WorldCom Scandal 2002: $79.5 Billion Fraud and Bankruptcy Explained

Adam Hayes, Ph.D., CFA, is a seasoned financial expert with over 15 years on Wall Street as a derivatives trader. With deep knowledge in economics and behavioral finance, he holds a master’s in economics from The New School for Social Research and a Ph.D. in sociology from the University of Wisconsin-Madison. Adam is a CFA charterholder with FINRA Series 7, 55, and 63 licenses and currently teaches economic sociology and finance at Hebrew University in Jerusalem.

What Was WorldCom?

Founded in 1983, WorldCom was a leading American telecommunications company specializing in discount long-distance services. It grew rapidly through aggressive acquisitions, becoming the largest long-distance provider in the U.S. at its peak. However, WorldCom became synonymous with one of the most notorious accounting frauds in American corporate history, culminating in a massive bankruptcy and a major shakeup in the telecom industry.

Key Points to Remember

• Established by Murray Waldron, William Rector, and Bernard Ebbers in 1983.
• Grew by acquiring numerous competing telecom firms to dominate the U.S. long-distance market.
• Used fraudulent accounting methods to conceal financial losses from investors.
• Filed for bankruptcy in 2002 after an $11 billion earnings adjustment and a $79.5 billion fraud revelation.
• Reemerged from bankruptcy, rebranded as MCI, and was acquired by Verizon in 2006.

The Growth and Deception of WorldCom

Initially founded as Long Distance Discount Service after AT&T's breakup, WorldCom leveraged court-ordered cheap access to phone lines to offer low rates. CEO Bernard Ebbers aggressively expanded the company by acquiring up to 30 telecom competitors. At the dot-com bubble's height, WorldCom's market value soared to $186 billion. However, after the tech bubble burst and telecom spending plummeted, WorldCom's revenues shrank dramatically.

To mask declining profits, WorldCom engaged in deceptive accounting by capitalizing ordinary expenses, which artificially inflated earnings by billions. This included $3.055 billion in 2001 and $797 million in early 2002, falsely reporting a $1.38 billion profit instead of a loss.

Fast Fact

Bernard Ebbers was known for his signature 10-gallon cowboy hat and boots, embodying a larger-than-life image.

How the Fraud Unfolded

Facing financial losses due to aggressive acquisitions and falling revenues, WorldCom’s executives manipulated financial statements to hide the truth. Capital expenditures were improperly recorded, and expenses were disguised as investments to boost reported profits. This accounting manipulation was straightforward but devastating.

Critical Insight

By misclassifying expenses as capital investments, WorldCom exaggerated its net income by $3.8 billion, misleading investors and regulators.

Whistleblowers Who Exposed WorldCom

Internal auditors Cynthia Cooper and Gene Morse played pivotal roles in uncovering the fraud. They investigated suspicious financial records, including unexplained reserves, questionable capital expenditures, and complex accounting terms used to conceal transactions. Despite resistance from CFO Scott Sullivan, Cooper and Morse alerted external auditors and the audit committee.

Cynthia Cooper’s courage earned her Time magazine’s Person of the Year in 2002. She has since become a renowned author, consultant, and speaker on corporate ethics.

WorldCom’s Bankruptcy and Aftermath

After adjusting earnings by $11 billion for 1999-2002 and revealing the $79.5 billion fraud, WorldCom filed for Chapter 11 bankruptcy on July 21, 2002. The company faced $41 billion in debt against $107 billion in assets. Bankruptcy allowed WorldCom to continue operations, pay employees, and restructure.

Key executives faced legal consequences: CEO Ebbers was sentenced to 25 years (released early in 2019 for health reasons), and CFO Sullivan received a five-year sentence after cooperating with prosecutors. The company reemerged as MCI in 2004 and was acquired by Verizon in 2006. Lawsuits against banks involved settled for $6 billion, compensating bondholders and shareholders.

The scandal prompted the Sarbanes-Oxley Act of 2002, which increased corporate accountability and penalties for fraudulent accounting.

Who Was Responsible?

The scandal involved multiple parties: executives like Ebbers and Sullivan, the internal audit team, the board of directors, and external auditors Arthur Andersen, who ignored warning signs. Wall Street analyst Jack Grubman also faced penalties for issuing misleading positive ratings despite poor telecom performance.

Ebbers and his defense initially denied knowledge, but internal communications exposed their complicity.

Summary: What Became of WorldCom?

WorldCom’s story is a cautionary tale of rapid growth overshadowed by greed and deception. The company’s fraudulent accounting practices to mask losses led to the largest bankruptcy in U.S. history at the time. Thanks to whistleblowers and regulatory action, the company restructured, was rebranded as MCI, and eventually acquired by Verizon, leaving behind a legacy of lessons on corporate transparency and ethics.

Key Figures in the Scandal

Bernard Ebbers (CEO), Scott Sullivan (CFO), the accounting firm Arthur Andersen, and analyst Jack Grubman were central figures in the scandal. Whistleblower Cynthia Cooper and auditor Gene Morse were instrumental in exposing the fraud.

Cynthia Cooper’s Role and Legacy

As the vice president of internal audit, Cynthia Cooper identified financial discrepancies and bravely reported them, despite pressure from company leadership. Her efforts earned her national recognition and cemented her role as a leading voice against corporate fraud.

Final Takeaway

WorldCom exemplifies how unchecked ambition and deceptive accounting can devastate companies and investors. Its downfall led to stricter regulations and serves as a perpetual warning: if financial results seem too good to be true, they warrant closer scrutiny.

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