In re WorldCom, Inc. Securities Litigation

Facts

WorldCom, founded by Bernard Ebbers in 1983, grew through acquisitions to become the second-largest telecommunications company globally by 1998 after acquiring MCI Communications. Between 1996 and 1999, WorldCom completed major acquisitions including MFS Communications (with UUNET Technologies), CompuServe, ANS Communications, and SkyTel Communications. In October 1999, WorldCom announced a $129 billion merger with Sprint to acquire wireless capabilities, but the Department of Justice recommended blocking the merger in May 2000, and WorldCom terminated the agreement in July 2000. WorldCom’s stock price fell from $48 per share in September 1999 to the low $30s by August 2000. In September 2000, WorldCom acquired Intermedia for $6 billion, assuming massive debt obligations. Ebbers’ personal finances were heavily leveraged against WorldCom stock, with essentially all his holdings pledged to secure personal debt totaling over $315 million by 2001, primarily with Citibank and Bank of America affiliates. As WorldCom’s stock declined, Ebbers faced margin calls, and WorldCom extended over $250 million in loans and guarantees to him by May 2001. WorldCom’s largest operating expense was line costs, accounting for roughly half its expenses and reported as the E/R (expense-to-revenue) ratio. Before 2001, WorldCom reduced apparent line costs by releasing reserves set aside for anticipated bills, reducing the reserve period from 24 months to 90 days by late 2000. Beginning April 20, 2001, senior management fraudulently capitalized $771 million in line costs as “prepaid capacity” to manipulate the E/R ratio, continuing through first quarter 2002. Internal documents from March-April 2001 showed projected line costs materially higher than publicly reported figures. WorldCom’s internal audit discovered the fraud in May 2002, leading to June 25, 2002 announcement of restatement and July 21, 2002 bankruptcy filing. The 2004 restatement included approximately $76 billion in adjustments, reducing net equity from $50 billion to negative $20 billion. For the May 2000 offering, underwriters conducted minimal due diligence documented in a May 26 Cravath memorandum, primarily consisting of a May 17 telephone call with CFO Sullivan and review of board minutes and public filings. For the May 2001 offering, due diligence included April 30 and May 9 telephone calls with Sullivan and May 9 call with Andersen, but Sullivan did not disclose the line cost capitalization. Several underwriters internally downgraded WorldCom’s credit rating in February 2001 and engaged in hedging strategies to reduce their exposure while publicly underwriting the offerings.