(4 of 5)
Grubman gives the episode a surreal quality. A star telecom analyst, he was paid $20 million a year for covering the stocks of companies like WorldCom that send billions of dollars in investment-banking business to Salomon. He was so tied in at WorldCom that for a time he even advised Ebbers on takeover strategy. Grubman typically avoids the press. Last week a camera crew from financial channel CNBC tracked him down near his New York City residence and tried to interview him on the fly--evoking images of paparazzi stalking a movie star. "Nobody saw this coming," Grubman said, denying that his downgrade of WorldCom's stock to "underperform" the day before the firm restated earnings had anything to do with fraud rumors. Grubman, in fact, maintained a "buy" rating on the stock while it plummeted 90% from its peak in June 1999.
How, exactly, did WorldCom cook its books? By treating routine expenses as capital investments. Normal operating expenses must be subtracted from a company's revenues in the year they occur. But capital expenditures can be subtracted from revenues a little at a time over many years. In the short term, that lets money flow to the bottom line and boosts financial results. It's the oldest trick in the book, and mind-numbingly simple. Dennis Beresford teaches Accounting 101 at the University of Georgia and says what happened at WorldCom is "plain vanilla" trickery that he covers on the second day of class.
Yet WorldCom's auditor--Arthur Andersen, the firm convicted of obstructing justice in the Enron case--somehow missed it. Andersen, which was paid $4.4 million a year to certify that WorldCom's books were honest, says WorldCom CFO Sullivan never handed over the material Andersen requested. "That's like a police officer saying the criminal didn't turn himself in," scoffs analyst Patrick Comack of the brokerage Guzman & Co.
Even though WorldCom's new management, led by Sidgmore, has come forward with the bad news, stock analysts are skeptical about whether they have the full story. WorldCom's "line cost" category is a big bucket, says analyst Susan Kalla of Friedman, Billings, Ramsey. "People knowledgeable about WorldCom say they also capitalized expenses related to software development, maintenance and labor." She suspects that some other telecoms have been just as loosey-goosey with their numbers.
WorldCom's woes are hardly new. Indeed, part of the shock flows from investors' knowledge that though the company has been in decline for several years, it still managed to paper over its books. When the Internet bubble burst early in 2000, it took down many of WorldCom's biggest customers. The slide accelerated after regulators blocked the firm's $129 billion acquisition of Sprint in July 2000. In March the SEC launched a probe into how and why WorldCom had loaned Ebbers $366 million, most of which he ostensibly used to purchase WorldCom shares. The SEC also looked at the company's books just as scandals at other telecoms--Global Crossing and Qwest--were spooking investors. The loans led to Ebbers' ouster at the end of April (with a golden handshake worth $1.5 million a year for life). That's when Sidgmore took over and asked Cynthia Cooper, 37, vice president of internal audit, to take a close look at WorldCom's books. She found the bogus accounting and alerted WorldCom's board.