By Jane Black The Securities & Exchange Commission's reaction to WorldCom's (WCOME) admission that it had inflated earnings by $3.8 billion over five quarters was both swift and harsh. On June 26, less than 24 hours after WorldCom confessed to sweeping accounting irregularities, SEC Chairman Harvey Pitt stood before the Economics Club of New York and quoted the classic 1976 movie, Network: "I'm mad as hell, and I'm not going to take it anymore," he declared. "What happened at WorldCom...is an outrage."
The next morning, the SEC filed suit in federal court demanding, among other things, that WorldCom cease making payments to present or former executives. The request is a none-too-subtle attack on embattled former CEO and Chairman Bernie Ebbers, who was slated to receive $1.5 million a year in severance for life -- despite the fact that WorldCom investors have seen more than $142 billion in value evaporate since the end of 1999.
The SEC already had been circling Ebbers. For months, the commission has been investigating $408.5 million in loans Ebbers received from WorldCom to cover margin calls he made on company stock. But legal experts say the SEC's immediate court filing coupled with the highly unusual demand that WorldCom halt payments to Ebbers & Co. means this is going to get personal.
THE FALL GUY. The SEC's mandate is twofold: To deter corporate chicanery and instill public confidence in the markets. But its powers are fairly limited. It can ask a court to order individuals not to violate the law in future, and it can ban tarnished executives from becoming officers or directors of a public company. And while the SEC can't send anyone to prison, it can shame corporations and CEOs who have behaved badly. That's why Ebbers is likely to become the fall guy for the rotten core of American business -- and for the shattered telecommunications industry.
Experts says it's clear that the SEC is going after Ebbers. It generally takes months, if not years, for SEC investigations to end up in court. Take the Waste Management scandal, which was uncovered in 1997. At the time, it was the biggest case of corporate fraud in U.S. history. Yet, the SEC didn't file suit for nearly four years. "That's typical. In cases like [Waste Management], no one is going anywhere," says Samuel Winer, a securities lawyer Foley & Lardner in Washington, D.C. "The fact that they sued [WorldCom] immediately shows that the SEC is trying to make a statement."
Nor did the SEC ever request that Waste Management executives stop receiving company money while under investigation. In WorldCom's case, the SEC would not only bar executives from receiving severance and bonuses but it would also prohibit the company from paying executives' legal bills, which undoubtedly will run into the millions. Neither WorldCom nor Ebbers returned calls for comment.
"BACK OF THE LINE." In the past, executive compensation hasn't been an SEC priority. But its move seems designed to ensure that insiders don't wring the last pennies out of a company heading toward bankruptcy. "The SEC wants these guys to get in line with the rest of the creditors -- preferably the back of the line," says Winer. The court hasn't ruled on whether to grant the SEC's request.
If the SEC proves that Ebbers had knowledge of the fraud -- or even rubber-stamped accounting records -- the penalties could be stiff. He would likely be barred by a court from ever holding office in a public company, be sued by shareholders, and be charged with criminal action by the Justice Dept.
Moreover, if the SEC finds that the fraud was ongoing before 2001 -- and Ebbers knew about it -- he would have to return stock options, bonuses, and other perks he received. Ebbers would be required to return his earnings -- a $10 million bonus in 2000, other compensation, and 1.2 million stock options -- plus interest.
PERSONAL RUIN. Even if Ebbers is exonerated, he's still in hot water. For one, he owes more than $400 million to WorldCom. The loans are secured by personal assets, including a yacht-sales company and a soybean farm. But mostly, it's Ebbers' now-worthless WorldCom shares that backed the unorthodox arrangement.
With a temporary stop on his $1.5 million annual severance and little prospect of future corporate work, it's going to be tough for Ebbers to pay off this huge bill. And if he chose to declare bankruptcy, he would forfeit rights to future payments from WorldCom, according to its amended proxy statement filed on May 20.
The irony is that Ebbers finds himself in this predicament because, unlike former former Enron Chairman Kenneth Lay and Global Crossing CEO Gary Winnick, he didn't sell his stock as the price slid. Instead, he borrowed money from WorldCom to pay off his loans in an effort to avoid flooding the market with his shares -- and driving down the share price even further. Had he simply sold stock to cover his bets, he would have gotten as much as $10 a share. Trading in WorldCom was halted on June 26, at just 83 cents per share, down from a high of $64 in June, 1999, due to the shakeout in the telecom industry.
Ebbers also differs from Winnick and Lay in that his stock had lost most of its value long before it was revealed that WorldCom committed accounting fraud. Nonetheless, if found culpable, Ebbers is likely to be punished most harshly. Besides possible prison time, he faces personal ruin. But try telling that to investors. Like the SEC, they would be more than happy to see Ebbers pay a crushingly heavy price. Black covers technology for BusinessWeek Online in New York