March 3, 2004 11:31 a.m. EST
U.S. Indicts WorldCom Chief
In Switch, CFO Sullivan Pleads Guilty,
Agrees to Testify Against Former Boss
PULLIAM, ALMAR LATOUR and KEN BROWN
After trying for two years to build a case against Bernard J. Ebbers, the federal government finally charged the man at the top of WorldCom Inc., amid growing momentum in the prosecution of the big 1990s corporate scandals.
Mr. Ebbers was indicted Tuesday for allegedly helping to orchestrate the largest accounting fraud in U.S. history. The former chairman and chief executive, who had made WorldCom into one of the biggest stock-market stars of the past decade, was charged with securities fraud, conspiracy to commit securities fraud and making false filings to regulators.
Mr. Ebbers turned himself in to the Federal Bureau of Investigation on Wednesday. Mr. Ebbers walked into the FBI building in New York City for processing prior to his arraignment Wednesday in federal court.
After a grueling investigation, prosecutors finally got their break from an unlikely source: Scott Sullivan, WorldCom's former chief financial officer. He had vowed to fight charges against him and was set to go to trial in late March. But instead, after a recent change of heart, he pleaded guilty Tuesday to three charges just before Mr. Ebbers's indictment was made public. Mr. Sullivan also signed an agreement to cooperate in the case against his former boss. (See related article1.)
The indictment, which centers around the two executives' private discussions as they allegedly conspired to mislead investors, shows that Mr. Sullivan's cooperation already has yielded big results for prosecutors. "Ebbers and Sullivan agreed to take steps to conceal WorldCom's true financial condition and operating performance from the investing public," the indictment stated.
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WorldCom, now known as MCI, is one of the world's largest telecommunications companies, with 20 million consumer and corporate customers and 54,000 employees. The company's investors lost more than $180 billion as the accounting fraud reached $11 billion and drove the company into bankruptcy. Ultimately almost 20,000 employees lost their jobs.
Attorney General John Ashcroft traveled to New York Tuesday to announce the indictment, as years of prosecutors' efforts in WorldCom and other big corporate fraud cases finally start to bear fruit. Little progress had been made in the WorldCom case since five employees pleaded guilty to fraud charges in the summer of 2002. As outrage over the wave of corporate scandals built, prosecutors struggled with several key puzzle pieces as they sought to assign blame for the corporate wrongdoing.
They were initially unable to make cases against Mr. Ebbers and Enron Corp. Chief Executive Jeffrey Skilling. And Mr. Sullivan and former Enron Chief Financial Officer Andrew Fastow gave every indication that they were going to vigorously fight the charges against them. Enron, the Houston-based energy company, filed for bankruptcy-court protection in 2001.
But in recent weeks a lot has changed. In January Mr. Fastow pleaded guilty and agreed to cooperate with prosecutors. Soon afterward the government indicted his former boss, Mr. Skilling. Meanwhile, highly publicized fraud trials of the top executives of Tyco International Ltd. and Adelphia Communications Corp. are under way in New York and prosecutors have continued to make plea agreements in the cases stemming from the fraud at HealthSouth Corp. Two former HealthSouth executives agreed to plead guilty Tuesday (see article2). Former HealthSouth Chairman Richard Scrushy was indicted last year.
Mr. Ashcroft in his announcement Tuesday said that two years of work had paid off with more than 600 indictments and more than 200 convictions of executives. "America's economic strength depends on ... the accountability of corporate officials," he said.
Mr. Sullivan, a close confidant of Mr. Ebbers, pleaded guilty to three counts of securities fraud. He secretly began cooperating with prosecutors in recent weeks, according to people close to the situation.
"I took these actions, knowing they were wrong, in a misguided effort to preserve the company to allow it to withstand what I believed were temporary financial difficulties," Mr. Sullivan said in a firm voice to a crowded courtroom in federal court. His voice seemed to break when he added, "I knew there was no justification."
After spending about $14 million in legal fees and hiring well-known trial lawyer Roy Black, Mr. Sullivan did an about-face that appeared to surprise even some members of his legal team. Mr. Sullivan's lawyers had been working 18-hour days for months trying to craft a defense that Mr. Sullivan had stayed within the realm of acceptable accounting standards at WorldCom.
The case against Mr. Ebbers turns on a pivotal moment in September 2000, when Mr. Sullivan told Mr. Ebbers that the company's financial results would not meet Wall Street's expectations. According to the indictment, Mr. Sullivan told Mr. Ebbers that the company should issue an "earnings warning to alert the public about WorldCom's deteriorating financial performance." Mr. Ebbers refused, the indictment states.
Instead, the indictment alleges, the executives began taking steps to conceal WorldCom's true financial picture from the public. Their actions meant that WorldCom reported profits instead of losses for seven quarters amid a widespread collapse in the rest of the telecommunications industry.
Since WorldCom disclosed the accounting fraud on June 25, 2002, Mr. Sullivan, 42, had vigorously maintained his innocence. He now stands ready to take the stand and testify against his former boss. Instead of the maximum of 165 years he faced under the indictment that was filed against him in August 2002, Mr. Sullivan faces a potential prison term of 25 years, which could be reduced if the government receives substantial cooperation.
Mr. Sullivan finally agreed to plead, says his aunt Patricia Sullivan, "because he has an infant daughter and he'd like to be there to watch her grow up."
Mr. Ebbers, 62 years old, a former high school basketball coach, started WorldCom as a tiny reseller of long-distance services to a chain of motels in Mississippi. He built an empire and became a corporate cult hero in the late 90s. But Mr. Ebbers borrowed heavily along the way, and over 10 years accumulated $1.3 billion in personal debt, including over $400 million from WorldCom's coffers. WorldCom's board eventually ousted Mr. Ebbers in April 2002. A deeply religious man who started each board meeting with a prayer, Mr. Ebbers has continued to teach Sunday school at his church since then.
Reid Weingarten, Mr. Ebbers's attorney, said in a statement that he is disappointed that the Justice Department brought charges against his client. "We know the evidence in this case, we know our client and we know that Bernie Ebbers never sought to mislead investors, never sought to improperly manipulate WorldCom's numbers, never improperly took any money and never sought to hurt the company he built," said Mr. Weingarten. "We do not believe that a fair-minded jury will conclude that Bernie Ebbers ever acted with criminal intent."
At his press conference, Mr. Ashcroft said that rather than disclose WorldCom's true condition to investors, Mr. Sullivan, with the approval of Mr. Ebbers, "directed co-conspirators to make false and fraudulent adjustments to WorldCom's books and records."
Prosecutors clearly needed to get guilty pleas from the second-highest ranking officers at WorldCom and Enron so they could move their cases up the corporate ladder. In both cases, lower-level employees who pleaded guilty did not have enough evidence to bring charges against the top executives.
Lynn Turner, former chief accountant of the SEC, said the plea deal by Mr. Sullivan should be very significant in securing a conviction of Mr. Ebbers. "The CFO is in a way like the brain of the information system for the company, the central switchboard for all the information that comes in and goes out of the organization. The CEO can't function without the CFO, they're joined at the hip."
Progress in the case of Mr. Ebbers had proved to be elusive. The chief executive refused to use e-mail, funneling all correspondence through his secretary. Most conversations of substance were not written down, per company policy, a practice that left investigators with virtually no paper trail leading to his door.
Mr. Ebbers has steadfastly proclaimed his innocence since WorldCom disclosed the fraud. On that Sunday, he walked to the front of his church in Brookhaven, Miss., and told the congregants that he had nothing to do with it. "I just want you to know you aren't going to church with a crook," a teary eyed Mr. Ebbers said. "No one will find me to have knowingly committed fraud."
Mr. Sullivan's refusal until now to admit he did anything wrong made it virtually impossible for prosecutors to pin the fraud on his longtime boss. The woman who unearthed the fraud originally as WorldCom's head of internal audit, Cynthia Cooper, had told authorities that she did not believe Mr. Ebbers knew about the fraud.
The criminal indictment against Mr. Ebbers alleges that he not only knew about the fraud but also led efforts to artificially boost the company's revenue. It describes a crucial meeting between Mr. Ebbers and Mr. Sullivan in September 2000, at which the conspiracy to defraud investors allegedly began. One of the key factors stumping prosecutors over past months has been proving that Mr. Ebbers knew that what he was doing was illegal. People close to the situation say Mr. Sullivan provided prosecutors with evidence that made clear the alleged criminal intent behind Mr. Ebbers's actions.
Starting in the fall of 2000, Mr. Ebbers and Mr. Sullivan instructed subordinates to make entries to WorldCom's books that both artificially boosted the company's revenue and lowered its expenses, the indictment says. Eventually that process became so routine it was referred to internally as the "close the gap" process, the indictment says.
Much of the attention in the WorldCom case has focused on efforts by Mr. Sullivan and other members of the accounting staff to artificially lower WorldCom's costs by shifting so-called line costs to the balance sheet, spreading the costs out over many years to prop up the company's financials. The indictment alleged that Mr. Ebbers had knowledge of and approved those measures. Line costs are the charges that phone companies pay for access to each others' networks.
The indictment also sheds new light on another aspect of the WorldCom fraud: alleged efforts by Mr. Ebbers, along with Mr. Sullivan, to artificially boost revenue. Mr. Ebbers paid particular attention to the company's monthly revenue, according to the indictment, closely tracking the company's it through a report referred to inside WorldCom as "MonRev," a term coined by Mr. Ebbers, the indictment says. Mr. Ebbers "carefully scrutinized every MonRev report," the indictment says, even requesting that his report "be printed on special "green bar" computer paper to facilitate his review," the indictment says.
The indictment points to numerous instances in which Mr. Ebbers was involved in efforts to artificially boost revenue. In the third quarter of 2001, for instance, Mr. Ebbers and Mr. Sullivan, "through the close-the-gap" process, caused WorldCom to report publicly revenue growth of 12%," even though its real revenue growth was only about 6%, the indictment says.
The indictment also includes other pieces of evidence that link Mr. Ebbers to the revenue fraud. It cites a memo that he wrote, in July 2001, to a senior WorldCom officer requesting information concerning "those one time events that had to happen in order for us to have a chance to make our numbers."
One of the reasons it has taken prosecutors until now to indict Mr. Ebbers is that they focused their efforts -- unsuccessfully at first -- to linking him to the accounting fraud involving the line costs. Then, in the fall of 2002, investigators and prosecutors began hearing in interviews with witnesses about the close-the-gap process.
Prosecutors filled several three-ring binders with evidence on the MonRev issue. One big breakthrough came in late 2002 when prosecutors and investigators found pieces of evidence, including a voicemail from Mr. Sullivan alerting Mr. Ebbers that there was "fluff" and "junk" in the company's numbers.
Last summer, prosecutors met with Mr. Weingarten, Mr. Ebbers's lawyer, detailing some of the charges they were considering against him. Mr. Weingarten responded with a legal brief, detailing his arguments for why prosecutors should not charge him.
Prosecutors still did not move to indict Mr. Ebbers following the meeting, however. Without Mr. Sullivan's cooperation, the case against Mr. Ebbers was considered circumstantial, according to lawyers familiar with the case. What's more, the accounting issues at stake were fuzzier and, perhaps, harder to prove in a trial, lawyers close to the case say.
Mr. Sullivan's decision to plead guilty was made by him and his family and not on the advice of his lawyers, people familiar with the situation say. These people say he only came to the decision in recent weeks, prompted by personal circumstances including the illness of his wife, who suffers from a case of diabetes so severe that she frequently slips into comas. Mr. Sullivan wanted to put the matter behind him, they added.
The defense had planned to argue that Mr. Sullivan did nothing wrong when he spread out the costs of phone-line leases over several years, rather than taking the full cost each quarter. In several court hearings in recent months, Mr. Sullivan's lawyers had said that under certain circumstances long-term line leases can be spread out and that Mr. Sullivan's accounting treatment of WorldCom's line leases met with such conditions. The defense could have proved uncomfortable for other companies who use similar methods.
"It's basic accounting principles that leases can be either expensed or capitalized, depending on the terms or conditions of the leases," Mr. Nathan said at a recent court hearing before Judge Barbara Jones.
Mr. Sullivan's lawyers crafted their defense around the notion that WorldCom had correctly allocated expenses associated with the start-up costs of a new phone network. But the defense faced several big problems.
It failed to obtain the actual WorldCom leases and supporting documents. Mr. Sullivan's team subpoenaed the government for the leases but the government refused to turn them over, arguing that the amount of paper work requested was unwieldy, consisting of computer files equaling 70 million pages, more than one million e-mails and 470,000 attachments.
In another blow to the defense, prosecutors also successfully argued that a so-called white paper could not be introduced as evidence at Mr. Sullivan's trial. Mr. Sullivan had prepared the paper during one frantic weekend in June 2002 when the audit committee of WorldCom's board first demanded an explanation for the accounting discrepancies. The defense had hoped it could serve as evidence of Mr. Sullivan's belief that he didn't intend to do anything wrong. But prosecutors said the document was hearsay and the judge agreed with them.
Prosecutors also had reams of evidence that Mr. Sullivan allegedly tried to hide his actions from auditors as the money involved in the fraud mushroomed.
The Securities and Exchange Commission on Tuesday also charged Mr. Sullivan with engaging in a multibillion dollar fraud and announced that he had consented to a permanent bar from serving as an officer, director or accountant of a public company. No SEC charges were filed against Mr. Ebbers.
In the Enron case, prosecutors painstakingly slogged through hundreds of thousands of pages of documents and brought charges against nearly two dozen employees. But it was only after a critical handful of executives agreed to cooperate, that the Justice Department was able to convince Mr. Fastow, the former CFO, to enter a guilty plea. Prosecutors had threatened his wife with a lengthy jail term.
Mr. Fastow's decision to cooperate allowed prosecutors to bring charges against Mr. Skilling, Enron's former chief executive officer. Prosecutors say they are still trying to gather evidence against former Enron chairman Kenneth Lay.
Mr. Skilling's lawyers are arguing that his activities at Enron were essentially the same as the actions of senior executives at many other corporations during the 1990s.
Meanwhile, in a dingy New York state courtroom a few hundred feet to the north of the federal courthouse where Mr. Sullivan entered his plea, the two former top executives of Tyco International Ltd. are on trial. The executives, former Chief Executive L. Dennis Kozlowski and former Chief Financial Officer Mark H. Swartz, are charged with looting Tyco of $600 million in unauthorized compensation and illicit stock sales. The trial has been a hard-fought one, with the defense putting up a stronger case than most observers had expected. But in months of meticulous, often-dull testimony, prosecutors have laid out a strong case for their central allegation that the defendants supplemented their already-huge pay packets by dipping into Tyco coffers for loans and then found creative ways to get those loans forgiven -- without board approval.
Guilty pleas by lower-level employees helped the government get a quick indictment against Mr. Scrushy, HealthSouth Corp.'s former chairman. While 15 former company executives admitted to the fraud, the key pleas came from two former chief financial officers, including one who wore a wire and recorded a conversation with Mr. Scrushy.
After Tuesday's hearing, Mr. Sullivan stood up and reached for the hand of one of his lawyers, his cousin Julia Sullivan. As the courtroom buzzed with chatter, the two looked at each other, bit their lips and were obviously overcome with emotion.
--Mark Maremont contributed to this article.
Updated March 3, 2004 11:31 a.m.
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