# WorldCom Scandal: Unraveling Fraud and Bankruptcy

![WorldCom: A telecom company that committed accounting fraud and underwent one of the largest bankruptcies in U.S. history.](https://www.investopedia.com/thmb/3sazK2j6VYSP_WzHVK2lRaoanbg=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/worldcom.asp-final-c991771045c346d79184fdc6d1fd6618.png)

*— Ryan Oakley / Investopedia*

> **Definition**
>
> WorldCom was a major telecom company and one of the largest long-distance providers in the U.S. until its collapse in 2006 due to an accounting fraud scandal and subsequent bankruptcy.

## What Was WorldCom?

WorldCom, once a leading U.S. telecommunications provider, became infamous for one of the largest accounting scandals in history. Following aggressive acquisitions leading to hidden financial troubles, the company's [fraudulent activities](https://www.investopedia.com/terms/c/cookthebooks.asp) surfaced, leading to a historic [bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp) and the eventual sale of its assets to Verizon.

### Key Takeaways

*   WorldCom, founded in 1983, became one of the largest U.S. telecom providers but was embroiled in a major accounting scandal leading to its bankruptcy in 2002.  
    
*   The company fraudulently inflated its income by capitalizing expenses, which led to a reported $3.8 billion exaggeration of income, masking its true financial condition.  
    
*   Whistleblowers such as Cynthia Cooper exposed the fraud, revealing the abuse of reserves and misclassification of capital expenses as investments.  
    
*   Key executives, including CEO Bernard Ebbers, faced severe legal consequences, including prison sentences for their roles in the scandal.  
    
*   The fallout from WorldCom's collapse contributed to the enactment of the Sarbanes-Oxley Act, aimed at improving corporate accountability and financial transparency.

## Unpacking WorldCom's Account of Fraud

WorldCom is now a byword for [accounting fraud](https://www.investopedia.com/ask/answers/032715/what-accounting-fraud.asp) and a warning to investors that when things seem too good to be true, they just might be. The company was founded in 1983 as Long Distance Discount Service. It was established after the breakup of AT&T by Murray Waldron, William Rector, early investor Bernard Ebbers, and their business partners. The group secured a $650,000 loan, which allowed them to buy the technology to route long-distance calls.

After courts ordered AT&T to lease its lines to new businesses cheaply, CEO Ebbers offered customers very low rates. This allowed him to build the company into one of America’s leading long-distance phone companies by acquiring as many as 30 competing telecom companies. During the [dotcom bubble](https://www.investopedia.com/terms/d/dotcom-bubble.asp) peak, WorldCom's [market capitalization](https://www.investopedia.com/terms/m/marketcapitalization.asp) soared to $186 billion.

When the tech boom turned to bust, and companies slashed spending on telecom services and equipment, WorldCom resorted to accounting tricks to maintain the appearance of ever-growing profitability. By then, many investors became suspicious of Ebbers’ story—especially after the [Enron](https://www.investopedia.com/terms/e/enron.asp) scandal broke in the summer of 2001.

In 2002, it was revealed that Ebbers borrowed $408 million from WorldCom’s board of directors to cover [margin calls](https://www.investopedia.com/terms/m/margincall.asp) on loans backed by company stock. At the same time, the company’s accounting fraud and real financial situation were coming to light as the U.S. [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp) began to investigate. As a result, Ebbers met his downfall and resigned as CEO on April 30, 2002. In 2005, he was convicted of [securities fraud](https://www.investopedia.com/terms/s/securities-fraud.asp), conspiracy, and making false filings, and he was sentenced to 25 years in prison.

> **Fast Fact**
>
> Ebbers was a larger-than-life figure whose trademark was a 10-gallon hat and cowboy boots.

## How WorldCom Manipulated Financial Records

There were several factors that pushed WorldCom into a loss. The company pursued acquisitions aggressively, buying up rival companies in an attempt to gain [market share](https://www.investopedia.com/terms/m/marketshare.asp). This, coupled with a major drop in revenue and rates, pushed the company further into the [red](https://www.investopedia.com/terms/r/red.asp). Executives needed a way to prove WorldCom was still financially viable to its board and shareholders.

WorldCom used a series of questionable [accounting](https://www.investopedia.com/terms/a/accounting.asp) techniques to hide its financial position, which inflated its profits. This amounted to billions in capital expenditures being improperly recorded on the books. But this was hardly a sophisticated fraud.

To hide its falling profitability, WorldCom inflated net income and cash flow by recording expenses as investments. By [capitalizing](https://www.investopedia.com/terms/c/capitalize.asp) expenses, it exaggerated income by $3.8 billion, including $3.055 billion in 2001 and $797 million in the first quarter of 2002, reporting a net profit of $1.38 billion instead of a [net loss](https://www.investopedia.com/terms/n/netloss.asp).  

> **Important**
>
> To hide its falling profitability, WorldCom inflated its net income and cash flow by recording expenses as investments, reporting a profit of $1.38 billion—instead of a net loss.

## The Heroes Exposing WorldCom's Fraudulent Practices

Several individuals played a key role in exposing the fraud at WorldCom. These people included Cynthia Cooper, who was vice president of WorldCom’s [internal audit](https://www.investopedia.com/terms/i/internalaudit.asp) department, and Gene Morse, another auditor. They became concerned about several inconsistencies in the company’s financial records, including:

*   The use of [reserves](https://www.investopedia.com/terms/r/reservefund.asp) to boost the company’s income
*   The company’s [capital expenditures](https://www.investopedia.com/terms/c/capitalexpenditure.asp), which another employee questioned and was fired over
*   Complicated accounting terms (such as prepaid capacity), which were used to hide the movement of [capital](https://www.investopedia.com/terms/c/capital.asp)
*   The lack of evidence to substantiate certain financial [transactions](https://www.investopedia.com/terms/t/transaction.asp), including a $500 million capital expenditure

Cooper and Morse conducted investigations on their own as well as an audit. They were challenged by the company’s [chief financial officer (CFO)](https://www.investopedia.com/ask/answers/what-does-chief-financial-officer-cfo-do/), Scott Sullivan, who requested that the process be delayed. They contacted KPMG, the external auditor that replaced Arthur Andersen, as well as WorldCom’s audit committee.

As a result of her diligence, Cooper was named a Person of the Year by Time and was featured on the magazine’s cover in 2002. She is now an author, consultant, and internationally recognized speaker.  

## The Collapse of WorldCom: From Fraud to Bankruptcy

The company could no longer keep up once things started to unravel. In fact, WorldCom had to [adjust its earnings](https://www.investopedia.com/terms/a/adjusted-earnings.asp) for the period from 1999 to 2002 by $11 billion, and the fraud was estimated to be in the neighborhood of $79.5 billion.

Bankruptcy was the only option. WorldCom filed for Chapter 11 bankruptcy on July 21, 2002, only a month after its now-former auditor, Arthur Andersen, had been found guilty in court and lost its license to practice accounting. By this time, the company was indebted to its creditors by as much as $7.7 billion. In its filing, the company noted $107 billion in [assets](https://www.investopedia.com/terms/a/asset.asp) and $41 billion worth of [debt](https://www.investopedia.com/terms/d/debt.asp).

The filing allowed WorldCom to provide some restitution. Doing so allowed existing customers to continue receiving services. WorldCom was also able to pay its employees and keep its assets. It also provided some much-needed time to [restructure](https://www.investopedia.com/terms/r/restructuring.asp) even though it lost its luster within the corporate marketplace.  

## The Consequences and Recovery After WorldCom's Scandal

Some of the key personnel involved in the firm’s accounting scandal received harsh punishment for their roles, including:

*   Bernard Ebbers was convicted of securities fraud, conspiracy, and seven counts of false SEC filings. Ebbers was granted early release from prison on Dec. 18, 2019, for health reasons after serving about 13 years of his sentence. He died in 2020, shortly after his release.
*   Former CFO Scott Sullivan received a five-year jail sentence after pleading guilty and testifying against Ebbers.

[Debtor-in-possession financing](https://www.investopedia.com/terms/d/debtorinpossessionfinancing.asp) from Citigroup, J.P. Morgan, and GE Capital helped the company survive during bankruptcy. It emerged from bankruptcy in 2004 and rebranded itself as MCI—a telecom company WorldCom acquired in 1997. Verizon purchased MCI and its assets in 2006. WorldCom’s former banks settled lawsuits with creditors for $6 billion without admitting liability. Around $5 billion went to the bondholders, with the balance going to former shareholders.

In a settlement with the SEC, the newly formed MCI agreed to pay shareholders and bondholders $500 million in cash and 10 million shares of MCI.

This spate of corporate crime led to the [Sarbanes-Oxley Act](https://www.investopedia.com/ask/answers/052815/what-impact-did-sarbanesoxley-act-have-corporate-governance-united-states.asp) in July 2002, which strengthened disclosure requirements and the penalties for fraudulent accounting. In the aftermath, WorldCom left a stain on the reputation of accounting firms, investment banks, and credit rating agencies that had never quite been removed.  

## Identifying the Culprits Behind WorldCom's Downfall

Although no one actually admitted their part in the scandal, there were several players who were at fault—some within the company and others who weren’t even employed by WorldCom.

Arthur Andersen, the accounting firm that audited WorldCom’s 2001 [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp) and reviewed WorldCom’s books for Q1 2002, was found to have ignored memos from WorldCom executives informing them that the company was inflating profits by improperly accounting for expenses.

Key management personnel, including WorldCom CEO Bernie Ebbers and CFO Scott Sullivan, the company’s board of directors, and its internal audit team, were also singled out for their lack of oversight, ignoring of [accounting principles](https://www.investopedia.com/terms/a/accounting-principles.asp), and committing fraud. Ebbers and his lawyer initially denied any involvement or knowledge of the fraud. These claims were refuted by a _Wall Street Journal_ report, which cited internal communications to the contrary.

[Wall Street](https://www.investopedia.com/terms/w/wallstreet.asp) analyst Jack Grubman gave the company consistently high ratings even though the company (along with other telecoms) performed poorly. Grubman was fired from his job at Salomon Smith Barney and was fined $15 million by the SEC. He was also banned from any activity in securities exchanges.  

## What Happened to WorldCom?

WorldCom was a telecommunications company that provided discount long-distance services to its customers. The company was embroiled in one of the largest accounting scandals in the United States, which led to an equally large bankruptcy filing. The company used fraudulent accounting practices to cover up its losses by making itself look more profitable than it was. Several individuals were concerned about fraudulent financial transactions and reported the inconsistencies to authorities. Its bankruptcy helped the company restructure, rebranding itself as MCI. This new entity was sold to Verizon in 2006.

## Who Was Involved in the WorldCom Scandal?

Several key individuals and entities were involved in the WorldCom scandal. Some of the most notable names include CEO Bernie Ebbers, CFO Scott Sullivan, and the company’s auditing firm, Arthur Andersen. Wall Street analyst Jack Grubman also played a role in providing the telecom company with positive ratings.

Cynthia Cooper was a key player in bringing attention to the company’s financial inconsistencies. Together with auditor Gene Morse, Cooper investigated and reported WorldCom’s questionable accounting practices. She was named a Person of the Year by Time in 2002.

## What Happened to Cynthia Cooper?

Cynthia Cooper was largely responsible for bringing attention to WorldCom’s questionable accounting practices. She discovered several inconsistencies in the company’s financial statements and reported them to auditors and the company’s board. In her book “Extraordinary Circumstances: The Journey of a Corporate Whistle-Blower,” Cooper said it was a difficult time in her career. But she was awarded by Time by being named a Person of the Year in 2002. She is now a speaker and consultant.  

## The Bottom Line

WorldCom was once a leading U.S. telecom giant known for its aggressive acquisition strategy, yet it became infamous for one of the largest accounting frauds and bankruptcies in U.S. history. Executives used fraudulent accounting practices to disguise financial losses, inflating profits by billions to maintain investor confidence.

The scandal, exposed by whistleblowers like Cynthia Cooper, led to significant legal repercussions for key figures, eventually resulting in bankruptcy. WorldCom’s downfall serves as a stark reminder to investors and corporate leaders: Scrutinize financial reports closely, and remember that rapid, untethered growth often signals potential risk.

> **Article Sources**
>
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>     
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>      
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