Born in Edmonton, Canada, in 1941, Bernard Ebbers (pictured) ran a motel chain before investing in a telephone company called Long Distance Discount Service. He was appointed its CEO in 1985 and would take over 60 communications companies before changing the firm’s name to WorldCom in 1995. In 1998 it took over MCI Communications, making it the second-largest telephone company in the world. At the peak of the tech bubble, WorldCom had a market cap of $186bn, giving Ebbers an estimated fortune of $1.4bn.
How did the scam work?
To fuel the expansion, Worldcom took on a lot of debt. In order to keep creditors willing to lend money, as well as to meet the expectations of Wall Street analysts, WorldCom’s management started fiddling the books to the tune of $11bn. Most of the fraud involved underreporting line costs (the amount that WorldCom had to pay for use of the telephone lines). WorldCom did this by treating ordinary expenses as investment and dipping into funds set aside for future expenses. Overall, experts estimate that $7bn worth of line costs were hidden in this way.
What happened next?
Between 1999 and 2001 the share price started to fall due to the bursting of the tech bubble and regulators blocked a proposed merger with Sprint amid concerns about the company’s debts. This placed Ebbers in a difficult situation as he had borrowed money against his Worldcom shares to fund his own companies, which meant that he had to put up more collateral each time the shares fell. In order to avoid a fire sale, the firm ended up lending him $400m. By April 2002 WorldCom was facing increased pressure from its creditors, leading Ebbers to resign. The firm declared bankruptcy a few months later.
Lessons for investors
Large amounts of debt and high growth expectations can tempt executives into cutting corners. That can be costly. Share-holders were completely wiped out and bondholders got around 36% of the face value of their bonds. The banks involved in underwriting WorldCom bonds later paid out $6bn in various lawsuits, but most of the money went to state pension funds rather than ordinary investors. In 2005, Ebbers (who was effectively bankrupted) was sentenced to 25 years in prison.