI committed the largest corporate fraud in U.S. history, estimated at $11 billion.1 WorldCom/MCI’s fraud-induced bankruptcy cost investors – many of who are workers’ pension funds -- more than $200 billion in equity and bond losses. This is three times the size of Enron. WorldCom/MCI’s lies and false financial reports caused a speculative bubble in the telecom industry. When the bubble burst, tens of thousands of CWA members and other telecom employees working for telecom carriers that played by the rules lost their jobs.
Yet, WorldCom/MCI has yet to be punished for its huge crime. In fact, the U.S. government has made crime pay by rewarding the largest corporate criminal in U.S. history with lucrative government contracts, tax benefits, and a premature and inadequate settlement of the civil fraud case. The U.S. government has yet to file criminal charges against WorldCom/MCI.
Crime Must Not Pay – Punish WorldCom/MCI
The U.S. government must send the message that crime does not pay. It must punish WorldCom/MCI with penalties that are commensurate with the magnitude of the crime.
1. The General Services Administration (GSA) must debar WorldCom/MCI from future federal contracts, as it did with Enron and Anderson Accounting
2. The Securities and Exchange Commission (SEC) must impose a meaningful penalty in the range of $4 – 5 billion in the civil fraud case against WorldCom/MCI.
3. Congress and the I.R.S. must block WorldCom/MCI’s ability to profit from corporate tax loopholes.
4. The Department of Justice must bring criminal charges against WorldCom/MCI.
WorldCom/MCI: Poster Child of Corporate Fraud
WorldCom/MCI’s massive fraud was not simply the act of a few bad apples at the top. Fraud permeated the corporate culture at WorldCom/MCI for three years, 1999 through first quarter 2002. WorldCom/MCI engaged in a “concerted program of manipulation that gave rise to a smorgasbord of fraudulent journal entries and adjustments – many of them of the precise kind contemporaneously and publicly prosecuted by the SEC,” reported bankruptcy court examiner and former U.S. Attorney General Dick Thornburgh. (Thornburgh I at 105)
After an exhaustive study of WorldCom/MCI, Thornburgh concluded that WorldCom/MCI is the “poster child for corporate governance failures” with an unparalleled “egregiousness, arrogance, and brazenness.” At WorldCom/MCI, according to Thornburgh, “every level of ‘gatekeeper’…was derelict in its duties…” (Thornburgh II at 3)
Fraudulent accounting was built into the culture at WorldCom/MCI. When WorldCom/MCI’s revenue figures did not meet or exceed the financial targets, WorldCom/MCI took “extraordinary and illegal steps” improperly to inflate revenues. (Thornburgh I at 117-118) According to Thornburgh, 400 adjustments were made over the three-year period, illegally drawing down excess reserves into earnings and by taking the “brazen and radical step” of booking line costs as capital items. (Thornburgh I at 8) WorldCom/MCI has admitted to $9 billion in fraudulent accounting; reports place the total at $11 billion and counting (“WorldCom/MCI Audit May Rise to $11 Billion”, Wall Street Journal. April 1, 2003). Despite two lengthy reports of over 400 pages, Thornburgh concludes that his investigation still has not uncovered the full depth and breadth of WorldCom/MCI’s illegal behavior. (Thornburgh II at 2)
At the time of the WorldCom/MCI merger in 1998, CWA predicted that the only way the combined WorldCom/MCI could meet the high profit margins and merger-related synergies that the Company promised Wall Street would be through draconian cost-cutting and lay-offs. As it turns out, WorldCom/MCI did not cut costs to meet Wall Street’s margin expectations; rather, the Company cooked the books.
WorldCom/MCI’s Victims: American Workers and Retirees
WorldCom/MCI’s fraudulent accounting and subsequent bankruptcy had two primary classes of direct victims -- investors and workers.
WorldCom/MCI investors lost more than $200 billion in equity and bonds from WorldCom/MCI’s fraud-induced bankruptcy. Among the largest group of victims were workers’ pension funds. CWA estimates that jointly administered Taft-Hartley funds and public pension funds lost at least $70 billion in equity alone.
More than 22 states lost more than $2.6 billion in their public employee retirement funds as a result of WorldCom/MCI’s bankruptcy. Local government pension funds lost billions more. In the midst of the worst state and local fiscal crisis since the Depression, these losses put at greater risk the retirement security of teachers, firefighters, police, and other state and local government employees whose deferred wages were squandered by WorldCom/MCI’s fraud.
These states and their WorldCom/MCI-related pension fund losses include Alabama ($275 million), California ($580 million), Florida ($90 million), Illinois ($58 million), Indiana ($66 million), Iowa ($32 million), Kentucky ($56 million), Maryland ($52 million), Massachusetts ($25 million), Michigan ($116 million), Montana ($29 million), New York ($300 million), North Carolina ($100 million), Ohio ($306 million), Oklahoma ($25 million), Oregon ($63 million), Texas ($280 million), Utah ($23 million), Virginia ($44 million), Washington ($84 million), West Virginia ($1.5 million), and Wisconsin ($29 million.)
More than 22,000 WorldCom/MCI employees lost their jobs and thousands more lost much of their 401(k) retirement savings – which was heavily invested in WorldCom/MCI stock -- from WorldCom/MCI’s fraud-related bankruptcy.
In addition, tens of thousands of employees working for other telecommunications companies that played by the rules lost good jobs and careers as a result of WorldCom/MCI’s fraud-induced destabilization of the entire industry.
For three years, from 1999 to first quarter 2002, WorldCom/MCI’s inflated numbers allowed the company to raise capital, acquire assets, and undercut competitors who had to meet financial goals and raise capital based on honest financial reporting. By illegally inflating its earnings, WorldCom/MCI was able to drive telecommunications prices down to artificially low levels throughout the industry. WorldCom/MCI could price low because it could make up its losses with illegal accounting, in essence inventing earnings.
Competitors such as AT&T and Sprint were trying to compete with WorldCom/MCI in the marketplace. According to Charles Noski, AT&T’s vice chairman: “We were constantly dissecting all of the public information about WorldCom/MCI and we would scratch our heads and try to figure out how they were doing it.” (“WorldCom/MCI Rivals Vexed by Phantom Competitor”, Tulsa World, July 7, 2002)
These companies turned to job elimination as a means to compete with WorldCom/MCI’s price-cutting. AT&T eliminated 18,000 CWA-represented jobs as it tried to match fraudulent prices set by WorldCom/MCI.
WorldCom/MCI’s fraudulent accounting destabilized the entire telecommunications industry. Job cuts rippled throughout the industry, as other CWA-represented telecommunications carriers eliminated an additional 55,000 jobs. CWA has prepared a preliminary conservative estimate of $7.3 billion as the monetized loss to CWA-represented workers and their communities as a result of this job loss. The cost grows as other laid-off employees represented by other unions, plus non-union and management employees are added to the estimate.
WorldCom/MCI’s penalty must take into account the huge loss already suffered by telecommunications workers due to WorldCom/MCI’s fraud.
Rather than Punish WorldCom/MCI, U.S. Government Rewards WorldCom/MCI with Lucrative Government Contracts
Despite this record of fraud and destruction, the U.S. government continues to award WorldCom/MCI lucrative government contracts. In May 2003, the Bush Administration awarded WorldCom/MCI a $45 million no-bid contract to build a wireless network in Iraq, even though WorldCom/MCI is not a wireless carrier, and a seven-year contract to provide satellite services to the National Oceanic & Atmospheric Administration. (Wall Street Journal, May 15, 2003) In November 2002, the Bush Administration extended WorldCom/MCI’s $750 million contract to provide telecom services to other federal agencies. WorldCom/MCI earns in excess of $750 million annually from federal contracts.
The U.S. government must debar WorldCom/MCI from future federal contracts
Debarring WorldCom/MCI from future federal contracts is consistent with the position taken by the General Services Administration (GSA) in March 2002 when it suspended future federal contracts with Enron for 12 months and with Arthur Anderson LLP for as long as that firm remained under indictment. According to GSA General Counsel Raymond McKenna, Enron and Anderson were debarred from future federal contracts because they did not have a “satisfactory record of business ethics and integrity.” (“GSA Suspends Enron and Arthur Andersen and Former Officials,” GSA #9930, Mar. 15, 2002)
Similarly, MCI WorldCom/MCI does not have a “satisfactory record of business ethics and integrity.”
Under Federal Acquisition Regulations, GSA is empowered to debar or suspend companies from contracting with the federal government when a “lack of business integrity or business honesty” is of such serious nature that it affects the “present responsibility” of the contractor. Under the regulations, the GSA can also suspend or debar companies for “falsification of records” and “making false statements.” (Federal Acquisition Regulations 9.406-2) WorldCom/MCI’s fraudulent practices affect its “present responsibility” as a federal contractor. For three years, WorldCom/MCI filed false reports with the SEC and made false statements to regulators, investors, policymakers, and the public about its financial condition.
Sen. Susan Collins, Chair, Senate Governmental Affairs Committee, has launched an investigation into WorldCom/MCI’s federal contracts and is pressing the GSA to launch an independent investigation to determine whether WorldCom/MCI should be suspended or debarred from federal contracting.
On June 2, 2003, the GSA Inspector General recommended that the GSA initiate suspension proceedings against WorldCom/MCI.
As MCI WorldCom/MCI struggles through its bankruptcy and continues cost cutting and lay-offs, service will inevitably decline. WorldCom’s auditor KPMG LLP reported to the SEC WorldCom/MCI persistent problems with customer care and billing, inconsistent record keeping, and record retention. (“WorldCom Woes Hit Users; Audit cites customer support problems,” eWeek, June 16, 2003)
Nine organizations, including CWA, have asked the federal government to debar WorldCom/MCI from federal contracts, as it did with Enron and Arthur Anderson LLP.
SEC Fails to Impose Meaningful Penalty on WorldCom/MCI in Civil Fraud Case
In June 2002, the Securities and Exchange Commission (SEC) filed suit against WorldCom/MCI for accounting fraud and violation of U.S. securities law. On May 19, 2003, the SEC and WorldCom/MCI announced a proposed $500 million settlement of the fraud case. Under terms of the settlement, the $500 million penalty would be distributed to victims of the fraud, pursuant to the Fair Funds provision of Section 308(a) of the Sarbanes-Oxley Act of 2002. (SEC Litigation Release No. 18147, May 19, 2003) District Court Judge Jed S. Rakoff refused to sign off on the settlement, pending public comments and further disclosure.
The settlement is premature. All the facts are not yet in. Moreover, the $500 million penalty is inadequate, providing less than a penny on the dollar to victims who lost more than $200 billion due to MCI WorldCom/MCI’s illegal behavior. It is smaller than the $600 million fine paid by junk bond superstar Michael Milken in the 1980s.
The paltry penalty fails to send the message that crime does not pay. It would leave WorldCom/MCI with its fraudulently obtained assets intact, able to emerge from bankruptcy with the best balance sheet in the industry. This is equivalent to allowing a counterfeiter to keep the counterfeit money.
The SEC’s proposed settlement is not only inadequate; it also fails to direct the distribution of the penalty to workers’ pension funds, the clear intent of Congress when it passed the Sarbanes-Oxley Act. Rather, the SEC gives greatest weight in the distribution plan to arbitragers and short-term investors, rather than to long-term investors such as pension funds. (SEC Submission to District Court, June 6, 2003)
WorldCom/MCI Set to Claim Billions of Dollars in Tax Loopholes, Unless Congress and I.R.S. Act
WorldCom/MCI is compounding its illegal behavior through corporate tax loopholes.
WorldCom/MCI is structuring its bankruptcy reorganization to collect what Business Week (May 12, 2003) calls “one of the biggest single corporate tax breaks of all time.” WorldCom/MCI plans to game the U.S. tax code to receive more than $6.6 billion – and probably closer to $10 billion – in Net Operating Loss (“NOL”) and other tax credits in order to shelter future earnings from taxes.
Section 108(a) of the Internal Revenue Code provides that income from a cancellation of debt (“COD”) is excluded from a taxpayer’s gross income if the cancellation occurs in a Chapter 11 bankruptcy proceeding. Under Section 108(b) of the tax code, a taxpayer benefiting from this income exclusion must reduce its tax attributes, including net operating losses (“NOLs”). The purpose of these rules is to allow bankrupt companies to deter, but not to avoid, tax on their COD income. (Sen. Rpt. No. 96-1035; 96 Cong.2d Sess)
WorldCom/MCI is exploiting an ambiguity in tax law. Rather than treat its NOLs and other tax attributes on a consolidated basis, the company is interpreting the law in a manner that allows it to deal with the NOLs on a separate basis. This would allow WorldCom/MCI to preserve its NOLs and other tax attributes, so that an estimated $10 billion or more of income will be tax-free. At a 38 percent tax rate, this equals $3.8 billion (or more) in tax carry-forward credits.
If WorldCom/MCI were to succeed in this maneuver, it would emerge from bankruptcy with no tax liability for years to come. The government would be rewarding the largest perpetrator of corporate fraud in U.S. history with a monumental tax break.
Congress should protect against any ambiguity in the law by passing an amendment that would clarify that the treatment of NOLs and other aggregate tax attributes under Section 108 of the Internal Revenue Code must be taken at the consolidated level.
This is good tax policy. It would foreclose abuse of this corporate tax loophole by WorldCom/MCI or any other taxpayer.
WorldCom/MCI is also seeking a $300 million refund from the Internal Revenue Service for taxes paid on its fraudulently overstated earnings. Although the U.S. Senate passed legislation in May 2003 to close this corporate tax break, the Senate provision does not apply to MCI WorldCom/MCI whose inflated earnings were booked prior to the date of the legislation.
Abuse of Workers Rights
WorldCom/MCI has a poor record of respect for workers’ rights, dating back to 1986 when MCI closed an operator center in Michigan and fired the workers after they voted for CWA representation. More recently, WorldCom/MCI’s 17,000 laid-off workers had to fight for minimal severance benefits of less than $5,000 per employee, and only won those benefits with the assistance of the AFL-CIO. Employees saw their retirement savings eroded, since an estimated 43 percent of employees’ 401(k) retirement savings were invested in WorldCom/MCI stock. WorldCom/MCI announced another 5,000 lay-offs in February 2003.
Yet, MCI WorldCom/MCI’s new Board is paying its new CEO Michael Capellas $20 million over the next three years. (Wall Street Journal, Dec. 17, 2002)
State Action and Private Litigation against WorldCom/MCI
Attorneys general from Oklahoma, West Virginia, Massachusetts, Indiana and the Alabama Securities Commission filed notice on May 13, 2002 that they are opening criminal investigations into MCI WorldCom/MCI. These state filed objections to the MCI WorldCom/MCI Disclosure Statement in bankruptcy court.
CALPERS, the California Teacher’s Retirement Fund, the LA County Employees Retirement Fund, the University of California, the New York Teachers Retirement Fund, and others are suing MCI WorldCom/MCI for securities fraud.
The United Church of Christ has asked the FCC to bar WorldCom/MCI from transferring its licenses.
Conclusion
A basic principle of U.S. law enforcement is that crime does not pay. This message has yet to be sent against the largest perpetrator of corporate fraud in U.S. history. It is long past time for the federal government to punish WorldCom/MCI through debarment from federal contracts, closing of tax loopholes, and levying a large multi-billion dollar penalty commensurate with the magnitude of WorldCom/MCI’s violations. Finally, there is ample evidence for the Department of Justice to charge WorldCom/MCI with criminal violations.
Dated: June 17, 2003
WorldCom/MCI Chronology of Fraud and Criminal and Civil Investigations
June 25, 2002 WorldCom/MCI announces misstated earnings of $3.8 billion
June 26, 2002 SEC files suit against WorldCom/MCI
July 17, 2002 CALPERS, California State Teachers Retirement, and LA Employees Retirement funds file $318.5 million suit against WorldCom/MCI for fraudulent bond offering
July 21, 2002 WorldCom/MCI files for Chapter 11 bankruptcy, costing investors $175 billion
Aug. 1, 2002 WorldCom/MCI executives charged with securities fraud
August 8, 2002 WorldCom/MCI amends misstated earnings total to $7.2 billion
Aug. 13, 2002 New York Teachers’ Retirement Fund as lead plaintiff in shareholders suit against WorldCom/MCI
August 28, 2002 Federal prosecutors indict former WorldCom/MCI CFO Scott Sullivan on six felony counts
Sept. 26, 2002 Former WorldCom/MCI controller David Meyers pleads guilty to fraud (and to state securities fraud on Oct. 14, 2002)
Oct. 8, 2002 WorldCom/MCI accounting executive Buford Yates pleads guilty to fraud
Oct. 15, 2002 United Church of Christ petitions FCC to block Debtor-in-Possession transfer of licenses
Oct. 30, 2002 Communications Workers of America, Gray Panthers, Black Chamber of Commerce and other groups call upon the U.S. General Services Administration to block WorldCom/MCI from future federal contract bids
Nov. 4, 2002 Bankruptcy court report by former Attorney General Richard Thornburgh finds WorldCom/MCI gave former CEO Bernie Ebbers $1 billion in personal loans
Nov. 5, 2002 WorldCom/MCI raises total of accounting misstatement to $9 billion
Nov. 5, 2002 Securities and Exchange Commission files additional charges against WorldCom/MCI, declaring the company fraudulently inflated earnings by a total of more than $9 billion
Nov. 26, 2002 WorldCom/MCI strikes partial settlement deal with SEC over civil fraud. SEC continues investigation into financial fraud
Dec. 2, 2002 New WorldCom/MCI CEO Michael Capellas takes over, with $50 million four-year compensation package
Jan. 17, 2003 University of California files securities fraud suit against WorldCom/MCI for $353 million loss
Feb. 4, 2003 WorldCom/MCI announced 5,000 additional lay-offs
March 12, 2003 Internal report prepared by law firm Wilmer Cutler & Pickering finds WorldCom/MCI former-CEO Bernard Ebbers knew about the accounting fraud
April 1, 2003 WorldCom/MCI raises total of accounting misstatement to $11 billion
May 13, 2003 State Attorneys Generals of Oklahoma, West Virginia, and Massachusetts and the Alabama Securities Commission file objections to MCI WorldCom/MCI’s disclosure statement; announce criminal investigation against MCI WorldCom/MCI
May 19, 2003 MCI WorldCom/MCI and Securities and Exchange Commission propose $500 million fraud-charge settlement. U.S. District Judge Jed S. Rakoff who is overseeing the fraud case does not sign off on the settlement, pending public comment and further disclosure.
May 21, 2003 Senate Governmental Affairs Committee opens an investigation into possible debarment of MCI WorldCom/MCI from federal contracts.
June 2, 2003 GSA Inspector General recommends investigation into suspension of MCI WorldCom/MCI from federal contracts
1 SEC First Amended Complaint; “WorldCom Audit May Rise to $11 Billion,” Wall Street Journal, Apr. 1, 2003; “WorldCom Report Finds Ebbers Played Role in Inflating Income,” Wall Street Journal, June 6, 2003; First Interim Report of Dick Thornburgh, Bankruptcy Court Examiner, Nov. 4, 2002 (“Thornburgh I”); Second Interim Report of Dick Thornburgh, Bankruptcy Court Examiner, June 9, 2003 (“Thornburgh II”).
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