Under WorldCom's Latest Cloud


By Steve Rosenbush and Charles Haddad As recently as July 23, it appeared WorldCom was well on its way toward emerging from Chapter 11 bankruptcy protection. About 90% of its creditors had signed up for a restructuring plan for the telecom carrier, which has admitted to more than $9 billion in accounting irregularities, and the outfit had reached a $750 million settlement with the Securities & Exchange Commission. WorldCom, which now operates under the name MCI (MCWEQ), looked like it was in a strong position heading into an Aug. 25 hearing, where Judge Arthur J. Gonzalez, could decide whether to accept the plan. WorldCom insiders were talking about emerging from bankruptcy as early as September.

That outlook took a sharp turn for the worse as an entirely new set of fraud allegations emerged. Rivals Verizon Communications (VZ), SBC Communications (SBC), and AT&T (T) claim that WorldCom cheated them out of millions of dollars in fees by illegally disguising long-distance traffic as local calls. The allegations, first reported July 26 by the Web site of The New York Times, are under investigation by U.S. Attorney James Comey of the Southern District of New York.

Verizon and other rivals clearly hope the news will aid their apparent campaign to drive WorldCom into liquidation. They hope the latest round of investigations finally could compel the Justice Dept. to file criminal charges. Such charges, which helped push former accounting giant Arthur Andersen into liquidation, also could tip WorldCom over the edge because liability stemming from criminal charges would take precedence over investors' claims.

MUTED REACTION. "The Justice Dept. hasn't spoken yet -- and anything the Justice Dept. does is exempt from bankruptcy [law]," Verizon General Counsel William Barr, a former attorney general in the Reagan Administration, told BusinessWeek Online. Michael Capellas, Chairman and CEO of MCI, in responding to the charges, says: "As I have said all along, we will do the right thing. We have a zero-tolerance policy and if any wrongdoing is discovered you can be certain that we will take appropriate action swiftly."

So far, markets are reacting cautiously. WorldCom shares and bond prices declined July 28, but not enough to suggest that investors expect liquidation. Trading in WorldCom debt was intense, with $700 million worth of bonds changing hands -- about seven times the average daily volume. Yet the price fell only 3 cents, to 27 cents on the dollar, from 30 cents on Friday, a 10% decline. The shares fell 2 cents, to 55 cents, a 3.5% decline.

Most industry experts believe the government would have a tough time bringing charges against WorldCom over the arcane issue of access fees. Paid by long-distance companies to local phone companies for the use of the latter's networks, these fees are a huge expense for carriers like WorldCom. Since long-distance providers largely lack their own wires into customers' homes and offices, they must pay others to carry a portion of almost every long-distance call.

HOST OF VARIABLES. Telecom analyst Richard Klugman of Jeffries & Co says he's skeptical of the charges. He says the timing of them and the accusers are "awful suspicious. The long distance carriers have always used whatever means possible to try and reduce access charges," he says. "It's the nature of the business. MCI strikes me as having acted reactively but not conspiratorially." Klugman called calculating access charges as much an art as a science, given all the

different factors involved.

Of course, should the government decide to file fraud charges, the outlook for WorldCom's restructuring would darken. At the very least, new charges would delay completion of the restructuring for at least half a year, according to one adviser to the WorldCom creditors' committee. It would also "throw cold water," as the adviser put it, on a report by court-appointed auditor Nicholas Katzenbach, which assured the judge that internal controls were working and that fraud had been limited to a small, inside group of upper executives.

If additional charges were filed, they would delay auditing of WorldCom's finances, now due at yearend, until sometime at least in the first quarter of 2004. And if it appears that Katzenbach's report is wrong and that new fraud controls aren't working, WorldCom also could have a hard time holding onto government business. For now, according to insiders, the General Services Administration is currently leaning toward maintaining its $1 billion-a-year account with the outfit.

WHAT IF... Despite the view of investors and analysts that a fresh round of charges is unlikely, no one can rule out a worst-case scenario: a new set of charges is filed, preventing WorldCom from coming out of bankruptcy and issuing new stock. The company has signed a disclosure statement with the SEC certifying that its financial reporting was accurate. That statement likely would be called into question if new charges were filed, says Richard Tilton, chief executive of Greenacre Asset Advisors, an investment firm currently advising a WorldCom creditor.

"How could a broker sell MCI stock to retail customers with such a cloud continuing to hang over the company? After all this time, we may still not know what MCI's true finances are," Tilton says. New charges against WorldCom may seem unlikely, but the threat can't be ignored -- and that will haunt WorldCom until the issue is resolved. Rosenbush writes for BusinessWeek in New York, and Haddad is a correspondent in the Atlanta bureau


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