[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
WRONG NUMBERS: THE ACCOUNTING
PROBLEMS AT WORLDCOM
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JULY 8, 2002
__________
Printed for the use of the Committee on Financial Services
Serial No. 107-74
83-079 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2002
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice BARNEY FRANK, Massachusetts
Chair PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska MAXINE WATERS, California
RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma KEN BENTSEN, Texas
ROBERT W. NEY, Ohio JAMES H. MALONEY, Connecticut
BOB BARR, Georgia DARLENE HOOLEY, Oregon
SUE W. KELLY, New York JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio MAX SANDLIN, Texas
CHRISTOPHER COX, California GREGORY W. MEEKS, New York
DAVE WELDON, Florida BARBARA LEE, California
JIM RYUN, Kansas FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina CHARLES A. GONZALEZ, Texas
DOUG OSE, California STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York JOSEPH CROWLEY, New York
GARY G. MILLER, California WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
SHELLEY MOORE CAPITO, West Virginia BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
Terry Haines, Chief Counsel and Staff Director
C O N T E N T S
----------
Page
Hearing held on:
July 8, 2002................................................. 1
Appendix:
July 8, 2002................................................. 153
WITNESSES
Monday, July 8, 2002
Dick, Melvin, former Senior Global Managing Partner, Technology,
Media, and Communications Practice, Arthur Andersen............ 22
Ebbers, Bernard J., former Chief Executive Officer, WorldCom..... 20
Grubman, Jack, Telecommunications Analyst, Salomon Smith Barney.. 24
Roberts, Bert, Chairman of the Board, WorldCom................... 104
Sidgmore, John, President and Chief Executive Officer, WorldCom.. 102
Sullivan, Scott, former Chief Financial Officer, WorldCom........ 21
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 154
Capito, Hon. Shelley Moore................................... 156
Clay, Hon. Wm. Lacy.......................................... 157
Ferguson, Hon. Mike.......................................... 159
Ford, Hon. Harold E. Jr.,.................................... 160
Gillmor, Hon. Paul E......................................... 162
Jones, Stephanie T........................................... 164
Israel, Hon. Steve J......................................... 166
Kanjorski, Hon. Paul E....................................... 168
Moore, Hon. Dennis........................................... 170
Ney, Hon. Bob W.............................................. 172
Royce, Hon. Ed............................................... 174
Sandlin, Hon. Max............................................ 176
Sherman, Hon. Brad........................................... 178
Waters, Hon. Maxine.......................................... 179
Dick, Melvin................................................. 182
Grubman, Jack................................................ 186
Roberts, Bert................................................ 195
Sidgmore, John............................................... 199
Additional Material Submitted for the Record
Baker, Hon. Richard H.:
E-mail from Jack Grubman regarding SSB Bond Research-
WorldCom, Inc. June 24, 2002............................... 206
E-mail from Robert Waldman to Scott Sullivan, June 24, 2002.. 207
Salomon Smith Barney Clarification on WorldCom Report, June
24, 2002................................................... 208
Biggert, Hon. Judy:
ICG letter (with attachments), July 2, 2002.................. 210
The Telecom Manager's Voice Report, May 20, 2002............. 217
SEC letter to WorldCom, March 7, 2002........................ 225
Ford, Harold E. Jr.:
Business Roundtable Statement on Restoring Investor Trust,
July 8, 2002............................................... 235
``The Free Market Needs New Rules'' New York Times, July 8,
2002....................................................... 237
Kanjorski, Hon. Paul E.:
Citigroup letter, July 11, 2002.............................. 239
Congressman Kanjorski and Congressman Shays Press Release,
Salomon Smith Barney's Initial Response on IPO Allocations
to WorldCom Executives, July 12, 2002...................... 241
Letter to Jack B. Grubman, Managing Director, Salomon Smith
Barney, July 8, 2002....................................... 243
Maloney, Hon. Carolyn B.:
``Account-Ability: WorldCom may not turn Eyes from Ebitda,''
Dow Jones Newswire, June 27, 2002.......................... 244
``Inflated Profits in Corporate Books is Half the Story,''
Wall Street Journal, July 2, 2002.......................... 245
Sherman, Hon. Brad:
SEC letter dated May 21, 2002................................ 246
Sullivan, Scott:
Arnold & Porter letter, July 8, 2002......................... 247
Arthur Andersen, 2001 Audit Plan and Proposed Fee Arrangements
for WorldCom, June 6, 2001..................................... 250
Arthur Andersen, Report to the Audit Committee of WorldCom Year
Ended December 31, 2001........................................ 268
Creative Accounting Chart........................................ 285
FCC Chairman Michael K. Powell, press release, June 26, 2002..... 286
Salomon Smith Barney Research Report by Jack Grubman with
clarification, June 21, and June 24, 2002...................... 287
SEC press release of Sworn Statement of WorldCom pursuant to
Section 21(a)(1) of the Securities Exchange Act of 1934........ 292
State and Local Pension Plans (WorldCom Losses) Chart............ 297
WorldCom Insider Sales (1996 to Now)............................. 298
WorlCom Minutes of the Regular Meeting of the Audit Committee of
the Board of Directors, February 6, 2002....................... 299
WorldCom Minutes of the Regular Meeting of the Audit Committee of
the Board of Directors, March 6, 2002.......................... 302
WorldCom Minutes of the Special Meeting of the Board of
Directors, April 29, 2002...................................... 307
WorldCom Minutes of the Special Meeting of the Board of
Directors, May 21, 2002........................................ 310
WorldCom Minutes of the Quarterly Meeting of the Board of
Directors, May 23, 2002........................................ 313
WorldCom Separation Agreement for Bernard J. Ebbers.............. 319
WorldCom Table of Events......................................... 326
WRONG NUMBERS: THE ACCOUNTING
PROBLEMS AT WORLDCOM
----------
Monday, July 8, 2002
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to call, at 1 p.m., in Room
2128, Rayburn House Office Building, Hon. Michael G. Oxley
[chairman of the committee] presiding.
Present: Representatives Oxley, Leach, Roukema, Baker,
Bachus, Castle, Royce, Barr, Kelly, Manzullo, Green, Toomey,
Shays, Shadegg, Grucci, Hart, Capito, Ferguson, Tiberi, King,
Gillmor, Lucas of Oklahoma, Biggert, Cantor, Rogers, LaFalce,
Frank, Kanjorski, Waters, Sanders, Maloney of New York, Watt,
Ackerman, Bentsen, Maloney of Connecticut, Hooley, Sherman,
Sandlin, Meeks, Lee, Inslee, Moore, Gonzalez, Jones of Ohio,
Capuano, Ford, Hinojosa, Lucas of Kentucky, Shows, Crowley,
Clay and Ross.
Also Present: Representative Wu.
The Chairman. The committee will come to order. This
hearing of the Committee on Financial Services will begin. As
you all know, we have a number of witnesses to hear from today.
The Chair would strongly urge all Members to submit opening
statements for the record in order to allow more time for
questioning the witnesses. Without objection, all Members'
opening statements will be made part of the record.
The Chairman. The Chair now recognizes himself for 5
minutes for an opening statement. I would like to begin by
thanking my colleagues for returning early from their
Independence Day district work period in order to take active
roles in this important hearing. On July 4, we celebrated the
226th anniversary of the issuance of the Declaration of
Independence, which opened the door to freedom and self-
government for Americans and eventually all mankind. We
celebrated American ideals such as selflessness, respect for
others and obedience to a higher law. We honored the ultimate
sacrifice of our heroes who long ago and just last year placed
those virtues above self-interest and beyond the temptations of
affluence, protecting others instead of themselves.
Unfortunately we must return to the peoples' House today to
investigate an historic and outrageous contrast to those ideals
and yet another example of the decline of ethics in American
culture during the 1990s. The latest company to abuse the
public trust is WorldCom. It appears now that senior WorldCom
executives deliberately hid almost $4 billion in expenses
disguising its true performance in order to keep earnings in
line with analysts' estimates. The announcement of this fraud
turned WorldCom from a world beater into a penny stock and
forced it to lay off thousands of blameless employees.
If these charges are proven, WorldCom executives who
participated in the fraud should have to return any profits
from stock sales made during the five quarters of misreported
earnings. It would be simply wrong to allow them to profit from
criminal behavior. I would note that the committee's corporate
and accounting reform legislation, CARTA, which passed this
House on a strong bipartisan vote on April 24, includes a
disgorgement mechanism for situations like this.
During the telecom boom of the 1990s WorldCom stock was
highly prized and was held by State pension funds,
institutional investors and millions of average Americans. The
stock has plummeted from a high of nearly $65 a share just a
few years back. This betrayal to the spirit of the Fourth of
July by senior WorldCom managers is so immense that it could
cost tens of thousands of workers and average citizens their
livelihood and life savings.
How could something like this happen, and what could be
done to try to prevent a recurrence? To get the answers we have
invited a number of individuals here today who know or should
have known what happened. They owe this committee and the
public a thorough explanation. Our witnesses include former and
current CEOs of WorldCom, its chairman of the board of
directors, its former chief financial officer, its former
comptroller, the Arthur Andersen partner in charge of the
WorldCom audit, and Jack Grubman, a telecom analyst from
Citigroup's Salomon Smith Barney unit who had an unusually
close relationship with WorldCom executives and was for years
WorldCom's biggest advocate on Wall Street.
In the committee's ongoing inquiry into the research
practices of equity analysts, we want to explore the nature of
these relationships and try to determine whether Mr. Grubman's
failure to recommend that investors sell their WorldCom stock
until it became virtually worthless can be explained by the
hundreds of millions of dollars in underwriting fees that his
firm collected from WorldCom. In the late 1990s, many so-called
experts proclaimed there was virtually unlimited potential for
telecommunication companies to carry high-speed data over their
fiber optic networks. As we have seen recently with the
difficulties experienced by Global Crossing and others, that
demand did not materialize.
During my two decades of service in this House, I worked on
telecommunications issues of all kinds. It was long ago clear
to me that the value of a robust, competitive
telecommunications environment is met through America's economy
and our continued role in the forefront of the world
marketplace. While different companies dealt with a changed
market reality in a variety of ways, none as yet has shown the
audacity to commit fraud on a scale that has been alleged here.
I am hopeful that we will be able to learn a great deal
from our witnesses today. At the same time I am also aware that
the concurrent investigations by the SEC and the Department of
Justice will continue, as will this committee's efforts, until
a loud, clear message has been sent that accounting fraud and
all businesses' illegalities will simply not be tolerated. I
fully expect the results of the investigations of the SEC and
the Justice Department to return to the American public the
confidence needed to invest in America's telecommunications
companies and other industries.
On Wednesday our committee agreed to a request from the
Justice Department to assist them by not calling Ms. Cynthia
Cooper, vice president for internal audits for WorldCom, and
Mr. Max Bobbitt, a member of WorldCom's board of directors and
chairman of its audit committee, to testify today.
The thousands of fired WorldCom employees who face an
unknown future and the millions of investors who lost so much
of their retirement savings all apparently due to the greed and
selfishness of a few rich insiders demand that we engage in a
search for truth and justice. And make no mistake, the
consequences of this sort of criminal activity should it be
proved should be severe, and it may mean time in Federal
prison.
From the Founding Fathers to the heroes of 9/11 to our
soldiers fighting the war against terrorism, Americans have
always proven themselves willing to take risk and do so in an
honest and forthright manner. Today we urge corporate America
to live up to those ideals.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 154 in the appendix.]
The Chairman. The Chair's time is expired, and the Chair
recognizes the Ranking Member, the gentleman from New York, Mr.
LaFalce for an opening statement.
Mr. LaFalce. I thank the Chair. Once again, our committee
is beginning an inquiry into fraudulent accounting practices at
a major United States corporation. This time the company being
investigated is WorldCom. Even after the string of revelations
and failures that we have suffered through over the past year
and a half, the magnitude of WorldCom's deception is
staggering. The disclosure that WorldCom had improperly
accounted for $3.8 billion in expenses sets yet another new
record for the largest corporate financial restatement. This
news dealt a profound blow to market confidence, one that
threatens to undermine a sustained recovery of our markets and
our economy.
No more proof should be needed that Enron, Global Crossing
and others using deceptive accounting practices were not
aberrations. Earnings manipulation has become all too common a
practice amongst our publicly traded companies, both large and
small. The simplicity and the audacity of the deception at
WorldCom provides ample evidence of a profound change in
culture within our publicly traded corporations. The imperative
of meeting analysts' quarterly projections has trumped the
interests of shareholders and indeed threatened the long-term
prospects of the companies themselves. The safeguards we have
relied upon to protect investors have failed at every level.
Auditors, audit companies and boards of directors have not been
able to provide the protections to which shareholders are
entitled, and the markets alone cannot provide change of the
magnitude needed to restore these safeguards.
There is an urgent need for strong and reasoned legislation
to restore the market confidence that has been squandered by
greed, incompetence, fraud and weak regulation. This committee
squandered our earlier opportunity to craft legislation that
would truly address the systemic problems we have seen,
producing only a weak bill that included no real reform. Today,
however, the Senate will begin floor debate on a much stronger
bipartisan bill produced by the Senate Banking Committee, a
bill with many provisions quite similar to those we advanced
both in committee and on the House floor and that were rejected
on basically a party-line vote. Our hearings today should
provide impetus to us to deepen our resolve and strengthen the
House approach, and I hope the Senate will strengthen the
Sarbanes bill, making it even more similar to ours, and then
pass it expeditiously.
To provide the reform we need, legislation must at a
minimum, one, create a tough public regulator for auditors;
two, strengthen corporate governance; three, ensure that
corporate executives are held responsible for their actions;
four, restore the independence of auditors; and five, eliminate
the conflicts of interest faced by securities analysts.
I look forward to going to conference and to enacting a
strong bill that addresses all of these vital concerns. I look
forward to President Bush's speech tomorrow where I hope after
a year and a half he will finally join with us in trying to
effectuate these reforms. Given the impact that each new
revelation of accounting fraud has had on our markets, we
cannot afford delay. Our country and our markets are looking to
us to enact meaningful, not cosmetic, reform, and the health of
our economy depends on our efforts.
I thank the Chair.
The Chairman. The gentleman's time has expired. Other
Members seeking to give an opening statement?
Gentleman from Iowa Mr. Leach is recognized for that
purpose.
Mr. Leach. Thank you, Mr. Chairman.
The issue of the year is moral clarity. In international
affairs the President suggested that there are tactics such as
terrorism which civilized societies cannot countenance.
Likewise with corporate governance.
Moral clarity requires that CEOs of public corporations not
put personal interests above shareholder values. To put it
plainly, it is self-dealing for a corporate head to give
himself a multi-$100 million loan, and it is a dereliction of
duty for a board to go along.
Moral clarity requires that certified public accountants
make clear that 2 minus 3 doesn't equal plus 1. If there is no
confidence in numbers, there can be no confidence in our market
system.
Moral clarity requires that investment advisers shed
conflicts of interests. Trust based on independence of judgment
must be the bottom line.
Moral clarity requires that American corporations abide by
American law and regulation and not be allowed to seek shelters
from taxes and rules to protect the public by removing assets
to lax regulatory jurisdictions and offshore tax havens.
Companies can't have it both ways, the protection of our
government and the stability of our market system, without the
responsibility to shoulder a share of the cost of maintaining a
free society based on the rule of law.
Moral clarity requires that Congress, the peoples' body,
shine the spotlight of accountability on wrongdoing and
establish the institutional means to reestablish trust in our
system. A small but significant step this Committee could take
is to insist on the merger of the SEC and the Commodity Future
Trading Commission (CFTC.) If people think there is a case for
a new Department of Homeland Security because the FBI and CIA
do not communicate well, the case for regulatory streamlining
is even more compelling. White collar crime committed by
company officers under a corporate veil must be pursued as
vigorously as common street crime. Indeed, because trust in the
system is at stake, white collar crime must be pursued more
vigorously.
Finally although this is not a WorldCom issue, Congress is
obligated to pass legislation to ensure that derivative
contracts are automatically netted in the event of bankruptcy.
One of the lessons of the past few months is the rapidity with
which significant companies can falter. Laws must be put in
place which assure systemic stability as well as require
individual accountability.
Moral clarity requires that we both look and that we act.
Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired.
The gentleman from Massachusetts is recognized.
Mr. Frank. I pass.
The Chairman. The gentleman passes.
The Chair would indicate that a number of Members wishing
to give opening statements--and I have had some conversations
with the Ranking Minority Member--if it would please the
committee, we would limit the opening statements to 2 minutes--
and--let me finish--and the Chair then would be pleased then to
be generous with the 5 minutes for questions. I think that
would allow us to get our statements on the record as well as
get to questions for the panel.
Gentlelady from California.
Ms. Waters. Mr. Chairman, I respect the fact that this is a
large committee, and you have to do everything that you can to
manage it. However, we are confronted with one of the biggest
problems facing America. We are besieged with comments and
questions from our constituents, and people are asking what do
we feel, what are we going to do. And I intend to use this time
to put on the record in a very clear and certain way exactly
how I feel, what I intend to do about it. I think it is
important that we have the 5 minutes that you would normally
give to all of the members of this committee who wish to have
it.
The Chairman. The gentlelady yield back?
Ms. Waters. Yield back the balance of my time.
The Chairman. The gentleman from New York.
Mr. LaFalce. You and I did have a prior conversation when I
indicated that I could understand the rationale behind your
desire to have Members voluntarily go along with the 2 minutes,
and if the Members could go along with the 2 minutes
voluntarily, I think it could be good because it is still going
to be an hour and a half before we get to the panelists if we
just speak 2 minutes apiece. But if some Members such as Mrs.
Waters believe they must take longer, I would hope the Chair
would be able to make an exception.
The Chairman. We will try to accommodate the Members.
Further opening statements. The gentleman from Louisiana?
The gentleman from Pennsylvania.
Mr. Kanjorski. Mr. Chairman, we meet yet again to examine
the legal problems plaguing America's corporations. As more and
more scandals have come to light in recent months, the business
section of our newspapers have read more and more like the
crime page. WorldCom's recent announcement that it overstated
its earnings by at least $3.8 billion in 2001 and in the first
quarter of 2002 is only one of the latest examples of this
unacceptable behavior.
With the revelations of WorldCom's questionable accounting
practices, it has become increasingly apparent that these
scandals do not result from some idle mistakes or a few
fraudulent acts. For me the WorldCom deceit is just the latest
development to make clear that there is a systemic problem with
accounting irregularities, executive abuse, and corporate
governance and misconduct in our country's securities markets.
It also greatly troubles me how so many corporate insiders,
outside auditors, investment bankers, research analysts and
countless others could miss the simple, yet staggering
accounting deception.
The corporate misdeeds at WorldCom, Tyco, Adelphia, Rite-
Aid, Exxon, Global Crossing and Enron have also challenged the
credibility of corporate financial reporting systems. Congress
must therefore take strong, decisive and quick action to
bolster investor confidence. Only a strong law will restore
confidence in the integrity of the market, protect our hard-
earned investments made by millions of middle-class Americans.
Accordingly, I hope the Senate will pass a strong corporate
accountability bill in the coming days. We must hold corporate
executives accountable, enhance the independence of auditors,
improve oversight of the accounting profession, and end stock
analysts' conflicts of interest. Before the August recess we
must send to the President's desk legislation that is much
stronger than the weak bill passed by the House in April.
Moreover, as we work to hold America's corporate leaders
accountable, we hope that our Nation's top executive will take
accountability within his own White House. In recent days we
have heard much about President Bush's repeated failing to file
timely reports with the SEC regarding his insider sale of
Harken energy stock in the early 1990s. His staff has
unfortunately analogized these late filings as getting caught
driving 60 miles per hour in a 55-mile-an-hour zone.
Nevertheless I hope the President in his speech tomorrow will
refute his aides' careless dismissal of the SEC rules. If the
President seriously wants to strengthen corporate
accountability, he needs to send a message that everyone must
follow the law. We cannot allow the environment of permissive
attitudes toward enforcing our country's securities regulations
to continue.
In closing, Mr. Chairman, investors expect to be able to
trust the information the companies provide to them. Congress
must therefore examine what went wrong at WorldCom and other
companies to restore investor trust and protect our Nation's
overall economic health. Congress must also quickly pass, the
President must sign, real corporate accountability reform. I
will continue working toward that important goal.
The Chairman. I thank the gentleman's cooperation.
[The prepared statement of Hon. Paul E. Kanjorski can be
found on page 168 in the appendix.]
The Chairman. Gentleman from Louisiana, Mr. Baker, chairman
of the Capital Market Subcommittee.
Mr. Baker. Thank you, Mr. Chairman, for calling this
important hearing. The circumstances which bring us to this
point today were actually unimaginable 12 months ago in that a
series of Fortune 500 corporations could fall precipitously to
ashes after recurring revelations of corporate mismanagement.
The amazing fact, in my opinion, is that in this aftermath, our
capital markets remain sound, and the economic fabric has not
been torn, although I do believe it needs a pretty good
washing.
It is clear that this committee's responsibility is to act
and to examine all of the consumer protections that seemed to
have failed in these instances. In this effort, however, we
should recognize we have the obligation not to make matters
worse. In drafting reform we should not construct rules so that
capital markets cannot function efficiently. We cannot ensure
that no one ever experiences a loss. Investing is inherently
risky. Companies do succeed, but companies fail. The end
product of this process should be a plan that provides
accurate, real-time information to investors and shareholders
to enable confident decision-making. All the material facts
relevant to the true financial condition of a company should be
made available in a real-time manner in a valid reporting
system for all market participants.
The benefits of such a system are multiple, but two
principal ones are clear: real transparency that yields
investor confidence, and dramatic reduction in market
volatility that exists today when management attempts to beat
the street with 90-day earnings estimates.
When any part of the capital market system fails to meet
professional standards of conduct, there should be clear,
decisive action to punish those responsible. Providing the SEC
with the necessary resources to pursue enforcement action is an
essential part of the reform, but it is not necessary to create
an entirely new agency with new budgets to perform the task.
We only recently have succeeded in passing legislation to
bring about pay parity for the SEC. FASB today still relies
principally on the sales of reports and publications to
generate the funds for its operation. Critical resources should
be utilized in the most efficient manner possible through the
experience and enforcement staff of the SEC. Any proposal to
build additional agencies for the purpose of performing the
work of that agency just doesn't make financial or common
sense.
In the course of this examination today, disclosures should
be made that are helpful to the committee's work and
understanding where the rules were inadequate or where
professional decision-making failed. It is increasingly clear
reform of major proportion is required. It is not clear, at
least to me, that every CEO, every accountant, every analyst,
every broker or investment banker is a crook.
We should legislate to minimize the opportunity for
aberrant actors to manipulate the system with impunity while
facilitating the orderly conduct of the most vibrant capital
market in the world. There are many ways to that end. The SEC
and other regulators have accomplished much in the past 6
months. This committee's own action with regard to rules
governing analyst conduct issued last fall was an important
step forward. I am hopeful when the Senate concludes the work
on this subject this week, a productive conference can be
initiated that will lead to a bill we can all support.
In the end it is to no one's advantage to have continued
restatements of financial condition or, worse, business
failures resulting from any inappropriate or unprofessional
conduct. What is even more troubling to me, however, is that a
corporation may comply with all the current disclosure
requirements, be examined by a competent firm, reviewed by all
the market analysts, and be found to be compliant with all the
rules while at the same time have material underlying financial
deterioration that is not observable with the current
disclosure requirements. This must change.
Today it will be unfortunate indeed if our invited
witnesses choose not to be forthcoming in responding to
inquiries of the committee. Withholding critical information
from the Congress will only exacerbate expedient resolution,
strengthen our resolve to achieve our goal, and ultimately
bring about criminal penalties for those who abuse their
corporate authority. Corporate management does work for
shareholders, but shareholders are our constituents to whom we
have a high obligation to ensure they receive fair treatment.
I thank you, Mr. Chairman, for your continuing leadership
on this important matter.
The Chairman. Gentleman's time has expired. Further opening
statements?
The gentlelady from California Ms. Waters.
Ms. Waters. Thank you very much, Mr. Chairman. I sincerely
thank you for calling this hearing, and I really do appreciate
your patience in allowing me and other Members to take the time
that we need in order to give our opinion about what is going
on.
Americans are watching and waiting to see if the Members of
Congress are going to get serious about investigating corporate
crime and supporting tough legislation to prevent the corporate
fraud schemes we have seen unveiled in recent weeks. WorldCom,
Incorporated, joins a growing list of corporations accused of
wrongdoing and criminal activities, Enron, Arthur Andersen,
Tyco International, Adelphia Communications, Rite-Aid, Global
Crossing, Xerox and more to come, corporations whose executives
stand accused of abuse of stock options, sweetheart loans,
conflict of interest, excessive compensation and severance pay,
and now the Securities and Exchange Commission has filed a
fraud lawsuit in Federal court against WorldCom, Incorporated.
This suit alleges WorldCom, Incorporated, was directed and
approved by top managers to keep earnings in line with Wall
Street expectations and to support WorldCom stock prices.
In essence, WorldCom has revealed they inflated their books
by $3.9 billion. They treated ongoing operating costs as
capital investments. They reduced their operating expenses,
that is, the costs they paid to other carriers for using their
networks, by spreading the costs into the future. This improper
accounting is no error, no mistake. It is calculated to enhance
the company's net income and to hike its earnings before
interest, depreciation, taxes and amortization. This made
WorldCom appear healthier than it was and thus more attractive
to investors.
A syndicate of banks holds $2.6 billion in unsecured loans
and bondholders about $30 billion of WorldCom bonds, all of
which are in jeopardy. The banks could call in their loans, and
the WorldCom bonds could be thrown into default. My own State
of California public employee retirement pension funds could
lose approximately $580 million. WorldCom could easily file the
largest bankruptcy in history. The impact of such a bankruptcy
will be felt around the world. Aside from the 17,000 WorldCom
employees, thousand of employees in related industries could be
laid off. Thousands of pensioners could lose their pensions,
and the damage to our economy is incalculable.
This cowboy capitalism must stop. The President of the
United States cannot simply treat this as damage control for
its future election of stump speech with the right sound bites
is not good enough. The President of the United States must
support tough legislation, and he must use the power of the
White House to get the support of the usual course of defenders
of the megathieves of corporations to vote to live up to their
tough on crime rhetoric with mandatory minimum sentences.
The shameful corporate culture of old boy relationships
where major banks led by Citigroup, with J.P. Morgan, Bank of
America, Fleet Boston, Bank One and Wells Fargo, made billions
of dollars of uncapitalized loans to WorldCom without any due
diligence, but at the same time cannot find in their corporate
hearts a way to provide home mortgages to working families to
own a home, and it is disgusting.
The analyst, Mr. Jack Grubman from Salomon Smith Barney,
with close ties to WorldCom--and, by the way, he refers to
close ties and conflict of interest as synergy--is the one who
recommended WorldCom as a good investment while WorldCom was on
the brink of collapse, and he should be indicted. The founder
Mr. Ebbers, the board of directors, and certainly the auditor
of the now infamous Arthur Andersen should have known and
should be held responsible. Mr. Sullivan committed the
simplest, most easily detectable accounting fraud. He lied
about operating costs, his debt, and is still trying to justify
operating costs as capital costs. Everyone should have known,
and I believe they did know.
I was alerted that the principals we have here today will
take the Fifth Amendment, and that is their constitutional
right to do so. However, I expect the Justice Department to
determine if there was a conspiracy to commit fraud. I expect
the Justice Department to go after WorldCom's auditor, the
consistently insider conflict of interest wrongdoer Arthur
Andersen, once again. I expect Mr. Sullivan to return the $10
million retention bonus given to him. And I expect the SEC and
the Justice Department to delve into the sale of his WorldCom
stock to determine if he benefited from the inflated stock
prices that he created.
The Chairman. The gentlelady's time has expired. I Wish to
wrap up.
Ms. Waters. Fraudulent accounting practices even at the
risk of jeopardizing the completion of his multimillion-dollar
mansion.
I expect the Justice Department to examine Mr. Ebbers'
WorldCom loans and stock options to determine if he benefited
from the cooking of the books.
I demand the SEC to exercise its authority to getting to
the details of the WorldCom fraud. What other operating
expenses have been reported as capital expense? How can we
protect the pensioners, and how will MCI and other customers be
protected?
The immoral and unconscionable practices of corporate
America have been festering for a long time. Corporate America
in general and some particular corporations such as Enron and
WorldCom have gained power and influence by their connection to
politicians by the way of campaign contributions and cozy
relationships. These--
The Chairman. The gentlelady's 6 minutes have expired.
Ms. Waters. Unanimous consent for 30 seconds.
Mr. Green. I object.
The Chairman. Gentleman objects. Let me indicate the
gentlelady can submit the rest of her written statement for the
record, as all Members may do.
[The prepared statement of Hon. Maxine Waters can be found
on page 179 in the appendix.]
The Chairman. The Chair now recognizes the gentleman from
Alabama.
Mr. Bachus. Thank you Mr. Chairman.
What this hearing and the Enron hearing and all these
hearings really boil down to is the accuracy of financial and
accounting records. The American people need to have the
confidence that those records are accurate, and that--and if
they don't have that confidence, it actually undermines
something that I am a strong advocate and supporter of, and
that is our capitalistic system.
Now, the word ``capitalism'' has taken a beating in the
past several months, as has ``free market.'' And, in fact,
there are some in this Congress who would use this opportunity
to undermine our capitalistic system and our free market
system. We can't allow that to happen, and the best way not to
allow that to happen is for us to be vigilant in defending
capitalism, but also vigilant in rooting out the excesses and
rooting out wrongdoing, and that primarily will have to be the
job of the Securities and Exchange Commission, not of this
Congress. It is the Securities and Exchange Commission that
will do the investigations.
And because of the urgency of the matter, there cannot be
any sacred cow. We have to do everything we can do to
effectively restore the confidence of the American people. In
that regard, Chairman Pitt is an honest man, he is a good man,
he is a capable man, and I think he has done a good job at the
Securities and Exchange Commission. However, I will say that
there is now some question over whether he is the right person
and this is the right time for him to be Chairman of the
Securities and Exchange Commission. I say that as a supporter
of the Bush administration. I say that as a supporter of the
job he has done. But we have to have someone heading up that
agency that does not have to recuse themselves in over half the
cases that are at the Securities and Exchange Commission.
We can defend capitalism, we can defend the administration,
and we can defend the honor of Harvey Pitt and still ask that
question.
The Chairman. Gentleman's time has expired.
The gentleman from Vermont.
Mr. Sandlin. Thank you, Mr. Chairman, and thank you for
holding this important hearing. I look forward to the question
period, but would like to make a more general statement at this
time.
We are here today no doubt to be absolutely shocked again
and disturbed again that WorldCom has apparently cooked the
books with the help of Arthur Andersen to the tune of some 3.9
billion. A few months ago we were absolutely shocked and
disturbed of Enron's nefarious ways. We are also shocked at
Xerox, Global Crossing, Adelphia and Tyco. And I suppose that
we are also shocked that, according to the Huron Consulting
Group, over the past 5 years nearly 1,000 companies were forced
to correct their financial statements.
The two important questions that we have to address today
and in the future are, first, what is going on in our country
today that allows for the kind of corporate thievery and
deception that we are seeing; and secondly, what are we in
Congress really beyond sound bites going to do about it? How do
we change the culture in this country and the role of Congress
and the White House so that we put an end once and for all to
this outrageous corporate behavior that we are seeing?
Let's talk a little bit about general culture. Last month,
as you know, Mr. Chairman, the Republican Party held a fund
raiser here in Washington and in one night raised $33 million
from some of the largest corporations and wealthiest
individuals in this country. And in truth the Democratic Party
has had similar type of events. It is no secret to any American
that the wealthy and the powerful, because of their campaign
contributions, have enormous influence over the political
process that goes on here. Why else would they contribute
hundreds of millions of dollars to the President, to the
chairmen of congressional committees and to most of the Members
in Congress?
So number one, Mr. Chairman, before we lecture those guys,
let us have the honesty to do the right thing and to call for
real campaign finance reform so that this institution does not
get swamped with money that comes from the wealthy and the
powerful. Let us limit the amount of money that can be
collected and spent on elections and let us move toward a
public funding of elections.
Secondly, through words and legislation, Congress must make
it very clear to corporate America that the kind of outrageous
greed that we are seeing there cannot form the basis for a
healthy society or a stable economy. Forget for a moment the
scandals that we are dealing with today. Let everybody know
today that without these scandals, the average CEO of a major
corporation is earning 500 times what the workers in those
companies are earning. Today while CEOs pocket tens of millions
in salaries, bonuses, golden parachutes and other benefits,
they cut back on the wages, health care and pensions of their
workers. The result is that the people on top earn obscene sums
of money while millions of workers are working longer hours for
lower wages than they were 20 years ago. The wealthiest 1
percent of the population today, including those gentlemen, now
earn, own more wealth than the bottom 95 percent. And because
of government inaction, while the rich get richer, our veterans
can't get the health care they need at the VA hospital, our
kids aren't getting the education that they need, our seniors
are not getting prescription drugs, and on and on it goes.
[The prepared statement of Hon. Max Sandlin can be found on
page 176 in the appendix.]
The Chairman. Gentleman's time has expired. Gentleman from
Illinois Mr. Manzullo.
Mr. Manzullo. Thank you, Mr. Chairman.
Every situation has a face to it, and the congressional
district that I represent, Rockford, Illinois, there are 1,000
faces. These are the employees at the MCI in Rockford,
Illinois, who are watching this on C-SPAN back home, hoping and
praying that as a result of what has happened to the corporate
hierarchy, that they will retain their jobs. Rockford,
Illinois, has unemployment at 8 percent, a city that has been
savaged by a real hit to the manufacturing sector, and a city
that in 1981 led the Nation in unemployment at 25.9 percent.
But to the 1,000 families out of a city of 150,000 people, they
are the ones we should be talking about. They are the ones that
we ultimately should be concerned about. It is their lives,
their families.
MCI in Rockford is the largest minority employer in the
northern part of the State of Illinois. What they are doing at
that center is nothing less than miraculous. As they come in
there, this is the opportunity for people to become
entrepreneurs and earn high commission-based salaries. When
they change shifts, the people that come into work are as happy
as those that are leaving work, high five, shouts of
exclamation, people really enjoying working, enjoying the
spirit of freedom and entrepreneurship. It is to their
interests that ultimately we should look. They are the ones who
are the innocent victims.
The Chairman. Gentleman yields back.
Are there further opening statements?
The gentlelady from New York.
Mrs. Maloney of New York. Thank you, Mr. Chairman.
As our constituents view this hearing today, they are
rightfully outraged. This time the company's name is WorldCom,
and the damage is the evaporation of 150 billion in stock
market value, the layoff of tens of thousands of innocent
workers, 300 million in losses for New York State's pension
funds, and yet another damaging blow to the overall reputation
of American business.
United States' markets are based on trust. Investors around
the world seek out this country because we are usually honest,
transparent and a safe haven where rules are enforced. From the
facts we now have, it appears that several of our witnesses
epitomized the absence of ethical behavior that is plaguing
some companies in our country.
As a Congress, it is our job to recognize the recurring
series of real and apparent conflicts of interest in the recent
scandals. Clearly the Sarbanes bill in the Senate addresses
these conflicts--some of these conflicts, and I hope it will
pass the Senate and the House and be enacted into law. It
recognizes that we need to separate auditing and consulting and
to create an independent oversight board with real powers. We
need to address the independence and ethics of stock analysts
and corporate boards of directors.
At Enron members of the board were compensated $350,000 a
year to rubber-stamp management's proposals that allowed the
company to hide its true financial condition off the books. The
WorldCom board allowed hundreds of millions of low-interest
loans to Mr. Ebbers. While it is uncertain exactly what the
Enron board did to earn its money, it did approve a very high-
minded book on its code of ethics, and I have it here, and it
is on the Internet, and it talks about their high standards of
honesty. Yet this board took the unusual step of overwriting
their own code of ethics to approve some of their financial
deals. So we clearly need steps to strengthen corporate
governance and the independence of boards.
I for one would like to hear more from the honest CEOs,
CFOs, managers and workers in our country about ways that we
can improve the system so that this does not happen again and
damage workers, damage pensions, damage the trust in the
American system. I really believe the real strength of our
system is the trust that people have in our financial markets
and our management, and it has been severely damaged by the
actions of some companies.
The Chairman. Gentlelady's time has expired.
Mrs. Maloney of New York. I would like to end with
something very positive, because we still have to remember, Mr.
Chairman, that we have the deepest and the strongest financial
market in the world, and we need to keep it that way, and we
need to take the steps to correct the wrongs that have
happened. Thank you.
The Chairman. Further opening statements?
The gentleman from Wisconsin Mr. Green?
Mr. Green. Just like you I eagerly await the testimony from
our witnesses and the questions of those witnesses, and as such
I'll submit any comments I have for the record.
The Chairman. Other opening statements?
Gentleman from California Mr. Sherman.
Mr. Sherman. Mr. Chairman, I have little fear that we will
hear big rhetoric on this issue, but my fear is that we will
take tiny action, and then with the audacity that would make
David Duncan blush will announce that we've solved the problem.
There are many ideas on how to strengthen the system. I
would like to bring to the committee's attention two new ones
and two old ones. The first new one is that perhaps the top
1,000 companies should be audited every 6 months instead of
every year. This would only modestly increase audit costs. The
world operates more than twice as fast as it did when the 1933
Securities Act was adopted, and I think WorldCom might have
found it more difficult to misstate five different quarters if
they had been audited every other quarter.
Second, we ought to have a way of certifying as independent
those stock analysts who do not work for investment banking
firms and get no compensation from underwriters, consultants or
issuers. Now, anyone can pontificate on the value of a stock,
but perhaps investors would learn to trust those who do not
have their bread buttered by those who would like to see only
positive results or positive recommendations.
Mr. Chairman, this committee rejected on a rather close
vote, one vote, instructing the SEC to read the filings of the
top 1,000 companies, and instead we passed a provision saying
it was the sense of Congress that the SEC do so, but we are not
instructing them to do so. This suggestion has been reacted to
with great hostility by Chairman Pitt, who as of yet has not
resigned. Chairman Pitt not only hates the idea, or virtually
any idea, but he has reneged on his promise to this committee
to even provide a cost estimate for that concept.
Second, WorldCom is another Arthur Andersen client.
The Chairman. Gentleman's time has expired.
Mr. Sherman. Perhaps we ought to look at the structure of
Arthur Andersen, as Mr. Tauzin did on the morning shows
yesterday, and we'll find the need for reform there.
[The prepared statement of Hon. Brad Sherman can be found
on page 178 in the appendix.]
The Chairman. Is there further--gentleman from Connecticut
Mr. Shays.
Mr. Shays. When we looked at Enron, every part of this
system seemed to fail, and almost everyone connected with the
system, the board of directors, the management, the employees
who had knowledge of bad practices, the rating agencies, the
banks, the investment houses, auditors, law firms, consultants,
regulators. So now we look at WorldCom, and we are going to be
looking at other companies in the future. When E.F. Hutton used
bogus movement of funds, they were fined, and no one served
time in jail.
I represent one of the richest districts, a district that
has a lot of the important folk who seem to run our businesses,
and they as well as the poorest in my communities have all come
to me and said, you have all the laws on the books, enforce
them. We need regulators who enforce them, regulators who don't
have to recuse themselves. But ultimately they all ask this:
Could some of these crooks spend time in jail?
The Chairman. Gentleman's time has expired.
Further--gentleman from Washington State Mr. Inslee?
Mr. Inslee. Thank you, Mr. Chair.
Strikes me that at this moment of substantial risk to our
whole economic system, that we owe the people something more
than weak tea. And when you think about it, this is sort of a
Teddy Roosevelt moment, and Teddy Roosevelt did not say, speak
loudly and carry a small twig.
When I went home this week, the sounds I heard were not
just firecrackers, but there were people who were outraged not
just at the culprit sculduggery that's going on, but also at
the House and the administration who has given them nothing but
weak tea to date, and I would suggest we need perhaps fewer
speeches and more action.
I am going to suggest too, Mr. Chairman, that we need to
see in the next 24 hours in this country. Number one, the
President of the United States needs to ask for Mr. Pitt's
resignation, and he needs to do that because this country right
now needs an agent of change, not someone you have to drag
kicking and screaming every time you want to regulate in the
most modest way one of his former clients. We need something of
a cop that doesn't take 6 months to figure out how to define
armed robbery. We need somebody more like Eliot Ness and less
like Barney Fife on this important job when the whole economic
system is in question with confidence in our financial markets
right now.
Number two, it is not just the administration that needs to
get serious. This committee needs to get serious.Mr. Chairman,
I would ask you to reconvene this committee not just for a
hearing, but for an action, for a vote to revote that
pathetically ineffectual bill that we sent over to the Senate
when we voted on it April 11 when we had a lot of my good
friends on the Republican side of the aisle who refused to
understand how systemic, how broad, how deep, how threatened
this problem is, who voted time and time again against
meaningful reform, against having a really, truly independent
accountancy board.
The Chairman. Gentleman's time has expired.
Mr. Inslee. Mr. Chairman, I think you need to call a
revote. Since April 11 this is a new world, and I hope some of
my Republican friends decide to be more like Teddy Roosevelt,
less like some other folks who haven't done the job and haven't
cut the mustard.
The Chairman. Gentleman from California Mr. Royce.
Mr. Royce. Thank you, Mr. Chairman.
Today this committee has been summoned to address a 3.8
billion misstatement of earnings at WorldCom through 2001 and
the first quarter of 2002. This restatement at WorldCom marks
for us yet another example in a seemingly endless parade of
corporate accounting scandals in which corporate managers are
found to have manipulated financial data, and are found to have
enriched themselves by hundreds of millions of dollars, while
leaving shareholders to suffer the consequences when the truth
about their company's financial health finally becomes public.
The same culture of deceit and self-interested behavior by
management that contributed to the demise of Enron, that
contributed to Global Crossing's problems also appears to have
afflicted the management at WorldCom. Executives who engage in
this type of deceit should be divested of their ill-gotten
gains. I note that WorldCom filed a lawsuit on Friday seeking
to reclaim a $10 million bonus given to its former CFO.
Earlier this year I asked SEC Chairman Harvey Pitt when he
appeared before this committee if there were mechanisms
available to the SEC that would allow him to effectively
prosecute and to collect and return for the benefit of
shareholders all corporate managers' compensation obtained
through misconduct. That compensation obtained through
misconduct should be returned to the shareholders. He indicated
that there were. He indicated that he would do that. Well, his
job will hinge on whether he demonstrates the capability to
accomplish this task.
Now, the President will disclose tomorrow a new requirement
that top executives personally certify that their companies'
public financial reports are accurate. If this certification
should prove false, if there are self-dealings, they should go
to jail.
[The prepared statement of Hon. Ed Royce can be found on
page 174 in the appendix.]
The Chairman. Gentleman's time has expired.
The gentleman from Oregon Ms. Hooley.
Ms. Hooley. Thank you, Mr. Chair.
So many scandals, so little time. The list of corporate
greed running rampant and unchecked by the government grows
everyday. Look no further than the front page of today's Wall
Street Journal over the last 3 years. Merck booked 12.4 billion
in revenues it never received. In Oregon, 2,000 employees lost
their pension because of Enron.
I could go on and on, but this is the bottom line: This
committee and this committee alone has the responsibility to
not only find out who knew what in the WorldCom scandal, but to
actually legislate solutions to the deficiencies that have
brought us here today. If fire walls need to be implemented, if
new accounting rules must be promulgated, if executives need to
be held liable for their executive business decisions, we need
to get moving. It is painfully obvious that reform is needed.
Until we do so, investor behavior will rightfully be tepid and
unpredictable, which, as you undoubtedly will agree, is the
last thing this economy needs as it strains to throw off the
effects of last year's recession.
We need to get this done now, and we need to do it right,
and I yield back the remainder of my time.
The Chairman. Further opening statements?
The gentlelady from Illinois Mrs. Biggert.
Mrs. Biggert. Thank you, Mr. Chairman.
On the brink of the biggest bankruptcy court filing in U.S.
history, and in the wake of yet another announcement today that
a company cooked its books to inflate its profits, an
advertisement appeared in the Washington Post which I think
best sums up the sentiments of the investors and employees
across America: Enough is enough. When even one corporate
leader betrays the trust of his or her employees and the
millions of Americans who invest their future on Wall Street,
it erodes the strength of our capital markets, it erodes trust
in the foundations of capitalism, and it unnecessarily puts our
economy at risk.
Unfortunately, no one has felt the repercussions of this
corporate greed more than the 100 plus employees in my
district. At last count over 500 Andersen employees have lost
their jobs in the fallout, and an additional 500 WorldCom
employees may now face the same fate. Enough is enough, and
clearly we must make changes in order to rebuild the confidence
of the American people. We must restore the integrity of the
accounting industry, and we must ensure that those who broke
the law will serve prison time and return their ill-gotten
gains.
Our bill in the House, H.R. 3763, accomplishes two very key
things. First, it gives the SEC the authority to bar persons
accused of malfeasance from serving as officers or directors of
public companies. And second, the bill helps to ensure that
CEOs or other corporate executives do not profit from erroneous
financial statements. If a company inflates its earnings, and
restates them later on, executives who profit must return their
bonuses and other gains to the company on behalf of their
shareholders.
At the end of the day, I think the House bill will empower
the SEC to punish the crooks, not the honest brokers. Enough is
enough, and I yield back.
The Chairman. The gentleman from Kansas Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman, for conducting this
hearing. Due to constraints on our time, I would like to use my
time to ask a few questions, and I hope that these witnesses
and future witnesses at future hearings will answer. I ask
unanimous consent that my written statement be included in the
record.
The Chairman. Without objection.
Mr. Moore. Question: What can and should Congress do to
make sure Enrons, Global Crossings, WorldComs, Xeroxes and
Mercks don't keeping happening again and again and again?
Question: How many more are there?
Question: Who watches the corporate money, and who watches
the CFOs and the CEOs? How independent are directors of
corporate boards? Should corporate officers and management be
permitted to sell or dispose anything of value they receive
from the corporation when employees are in a freeze or lock-
down period, especially when the value of company stock is in
free-fall? Corporate internal auditors for WorldCom, what could
they have done that would have brought to management's
attention sooner the fact that $3.8 billion was misplaced or
misstated? And how can misplacing $3.8 billion happen without
other corporate officers or directors or auditors knowing it?
Question: Do whistleblowers have enough protection and
incentive to blow the whistle on the kind of practices that
were apparently going on at WorldCom?
Question: Do shareholders have a right to expect that
financial reports and audits will contain complete and accurate
information that will clearly state the value and financial
condition of the corporation? How do we protect investors
without overregulating business? What should happen to
corporate executives who knowingly and innacurately book
corporate assets and expenses to manipulate earnings, and
should their sentences be mandatory with no opportunity for
probation or parole? Are outside auditors really independent?
And finally, when is this all going to end?
[The prepared statement of Hon. Dennis Moore can be found
on page 170 in the appendix.]
The Chairman. Gentleman from Pennsylvania Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman. I want to thank you
for conducting this hearing today.
The nature and the magnitude of the fraud that was
committed at WorldCom is simply appalling, and it has been
devastating to employees, to investors, but most importantly,
in my judgment, to the trust and confidence that is absolutely
vital to the functioning of our capital markets, the markets,
after all, upon which our way of life depends.
I think it is hard to overstate the magnitude of the havoc
that's been wrought evidently by some of the people in this
room. I hope we will learn today, among other things, who is
responsible for this and why the fraud was not discovered
earlier. If instead witnesses choose to hide behind the fifth
amendment, I am confident that investigators, both civil and
criminal, will no doubt get to the truth, and our judicial
system will bring the appropriate people to justice.
Meanwhile, Mr. Chairman, it is for us to determine if there
are weaknesses in legislation or regulation or in the
enforcement of existing legislation and regulation that we can
correct and begin our part of the process of rebuilding the
investor confidence that is critical to all our well-beings. I
think this committee took a constructive step in that direction
with the legislation we have already passed, but I think we
need to keep an open mind about other measures that may be
necessary, and I yield the balance of my time.
The Chairman. Gentleman yields back.
The Chairman. The gentleman from Massachusetts.
Mr. Frank. To clarify, there was a reference earlier to the
putative firm of Salomon Barney Frank. I just wanted to report
that that merger is highly unlikely, and certainly has not yet
taken place.
The Chairman. I am relieved to hear that. The gentleman
from Texas wishes to be recognized.
Mr. Gonzalez. Thank you, Chairman Oxley, and thank you
Ranking Member LaFalce. In order to save time, I would like to
ask unanimous consent that my statement be entered into the
record.
The Chairman. All the statements will be made part of the
record.
Mr. Gonzalez. I yield back the balance of my time.
The Chairman. I thank the gentleman.
Are there further --
Ms. Waters. Mr. Chairman, unanimous consent to please
correct the record and make sure that Barney Frank is not
accused of anything.
The Chairman. Without objection.
Mr. Frank. Well, not of anything. Don't go too far.
The Chairman. The gentleman from Mississippi seeks
recognition?
Mr. Shows. Thank you, Mr. Chairman, members of the
committee. The events that bring us here today are tragic.
Thousand of workers have already been laid off, and indeed more
layoffs are sure to follow.
Countless Americans invested their money and their trust in
WorldCom only to see their savings vanish. Confidence in
corporate management across the board has been shattered and
Wall Street has taken a beating.
Mr. Chairman, this probably hits me harder than any of us
because WorldCom's headquarters is in my district. This is not
a happy day for any of us. WorldCom is a homegrown Mississippi
company, the first to make the Fortune 500. WorldCom's success
was a source of pride for its employees, shareholders
throughout the State, and all Mississippians, many
Mississippians invested in WorldCom because of that.
On June 25th, the announcement that WorldCom misrepresented
its profits margin by hiding nearly $4 billion in expenses
dealt a serious blow to consumer confidence, investors across
the country and to all Mississippians directly and indirectly
tied to the corporation. So when the world learned of WorldCom
financial abuses we in Mississippi took it harder than most.
To the people where I come from, small town values mean a
lot. We go to church, work hard, and we trust each other, and
we try to give each other a helping hand when it is needed. We
live by the Golden Rule and try to treat our neighbors as they
would treat us. Corporate greed is not a Mississippi value.
Fraud is not a Mississippi value.
Trust, honor, integrity represent the values Mississippians
expect in our community leaders, business leaders, political
leaders and religious leaders. In Mississippi we believe that a
handshake is the ultimate contract and your word is your bond.
Mississippi families need to know and want to know who is
responsible for and knew about the accounting irregularities at
WorldCom and how can we ensure that no more employees,
investors and businesses are casualties to corporate greed.
Those responsibilities must be forthcoming, so that the
investigation into WorldCom is expedient and thorough. No
longer will investors, employees, regulators and officials
accept elusive answers or half-truths. Honesty is the only
acceptable policy, period.
So now I address the WorldCom executives. WorldCom is not
the first corporation that has been caught practicing dishonest
accounting, and we don't want them to be the only one accused
of it. A few at WorldCom have made the decision that investors
have tainted the work and reputation of many honest, hard
working employees. Shareholders who trusted and believed in
your company and its leaders and investors whose pensions were
tied to WorldCom stock must piece together their portfolios in
retirement.
Now is not the time to characterize an entire company and
all its employees based on the illegal actions of a few
individuals. Now is the time for answers. Now is the time for
sound policies, not rhetoric. It is my hope that this hearing
will foster the resolve of government leaders and corporate
America to end corporate fraud and accounting irregularities.
At the very least, we should all come away from this hearing
demanding tougher penalties for those who misrepresent
financial information. Those who are responsible should and
must be held accountable.
As the Congressman who represents WorldCom headquarters, I
pledge to WorldCom employees, former employees, investors and
the American public my wholehearted effort to get to the bottom
of this tragedy.
Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. The
gentleman from New Jersey.
Mr. Ferguson. Mr. Chairman, I just ask unanimous consent
that my opening statement be entered in the record.
[The prepared statement of Hon. Mike Ferguson can be found
on page 159 in the appendix.]
The Chairman. Without objection, all the opening statements
will be made part of the record.
The Chair will now introduce our first panel of witnesses.
Mr. Melvin Dick, former Senior Global Managing Partner,
Technology, Media, and Communications Practice, Arthur
Andersen, appearing voluntarily; Mr. Bernard J. Ebbers, former
Chief Executive Officer of WorldCom, appearing under subpoena;
Mr. Scott Sullivan, former Chief Financial Officer of WorldCom,
also appearing under subpoena; and Mr. Jack Grubman,
Telecommunications Analyst, Salomon Smith Barney, appearing
voluntarily.
Gentlemen, you are aware that this committee is holding an
investigative hearing, and when doing so the Chair may decide
to take testimony under oath. Do any of you have any objection
to testifying under oath? The Chair then advises each of you
that under the rules of the House and the rules of the
committee you are entitled to be advised by counsel at the
table. Do any of you desire to be advised by counsel during
your testimony today?
Mr. Sullivan. Yes.
The Chairman. The gentleman, Mr. Sullivan, wishes to be
represented by counsel at the table?
Mr. Sullivan. Yes.
Mr. Dick. Yes.
The Chairman. And Mr. Ebbers as well?
Mr. Ebbers. Yes.
Mr. Dick. Yes.
The Chairman. In that case, would you please identify your
counsel for the record, Mr. Sullivan.
Mr. Sullivan. Irv Nathan.
The Chairman. Mr. Dick, did you indicate you wished to be
represented by counsel as well?
Mr. Dick. Yes.
The Chairman. And would you indicate the name of your
counsel, please?
Mr. Dick. Yes, it is Eliot Lauer, of Curtis Mallet-Prevost
Colt and Mosle.
The Chairman. And Mr. Ebbers.
Mr. Ebbers. Reid Weingarten.
The Chairman. And I would ask the counsel, the
aforementioned counsel to pull up chairs beside the witnesses,
or as close as you can get.
Counsel, you may move forward to sit at the table. Counsel,
will you be giving testimony today? Simply in an advisory
capacity. In that case, I would ask the witnesses to rise and
raise your right hand.
[witnesses sworn.]
The Chairman. You are sworn in. Each of you is now under
oath. You may now give up to a 5-minute summary of any written
statement that you may have, beginning with Mr. Ebbers.
TESTIMONY OF BERNARD J. EBBERS, FORMER CHIEF EXECUTIVE OFFICER,
WORLDCOM
Mr. Ebbers. Good afternoon, Mr. Chairman and members of the
committee.
I served as CEO of WorldCom for 17 years. During that time
I helped a small company rise to one of America's largest
corporations. I am proud of the work that I did at WorldCom,
and I believe that despite its recent problems WorldCom
continues to be a valuable company that provides important
services to many Americans and to the United States Government.
Within the last 2 weeks, following a restatement of
earnings by WorldCom, officials at the Department of Justice,
the SEC, various Congressional committees, and other law
enforcement agencies have launched a number of investigations
and proceedings relating to WorldCom.
Countless reports in the media have suggested that my
conduct as a WorldCom CEO may be examined in these inquiries.
During the last week I retained counsel to represent me in
connection with these proceedings. Although I would like, more
than you know, to answer the questions that you and your
colleagues have about WorldCom, I have been instructed by my
counsel not to testify based on my fifth amendment
constitutional rights.
After careful consideration I have decided to follow my
counsel's instructions, even though I do not believe I have
anything to hide in these or any other proceedings. I have
reached this decision because, one, the investigations appear
to be open-ended examinations of a variety of activities at
WorldCom, details of which have not been provided to me.
Second, I have not been advised of the specific conduct of
mine that is being called into question, and, third, I
understand that preliminary statements can be taken out of
context, as inquiries such as these become focused over time.
I hope the committee will not draw a negative inference
based on my assertion of these constitutional protections on
the instruction of my counsel or attempt to subject me to
ridicule by asking inflammatory questions, knowing that I will
not answer them.
I do not believe that I should be subject to legal harm as
a result of my exercise of a basic constitutional protection
found in the Bill of Rights. When all of the activities at
WorldCom are fairly aired, and when I get the opportunity, and
I am very much looking forward to it, to explain my actions in
a setting that will not compromise my ability to defend myself
in the legal proceedings arising out of the recent events, I
believe that no one will conclude that I engaged in any
criminal or fraudulent conduct during my tenure at WorldCom.
Until that time, however, I must respectfully decline to
answer the questions of this committee on the basis of my fifth
amendment privilege.
Thank you, Mr. Chairman.
Mr. Sandlin. Mr. Chairman, may I ask a question?
The Chairman. The Chair is recognizing the witnesses. If
the gentleman would suspend.
Mr. Sandlin. Yes.
The Chairman. Mr. Sullivan.
TESTIMONY OF SCOTT SULLIVAN, FORMER CHIEF FINANCIAL OFFICER,
WORLDCOM
Mr. Sullivan. Mr. Chairman, I have no prepared statement.
Based upon the advice of counsel, I respectfully will not
answer questions based upon my fifth amendment right to the
United States Constitution. I ask that the record be entered
for my counsel's written letter this morning to the committee.
The Chairman. Without objection. The letter will be
considered part of the record.
[The following information can be found on page 247 in the
appendix.]
The Chairman. Mr. Dick.
Mr. Dick. Chairman Oxley--
Mr. Sandlin. Mr. Chairman, can I ask a procedural inquiry
before we go further?
The Chairman. The gentleman will suspend. The gentleman
from Texas.
Mr. Sandlin. Mr. Chairman, Mr. Ebbers appeared before us
today. He took an oath. He then attempted to make an
affirmative statement, self-serving statement before this
committee, and then attempted to take the fifth amendment. It
is my position he has waived the fifth amendment. He is subject
to the jurisdiction of this committee. He must testify. I am
asking the committee to hold him in contempt, that it be
submitted to the floor of the House, that the U.S. Congress
hold him in contempt and he be required to testify.
To come up here and say that he has engaged in no criminal
activity and to set forth his affirmative statements in his
defense and then to refuse to testify is an outrage. It is not
in conjunction with the United States Constitution.
I suggest that he consult with his attorneys and then that
we hold him in contempt until such time as he elects to go
along with the subpoena of the committee and testify before us.
He did not take the fifth. Mr. Sullivan did it properly. Mr.
Ebbers is required to testify, and we should make him do that,
hold him in contempt until he decides to become forthcoming.
The Chairman. The gentleman's--it will be taken under
advisement. We now turn to the witness, Mr. Dick.
TESTIMONY OF MELVIN DICK, FORMER SENIOR GLOBAL MANAGING
PARTNER, TECHNOLOGY, MEDIA, AND COMMUNICATIONS PRACTICE, ARTHUR
ANDERSEN
Mr. Dick. Chairman Oxley, Congressman LaFalce, members of
the committee. I am Mel Dick. I am a graduate of the University
of South Dakota. Upon graduation in 1975 I joined Arthur
Andersen as a staff auditor. I was a partner at Andersen until
I left Andersen on June 1st of this year. I have spent the
majority of my career working with diverse telecommunications
companies.
Beginning with WorldCom's fiscal year ended December 31,
2001, I became the engagement partner responsible for
Andersen's audit of WorldCom. In addition to the year-end
audit, Andersen's work included quarterly reviews for the
first, second and third quarters of 2001 and the first quarter
of 2002.
On June 1st, 2002, I resigned from Andersen. I am presently
serving as the Executive Vice President and Chief Financial
Officer for an apparel company. One week ago today, on July 1,
while I was on a business trip, I was contacted by counsel for
the committee and invited to attend today's hearings. Through
my attorney I offered my full cooperation with the committee's
work, and I agreed to attend this hearing voluntarily.
The chairman's letter of invitation refers to the
disclosure by WorldCom on June 25th that approximately 3.1
billion in expenses were improperly booked as capital
expenditures in 2001, an additional 797 million of expenses
were improperly booked as capital expenditures in the first
quarter of 2002. The newspaper reports that I have read alleged
that senior financial management at WorldCom improperly
transferred line costs to capital accounts in the company's
accounting records.
Let me state clearly, and without any qualification, that
prior to June 21, 2002, when Andersen was first contacted about
this matter, neither I, nor any, to my knowledge, nor any of my
team members had any inkling that these transfers had been
made.
In fact, in connection with our quarterly reviews and our
year-end audit, the Andersen audit team specifically asked
WorldCom senior financial management whether there was any
significant top-side entries. On each occasion, management
represented to Andersen that there were no such items.
The fundamental premise of financial reporting is that the
financial statements of the company, in this case WorldCom, are
the responsibility of the company's management, not its outside
auditors.
WorldCom management is responsible for managing its
business, supervising its operational accounting personnel and
preparing accurate financial statements. It is the
responsibility of management to keep track of capital projects
and expenditures under its supervision. The role of an outside
auditor is to review the financial statements to determine if
they are prepared in accordance with generally accepted
accounting principles, and to conduct its audit in accordance
with generally accepted auditing standards, which require that
auditors plan and perform and obtain the audit, to obtain
reasonable assurance about whether the financial statements are
free of material misstatement.
Our audit and our reviews of WorldCom were performed by
experienced audit professionals. Our audit plan was the product
of a deliberative and diligent evaluation of a global
telecommunications company with over $100 billion of assets.
As with any audit, we planned our audit of WorldCom in
general reliance on the honesty and integrity of management of
the company. One of the key elements of evidence all auditors
rely upon is management's representations. As all auditors do,
we also tested and, based on our tests, concluded that we could
rely on management's process and internal controls, including
the internal audit function.
We relied on the results of our testing and the
effectiveness of these systems in planning and performing our
audit. At the same time we approached our work with a degree of
professional skepticism, alert for potential misapplication of
accounting principles.
Additionally, we performed numerous analytical procedures
at various financial statement line items, including line
costs, revenues in and plant and service, in order to determine
if there were significant variations that required additional
work. We also utilized sophisticated auditing software to study
WorldCom's financial statement line items, which did not
trigger any indication that there was a need for additional
work.
In performing our work we relied on the integrity and
professionalism of WorldCom senior management, including Scott
Sullivan, WorldCom CFO, and David Myers, WorldCom Controller,
and their staff. If the reports are true that Mr. Sullivan and
others at WorldCom improperly transferred line costs to capital
accounts so as to misstate the company's actual performance, I
am deeply troubled by this conduct.
In addition, if reports are true that WorldCom's internal
auditors discovered these entries, I would be very interested
to know how and when they discovered these entities. I do not
know the specifics of what Sullivan did or directed others at
WorldCom to do, and I have not had an opportunity to review the
entries at issue here.
I understand that Mr. Sullivan has acknowledged that he
never told Andersen about the accounting he is said to have
employed. At this point, however, while I can explain our
general approach to the WorldCom audit and explain generally
the work we did, I do not have enough information to comment on
the entries that WorldCom senior financial management are said
to have made or how they were hidden from Andersen auditors.
Mr. Chairman, I will answer any questions you or the
members of the committee may have for me.
[The prepared statement of Melvin Dick can be found on page
182 in the appendix.]
The Chairman. Thank you, Mr. Dick.
Mr. Grubman.
TESTIMONY OF JACK GRUBMAN, TELECOMMUNICATIONS ANALYST, SALOMON
SMITH BARNEY
Mr. Grubman. Thank you, Mr. Chairman. My name is Jack
Grubman. I am a telecom analyst at Salomon Smith Barney. I
appreciate your invitation to appear before this committee
today, and I voluntarily did so.
Let me say I am saddened by why we are here. I am saddened
that people lost money. I am saddened that people lost jobs. I
am saddened that a major company is enmeshed in a major
scandal. But I want to commend you and everybody on this
committee for acting quickly to try to find out what went wrong
here.
WorldCom is a company that I believed in wholeheartedly for
a long time. It fit my long held, honestly held investment
thesis that the newer, more nimbler companies would create
value. It evolved into a company that had an unparalleled array
of global network assets and a huge customer base after its
merger with MCI. That view of the company made me believe it
was best positioned to grow within this industry.
However, beginning in March of this year, we began a series
of downgrades of our views due to a variety of reasons, SEC
inquiry, changing CEOs, continued guidance changes downward of
earnings, continued rating agency downgrades. On March 18th, we
increased our risk profile to high from medium. On April 21st,
I and others downgraded WorldCom stock from buy to hold based
on new company guidance.
We increased our risk rating again on May 9th to
speculative, our highest risk rating. And finally on June 21st,
we did a one-notch downgrade to market underperform. With
respect to that last June 21st downgrade, I am aware that there
is speculation that I had advance knowledge of this fraud. That
speculation is categorically false. I had no advance knowledge
whatsoever of this fraud. The June 21st downgrade was normal
course business. We were doing our end of quarter reviews for
all of our companies.
Before our downgrading, on Monday, June 17th, S&P
downgraded the debt two more notches. A day before our
downgrade Moody's downgraded the debt two more notches. In
addition, we were concerned about yet lowering numbers again.
We were concerned about continued softness in corporate America
and what that meant for telecom spending. We were concerned
about the bank facility and the negotiations around that.
The June 21st downgrade was just the latest in a series of
downgrades that we have done over the past 3 months, and we
were not alone in that. Many firms on Wall Street, including
Sanford Bernstein, who is a pure research house with no
investment banking, downgraded WorldCom's stock opinion several
times, and several had buy ratings til the bitter end,
including Sanford Bernstein.
As far as the topic of this hearing today, the fraud at
WorldCom, of course it influenced our analysis. The company's
public financial statements are a starting point for our work.
If the public statements are fraudulent, I and other analysts
have flawed information to go on. If we had had a truer picture
of WorldCom's financial results earlier, no doubt our opinion
would have changed. An equity research analyst has a job to
make judgments, to make forecasts about the industry and
companies they follow. You use publicly available information,
and you augment that by regular relationships and conversations
with company management, suppliers, customers, regulators, et
cetera.
Audited financial statement are very important in how we do
our work. That is a starting point of our work. But we are not
auditors, internal or external. Our judgments are only as good
as the public statements.
Two other quick topics before I end my statement. As far as
my relationships with managements of WorldCom and other
companies, I value close relationships with management. It
gives me the ability to put context around the numbers and
assess whether management can execute their business plans.
As far as investment banking conflicts with analysts, it
goes without saying in full service firms that research is a
product used by the bank. If a research analyst has stature and
credibility with investors and happens to have a favorable view
of a company, that will help get banking business. If, on the
other hand, you have an unfavorable view that will hurt. In all
instances, the lifeblood of an analyst's reputation and
credibility is integrity and honestly held research opinions
with investors, and that is something that I have always
practiced.
I have certainly made mistakes. I clearly did not call the
collapse of the telecom space over the last 2 years. All of my
beliefs have been honestly held, and I look forward to
answering all of your questions.
Thank you, Mr. Chairman.
[The prepared statement of Jack Grubman can be found on
page 186 in the appendix.]
The Chairman. Thank you, Mr. Grubman. The Chair will begin
the questions.
Mr. Dick, your responsibilities included the full range of
Arthur Andersen's Global Technology, Media and Communications
Service; that is, audit, tax and consulting, and you were the
lead engagement partner at USWest from 1987 through 1996, at
Level III Communications from 1998 through 2000. As you know,
Andersen billed WorldCom hundreds of dollars per hour for your
services, and yet you apparently missed the massive fraud
perpetrated by the WorldCom execs in 2001 and the first quarter
of this year, which included transfers of expenses to capital
expenditures exceeding $600 million in each of the five
quarters.
The obvious question is, how could your audit team miss
that senior financial managers were doing this and also fail to
identify transfers of such a massive amount during the annual
audit?
Mr. Dick. Chairman Oxley, we performed our audit in
accordance with generally accepted auditing standards, and let
me explain what that means. Initially, as we go through that
process of designing our audit plans and carrying out our audit
plans, we gain an understanding of the company's business. And
in the case of WorldCom we did. WorldCom was a company with a
hundred billion dollars of consolidated assets, $35 billion of
revenues for last fiscal year, roughly $15 billion of line
costs, and some $40 plus billion of plant and service.
In performing our audit, we gained an understanding of the
business. We gained an understanding of the transaction
processing systems that WorldCom used to produce those
financial statements. As you can imagine, a company of
WorldCom's size has literally thousands and thousands of
transactions that flow through its systems, of processing its
billings, collecting its cash from its customers, paying its
bills, et cetera.
As we planned our audit and executed our audit, we tested
those systems. But we didn't just test those systems, we also
looked at the financial statements as a whole. We looked for
significant variations between accounts, between year end. We
planned our audit in accordance with results from previous
audits. We plan our audits in accordance with the integrity of
the management controls and systems that are in place. And we
carried out our audits in those.
In addition, we used some very sophisticated software that
analyzes the financial statement line items and the
relationships on those line items, to determine if any
additional work needed to be done.
In addition to that, we did inquire of WorldCom's senior
management, their financial management, if they made any top-
side entries of the type that are purported to have been made,
and we did that on a quarterly basis and in connection with our
annual audit. In fact, we submitted a written list along with
that request and other schedules or analysis that we wanted
from the company.
The Chairman. Who did you submit that list to?
Mr. Dick. That list would have been submitted to senior
financial management, people underneath the direction of Mr.
Sullivan and Mr. Myers.
The Chairman. And who is Mr. Myers?
Mr. Dick. Mr. Myers is the former Controller of WorldCom.
The Chairman. And you have records of that, of that
correspondence?
Mr. Dick. We do.
The Chairman. Let me turn to Mr. Grubman. Mr. Grubman, you
have been saying that you over years had a personal
relationship with Mr. Ebbers, that you forged a close
relationship, I think, over pool games and greasy hamburger
joints.
In light of this unusually close relationship, did you ever
receive inside information about WorldCom that other investors
and analysts were not privy to?
Mr. Grubman. I had a good working relationship with Mr.
Ebbers and other managers within the telecom industry. And let
me--I will answer your question directly, but let me put this
in context. Like I said in my opening remarks, and in the
broader statement I filed with the committee, I think it is
very important for analysts to get to know management.
You have to put context around the numbers. You have to
assess their ability to run their business. In some of those
occasions there are social events. When you talk to a
management team, there is information that you glean that may
not be public but may not be material. For example, if an
analyst talks to companies regularly and learns about their
views on pricing in an industry, demand trends in the industry,
their opinion about regulatory policies, that is appropriate
color to get from management. And, in fact, Regulation FD
contemplated that with their new rules a couple of years ago.
The Chairman. Let me ask you this. Did you ever attend a
board meeting for WorldCom?
Mr. Grubman. Yes. And there are occasions when an analyst
does get material, nonpublic information. Analysts, including
myself, always try to avoid that. It conflicts you. You can't
talk to investors. And those instances occur very infrequently
and for short durations.
The Chairman. How many times did you attend a WorldCom
board meeting?
Mr. Grubman. To the best of my recollection, I have been to
maybe three WorldCom board meetings over the years.
The Chairman. Is it rather unusual for analysts to attend
board meetings?
Mr. Grubman. It is rare, as it has been for me over the
years. When you attend, it is usually in connection with a
specific event.
The Chairman. Were you the only member of the analyst
community at those particular board meetings?
Mr. Grubman. At the particular board meetings that I
attended, it was just myself and other members of my firm.
The Chairman. And so your testimony is that you attended
the board meetings, but that none of the information that you
received at that point were in any way used in your analysis or
recommendations?
Mr. Grubman. My testimony is, when I attended these board
meetings, which was only perhaps only three times over 12
years, it was for a specific transaction that Salomon Smith
Barney was advising WorldCom on. At those board meetings I was
privy to material, nonpublic information, that was then
released and publicly disseminated, usually within 1 to 2 days
after those board meetings. After then I was able to conduct my
business as normal.
The Chairman. It is safe to say that you did have a special
relationship with Mr. Ebbers and the board?
Mr. Grubman. I think I had a good working relationship with
Mr. Ebbers. I don't think I had a special relationship with the
board, no.
The Chairman. The gentleman from New York.
Mr. LaFalce. It is my understanding that in November of
2000, investors filed a securities fraud complaint charging
that MCI WorldCom, Messrs. Ebbers, Sullivan and other insiders
had concealed material, false information about its receivable
and earnings performance while personally unloading almost $80
million of stock at inflated prices.
It is my further understanding that ultimately that case
was combined with others, and plaintiffs filed a consolidated
amended class action complaint in June of 2001. Mr. Dick, Mr.
Grubman, as the auditor and as the analyst, were you aware of
the gravamen of those lawsuits?
Mr. Dick. I am sorry? Was I aware of?
Mr. LaFalce. The gravamen, the importance of them, the
thrust of them, the primary allegations of them?
Mr. Dick. Yes, I was aware of the lawsuit.
Mr. LaFalce. And Mr. Grubman, were you aware?
Mr. Grubman. I can't recollect now if I was aware at the
time. I am sure subsequently though I became aware.
Mr. LaFalce. At some time subsequent to November of 2000,
when it was initiated, as perhaps the premier analyst for
WorldCom are you telling me you weren't aware?
Mr. Grubman. I am saying at the specific moment you asked,
I am not--
Mr. LaFalce. How about sometime between November of 2000
forward?
Mr. Grubman. Yes. I probably became aware of that lawsuit.
Mr. LaFalce. Now, their complaint did allege that the
company, quote, ``resorted to a myriad of improper revenue
recognition and sales practices in order to report favorable
financial results.'' In March of 2002, the U.S. District Court
for the Southern District of Mississippi, did dismiss that
complaint. But the Court said that the reason it was dismissing
it is because it couldn't attain, quote, ``the heightened
pleading standard requirements for this type of case.''
By the way, those heightened pleading standards were
standards that were enacted by Congress when they passed the
PSLRA, the Private Securities Litigation Reform Act. But the
Court went on to say, that in reviewing the complaint, quote,
``the reader reacts by thinking that there must have been some
corporate misbehavior.''
Well, shouldn't the auditor and shouldn't the analyst have
reacted by concluding that there must have been some corporate
misbehavior, or is this something that just a federal court
judge on a casual reading of a complaint would conclude?
Mr. Dick.
Mr. Dick. When we performed our audits for 2001, our audit
testing and processes included looking at the company's revenue
systems, their billings to their customers. And we tested that
and did not find any--
Mr. LaFalce. What didn't you find that you should have
found? And why didn't you find it?
Mr. Dick. Well, as I said, when we performed ouraudit --
Mr. LaFalce. Not when you performed it. Looking back now,
what didn't you see that in retrospect you should have seen?
Mr. Dick. Chairman, sorry, Congressman, I can't respond
specifically to that question. I can only respond to the audit
work that we did do, because I do not know--
Mr. LaFalce. Let me ask you this. If you are an auditor for
a publicly traded corporation and serious lawsuits are brought,
does that not create some type of heightened requirement on the
part of the auditor to at least investigate more carefully what
the allegations of wrongdoing are?
Mr. Dick. Yes. In connection with our audit, we did do work
on WorldCom's revenue systems, and we also discussed this with
WorldCom's corporate counsel and their external counsel
representing them in this case, and satisfied ourselves as to
the appropriateness.
Mr. LaFalce. Did you discuss this with the counsel for the
investors?
Mr. Dick. No, I don't believe so.
Mr. LaFalce. Do you think that might be a good idea in the
future?
Mr. Dick. I can't speak to that, Congressman. I don't know.
Mr. LaFalce. You don't know whether that would be a good
idea or bad idea?
Mr. Dick. Not necessarily being considered--
Mr. LaFalce. Mr. Grubman, as the premiere securities
analyst, what heightened diligence did you adopt when you did
determine that there were these serious allegations of
corporate misbehavior?
Mr. Grubman. As a matter of course, the receivables write-
down of course we were all aware of, because they did it in the
third quarter of 2000 on their publicly disseminated earnings
call, went through the reasons for that. As far as this
specific instance, I don't recall specifically the type of
things we did. But, broadly speaking, when an inquiry like this
comes up--
Mr. LaFalce. Broadly speaking means you just don't know
what you did with respect to WorldCom; is that correct?
Mr. Grubman. No. What I am saying is, again, we start with
the public financial statements. We obviously questioned all
companies, including WorldCom, about the reasonableness of
those numbers and what is behind their numbers. But we don't
have, nor are companies required to give equity analysts access
to invoices, audit trails and the like.
Mr. LaFalce. Let me ask this question of Mr. Dick and Mr.
Grubman. Mr. Dick, it is my understanding that the consulting
fees for Arthur Andersen were about twice as much or more as
the auditing fees, and I am wondering if you had any
responsibility for pursuing consulting fees. And Mr. Grubman, I
am wondering what the investment banking fees were for your
company for WorldCom and whether or not your compensation was
in any way related to the amount of investment fees that were
generated for your company.
The Chairman. The witness may respond. The gentleman's time
has expired.
Mr. Dick. The Arthur Andersen fees, 2001, were
approximately $16.8 million, of which 4.4 million related to
the annual audit services, 7.6 million related to tax services,
another 1.6 million that related to nonfinancial statement
audit services, and then all other fees of $3.2 million, none
of which included any fees for work on financial systems,
design or implementation.
Mr. Grubman. As far as the fees to Salomon Smith Barney, I
don't know the precise number. But I will estimate that from
about 1998 through 2001, cumulatively, I want to say roughly
$80 million, but I don't know an exact number. As far as my
compensation, it is a function of many factors, one of which
that goes into that factor is banking revenues to the firm. I
have no direct tie to banking revenues in terms of a direct
percent of banking revenues or fee-by-fee type of thing.
And just to try to be a little more responsive to your last
question, when things like lawsuits come public for a company,
unlike with auditors, where there is one auditor per firm,
there are dozens and dozens of analysts and thousands of
investors and rating agency folks that follow a company like
WorldCom, very widely followed, very widely held. So the entire
body of research community, debt and equity, buy side and sell
side, in a continuum continually question the company,
especially when something like this happens. But again, we can
only start with what is filed publicly.
The Chairman. The gentleman from Iowa, Mr. Leach.
Mr. Leach. Well, thank you, Mr. Chairman. I wanted to
return to a comment of Mr. Manzullo earlier when he said issues
come down to faces. I represent 3,000 WorldCom employees in
Cedar Rapids, Davenport and Iowa City, Iowa. Let me tell you,
they are pretty upset. They wonder what happened at the top.
They wonder about their futures. They are hard working, decent
folk.
I also represent an insurance company that informed me this
weekend that they held millions and millions of dollars of
WorldCom debt. They have assets to easily handle this, but they
are fit to be tied. And like everyone on this panel, we
represent thousands of people who held WorldCom stock,
thousands more who didn't but whose stock has gone down because
of the loss of confidence in the market, because of companies
like WorldCom.
And what I would like to get at a little bit, first on the
accounting side, we learned from the Enron circumstance that
Arthur Andersen followed in its view generally accepted
accounting practices even though Enron had 2 or 3,000 off-shore
entities that clearly booked profits in such a way that they
didn't reflect a fair view of the company, and it is a fair
view of the company which is the most important thing.
We hear today a very different story from Andersen, which
is, as I hear it, that the wool was pulled over your eyes. Now,
the question I have here is that accounting is the one
profession that you are supposed to, as early as possible, to
see evil, hear evil and report evil, none of which occurred
here.
And so one of the larger queries from an accounting
perspective is that it is, as I understand it, one of the
duties of certified public accountants to look diligently for
fraud. It is one of the duties of a certified public accountant
to be particular suspicious if there are aspects of the company
that seem to be getting in a little bit of difficulty. And
there seems to be what appeared, in retrospect, to be efforts
to report profits even though they might not have existed.
And so when we get down to this, the question is, you have
a very major company that you are looking at. Did you have
adequate personnel? Did you have adequate diligence? Did you
look at this circumstance as one in which the public interests,
the employee interests was first and foremost your concern, or
was it one of just doing a job that was related to other jobs
that were also created for your company in other kinds of ways?
Mr. Dick. No. We did in fact look at and approach this
audit with those views in mind. I led a very experienced team,
including other partners and managers that worked on the audit
of Enron. We planned our audit, took into consideration our
previous experience from prior audits, took into consideration
our understanding of the company's business environment, their
processes, their procedures and their controls. And we tested
it, and we did not see anything that came to light, as has been
purported to come to light.
Mr. Leach. Well, all of us know we have done things in life
that have been less perfect than otherwise. But the fact of the
matter is that we rely in our system on good numbers, and we
rely on certified public accounts for a vigorous effort.
And when things go astray, they are truly remarkable in
their consequences. And this consequence is not just to a few
officers, but to all of the employees, and in a systemic way,
to American society.
And I think the lessons here are very large for public
accountants. And of all of the professions I know of that we
want to reinvigorate with trust, it is your profession. And yet
of all of the circumstances that have developed where it is
pretty hard to do it at this time, it is your company.
And so I am wondering if you want to tell the Committee if
you think you had a systemic problem within your company, or is
this an aberration. As we also heard this morning that you are
no longer the largest series of losses, you have got another
company that is almost triple the size of your losses that were
perhaps improperly booked, or profits that were improperly
booked, by also your company.
Did your company pursue a strategy of easy accounting to
get clients?
Mr. Dick. I don't believe our company did. I can tell you,
as we executed on our audit of WorldCom in addition to all of
the testing we did, basic premise, as I mentioned in my opening
remarks, is that in addition to relying on the management
processes and procedures and the controls in place, we do as
auditors, as all auditors do, rely on the integrity and the
competence in management. And based on our planning, we had no
reason to believe there would be any indication that the
purported activities would take place or did in fact take
place.
You know, your responsibilities under generally accepted
auditing standards is to make sure when we do our audit that we
properly plan it, we properly execute it, that we consider the
processes and procedures, and that the financial statements are
free of material misstatement, be it from misapplication of
accounting principles or from fraud. In--not all cases, though,
can there be absolute assurance that there will not be the type
of activities that are purported to have taken place at
WorldCom.
Mr. Leach. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. The
gentleman from Massachusetts, Mr. Frank.
Mr. Frank. Mr. Chairman, first just a statement about Mr.
Ebbers' statement, not about WorldCom, but about the legal
profession. Your counsel did not instruct you to do anything
unless you are working for him, which would be an odd
relationship. Counsel may advise you. You may follow the advice
or not. But people often like to blame lawyers for even more
than lawyers ought to be blamed for. And they are not in a
position to instruct their clients.
Mr. Dick, I was somewhat struck, I am learning, as a lot of
my colleagues are, about various things. There may be less to
accounting than meets the eye.
On page 2 you say, "The fundamental premise of financial
reporting is that the financial statements of a company...are
the responsibility of the company's management, not its outside
auditors." .
Now, I hadn't thought that an either/or proposition. What
you are telling me here is--in English--it is not your
responsibility. I must say I felt a little bit like Mr.
Grubman, too. I will get to this, but I have had occasion to
quote the great sage Tom Lyra, and it is the Wernher von Braun
song when he talked about the V-2 rockets: When the rockets
come up, who cares where they come down? That is not my
responsibility said Wernher von Braun. And I think we are
getting a little bit of that here.
Audited statements from one of the big accounting firms are
not the responsibility of the outside auditors? Is that
correct?
Mr. Dick. Well, the financial statements themselves and the
preparation of those financial statements--
Mr. Frank. Mr. Dick, we know what we are talking about. We
only have like 5 minutes. Do you really mean to say that the
financial statements are not the responsibility of the auditing
firm? They can be the responsibility of both. Is there no--is
there no responsibility on the part of the auditing firm for
the audited statements?
Mr. Dick. Well, the auditing firm's responsibility is to
perform their audit in accordance with generally accepted--
Mr. Frank. What do you guys do, just check the arithmetic,
give them a gold star if they added right? This is a very
minimalist function that you are describing. I am reading your
statement. Clearly what this conveys is that you have no
responsibility for those statements. The fundamental premise is
that the financial statements are the responsibility of
management, not its outside auditors, no responsibility on your
part for the statements?
Mr. Dick. The outside auditor's responsibility is to
perform an audit of those financial statements and to plan and
perform that audit to--
Mr. Frank. Mr. Dick, you are not answering the question. Do
you have any responsibility for the statements? None
whatsoever?
Mr. Dick. In my prepared remarks I indicated that the audit
is--
Mr. Frank. I just read your prepared remarks. We know what
is in them. I am trying to get you to tell me if you stand
behind them. Is it your position that the auditors have no
responsibility, what this would imply, for the financial
statements?
Mr. Dick. Well, the audit responsibility is to audit in
accordance with generally accepted auditing standards, and to
ensure--
Mr. Frank. I understand. But I asked you a direct question
whether or not you have responsibility. If someone reads a
financial statement and it says audited by X accounting firm,
should I think that the firm takes some responsibility for
that?
Mr. Dick. Well, those statements are prepared by management
and audited by the accounting firm.
Mr. Frank. Gee, I congratulate you on your ability to evade
so calmly, Mr. Dick. I think what we are getting here, frankly,
is an underassessment. Let me put it to you this way. I think
in general, in other contexts, auditing firms don't give
themselves such a small role.
Mr. Grubman, a couple of questions here. When you mentioned
going to the board meetings, I was a little surprised because
you said you went to those board meetings to help them with
financial transactions. That is part of the conflict that
bothers me. You are an independent analyst, theoretically, but
then you go to board meetings and help structure transactions
which you then later independently analyze? Does not that cause
you some troubles?
Mr. Grubman. I didn't say that. What I said is on the few
occasions that I went to those board meetings it was to comment
on pending announcements of mergers.
Mr. Frank. Well, I am pretty sure you said, we can check
the transcript later, because you were doing transactions with
them.
Mr. Grubman. When I say transactions, I meant merger and
acquisition.
Mr. Frank. Were you advising on those?
Mr. Grubman. Salomon Smith Barney--
Mr. Frank. No, you, Mr. Grubman.
Mr. Grubman. No. I as the research analyst when I am--
Mr. Frank. I know what you are. We only have a few minutes.
Mr. Grubman. I am trying to answer this.
Mr. Frank. You went to the board meeting, your company,
Salomon Smith Barney, is advising on a merger. You are there as
the analyst. Who is paying you to go there to do what?
Mr. Grubman. I am there only to provide the market color,
the likely--
Mr. Frank. The market color? What are you, Phil Rusito?
What do you mean, the market color? I don't understand. You do
the chatter? What does that mean?
Mr. Grubman. I am there, as other analysts in similar
situations and other transactions are there, to provide what is
the likely investor reaction to a deal that is--
Mr. Frank. But you have given them advice which they should
take into account, presumably, when you tell them what you
think the investor reaction is going to be; that is something
presumably that they take into account in making decisions,
correct?
Mr. Grubman. It is--my involvement comes in--
Mr. Frank. Mr. Grubman, how cautious can you be? You mean
you tell them things and the assumption is they are going to
pay no attention whatsoever you do. What are you there for,
lunch?
Mr. Grubman. No. What I am saying is after a transaction
has already been contemplated, and decided to go forward, I am
then there in a very short period--
Mr. Frank. You are telling me you give that information
only after the final decision has been made? It is never a
factor in the decision?
Mr. Grubman. That is typically the--
Mr. Frank. I didn't say typically. Don't be so cautious
where you don't answer my question. I am asking, in any of
those instances, were you giving advice before the transaction
was completed, advice about how the market was going to react,
advice of any kind?
The Chairman. The gentleman's time has expired. The
gentleman may answer.
Mr. Grubman. As I said, I typically--
Mr. Frank. I didn't ask what you typically did. I said what
you actually did.
Mr. Grubman. I am trying to--
Mr. Frank. You are trying to not answer the question. But
what did you actually do in these three cases? Did you give
information before the transactions were completed?
Mr. Grubman. In all three cases, right before the
transactions were completed I was asked to give investor
reactions. How far before--
Mr. Frank. Which reaction you subsequently shaped or helped
shape?
Mr. Grubman. Well, you know, once the transactions are
publicly disseminated, there are a lot of people who follow
this stock, a lot of investors. I am a voice. I am not going to
not acknowledge that I have a significant voice. But I am one
of many voices.
Mr. Frank. We have--I just would say one thing. We have
increased substantially the modesty factor in the financial
profession, at least for today.
The Chairman. The gentleman from Louisiana, Mr. Baker.
Mr. Baker. Thank you, Mr. Chairman. Mr. Grubman, I want to
thank you for your voluntary participation here today. I think
it is a value to have those involved in this misfortune to give
some perspective on what occurred so we can, in some form or
fashion, move to remedy this for future instances.
I need ask a few background questions before I get to my
main point. Page 3, third paragraph, you say: ``Let me say
again I have no advance knowledge of any kind about WorldCom's
accounting fraud. I first heard about it when it was reported
late in the day June 25 on CNBC.''
To what fraud were you making reference?
Mr. Grubman. To the $3.8 billion fraud.
Mr. Baker. I assume that, for the record, you have a
professional working relationship, or had with Mr. Scott
Sullivan at the time that these activities were engaged?
Mr. Grubman. Yes. Mr. Sullivan and I had a good working
relationship over the years.
Mr. Baker. For the same purpose, you have a professional
working relationship with Mr. Robert A. Waldman, Salomon Smith
Barney corporate bond research analyst?
Mr. Grubman. Yes. He is the bond analyst.
Mr. Baker. And, Mr. Grubman, for the record you were the
senior telecommunications analyst for Salomon Smith Barney at
the time of these transactions?
Mr. Grubman. At the time of?
Mr. Baker. Of the event.
Mr. Grubman. Yes.
Mr. Baker. For the record, Mr. Chairman, I want to make it
clear that the statement of Mr. Grubman in his written
testimony, verified orally, establishes no prior knowledge of
any accounting fraud, specifically a $3.8 billion off balance
sheet transaction, prior to June 24th. I have been provided e-
mail, and don't know the varacity of these, Mr. Grubman. So I
will say that in that light. But they are very troubling.
Mr. Robert Waldman sends an e-mail to Scott Sullivan on the
morning of June 24th at 10 o'clock. Quote, ``things are nuts
again. Latest rumors are now that WCOM,'' I assume that is
WorldCom, ``has an undisclosed 3 billion off balance sheet
liability, and that by not buying on the MCI PFD dot,''
whatever that is, ``the company has no ability to upstream
cash. I cannot overemphasize how important communication is
with the market. Even if there is not anything new, it still
gives the market access to you, Bob.''
At 10:42 a.m. on June 24th: ``Good afternoon. Our bond
analyst, Robert Waldman, published a WorldCom note which we
thought would be of interest to our clients. Please see
attached.'' That is from you to an undisclosed recipient
because the name was redacted.
I then turn to a June 24th Salomon Smith Barney publication
from the Corporate Bond Research Division which indicates ``we
want to clarify a couple of statements to the bond market made
in a recent research report by Jack Grubman.'' And one of the
signatories on that document is Mr. Robert Waldman.
I raise that to only establish that there appears to be a
day-to-day business relationship between the three principals
to whom I make reference, and that it would be a very difficult
thing for me to conclude that a memo coming into the office at
10 o'clock in the morning, making reference to the off balance
sheet transaction on which you would then make further comment
at 10:42 to the undisclosed recipient, that there was not some
communication as to the potential downside consequences of the
discovery of the WorldCom off balance street transaction.
Can you give me your response?
Mr. Grubman. Yes. First of all, the e-mail you referred to
coming from me to clients attaching Waldman's corporate
research note, that was his separate corporate research note
that we became aware of that he publicly disseminated to his
clients. The e-mail that you refer to from Mr. Waldman to Mr.
Sullivan I knew nothing about. In fact, I did not know a thing
about it until this morning when members of my firm told me
about it, and I actually did not physically see it until
literally when you were talking and it was given to me.
Mr. Baker. Well, you can understand my reason for concern.
Three professionals who work on a day-to-day basis transacting
this sort of business activity, sharing perspectives and
comment for the benefit of your clients and that at 10 a.m. a
document comes in which you today say you had not seen.
Mr. Grubman. I never saw it.
Mr. Baker. And then 42 minutes later a transmission is out
of the office which makes reference to something which was not
disclosed to me. Mr. Chairman, I wanted to insert all three
documents for the record. I think it warrants further inquiry
at the appropriate time.
The Chairman. Without objection.
[The following information can be found on page 206--208 in
the appendix.]
Chairman Baker. Mr. Ebbers, did you authorize or did you,
or were you aware of the $3 billion off balance sheet
transaction which resulted in the restatement at a subsequent
time?
Mr. Ebbers. On the instruction of counsel I respectfully
decline to answer on the basis of my fifth amendment
constitutional right.
Chairman Baker. Mr. Chairman, I would like to raise a point
of order established earlier in the record wherein the
gentleman did invoke his fifth amendment privilege pursuant to
a statement of purpose for being in appearance before the
committee today.
It is my understanding on counsel's advice from the
committee, at your instruction, Mr. Chairman, that anything
brought to the attention of the committee in the gentleman's
statement may be within the purview of appropriate question.
Matters not raised by the gentleman in his defense statement
would be subject to fifth amendment protection.
Could the Chair advise as to whether or not that is the
ruling?
The Chairman. The Chair would first ask the witness. Mr.
Ebbers, is it your attention to refuse to answer all questions
based upon your fifth amendment right against self-
incrimination?
Mr. Ebbers. Yes.
The Chairman. At this time the Chair would note that the
witness, Mr. Ebbers, has invoked his fifth amendment right
against self-incrimination. It appears to the Chair that
questions closely related to the matters discussed by Mr.
Ebbers in his opening statement may be permitted. However, in
the event the witness chooses to refuse to answer such
questions, any vote on a contempt of Congress resolution would
occur at a later time after proper committee consideration.
Because the Chair does not have a copy of the witness'
opening statement, it is impossible to determine as to which
matters he has waived his fifth amendment privilege against
self-incrimination. Therefore, the chairman would reserve the
right to recall the witness in the future to answer such
questions as concern matters he discussed in his opening
testimony.
Mr. Baker. Just to follow up, I have clear recollection,
and I think it will be in the public record without any
question, that the gentleman expressed some concern that he had
not yet been, as of this date, been made aware of the actions
which would cause questions of his conduct.
The gentleman, Mr. Grubman, referred to the fraudulent acts
on questioning as the transaction involving the $3.8 billion
off balance sheet fund allocation which resulted in the
downgrading of the stock and the significant stock losses that
occurred thereafter.
It is my opinion, Mr. Chairman, and I ask for your ruling,
that to ask Mr. Ebbers, pursuant to his fifth amendment
invocation notwithstanding, that questioning the gentleman with
regards to the transaction relating to the off balance sheet
$3.8 billion fund move is within the scope of his statement,
because he has indicated he is not aware of what he did that
related to the alleged fraudulent conduct, which is the
movement of the $3.8 billion.
I would suggest to the chairman that failing to answer that
question is now clearly in contempt of the committee's actions.
The Chairman. If the gentleman would yield, the Chair would
indicate that he will keep that under advisement. We will check
the testimony in the presented record, the official record, in
that regard.
Mr. Baker. If I may, Mr. Chairman, just reserve, with the
indulgence of the minority, reserve at an appropriate time,
pursuant to advice of House counsel, to revisit the issue at
the appropriate time during the hearing when judgments have
been rendered.
The Chairman. Without objection.
Mr. Sandlin. Point of order, Mr. Chairman.
The Chairman. The gentleman from Texas seeks a point of
order.
Mr. Sandlin. I am not aware of this new theory of selective
fifth amendment. I believe clearly that the witness appears
before our committee under subpoena. He was sworn in. The
jurisdiction of the committee was invoked. He made affirmative
statements, as has been indicated by my colleague and friend
from Louisiana, attempting to absolve himself of liability and
indicating he had no knowledge of the information before us,
and then refusing to testify.
It is my position he has waived his fifth amendment
protections for all purposes. He is now before the committee to
testify on a broad range of issues any question we may ask him.
In the event that the Chairman wants to examine this further as
far as his statement, his written statement should be provided
to the committee forthwith, that we should right now hold him
in contempt of court. The Chairman should--contempt of the
committee. The Chairman should set a hearing now for the
contempt proceeding, and we could at that time take testimony
from Mr. Ebbers, an explanation to show cause order or whatever
to show cause why he should be held in contempt.
Mr. Baker. Would the gentleman yield?
Mr. Sandlin. I would yield.
Mr. Baker. I would suggest in deliberative fairness that we
check the record with regard to his statement in response to
the question asked relative to the movement of $3.8 billion off
the balance sheet. Should it be determined at that time that
that was within the purview of the--not within the fifth
amendment privilege, at that time it would be appropriate--or I
would suggest that a motion should be offered with regard to
finding the gentleman in contempt.
Mr. Sandlin. Reclaiming my time. That would be fine. But,
Mr. Chairman, I want to make sure we go forward with this and
take care of it. It is important to the committee, and while I
agree with my colleague from Louisiana that the information
concerning the $3.8 billion in the accounting practices were
clearly waived, I believe we should also look at the issues as
far as the fact that every protection of the fifth amendment
has been waived. He is now before the committee for all
purposes.
The Chairman. I thank the gentleman.
The gentleman from New York Mr. LaFalce.
Mr. LaFalce. Mr. Chairman, of course it was my desire that
Mr. Ebbers would come before us and testify, and I would have
been amazed if he decided to do so, and I would have been
amazed given the gravity of the allegations that have been made
had he not invoked the fifth amendment privilege.
The question of waiver of a fifth amendment privilege is a
complex legal issue, and I personally would like to have time
for our staff to do the legal research that I think is
necessary in order to make an objective judgment as opposed to
a political judgment as to how we should proceed. So I reserve
judgment myself and trust that the Chair, too, will reserve
judgment until such time as we are able to do appropriate,
thoughtful legal research and then render a judgment.
Mr. Frank. Mr. Chairman.
The Chairman. Mr. Frank.
Mr. Frank. Mr. Chairman, we have a lot of things that we
want to correct in this world, terrorism and now some, although
not comparable, terrible financial abuses, but there's a common
thread, and that is we still have a Constitution. And while I
agree that we could do research here, I want to say now--and I
don't know what we'll be dealing with when we come back--I am
in favor of a pretty broad view of the U.S. Constitution. We
are, after all, a legislative body. Our major role is to try to
make laws. I think we should make some.
I think we suffer here from a system in which there's a
kind of an aggressor's law going on in which bad practices
drive out good practices or diminish them because people get a
competitive advantage for doing things that they don't really
do. But we are not a prosecutorial body, and my own view is
that we ought to be very, very reluctant to be narrowing
constitutional protections.
And I don't want to make our constitution protections traps
for the unwary. I think it would be a mistake for us to try and
come up with a new theory of waiver in this sort of a
situation, and the Chairman would have had a right to say, if
you're going to plead your right of self-incrimination, you
don't get to make a statement. But I myself would want to have
a much more explicit waiver before I would want to say that
constitutional rights get subordinated.
And I just think that this is a time when we have to be
very careful that our determination to deal with a lot of
problems doesn't lead to any diminution of the Constitution. I
would rather err on the side of overinterpreting rather than
underinterpreting constitutional rights.
The Chairman. The Chair is prepared to rule. It's obvious
that the gentleman will continue--
Ms. Waters. Will the gentleman yield?
The Chairman. It is obvious that the gentleman will
continue to invoke his fifth amendment rights. That being the
case, the Chair has no option but to excuse this witness from
further testimony today. The Chair would instruct the witness
that he reserves the right to recall Mr. Ebbers at any time,
and the witness is therefore--
Ms. Waters. Mr. Chairman. Mr. Chairman.
The Chairman. Are there further questions for the
witnesses?
Mr. Kanjorski.
The Chairman. For the purpose of questioning the witnesses?
Ms. Waters. On the ruling that you just--
The Chairman. Gentlelady from California.
Ms. Waters. Mr. Chairman, I recall very specifically that
in Mr. Ebbers' opening statement, he admonished us not to ask
him questions because he intended to exercise his
constitutional fifth amendment right. It's all right for him to
exercise that right, but it's not all right for us to comply
with his request--well, not request, his direction to us not to
question him. I intend to question him, and if he wants to
exercise his fifth amendment right, he can do it once, he can
do it twice, he can do it thrice, he can do it a thousand
times, but to excuse him and accommodate him because he does
not wish to be questioned is not acceptable, and I yield back
the balance of my time.
The Chairman. The Chair would indicate that the witness may
leave.
Mr. Sandlin. Mr. Chairman, could we have a vote on that, or
do we have an opportunity to object to the ruling of the Chair?
Mr. Moore. Point of order on that, Mr. Chairman.
The Chairman. The gentleman from Kansas.
Mr. Moore. Mr. Chairman, I would inquire at this point of
the Chair is your ruling is that he is released at this time,
but not released from the subpoena, but free to go at this
time, or he is released from the subpoena?
The Chairman. As the Chair has indicated, I would maintain
the ability to recall the witness at any time. I think it's
important, as the gentleman from Massachusetts and the
gentleman from New York stated, that we want to be on solid
legal grounds here, and to make a decision at this point
without the full record and the full advice of counsel I think
would be a mistake, and that's why the Chair made that
decision.
Mr. Sandlin. I would like to object to the ruling of the
Chair. We can have the statement read back right now.
Mr. Moore. Mr. Chairman, one further statement. He is
advised by counsel. He is not here without counsel. I was a
prosecutor for 12 years. There is an appropriate way to take
the fifth amendment and not an appropriate way to take the
fifth amendment. He said that he was going to assert the fifth
amendment privilege, and then he went ahead and testified and
denied any wrongdoing. So I think he has waived his privilege,
and I would ask counsel to conduct further legal research
before a definitive ruling is made here.
The Chairman. The counsel will be doing an appropriate
response, both Minority and Majority counsel.
The gentleman from Massachusetts.
Mr. Capuano. Mr. Chairman, I really don't want to vote to
overturn your ruling, but I would respectfully ask you to
rescind it for the simple reason if Mr. Ebbers wants to leave,
let him leave. That's his prerogative if he wants to do that.
If nobody wants to ask him questions, you don't have to ask him
questions. If he doesn't want to answer them, he doesn't have
to answer them. But I don't feel compelled as a member of this
committee to be nice to Mr. Ebbers after what he has done both
to this committee, to my constituents and the American public.
If he wants to leave, there's ramifications for it, go ahead
and leave. He didn't have to come in the first place. There's
ramifications for that as well. But to be nice to him simply so
he can go off and count his money, I don't understand what
message that is sending to the American public. He doesn't have
to answer questions.
I respect what you are doing, and I agree with you we
should wait to get legal rulings on whether he has or has not
given up his fifth amendment right, but that doesn't mean that
he shouldn't be here.
The Chairman. I appreciate what the gentleman is saying.
Let me say this: I--the Chair thought it would be in the best
interest of getting information that we didn't have the parade
of questions to Mr. Ebbers which he would obviously not answer.
It may make for good television, but it doesn't make for good
legislating or information gathering. That was the purpose of
what the gentleman wanted to do.
Now, I would ask the Members to consider that when we're
trying to get at this information, and it's obvious that he's
not going to answer those questions under advice of counsel.
That is his constitutional right, as the gentleman from
Massachusetts pointed out.
Mr. Frank. Mr. Chairman, yield for 10 seconds. I understand
you wanting to focus on getting information. I would just say
it's been experience we weren't getting that much information
from Mr. Dick and Mr. Grubman either.
The Chairman. The gentleman from Louisiana.
Mr. Baker. Mr. Chairman, I understand the Chair's ruling
and would only for the record to establish that I did ask Mr.
Ebbers a question which I do believe was within the scope of
his testimony, and I certainly understand the need for
deliberative research before we reach final conclusions, and we
are awaiting on House counsel to advise the committee as to
whether or not the question was or was not within the scope of
the testimony. We are also waiting at this time for
transcriptions of the gentleman's oral statement of which we do
not have a copy yet. Upon receipt of the statement, and upon a
determination by House counsel of the question being within the
scope, I think the Chairman is indicating that you would then
extend an invitation to Mr. Ebbers if necessary, subpoena Mr.
Ebbers to again return to this committee to answer
appropriately questions that are within our fifth amendment
right to ask. Is that the Chairman's position at this time?
The Chairman. That is correct. And let me just simply say
that we would--I would simply request that the witness stay. We
will proceed with regular order, but I would ask the Members to
understand that the questions are not going to be answered and
that we need to move on. So with that-- .
Mr. Gonzalez. Chairman, point of order.
The Chairman. Gentleman from Texas.
Mr. Gonzalez. Do we not have to ask the witness a question
for him to invoke? If we discover that we are correct that
there was a waiver, because he did use it as a sword and not a
shield, and that is a basic precept of law, then all this time
would have been wasted today with Mr. Ebbers being here. I
think we should be allowed to ask the questions. He may be
invoking his privilege, but in the future if we discover later
today or tomorrow, whenever, that he did, in fact, waive his
privilege--
The Chairman. Members may ask any question they want. I
simply ask the Members to be judicious in that regard so that
we can move.
Who seeks recognition for questions?
Mr. Kanjorski.
Mr. Kanjorski. Thank you, Mr. Chairman.
Mr. Dick, I have got to go back to you because you are
really shaking up my faith in the auditing system. Following on
what Mr. Frank had indicated to you, you're indicating that you
just checked the mathematics of whatever management gives you,
and that's what you consider an audit?
Mr. Dick. No. Let me just reemphasize again that the
preparation, the actual financial statements themselves are
prepared by management. The auditors' responsibility is to
perform an audit on those statements to make sure they are--
Mr. Kanjorski. Just the statements, not the underlying
materials that those statements are based on. The only thing
you do is look at the actual--they provide you with a balance
sheet and profit/loss statement, and you just check over that
to make sure that's accurate?
Mr. Dick. When auditors perform their audits, they do a
number of things.
Mr. Kanjorski. What did you do in these things, and what
are you trying to tell us, that you didn't have a
responsibility to pick up this 3.8 billion? You didn't pick it
up, and what--we're interested in why didn't you pick it up, or
aren't you the proper party? Should we have a government
auditing or government accounting office that handles major
corporations and take the accounting firms out of it, because
apparently--apparently from what you told me, anything Mr.
Sullivan or the inside financial people within that company
told you, you are going to presume their honesty. And if you
presume their honesty, I don't know why we have to spend $4-1/2
billion and have some writing at the bottom that Anderson
looked this over and it's all good, because it doesn't mean a
damn thing. If they are liars at the top, all you do is certify
their fraud or abuse.
Mr. Dick. We simply did not rely on management's
representation. When we performed our audit, we did specific
testing.
Mr. Kanjorski. This wasn't off balance sheet material, was
it? The 3.8 million was just recorded in the wrong area. It was
recorded as a capital investment as opposed to a normal
expense. It appeared on the balance sheet. I just heard my
colleagues saying these are off balance sheet records. It
appeared, didn't it?
Mr. Dick. I have not specifically seen what they have done
but based on what I have read--
Mr. Kanjorski. You mean you certified this audit and didn't
look at it before you came here today?
Mr. Dick. With regard to the 3.8 billion--
Mr. Kanjorski. You weren't curious enough to know how these
guys snookered your outfit to certify something that misstated
3.8 billion, and you didn't figure out what they did yet?
Mr. Dick. Congressman, that information has not been
provided to me. What we did when we did our audit was to test
the underlying transactions. We did analytical reviews.
Mr. Kanjorski. Do you know where you missed it? Do you know
now where this 3.8 billion was placed by Mr. Sullivan and his
cohorts, or don't you?
Mr. Dick. I do not because I have not been provided the
information as to what they did or did not do.
Mr. Kanjorski. Isn't that a public record now or not?
Mr. Dick. I don't know if it is or isn't. It has not been
made available to me.
Mr. Kanjorski. You really did prepare yourself to testify
and explain and assist the Congress as to what we should do or
shouldn't do in helping proper accounting in American
corporations because you are the principal party. You're paid
$4-1/2 million, and over the last month you didn't take the
opportunity to find out, gee, I fouled up, I wonder if I should
find out what I did, or did I foul up? Who fouled up? We don't
know. You can't tell us.
Mr. Dick. I don't think we know yet.
Mr. Kanjorski. We don't know.
Mr. Dick. That information was not provided to me.
Mr. Kanjorski. Mr. Grubman, information has come to me--and
you're a little bit more here--more than an analyst. You sat at
these three board meetings. You were telling the color of the
market, whatever the hell that means. But I have information
that Salomon Smith Barney was offering special IPO information
to executives of WorldCom on a specialized basis. Do you have
any knowledge of that?
Mr. Grubman. I have no recollection of that.
Mr. Kanjorski. No recollection. You have no recollection,
no knowledge, no nothing.
Mr. Grubman. I--
Mr. Kanjorski. Mr. Grubman, be very serious about this now.
Do you know or have you heard or are you in possession of any
indication that special friend IPO offerings were made
available to certain executives and members of the board of
WorldCom from your investment banking company?
Mr. Grubman. I'm trying to think if I can answer that
specifically yes or no. I just don't recall, because that's not
something that I would be involved with, so I can't recall. I'm
not saying no, I'm not saying yes. I just can't recall.
Mr. Kanjorski. Did you make any offerings or indications of
those offerings in those hamburger sessions or pool sessions
with Mr. Ebbers?
Mr. Grubman. Not that I can recall.
Mr. Kanjorski. You can't recall that. For an analyst as
brilliant as you are, you have a terrible recollection.
Mr. Grubman. That's not what I do for a living. I can't
recall anything along those lines.
Mr. Kanjorski. Your testimony is you can't recall, but you
can't deny on behalf of your company that special IPO offerings
were made available to the executives and members of the board
of WorldCom?
Mr. Grubman. My company is a big company, so therefore I
cannot say definitively one way or the other if what you're
saying is true or not.
The Chairman. The gentleman's time has expired.
The gentlelady from New York.
Mrs. Kelly. Thank you very much, Mr. Chairman.
Mr. Ebbers, since you're still here with us, I just want
say something to you. You had a great idea. You put together a
great company, a large company. A lot of people bought into
your idea, and there's no real reason why you weren't entitled
to have a good substantial amount of pay. It was your idea, you
ran the company. I don't see any problem with that.
The problem I see is what's happened. The problem I see is
the severance package you walked out of that company with. It's
my understanding you get $1.5 million for life. You get time on
the private company plane. You get a full insurance package for
both life and health. I have a real hard time explaining that
to the people who live in my district, the single mom who
decides if she has a little extra money left over at the end of
the month whether to take her kids to McDonald's or Burger
King. She doesn't have packages like you have.
It's okay you got compensated, Mr. Ebbers, but I sure wish
you could find it in your heart to say something besides the
fact that you will not answer the questions for this committee.
I think you throw a terrible, terrible burden on the committee
by your being uncooperative, and I think you certainly
demonstrate to the single moms and to the families and to the
rest of America that it may be okay for somebody to try to get
by. That's not a model we want our kids to know about. It's not
the right thing. So I just have that to say to you.
Now, Mr. Dick, I want to talk to you a minute. The public
has a certain amusement in the Wild West atmosphere of
business, but we really think of the accountants as being the
cavalry, and in this instance it's sort of like you were
General Custer, and the people at WorldCom were the Indians,
and you got slaughtered. I have tried to figure out how. We
need to know that piece of information.
I want to know what system was in place, who talked to
whom? You have repeatedly said, well, that information was not
made available, and yet we have to understand that there were
some really serious problems here. You had, for instance,
journal entries given to you, I assume. Were the journal
entries given to you?
Mr. Dick. No.
Mrs. Kelly. You had no journal entries given to you?
Mr. Dick. When we performed our audit, we had a step in our
audit, we requested in connection with our quarterly reviews
and our audit if there were any top side journal entries. These
would be journal entries that would be made to the financial
statements outside of the normal transaction processing system
of the company.
Mrs. Kelly. Didn't that raise an alarm with you, Mr. Dick?
Mr. Dick. Well, in addition to asking that, in addition to
all of the other work we performed, when we looked at it in the
analytical procedures we looked at, it didn't raise any unusual
items.
Mrs. Kelly. When you say you looked at it with analytical
proceeding. What kind of analytical proceeding could you
possibly have followed if you were auditing books--you didn't
get the journal entries, and we know now that Mr. Sullivan
spread this out apparently over a great course of accounting.
At some point when you're going in and getting these smaller
pieces of information, didn't any red flags appear?
Mr. Dick. Well, when we performed our audit, as I mentioned
before--
Mrs. Kelly. Who gave you the information you performed your
audit on? Where did it come from; Mr. Sullivan?
Mr. Dick. The information we are auditing comes out of the
transaction systems and the processes of the company. And so
we--
Mrs. Kelly. No, sir. I want a name. I want to know who was
running those systems.
Mr. Dick. The company's transaction processing systems were
ran under the direction of Mr. Sullivan and Mr. Myers. Mr.
Myers was the controller of WorldCom.
Mrs. Kelly. And they gave you the information from those
systems; is that correct?
Mr. Dick. Well, when we do our audits, we are working with
people throughout the company, and we're looking at and testing
transactions from a variety of their systems, be it their
billing systems, be it their systems to pay their bills, to pay
their employees, et cetera. And when we're testing those
systems, we are taking selected transactions, looking at those
transactions, and looking at the specific processes and
procedures and controls that are in place by the company to
ensure that those transactions are processed properly through
those systems. And based on that testing, we then place
reliance on the numbers that come out of those systems that go
into the financial statements.
That's just one aspect of our audit. In addition to that,
we look at the overall financial statements and the overall
ratios of things that go through the company's financial
statements. For example, I mentioned in my opening remarks, we
have software that we used that has been developed and analyzes
the relationships on the financial statements, for example, the
relationship of sales to accounts receivable, and look at that.
The Chairman. The gentlelady's time has expired.
The gentlelady from California Ms. Waters.
Ms. Waters. Thank you very much.
Quickly, Mr. Dick, do you not have the responsibility for
looking at the capital outlay and determining whether or not
those kind of dollars have really been spent in a fashion that
complies with the definition of capital outlay? Would it have
been $10 billion? You don't know or can't sense or tell whether
or not it has been that kind of capital outlay that would cause
you some concern?
Mr. Dick. When we performed our audit, we did, in fact,
look at the processing and the procedures and the transactions
that related to capital outlays.
Ms. Waters. But you wouldn't know whether or not they
bought new buildings, machinery or equipment. You don't see
that is what you're saying?
Mr. Dick. For those transactions that we would have looked
at and audited and selected in our sample, we would have taken
what's called authorization for expense.
Ms. Waters. Do you have anything to do with helping to
determine depreciation on these capital outlays that fall
within the capital accounting?
Mr. Dick. Our audit procedures would have covered testing
of the depreciation.
Ms. Waters. Well, you didn't do that. That's what the trick
is all about. The accounting trick here is they took operating
expenses that would have been debt out of their operating costs
and put it over into this column that says we have $3.8 billion
in capital outlays, and you never detected the difference.
That's what you're telling us? Yes or no?
Mr. Dick. When we performed our audit, we looked at those
transactions that we tested and determined--
Ms. Waters. Couldn't you tell that the operating expenses
simply were payments for access to the right of way that they
were paying to companies in order to use their lines?
Mr. Dick. When we did our testing, we did test selected
transactions.
Ms. Waters. How did you determine that they were correct,
that that was exactly what had happened?
Mr. Dick. For those transactions--
Ms. Waters. Okay. That's enough.
Mr. Ebbers, why did you borrow $408 million from the
company, what did you spend it on, and do you have--is it
capitalized in any way, and what's your repayment schedule?
What arrangements do you have to repay the money? Do you have a
sweetheart deal or not? Mr. Ebbers?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer to the basis of my fifth amendment
constitutional rights.
Ms. Waters. Thank you.
And now I would like to ask Mr. Grubman, did you ever
consult or discuss with Mr. Ebbers, Mr. Bobbitt, Mr. Sullivan
or any of the WorldCom management prior to downgrades, during
downgrades or after downgrades, and did you carefully and
slowly downgrade, which helped to keep WorldCom investments
possible; and given that there are investors who specialize in
marginally troubled corporations, didn't this keep WorldCom
afloat until a very special date that you didn't mention, June
24? You talked about what happened from March up to June 17. On
June 24, you took an action prior to something public happening
on June 25.
So will you start at the top and first answer, did you ever
consult with or discuss with Mr. Ebbers, Mr. Bobbitt or anybody
else what you were going to do before you downgraded?
Mr. Grubman. First of all, just to correct, it was June 21
when we issued our last downgrade, as I said in my opening
statement, and that is the date of the report.
Ms. Waters. What did you do on June 24?
Mr. Grubman. We didn't do anything on June 24.
Ms. Waters. You didn't have a sale report?
Mr. Grubman. On June 21, we downgraded the stock from
neutral to market underperform. There's actually a lower rating
called sell. That was done on June 21.
Ms. Waters. When did you do sell?
Mr. Grubman. We never did.
Ms. Waters. So you never advised sell.
Mr. Grubman. We had a market underperform, and then the
accounting fraud was unveiled. The stock stopped trading, and
then at that point there's nothing for us to do.
Ms. Waters. So, all right. Start at the top. Let's go to
the top. Did you ever discuss downgrades with any of the people
that I mentioned or anybody else in management prior to
downgrades, during or after?
Mr. Grubman. Typically when we change a rating on a stock--
Ms. Waters. No, no, no. I don't want what you do typically.
I want specifics. Did you ever discuss with Mr. Ebbers, Mr.
Bobbitt or Mr. Sullivan, or any other management--
Mr. Grubman. I do not ever recall, and I am quite sure we
did not prior to downgrading a stock discuss the possibility
that we were going to downgrade. After we actually released a
rating change as a matter of course on any company--
Ms. Waters. Did you ever discuss downgrades with any of the
people I have identified or anybody else in the WorldCom
management before, during or after?
Mr. Grubman. Well--
Ms. Waters. Let's start with before. Did you ever do it
before?
Mr. Grubman. I do not believe I ever discussed before--
Ms. Waters. But you may have.
Mr. Grubman. I don't think I have.
Ms. Waters. But you don't know for sure.
Mr. Grubman. Well, I'm cognizant of not giving a
categorical answer if I don't have 100 percent memory, but I am
quite confident we never did. That was never our practice.
The Chairman. The gentlelady's time has expired.
The gentleman from Alabama Mr. Bachus.
Mr. Bachus. Thank you, Mr. Chairman.
It's my understanding that the privilege against self-
incrimination can be waived in one of three ways: By failing to
assert it, by specifically declining to assert it, and the
third way is by testifying as to matters--testifying as to
matters and then later attempting to assert a privilege. Now,
it's my understanding that Mr. Ebbers said his conduct at all
times was appropriate. So I'm going to ask him a question about
his conduct knowing that he's already testified as to his
conduct. In fact, he said his conduct at all times.
My question is this: Did your conduct, Mr. Ebbers, ever
include discussing accounting practices with other employees of
WorldCom?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Bachus. Were you aware of accounting practices which
included certain line costs, including telecom, access and
transport charges, being booked as capital expenditures?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer it on the basis of my fifth amendment
constitutional rights.
Mr. Bachus. Thank you.
Mr. Moore. Point of order, Mr. Chairman.
The Chairman. The gentleman from Kansas.
Mr. Moore. I would ask the Chair to reserve the gentleman
from Alabama's question, and ask that the witness be cited in
contempt of Congress or this committee for failure to answer
the question, and ask the Chair to reserve ruling.
The Chairman. The Chair has indicated that he has already
reserved ruling on that, and I thank the gentleman.
Mr. Bachus. Mr. Grubman, let me ask you these questions.
You said in making your downgrades and observing the conduct of
WorldCom in making your ratings, you relied on the--you relied
on such documents as public companies--well, I'm sorry, you
relied on the accuracy of its audited financial statements and
other SEC filings; is that correct?
Mr. Grubman. Correct.
Mr. Bachus. So that means you examined their audited
financial statements?
Mr. Grubman. Yes.
Mr. Bachus. In observing their audited financial
statements, did you observe their practices of booking certain
line costs as capital expenditures?
Mr. Grubman. I want to answer that, but I want to get back
to Congressman Waters. Can I just clarify an answer I gave to
her?
Mr. Bachus. Why don't you clarify--
Mr. Grubman. I need to clarify one thing.
Mr. Bachus. Not on my time.
Mr. Grubman. Could I clarify one thing?
The Chairman. I will grant the gentleman extra time.
Mr. Grubman. What you're referring to, Congresswoman
Waters, was a voice mail we sent out June 24. I was thinking
about a written report. That voice mail on June 24 was just as
I put into my larger statement that I submitted to the
committee, a--in a sense an update to what we put out June 21.
And in that voice mail I said that, you know, the reasons for
our downgrade are what we reported, but that I did not believe
WorldCom was a bankruptcy candidate, because I was, you know,
worried that some people thought that is what we were thinking.
I think that's what you are referring to on June 24, but there
was no rating change.
To answer your question, and thank you for your indulgence,
that is an extremely good question because it gets to the heart
of the matter of how could all these analysts, myself included,
not figure this out, really. Well, first of all, let's think
about what happened. Allegedly line costs got shifted to
capital expenditures over a five-quarter period. In the--
Mr. Bachus. Possibly as much as 10 years.
Mr. Grubman. Okay. I'll leave that to others to uncover. At
the beginning of 2001, just like at the beginning of every
year, WorldCom and other companies give financial guidance, as
you know. In their case their capital expenditure guidance was
7-, $7-1/2 billion. That's what they reported. So red flag
number one would have been if they reported $9 billion of cap
ex. So they didn't overrun that.
Secondly, that was quite a bit lower from their year 2000
capital expenditures, which were around 10- to $11 billion.
Furthermore, during the course of 2001, they filed an 8(k)
where they actually lowered cap ex a little bit more.
Two, on the other side of the equation, the line cost side,
if you look at the consolidated WorldCom, Incorporated, and
compare that to their only real competitor, AT&T, 2000, 2001,
first quarter 2002, the EBITDA margins that Ms. Waters referred
to in her opening remarks, for WorldCom, Incorporated, the
trends were 36 percent, 30 percent, 27 percent first quarter
2002 on the reported numbers; AT&T's, 38 percent, 32 percent,
29 percent. So for those of us who are looking at both
companies, the level and trajectory of the reported EBITDA
margins seemed right.
Mr. Bachus. We are talking about their audited financial
statements. If you looked at their audited financial
statements, you should have looked at operating expenses and
should have seen--
Mr. Grubman. You mean the financial statements that were
publicly filed?
Mr. Bachus. Right.
Mr. Grubman. That's what I'm saying. Based on the financial
statements that they filed, their capital expenditures were in
line.
Mr. Bachus. But it didn't reveal what those capital
expenditures were. It revealed those were line costs, right?
Mr. Grubman. No.
Mr. Bachus. So they misrepresented that on their filings.
Mr. Grubman. They did not reveal anything like that within
their capital expenditures. But what added to the sense of
comfort, if you will, on Wall Street is WorldCom actually had a
lot of transparency in their capital expenditures. Each quarter
they would break out where they went, what part of the world.
Mr. Bachus. Where did they say they were taking the line
cost including the telecom access? Where did they say they were
booking that as capital expense?
The Chairman. The gentleman's time has expired.
Mr. Grubman. There was a line called line cost in their
income statement, which is where we thought they were.
The Chairman. The gentleman from Vermont Mr. Sanders.
Mr. Sanders. Thank you, Mr. Chair.
According to news reports, just five people at WorldCom
received over $600 million in loans compensation and stock over
the past few years. Much of this wealth was apparently created
due to an alleged $3.8 billion fraud, which led to the firing
of 17,000 workers and the loss of more than $150 billion in
shareholder wealth, including billions in lost pension assets.
My question is, wouldn't it be a good idea to use this $600
million fund to compensate the 17,000 WorldCom employees who
have lost their jobs and the pensioners who have lost their
life savings as a result of WorldCom's alleged fraud? My
question is to Mr. Ebbers and Mr. Sullivan.
Mr. Sullivan. Congressman, based on the advice of counsel,
I decline to answer the question based upon my fifth amendment
to the U.S. Constitution.
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sanders. Mr. Grubman, you have indicated that you have
had a close personal relationship with Mr. Ebbers. According to
the Washington Post, you waited until June 24 to advise your
clients to sell WorldCom stock, just 1 day before the company
announced to the world that it improperly accounted for 3.8
billion in expenses over the last five quarters. The other
telecom firms that you have recommended over the years, as I
understand it, are such companies as Windstar Communications,
XO Communications, Qwest Communications International and
Global Crossing, and all of those companies are either in
bankruptcy or now trade for pennies a share.
My question for you, Mr. Grubman, did you have close
personal relations with some of the management in those
companies as well?
Mr. Grubman. Okay. First of all, as I said, I had a good
working relationship with Mr. Ebbers and with other management
teams, some of the companies you mentioned.
Mr. Sanders. Windstar.
Mr. Grubman. Not really.
Mr. Sanders. XO Communications?
Mr. Grubman. To some degree. Qwest and in some cases Global
Crossing.
Mr. Sanders. And every one of those companies are now in
bankruptcy or trading for pennies per share; is that correct?
Mr. Grubman. Well, yes. But that's not the cause and
effect.
Mr. Sanders. Well, what the cause and effect is, you were
telling people to buy those stocks, and you had a personal
relationship.
Mr. Grubman. No.
Mr. Sanders. No?
Mr. Grubman. Just to correct one thing again, our downgrade
from neutral to market underperform is June 21.
Mr. Sanders. I am quoting from the Washington Post.
Mr. Grubman. They are incorrect. It is June 21.
Mr. Sanders. Let me ask you this, Mr. Grubman.
Mr. Grubman. Can I--
Mr. Sanders. Very briefly.
Mr. Grubman. We had a long-held investment thesis in the
telecom industry, and for many years it worked quite well, and
people made a lot of money. Unfortunately over the last 2
years, the entire telecom sector collapsed. The broader
technology sector collapsed. In terms of sheer market values,
there has been more loss in Cisco by a factor of three than in
WorldCom.
So the fact is, yes, I did not either recognize or
understand the depth and length of a lot of the factors.
Mr. Sanders. Let me pick up on that point and suggest a
reason why. WorldCom, AT&T Wireless and Windstar alone
generated 449 million in investment banking fees for your firm
from '97 to 2001, according to Thompson Financial. Don't you
think that there is an inherent conflict of interest for firms
that provide, quote/unquote, independent analysis of the same
companies, presumably what you were supposed to be doing, while
these companies are giving the firms hundreds of millions of
dollars in investment banking fees?
Mr. Grubman. This is an important issue, and it's an issue
that a lot of people are looking, NYSE, SEC, NASD. Merrill
Lynch adopted some policies which we adhere to.
Mr. Sanders. What do you think?
Mr. Grubman. Well--
Mr. Sanders. Your firm is making substantial sums of moneys
in investment fees, and you are giving advice.
Mr. Grubman. An analyst can maintain, as I think I have,
notwithstanding the poor stock performance, honestly held
opinions and integrity and can still be part of a full-service
firm because at the end of the day the--
Mr. Sanders. I respectfully disagree with your assertion,
and I want to ask Mr. Dick a question.
Mr. Dick, it appears very clearly that Arthur Andersen
failed in their audit of WorldCom. You failed in the audit of
Enron. You failed in the audit of Sunbeam. You failed in the
audit of Waste Management. You failed in the audit of McKesson.
You failed in the audit of Baptist Foundation of Arizona. What
was Arthur Andersen doing? I mean, how do you--it is
incomprehensible to me that a major accounting firm can have
such a dismal record in trying to determine what the financial
health of a company is. It's almost beyond comprehension.
Mr. Dick. I can only speak to my work on WorldCom.
Mr. Sanders. You did speak to that, and I don't think many
of us were convinced by what you said.
The Chairman. The gentleman's time has expired, and the
gentleman may respond.
Mr. Dick. As I mentioned, we did perform our work, and we
did the appropriate tests under generally accepted auditing
standards, including looking at the various financial ratios.
Mr. Sanders. Thank you.
The Chairman. The gentleman from Illinois Mr. Manzullo.
Mr. Manzullo. Mr. Ebbers, could you tell us when you found
out about the improper accounting activities at WorldCom/MCI?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Manzullo. Thank you.
Mr. Grubman, in your statement you state on page 2,
analysts do not have access to internal company info such as
audit trails and internal entries, invoices and the like. In
short, analysts are not auditors.
And then I go to Mr. Dick's statement, who says, the
fundamental--deferring to the auditors, you base your opinion
upon them. And the auditor says, the fundamental premise of
financial reporting is that the financial statements of a
company, in this case WorldCom, are the responsibility of the
company's management, not its outside auditors. So we're trying
to find out who's responsible for the information.
I have before me, Mr. Dick, from Black's Law Dictionary a
definition of the word "audit," and it says, inspection and
verification--this is IRS--of a taxpayer's return or other
transactions possessing tax consequences. When the IRS does an
audit, they go behind the statement. If somebody says he bought
a building, they go and look at the deed. If somebody says he
went out and acquired inventory, they look at documents,
checks, receipts, things of that nature. And Black's also says
a systematic inspection, not spot; systematic inspection of
accounting records involve analyses, tests and confirmations.
What did you do to confirm that the information given to
you by WorldCom-MCI was correct in the process of your doing
the audit?
Mr. Dick. When we performed our audit test on various
transactions, we would have looked at the underlying supporting
documentation that you referred to.
Mr. Manzullo. No, no, no, beyond that. Did you ever go to
the courthouse, for example, and look at a deed? Did you look
at any other documents, any documents other than what WorldCom
gave you?
Mr. Dick. We looked at those underlying documents that we
deemed appropriate to finish our audit.
Mr. Manzullo. Did you look at any documents to verify or
confirm the statements of WorldCom/MCI other than the documents
that they gave you?
Mr. Dick. Well, we look at the systems, we look at the
controls.
Mr. Manzullo. You're not answering my question.
Mr. Dick. With all due respect, I am not trying to avoid
your question.
Mr. Manzullo. I understand what you do, and you failed. My
question to you is this: Did you at any time ever go beyond the
documents furnished to you by WorldCom/MCI to confirm, verify
or to test their accuracy?
Mr. Dick. In certain instances we would have obtained--for
example, when we're looking at material contingencies and legal
matters, we do get confirmation from outside counsel as to
the--
Mr. Manzullo. Not outside counsel. I'm talking about
factual documents, not opinions of lawyers.
Mr. Dick. There are other cases when we might get
confirmations relative to the accounts receivable of the
companies. We would look at appraisal documents relative to the
underlying security for receivables the company may have had.
Mr. Manzullo. For example, on the--when you see something
that's amortized over a period of time, that would show up in
the audit; isn't that correct?
Mr. Dick. That's correct.
Mr. Manzullo. Did you ever take a look to see what was
exactly amortized and if it was amortized over a correct period
of time?
Mr. Dick. We did testing in that area for amortization and
depreciation, yes.
Mr. Manzullo. And the testing did not show this is where
the books were cooked; isn't that correct?
Mr. Dick. When we did our testing, our testing of those
transactions were that they revealed that they were
appropriately recorded.
Mr. Manzullo. How could anybody rely upon an audit of any
corporation in America?
Mr. Dick. I think, as has been reported, the company has--
it's been reported that the company made entries outside of
their normal transaction systems. We asked if they made those
entries. We obviously would have looked at the underlying
support.
Mr. Manzullo. You asked somebody if they're dishonest?
Mr. Dick. No. We asked if they had made those entries.
Obviously if they had made those entries and they would have
been given to us, we would have looked at the underlying
support for those entries.
Mr. Manzullo. But at what point do you notice a red flag?
Mr. Dick. Again, as I mentioned, when we did our audit
work, we tested the underlying procedures. We did--
Mr. Manzullo. But you did it all wrong.
The Chairman. The gentleman's time has expired.
The gentleman from New York.
Mr. LaFalce. Thank the Chairman.
Mr. Wu from the State of Oregon has indicated great
interest in these hearings, and I ask unanimous consent that he
be allowed to sit in on the hearing; not to participate in
them, but merely to observe the proceedings.
The Chairman. Without objection.
The gentlelady from New York Mrs. Maloney.
Mrs. Maloney of New York. Thank you, Mr. Chairman.
Mr. Ebbers, you testified earlier that you did not engage
in any criminal or fraudulent conduct, that your conduct was
appropriate, and I would like to ask a question about your
conduct. First of all, do you meet regularly with your
auditors, and was the question of capital expenditures ever
discussed? And what was the normal procedure for your review of
the financials at the close of each quarter?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mrs. Maloney of New York. Mr. Dick, did your firm also
provide tax consulting to WorldCom?
Mr. Dick. Yes.
Mrs. Maloney of New York. So you provided tax consulting,
regular consulting, and you were the auditor, and with all of
this assistance, you couldn't see any problems.
Mr. Dick. We did, in fact, provide all those services.
Mrs. Maloney of New York. Did WorldCom certify to you that
their financials were accurate? That is one of the reforms that
Secretary O'Neill is calling for, that CFOs and CEOs verify
that their financials are accurate and they face criminal
penalties if they lie. Did they certify to you that these are
accurate?
Mr. Dick. We would have received a representation letter
from them.
Mrs. Maloney of New York. They did certify. How did you not
see some red flags when the filed taxes of WorldCom were so
different from what they reported as their earnings?
And I would like to place in the record, Mr. Chairman, an
article by Alan Murray in the Wall Street Journal in which he
reports between the years of '96 and 2000, WorldCom reported 16
billion in earnings, yet at the same time they had less, much
less, than a billion that they paid in taxes. So how can you be
having $16 billion of earnings and then not report to the IRS
such a different story?
The Chairman. Without objection.
Mrs. Maloney of New York. And you prepared both sets of
books; is that right? So you prepared the earnings that were 16
billion and then the set of books for the IRS that was far
less; is that correct?
Mr. Dick. Arthur Andersen was not responsible for preparing
the tax returns for WorldCom.
Mrs. Maloney of New York. Did you look at the tax returns?
Mr. Dick. I don't know if we looked at the tax returns
during those years that you referenced.
Mrs. Maloney of New York. Certainly that would have raised
a red flag that the tax returns were different from what the
earnings were. And some have called for a reform that publicly
held companies reveal their taxes so analysts have more
information and the public has more information, and I would be
concerned that a company has multibillions in earnings, and yet
their taxes--Enron had billions in earnings, and yet they paid
no taxes and reported losses to the IRS.
Mr. Dick. I can't speak to the specific circumstances that
you refer to.
Mrs. Maloney of New York. Would that have helped you maybe
conclude or maybe do a better audit if you had looked at the
tax return? Would that have helped you possibly uncover the
fraud?
Mr. Dick. In connection with our audits, we would have
reviewed the tax accruals that are made on behalf of the
company in connection with our 2001 audit. It's not uncommon
that companies will report a different amount in their
financial statements for their book income as opposed to their
taxable income. Those differences--
Mrs. Maloney of New York. Don't you think it would be
helpful to have a unified definition of both book income and
tax for purposes--
Mr. Dick. I believe there is a commonly accepted definition
of book income and tax income.
Mrs. Maloney of New York. Well, I would like to ask Mr.
Grubman, you testified that you really believed in WorldCom.
Mr. Grubman. For a long period of time.
Mrs. Maloney of New York. Did you buy stocks yourself? Did
you invest yourself?
Mr. Grubman. I have been on Wall Street since 1985, and I
never personally owned a stock that I follow.
Mrs. Maloney of New York. Now as we speak, Attorney General
Eliot Spitzer is reviewing your e-mails and other analysts' e-
mails and reviewing the internal documents of analysts. Will
his investigation reveal that your internal e-mails were the
same as what you said publicly, or will there be a difference?
Mr. Grubman. I believe that when that investigation is
complete and our internal e-mails are revealed, that there will
be a consistency between our external and internal views.
The Chairman. The gentlelady's time has expired. The
gentleman from Wisconsin, Mr. Green.
Mr. Green. Thank you, Mr. Chairman. First off, I have a
question for Mr. Ebbers. And I want to follow up on questioning
that both Mr. Bachus and Mr. Manzullo have presented to you. If
you were aware of accounting--the accounting practices that
Representatives Bachus and Manzullo referred to. That is
shifting certain expenses to capital expenditures, whose
counsel and advice did you use to make such a decision? And
furthermore, were you aware that that decision that you made,
if disclosed, would be questioned and controversial publicly.
Mr. Ebbers. On the instructions of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Green. My next questions are for Mr. Dick. Mr. Dick, in
your written testimony, you talk about working, when you
conduct an audit, when an audit is conducted, that you work
with people throughout the company in conducting an audit. Can
you tell me, in this case of WorldCom, who it was you worked
with in preparing the outside audit? Who did you turn to in
preparation for the outside audit?
Mr. Dick. That's a very broad question in terms of a
company the size of WorldCom. But we would have worked with,
and I will be very brief here.
Mr. Green. Kind of management positions.
Mr. Dick. People involved with the revenue processing
systems, billing the customers, collecting the cash from the
customers. People involved with the processing of the capital
transactions or the authorization for expenditures, as I
mentioned before. They would have been people in the accounting
organizations throughout the company responsible for paying the
bills and so forth.
Mr. Green. You just indicated that you'd be working with
people who authorized transactions and expenses. You couldn't
have worked with them too closely if you weren't able to
discover the decisions that have--the bookkeeping decisions
that led to this whole fiasco.
Mr. Dick. Well, as I mentioned before, when we tested the
systems, we did not find--we were satisfied that we had done
sufficient amount of work and that the transactions that were
tested and those systems could be relied on. That is what we
call compliance testing. In addition to that, we reviewed the
overall financial statements and looked at certain ratio
analysis in the context of the financial statements. WorldCom
had consolidated net assets of 104 billion, they had property
and services 49 billion, revenues of 35 billion and line costs
of about 15 billion.
And we looked at those numbers. I believe Mr. Grubman
mentioned trends that had been reported, and in the context of
that review, plus our using our software that we have that
analyzes the financial statement line items, nothing came to
our attention that would suggest we should do additional work
now, we didn't stop there. As I mentioned before, we did ask,
had the company made any type of top side or journal entries.
And these are entries, as I understand it, based on what's been
reported, the company made entries to their accounting systems
that were outside of the normal transaction system.
Mr. Green. So you--you asked that question of those whom
you worked with and just took the answer at face value, no
further questions. That was the end of the analysis.
Mr. Dick. We asked that question, and in addition--and we
asked and provided a listing request that those type of journal
entries be made available to us.
Mr. Green. Well, let me ask you this. My time's running
short. When you're presented with information for your audit,
does anybody at a company, a client like WorldCom, are they
required to swear to the information that's given to you? I
mean, do you do anything to have individuals guarantee the
veracity and accuracy of that information?
Mr. Dick. Well, we look for collaborating evidence. We look
for backup support.
Mr. Green. I understand that. Do you ask anyone?
Mr. Dick. We get management representations.
Mr. Green. But do you have them, in writing, sign off,
swear to the accuracy of the information?
Mr. Dick. Yes, in writing they sign off as to the accuracy
of those financial statements.
Mr. Green. Well, I would sort of suggest that given the
beating that Andersen's been taking here, if you got it in
writing and it was sworn to, you may want to contemplate your
own legal action given the damage that all of this is doing to
Andersen.
The Chairman. The gentleman's time is expired. The
gentleman from North Carolina, Mr. Watt.
Mr. Watt. Thank you, Mr. Chairman. Mr. Grubman, can I
presume that if you had gotten accurate financial information
you probably would have given some different advice to your
investors? Yes?
Mr. Grubman. Well, that is correct. If we--
Mr. Watt. Okay. That's not a trick question.
Mr. Grubman. Well, I know.
Mr. Watt. I just wanted to--Okay. So you relied on, to some
extent, the financial information that you got and goodwill and
relationships and things and you feel like you gave what, at
the time was reasonably good advice, in retrospect, probably
not good advice, but at the time you gave it, you gave it in
good faith and you thought it was good advice.
Mr. Grubman. Yes.
Mr. Watt. Okay. Mr. Dick, based on everything I've heard
from you, you followed generally accepted accounting
principles. You asked Mr. Sullivan and Mr. Myers the right
questions. You had a computer model and they just lied to you,
I take it, is what you're--and--but you took what they were
saying in good faith and you say that generally accepted
accounting principles allows you to do that, so this obviously
is not your fault; is that right?
Mr. Dick. That's correct.
Mr. Watt. Okay. So then we're back to Mr. Sullivan and Mr.
Myers and all the other people who were lying to you. Mr.
Sullivan, of course, is not lying today because he's not
testifying today. He's not moving his mouth so he's not lying.
But I guess the question I'm stumped on is we have some
generally accepted accounting principles. They didn't work. You
applied them. They didn't work. Are there changes that we
should be contemplating, either in this committee or at the SEC
as our governmental agency that would, in the future, prevent
this kind of thing from happening? Mr. Dick, I'm addressing
that question to--
Mr. Dick. Yeah. I might just start by answering, when we
apply--generally accepted auditing standards, our standards
that are out there--
Mr. Watt. I didn't ask that question. I'm asking you are
there some things that should--some changes that should be made
either in the law, or in generally accepted accounting
principles that we could adopt or the SEC could adopt to
prevent this kind of thing from--I'm not even looking
retrospectively. I've taken your word. I've taken Mr. Grubman's
word. He didn't do anything wrong. I've taken your word that
you didn't do anything wrong.
What I'm trying to do is look forward at what we can do as
a committee, as a Congress, as a SEC to prevent this kind of
thing from happening again, because if Mr. Grubman didn't do
anything wrong, and you didn't do anything wrong, then some
where the system is broken, and we need to figure out how to
fix the system to make sure that this doesn't happen again. I
mean, it's happened with Enron, it's happened with WorldCom. I
mean, you know, you reach a point where you have got to make
some adjustments. And I'm trying to figure out what kind of
adjustments we need to be contemplating to make sure that this
doesn't happen again.
Mr. Dick. It's probably not in my place to--
Mr. Watt. Well, you're a witness and I asked the question,
so it's in your place today, whether you like for it to be in
your place or not. It is today in your place to give me your
opinion about what we could do to adjust the laws or general
accounting principles to make sure that this doesn't happen
again. I mean, you were at the center of this and I'm asking
you for advice about how we can keep this from happening. I'm
not beating up on you. I have taken your word for it.
Mr. Dick. That is a fair comment.
The Chairman. Okay. The gentleman's time has expired. The
witness may respond.
Mr. Watt. Mr. Chairman, just for inquiry purposes, since I
didn't make an opening statement and you promised those of us
who didn't make an opening statement extra time, I'm going to
hold you to your promise.
The Chairman. You have a long memory except for the
baseball game.
Mr. Watt. I lost that game. I remember that. I lost last
year's game. I remember that. I've got a long memory there,
too.
Mr. Dick. Congressman, your comment is a fair comment. And
as I understand it, numerous things are being proposed by this
committee.
Mr. Watt. I want to know what you would recommend, Mr.
Dick. That's--I mean, that's all I've asked today. I want your
recommendations, if you have any.
Mr. Dick. I don't have any specific recommendations. I'm
aware that a number of proposals have been put forth before a
number of other people.
Mr. Watt. I know about the number of proposals. I want to
know what you are recommending. I mean, you saw this. You now
understand the consequences of what happened. Surely, in the
middle of this, you would have some kind of suggestion to make
to us that would prevent this from happening. Otherwise, Bell
South or all of the other communications companies, or any
other corporate official who tells you a lie, that you--that
you can't correct, detect, we're going to be back here again
next week.
Mr. Dick. I think some of the proposals that have been put
forth would address some of those. I will tell you, I don't
believe there is a way to build 100 percent fail-safe system in
terms of, again, what's been purported to have happened here,
where entries were made and there's questions as to whether
those entries were appropriately made, and whether people were
misled or not.
So, I'm not trying to evade your question, sir. I'm just
saying there isn't a way to build a fail-safe system to
possibly avoid this kind of a situation that's been purported
to have happened.
The Chairman. The gentleman's time has expired.
Mr. Watt. I am distressed, Mr. Chairman, I just want to say
I'm very distressed about that because basically, what you're
saying is you, being hands on, can't give us any advice that
would allow us to tell the public that a system that has worked
for years when somebody lies in the system, it breaks down and
we can't guard against that.
The Chairman. The gentleman's time has expired. The
gentleman from Connecticut, Mr. Shays.
Mr. Shays. Thank you, Mr. Chairman. Mr. Dick, how many
employees at Arthur Andersen oversee WorldCom's account,
approximately.
Mr. Dick. Approximately there would have been say, eight to
10, 12 individuals involved with the audit at various times
throughout the year.
Mr. Shays. Not hundreds?
Mr. Dick. Well, I'm speaking in terms of full-time people
on a global--
Mr. Shays. Right. You're playing games with me. You know,
the equivalent number, whether they're part-time employees, you
have a hundred employees who work half-time.
Mr. Dick. The equivalent number would have been probably
been 10 to 12 full-time people.
Mr. Shays. During this time you have stated that you were
unaware of why this happened. And you show no curiosity it
appears as to finding out. Aren't your employees in WorldCom as
we speak?
Mr. Dick. No, they are not. We are no longer the auditors
of WorldCom.
Mr. Shays. In the transactions that took place, it's your
testimony that you complete a year to year analysis. You go
from year to year and you compare numbers; is that correct?
Mr. Dick. That's correct.
Mr. Shays. Okay. What was the profit of the company in
1999?
Mr. Dick. I don't recall the profit for '99.
Mr. Shays. Was it approximately $3.8 billion?
Mr. Dick. That sounds probably right.
Mr. Shays. What were the transfers?
Mr. Dick. I'm sorry?
Mr. Shays. What were the illegal transfers? What were the
amounts?
Mr. Dick. I don't know if there were any transfers for '99.
Mr. Shays. Wasn't that 3.8 billion?
Mr. Dick. It's been reported that it was 3.8 billion during
2001 and the first quarter of 2002.
Mr. Shays. So it was equal pretty much to the profit of the
company. Would you explain to me why you would not notice if
you looked at an account from one year to the next, why you
wouldn't have noticed 3.8 billion transfer? Just comparing it.
And then looking at the profit of the company.
Mr. Dick. In comparing the company's line cost between
2000, 2001, in both years they were approximately $15 billion.
Mr. Shays. How about in 1998?
Mr. Dick. I don't know what the numbers were for 1998.
Mr. Shays. Thank you. Mr. Grubman, would you tell me how
many times did you meet with the board?
Mr. Watt. As I said earlier, I think perhaps two or three
times, not, you know, in that zone. I don't know the exact
number.
Mr. Shays. Did you ever receive remuneration for appearing
before the board?
Mr. Grubman. Me personally, no.
Mr. Shays. Who would have then, your company, for you
appearing what?
Mr. Grubman. Well, as I said earlier, those occasions where
I did appear on the board, it was in connection with merger
transactions that my firm was involved in. My role was to give,
you know, the view of what the investor reaction would be. I
was frozen on those occasions. And I was just one of the
members of our firm, you know.
Mr. Shays. What was your role in those meetings?
Mr. Grubman. My role in those meetings was to basically,
you know, give my view on--usually this was only a day or so
before, not always, but it was usually short duration before a
transaction was announced. And I have done this with other
companies, too. Where they have a deal, they're going to
announce, and I'm the one who talks to investors. Bankers don't
talk to investors. I talk to investors every day. So I give, at
least my view, of what I thought the investor reaction would be
the type of issues they would have to, you know, talk about.
Mr. Shays. In response to Mr. Kanjorski's question, I
wasn't clear as to what your answer was. He asked you if Smith
Barney provided any special IPO opportunities for any Board of
Directors management family members of WorldCom. And what was
your answer?
Mr. Grubman. My answer is I don't know if that's true or
not. That's not what I do. That's not my job, so I don't know.
Mr. Shays. Well, that's not your job. But I don't
understand that's not your job. How does that relate to whether
or not you knew? You seem to suggest that you might know. Are
you saying, categorically under oath, that you are not aware of
any sweetheart financial opportunities for anyone at WorldCom?
Mr. Grubman. What I'm saying is I can't recall if anything
like that happened because it's not something that I paid
attention to. But I can't categorically say it didn't happen.
At this--I just can't recall, I just can't recall.
Mr. Shays. How do you, in your business as a senior
analyst, how do you make your money?
Mr. Grubman. Well, my compensation is first and foremost,
driven by what my perceived market value is by the senior
management of the firm.
Mr. Shays. Does your company give you any IPO opportunities
in any company, whether or not it's the company that you're
analyzing?
Mr. Grubman. No, I've never participated in any IPO
opportunities in any company I followed.
Mr. Shays. Does your company give IPO opportunities for
anyone else in--
Mr. Grubman. I don't know that. I don't know.
Mr. Shays. Thank you.
The Chairman. The gentleman's time has expired. Mr.
Ackerman.
Mr. Ackerman. Thank you very much, Mr. Chairman. Mr. Ebbers
and Mr. Sullivan, you are evidently the chief executive
officers and the chief financial officer, at least formerly, of
a communications company. And yet you seem to have a great deal
of difficulty today communicating. It seems to me that there
are thousands of people in this country who believe that you
have ruined their lives, and the lives of their children and
their families. And it seems to me that there are probably
millions of people in this country that are attributing to you
a major role in undermining the public's faith in the free
market system. What I would like to know is a simple question.
Do you sleep well at night? Mr. Ebbers?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Ackerman. Mr. Sullivan.
Mr. Sullivan. Congressman, based on the advice of counsel,
I respectfully decline to answer the question based upon my
fifth amendment rights to the U.S. Constitution.
Mr. Ackerman. It was a pretty simple question. I guess that
leaves Mr. Dick and Mr. Grubman. I don't care how you sleep at
night. You've testified today that you've done a job based on
information and communications that you have received from the
two gentlemen sitting in between you, among others. Have they
deceived you? Have they lied to you? Have they committed any
crimes? Mr. Dick?
Mr. Dick. I don't know if they've committed any crimes. I
can tell you that when we did our audits, we asked for the
journal entries that have put--
Mr. Ackerman. Oh, stop giving us these happy horsefeathers.
Do you still feel the need to cover up for these guys? I
thought you were off the job. Would you certify their audits
today?
Mr. Dick. Not based on the information I know today, no.
Mr. Ackerman. So the information they gave you before was
incorrect, right?
Mr. Dick. I don't know if it was or it wasn't.
Mr. Ackerman. Then why wouldn't you certify it today. You
know. You can say it.
Mr. Dick. Well, I've been provided--
Mr. Ackerman. Was the information they gave you previously
the truth? Yes or no?
Mr. Dick. Based on what's been reported, no.
Mr. Ackerman. So would you certify it today?
Mr. Dick. No. We could not.
Mr. Ackerman. So did they lie to you?
Mr. Dick. I don't know if they did or they didn't.
Mr. Ackerman. Yeah, that's your problem. That's your
problem. You're still on the job. The covering up you and your
company have done for them has taken deep root in your soul and
in your conscience and you can't even say it. Mr. Grubman. Did
they lie to you? Did they deceive you? Did they commit any
crimes?
Mr. Grubman. I can't answer that.
Mr. Ackerman. Thank you.
Mr. Grubman. No, I can't answer that last question about
the crimes because I am not qualified. But if what was alleged
was true, then I was deceived by the company reports.
Mr. Ackerman. So you believe they lied to you.
Mr. Grubman. If what is alleged is true because I don't
want to, you know, say anything that's not true, if what is
alleged is true, then for at least the last five quarters of
what we know, I and others were lied to.
Mr. Ackerman. You are an analyst, right?
Mr. Grubman. Yes.
Mr. Ackerman. Did you analyze everything or did you just
take their word for it and say if what they said is true, when
you analyze something and put it out to the public and tout
these stocks, do you say if what they said is true is true then
it's a good company. Or do you just say it's a good company.
Mr. Grubman. No. We analyze it. I don't know if you were
here for my question to--my answer to the Congressman from
Alabama, but in looking back at as to should we have caught
this, should me and other analysts and the rating agencies
should have caught this, the answer was based on the financial
results, stress testing the results, the reasonableness of
their capital spending trends, their margin trends, their
financial performance relative to their competitors. There were
no red flags. Even the--
Mr. Ackerman. So what you're saying is anybody who gives
you a pro forma formula, that they went along within certain
parameters and margins of the rest of the industry, then that
doesn't raise any red flags to you? That's what you analyzed?
Mr. Grubman. No. What I am saying is we are a user of the
audited financial results. We don't get the opportunity to look
inside the books. It's like buying a car. If the brakes don't
work, you've got a problem. So if the numbers are--
Mr. Ackerman. So you relied on Andersen also?
Mr. Grubman. I rely on whoever certifies whichever
companies financial results I'm looking at.
The Chairman. That's the gentleman's last question. Your
time has expired.
Mr. Ackerman. That was.
The Chairman. Mr. Royce.
Mr. Royce. Thank you, Mr. Chairman. I was going to ask Mr.
Grubman a question. And what I was going to ask was whether the
structure of the compensation package that you have at Salomon
is related in any way to the amount of business that Salomon
created by underwriting and selling this stock. I understand
there's some 22 billion over a period of 5 years that you
underwrote. Do you think--is there a relation there to your
compensation package?
Mr. Grubman. Okay. First of all, we actually never
underwrote stock. It was all bonds, just to set the record
straight. As far as the compensation, my compensation package
as I alluded to earlier, has a lot of factors in it. How the
firm does, which includes banking revenue, trading revenue,
stock performance, how I rank with investors, like in the
institutional investor poll. And so certainly, all of that is a
factor in my compensation on top of what the senior management
of the firm views as my value in the marketplace.
Mr. Royce. Well, let me ask you this. Do you think your
optimistic advocacy of WorldCom's acquisition-based business
model, do you think that had any effect on the underwriting
fees that were generated by Salomon?
Mr. Grubman. It goes without saying that when a company
looks to do business with a Wall Street firm, they consider a
lot of factors, the strength of that firm if--I've had
situations where my research views, right or wrong, in terms of
stocks, have been well known for a long time. They have helped
us get banking business and they have hurt us in getting
banking business.
Mr. Royce. Well, let me point out that this type of
advocacy, by analysts that were presumed to be independent,
helped push the market capitalization of this stock to $120
billion at its peak. You know, now I think it's at $355
million. Now it's not enough to pay the loan back that Mr.
Bernie Ebbers, who's with us today and who doesn't want to
answer any of the questions, it's not enough to cover that
loan.
So, my question here on compensation is really one of how
is that based and how is that bonus compensation compiled,
because as I understand it, you're the best paid, if not one of
the best paid on Wall Street, at least that's what's reported
in the papers.
Mr. Grubman. That the--first and foremost, your value and
worth as an analyst to the firm you work for, and to banking
clients, starts and stops with your credibility if the market
plates with investors. And if you blow that then you have no
value to anyone.
Mr. Royce. Okay. Let me be more specific. Maybe I am not
being specific enough. Have you ever received compensation tied
to a specific investment banking deal? Is that the way--
Mr. Grubman. No, I never have.
Mr. Royce. You never have. And so your argument is that--
and I assume your compensation it's been reported in the area
of $20 million. Am I roughly in the ball park?
Mr. Grubman. My compensation, if you start with the
contract that I was offered in 1998, for Salomon Smith Barney,
to retain me because there is a competitive offer in the
market, over the course of the last 4 compensation years, I've
probably averaged that amount. That's not just cash stock and
other things in terms of my cash comp, you know, salary and
bonus, probably peaked maybe around $15 million in '99, and
actually last year was substantially below that, well below
half that.
What goes into all of those factors is a multitude of
things, and there's no denying, you know, your contribution to
banking revenues is part of it, just like your stock
performance, just like how investors view you, internal polls,
a whole multitude of factors. No one could sit here on Wall
Street and deny to anybody in this committee that banking is
not a consideration in the compensation of analysts and full
service firms.
Mr. Royce. Do you think that the prospect of this large--
you don't want to call it a bonus, but this large compensation
package, this way of maintaining and attracting banking clients
clouds in any way your judgment?
Mr. Grubman. It doesn't cloud my judgment because I care
first and foremost about my reputation with investors, which I
know has been damaged because of the stock performance of the
last 2 years.
Mr. Royce. Let me ask you another question, because you've
reported a close personal relationship with Mr. Bernie Ebbers,
and if you don't want to make evaluations about underwriting,
let me just ask you, in terms of the decision-making process
for the short-term gain of running up stock prices by those who
are in corporate governance, and doing so by managing earnings,
by adjusting the accounts, do you think--do you think that this
is driven, part of this problem, by the desire to show stable
earning growth?
Is that driven, this tendency to make journal entries and
push 3.9 billion out of expenses and capitalize that so that
that can be shown on the income statement? Is this being driven
by management's desire to show these types of constant earning
growths year to year, the very earnings growth that you tout
when you're going to the public and urging them to buy these
shares?
The Chairman. And that'll have to be the gentleman's last
question. The gentleman's time has expired. But please respond.
Please respond.
Mr. Grubman. This brings up a very important topic and part
of my answer, some people may not like because you have to look
beyond the sell-side analyst and you have to go through the
entire supply chain of who buys and sells stock.
I agree that over the past, certainly half a decade, that
the entire market has become much more short-term oriented than
long-term oriented. In fact, one of my major failings over the
last 2 years in terms of our stock picking has been for 17
years, I have been very well known as one that has more long-
term views than short-term views. Broadly speaking, the market
which is not just Wall Street firms, it is the mutual funds and
pension funds and money managers out there who increasingly, by
their clients, are getting graded every quarter, Morningstar,
and all these guys put all these stars against funds.
And so the pressure comes all the way up and down the
supply chain, and I think that it probably--I mean, I can't say
specifically what happened here because I don't know, or in
other companies. But that pressure to perform quarter in and
quarter out doesn't stop and start with Wall Street. It goes
all the way through the supply chain of who manages money, and
each client at each turn of the corner puts increasing pressure
to perform on a quarterly basis. So it is a big issue.
Mr. Royce. Well, apparently without anybody auditing to see
whether any of it's true, at least those responsible.
The Chairman. The gentleman's time has expired. Mr.
Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. Mr. Grubman I guess
this year won't be as good as the prior years for you, given
how well or how poorly some of your stock picks have done. But
I want to ask Mr. Dick, Mr. Dick, how long were you the lead
auditor for the Andersen team on WorldCom and its predecessor?
Mr. Dick. I became the lead auditor in 2001.
Mr. Bentsen. And how long were you on the team?
Mr. Dick. From 2001 until we were--
Mr. Bentsen. But prior to that, did you--
Mr. Dick. Prior to that, I was not on the direct audit
team. There would have been a transition process that took
place during the latter half of 2000. But I would not have
participated directly in connection with the audit of 2000.
Mr. Bentsen. So prior to--prior to 2001, you did not review
WorldCom's books at all?
Mr. Dick. That's correct.
Mr. Bentsen. In--when you took over as part of the audit
team and head of the audit team, and you prepared the 2001
books or prepared the 2001 audit, you looked at WorldCom in a
consolidated fashion and then presumably you took it apart and
the different parts, the MCI part, the WorldCom and the other
components that make it up, did you back into those
consolidated numbers or did you just take the numbers at face
value front and back.
Mr. Dick. Our audit would have tested individual
components, looked at individual components and then it would
have been consolidated together into the consolidated financial
statements.
Mr. Bentsen. Now, line costs which are the issue here, with
respect to whether they were adjusted from an operating expense
to a capital expense, line cost in this type of corporation are
fairly substantial items; is that correct?
Mr. Dick. That's correct.
Mr. Bentsen. I mean, in fact these line costs are perhaps
one of the most substantials items. If you read the 10K
throughout the management's discussion, they talk about line
cost as a percentage of revenue. I think you said it's
approximately an annual $15 billion expense of the company.
Presumably, the auditor would track those costs and how they
were being dealt with as an expense, would you not?
Mr. Bentsen. In connection with our audit, we would have
had specific procedures that would have tested the systems that
gave rise to those numbers of line costs, yes.
Mr. Bentsen. But you wouldn't--but in doing so, you
wouldn't look to see whether or not there were changes. I mean,
you just took the numbers that came from management and said
fair enough, those look good to us.
Mr. Dick. Well, we would have tested the under--you know,
some of the underlying amounts, billings for line costs that
gave rise to those numbers, and we also would have gone through
an analytical review process of comparing those costs to
previous years, comparing those costs as a percentage of
revenues for example, many of the line costs or a fair amount
line cost is driven by the amount of traffic and the amount of
revenues.
Mr. Bentsen. Let me ask you this: Also, line costs or any
expenditures, whether they are counted as an operating expense
on an annual basis or capitalized over a period of time, would
also have affected the tax work that Andersen would have done
for WorldCom?
Mr. Dick. I don't believe so. We were not involved with in
preparing their statutory tax returns.
Mr. Bentsen. But you were compensated for tax work, I think
you said, at the outset of your testimony.
Mr. Dick. Yes. We provided tax services related to tax
planning, tax organization, et cetera.
Mr. Bentsen. Did you also--last year WorldCom had an
offering of about $11 billion in debt. Did you provide a
comfort letter to the underwriters where you went back and
reviewed both the first--I don't know if the second quarter was
in, but the first quarter of 2001 financials or the 2000
financials. Doesn't that comfort letter give you an opportunity
as the auditor to go back and take a second look at the books
and provide the underwriters with some comfort that what they
are getting from the company and from the auditors who have
been compensated by the company are, in fact, what's there.
Mr. Dick. We would have provided a comfort letter, and the
consent to our report. And would have done the appropriate
procedures to insure that nothing--we weren't aware of or
nothing came to our attention. On the financial statement--
Mr. Bentsen. And so what you're telling us is the company
handed you their financials. You ran some tests. You backed--
you broke it apart, you backed it back together, backed it back
into the numbers by breaking it apart, looked at it
consolidated, looked at it separated. But in the midst of all
that, apparently, the CFO, which you are now CFO of the company
yourself. But the CFO switched $3.9 billion from an operating
expense to a capitalized expense, and that because of the way
you conduct your audit, there was no way you could have found
that.
How is it that an internal auditor, who doesn't have the
name of Arthur Andersen or any other firm, was able to find it
and you all were not, given the fact that you did the
financials, you came back, you did the quarterly financials?
You do tax work for the company, or you did, and you gave a
comfort letter where you supposedly went back and reviewed the
financials again and reviewed the quarterly data.
Mr. Dick. As I said before, I have not seen the specific
entries that have been purported to be made, nor am I aware of
how an internal audit would have uncovered the issues that have
been, so I can't--can I speak to the fact that we did our audit
and I believe we did a good audit in accordance with generally
accepted audit standards. I don't know what gave rise to the--
Mr. Bentsen. Well, let me ask you this. How much--
The Chairman. The gentleman's time has expired.
Mr. Bentsen. I would invoke the Watt rule on this if I
might, Mr. Chairman.
The Chairman. The gentleman is correct.
Mr. Bentsen. How much did 3.9 billion, or we'll say 3.2
billion, 3.1 billion in 2000, make up of the total capitalized
expense of the company? I know you didn't do the 2000 audit.
But presumably, doing the 2001 audit you would have some idea
what the 2000 numbers would look like. I mean, that's a pretty
significant number, is it not, of the firm?
Mr. Dick. Well, the total plant and services--.
Mr. Bentsen. And it's a significant number of the line
costs.
Mr. Dick. That's correct. It is a significant number of the
line cost. The total property and service of the company,
before depreciation in 2000 was approximately 45 billion on a
consolidated basis. And in 2001, it was 49 billion.
The Chairman. The gentleman's time has expired. The
gentleman from the first State, Mr. Castle.
Mr. Castle. Thank you very much. Over here. Thank you very
much, Mr. Chairman. Let me go to you, Mr. Grubman, if I can,
with respect to all this. On page 7 of the testimony I'm
looking at, it says it is critical to understand that, but for
WorldCom's fraud, I would have seen a more dire picture much
earlier. You indicated earlier to Congressman Ackerman that you
can't answer about crimes but you were lied to. I don't know if
you used the words, if that was deleted later in your testimony
or if you used it today. But are you referring to fraud as a
crime, or fraud in a general sense, or how would you define
fraud? Fraud typically is defined as a crime.
Mr. Grubman. Yeah, I know. I am not a lawyer. So I know
I'll have to be very careful, especially in this crowd. But the
fact of the matter is, what I was referring to is all during
2001, there was roughly $3 billion and change of expenses that
were reported as capital spending as the allegations charge.
And had that been reported correctly, if, in fact, that ends up
being true, we would have seen in the first quarter of 2001,
you wouldn't have to wait all year, which--
Mr. Castle. You would have seen earlier that there was a
problem. And therefore recommendations might have been
different.
Mr. Grubman. Well because the numbers would have been lower
and it would have given a different view of what--
Mr. Castle. Right. But I assume you're not stating whether
it was a crime or not.
Mr. Grubman. No, I am not.
Mr. Castle. Just wanted to check on that. Maybe a more
careful choice of language would be in order, if that's the
case. Perhaps it was a crime too. You represent the best
argument which I've seen. I've been looking for you as a matter
of fact. Not you individually, but the person like you because
you represent the best argument I've seen yet. When I came in
here before I read this testimony, coming down here, I really
wasn't sure whether we really should separate the research from
banking. And I'm convinced now that we absolutely should
separate it, and I'm not convinced by your argument otherwise.
And you've made several points here today, indication in
answers to various questions that your research was fair and
impartial, in spite of the fact that your firm also did
banking, and in spite of the fact that your compensation may
indeed have, in some ways, been tied to banking, indirectly, if
not directly; is that correct?
Mr. Grubman. Yes.
Mr. Castle. I mean, how can you--seriously, realistically
argue that you can be put in that position that any good
analyst could be put in the position of research making
recommendations on stocks, bonds or other investments
instruments in the same situation in which you're trying to
encourage banking? And I realize you've already said that in
certain circumstances, maybe because of your recommendations
they didn't even come to you. But once they've come to you,
isn't there an overwhelming amount of evidence that you're
going to, in that case, always be more supportive of the
companies than they should be?
Mr. Grubman. You know, what you raise is, you know, an
important point because there are a lot of, you know there's
conflicts that you have to navigate through. You have to be
cognizant that you're only as good as your reputation in the
marketplace and clearly, those issues have gotten raised to
greater heights over the last year or two. But having said
that, now, I haven't done, you know, some huge statistical
analysis of every stock in every industry. But let's talk about
the company we're talking about today.
Mr. Castle. Don't do it in too much detail because I have
other questions.
Mr. Grubman. Okay. Sanders and Bernstein is a great
research house.
Mr. Castle. But they do not have investment banking.
Mr. Grubman. They do not have investment banking. And
Fortune Magazine said that they are the last honest research
house. You know what, they had a buy on WorldCom. They had a
buy to the bitter end. There was no banking considerations.
Why? Because the analysts there--
Mr. Castle. But that's one example. And there probably are
a lot of examples either way.
Mr. Grubman. That's what I'm saying.
Mr. Castle. Let me go onto my next question. You indicated
to Congressman Shays that you talk to investors every day. I
got a hunch you wouldn't talk to me. Actually since you're here
you might talk to me now. But you wouldn't have talked to me
before I started asking you questions. What investors do you
talk to? You don't talk to the guy with the 401K, the average
person on the street, the person with $50,000 to invest. Who do
you talk to when you say investors, in a general sense? I
assume you're talking to big corporate--
Mr. Grubman. I talk to institutional investors, mutual
funds, pension funds managers, all that who indirectly are
representing a lot of individuals, obviously. And then, within
our firm, and I think this is probably similar in other firms
who have big retail systems, we talk to, you know, our larger--
Mr. Castle. Major larger people is who you're talking to?
Mr. Grubman. Our retail brokers.
Mr. Castle. Did you ever recommend to investors that you
talked to to sell WorldCom?
The Chairman. Gentleman's time has expired. The witness may
respond.
Mr. Grubman. I doubt it. No. I mean because we had a buy on
it until April of this year. But we don't talk to individual
investors.
Mr. Castle. I know my time is up, but it just stuns me that
you could watch it go down 99 percent or something of that
nature and nobody, you did not make a recommendation to sell. I
yield back. Mr. Chairman.
The Chairman. Gentleman's time has expired. The gentleman
from Connecticut, Mr. Maloney.
Mr. Maloney of Connecticut. Thank you, Mr. Chairman. Mr.
Dick, I would like to go back to the ground that my colleague,
Congressman Bentsen, was inquiring about. But he was inquiring
about it from sort of the bottom up dealing with the
individual, the line expense accounts and the capital accounts
and the aggregation of that into the overall picture. I'd like
to turn it around and look at it from the other way. You said
earlier that you had requested information from management
about any top side journal entries, and that the management had
said no, there were no such top side journal entries. First
question, did I just characterize your testimony correctly?
Mr. Dick. We requested whether there were any top side
journal entries as purported here, and we were not given any--
that there wasn't any.
Mr. Maloney of Connecticut. Okay. Fine. Then let me ask the
next question. When you're told that, what do the generally
accepted auditing standards say is the appropriate way to test
the management's representation to that effect?
Mr. Dick. Well, we would get--in addition to requesting it,
we got written confirmation that the financial statements were
complete and they were in accordance with generally accepted
accounting principles. But we would have taken all of the other
work we had done and based on testing the systems as I've
mentioned in the previous answers, analytically reviewing the
financial statements and running our software related to the
ratios on the financial statements, taking that all together
and our understanding of the company, we would have reached a
conclusion that we didn't need to do any further work.
Mr. Maloney of Connecticut. I heard you say that, but that
wasn't my question. My question was, what do the generally
accepted auditing standards ask you or require you to do in
regard to testing management's representations about top line
journal entries? What is it you're supposed to do?
Mr. Dick. Well, they would--I think they would
specifically--I mean, there wouldn't be anything that would
probably be specific. It would be in context of all of our work
that we've performed and our knowledge that we've gained from
performing that work as to whether or not there would be or
wouldn't be. But we do ask the question and we do get written
representation from management to that effect.
Mr. Maloney of Connecticut. All right. Well, I think we'll
just leave it at that. What you have said today is that you
asked the appropriate questions, and not only did you ask the
appropriate questions, you then pursued those questions
consistent with generally accepted auditing standards. That is
what you said on many, many occasions, and that will obviously
be reviewed on other circumstances.
And I thank you for your testimony today. Mr. Grubman, if I
could just move to you quickly. You have referred twice today
at least to your investment thesis in regard to this
corporation.
Mr. Grubman. Yes.
Mr. Maloney of Connecticut. Could you give us a thumbnail
sketch? And I emphasize thumbnail sketch as to that investment
thesis.
Mr. Grubman. Yes. This is something that really began in
the mid '80s. First, we believed that as markets deregulated,
first the long distance market with the AT&T divestiture, and
then the Telecom Act that was passed in these Chambers in '96,
the local markets, that the newer start up entrance would gain
market share, innovate, create jobs, take market share. That
worked perfectly in long distance.
Unfortunately, it did not end up working in local. WorldCom
was an outgrowth as LVBS of that first thesis. In the mid '90s,
I wrote a very big report called "The Global Telecom Jigsaw
Puzzle" where I hypothesized there would be several spheres of
influence among bigger companies. WorldCom evolved into one of
those companies with their end-to-end array of assets that I
thought would allow them to serve telecom intensive global
customers around the world with a multitude of services.
Mr. Maloney of Connecticut. Okay. Now let me follow that up
with a question. Tell me what you think the relationship was
between that investment thesis and what the investment banking
side of the house was doing in regard to it's investment
decisions. In other words, how did your thesis as an analyst
inform and then change or motivate the investment side of the
house in its decision making?
Mr. Grubman. That's a good question because it aligns the
cart and horse right. My research had a view, a view long
before I worked for a firm with a big investment bank. I was at
PaineWebber for, you know, 9 years prior to Salomon. That view,
for better or worse, helped shape where the investment banking
opportunities were for my firm. It helped us with, as you could
imagine, one set of companies, it hurt us as you could imagine
with another set of companies.
Mr. Maloney of Connecticut. Thank you. My time--
The Chairman. The gentleman's time has expired. The
gentleman from Michigan, Mr. Rogers.
Mr. Ebbers. Mr. Chairman, may I be excused to go to the
restroom please?
The Chairman. Yes I was just commenting to staff, the
gentleman may be excused. Let's--why don't we just take a 5-
minute break here. The witnesses have been at the table for a
long time.
[recess.]
The Chairman. The committee will reconvene. If Mr. Grubman
and Mr. Sullivan could come forward. If we could find Mr.
Grubman, and we can get started. The gentlelady from Illinois
is recognized.
Mrs. Biggert. Thank you, Mr. Chairman. Mr. Dick, in your
auditing career, is it normal practice for CEOs or members of
the executive committees of companies to take large loans from
their companies? Is this a policy that you have run into?
Mr. Dick. I haven't seen it in any--maybe occasionally I've
seen it occasionally, where there would be loans to executives
for companies.
Mrs. Biggert. Well, this was true in WorldCom, and did you
see--how does that show up on the books?
Mr. Dick. It shows up as a receivable on the company's
books on their balance sheet.
Mrs. Biggert. And is there usually a purpose? Do they state
the purpose for the loans?
Mr. Dick. I believe there is appropriate disclosure in
their financial statements regarding the loans with related
parties.
Mrs. Biggert. Is it something that has to be approved by
the executive committee of the company?
Mr. Dick. I don't know for what it would have specifically
been. I imagine that could have been the case.
Mrs. Biggert. Did you work with Ms. Cooper, who is not here
today because of the request of the Justice Department?
Mr. Dick. Did I work with her?
Mrs. Biggert. Yes.
Mr. Dick. We would have worked--our audit plan would have
taken into consideration an understanding what the internal
audit plan for WorldCom would have been. And we would have
reviewed the outcome of their work, made inquiries as to the
outcomes of their work, whether it should affect our plan as
well.
Mrs. Biggert. But you would have gone over the audit with
her?
Mr. Dick. We would have gone over the, you know, the
result, I mean, she would have participated in, I believe,
discussions with the audit committee on the results of audits.
Mrs. Biggert. Okay. Thank you. Mr. Grubman, just in time.
I'm just curious about what convinced you to move your WorldCom
recommendation from buy to neutral. I know you talked a little
bit about that. But I am really--even, in fact, more curious
about what finally led to you make the underperform
recommendation, and I have read that you have been considered
the number one investment analyst in the country. But the
record shows that WorldCom share prices ranged from a high, you
know, a $60 high in 1999 down to the 20s, and then the teens in
2001. And then it was only in April of 2002 that you moved from
the buy to neutral at $4 a share and then on June 21 to--you
changed your opinion to an underperform. What's the--the
question is, what's the criteria that you use to make those
recommendations or ratings?
Mr. Grubman. In general, my recommendations tend to be more
based on longer-term criteria than quarter in, quarter, out.
This is as a broad--this is how I do my job. And as I outlined
in earlier testimony, I just viewed WorldCom as the preeminent
company in this industry, especially after the MCI merger, the
assets, and the customers.
During the course of 2001, after WorldCom's stock had
dropped quite a bit in 2000, WorldCom stock stayed pretty flat
during the course of the year in a market that went down. So it
was actually, on a relative basis, not a bad performer.
During the course of 2002 what led me--and I think during
this same day about 10 other firms--to downgrade the stock,
there was a lowering of their financial guidance. It got to the
point that it was difficult to continue to recommend the stock
given where the evaluations were.
Mrs. Biggert. About how many stocks do you downgrade a year
to sell or to underperform?
Mr. Grubman. Well, the underperform downgrade June 21st,
which was a one-notch versus two-notch, what we did in April,
as I said, that was based on several very important factors.
The rating agencies, 1 day and 3 days before what we did,
downgrading to the equivalent of Single B which was a very
harsh downgrade, it took the market by surprise.
My staff was reviewing the earnings models for all of our
companies--
Mrs. Biggert. But how many other companies have you just
done a sell and not jumped from neutral to downgrade, but from
neutral to sell?
Mr. Grubman. Well, we didn't have a sell. We went from a
neutral--
Mrs. Biggert. Other companies, not WorldCom. What about
McLeod or what about some of these others, or Global Crossing?
Would you--did you go to a sell on those?
Mr. Grubman. What happened with them where we had neutrals
on--either they went bankrupt or we just suspended coverage.
This was a company that we did not think was going
bankrupt, as we wrote. But we thought--a market underperformer
was an appropriate rating, you know, until certain things were
more visible, like their bank facility and what we thought was
going to have to be a recapitalization to deleverage the
balance sheet.
The Chairman. The gentlelady's time has expired. The
gentlelady from Oregon, Ms. Hooley.
Ms. Hooley. Thank you, Mr. Chairman.
Mr. Dick, I think there are probably--I will move this way
so I can see you. I think there lots--there are people watching
today with their mouths hanging open, people that own
companies, people that are in charge of organizations that
thought that auditing companies would come in and find some of
their problems.
I can remember sitting as a board of county commissioners,
our auditing company, I expected that if there was any
irregularities in any of the units, for them to let us know
that. So we relied on them. Auditing firms probably had one of
the best reputations in the country of any kind of business
because people expected them to, if there were problems, to
identify what those problems were. And yet here is a
discrepancy of $3.8 billion that you don't find.
And I want to know, did you--have you sat down and said to
your colleagues, how in the world did we miss a $3.8 billion
discrepancy? Have you talked about that? Have you said, how did
we miss it? And, what would we do in the future?
Mr. Dick. That is a good question. And again, let me just
reemphasize, I have not seen the actual entries that have been
purported to me, or do I know how it was uncovered by internal
audit. I have asked, since I became aware of this, other
members of the audit team whether or not they had any knowledge
of this, whether or not there was anything that we had done
that was--should have revealed this to us. And I have
concluded, based on the work that we did and my understanding
of the work that other members of the team did, that we did our
audit, and we did our audit in accordance with all of the
things one would expect to do.
Ms. Hooley. You may have done that. But, I mean, you have
got to be saying, what have we got to do different in the
future? What do we need to do differently? I mean, if people
are going to trust auditing companies, they have to have some
faith that you are going to do things differently so this
doesn't happen again. So what are you going to do differently?
I mean, you say you already did all of the things you are
supposed to do. What are you going to do differently?
Mr. Dick. In this case, Congresswoman--and I am not trying
to be evasive--I don't know the specifics, what gave rise to
it, therefore I cannot--
Ms. Hooley. Is anybody sitting down and asking that
question? Are you talking to one another?
Mr. Dick. As I said before, I have had some initial
discussions with other members of the team.
Ms. Hooley. Do you think we should do something
differently? Congress? What kind of--what do we need to do to
help you?
Mr. Dick. Again, in this specific circumstances--
Ms. Hooley. Well, let's just talk in general. What do we
need to do differently? We need to protect the investors out
there. We need to protect the public. What do we need to do
differently?
Mr. Dick. Well, as I mentioned before, I think there are a
number of proposals, a number of things that are being
considered by this committee and others. And again, the actions
that may come out of those considerations may or may not
necessarily produce any type of a fail-safe system that would
prevent this kind of--purported kind of activity from having
taken place.
Ms. Hooley. Okay. Mr. Grubman, a couple of questions.
Mr. Grubman. Yes.
Ms. Hooley. Do you consider yourself an independent
analyst?
Mr. Grubman. Yes.
Ms. Hooley. Then why were you a participant in the WorldCom
board meetings?
Mr. Grubman. As I said earlier, I don't know if you were
here--
Ms. Hooley. I was here.
Mr. Grubman. On only a few occasions when I was brought
over the wall and thus frozen from doing my job with investors,
did I participate in WorldCom board meetings on very specific
items.
Ms. Hooley. But with your compensation, do you think it is
possible to be objective when WorldCom is essentially paying
your salary?
Mr. Grubman. WorldCom is not paying my salary. Salomon
Smith Barney is paying my salary.
Ms. Hooley. But then they underwrite WorldCom. Is that
right?
Mr. Grubman. WorldCom is one of the investment banking
clients of the firm. At our firm, investors are extremely
important. The retail system and the capital markets bring
revenue into Salomon Smith Barney that is at or above what
investment banking revenues are. So all constituents are very
important. An analyst who ends up losing all credibility with
investors will have a very short-lived value to the firm.
Ms. Hooley. Do you think it is a good analogy between, for
example, pharmaceutical companies, if they want to do--if
somebody wants to do research, medical research, usually they
can't do any independent study because you can't get anyone to
pay for it; so then they go to the pharmaceutical companies and
they help pay for the research. And that is why, for example,
people pay, you know, $200 a month for Celebrex, when they
probably could be using aspirin that is only slightly more
effective.
I mean--and we ask our researchers to be independent. It is
hard to do that. I mean, do you think analysts can be
objective?
The Chairman. The gentlelady's time has expired. The
witness may answer.
Mr. Grubman. Yes, I think that we can. And in our case, we
adopted, we at Salomon Smith Barney adopted the Merrill-Lynch
proposals. And therefore on a going-forward basis, there will
be no direct input at all from the investment banking
department into the compensation of analysts. And I like to
think that my behavior and the rest of the staff at Salomon
Smith Barney won't change as a result of that.
The Chairman. The gentleman from Pennsylvania, Mr. Toomey.
Mr. Toomey. Thank you. My first question is for Mr. Dick. I
take it from your repeated responses to other questions that
you would not agree with my assessment that the audit that your
former employer did for WorldCom was a total disaster? You seem
to believe that you performed the function properly.
The problem I have with that, is that in your own
testimony, on page 2, one of the things you stated is that the
role of an outside auditor is to review the financial
statements to determine if they are prepared in accordance with
the generally accepted accounting principles. Well, these
weren't, unless you are suggesting that this shift from--of
line items, the line charges to a capital cost was--is
consistent with GAPP accounting. But I don't think you are
suggesting that.
Mr. Dick. I am not suggesting that.
Mr. Toomey. So clearly it fails that test of what the
proper role of an auditor is. And the Andersen audit failed
that test. Then it goes on to say, "and to conduct its audits
in accordance with the generally accepted auditing standards,
which require that auditors plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement." .
Well, of course they weren't free of those misstatements.
They had gross misstatements.
I guess I am trying to understand how this cannot be
perceived by yourself as a huge failure. For instance, what is
that plan to obtain that reasonable assurance? Do you, for
example look at sample transactions that go into a given line
item? Is that a test?
Mr. Dick. Yes, we did.
Mr. Toomey. Are they intended to be representative
samplings; are they random; are they intended to get to the
gist of whether these accounts are likely to be accurate?
Mr. Dick. They would be intended to be representatives.
Mr. Toomey. The line charges, as they seem to be described,
that were misplaced or misrepresented, they were like 20
percent, roughly, of the total line charges that were reported.
Is that about right, according to the numbers that I have?
Mr. Dick. The numbers I reported, 3.8 billion versus
roughly 15 billion.
Mr. Toomey. So, thereabouts. That is a pretty substantial
percentage that is missing from what ought to be there, right?
And then an equal amount that shows up somewhere where it
doesn't belong?
Mr. Dick. Of that line item, yes. I agree.
Mr. Toomey. I am not sure which of the accounts, I have got
a consolidated financial statement here, and I am not sure
which exactly of these capital accounts those line charges got
buried in, whether it is in plant and equipment or good will or
otherwise. But if you look at the change in these capital
accounts from one year to the next, a $3 billion change is
pretty substantial. It is a very large percentage with respect
to the change.
And I would think that any reasonable representative
sampling of how did this capital account change so much would
gave rise to perhaps discovering that there are some things in
there that didn't belong in there.
Should not a system intended to give you the reasonable
assurance that you are supposed to obtain, should not it help
you discover that?
Mr. Dick. Well, in our audit--we did the appropriate audit,
in my opinion, in accordance with our standards that we
followed. And we tested the transactions, we analyzed it --
Mr. Toomey. Do you think you tested enough transactions?
Mr. Dick. Based on our audit work we did, yes.
Mr. Toomey. Even though you didn't discover this massive
problem?
Mr. Dick. Well, we tested sufficient transactions to rely
on the system of controls in place for those transactions. But
what has been reported here is that the company made journal
entries outside of the normal transaction systems. I have not
seen those journal entries. But in fact if they have been made,
and we did in fact ask and make inquiries of those, you know,
we would have been misled.
But in addition to those testing of those transactions that
we did, we looked at the financial ratios of the company. And
the--
Mr. Toomey. Because I am short on time here--so you did
look at sample transactions from the very capital accounts
which were inflated?
Mr. Dick. We looked at sample transactions from various
capital accounts. I don't know if it is from the specific
capital accounts that were inflated, because I haven't seen
them.
Mr. Toomey. What you are implying, then, is that there may
be very large capital accounts for which you did not look at
any sample transactions then.
Mr. Dick. We probably would have looked at sample
transactions from most significant--
Mr. Toomey. It seems to me that the system, the plan
designed for this purpose, clearly seemed inadequate. I am
surprised that there is no acknowledgment of that.
Let me ask a separate question. Throughout the course of
the audits that you were involved in, was there any time in
which anybody at WorldCom in any way, in your opinion,
attempted to obstruct your investigation; actively, for
instance, prevent you from looking at documents you wanted to
look at or forbid you from looking at transactions?
Mr. Dick. Not that I am aware of.
The Chairman. The gentleman's time has expired. The
gentleman from Texas, Mr. Sandlin.
Mr. Sandlin. Thank you, Mr. Chairman.
Mr. Ebbers, you are the former CEO of WorldCom; is that
correct?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Sandlin. Yet in your sworn testimony earlier today, you
said, "I served as CEO of WorldCom for 17 years." now, did you
think you did an appropriate job in approving the handling of
expense for WorldCom?
Mr. Ebbers. Is that a question?
Mr. Sandlin. Yes, sir.
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Sandlin. And yet in your testimony today, you said, "I
am proud of the work that I did." Do you know the value of
WorldCom stock today?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Sandlin. In your sworn testimony today, you said,
"WorldCom continues to be a valuable company." now, you know
that there are certain civil and criminal penalties for filing
false statements and false affidavits, don't you?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my fifth amendment
constitutional rights.
Mr. Sandlin. Yet in your sworn testimony already before us
today, you said, "I believe no one will conclude that I engaged
in any criminal or fraudulent conduct during my tenure at
WorldCom." .
Now, you also indicated you didn't believe you had anything
to hide. That is what you said in your previous testimony
today, isn't it?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sandlin. Now you are trying to take some selective sort
of fifth amendment privilege, I see.
Now, let me ask you this. Are you a citizen of the United
States of America?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sandlin. You won't even tell this committee if you are
a citizen of the United States. That is a question.
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sandlin. So if we put off this hearing today and we
have this subpoena out, and you go away to come back for a
contempt, we have no guarantee that you are coming back. You
have access to tremendous amounts of money since--although the
stock is now at 6 cents a share today, you sold yours for 35
million at its peak in June of 2000. Since we don't know you
are a citizen, we don't know if we can require you to get back
or not, do we?
Mr. Ebbers. On the instructions of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sandlin. Mr. Chairman, I am going to renew my motion
for contempt and ask that the witness be held in contempt. He
has waived his fifth amendment rights. I asked him questions
off his own sworn testimony, which I would like to deliver to
the Chair. He is now refusing to answer those questions. I
don't believe he is a citizen of the United States of America.
I don't believe that we have a way to guarantee his
reappearance before this committee for the contempt hearing. I
would like a motion for show case to issue setting a date
certain. I would like some security that he will return, that
after the hearing he be held in contempt of the committee, that
this be taken to the House floor and he be held in contempt of
the United States Congress until such time as he answers the
questions before this committee.
It is not that difficult. He is trying to invoke the
protections of the United States Constitution for himself, but
he will not cooperate with the United States Congress. He is
attempting to invoke the protections of our Constitution at the
same time that he won't even say whether or not he is a citizen
of the United States. And I don't think he is. We will find out
if he will answer it.
So I am reviewing that motion for contempt. I am going to
deliver his transcript to the Chair and ask that you look at
that and hold him in contempt.
The Chairman. The Chair has indicated before, it will take
that under advisement and take a look at the testimony.
Mr. Sandlin. Mr. Chairman, what kind of--I don't think it
is improper to inquire as to the citizenship status. And I
don't think that is deserving of a fifth amendment protection.
He is either a citizen or he is not.
The Chairman. The Chair would ask counsel's opinion first
before we proceed further.
The gentlelady from Pennsylvania.
Ms. Hart. Thank you, Mr. Chairman.
Mr. Grubman, Pennsylvania's Teachers' Pension Fund has lost
69 million on a sale of WorldCom stock already, and bonds as
well, for the fiscal year that ended June 30th. They are
carrying 17 million in unrealized losses on WorldCom bonds that
they still own. That is the Teachers' Pension Fund in
Pennsylvania. I know the California fund has lost a lot. And a
number of those funds that invested based on analysts
recommendations in WorldCom have lost extremely large sums of
money.
In the year 2000, WorldCom just met its operating earning
target two quarters in a row by tiny fractions of a cent.
Aren't the odds of that happening two quarters in a row
extremely rare, and shouldn't that have been some kind of red
flag to analysts and the directors of the company?
Mr. Grubman. First--and this is sincere. I mean, let me say
that as I said in my opening remarks, it is tragic what has
happened to investors and employees with WorldCom, in general
with the telecom space.
As far as just meeting by fractions of a penny, well, you
certainly take that into consideration in terms of looking at
just how they did it. Now, I don't recall specifically quite
how they got to those numbers. But from the best of my
recollection, it wasn't necessarily because of, you know, low
tax rates, anything on a book basis, not a cash basis.
WorldCom was actually a quite high-tax payer if you go back
and look at their statements. So the first thing you look at is
do they make the number kind of below the line, below the
dollar line or below the operating income line? In the case of
WorldCom, that wasn't true.
And as you point out, while that was true for the first
couple of quarters, in the second half of the year, you know,
in fact that started missing. You may also recall at the end of
2000, they took a--they did a big change to their going-forward
guidance. So probably had that lingered for 5, 6, 7 quarters,
maybe you look at it, you look at what the source of it is. If
it is all of a sudden a 20 percent tax rate, that throws up
more of a red flag. That wasn't the case.
Ms. Hart. So you would wait a number of quarters?
Mr. Grubman. You look at quarter in, quarter out. As I said
to the earlier question, when it comes to the topic of this
discussion, the capital spending trends were completely in line
with guidance. And don't forget, no one was hiding cash out of
the door. Cap X is still cash outlays, it is just spread out
over the income statement as opposed to expensed in periods.
Ms. Hart. In a typical situation when they are that close
to meeting expectations, though, do you normally take an extra
look at the company?
Mr. Grubman. Well, you do that anyway. I mean, in fact
sometimes you take a harder look when they blow away
expectations. Because telecom is an industry, it is not like,
you know, biotech or whatever. And a telecom company the size
and stature of a WorldCom, you would probably be more
suspicions if they blew away the estimate.
Ms. Hart. Thank you, Mr. Grubman.
Mr. Sullivan, reflecting on that fact, that two quarters in
a row WorldCom met its operating--the target the analysts had
placed there for it by tiny fractions of a cent, does that--
sounds to me, anyway, like the analyst's recommendations were
looked at first, and then perhaps the accounting was done so
that you did meet the expectations. Is that the case with
WorldCom?
Mr. Sullivan. Congresswoman Hart, I have asserted my right
to--my fifth amendment right to the Constitution today for all
questions. I had no prepared statement on the advice of
counsel.
Ms. Hart. You decline to answer that again. Thank you, Mr.
Sullivan.
Mr. Dick, in your testimony, it was referred to earlier, I
think Ms. Hooley actually asked you regarding the
responsibility of the company, some of the other--my colleagues
have asked you about who is responsible for the audit. It is
mostly--you state it is something like, it is mostly the
responsibility of the management of the company, not the
outside auditors, to present the financial statements.
Mr. Dick. I think I stated it is the responsibility of the
management to prepare the financial statements. The auditors
would be responsible for auditing the financial statements.
Ms. Hart. To audit. In your testimony, you stated that you
relied on the integrity and competence of management. To what
degree do you do that? When do you start to question
management? You mentioned that there is some kind of test done.
I would like you to go into that and explain what kind of test
you do. Could do you that for me briefly?
Mr. Dick. Well, the type of tests we do relate, again, to
the transaction systems. For example, we might select a
particular billing or an invoice that had been paid. And we
will look at it for proper approval and that it flowed through
the company's systems, then ultimately got into the company's
financial statements.
In terms of reliance on integrity of management, that is a
much more subjective evaluation. It would be--the kind of
things one would consider would be, have we ever had
significant issues or concerns with representations from
management? Have we had concerns about the management's
attitude?
Ms. Hart. Would those concerns have generated from you, the
auditor, or would they have generated from somewhere else?
Mr. Dick. They would have been from the auditor's
perspective.
The Chairman. The gentlelady's time has expired. The
gentleman from New York, Mr. Meeks.
Mr. Meeks. Thank you, Mr. Chairman.
Mr. Sullivan, when you came up with this practice of taking
money out of the operating fund and putting it into the capital
fund, had you done that previously? Was it many times you had
done it, or was this the first time that you engaged in such a
practice?
Mr. Sullivan. Congressman, based on the advice of counsel,
I assert my fifth amendment right to the U.S. Constitution.
Mr. Meeks. What about with the reserve funding? Did you do
anything with the reserve funding that kind of changed the
books or something, or how we can find all of the money that
was in the reserves? Is there anything that we should know
about now that you would like to talk about?
Mr. Sullivan. I assert my fifth amendment rights.
Mr. Meeks. Mr. Dick, you are with Andersen, and you do the
accounting. You said you looked at some of the documents, et
cetera, and you, based upon the information you was given,
there is nothing that you could come up with to show that there
was anything wrong or any money that was from one account put
to another; is that correct?
Mr. Dick. Yes. I just--I am no longer with Andersen.
Mr. Meeks. But when you were there.
Mr. Dick. When I was there, we would have performed our
audit.
Mr. Meeks. Would you say also, based upon your examination
in regard to the reserve fund, did you find or detect anything
that could show that maybe there was some additional money,
maybe more than 3.8 billion, there is some money that might
have been accounted for in the reserve funding that now was
shifted? Is there any evidence of that in your audit?
Mr. Dick. In your audit of 2001 we looked at the company's
reserves and whether there had been any shifting out of those
reserves and didn't find anything inappropriate.
Mr. Meeks. Do you have the ability to detect whether or
not, now thinking back, based upon the principles that you
utilized, knowing what has taken place with the operating funds
going into capital funds, would you think that there is
anything that you could have possibly done or would you look at
now to detect whether or not any of the reserve funds were
transferred?
Mr. Dick. Well, when we performed our audit for 2001, we
looked at--when I refer to reserve funds--or you are referring
to reserve funds, I am not certain--but reserves are generally
considered allowances for bad debts, for example. We would have
looked at the appropriateness of that allowance, whether that
allowance was building up based on the aging of their accounts
receivable, whether they would have reduced that allowance
based on better collection experience, these type of things
when we look at the reserves.
Mr. Meeks. Could there have been any cooking of the books
with respect to the money that was put aside for reserves for
bad debts, et cetera?
Mr. Dick. I am not aware of any.
Mr. Meeks. Let me ask this question, and maybe we are
missing it. I don't know whether the role of auditor--in your
years as being an auditor, have you ever in your--you know,
auditing books, et cetera, uncovered any fraud or ever been
lied to by any client?
Mr. Dick. In terms of uncovering fraud, I haven't--in our
auditing--in my experience as an auditor, there might be minor
instances of fraud or illegal acts that might take place at a
company. I have never been associated with or never personally
been involved with any significant fraud that has been
uncovered at a company.
Mr. Meeks. So my question is, if you found, whether it is
minor fraud or major fraud, et cetera, what did you do in that
instance?
Mr. Dick. Well, in cases where an auditor has become aware
of fraud or illegal acts, their responsibility is to notify
management.
Mr. Meeks. You said there has been one case, or a case.
Mr. Dick. If I would have personally become aware of it in
connection with the audit, we would have notified management
and the board, the company's board, of that act.
Mr. Meeks. Have you done that in the past?
Mr. Dick. I can't think of any specific instance right now.
Mr. Meeks. So most of the time, what you just try to do is
to make sure that you make a presumption, I guess, that the
figures that you are given by management are correct. And you
then just try to make sure that as you add them up, that those
numbers are correct. So there is nothing probing that you would
try to do, other than whatever you have in your computer?
Mr. Dick. No. In connection with our work, and in fact in
connection with our work for WorldCom, we have a responsibility
to make sure that the financial statements are not materially
misstated, as I mentioned in my testimony.
We would, in fact--that would be from--
Mr. Meeks. But you didn't do anything probing?
Mr. Dick. If I could finish, please.
We would have done probing. We would have asked the
questions. We would the asked management and got
representations, and we would have evaluated whether or not we
thought there was an opportunity.
Mr. Meeks. My last question is, in response to a couple of
my colleagues, you know, you have indicated that there are a
couple of proposals that may be coming out of this body,
whether from the Senate side or from the House side, that might
be useful for us in the future. I was wondering, since you know
that there are proposals coming out, which specific ones that
you reviewed would you recommend that we strongly consider that
will help prevent this from happening again in the future?
Since I know you know of--everyone knows, that is public
knowledge, that is something that is public knowledge, what we
are considering.
Is there any specific one or two or three of them that you
would strongly recommend? I know that there is nothing that is
going to be fail-safe, but you would strongly recommend to us
as a body to consider?
Mr. Dick. As I said before, there are a number of proposals
outstanding. I guess in thinking about those proposals, there
has been a lot of discussion and maybe now a rule--I am not
certain if it has formally passed--of executives, CEOs, and
CFOs of companies having to certify that their financial
statements are correct.
I guess as a CFO, I believe that is a very significant
change or proposed change that--I am not sure I understand
exactly where that is, but I have heard about that proposal.
The Chairman. The gentleman from Ohio, Mr. Tiberi.
Mr. Tiberi. Thank you, Mr. Chairman.
Mr. Dick, following up on a question by Mr. Bentsen, you
stated that you were not aware of how the internal audit
discovered the financial fraud accounting practices at
WorldCom. Is that correct?
Mr. Dick. That is correct.
Mr. Tiberi. Can you detail to us what your relationship or
your committee's relationship was and your interaction was with
the internal auditors at WorldCom?
Mr. Dick. As we would have done our audit work, we would
have interacted with internal audit to understand what audits
they were doing. We would have--for example, internal audit
gave a readout at the audit committee. And we would have
understood that readout. We would have participated in that.
We would have reviewed selected--and I don't know if it
would have been all--but we would have reviewed selected
internal audit reports that were issued by internal audit, as
necessary. We would have followed up with questions, if
appropriate, as to the type of points or observations that
internal audit had, to see if that should impact or would
impact our audit plan that we were executing on.
Mr. Tiberi. Do you believe that we would be here today,
that the public and the investor community would know what we
know about WorldCom and its fraudulent accounting practices, if
it hadn't been for Ms. Cooper?
Mr. Dick. Again, I am not sure--in fact, I do not know what
internal audit did to uncover this. So I don't know if I can
answer whether we would be here today or not.
Mr. Tiberi. I hate to beat a dead horse, but you have heard
over and over again today, I guess the assumption was prior to
the last year, that auditing firms could uncover fraudulent
behavior by companies and executives in those companies. Is
that statement not true?
Mr. Dick. Well, I think there is a belief that auditors can
uncover all fraud; and auditors have a responsibility, as I
said in my written testimony, to make sure there aren't
material misstatements, and to plan and design our audit in
that approach.
There will be instances, I believe, and have been
instances, where external audits will not uncover fraud of any
nature. If there is going to be a concentrated effort--and I
don't know--I mean, it has been reported--there is going to be
a concentrated effort, that is going to be very difficult under
any circumstance to potentially uncover.
Mr. Tiberi. Thank you. Mr. Grubman.
Mr. Grubman. Yes.
Mr. Tiberi. You mentioned earlier that the institutional
investor is the primary person that you deal with on a daily
basis; is that correct?
Mr. Grubman. That is the investor that I talk to day in and
day out.
Mr. Tiberi. When you talk to that investor day and in and
day out, do you disclose your relationship or Salomon's
relationship with a potential client, like in this particular
case, WorldCom?
Mr. Grubman. In all written material that Salomon Smith
Brothers--Salomon Smith Barney puts out, that goes to
everybody, retail investors as well as institutional investors,
and on the Internet, all banking--we disclose that we have a
banking relationship, if we do, with the particular company
that is in question, yes.
Mr. Tiberi. How many companies which you have recommended
have filed for bankruptcy Chapter 11 in the last 2 years?
Mr. Grubman. I don't recall the exact number. But it is--it
has been quite a few, unfortunately.
Mr. Tiberi. On March 21st of 2001, a year after, I think
everybody would argue, most telecom companies began to sink,
you issued a 28-page research report titled ``Grubman's State
of the Union: Does He Ever Stop Talking?''.
In that report, you urged investors to purchase your top 10
picks. Do you remember which ones those were?
Mr. Grubman. Yes, it was a--what we called an eclectic
basket of names that ranged from Verizon, which is a regional
Bell operating company, to, unfortunately, several small
emerging names, some of whom have gone bankrupt.
Mr. Tiberi. Right. Let me give you those 10. Broadwing,
down 83 percent since your report. WorldCom, down 99.9 percent
since the report. Qwest Communications, down 94.7 percent.
Allegiance Telecom, down 90.7 percent. Global Crossing, down
99.9 percent. Metro Media Fiber Network, down 99.9 percent.
McLeod, down 99.9 percent. Windstar Communications, down 99.9
percent. And XO Communications, down 99.9 percent.
In November of 1999, you reversed your long course on AT&T
by issuing a buy recommendation. And, in fact, Smith Barney, at
the same time, was jockeying for a $10.6 billion AT&T Wireless
IPO. Did the prospect of getting the investment banking fee
from AT&T influence the sudden shift?
Mr. Grubman. No. Our work on the AT&T research started in
August of 1999. AT&T, who I was cautious on to say the least,
from about 1995 onward, was undergoing a huge transformation.
They had bought two cable companies. They were the largest
cable company in the United States. They were a large company
in my group. And it is my obligation, when a company like that
goes through a massive transformation, to take a second look,
which we did.
Secondly, we have had a long-held view that the regional
Bell operating companies were particularly vulnerable on all
sorts of fronts, most notably on the residential side from
cable companies, and a view we reiterated just a few months ago
in a big report.
So on AT&T, this was a company we had not liked very much,
undergoing a massive transformation in terms of its asset base.
We owed it to ourselves and our investors to take a fresh look,
which we did, and we wrote a very large report. The investment
thesis there was AT&T, by virtue of being the biggest cable
company in the United States, we thought over a 3- to 5-year
period would develop what we call the triple play of voice,
video, and data to a large swath of customers. A collateral
benefit of that was going to be that it would be able to
protect a big chunk of its consumer long distance base as a
result of that.
Mr. Tiberi. Just one last question, Mr. Chairman.
Mr. Grubman, correct me if I'm wrong, but the nine
companies that I mentioned that tanked, whose stocks have since
tanked, didn't they have a relationship, a financial
relationship, an underwriting relationship, with your firm?
Mr. Grubman. The stocks that you cited were all stocks that
I believed in, and as a result of our research and other
considerations in the firm, yeah, we did banking business with
them; just like stocks that I chose not to cover or did not
believe in, you know, had negative consequences to the firm.
Mr. Tiberi. Thank you.
The Chairman. The gentlelady from California, Ms. Lee.
Ms. Lee. Thank you, Mr. Chairman. Let me just say that this
world, the world of WorldCom, is really a world that very few
of us would ever get a glimpse of until now, unfortunately. And
I must say that it is very disturbing and almost unbelievable,
and really appears to be criminal for what has happened to
thousands and thousands of men and women.
I would like to know just a little bit more about your
world. Are there any conflict-of-interest rules, any ethical
guidelines that govern your work and your behavior, your
industry?
Now, you indicated to Congresswoman Maloney--and, Mr.
Grubman I am asking you specifically, since I can't ask the
other two gentlemen for an answer to these questions--but you
indicated that you had never owned any stock of your clients.
But let me ask you about what we here call gifts, perhaps you
may call it business entertainment, amenities, such as were you
a passenger on a WorldCom aircraft, those kind of goodies that
come with some industries.
What type of firewalls do you have in your business that we
can understand a little bit more about?
Mr. Grubman. Well, obviously, there are formal firewalls
between banking and research. And you only get taken over on
special occasions for short periods of time. As I said earlier,
you are frozen and can't do your job at that point. So that is
why you don't like to do that. As far as conduct is concerned,
which I think--
Ms. Lee. I will ask you about being frozen. Keep going. I
am sorry.
Mr. Grubman. I and every other analyst on Wall Street try
to get to know management, because it is a way for us to
determine if we think a management team has the ability to
execute its stated business plan. There is no apologies for
that. Every analyst on Wall Street tries to do that. There are
occasions where there are social events involved that happen.
In the case of WorldCom, over the course of a dozen years
that I think I have known Mr. Ebbers, I think anyone in this
room would describe it as a sort of handful of occasions where
you would suggest that I was in any kind of quasi-social
atmosphere.
Ms. Lee. You said, and you said in your statement, and also
you responded to I think Mr. Sanders by saying that your
relationship was a good working relationship. But there have
been reports--others have couched it by saying that it is a
personal relationship.
Could you make that distinction and clarify for us what
that relationship is? Is it personal, or was it a working
relationship?
Mr. Grubman. Well I--my view of my relationship with Mr.
Ebbers is that it was a very good working relationship. If you
actually added up the number of times over a dozen years that
we actually saw each other and spoke to each other, it would be
surprisingly low, given what the press accounts seem to think.
Ms. Lee. So you don't consider it a personal relationship?
Mr. Grubman. I consider Mr. Ebbers someone I like, someone,
you know, I liked to be around when I was around. But it was--
it was clearly based on work. There was almost never an
occasion, or very rare, where we were together that work wasn't
a dominant topic. So it was a relationship that I liked. And I
not going to sit here and deny that I didn't like Mr. Ebbers,
clearly. But it was born out of our working relationship and
that is what it was.
Ms. Lee. So it was not a personal relationship?
Mr. Grubman. Well, I don't know. I view--as having a
personal relationship with people who I see every day, I talk
to every day, I do things with every day, that was not the case
here.
Ms. Lee. Let me ask you about being frozen. What does that
mean, and could you explain a little bit more about that, and
when does the freeze end? Do you ever get to thaw out after
being frozen? I mean, I am not clear on how that works.
Mr. Grubman. It is very straightforward. And as I said, you
hate being in that position as an analyst. I am supposed to
talk to investors every day. I am supposed to talk to our
retail sales force, our institutional sales force. When, as an
analyst, for whatever reason, you are quote/unquote ``frozen,''
sort of my term--I am not sure that is the official term, that
is my term, because that is what it feels like--you are
prohibited from talking to your clientele of the particular
company on which you are frozen. Because it is so severe, it
tends to be very infrequent and on short duration.
Ms. Lee. For how long? Can you ever come back after this
and conduct more evaluations of the same company?
Mr. Grubman. Yeah, you do that all of the time, when you
get unfrozen or thawed out. Then the only reason that happens
is because whatever you are frozen about has now become
publicly disseminated.
Ms. Lee. Thank you.
The Chairman. The gentleman from New Jersey, Mr. Ferguson.
Mr. Ferguson. Mr. Ebbers, as recently as last February you
were quoted as saying that, quote, ``WorldCom has a solid
balance sheet, manageable leverage, and nearing $10 billion in
available liquidity. Bankruptcy or credit default is not a
concern,''.
In light of that statement, what credibility do you feel
like you have today with your former employees and with
investors in America?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional right.
Mr. Ferguson. Well, I am terribly disappointed that Mr.
Ebbers and Mr. Sullivan have chosen not to testify here today.
Your silence may have saved you today, but we can promise you
this: We are going to get answers to the questions that need to
be asked. Eventually we are going to get to the bottom of this
situation, and there will be consequences.
While it is your constitutional right to maintain your
silence, note that it speaks volumes that there is no dispute
that you have caused employees to lose their jobs and countless
other hard-working Americans to lose their savings, and in some
cases their life savings.
Since it seems that there are some individuals who insist
on illegally or unethically manipulating the system, let me be
very direct and succinct. To the corporate CEOs and the
accounting firms that audit their companies, let me be very
clear. If you violate the public's trust, if you flush down the
drain the retirement security of millions of Americans, you
will go-and you deserve to-go to jail.
And to company executives, you will not be able to walk
away with millions of dollars after bringing a company into
bankruptcy without there being consequences.
Mr. Grubman.
Mr. Grubman. Yes.
Mr. Ferguson. I want to pick up on a couple of the points
that Mr. Tiberi was making a moment ago. He went through a list
of companies that you had recommended who are either in
bankruptcy or have seen their stocks down anywhere from 83 to
99.9 percent.
On April 25th--I am certain you are aware of this. On April
25th, 2002, Money magazine published a story entitled, ``Is
Jack Grubman the Worst Analyst Ever?'' what is your response to
that? What is the answer to that question?
Mr. Grubman. Well, I would obviously disagree with the
premise. But, look, I am not happy with what happened to my
sector over the last 2 years. It is an embarrassment and a
humiliation. I am not happy that people lost money. I am not
happy that people lost jobs. I am not happy that the Telecom
Act of 1996 ended up not materializing the way that a lot of
people, probably in this room, thought that it would.
So that doesn't make me feel particularly good.
Mr. Ferguson. Let me get back to the AT&T issue. Mr. Tiberi
before was asking you about the AT&T, about some perceived
conflict. During a CNBC interview on October 6th, Erik
Gustafson--I don't know Erick Gustafson, but apparently he is a
respected mutual fund manager--commented on the reversal of
your recommendation.
And his quote was, quote, ``There is no coincidence in the
financial markets. There is no coincidence in the financial
business at all, Darby. Clearly, Jack upgraded the stock
because he wanted a part of the deal. Lo and behold, his firm,
Salomon Smith Barney, was one of the three in the underwriting
consortium,''.
My question, following up on Mr. Tiberi's question, was are
there companies, and can you think of any examples to give us,
that your firm has a banking relationship with, which you have
given a negative recommendation for?
Mr. Grubman. Well, first let me respond to that, I would
argue, allegation. We took our buy off AT&T in October of 2000
for a very simple reason: They said never mind. We spent a lot
of time and wrote a big report that was very detailed, because
we bought into the notion that we still do today with the cable
companies, you can have this triple play, as I mentioned.
And with AT&T--
Mr. Ferguson. There is nothing to Erik Gustafson's
allegation? He is completely off the mark?
Mr. Grubman. That is my view. AT&T, 10 months after we
upgraded for the reasons I outlined, said never mind, we are
going to break the company apart. That completely undermined my
entire reason for upgrading the--
Mr. Ferguson. Can you give me an example? My time is short.
Can you give me examples of companies that your firm has
banking relationships with that you said, this one is a dog,
get far away from it, it is the worst thing you have ever seen?
Can you give us some examples of when that has happened?
Mr. Grubman. Sprint. The Bells. Sprint, who we have been
cautious on for 2 to 3 years.
Mr. Ferguson. You are going to give me one stock, comparing
with all of these others which you said, this is where--this is
going to take you to the top. And they are down 83 to 99.9
percent.
Mr. Grubman. As I said, Sprint is an example. The Baby
Bells, who our firm does various banking relationships with, we
have not been bullish on. And we never follow about half of the
new companies that came public, all of which were brought
public by major firms like ourselves.
The Chairman. The gentleman's time has expired. The
gentleman from Washington State, Mr. Inslee.
Mr. Inslee. Thank you, Mr. Chairman.
Mr. Grubman, I am pleased that you are here today, because
I think you are a walking, talking exhibit about why the
Republican Party has been wrong in the U.S. House of
Representatives, refusing to adopt meaningful reforms of your
industry that have the capacity of preventing enormous loss of
retirement income that you have been associated with. So I am
glad you are here.
And, Mr. Dick, I think you are a walking, talking epitome
and example of why the Republican Party has been wrong in
standing between the American people and meaningful reform of
the accounting industry so that we can avoid these horrendous,
repeated, multiple disasters.
So I appreciate your testimony, because any Congressman,
Republican or Democrat, who doesn't understand the need for an
aggressive, assertive reform effort now, after listening to
you, just is asleep at the switch. I am hoping that some more
of my Republican colleagues have the epiphany that Mr. Castle
has had; that we will now be able to revisit this and in fact
have a meaningful bill, when we had a weak-kneed, totally
ineffectual bill go out of here before because of their
resistance.
Now, Mr. Grubman, I want to ask you a question. You
referred to fraud, I believe, in your testimony. I wanted to
let you know if you sell crack, 50 grams of crack in the United
States, you go to jail for a mandatory 10 years. The judge
can't reduce it. Mandatory 10 years.
Now, there is some suggestion that some folks at WorldCom
were selling a fiscal crack. I want to ask you: Do you think
people who are intentionally responsible for selling that type
of misinformation ought to spend a mandatory 10 years, just
like those who sell crack in this society?
Mr. Grubman. I don't know about what the right mandatory
sentencing requirement is. But I would say that, directionally,
if people committed widespread fraud, they should pay for it.
Mr. Inslee. Don't you think they ought to pay the same
amount as somebody in the inner city selling 50 grams of crack?
Shouldn't we make that the statute? Don't you agree with that?
After you have seen the devastation that has happened to people
who followed your advice that you say is a result of defrauding
you, don't you think that ought to be the law in this country?
Mr. Grubman. Well, again, with all due respect to the folks
who are more qualified than me in terms of sentencing mandates,
all I would say is, is taking a life away with a drug and
taking one's, you know, life away maybe another way, because of
fraudulent financials, both should be dealt with severely.
Mr. Inslee. Well, I certainly am heartened by your comment.
You have been involved, you have told us, supposedly as an
independent analyst. An independent analyst. You have told us
today that this independent analyst, following the existing
rules of law, apparently, was sitting in board of directors
meetings when there are mergers, on just a small number of
occasions you told us. I think you said three.
Mr. Grubman. A few.
Mr. Inslee. You have told us that no one in your industry
can deny that, quote, ``independent analysts are in fact
receiving income associated with the investment banking side of
their business.''
Mr. Grubman. Indirectly, through the comp process.
Mr. Inslee. That no one can come to the public and say that
they are independent in the sense that they are free of
influence from the investment banking side.
Well, would you, based on what you have told us and based
on your experience, would you encourage some of my Republican
friends to revisit their reluctance to join us in building a
firewall between those segments of the industry?
Mr. Grubman. Okay. As I said, by the way, we at Salomon
Smith Barney adopted the Merrill Lynch proposal, which will now
have no investment banking revenues coming into the comp pool
for research. So we have done at least that so far.
I still think, and I know there is a lot of people trying
to figure this out, that you can be an independent analyst and
part of a full service firm. But having said that, clearly if
for no other reason than public perception, if not reality--and
as we speak today, public perception is as important I think as
reality--we probably need to figure out. And people a lot
smarter than me will figure this out.
Mr. Inslee. Thank you.
Just one more comment to Mr. Ebbers. Mr. Ebbers, you have
invoked your fifth amendment. You have a constitutional right
to do so. I think that all constitutional rights are important
in that regard. But the trouble is, you have come to us in what
I think is a bit of an arrogant position and testified about
these factual issues, including how you are proud of your work,
the company is valuable, it provides important services, no one
can conclude that you have been involved in criminal or
fraudulent conduct. And then you expect not to answer questions
about that.
I want to give you a chance to make sure you make a
decision, a rational decision, which horse you are going to
ride: testifying or invoking the fifth amendment.
So I would ask you, sir, do you withdraw your original
comments that you gave to this committee before you invoked the
fifth amendment? Do you want to withdraw these comments and ask
this committee to disregard them and strike them from the
record?
Mr. Ebbers. On the instructions of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
The Chairman. The gentleman's time has expired. The
gentlelady from West Virginia, Ms. Capito.
Mrs. Capito. Thank you.
I have a question for Mr. Dick. In the March 21st testimony
of Michael Salisbury before our Subcommittee on Oversight, he
stated that WorldCom had entered into two IRU transactions with
Global Crossing, swap transactions. I am wondering, did
WorldCom restate its revenue or earnings figures downward to
remove these transactions with Global Crossing? And do you have
any knowledge of this?
Mr. Dick. I don't have any knowledge whether they restated
their revenue figures downwards or would have needed to.
Mrs. Capito. Do you have any information that--as to
whether the SEC has been questioning these swap transactions
with Global Crossing?
Mr. Dick. I don't know specifically if the SEC is
questioning those specific transactions.
Mrs. Capito. Okay. Thank you.
An additional question. In its July 1st statement to the
SEC, WorldCom said it is reviewing its accounting for reserves
for 2000 and 1999. Can you describe for the record what does
that exactly mean; and do you have any knowledge, based on your
experience, of the amount involved?
Mr. Dick. I don't know specifically what that might mean. I
believe that it would relate to reserves that WorldCom has
recorded on its books or had recorded on its books during these
years.
Okay. I do not know what amounts that would be that they
are reviewing or looking at. I just don't have any knowledge. I
haven't been party to any of that.
Mrs. Capito. Okay, thank you. I have no further questions,
Mr. Chairman.
The Chairman. The gentleman from Kansas, Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
Mr. Ebbers, you did read a statement when you started here
this afternoon. I am just going to read one part of a sentence.
"I am proud of the work that I did at WorldCom. I believe that
in spite of its recent problems, WorldCom continues to be a
valuable company." did you say that, sir?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Moore. Mr. Grubman, did you hear--were you here when
Mr. Ebbers testified earlier?
Mr. Grubman. Yes, I was.
Mr. Moore. Did you hear him say that?
Mr. Grubman. Yes, I did.
Mr. Moore. He said WorldCom continues to be a valuable
company. You heard him say that?
Mr. Grubman. Yes, I did.
Mr. Moore. Do you know what the price of WorldCom stock was
on July 1st, just 7 days ago? Does 6 cents ring a bell?
Mr. Grubman. I was going to say under 10 cents.
Mr. Moore. About 6. Does that suggest great value to you of
a company?
Mr. Grubman. No, it doesn't.
Mr. Moore. In fact the stock, you said earlier, had--the
trading had been suspended; is that correct?
Mr. Grubman. After the announcement came out it had been
suspended, it started trading again. There was a question of
delisting. So I am not sure.
Mr. Moore. So it is trading now?
Mr. Grubman. I don't know.
Mr. Moore. It is a buy or sell?
Mr. Grubman. I don't think there is an analyst on Wall
Street that would put a rating on it right now.
Mr. Moore. There is no real value right now, is there?
Mr. Grubman. There is no way to analyze it.
Mr. Moore. All right. You heard the discussion earlier
about a proposal that CFOs and CEOs be required to swear to the
truthfulness of financial statements. Do you personally think
that is a good idea?
Mr. Grubman. I personally think, as a user of financial
statements, anything is a good idea to further ensure that they
are truthful. Now, if we all think having CEOs sign financial
statements will ensure that, or if it is just cosmetic, if it
is just cosmetic, who cares.
Mr. Moore. I am talking about a financial statement, if it
is not true, they can be prosecuted in Federal court and go to
prison. Does that sound like a good idea to you?
Mr. Grubman. If, in fact, it is enforced, then that is a
good idea.
Mr. Moore. Well, that is what the Justice Department is
for, is to enforce those and prosecute people who make false
financial statements. Do you understand that?
Mr. Grubman. I am a user of financial statements.
Mr. Moore. So can I conclude that it is a good idea, then?
Mr. Grubman. I think--yes. My personal opinion.
Mr. Moore. Thank you. That is what I asked for.
Did you, during the three board meetings or any other time,
have personal or telephone conversations with Mr. Sullivan,
Scott Sullivan, sitting right next to you, about the accounting
methods that he was using? I am talking about line expenses
were booked as capital expenses. Let me back up. Strike that
for just a minute.
Have you read at least allegations that Mr. Sullivan
instructed that?
Mr. Grubman. Yes, I have.
Mr. Moore. Did you ever have any conversations with him,
either by telephone or in person, about that accounting method?
Mr. Grubman. No.
Mr. Moore. Okay. Did you hear that was being done prior to
disclosures in the press?
Mr. Grubman. I had no knowledge at all of any rumors or
anything about that.
Mr. Moore. Okay. You a moment ago said that Sprint was a
dog.
Mr. Grubman. No, I didn't say that. He asked me if there
was an example of a firm, of a company where we didn't have a
buy that our firm does banking business, and Sprint was one.
Mr. Moore. Okay. Sprint is in my district.
Mr. Grubman. I actually--I actually probably made my
reputation on the street early on by recommending the old
United Telecom when Sprint was bleeding.
Mr. Moore. Do you recall a Washington Post article dated
July 6, 2000, in which the statement was made--I am going to
read this for the record--that the most consistent and strident
voice forecasting approval of the WorldCom/Sprint deal was the
analyst who worked for the company that helped put it together,
Jack Grubman of Salomon Smith Barney, Inc.?
As WorldCom's investment banker, Salomon stood to pocket
billions of dollars if the deal closed. Do you recall that?
Mr. Grubman. I don't recall that quote.
Mr. Moore. Would you like to see it?
Mr. Grubman. No.
Mr. Moore. Is that true?
Mr. Grubman. Again, I thought that the merger made sense
for pure fundamental reasons. There is no denying Salomon Smith
Barney was advisor on that.
But, if Sprint and WorldCom had come together, put aside,
you know, what we know today--because Bill Esrey, who you
obviously know quite well, sure thought the numbers he was
seeing with WorldCom were right, or else he wouldn't have
agreed to take their stock--you would have had, you know, quite
an incredible set of assets with Sprint PCS, plus their Global
assets.
Mr. Moore. Does that suggest--I am looking for answers
here--not just WorldCom--looking for answers of what Congress
can or should do. You heard my questions, I think, in the form
of my opening statement.
Does that suggest any kind of conflict to you? Being an
advisor there and also standing to pocket billions of dollars
if the deal closed?
Mr. Grubman. Don't forget, while Salomon Smith Barney might
have been the advisor to WorldCom, it is the investment bankers
who, you know, do that work. My role is an analyst.
Mr. Moore. Could that in any way color the analysis that
you do, billions of dollars?
The Chairman. The gentleman's time has expired. The witness
may respond.
Mr. Grubman. I do my best every time to filter out things
that I think are inappropriate that would color my analysis.
The Chairman. The gentleman from New York, Mr. Grucci.
Mr. Grucci. Thank you, Mr. Chairman.
Mr. Grubman, could you take me through the process that you
go through when you analyze a company to make a recommendation?
What is the procedure that you go through? And obviously don't
be too long because I need some time to ask a few other
questions.
Mr. Grubman. Well, you look at a variety of factors. You
look at--you know, you build a financial model. Either--you
talk to the company. You get their views on what you think
their growth rates will be in terms of demand and revenue. You
stress test their assumptions about things like pricing. In my
industry, you have to factor in the regulatory environment, as
you know. There have been a multitude of court cases up and
down the various circuits to the Supreme Court, so we have to
factor in that type of thing.
So, you know, you try to build a quantitative model; and
then you try to factor in qualitative variables, the business
environment, regulation, demand outlook, such.
Mr. Grucci. When you talk to the company, what are some of
the questions that you would ask them?
Mr. Grubman. Well, if it's a start-up company where really
a lot of the value is going to be predicated upon them
executing over a long period of time--
Mr. Grucci. This is not a start-up company. What kind of
questions would you ask a company of this size?
Mr. Grubman. What you would ask--let's take the case of
WorldCom. They had three or four broad areas of business, voice
long distance, data, Internet and international operations. So
you try to drill down in each of those categories what's going
in those businesses, what's going on in the competitive
landscape, what's going on in pricing.
Mr. Grucci. Do you test any of these things to make sure
what you're being told is accurate?
Mr. Grubman. Again, this is where you are talking about the
qualitative stuff. So this is why it's important to try to talk
to as many companies as possible. If WorldCom says we think we
are seeing stability in pricing, you go to Mr. Moore's district
and ask SPRINT or you go to New Jersey and ask AT&T and you try
to triangulate what the major competitors within a given
industry's segment are saying. A lot of it is anecdotal and a
lot of it is qualitative, as opposed to hard quantitative fact.
Mr. Grucci. Would you define for me the term "independent
analysis"? What defines you as being independent? I heard
during the course of this afternoon that you can sit in on
corporate board meetings. You can be part of discussions that
were taking place with mergers. How do you become independent
if you're so interwoven with the activities of the company?
Mr. Grubman. Well, you're not really interwoven. On a
select few occasions you are brought into that realm.
Mr. Grucci. If you were brought in on one occasion, even
just one occasion, an occasion of a magnitude of a company like
WorldCom or any other of that caliber, you sat in on those
types of discussions, how could you then be independent?
Mr. Grubman. I'm not saying it's not hard, but I mean that
is--that's what I and other analysts do for a living. And you
come back to one thing. You have to have--
You know, when people ask me, you know, why all these
stocks went down and why are we stuck with it for a long time,
it would be easy for me to just blame the banker and say, no,
they made me do it. No, I believe it is I made a mistake on the
research side; and I am not blaming anyone else. You try to
stay independent. You have your own views of the industry, but
there is a--there is a connection between your views of an
industry and what the bankers in your given firm are then
likely--I think a previous questioner had brought that up--are
then likely to do with that.
Mr. Grucci. My time is starting to run short, and I wanted
to ask Mr. Dick a question, and it is more of an inquisitive
type of a question. What do you think ought to be done to be
able to prevent these types of accounting errors or
misinformation from coming to the accounting firms then going
forward? What kind of steps ought Congress be taking to be able
to ensure that people who, when I go home and talk to my
constituents and they tell me how much money they've lost,
whether it was in WorldCom or some other corporate failure
because the market right now is just not--it is not keeping
pace with the consumer confidence that exists out there.
The economy appears to be gaining strength, but there is
absolutely zero confidence in the corporate governances of our
largest corporations. We hold ourselves out as this great
place, to come to America where your dreams can come true for
those who work hard. Those who are working hard, their dreams
are evaporating; and I truly believe it won't stop until
someone is dragged off and sent to jail. I would like you to
hear from you what you think ought to be done in order for
Congress to take the type of action it needs to take to help
your industry prevent these things in the future.
Mr. Baker. [Presiding.] The gentleman's time has expired,
but please respond.
Mr. Dick. I think there are a number of proposals, as I
understand it, that are under consideration; and this committee
and others are in a far better position than I am, quite
frankly, to address those and to do those particular things. My
only comment is that no matter what type of safeguards,
measures, processes, whatever's put in place, there can be--you
cannot define or design an entirely fail-safe system where, you
know, these types of things that are reported to have happened
will not happen in the future or where people may make
investments and those investments may not turn out. And I am
not trying to be coy or anything.
Mr. Grucci. That's not an encouraging statement.
Thank you, Mr. Chairman.
Mr. Baker. Thank you, Mr. Grucci.
Mr. Sherman.
Mr. Sherman. Just a couple of preliminary comments.
First, Mr. Chairman, I want to take this opportunity to
commend the Financial Accounting Standards Board whose slow and
ineffectual response to Enron has made this Congress look
speedy and decisive.
I also note, Mr. Chairman, we have gone directly from Enron
to WorldCom. We have skipped over Global Crossing, Xerox, et
cetera, et cetera; and I can understand that because these
hearings are going to take awhile. Perhaps you and Mr. Oxley
want to consider the creation of several subcommittees to hold
simultaneous hearings so all the pillars of the corporate
community who wish to do so will have an opportunity to assert
their fifth amendment rights.
Mr. Baker. We will take your advice under advisement, but I
can't imagine why anybody would not participate in all of these
meetings.
Mr. Sherman. Speaking about fifth amendment rights when
they are asserted, I expect that folks will get better legal
advice than Mr. Ebbers. Mr. Ebbers, did you help a small
company rise to one of America's largest corporations?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sherman. Thank you. I would note that I took those
words directly out of the statement that you presented to the
committee, so you're refusing to testify that what you said
under oath is true. But I think any further questioning would
be fruitless.
I want to go onto the fact that WorldCom is another client
of Arthur Andersen, that, as Chairman Tauzin of a committee
that once had jurisdiction in this area noted on the Sunday
talk shows, Arthur Andersen was the one firm that had the
engagement partner in total control of the audit with what was
called the quality review or technical review department
operating on a don't-ask, don't-tell basis. It's my
understanding, Mr. Dick, that you were able to make the
decision and if somebody in the quality review department or
back in Chicago, if you didn't want to consult them, you didn't
have to.
Now my colleagues will remember that, pretty much on a
party-line vote, we rejected the idea of solving what I call
the Arthur Andersen problem and requiring that all accounting
firms have the quality review department sign off on publicly
traded corporations audits. But I'd like to ask you, Mr. Dick,
what was--did the quality review department, or whatever you
happen to term it at Arthur Andersen, were they involved in
this audit or did you pretty well make the decisions in your
own office.
Mr. Dick. We had an extensive--what I would call quality
control process that took place on this audit. In addition to
myself as the lead engagement partner, there was another audit
partner involved in the account. There was also an advisory
partner who had no involvement with any of the audit work.
There was a concurring partner who we discussed all significant
transactions, activities, our audit approach, our audit scope,
et cetera. Furthermore, if we had any--
Mr. Sherman. Were there folks involved back in Chicago?
Mr. Dick. Yes. Furthermore, if we had any questions
relating to accounting for various transactions--for example,
during 2001, WorldCom no longer had control of the subsidiary
in South America--that accounting was cleared and reviewed with
our people in Chicago.
Mr. Sherman. I thank you for your answer, and I want to go
on to another question. Because this was not a question of a
tough accounting issue as far as I can tell but just the field
work not discovering 3 billion plus dollars. Am I correct in
estimating that you have had at least 20,000, maybe 30 or
40,000 hours of field work involved in this audit?
Mr. Dick. I don't recall the specific number. It was
probably between 10 and, say, 15 or 15 and 20,000 hours.
Mr. Sherman. So roughly 15,000?
Mr. Dick. Roughly.
Mr. Sherman. Now back when I was involved in audits, one of
the first things you did was made sure debits to asset accounts
were not overstated. You in your opening statement indicated,
well, this is a company with $100 billion in assets. But a key
thing to check is not the whole $100 billion but the additions
to the asset accounts. This $3 billion that was misclassified
and missed. In making sure that the debits to asset accounts
were not overstated, what percentage of that was that $3
billion, what percentage of it was the--all the additions to
asset accounts? How much did the assets grow on the financial
statements from fiscal 2000 to fiscal 2001?
Mr. Dick. Well, I think there was--as previously mentioned,
the capital expenditures of the company were approximately 7 to
$8 billion.
Mr. Sherman. So a key part of the audit is to make sure
that when the company says we've added $7 billion to our assets
that they've actually added $7 billion to their assets and
three out of the seven wasn't added to their assets. And you've
got people under your supervision spending 10, 15, 20,000
hours, how did they miss this?
Mr. Baker. That is the gentleman's last question, but
please respond.
Mr. Dick. Those hours were being spent on all our areas. We
did in our auditing--as I mentioned before, we did test
specific additions and looked for the appropriateness of those
additions being either capital or whether they were line costs.
I mean, whether they should have been expensed on the income
statement.
Mr. Baker. Gentleman's time has expired.
Mr. Barr, did you have questions?
Mr. Barr. None at this time.
Mr. Baker. Mr. Gonzalez.
Mr. Gonzalez. Thank you Mr. Chairman.
Members of the committee have been provided the most recent
revised statement by WorldCom that was filed today with the
SEC, and it is affirmed as accurate and signed by Michael H.
Salisbury, General Counsel. As indicated earlier by my
colleague on the other side, this is the same Michael Salisbury
who appeared before the Subcommittee on Oversight and
Investigations on March 21, 2002. Mr. Chairman and members of
the committee, I would like to read a couple portions of his
testimony that day:
``The competitive sectors of the telecommunications
industry have experienced difficult times recently, primarily
as the result of the failure of the Federal Communication
Commission and the Department of Justice to engage in timely
and effective enforcement actions. Accounting issues also have
contributed to the problems experienced by some companies. The
subcommittee's correct in considering both Federal policies and
accounting issues at this hearing.''
He goes on: ``Under factors contributing to the industry's
problems, quote, the subcommittee also asked to what extent the
following factors served as a trigger for industry problems:
use of unique accounting standards and the issue of pro forma
revenue projections.'' WorldCom does not use unique accounting
standards and does not issue pro forma revenue projections.''
His last statement, closing statement, was as follows:
``Conclusion: The current problems in the competitive
sectors of the telecommunications industry were not caused
primarily or even significantly by accounting issues or
assumptions about capacity utilization. Rather, those problems
resulted directly from unrelenting efforts of the Bell
Companies to retain their monopoly power and the fundamental
failure of the SEC and Department of Justice to properly and
effectively implement and enforce the law. In WorldCom's view,
those failures have destroyed far more market capitalization
and robbed far more value from shareholders' investments than
any accounting issues.''
Can you believe we are here 3 months later, which really
leads me to believe I am not real sure that Mr. Salisbury
should be affirming as accurate these reports filed with the
SEC.
In this revised statement, Mr. Dick, discovery of line cost
transfers during May, 2002, Cynthia Cooper, Vice President and
internal auditor, began an investigation of certain of the
company's expenditures and capital accounts. This audit had
been scheduled for third quarter 2002, but Ms. Cooper advanced
it. Ms. Cooper determined that a number of questionable
transfers had been made into the company's capital accounts
during 2001 and the first quarter of 2002 and then goes on, Mr.
Sullivan indicated the line cost transfers began in the third
quarter of 2001 and that previously these costs had been
expensed. Now the question or the period in question, wasn't
this during your watch, Mr. Dick?
Mr. Dick. I was the engagement partner during 2001.
Mr. Gonzalez. Why would Ms. Cooper be privy to certain
information that put her on alert as to what was transpiring as
either inappropriate or illegal and you were not?
Mr. Dick. I can't answer that, because I don't know what
procedures or what she had done or what caused her to do the
audit she did and I don't know what the specific findings were.
Mr. Gonzalez. The frustration members of the committee and
I share, Ms. Hooley and Mel Watt and others, is that we turn to
you as members of your profession for guidance and don't want
to act independently. We want to know what is best for the
profession in serving a, well, important need. Yet you come to
us, and you really don't say that much. The problem is, how do
you confirm and verify the information on which you base your
decisions and your judgment and your reports? Then, in turn,
Mr. Grubman looks at your work and makes his decisions.
It's the old thing with accountants, garbage in, garbage
out. How do you determine it's not garbage in? You're telling
me you can't ask any questions and, if you do, if a CEO or CFO
simply gives you a response, that you are going to believe it
at face value.
Mr. Dick. I mentioned before that we performed our tests;
and we did those tests based on our understanding of the
company's processes, procedures, their system of internal
controls that they had to process.
Mr. Gonzalez. But you would agree it's totally inadequate;
and it didn't work in this case, did it?
Mr. Dick. I can't say whether it worked or not because I
honestly--and I am not trying to avoid your question.
Mr. Gonzalez. But you failed to detect these transfers
which clearly do not appear to be appropriate.
Mr. Dick. I am not aware of the specifics behind those
transactions--those transfers.
Mr. Gonzalez. Quickly, Mr. Chairman, I would like to ask
one last question of both Mr. Ebbers and Mr. Sullivan. It's a
two-part question, and let's see if I can kind of frame it
here. Who in WorldCom made the decision to transfer the costs
associated with charges paid to local telephone companies for
the use of their networks and categorized those costs as
capital costs after each business segment reported their
results? Who made that decision and when was the decision made,
Mr. Ebbers?
Mr. Ebbers. On the instruction of counsel, I respectfully
decline to answer on the basis of my constitutional rights.
Mr. Sullivan. Based upon the advice of counsel I
respectfully decline to answer the question based on my fifth
amendment to the U.S. Constitution.
Mr. Gonzalez. Thank you very much.
Mr. Baker. Ms. Tubbs Jones?
Mrs. Jones of Ohio. Thank you, Mr. Chairman.
Mr. Ebbers, can you tell me who your counsel is, please?
Mr. Ebbers. Mr. Reid Weingarten.
Mrs. Jones of Ohio. Do you want to spell that for the
record?
Mr. Ebbers. I don't know how.
Mr. Weingarten. R-e-i-d W-e-i-n-g-a-r-t-e-n.
Mrs. Jones of Ohio. Mr. Sullivan, who is your counsel, sir?
Mr. Sullivan. Irv Nathan, N-a-t-h-a-n, with the firm of
Arnold & Porter.
Mrs. Jones of Ohio. Thank you.
Mr. Ebbers, I know the answer I am going to get. You're not
going to answer because of your fifth amendment right against
self-incrimination.
I come to the committee as a prior judge and a prior
prosecutor, and I recognize that your fifth amendment right is
not absolute. At some point, even when you choose to take the
fifth amendment, you will be required to respond to some of the
questions that are being put to you. I trust that your counsel
has given you good advice, but I would also suggest to you--
both you Mr. Ebbers and Mr. Sullivan--the fact that you appear
here just to say that you're exercising your fifth amendment
right doesn't make you look any better in the eyes of the
public who have been damaged by the activities of your company
and your corporation.
I won't ask you any more questions since I know what the
answer is going to be, and I move on to Mr. Grubman. How long
have you been in the business as an analyst, sir?
Mr. Grubman. I started in 1985.
Mrs. Jones of Ohio. How long have you been with Salomon
Smith Barney.
Mr. Grubman. Salomon Brothers in March of 1994.
Mrs. Jones of Ohio. During some of the questioning by my
colleague, Congresswoman Barbara Lee, you struggled with what a
personal relationship is, trying to distinguish and scoot away
of what was personal and not personal. You would suggest,
however, you probably had a drink with Mr. Ebbers on occasion.
Mr. Grubman. I was struggling, I guess, with semantics. I
have known Mr. Ebbers probably for about a dozen years. We have
on occasion, you know, seen each other. Yes, I have had an
occasional drink or whatever.
Mrs. Jones of Ohio. Let's not get hung up on the personal
relationship. The fact is, you knew him and did business with
him and you knew about his business and you made
recommendations to people about investing or not investing in
his company.
Mr. Grubman. Right.
Mrs. Jones of Ohio. Based on that relationship and what we
know now about what you said about WorldCom and what is
happening, what would you suggest we as Members of Congress do
to regulate that relationship, sir? And I need a short answer.
Mr. Grubman. Analysts are always going to try to get to
know management, and I think if you attempt to somehow forbid
that from happening, that will--despite why we're here today, I
think will damage investors.
Mrs. Jones of Ohio. Let me stop you right there for a
moment, please. You think it would damage investors. We are
attempting to regulate the accountants from being auditors and
consultants. That has been a problem for all of us, has it not?
Mr. Grubman. Yes.
Mrs. Jones of Ohio. Would there not be a similar dilemma
between the relationship you have with WorldCom as an analyst
and you have as part of Salomon Smith Barney?
Mr. Grubman. I understand what you're saying.
Mrs. Jones of Ohio. You understand what I'm saying.
Mr. Grubman. You're saying separating banking from
research?
Mrs. Jones of Ohio. Yes.
Mr. Grubman. I wanted to make it clear.
Again, there are a lot of people that are looking at this,
all the various self-regulatory bodies so forth and so on. I
guess my view--and, again, this is my view--is I think--I think
and I believe that an analyst could be objective and still be
part of a full service.
Mrs. Jones of Ohio. Can you tell me how much--how you have
financially benefitted from that relationship as well as
Salomon Smith Barney even though you think it's okay?
Mr. Grubman. Salomon Smith Barney, obviously, did banking
transactions with WorldCom.
Mrs. Jones of Ohio. The question is not whether they did or
did not do. I want to know to what tune and how have you
financially benefitted in dollar amounts?
Mr. Grubman. I do not have a direct tie to any one company
or any one banking fee. As I stated earlier in these
testimonies, I have been highly compensated for quite some
time, particularly the last 3, 4, 5 years. Part of that is due
to my perceived market value by the firm.
Mrs. Jones of Ohio. We think you're a great guy and made a
lot of money. The point I'd like to get an answer, Mr.
Chairman, in writing is how much financially you have
benefitted from working with Salomon Smith Barney as a result
of your analysis of WorldCom. And whatever it is, it is. I
mean, because the guy from Global Crossing told me he made $3.5
million, got a $10 million dollar loan forgiveness, and he
doesn't give a darn about anybody else. He thinks Arthur
Andersen's relationship is great. I want to know what it is.
Mr. Grubman. My compensation is not tied to WorldCom. I--my
compensation is not tied to any one company. So that has to be
clear.
I have been compensated over the past 4 years roughly $20
million per year on average, about half that amount last year
on some of the cumulative basis, including loans, including
stocks, options, cash, whatever. But that is not tied to any
one company.
Mrs. Jones of Ohio. But it's tied to the work you do for
Salomon Smith Barney, which in fact has some dealing with
WorldCom. Is that a fact?
Mr. Grubman. It's tied to my work with Salomon Smith Barney
which has dealings with lots of firms including WorldCom.
Mr. Baker. The gentlelady's time has expired.
I would like to make an announcement for the benefit of the
members about how we should continue to proceed.
I would like to go ahead with Mr. Capuano, Mr. Lucas and
Mr. Shows, if possible, in the time remaining until we have to
go to the floor for votes. I would like for the committee to
recess to give our witnesses and others who are affected here
this evening while we conclude the votes--I understand we have
one 15-minute and two fives. That always translates to 30
minutes anyway--if we can get people to reconvene at 7:15, that
will give people opportunity to attend to personal business and
then pick up with remaining members who were not addressed on
Panel I. If we finish Panel I, we will dismiss these witnesses
and proceed to Panel II when we return.
Mr. Capuano, you're recognized.
Mr. Capuano. I don't intend to ask any questions of this
panel. Because, frankly, I have been sitting here all afternoon
and heard every word you have said, and I have not learned
anything new that I didn't read in the papers, and I honestly,
frankly, don't believe much of what you said to me. So,
therefore, asking questions is really a waste of time.
If this wasn't real, I really think this is great for
Monday afternoon TV. This is the worst soap opera I have ever
heard. The only unfortunate part is it's real.
We have 17,000 laid-off employees, probably 100,000 people
in the pension systems who are now losing their money, not to
mention the millions of other people who have invested in this
company.
We've got a CFO who, according to all reports, again has
cooked the books to the tune of $4 billion in a lie that anyone
who is taking introduction to Accounting 101 knows how to
avoid.
We have a CEO who made hundreds of millions who apparently
didn't have any idea what was going on in the financial world
of his own multi-billion-dollar corporation. I guess all he did
know was how to borrow $400 million from the corporation.
We have an auditor who apparently can't audit, somehow
missed that simple $4 billion lie.
And we have an independent analyst who is neither
independent nor a very good analyst. Apparently, you don't
analyze anything. You take what the auditors say, and they take
what the CFO says.
I don't know what you're doing here except for the fact
that, between the four of you, my quick calculations have come
up with about $2 billion in salaries, fees and compensation
over the last 4- to 5-year period just in the four of you and
the companies you two work for. $2 billion.
I don't expect--now again that's an unaudited number, and
I'm not so sure it would change if it were audited. I don't
expect that those employees, those laid-off employees, those
pensioners or those investors will see a penny of the $2
billion you four people took out of this company. I don't think
any of you are going to stand up and say, I was wrong, sorry; I
donate back 1 year's salary. You think you could live on $80
million. I think maybe you wouldn't have to suffer. I don't
expect that to happen.
I sit here today and listen to--well, the only company I
only saw that was bad was SPRINT, but yet I advised my clients
who for 2 years pursued buying that very company. Who are you
lying to, your investors or your clients or us? Somehow, if it
was a dog, why did you pursue it for 2 years? Why did you only
get stopped because the European Union and the Department of
Justice said, no, sorry, can't do it?
My big fear here today is we are not going to uncover
anything new. My big fear today is that you will get away with
it. That's the fear that I hear from every one of my
constituents. They expect you to get away with it just like
some of your predecessors have over the years. Just like they
fear Enron will, Global Crossing will, Tyco will, K-Mart will,
Adelphia will.
You will possibly get away with it. What kind of a message
is that to the rest of America? How do you think that's going
to impact the stock market? You know better than I do. Get away
with it, great. Enjoy your hundreds of millions of dollars.
Enjoy the home that we can't touch for $18 million. You have
done the American dream. You've taken every penny you can take,
and you are going to keep it. God bless you, because I sure as
hell won't and my constituents won't. They will go to sleep at
night with your names on their lips and the names of your
companies on your lips cursing you for what they have lost for
their children. But I hope you're happy.
But beware, because all it takes is one of the four of you
to turn, one of the four of you. I am reading some of these
reports and I got to tell you, you guys better be watching each
other. We were just given the revised statement of WorldCom,
not the original one but the revised one that was done from the
restatement of earnings. Just a few sentences.
``Mr. Sullivan reported to Bernie Ebbers, Chief Executive
Officer of the company, until April 29, 2002.'' Mr. Ebbers,
that sounds like a toilet flushing around your head. Be
careful.
Also says, ``in February 6, 2002, the audit committee met
with Andersen, and it was Andersen's assessment that the
company's processes for line cost accruals and for the
capitalization of assets in the plant and property equipment
were effective.''
Mr. Baker. Gentleman's time has expired. Can you summarize?
Mr. Capuano. I certainly will.
I think you better watch what's flushing around your head.
Mr. Sullivan, you know you're the number one target. Ms.
Cooper says she discussed her investigation with Mr. Sullivan
on June 11, 2002. Mr. Sullivan asked her to delay her review
until the third quarter of 2002.
Gentlemen, I think you better watch your backs, and it's
not us to fear. I think it's the other members sitting at the
table and people who are not here today that you need to fear.
Your future's in jeopardy, but, rest assured, you'll get to
keep most of the millions that you, in my opinion, have stolen.
Mr. Baker. Gentleman's time has expired.
Mr. Ford?
Mr. Ford. In light of what Mr. Capuano said I want to make
my remarks brief.
I'm slightly surprised. I know Mr. Ebbers. He may not
remember me, but my district is across the way from
Mississippi. I represent Memphis, and about a thousand of the
employees at WorldCom have lost their jobs in the Memphis area,
and we certainly hope the best for them. We'll do all that we
can here to try to not only make life easy as we possibly can
for them but for the remaining 16,000 employees who have been
hurt by this, not to mention all the investors.
You know, the President will speak tomorrow, as most of you
know--and I'll get to the point I was trying to make. I know
Mr. Ebbers to be someone who has been a risk taker over the
years and has been very successful, and I'm slightly surprised.
I know you are here at the advice of your counsel not to make
statements and so forth, but that's not the Bernie Ebbers that
we have come to know in our area of the country.
That being said, the President will speak tomorrow, and I
think all of us expect him to express continued outrage of what
has happened. All of us expect him to talk hopefully strongly
in terms of punishing wrongdoers, evildoers as he likes to call
them. Many of us hope he will lay out a road map of how he can
restore investor and consumer confidence. I know I am a
believer, although I voted for the House version of a corporate
governance reform that's--what's right now percolating through
the Senate from Mr. Sarbanes committee is probably a better
bill in light of recent revelations and will probably find
quick passage in the Senate; and I do hope tomorrow the
President will express strong, strong support for that bill.
All that being said, Mr. Grubman and Mr. Dick, $3.8 billion
is a lot of money; and Mr. Capuano has expressed it very well.
I think his point is well taken. Having been to law school--I'm
not as a good a lawyer as he is or an accountant, for that
matter, but I've got a feeling he's on to something.
All that being said, I'd ask Mr. Grubman, and you've heard
the questions along these lines--and I was not here earlier in
the day and I apologize--what can we do and what would you
recommend--as you can tell, there is a lot of passion, heat and
spirit around this issue; and one of the things that Congress
is sometimes accused of doing is overdoing things or doing
things excessively. But you all have laid out a pretty bad case
of facts, however you look at it. You have damaged a lot of
people--not you, not to indict you or anyone.
But I am perplexed and puzzled by Mr. Dick's comments about
what my colleague, Mr. Sherman, was trying to get at about
quality process controls. How do you miss something like this?
And for the both of you, if indeed that was missed, what would
you suggest we do or not do? I mean--
I want to enter into the record--I have John McCain's op ed
piece from the New York Times I want to put in.
[The following information can be found on page 237 in the
appendix.]
Mr. Ford. I also want to enter into the record the Business
Roundtable's recommendations from many of the large CEOs or big
companies' CEOs across the country.
[The following information can be found on page 235 in the
appendix.]
Mr. Ford. But what would you suggest we do? We have seen
the Business Roundtable suggest transparency and independent
auditors and fairness, even those who took a lot of money from
the company based on fraudulent accounting to return that
money. Are these things you would find agreeable and, if not,
what would you recommend?
Because I have heard some of the things you said and the
money you made, and it's staggering amounts of money for
anyone, maybe not where you work but for the rest of us it's a
lot of cash, $20 million. And what you do in investment banking
and those who want to put up firewalls, but what you would
recommend, quickly. Give you a lot of chance to respond. But I
don't want--you have taken a lot of hits today, maybe rightly
so, maybe some not so. But there are a lot of people who are
hurting. So what you would recommend?
Mr. Grubman. Okay. This is my personal view, not
necessarily--I am not sure the firm would agree or disagree.
Someone in here said garbage in, garbage out; and that's
the first thing you have to start with. Who is the originator
of the data? It's the company, internal auditors, internal
financial people. Who then is the next line of defense? And I'm
not slinging arrows. I am just saying, who certifies that
stuff? It is the audit profession.
So the first thing you start with is how to make sure that
the originators of the information will not misbehave, and I
will leave it to you folks to figure out how to do it.
Then, when it gets to us, Wall Street, Moody's or S&P and
the rating agencies, certainly we need more transparency so all
investors understand, you know, what firms do, even though we
all put our disclosures, what are our reports, perhaps there
needs to be more transparencies. We adopted the Merrill Lynch
plan on having no banking fees directly coming into the
research pool. It never came in individual by individual.
So I think you start with the origination of the
information and then, when it gets to Wall Street, the rating
agencies and mutual funds and pension funds. I think there has
to be, I believe, more transparency of whatever potential
conflicts there may or may not be or at least people understand
what full disclosure--
Mr. Baker. Mr. Grubman, let me suggest, if further
explanation is warranted, would request on the gentleman's
request you respond in writing.
Mr. Shows has indicated a desire to be heard before we
recess the committee. If we conclude with Mr. Shows in a timely
manner, my intention would be to dismiss this panel.
Mr. Shows?
Mr. Shows. Thank you, Mr. Chairman.
It is more a statement than a question. I do have a
question.
According to the revised statement pursuant to section--
and, of course, as Mr. Sullivan--I know he's not going to
answer, so I will ask the other two gentleman--according to a
memorandum by Ms. Cooper, she discussed her investigation with
Mr. Sullivan on June 11, 2002. Mr. Sullivan asked her to delay
her review until the third quarter of 2002 and to audit the
second quarter of 2002 numbers. Now I know that he had a
severance package of $10 million, Mr. Dick. Was that severance
package supposed to come out before this time or after this
time?
Mr. Dick. I'm not familiar with that. I have read that Mr.
Sullivan had a severance package, but I'm not familiar with the
details, nor am I familiar with anything subsequent to when
Andersen was involved as the auditors, which was May 16 of
2002.
Mr. Shows. I think my point is pretty obvious, that
sometimes people are motivated by money to get that big
severance package; and I hope we look at this in this
deliberation.
But also I would like for the committee to look into the
fact about CEOs and CFOs getting these huge loans. Not only
WorldCom but Enron and other executives had this done. Because,
right now, we need to put that money in the fund for these
unemployed and these investors.
Thank you, Mr. Chairman.
Mr. Baker. Thank you, Mr. Shows.
Mr. Kanjorski.
Mr. Kanjorski. I have a request and ask unanimous consent.
I have just prepared a letter to Mr. Grubman dated July 8,
2002, for the purposes of inquiring on his part of his firm
Salomon Smith Barney as to what IPOs were offered or sold or
provided to any executives, directors or officers of WorldCom;
and I ask that that information be accumulated by Mr. Grubman
within the next 72 hours and provided to this committee.
Mr. Baker. Without objection.
Mr. Kanjorski. May a copy of this be entered into the
record and that the committee forward this letter to Mr.
Grubman.
Mr. Baker. Without objection, it's made part of the
official record; and the committee will forward the letter.
[The following information can be found on page 243 in the
appendix.]
Mr. Baker. I would further state that it's been a long
afternoon, and we will recess at this point until 7:15. But
pursuant to my earlier announcement, this panel is excused.
Thank you.
[Recess.]
The Chairman. The Committee will reconvene, and the Chair
will now introduce our second panel of witnesses. They are Mr.
John Sidgmore, President and Chief Executive Officer of
WorldCom, and Mr. Bert Roberts, Chairman of the Board of
WorldCom.
Gentlemen, you are aware that this committee is holding an
investigative hearing. When doing so, the Chair may decide to
take testimony under oath. Do either of you have any objection
to testifying under oath?
The Chair then advises each of you that under the Rules of
the House and the Rules of the Committee, you are entitled to
be advised by counsel at the table. Do either of you desire to
be advised by counsel during your testimony today? Mr.
Sidgmore?
Mr. Sidgmore. I do not.
Mr. Roberts. I do not.
The Chairman. In that case, if you please rise and raise
your right hand I will swear you in.
[witnesses sworn.]
The Chairman. Gentlemen, you are under oath. And we will
proceed with the testimony. Mr. Sidgmore, welcome to the
committee. This is a long day, and we appreciate your
steadfastness and patience as we work through this difficult
process. Mr. Sidgmore.
TESTIMONY OF JOHN SIDGMORE, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, WORLDCOM
Mr. Sidgmore. Well, thank you, Mr. Chairman, and good
evening.
My name is John Sidgmore, and I am the President and Chief
Executive Officer of WorldCom, Inc. About 2 months ago when I
agreed to take over as CEO, it was clear that the company faced
a lot of hurdles and challenges, but I never really imagined
what was going to wind up in store for us.
Since WorldCom's recent announcement regarding misstated
earnings for 2001 and the first quarter of 2002, there has been
an understandable outpouring of public anger and rage. While
the misdeeds we uncovered occurred before I became CEO, I want
to right here apologize on behalf of everyone at WorldCom.
I can assure you that WorldCom's new management team and
employees share the public's outrage over these events. I
cannot change the past, but I am responsible for what we do now
and in the future. My actions will be guided by my commitment
to restore public confidence in this great company and to
operate WorldCom according to the highest standards of ethics
and integrity.
I want to outline for the committee a number of important
steps that we have already taken and that we will take in the
coming months. I would like to remind everyone at the outset,
however, that WorldCom uncovered this problem internally. In
fact, we audited our external auditors. We found what they
missed and promptly brought this matter to the attention of the
SEC and the public.
This kind of initiative that was demonstrated by our
internal audit team is to be applauded and will continue to be
encouraged. From the time that I first heard about the
possibility of inappropriate line cost transfers and a
potentially major accounting problem on the morning of
Thursday, June 20th, WorldCom's management and board
investigated this matter and acted as swiftly as possible.
The actions taken by the board's Audit Committee and full
board between Thursday, June 20th, and Tuesday, June 25th, when
we took this matter to the SEC and made our public
announcement, are documented in a Section 21(a) statement that
WorldCom filed with the SEC, originally on Monday, July 1st,
and we clarified that SEC statement earlier today.
I know there is some conjecture in the media that Mr.
Sullivan may have raised these issues regarding line cost
transfers at meetings at the board in May or June.
However, I do recall that during a June 13th conversation
regarding SG&A and capital expenditure reduction measures Mr.
Sullivan indicated that the desired savings might not be
achieved fully due to write-downs that were planned for the
second quarter. In addition, at the June 14th board meeting Mr.
Sullivan gave a presentation on second quarter 2002 results,
including certain write-downs, and indicated that he would
continue to examine WorldCom's line cost commitments.
As you probably know, companies the size and complexity of
WorldCom frequently take write-downs to adjust for changes in
its business or in the accounting rules. I have to say I am
extremely puzzled that the wrongdoing was not uncovered or
discovered by Arthur Andersen, our external auditor at the
time, and they have not provided us with any real explanation.
What is even more remarkable is that Andersen's February 6th,
2002 report to our Audit Committee indicates that it was
Andersen's assessment that the WorldCom accounting processes
for line cost accruals and capitalization of assets were
effective, the very processes that later turned out to be
ineffective.
Beyond Andersen, many other questions remain. We won't know
all of the answers until the conclusion of the pending
investigations. But one of the most important steps we can take
is to make sure that our past transgressions are fully
investigated and that the wrongdoers are punished. We are
therefore cooperating fully with the various official
investigations, and there are many by the SEC, the DOJ and
Congress, to ensure that those responsible will be brought to
justice.
WorldCom is being proactive here. At management's
instigation, the Audit Committee, on June 24th, hired William
McLucas, former Chief of the Enforcement Division of the SEC to
perform an independent investigation of the facts and
circumstances surrounding this issue. He will not only
investigate our past and current management team, but also our
board members, regarding any individual involvement.
We know if we are to be a model for corporate behavior
going forward, we must be transparent and above reproach.
Therefore, in our July 1st SEC statement we clearly stated that
we were examining what additional earnings restatements might
be required for periods going back to 1999 with respect to
accounting for reserves established by the company.
We are committed to completing this analysis with the
assistance of our new external auditors, KPMG. Through these
and other steps, we plan to restore public trust in WorldCom.
And while our reputation has suffered a tremendous blow, we
think this is a great company and that the new management team
will do everything in our power to save it.
Millions of people have a real stake in this company's
survival, our customers, our employees, our lenders and our
shareholders. WorldCom has always been a competitive force in
the telecommunications marketplace and is a key component of
the Nation's economy and communications infrastructure.
Before concluding, I would just like to say a very small
number of words about the 60,000-plus employees we have at
WorldCom. Every member of this committee has our employees
living in their district. They are decent, hard working and
highly talented men and women. Many have spent an entire career
building a company that has changed the face of our industry, a
company they have every right to be proud of, and they don't
deserve to be tainted by the wrongdoing of a few.
Mr. Chairman, and members of the Committee, I reiterate my
apology on behalf of WorldCom. We will work hard to regain your
trust and that of the American people as well as rebuild the
value of this company. We will return your faith in us by
making a significant difference in the marketplace.
Thank you, Mr. Chairman, and I would be pleased to answer
any questions that you may have.
[The prepared statement of John Sidgmore can be found on
page 199 in the appendix.]
The Chairman. Thank you, Mr. Sidgmore.
Mr. Roberts.
TESTIMONY OF BERT ROBERTS, CHAIRMAN OF THE BOARD, WORLDCOM
Mr. Roberts. Good evening, Mr. Chairman. My name is Bert
Roberts. I am the Chairman of WorldCom's Board of Directors.
Over the years, I have been privileged to have numerous
opportunities to testify before Congressional committees.
Usually the subject matter pertained to some issue of
telecommunications policy, and ordinarily I would begin noting
how pleased I was to be here.
Today, however, given the circumstances, I must confess
that I am not at all pleased to be here. The accounting
improprieties that are the subject of today's hearing are an
outrage. However, I am here to testify voluntarily. I want to
work with the committee to restore the confidence in our
company going forward.
So let me begin where I think most appropriate, by echoing
John's sentiments and extending to this committee, to the
Congress, to the President, and to the American people my most
sincere apology. You have my commitment, our commitment to do
what we can to accomplish four critical objectives: To get to
the bottom of this, to bring wrongdoers to justice, to develop
safeguards for the future, and to save this great company.
When I first learned of a potential accounting problem on
June 20th, I was stunned. My emotions ran the gamut from
disbelief to concern to anger. When the problem was confirmed
and brought to the board's attention, the action was swift and
decisive. The actions taken by the board, after being apprised
of the situation, are summarized in statements we filed with
the SEC.
To my mind, the failure of our outside auditors to uncover
these accounting issues is inconceivable. That said, it is
important to emphasize that our company's internal controls
brought the problem to light. I commend our internal auditing
group not only for their discovery of the problem, but also for
having the fortitude to bring this matter forward to the
board's Audit Committee.
Mr. Chairman, I have been privileged to hold a senior
management position with MCI and now WorldCom for the better
part of 30 years. I have not only served on this company's
board for most of that time, but have also served on a number
of corporate, university, and charity boards.
My experience has been that in approving the company's
financial statements and records, the board is entirely
dependent upon the competence and veracity of the CFO and his
external auditor. The board's Audit Committee reviews matters
with the CFO and the outside auditor before making its
recommendations to the full board. But if financial documents
have been prepared and okayed by the CFO and further sanctioned
by the external auditor, neither the Audit Committee nor the
full board has the independent capability to look beyond these
approvals.
Indeed, we have never before had cause to question them. I
am shocked that our outside auditors failed to detect the
accounting issues that totaled nearly $4 billion. At this point
we have more questions than we have answers, but we are
absolutely determined to get those answers. We must. Restoring
public trust in our company and in the marketplace demands it.
I would like to amplify something else John mentioned.
WorldCom is a great company. I spent nearly 30 years trying to
open the telecom markets to competition, originally at MCI and
for the last few years at WorldCom. No other company in the
world has a legacy that rivals ours in terms of promoting
competition and advancing the Internet.
Unlike many of our competitors, we were never a monopoly.
Our company has had to compete for every one of our 20 million
plus customers. Today, we are the second largest long distance
company in the United States, the largest competitive provider
of local telephone service, the largest carrier of
international voice traffic in the world, and the world's
biggest Internet backbone provider.
We have world class employees whose great ideas and
marketing savvy have produced, year in and year out, innovative
services and customer savings. Savings may be the ultimate
measure of our success and our continuing value to the
marketplace. Since MCI introduced competition to the old Bell
system, residential consumers and business users have saved
many tens of billions of dollars.
The last 30 years in the telecom business have been
tumultuous. I have had to manage through many ups and downs.
Never before, though, has this company faced a greater
challenge. But never before has our resolve been greater.
In summary, we will meet this challenge. We will deal with
this matter openly, expeditiously and responsibly to help
restore trust in our corporate and financial institutions, and
we will rebuild the value of this great company and ensure its
long term viability.
Thank you, Mr. Chairman. I would be pleased to answer
questions that you and the committee may have.
[The prepared statement of Bert Roberts can be found on
page 195 in the appendix.]
The Chairman. Thank you, Mr. Roberts. Let me begin by
actually commending you for appointing Bill McLucas to head up
the internal investigation. Obviously he had a major role in
the Enron debacle. And with his experience at the SEC in the
Enforcement Division, I think I speak for all of the members of
the committee saying that he has great credibility.
Mr. Sidgmore, when can we expect the report, the McLucas
report, to be available?
Mr. Sidgmore. Well, this is going to sound evasive but it
is not. We have given Bill complete freedom to take the
investigation wherever it goes. So at this point in time I
think he is trying to get his arms around it. It will take some
period of time for him to go do all of the interviews and get
all of the information, because we want all of the facts.
I would guess, and Bill may not like this, but I would
guess probably 2 months, maybe 3 months.
The Chairman. Okay. Mr. Roberts, do you have a comment?
Mr. Roberts. No, I agree. He has full freedom as far as the
board goes. I would hope he would do it expeditiously, but more
importantly it has got to be thorough and get to the bottom of
the matter.
The Chairman. Mr. Sidgmore, Mr. Roberts stated in his sworn
statement that he first learned of the fraud on June 20. But
nowhere in your sworn statement today or in WorldCom's sworn
statement to the SEC on July 1, or in the unofficial transcript
of your comments on July 2nd at the National Press Club, or in
the company's press release on June 25 did you state when you
first learned of the transfers of expenses by Scott Sullivan,
or that you never knew or approved of Mr. Sullivan's accounting
transfers. So please state, if you will, for the record, under
oath, the date on which you gained any knowledge of the nature
and amount of transfer of line costs to capital expenditure
accounts during 2001 and the first quarter of 2002 by Scott
Sullivan, and that includes knowledge from any source about any
of the transactions which were improperly recorded by Scott
Sullivan as capital expenditures during the period in question.
Mr. Sidgmore. Okay. Well, let me give you the time line.
Basically the first time I heard that there was any kind of
significant problem was on the 20th of June.
I had breakfast with one of our board members, Judy Areen.
She is the head of the Georgetown Law School. She mentioned to
me that she had a meeting with the Audit Committee or with some
members of the Audit Committee the night before. They had some
serious accounting concerns. She asked if I was aware. I said
absolutely not.
The Chairman. Is she a member of the Audit Committee?
Mr. Sidgmore. Yes. So I went back to my office. She told me
that Max Bobbitt, the head of the Audit Committee, would be
calling. He called me at about--I am going say 10:00 or 10:30--
and said, you know, we think have got a really serious problem
here. We are not sure, but we think there is a significant
problem. We are going to have an Audit Committee meeting
tonight at KPMG. We are going to invite Scott Sullivan. We
really think you should come, and we briefed Bert, talked to
Mike Salsbury about it, and Mike went over with me--
The Chairman. Mike Salsbury being?
Mr. Sidgmore. He is our general counsel. So we had a fairly
large Audit Committee meeting, which included Scott Sullivan,
Mike Salsbury and myself, the Audit Committee, and Cynthia
Cooper, the internal auditor, and KPMG.
And so at that meeting, KPMG and the Audit Committee went
through their concerns about this line cost-capitalization
and--which really was the first time I had heard what the
details were of this. And basically they went through, I am
going to say, about an hour explanation of what their concerns
were. And then we asked Scott Sullivan to give his explanation,
and his explanation was reasonably lengthy.
But the long and the short of it was that the KPMG auditors
did not buy his explanation, at least at that point. We went
through a lot of discussion on it. We specifically asked KPMG
if they were ready to tell us that this was a problem or that
there was a restatement required or even a write-down. And they
said, no, they had not concluded that. They wanted to go
through the documentation with Scott. They wanted to see
Scott's explanation fleshed out. And they gave him basically
the weekend to do it.
So we set up an Audit Committee meeting for the 24th, later
in the evening, actually it was 5:00 I think. And at that
meeting, we got together with the Audit Committee and a couple
of additional board members, and then KPMG and Scott. At that
meeting, we heard sort of the full explanation from KPMG, also
from Arthur Andersen, about why both of these accounting firms
disagreed with the accounting. And they had concluded at that
point that the statements were not valid, we probably had to
restate.
The Chairman. So your testimony is, basically, not until
June 20th did you have a conversation with Mr. Sullivan or
anyone else in regard to that particular issue?
Mr. Sidgmore. Yes. There is only one other thing which I
was going to clarify. It is not necessarily directly related.
But on June 13th, I had a conversation with Scott Sullivan in
the context--in the context of cost savings that we were trying
to get out of our P&L. And you have to remember, until the
24th--or I am sorry, until the 20th, our major problem was
trying to get our financing situation straight and our P&L
straight because the company had lots of financial problems
even then.
And so what I wanted to do was take out about $2 billion
worth of costs from the business. And, you know, Ron Beaumont,
our Chief Operating Officer, had identified several buckets of
cost that we could look at. And on the 13th, it was the day
before our board meeting, we were pulling together the package
to show the board relative to these costs. And Scott mentioned
to me, you know, we may not be able to get all of those costs
out because there are going to be some significant write-downs
this quarter. We didn't get into line costs or any of that. We
have write-downs, we make adjustments to accounts. That is not
untypical in a company of this size.
So I didn't pay that much attention to it. That just went
away. On the morning of the 20th, after I heard from Max
Bobbitt, there was a voice mail from Scott telling me that this
had become problematic. But those were the only conversations I
had. So really the first time I knew there was any problem, I
mean serious problems with accounting was July 20th. I had
heard from Scott a little nervousness about some write-offs on
the 13th.
The Chairman. You meant June 20th?
Mr. Sidgmore. Yes.
The Chairman. Let me yield to the gentleman from
Massachusetts.
Mr. Frank. Thank you. The 3.8 billion was discovered a few
weeks ago. But for instance, Mr. Grubman noted that he had
begun to do some downgrading some time before. It is clear that
the 3.8 billion was hardly the sole cause here. It is important
for this reason. That is, obviously, it is outrageous that
there was fraud. But I don't want to lend support to the theory
that we are here with a who-done-it with one culprit and one
crime. We are talking about some systemwide problems, it seems
to me.
Even the motivation that led Mr. Sullivan to do this, no
one is alleging that this is an embezzlement. In the typical
cases that we call fraud, the employee is finagling the books
to get some money into his or her own pocket. Here Mr. Sullivan
is accused of doing this to get money into the corporation's
pocket. Now that doesn't make it any less a violation of the
law. But it does mean that the motivations are different. It is
not simply finding one, two or three crooks.
What troubles me is this. We have a system in which we have
been told increasingly that forms of compensation, incentivized
compensation are very important for top executives. I must tell
you, that whole concept troubles me. I would have thought that
if someone was being paid like a million and a half dollars to
run a corporation that he would not need an extra incentive to
have that corporation's interest at heart. Ordinarily in our
economy people who work for a particular entity are not
considered to be in need of a little extra, so they will really
do the job well.
But at any rate, we have developed this system in which we
have this extra incentive often tied to the stock price, and
tied to the stock price in a way if the stock price hits a
certain point the compensation can come, even if it later goes
down. Some of it may be tied to a certain number of years. So
what happens is we have given a number of people at the highest
reaches of the corporation incentives to play with the stock
price.
Again I want to stress, what Mr. Sullivan is accused of is
not putting money in his pocket, but violating accounting
rules, violating maybe the law to pump up the stock price of
the corporation.
So what we have then is that option system that gives that
incentive. Then we have the people who are supposed to check
it. I got to say with regard to boards of directors in general
it has been my impression--I was asked before in an interview
whether I thought that the board of directors was providing
checks and balances, and it seems to me that they were cashing
the checks and ignoring the balances. They weren't doing
anything.
The accounting does not seem to have been a strong eye,
partly because some of the accountants are told by some
companies, by the way if you don't go along with this I will
replace you. There are competitive pressures on the
accountants. There are pressures on the analysts. Mr. Grubman
acknowledged that, yes, there is some connection between the
report you give on a company and whether or not you get the
investment business.
So here is the problem, as I said, it is systemwide. Now, I
think that is why we have to not simply go after individuals,
but to deal with it--what we are dealing with here are the kind
of financial systems equivalent to steroids. We have banned
steroids, because if you want to run the race without steroids
you are disadvantaged by the guy who gets them.
Now, if you are trying to sell your stock and run your
company and you don't play these games, you may be
disadvantaged in the short run by the people who are playing
those games. Now, people may say that is only the short run.
Actually this whole business with the stock focus on the short
run may be giving a new and literal meaning for the
corporations to John Maynard Keynes' quote, ``In the long run
we shall all be dead, because some of you are going to be
because you got too short run intensive.''
But that is why I think we should be focusing not on this
or that wrongdoer, which I don't think is our job, but on what
systematically we can do to diminish, A, the incentive to play
with the stock price, and, B, to increase the safeguards
against that.
Now, I would ask you both to comment on that in your
experience. But let me throw in one other thing. This is
something that troubles me, the loans to Mr. Ebbers. I don't
want to ask Mr. Ebbers, because I think the fifth amendment is
an important part of the Constitution. I must say the test of
whether or not you really believe in constitutional principles
is whether you are prepared to apply them to people you are not
that crazy about. It is easy to be for the constitutional
rights of your friends. People you do not admire, when you
stand up for their constitutional rights, then you are serious.
Most free speech cases consist of the right of really obnoxious
people to say vicious things. But the loans to Mr. Ebbers, they
seem to have become a serious problem.
Let me ask you this. We have heard about hundreds of
millions of dollars. How much did Mr. Ebbers owe the company?
Is it secured? Are you at risk? How much of it is likely to be
at risk? And why did you have to do that in the first place?
Mr. Sidgmore.
Mr. Sidgmore. Well, first of all, I was not CEO then so I
don't want to make an excuse. But let me just describe what I
know about it, and then Bert can jump in.
Mr. Frank. You were both working for the company.
Mr. Sidgmore. We were both board members.
Mr. Frank. You weren't bystanders?
Mr. Sidgmore. He was the CEO.
The loans amount to a little over $400 million at this
point in time. At the time the loan was made there was an
enormous amount of perceived collateral, because first of all
the stock was at $24.
Mr. Frank. Perceived collateral?
Mr. Sidgmore. I tell you why I say that. The stock was at
$24 a share. So the stock alone provided a huge amount of
collateral against the loan. That is point one. Point two, he
had several other pieces of property that in total added up
to--the loan appeared to be well over--
Mr. Frank. Were they formally pledged? The property?
Mr. Sidgmore. I believe that they are.
Mr. Frank. They were collateral?
Mr. Sidgmore. At that time they were not fully pledged but
I think they are now.
Mr. Frank. Were they pledged at all?
Mr. Sidgmore. Yes, sir.
Mr. Frank. How much of the loan was secured other than by
the stock itself?
Mr. Sidgmore. I want to say that the stock was--I don't
know the answer to that question.
Mr. Frank. The point is this: What was your job at the
time, Mr. Sidgmore?
Mr. Sidgmore. We will get it for the record.
Mr. Frank. Nobody knew and nobody much cared is my point.
Mr. Sidgmore. We did. I don't remember the exact split at
this point. So anyway the point was that at the time it didn't
seem that--as outrageous--in retrospect it seems outrageous.
But at the time the theory was, the company, you know, didn't
want him to be out in the market selling all of his stock. The
theory of the case was it was over-collateralized. I am not
defending it. I am just saying that was the theory.
Mr. Frank. Isn't it a little contradictory--
The Chairman. The gentleman's time has expired. Let him
finish.
Mr. Frank. Can I ask him one quick question?
The Chairman. You already have two questions on the table.
Mr. Frank. I will withdraw that one and ask this one, which
is can you tell me, it seems to me it is contradictory when you
say it was substantially collateralized by the stock. But you
were worried that he would sell the stock and bring the price
of the stock down. I mean it seems on the one hand the stock is
pretty firm, but on the other hand it is pretty shaky.
Mr. Sidgmore. My point is he didn't have enough stock to
pay for the loan. Okay. Completely. So we had to have
additional collateral. We added to it.
Mr. Frank. But the reason you made the loan, the
corporation made the loans, was not as an incentive to him or
because he was the CEO, but because you were afraid that he
would otherwise sell the stock in a way that would depress the
value of the stock?
Mr. Sidgmore. Yeah. I want to be careful.
Mr. Frank. The CEO of the company. You have to bribe him
not to undercut the stock of his company.
Mr. Sidgmore. The Compensation Committee evaluated the
situation and recommended that we take this loan, because it
would ultimately be better for the company.
Mr. Frank. The Compensation Committee of the Board of
Directors? One more wonderful example of the firmness of the
Board of Directors.
The Chairman. The gentleman's time has expired. The
gentleman from Iowa, Mr. Leach.
Mr. Leach. Well, it is interesting as we think through the
day that there have been some winners and losers. Mr. Grubman
made $20 million a year for 4 years. The calculation that I
have, and it is off by up to 100 percent, is that the clients
that he advised and your company and seven or eight other
companies lost several hundred billion dollars.
That is a real distinction in winners and losers. Your
board took $400 million and lent it to your President, and you
both voted for that, I assume. I consider that a dereliction of
duty. Nothing else--it has nothing to do with whether that $24
a share was adequate. It is an improper act of a board of a
public company in the United States of America.
And I want to ask both of you, do you think it was right,
morally right, to do that? Mr. Sidgmore?
Mr. Sidgmore. I would say this. If I had to vote for it
again, I would not vote for it.
Mr. Leach. Mr. Roberts?
Mr. Roberts. I would say the same thing. Looking in
hindsight--
Mr. Leach. I agree looking in hindsight. But I will tell
you that is an easy one. Looking in foresight at the time, it
is inconceivable to me that a board would take $400 million of
the capital of the company and lend it to its President. I want
to come back to your situations.
Mr. Sidgmore, according to some paper I have been given, I
don't know if it is right, it indicates that you made about $87
million in insider sales, and because you are an insider they
have been called insider sales.
Mr. Sidgmore. That was in the Wall Street Journal this
morning.
Mr. Leach. And Mr. Roberts $22 million; is that correct?
And so the two of you sold, and then in order to possibly
maintain the value of the stock you lent your President money
so he could keep his stock?
I come from a small rural state. I have got a--I don't know
who produced this, but a chart here that says my State public
employee fund lost, $30 or so million in your company.
I have an insurance company in the largest city in my State
that lost over $100 million in corporate bonds in your company.
Those are huge losses.
Now, the irony is that we have looked basically at three
companies on the committee. We have looked at the Enron
Corporation. We have looked at the Arthur Andersen Company. We
have looked at your company.
Enron, frankly it is really sad for its employees but, when
it leaves the corporate landscape, is not going to be much
missed.
Arthur Andersen as it existed a decade ago was one of the
truly, truly great American companies. It somehow got
transferred in the decade of the 1990s and took on a different
ethic. And so it is hard judge whether it is bad or good that
it is being held accountable. I think to get down to only four
major public accounting firms is really unfortunate, but that
is what is happening.
Your company, on the other hand, is really vital to our
country. It is vital to an incredible industry. It is vital to
the competitiveness of American communications companies
worldwide. It is really important that your company be
transformed, reformed, reorganized, and maintained in one form
or another, whether it be under your management or some other
companies or some other individuals.
But this country is really in a pickle, because clearly
inappropriate decisions have been made, and yet just as clearly
this is a company with employees in my district, as you say,
every district in the country, that are really dedicated. They
look upward, and I will tell you they are just appalled by what
they have seen happen.
Now, I will also tell you, Mr. Sidgmore, my employees tell
me that they really have hope in you. They really like you.
They really hope it works. On the other hand, where do we go as
a country? What advice do you give to corporate boards? What
advice--what kinds of compensation are you now taking?
Mr. Sidgmore. Well, we will start with the last one if that
is okay. My current salary is a million dollars a year. When I
joined, I came back into operations 2 months ago, that was what
the Compensation Committee granted me. They also granted for,
voted for a large bonus package which we have chosen not to
implement at this time given where we are. So that is where it
is. It is about a million dollars a year.
I just want to address the stock option question also. This
is not a sympathy vote here. But with the 86 million or
whatever the number actually is, I want to say is in large
measure, a great majority of that is made up of original UUNet
stock that I earned while building UUNet from 1994 through
1996. And actually, when it converted to WorldCom, I still have
almost half of those shares in the form of WorldCom stock, and
most of those sales were made from 1987 through--1997 through
1999, I mean well before the loans were given.
So I can't really honestly see any tie whatsoever to the
loans. I do think that there can be changes made to the way
boards operate to prevent some of these things, and I also
think personally that probably--I mean, I think I would say
more than probably, I think it is likely that the options
situation has gotten out of control over the last few years.
And the option situation was terrific for the guys at the high
end while the companies were all growing. Now, it doesn't seem
to have that much impact anyway because the economy has
changed.
So, I mean I have all kinds of other situations on board
governance and so forth, but I don't want to take too much time
now.
The Chairman. The gentleman's time has expired. The
gentlelady from California, Ms. Waters.
Ms. Waters. Thank you very much.
Mr. Roberts, it is rumored that Mr. Sullivan told you and
perhaps the entire board about his accounting practices. He
told you how he reported the operating expenses that had put it
over in the capital outlay future columns.
Now, I don't know whether he told you directly or if it was
in a report or if it was in something that the board gets
routinely. But is it true that you were told at some point
about Mr. Sullivan's accounting practices what he had done?
Mr. Roberts. The answer is yes. John went through the
sequence. There was a board--after we found out on the 20th
there was the Audit Committee that John referred to that was
attended by a few. There was an update call on the Friday at 3
o'clock where the entire board was advised as to what was going
on.
Scott worked on his white paper across the weekend. On
Monday there was another Audit Committee meeting where Scott
basically presented several of us that attended that Audit
Committee--
Ms. Waters. If I may interrupt, did you know about it prior
to, what day did you just give me, June 20?
Mr. Roberts. No.
Ms. Waters. Did the board receive any kind of report from
Mr. Sullivan relative to the way that the accounting was taking
place prior to June 20th?
Mr. Roberts. Not that I recall. Scott Sullivan did make
presentations at each of the board meetings and presumably made
more--
Ms. Waters. We will be able to look back at these board
meetings and determine whether or not it was revealed in any of
his reports that maybe you didn't pick up. Have you looked at
that in retrospect?
Mr. Roberts. Yes, we have.
Ms. Waters. What did you discover?
Mr. Roberts. We discovered that there was nothing said at
those meetings with respect to the problem at hand.
Ms. Waters. Was there anything submitted in writing to the
board prior to June 20th?
Mr. Roberts. Was there?
Ms. Waters. Anything in writing. Anything written?
Mr. Roberts. No.
Ms. Waters. So no--
Mr. Roberts. Not that I know of. We have looked at the
board minutes. We have tested our memories on what was done at
the various board meetings. Although the Audit Committee was
not here, John and I have examined some of the Audit Committee
minutes, and there appears to be nothing that identified that
was a problem before we learned about it through our internal
auditor, who brought it for forward to the Audit Committee.
Ms. Waters. I would like to ask Mr. Sidgmore, what is going
to happen to this company? Are you going to file bankruptcy?
Are you negotiating with the banks to restructure the loans?
How do you plan on retaining your executives? Do you plan on
giving them retention bonuses to the tune of $2 to $3 million?
If so, where are you going to get the money from? And what do
you think your customers ought to do right now? A lot of
questions, but see if you can answer them.
Mr. Sidgmore. Well, first of all, we are fighting for our
life. I mean, I think that should be clear to everybody if you
read the newspaper. This is a tough time for the communications
industry and for WorldCom in particular.
Ms. Waters. What is the bank saying about the loans?
Mr. Sidgmore. We have got a number of proposals coming
together. Some potentially would include a Chapter 11 filing,
and some don't. Okay? And so we are not 100 percent sure where
that is going to wind up.
I can tell you this, I am confident, not positive, but I am
confident that we will pull this company together and turn it
around one way or the other, and I am quite confident that the
great majority of the customers and a great majority of the
employees will wind up with this company for a long time.
Ms. Waters. Do you anticipate coming to the government
asking to be bailed out in way, shape, form or fashion?
Mr. Sidgmore. That is not in our current plan, no bailout
or borrowing from the government. That's not in the plan. We
will ask for help from some agencies to help potentially calm
some agencies down where we have had some contract questions. I
think you have read about those in the papers; in other words,
people that are worried about giving us new business. But that
would be the extent of the favors we would ask at this point.
Ms. Waters. What about the retention bonuses? Do you plan
on giving out retention bonuses?
Mr. Sidgmore. We had a retention bonus plan in the company
for many years.
Ms. Waters. But you don't have money now. I'm asking you do
you plan on doing it now?
Mr. Sidgmore. Well, we're not going to certainly do it now
unless we wind up refinancing the company so that the company
is financially healthy. We certainly wouldn't do it now. But
there may be a rationale for putting a compensation plan
together for critical employees that we need to make sure we
keep with us as we go through this process.
The Chairman. The gentlelady's time has expired.
Ms. Waters. So you're going to try to do retention bonuses.
Mr. Sidgmore. We're going to try to do bonuses. I didn't
say retention bonuses.
The Chairman. Gentleman from Louisiana Mr. Baker.
Mr. Baker. Thank the Chairman for yielding.
Mr. Sidgmore, I've got several questions, and I will try to
be as brief as I can in asking them. When Mr. Ebbers departed,
you were brought on board as the new president and CEO. What
were you told as to the reasons for Mr. Ebbers' departure and
any problems you needed to rectify in your new capacity?
Mr. Sidgmore. I think it's fair to say that the board had
become, or at least some members of the board had become,
frustrated with the company's performance, stock's performance
and sort of the general direction of the company over the last
couple of years.
Mr. Baker. So there was no specific event or circumstance
of Mr. Ebbers' conduct in the preceding 6 or 8 months that
caused the board to have concerns, but rather a gradual
deterioration of business performance?
Mr. Sidgmore. I don't know if that's gradual, but there was
a deterioration of business performance, and there were some
concerns about the final negotiations surrounding his loans.
And so I guess the independent directors basically got together
and concluded that this situation was getting critical, and
they had a conversation with Mr. Ebbers about it, and he wound
up terminated.
Mr. Baker. I note in the explanation of the restatement
previously given to the SEC and the explanation of the
restatement made available to us today, in the last--on the
last page, paragraph 21, there is an explanation with regard to
Mr. Sullivan's disposition that the board acted on June 25 to
dismiss him without severance. When did you remove Mr. Sullivan
from his capacity as a board member?
Mr. Sidgmore. We have not--we have asked for his
resignation as a board member, but legally right now, without
getting in too many details, without entering some kind of
formal procedure, it's not easy to remove a board member
without a shareholder vote.
Mr. Baker. So your bylaws don't have a provision for
removal for cause if an individual is serving as a board member
and convicted of a felony relating to securities fraud?
Mr. Sidgmore. Like I said, we are looking at that. It may
require a formal procedure, but we have asked for his
resignation.
Mr. Baker. And I would point out that prior to your
capacity as being the new CEO, you were a board member for some
period of time, so appear to have some prior knowledge as to
the deterioration of company conditions coming into this new
responsibility.
Mr. Sidgmore. Yes. That's true.
Mr. Baker. On page 24 of the explanation of the
restatement, it said, we expect potential and certain material
reversals of reserve accounts for '99 and 2000. Can you
identify the nature of those reserve accounts and to what
extent the reversals are we talking about, or are we in
hundreds of millions?
Mr. Sidgmore. I will just tell you what we know, and we
don't know as much as you want us to know right now. The way
this situation came up was the day of our announcement about
the misstatements, an employee faxed to us a series of
transactions that they didn't recognize, that they were
concerned about, given the fact that this was just announced
and it was so explosive. So the list came out. There were about
seven or eight transactions that I recall on these pages. So we
actually turned that over to the SEC. We showed it to McLucas.
And we asked, you know, McLucas to go investigate it.
Mr. Baker. Was this as a result of your internal audit work
or Andersen's work?
Mr. Sidgmore. Actually this was a result of--I believe--I
think this was a result of an employee finding this, sent the
information to our comptroller, and our comptroller faxed it to
us.
Mr. Baker. So what was the capacity in which the employee
was engaged? Who discovered it?
Mr. Sidgmore. The person who sent it to me was Stephanie
Scott, who is now acting as comptroller of the company.
Mr. Baker. And at the time she made the discovery, she just
worked in the comptroller's office; is that right?
Mr. Sidgmore. That's right. Well, she didn't work in the
comptroller's office. She was actually the head of SEC
reporting, and she had some other financial responsibilities as
well.
Mr. Baker. Well, I want to join with Mr. Leach in
expressing my concern about this matter. Although you have a
narrow window of opportunity in which you appear to have a
favorable reception by the employees of the company, this is a
very horrendous set of circumstances, from my outside view
looking in, from the time of your arrival on April 30 until
now, as a former board member, with an inability to remove a
board member who was terminated by the company for apparent
misconduct, to--I am sure the board expressed significant
concerns to you at the time of your employment about company
performance and what they expected you to do in order to turn
it around, with the potential restatements coming with regard
to reserve accounts, with the difficulty that this might
present in future financial arrangements to turn the company
around.
This is very disturbing news, and I don't know what, if
anything, this Congress can do in light of the condition of the
corporation. But certainly knowing that the former CEO is now
retiring on $150 million a year and maintaining other assets
that can't be secured, this is not a proud day in a free
enterprise system, and I deeply hope that you have the will and
ability to turn this around and save the few dollars left in
investors' accounts who have faithfully contributed their
resources to you and your company and who are now planning to
have to work many more years into their retirement while the
former CEO lives in the south of France. This is really not
good.
The Chairman. The gentleman's time has expired.
The gentleman from Pennsylvania Mr. Kanjorski.
Mr. Kanjorski. Thank you very much, Mr. Chairman.
Mr. Roberts and Mr. Sidgmore, were either of you in the
hearing room when we had the panel of four before us?
Mr. Sidgmore. Yes. Both of us were.
Mr. Kanjorski. Did you find anything in response from any
of the four witnesses that made you proud of WorldCom or of the
free enterprise system?
Mr. Sidgmore. I didn't find anything.
Mr. Roberts. I didn't find anything.
Mr. Kanjorski. It is not the role of the government or the
Congress to impose itself in private--even for public
companies. And there's been an effort over the years to try and
cut loose entrepreneurial spirit in this country, and to a
large extent the telecommunications field represents in some
peoples' eyes a shining example of turning loose that free
enterprise spirit. But what I heard from your auditor today,
what I heard from the impartial, independent analyst, and what
I didn't hear from the former chief executive officer and chief
financial officer makes me wonder whether or not WorldCom is of
itself enough to shake the very confidence of the investing
public in large corporations that should know better, do know
better, but apparently have lost their confidence.
I am disturbed about the fact that Mr. Sullivan is still on
the board. What does a member of the board of directors get
paid by WorldCom?
Mr. Sidgmore. He gets paid nothing. He was fired as CFO and
an employee and has been severed. As a legal matter which we
are looking at, we have no easy mechanism to force him off of
the board, but I am hoping we will be able to accomplish that
in the near future, hopefully by resignation.
Mr. Kanjorski. Is he still sitting in on confidential
meetings?
Mr. Sidgmore. No. He has not been invited to any board
meetings since he was escorted out.
Mr. Kanjorski. Mr. Roberts, you have been chairman of this
corporation for a fairly decent period of time, haven't you?
Mr. Roberts. [Nods affirmatively.]
Mr. Kanjorski. And I have no reason to assume that you have
any evil intent or had any evil intent, but could you explain
to me how all of this could have happened, and you're chairman
of the board of directors, and you obviously don't know about
it?
Mr. Roberts. I think you should understand the way the
board works. This is not untypical of many companies, but
you're dependent as a board member to the numbers that the CFO
puts forward as he has been audited by the outside auditors and
reviewed by the audit committee. And I think we're in a
situation where, in fact, numbers were put forward. The
accounts of MCI/WorldCom were what they were. They were audited
by the external auditors, reviewed by the audit committee, and
then presented to the board on each of the occasions throughout
the year of the quarters that we're looking at, and also at the
end of the year. And every indication and every presentation
that was given to the board showed no indication of a problem
with either our accounting or our books. I am appalled that
this happened.
Mr. Kanjorski. And I think you probably genuinely are, but
I have a big question in my mind. Wasn't there a lawsuit,
stockholder lawsuit, filed in 2000 against WorldCom?
Mr. Roberts. We have a number of suits filed against us.
Mr. Kanjorski. But the one that was dismissed under the
Reform Act of '65. And didn't that talk about improper
activities on the part of officers of the corporation?
Mr. Roberts. I believe that lawsuit, from what I know about
it, was specifically focused on a write-down that the company
had at the end of 2000, the year 2000. It was dismissed by the
court.
Mr. Kanjorski. It was dismissed because the court said
under the act that our friends on the other side passed, took
the court's jurisdiction away. But, in fact, the court passed
on the clearness of wrongdoing, but it said the court no longer
had jurisdiction under the law to deal with it. Isn't that
substantially the dismissal? The dismissal wasn't the fact that
it was a clean bill of health, nothing happened. It was saying
that the court just lacked the jurisdiction under statutory law
to do anything about it.
Mr. Roberts. But nevertheless, the suit was dismissed, but
it's also the subject of what the SEC was investigating.
Mr. Kanjorski. When these suits are filed, and these facts
are alleged in the suit, and the SEC is doing some
investigation, would you all sit there and say, well, we are
just innocent lambs, and proceed along, or do you think as a
member of the board responsible for governance of a huge
corporation that a bell shouldn't go off or a tilt and say, we
better find out what this auditing committee is doing, and find
whether we should enlarge it or change it, or find out what the
CEO and CFO is doing, or change them? It just seems to me it
was like going around the maypole on May Day.
The Chairman. Gentleman's time has expired.
The gentlelady from New York is recognized.
Mrs. Kelly. Thank you, Mr. Chairman.
Mr. Roberts, we are all sitting with this chart about the
fact that you own stock, and you sold it. Can you tell me the
date that you sold the bulk of that stock?
Mr. Roberts. I think the stock that was referred to in the
Wall Street Journal this morning I believe was sold in the 1999
time frame, maybe as early as the first quarter of 2000. It
was, I think, mostly associated with exercise of stock options
that were a result of my efforts at MCI before the merger.
Mrs. Kelly. Okay. Thank you.
Mr. Sidgmore, you sold the bulk of your stock in May 2001?
Mr. Sidgmore. No. No. I sold a very small amount in May
2001, about $400,000 worth. And I believe, let me see where
that is--$440,000, these were sales from trusts that I had set
up for my niece and nephew's education. And basically we had
contributed the stock in December of 2000. This was just the
sale of it into their trust. Normally you wouldn't want to keep
stock in a college fund, or at least I wouldn't.
Mrs. Kelly. I am just wondering what occasioned your
selling of the stock, because obviously Mr. Ebbers wanted to
sell his stock, too, at one point. It's clear from the way this
graph shows us how it folds, how the fall or the crumbling of
WorldCom, that probably all wanted to sell your stock. And it's
interesting to me, and the reason I'm asking is that you have
been talking, Mr. Sidgmore, about a new management team, and I
am at a loss to understand where the new management team is
coming from. You were vice chairman. You were on the board. Mr.
Roberts was on the board. Who's new on this board, and why
should anyone in the public believe that WorldCom is getting a
new look?
Mr. Sidgmore. Well, if I could just respond. I was the
chief operations officer at WorldCom from January '97 till
September of '98. In September of '98, I moved out of my
operating role and had no operating responsibility whatsoever.
Mrs. Kelly. Excuse me, sir. Were you still on the board?
Mr. Sidgmore. I was a vice chairman and a board member. In
'99, I took the role basically as strategic development
officer, and basically what I did was look for acquisitions;
work on acquisitions, mergers, new technologies, new ideas and
that sort of thing. In the year 2000, I played almost no role
whatsoever, and in the year 2001, my entire role literally was
making speeches and to come up with an occasional idea on
Internet technology.
So everyone in the company knows and everyone on Wall
Street will tell you I haven't been involved at WorldCom in a
long time. I worked maybe 1 day a month. I reduced my salary by
20 to 1. Most of my stock was sold in '97 and '98, and then
some more in '99. But the stock you're referring to in '01 was
simply the transfer--a result of me transferring a bunch of
stock into the kids' trust fund in December of 2000, and I sold
it a few months later. And the reason I sold it is very simple.
I did the same thing a year before. The stock went down, and
the kids' trust fund went in half. So what I said was if the
stock goes back up, we're going to sell it this time so that
the kids can get back to even.
Mrs. Kelly. I don't have much time, but I am glad you saved
your kids' college fund. But my question is--and you are
perfectly within your rights to sell your stock even if it's in
the corporation where you're the vice chairman of the board. My
concern and my question that I ask you is who's new on that
board? You, Mr. Sidgmore, created two very, very important
companies. UUNET is something I am quite concerned about as a
part of WorldCom, and it was a strong corporation. I am asking
you what's going to guarantee me as a stockholder--I don't own
WorldCom stock, but if I were, what's going to guarantee me
that there's going to be a new administration at the top?
Mr. Roberts, you were there on the board. Where were the
questions that the two of you, having been involved with major
corporations prior to this time of being on the board, should
have been asking?
My final question to you, and you can answer that, but my
final question because I'm running out of time is do you
believe that Mr. Ebbers was so joined at the hip to Mr.
Sullivan that it prevented either one of you from asking the
appropriate questions?
Mr. Sidgmore. I guess the only thing I would say is we have
not been involved in operations. We operated as board members,
notwithstanding my ceremonial title and Bert's title as well.
Again, to repeat what Bert said before, we have to depend
on the CFO and the outside auditors to a great extent. Number
two, if you looked at the financials from last year and the
ratios to revenue from a line across to revenue and capital
expense, all of those things, as Mr. Grubman said, seem to be
in line. We didn't know that the transfers were happening, and
it was very, very difficult from our position to see that. So,
I think from our standpoint as board members, it would have
been very difficult to find something that Arthur Andersen
couldn't find in an audit and our original audit team didn't
find either.
The Chairman. The gentlelady from New York Mrs. Maloney.
Mrs. Maloney of New York. Thank you, Mr. Chairman.
I would like to ask Mr. Sidgmore, I would like to ask about
an item that I raised earlier that was reported in the paper
that WorldCom reported 16 billion in earnings to shareholders
between '96 and 2000, yet it reported less than a billion of
taxable income to the IRS during that same period. So obviously
WorldCom had two sets of books, one for the shareholders with
earnings and another set of books with losses or very little
earnings. So my question to you is do you think that it would
be a good idea for WorldCom to give the same information to the
shareholders that they give to the IRS?
Mr. Sidgmore. Yeah. And we can give you a reconciliation of
that if that would be useful to you.
Mrs. Maloney of New York. I would like to look at that.
Mr. Sidgmore. I want to say in most corporations,
especially ones that are this complex with 65 acquisitions and
all that, there is definitely going to be a difference between
tax accounts and book accounts, and that's not abnormal.
Mrs. Maloney of New York. Do you think it would be a good
idea for public companies to reveal their taxes? We heard
earlier from analysts and from auditors who said they just rely
on the information that's given to them. I think investors
would find it very interesting that what's being reported to
shareholders are great earnings, but to the IRS and other
companies it's a loss--very little earnings. That might help an
analyst have a little more information. I know if I was an
analyst, I'd start looking a little deeper if I saw that
difference. Do you think that be would a good idea to put that
out to the public?
Mr. Sidgmore. I am in favor of transparency generally,
which is why we're going along with all the investigators'
requests from all agencies, why we are making our information
available to anyone who asks. So I generally would favor that
kind of transparency.
Mrs. Maloney of New York. There has been some criticism of
the accounting form that you use, the EBITDA. I would like to
put in the record an article on this by Christine Nuzum, and in
it she says that there are a lot of people--or WorldCom,
because of your fraud, that it has hurt a lot of industries
that are associated with this type of accounting, EBITDA, or
earnings before interest taxes, depreciation and amortization,
to assess stocks. And many leaders in finance, Warren Buffett
and others, have been very critical of this form and said we
should probably go back to general accounting principles, GAAP.
And do you think that would be a good idea, or are you going to
continue to use this controversial form?
[The following information can be found on page 244 in the
appendix.]
Mr. Sidgmore. EBITDA has been the standard in the
telecommunications industry for a long time.
Mrs. Maloney of New York. Given the fact that so many have
gone bankrupt recently, do you think maybe it would be good to
rethink this?
Mr. Sidgmore. No. The biggest issue with EBITDA is you
don't count the cost of capital against yourself. In many of
these cases of the bankruptcies and even WorldCom, which is
struggling with our debt, huge interest payments don't show up
in the EBITDA calculation. So the EBITDA calculation masks the
cost of capital, and that's what happened to a lot of the
problematic telephone companies, including WorldCom and Global
Crossing.
Mrs. Maloney of New York. Don't you think it might be
better to just to go back to GAAP then?
Mr. Sidgmore. They're all under GAAP. GAAP is sort of the
general accounting rule. But the question of how you report
it--
Mrs. Maloney of New York. I mean, just don't go into
EBITDA. Just use GAAP instead of the other one.
Mr. Sidgmore. EBITDA is according to GAAP. The EBITDA
measure, when you highlight that, it doesn't show you what the
real cash flow of the business is, which today is the most
important measure, in my mind.
Mrs. Maloney of New York. Maybe we shouldn't use it. Maybe
we should go back to cash flow. Maybe then our auditors and
analysts might get a better understanding of what's taking
place in corporate America.
I want to go back to a question that was asked many, many
times with the prior panel. And how is your internal auditor
able to find this when Andersen, which was your tax auditor and
your tax adviser, your consultant and your auditor that was
involved in all these areas, they couldn't find it? And then I
want to ask, why are you continuing with this investigation
despite the fact that the Department of Justice has requested
you to discontinue the investigation immediately?
Mr. Sidgmore. First of all, we are not doing the
investigation. Bill McLucas is doing the investigation.
Mrs. Maloney of New York. Why is he doing it when the
Department of Justice has asked him to stop?
Mr. Sidgmore. They haven't asked him to stop. He's actually
working with the Department of Justice and the SEC on this.
They made certain requests to see certain witnesses before he
does, and we are complying with all that. But Bill is the one
that is actually doing the investigation. It's not us, the
company.
Mrs. Maloney of New York. Why was he able to find it?
The Chairman. The gentlelady's time has expired.
Mrs. Maloney of New York. Why was he able to find it when
the others could not find it?
Mr. Sidgmore. I don't know the answer to that question. He
did a terrific job and a terrific service for the company, and
I have no idea why Arthur Andersen didn't find it. I think I
made that clear in my opening comment.
The Chairman. The gentleman from Alabama.
Mr. Bachus. Thank you Mr. Chairman. Mr. Sidgmore, when you
operated an Internet backbone company, did you ever expense
capital expenditures?
Mr. Sidgmore. Did we ever capitalize expenses you mean?
Mr. Bachus. Yes.
Mr. Sidgmore. Some expenses, but not like this. There are
certain things that you can capitalize, but not operating
expenses traditionally.
Mr. Bachus. Not operating. How about telecom access charges
or transport charges?
Mr. Sidgmore. No, we did not. At UUNET we pretty much had
an annuity stream of revenue, and we were profitable from
January of '95 on.
Mr. Bachus. But you followed generally accepted accounting
practices.
Mr. Sidgmore. I certainly believe so.
Mr. Bachus. You have testified today that the accounting
irregularities, the dubious accounting that you first became
aware of on June 13 and then--
Mr. Sidgmore. No. On June 20, I became aware that there
were accounting irregularities. On June 13, which I really
didn't pay attention to except on the 20th, Scott Sullivan said
we may not be able to get all these savings.
Mr. Bachus. You're saying June 20.
Mr. Sidgmore. That's right.
Mr. Bachus. June 13, you had a little remote suspicion
there were some accounting irregularities.
Mr. Sidgmore. Not accounting irregularities, just that we
were going to have to take a write-off for something. But
that's not atypical in our business really.
Mr. Bachus. Now, you're quoted in early May as saying that
investor concerns over aggressive accounting to artificially
inflate revenues were red herrings. Would you reconsider what
you said then today?
Mr. Sidgmore. Well, I think--I didn't remember that exact
quote, but I think there were some concerns about our
increasing or inflating revenue through some billing
irregularities, and we felt at that time, and still feel, that
that was basically a red herring.
Mr. Bachus. The quote is, quote, ``that investor concerns
over aggressive accounting to artificially inflate revenue.''
Now, that's what they did here.
Mr. Sidgmore. They didn't inflate revenues, not in this
last scenario. What they did was that they took traditional
operating expenses and moved it into the capital account.
Mr. Bachus. By amortizing, it does increase profits.
Mr. Sidgmore. Increases profit, not revenue.
Mr. Bachus. What about artificially inflating revenues;
that would be wrong, too.
Mr. Sidgmore. That would be really bad.
Mr. Bachus. Do you believe that that has gone on now?
Mr. Sidgmore. We haven't heard of anything in that light,
but this is one of the reasons it's hard for us to be positive
of anything right now, to be honest with you, and that's why we
asked KPMG to go back and audit the books and really scrub them
for 3 years, and go back to '99 to make sure everything is
pretty clean.
Mr. Bachus. Was it Mr. Ebbers who was escorted out, and he
looked up--Sullivan was escorted out, not Ebbers.
Mr. Sidgmore. I don't know about Ebbers.
Mr. Bachus. Seventeen thousand employees lost their jobs
last week. Now, they weren't given--they are not being extended
on their health care or their life insurance, or they're not
going to be paid an annual pension, are they?
Mr. Sidgmore. No. They did get severance, and I would like
to say on this point, because I heard that several times today,
the reduction in force that caused 17,000 people to lose their
jobs has nothing to do with this accounting issue. We actually
had planned this about a month ago, and this is about our cost-
saving effort. This issue with the accounting problem
exacerbates our general financial condition.
Mr. Bachus. Let me ask you this last question. We've heard
reports that Max Bobbitt, who is chairman of the audit
committee--he's part of your senior management team now, I
guess?
Mr. Sidgmore. He's part of the board.
Mr. Bachus. That he's allowed a $1-a-month lease on a
WorldCom corporate jet?
Mr. Sidgmore. First of all, it's not Max Bobbitt. It's
another board member, Stiles Kellet. He's actually the head of
the audit committee--I'm sorry, compensation committee. There
was apparently some kind of deal made for Stiles to rent and
use the corporate jet--that we had an extra corporate jet at
one time--and he houses it in his facility in Atlanta. This was
a deal that was made between he and Mr. Ebbers, and we are
investigating that right now.
Mr. Bachus. By extra, if you are laying people off, it
might be prudent to sell an extra jet.
Mr. Sidgmore. We agree with you.
The Chairman. The gentleman's time has expired. The.
Gentleman from North Carolina Mr. Watt.
Mr. Watt. Thank you, Mr. Chairman.
Could I ask a couple of quick questions and maybe get some
quick answers? Mr. Sidgmore--Chairman can't find me most of the
time either--at some point you testified on June 20 or
thereabouts, 21st, that KPMG and Andersen both agreed that
there was a problem; is that right?
Mr. Sidgmore. No--well, almost. The 20th, we heard from
KPMG. On the 24th, Andersen--
Mr. Watt. They both agreed to that. Was that Mr. Dick who
was in that meeting or--I mean, the same guy that testified
earlier?
Mr. Watt. I'm not positive about that. I'm not positive it
was Mr. Dick. He was on the conference call.
Mr. Watt. Could you give us information about who that was?
The second question I have is just a great big why? I mean,
I think I could understand this whole Enron thing because
people were profiting personally, and I guess the question I
am--the thing that's just not adding up to me here is I don't
understand why two people--either one or two people in a
multibillion-dollar corporation would have the motivation to do
this. Either of the two of you care to comment on what the
motivation, Sullivan's motivation or Ebbers' motivation or the
combination of them? I mean, what was driving this?
Mr. Roberts. Well, I don't know that we can speak for those
two individuals that were not speaking earlier.
Mr. Watt. Your own interpretation. I mean, you obviously
got--you got some clue about what was driving this.
Mr. Roberts. Based on the information that was disclosed to
us during those days after the 20th, Scott Sullivan presented a
case that he believed that he was doing the right accounting
treatment. As a company, we listened to KPMG and other experts,
determined that it wasn't the right treatment, and that's why
we took the action that we took. But Scott put together the
white paper and made a case that he believed he was doing the
right thing.
Mr. Watt. So you escorted him out the door not because he
thought he did anything wrong or you thought he did, this was
an honest misunderstanding about what was generally accepted
accounting principles? Are you telling me that he still
believes that he was doing the right thing, and Andersen never
detected it, and KPMG thinks that he was doing the wrong thing?
Mr. Roberts. I am only speaking for what happened that
weekend that he presented the case that--
Mr. Watt. That wasn't my question. My question is why have
you concluded that this was done? I mean, an honest mistake?
Mr. Roberts. I can't answer that. I think we as a company,
John, myself and other members of the board, have determined
talking to KPMG and others that it was the wrong application of
accounting principles, and that's why we took the action that
we did.
Mr. Sidgmore. Could I just add that a lot of us are totally
mystified about this.
Mr. Watt. All of this is backward-looking, you know. My
policy in these hearings is try to look forward. And you said,
Mr. Sidgmore, that you had a whole list of things that you
would suggest going forward about corporate responsibility. Can
you just give us your top three?
Mr. Sidgmore. I think--I mean, first of all, I think in
terms of the audits, okay, I think there should be a main
auditor and an auditor to audit the auditor. Unfortunately
there are only four accounting firms left, but it seems to me
we need more scrutiny over the audit, particularly in light of
the coming potential regulations on, you know, CEOs signing
forms and that sort of thing. So from that standpoint, having
an audit and having the audit audited is probably a good thing.
In a strange way this is how we uncovered. We had our
internal audit group audit the audit. It turned out to be the
right thing, but it was too late. But I think that's one
scenario.
You talked this morning about the investment banks and the
conflicts of interest and everything. I agree that research
should be separated from banking. And on the board itself, I
think that the--I think over the next year or 2, the board
committees have to become a more important and more integral
part of the company's operations.
The Chairman. Gentleman's time has expired.
The gentleman from Illinois Mr. Manzullo.
Mr. Manzullo. Thank you, Mr. Chairman, and just a couple of
thoughts. On the first panel, Mr. Dick, the former partner at
Arthur Andersen and the head of the audit committee, stated
that the $3.96 billion misstatement of WorldCom represented
roughly 20 percent of the line items in terms of dollars on the
WorldCom balance sheet. The way I interpret it is that one out
of five line items examined by Arthur Andersen was incorrect;
that these statements should have raised a red flag with the
auditors. So if any auditing tests occurred, the auditors
should have more or less an 80 percent chance of testing a
correct line item and a 20 percent chance of finding an
incorrect line item.
Dick testified that Arthur Andersen billed 15,000 hours
among 8 auditors at WorldCom over a period of 1 year. These
numbers are extraordinary because if the auditors spent just 1
percent of their time during the year in reviewing WorldCom
line items, which is pretty conservative, this would equate to
150 hours or 19 days. If the auditors conducted 1 accounting
line item test each 8-hour day--I think that is also
conservative--and 20 percent of the line item costs should have
raised a red flag, the simple probability that the auditors
could have missed these incorrect line items is about 1
percent. In other words, the likelihood that the auditor should
have seen a cost which raised a red flag is about 99 percent.
And so much for the auditing committee.
But what I really wanted to demonstrate to you today is the
reason I have been here all day and got up at 4 o'clock in the
morning is because of the 1,000 MCI employees that are in my
congressional district. And I met with them on a couple of
occasions, and I said, what is it that--what questions could I
ask on behalf of you, my constituents; what words could I give
before this congressional committee? And they said two things:
Congressman, first of all, jail the wrongdoers. Put them in
prison for a long, long period of time. But at the same time,
the government, the SEC and Department of Justice and whatever
we do around here should remember that there are thousands of
innocent people out there, including these in Rockford,
Illinois.
I had visited several hundred business establishments and
factories since I was elected to Congress several years ago. I
have never seen employees with such a spirit of productivity
and ingenuity as those at MCI in Rockford. And Mr. Leach had
the same experience with his 3,000 employees.
Let me give you more particulars. MCI in Rockford is the
largest minority employer in that area. This is the city that
led the Nation in unemployment in 1981 at almost 26 percent. We
are 8 percent unemployment now. The steel tariffs could
endanger thousands of jobs in a city that is heavily
manufacturing. And what we are seeing there is something
extraordinary. We have lots of government programs for lifting
people up by their boots, but there at MCI, people have an
opportunity to become involved in the entrepreneurial spirit,
to make as much money as they want to, and they are making a
tremendous amount of money in telemarketing without having to
invest any capital. It is an extraordinary opportunity. And
these are 1,000 families desperately wanting to hold on to
their jobs. They have confidence in the two of you, and because
they know your backgrounds at MCI and UUNET. And my question to
you is their question: What can you tell the American people
that can give assurance to these 1,000 people that they have a
good probability of maintaining their livelihood?
Mr. Sidgmore. Well, like I said before, before the
restatement we had been working on a new strategic plan for the
company which included refinancing, selling some of the
businesses that are not central to the core strategy of the
company, reducing costs, both line costs and SGNA, and
retooling the company around a central piece that we think will
grow over the next few years. And you know, had the restatement
not occurred, I am highly confident we would have implemented
all those pieces already.
I do think if we can find a solution to our financial
issues in the short term, and I do think we will be able to, I
think we will go forward and implement that strategy, and I
think the lion's share of the company will wind up pretty much
intact, and we may eventually have a growing healthy thriving
business again.
You have to remember one thing here. The issues at
WorldCom, I mean, that existed before the restatement are not
unique to WorldCom. Most large telecoms today have the problem
that there's too much capacity out there at the same time that
the demand is not growing for the first time in a long time.
Everyone has been slow to get to this. But the real issue is we
have to restructure these businesses so that they are more
focused and that they're smaller and we find some new products
that people will buy. And I do think that can happen as long as
the debt load on all these companies gets reduced, and that's
really our fundamental problem right now. But I am confident.
The Chairman. The gentleman's time has expired.
The gentleman from Texas Mr. Bentsen.
Mr. Bentsen. I want to follow up on Mr. Watt's line of
questioning because I was thinking the same thing. According to
the document you all filed today with the SEC, the amendment,
how is it that the chief financial officer or member of the
board came up with this idea in the last several months, this
revolutionary theory that no one else had come up with in
accounting that somehow you could treat line costs, which are a
principal cost factor in the business that you all are in--that
you could treat that as a capital expense and not an operating
expense and just independently make that adjustment in a fairly
significant amount, about 10 percent of the capital cost on an
annual basis, and nobody knew about it?
I mean, that is what I think Mr. Watt is trying to get at,
and what I don't understand is where was his motivation to not
go and check with his auditor, to not talk to the members or
other officers or directors of the company? He just all by
himself, sitting in the CFO suite, and said, here's an idea, we
can start doing this now. And ironically it appears to match
very close to what earnings targets were for the company based
upon guidances that were given both by the company itself in
its discussions it would have with analysts as well as what the
analysts, including Mr. Grubman and others who followed the
company.
Now, perhaps it's all a coincidence, and perhaps he one
weekend came up with this idea, but how is it that no one else
knew? And were there ever any discussions within the board on
the questions--on the question of meeting those targets? Was
there pressure from the board on meeting earnings targets?
Mr. Sidgmore. See, that to me is one of the strange things.
The motivation really isn't there. Scott didn't sell any stock.
And we do review at board meetings the projections and the
quarterly targets and where we are year to date and all those
things, just like all boards do. But the thing that is--first
of all, we didn't make our targets for a couple of quarters
last year, so you think if we are going to go through all
that--
Mr. Bentsen. And your stock was in a dramatic decline.
Mr. Sidgmore. If you could hear me for 1 minute here, which
is very difficult for people to understand, but if you look at
line cost as a percentage of revenue, which is what we review
at every board meeting, we review line costs as a percentage of
revenue, we review people costs as a percentage of revenue,
those ratios were very strikingly similar to our historical
pattern, and they were right according to plan. And there was
nothing to make us believe that there was a problem there. What
we didn't know was--and the capital expense was going up
exactly according to plan. But what we didn't know was the
capital expense was going up, but we weren't actually buying
anything. We were using it to cover the operating expenses.
Mr. Bentsen. Again while he did not sell any stock, many of
you all still held stock, and the stock had dropped
dramatically in value, so there was an incentive in some period
of time to see the stock recover.
Let me ask this: On the meeting on June 24--you were at
that meeting, both of you were at that meeting, I believe--what
did Andersen say? Did you ask Andersen, why did you not catch
this, and what did your current auditor, KPMG, say? Is it
something they felt they would have caught?
We heard from Mr. Dick today, and he said he--they blessed
the documents that they were given by the--
Mr. Sidgmore. That's bothersome. But the question before
about having--
Mr. Bentsen. Bothersome is an understatement.
Mr. Sidgmore. One-fourth or one-third of the transactions
were bad. Well, it wasn't actually the one-third of the
transactions were bad, it was one-third of the amount was bad.
The whole thing was done with a small number of transactions, I
mean, four, five transactions out of tens of thousands. So, you
know, it would be more difficult to find than you might think.
Still in all, our view, with an audit you should be able to
catch something that large.
Mr. Bentsen. You said one thing, I think, is very important
on the question of attesting--of the CEO and CFO attesting to
the veracity of the financials of a company, something that's
been debated in this committee and will be debated later on.
But I think it's very interesting and telling that you tie that
to the need for more aggressive auditing, and basically it's
the cause and effect that once you put somebody's backside on
the line, then they are going to want a lot more questions than
have been asked.
It has been reported that the corporate board rules, the
governance rules, while there is a chairman, Mr. Roberts is the
chairman, that the real power under the rules vest in the CEO.
Has that rule been changed, or do you still have that sort of
introverted or contorted board, because it strikes me that this
board was never set up as--to have truly independent directors
minding the store.
Mr. Sidgmore. We have changed it to this extent. We haven't
officially changed it, but maybe we should look at that. Under
Bernie's reign, the president and the CEO, first of all, was--
according to the charter, ran the board meetings. So in a more
traditional company the chairman of the board sets the agenda
and runs the board meetings. And when Bert and I first talked
about this when I came in, we agreed quickly he'll run the
board meetings and do all the things that a chairman of the
board is supposed to do, and I'll run the company. And I am--
actually haven't thought about changing the official rule, but
we might.
The Chairman. The gentleman's time has expired.
The gentleman from Connecticut Mr. Shays.
Mr. Shays. Thank you, Mr. Chairman.
One of the most boring books I have ever read, but one of
the more interesting in one way, was a book--it was like the
500 men and women who control America. It was about the boards
of directors who were CEOs in other companies, and then they
worked for some nonprofit organization, and they were all
intertwined. And as the CEO salaries just ballooned, I began to
think of this: You scratch my back, I'll scratch yours. And
when I was about to leave and I heard the question about this
$400 plus million loan, which I should have picked up in the
wonderful notes our staff provided, and both of your
responses--and your responses were if you had to do it today,
you wouldn't have done it. Why was it such a good idea, you
know, 6 months ago or a year ago?
Mr. Roberts. If I could maybe just comment on that, the
loan wasn't $400 million day 1. What specifically happened was
the stock started to drop. It was either 27 or 24, something in
that range. And Bernie Ebbers wanted to sell stock to cover his
margin calls that he was getting from, I guess, brokerage
houses. The compensation committee of the board met with Bernie
and decided that it would be harmful to shareholders to have
the CEO of the company selling large blocks of stock.
Mr. Shays. Like WorldCom, highly leveraged--he was highly
leveraged in his own personal finances. Bottom line, he was
buying marginal stock, and unfortunately WorldCom is highly
leveraged. It's a company highly leveraged. It seems to reflect
the management. But you all are the directors, and I guess what
I am trying to understand is why I should have any faith in
this economic system where I wanted to privatize Social
Security or at least a part of it and thinking, my God, it's a
crooked system right now and doesn't work right, and even the
both of you, people I thought were kind of heroes in this
hearing agree to this. I need to know why.
Mr. Roberts. It was a judgment made at the time. We all
wish now that it would have been better off for the company if
Bernie just sold stock to cover his margin calls.
Mr. Shays. What kind of leverage did he have to have? What
kind of collateral?
Mr. Sidgmore. What kind of collateral did he put up? All
his WorldCom stock. He put up--he's got farms and large pieces
of real estate.
Mr. Shays. Basically you felt you had to do it, otherwise
he was going to sell the stock, and the stock would tumble.
Mr. Sidgmore. We did get appraisals on the collateral that
proved at the time that the collateral was worth well more than
the amount of the loan.
Mr. Shays. Not now.
Mr. Sidgmore. When was the last--
Mr. Shays. The collateral isn't close to being the 400
million.
Mr. Roberts. The collateral was only put up as the stock
continued to fall and he needed to put up more.
Mr. Shays. I want to know the collateral. But let me ask
you this. There wasn't much collateral. What was the interest
rate?
Mr. Roberts. I don't believe that is quite correct. I am
not suggesting that collateral is sufficient today or not, but
what the collateral is, it's a timber farm which was appraised
at $685 million that has a $400 million lien against it. It's a
ranch in Vancouver that is appraised at 56 -, $58 million, and
it's a boatyard that has a value of 30- or $40 million dollars,
plus the stock.
Mr. Shays. What was the interest he was charged, 2 to 3
percent or higher?
Mr. Sidgmore. Between 2 and 3 percent.
Mr. Shays. It's a pretty low interest rate, isn't it?
Mr. Sidgmore. It was our incremental cost of capital at the
time the loan went out.
Mr. Shays. Tell me a good decision the board of directors
made in any of the last 3 years. I am not trying to be funny,
but tell me something positive so I can feel better about some
part of my economic capitalist system which I have grown up to
revere.
Mr. Roberts. I mean, I think you have to look at the
company and decide. The company obviously had a substantial
capital improvement during the first part of that time before
the telecom industry started to move down. Depending on how far
you go back, there was within that time period, 1998, when
WorldCom acquired MCI, which from a WorldCom investor point of
view turned out to be a good decision. And I think if you look
at it from a company point of view, we have offered tremendous
services to customers, government and been a large employer
base.
Mr. Shays. I am one of your customers, and I do like your
service.
The Chairman. Gentleman's time from Connecticut has
expired.
The gentleman from California.
Mr. Sherman. Thank you, Mr. Chairman.
I left the room earlier, and I apologize for that, but I
wanted to see the President's press conference, and I need to
report to this committee that the President showed a profound
and unfortunate misunderstanding of what the SEC does. He was
questioned about his own investment in Harken, and he stated
that the SEC makes sure that complex accounting rules are
applied correctly. And the President painted a picture, perhaps
out of his own experience, that the SEC is looking over the
shoulder of those preparing the financial statements, or of the
outside auditor, in making sure that these complex accounting
rules are applied in a reasonable manner.
While the President had that image of the SEC, we in this
House of Representatives passed a bill that said it was the
sense of Congress that at least the SEC would read the
financial statements of the thousand largest corporations, come
up with questions, post those questions on its Web site, demand
a written answer, and post those answers on its Web site. And I
wish to put in the record at this point the response of that
sense of Congress--or actually the response to the hearings of
Harvey Pitt. The Chairman stated that he didn't think it was a
good idea for his people to read any of the financial
statements, and he refused to provide this committee with even
a cost estimate as to what it would cost to do the very things
that this House of Representatives has declared ought to be
done. And now the President is 1,000 percent behind a SEC Chair
who refuses to even consider doing the work that the President
thinks is already being done.
I am not inspired by confidence, Mr. Shays. I would hope
that eventually this committee will demand that the SEC goes
through a review process and an inquiry process at least with
the thousand largest corporations.
Now, the Arthur Andersen spin, roughly 15,000 field hours
auditing WorldCom didn't find $3 billion of asset additions
that were phony because they were hidden among a total of $7
billion of assets and therefore constituted only three-sevenths
of this very significant account. You have a great internal
auditor on your staff, Ms. Cynthia Cooper, who was able to find
this just during the month of May of this year. Can you
describe how many staff she deployed to find that which Arthur
Andersen could not discover in 15,000 hours that they billed
you for?
Mr. Sidgmore. I am not positive of that answer, but I think
she's got four people, herself--in total, which probably
includes some other projects.
Mr. Sherman. She was doing a number of things with four
people, and it took her a month with her staff of four while
doing other things to discover something about the size of
Mount Rushmore which in 15,000 hours Arthur Andersen could not
discover. I am going to stop telling people I'm a CPA.
Now, you say that this was harder to find because it was
four or five transactions. I assume you mean about four or five
transactions per quarter were reclassified by Mr. Sullivan. Do
I have that right, Mr. Sidgmore, when you say four or five
transactions?
Mr. Sidgmore. The only caveat I'm going to put on that is
that was the initial take on it, and we won't know the exact
count until KPMG completes its audit from last year. But I
believe it was a handful of transactions for the whole year.
But--
Mr. Sherman. But this handful would be a handful of
mountains, a hard to miss. If it's a handful, then each one is
hundreds of millions of dollars in size. And my limited
experience in auditing is if a company engages in 100,000
transactions, you can't just look at their orders of paper
clips. You also have to look at the $100 million transactions
even if there are only a few of them. I can't imagine how you
can miss a $100 million or $400 million transaction on the
theory there are hundreds of thousands of transactions and you
looked at the others.
Can--the one other thing I want to point out, there has
been some discussion initiated by the gentleman from Texas
about corporate governance, and I should remind my colleagues
that that is a creature of State law, and many States have
competed to have the weakest corporate governance, the hardest
system in which dissident shareholders would ever replace
shareholders. And perhaps we ought to have Federal standards in
this area instead of letting States compete for revenue by
having the weakest corporate governance standards in their
corporate law.
The Chairman. Gentleman from California Mr. Royce.
Mr. Royce. Thank you, Mr. Chairman.
Well, I have a copy of WorldCom's board minutes, and I did
want to ask you about an observation here in the minutes. It
states, that Mr. Sullivan indicated that Mr. Ebbers had
proposed a 50 percent reduction in internal audit compensation
expense, but that the final decision was to limit the reduction
to 10 percent. He indicated that the preparation of the
executive report as well as the commission's audit is consuming
significant audit resources. Now, luckily at this point,
Cynthia Cooper comes forward and she states that moving the
preparation of the executive report into Ron Beaumont's
organization would allow four persons who are dedicated part
time to completion of the report to work full time on the
audit. In other words, apparently what Mr. Ebbers tried to do
here was to cut the size of the internal audit staff by two so
that this would never be discovered.
Mr. Royce. My read of this is Cynthia Cooper, the internal
auditor, stood her ground, insisted there was another way to
get the personnel to complete the work; and it is probably
because of her that it was uncovered. Am I correct in my
reading of the WorldCom minutes?
Mr. Roberts. Are those the audit committee's minutes or the
board minutes?
Mr. Royce. Yes, they are.
Mr. Roberts. I thought that happened in the audit committee
and not the full board. Yes, I think Cynthia did stand her
ground; and we commend her for finding the problem.
Mr. Royce. Well, speaking of standing one's ground,
according to the Wall Street Journal, regulators probing
accounting fraud at WorldCom are increasingly concerned that
company officials haven't fully disclosed many details of the
widening scandal. It goes to a comment by SEC Chairman Harvey
Pitt, and he has called your disclosures to date wholly
inadequate and incomplete. He goes on to say that they
demonstrate a lack of commitment to full disclosure to
investors and less than full cooperation with the Securities
and Exchange Commission. How do you respond to these
allegations, and what in the way of further disclosure do you
intend to provide in order to answer the chairman of the SEC on
these questions?
Mr. Sidgmore. Well, first of all, I think Mr. Pitt was
commenting on our submission from a week--it was over a week
ago. Since that time, I have had a fairly lengthy conversation
with him; and we have been working with his staff to produce a
new document that would be more responsive, which we filed
today.
Mr. Royce. So if we contact the SEC we can expect a
different answer?
Mr. Sidgmore. We hope so.
Mr. Royce. Let me ask you another question. Mr. Ebbers
departed WorldCom, as we have discussed today, with a $1.5
million a year pension, medical and life insurance for life.
Should he die, his wife would receive three-quarters of a
million dollars a year for the reminder of her life, should he
expire. There has also been rumors about continued use of the
corporate jet, a corporate boat, as well as ongoing use of
corporate offices and administrative assistance.
My question is, how can either of you justify such a
settlement when last week you let 17,000 employees go? My
suspicion is that you must be trying to work your way out of
that commitment right now, in terms of that $1.5 million a
year. But what is the chance of actually obtaining that $406
million right now to help your company that you have loaned or
that both of you voted to loan to Mr. Ebbers?
Mr. Roberts. Well, first of all, the seven independent
board members that met and determined that they wanted to ask
for the resignation of Bernie late April also put together that
package. So that is how that came about. It was part of the
process of asking for the resignation.
In terms of the loan, it is Bernie's intent to pay it back;
and it is certainly the company's intent to get the loan paid
back. It was disclosed in the proxy, I believe, that we have
filed in terms of the payment schedule back.
We have also been working as a company with outside
investment houses to potentially see if we can get that loan
purchased from the company.
Mr. Royce. Has he put up that property that you say was
offered as collateral for sale in order to allow the infusion
of this cash into your--
Mr. Roberts. Part of it is. He has put up the boat yard, I
know; and he has at least received one offer, which I think
that he may have rejected. But I think that he may have another
offer for that.
In the case of the big piece of property, the timberland,
he is working, as we have tried to work, with people that are
interested and understand that particular business.
The Chairman. The gentleman from Texas, Mr. Sandlin.
Mr. Sandlin. Thank you, Mr. Chairman; and thank you, Mr.
Sidgmore, Mr. Roberts, for coming today. We appreciate you
being here to testify, rather than taking the bogus position
taken by those on the last panel.
I noticed 2 weeks ago, Mr. Sidgmore, at a press conference
you said that the deeds that were uncovered were part of the
past administration, correct? And, of course, as has been
established today, during the 2 years before being named CEO
you were the chief operations officer of this same corporation.
Mr. Sidgmore. Not the 2 years before. It was 1997 and 1998.
Mr. Sandlin. So you were part of that same administration
and you attended board meetings?
Mr. Sidgmore. Yes. Ever since then.
Mr. Sandlin. You mention that people on the board have to
be able to depend on the information given by professionals
such as accountants; is that correct?
Mr. Sidgmore. Correct.
Mr. Sandlin. But people also on the board, officers in
particular, have a fiduciary duty to the corporation; is that
correct?
Mr. Sidgmore. Correct.
Mr. Sandlin. It is the obligation of the officer and the
obligation of the board member to ask questions of the
advisors; is that correct?
Mr. Sidgmore. Correct.
Mr. Sandlin. And inaction by a board member or inaction by
an officer is not an excuse, is it?
Mr. Sidgmore. No.
Mr. Sandlin. It is more of an indictment, isn't it?
Mr. Sidgmore. It could be.
Mr. Sandlin. Now, you said earlier that WorldCom has
decent, hard-working employees; is that correct? And you said
that your corporation was fighting for its life.
Mr. Sidgmore. Correct.
Mr. Sandlin. I want to go over a brief summary of what we
are doing to fight for this company. Mr. Ebbers, although he
refused to testify and is in contempt of this Congress, he
dumped $35 million in stock. He got a contract for $1.5 million
for life, $430,000 loan, perks of riding around on an airplane.
We find out you sold $87 million. Mr. Roberts had $22
million of stock. Your corporation leased an airplane, an extra
jet to a board member for $1 a year, which is clearly a
violation of fiduciary duty; and I find it very unusual that
they are able to find that jet, but they can't find $3.8
billion in the accounting.
You employed crooked accounting procedures. You drove down
the price to 6 cents per share. So really, instead of fighting
for the life of the company, you are more or less fighting for
the lifestyle of these executives. Isn't that more accurate to
say?
Mr. Sidgmore. No, I don't think so at all.
Mr. Sandlin. Does Mr. Roberts have that same contract
agreement that Mr. Ebbers has?
Mr. Sidgmore. No, he does not.
Mr. Sandlin. You don't have the $1.5 million for life, Mr.
Roberts?
Mr. Roberts. No, I don't.
Mr. Sandlin. Have you ever had that?
Mr. Roberts. No, I did not.
Mr. Sandlin. What is your lifetime contract?
Mr. Roberts. I have no lifetime contract. Basically, what I
have is a retirement from the MCI Company. We froze the
retirement program when the companies merged. But my retirement
was based on an executive retirement.
Mr. Sandlin. It looks like everyone from the summary--
everyone at the top is getting millions of dollars, but we are
firing 17,000 employees, and we are pushing the stock down to 6
cents. That doesn't look like we are fighting for the life of
the corporation.
Let me ask one final thing. You said, Mr. Sidgmore, that
you had an agreement or contract now for a million dollar
salary, which doesn't appear to be out of line. But you also
said that there--you have a compensation package that you
elected--you and Mr. Roberts elected not to take at this time.
I am concerned about "at this time." I am concerned about--if
you can tell us what the terms of that compensation are.
Mr. Sidgmore. Well, we have never implemented it, so it is
not valid.
Mr. Sandlin. What were the terms of that contract?
Mr. Sidgmore. It was an annual bonus that would range in
size from a million dollars to $10 million, depending on the
performance of the company. There was also potentially a
retention bonus for myself and three of the other senior
executives.
Mr. Sandlin. How much would that retention bonus be?
Mr. Sidgmore. It would have been $7.5 million for 4 years.
Mr. Sandlin. Each year or the whole time?
Mr. Sidgmore. The whole time.
Mr. Sandlin. Are you saying now that you don't intend to
implement that at any time in the future?
Mr. Sidgmore. I didn't say that. Not at this time.
Mr. Sandlin. So it is okay to lay off the 17,000 employees
and drive the price down to 6 cents, it is okay for your former
chief executive officer to have a timber farm worth $658
million and a ranch worth $58 million, but you can't tell us
whether or not you are going to give up that package?
Mr. Sidgmore. I didn't say it was okay that we fired 17,000
people. I don't think it is okay. It is a terrible shame. I
don't blame it on the fact that the compensation packages
exist. The fact of the matter is, the telecommunications
industry is in disaster mode and there are many other companies
like ours that are out of business while we are still in
business.
Mr. Sandlin. That is a charming story, and we have gone
over some of those today like Enron and others that did similar
crooked accounting practices.
Thank you. I have no more questions. Yield back.
The Chairman. The gentlelady from Illinois, Mrs. Biggert.
Mrs. Biggert. Thank you, Mr. Chairman.
Mr. Sidgmore and Mr. Roberts, I have a published report
here that was issued May 20th, 2002, of the Telecom Manager's
Voice Report in which the publisher reports that internal
WorldCom documents indicate that the company may have
overbilled its customers by somewhere between $1.8 billion and
$3.5 billion; and our committee has also received documents of
individual overbilling of corporate clients. I also have
received a letter from the SEC which was written to WorldCom on
March 7th with a comprehensive request for information on
numerous accounting issues including billing policies. So I
would ask unanimous consent that these documents be entered
into the record, as appropriate.
The Chairman. Without objection.
[The following information can be found on page 217 in the
appendix.]
Mrs. Biggert. Okay. Can both of you gentlemen assure this
committee and your millions of customers that WorldCom is
committed to ensuring that these issues will be resolved to the
SEC's and the customers' satisfaction?
Mr. Sidgmore. Well, we are certainly working with the SEC
on all of these issues. We have complied with every request and
every piece of investigative work that they have asked us to
perform, and we are a hundred percent committed to working with
them and all government agencies whenever these issues come up.
Telephone companies often face these issues multiple times
a year. We investigate all of them.
Mrs. Biggert. But you will assure this committee?
Mr. Sidgmore. Yes.
Mrs. Biggert. And you, Mr. Roberts?
Mr. Roberts. I agree with exactly what John said. We will
get to the bottom of it.
Mrs. Biggert. Then, Mr. Sidgmore, you stated to WorldCom
customers and employees that the company remains viable and
committed to a long-term future. As Mr. Royce mentioned, last
week 17,000 WorldCom employees were dismissed, or at least in
the last week.
Secondly, how can you guarantee that your customers will
continue to be provided with services when there is a threat
and talk of a WorldCom bankruptcy and that is being suggested
daily?
Mr. Sidgmore. Well, let me just make this point, but I want
to make it carefully.
First of all, the 17,000 employees, those weren't all
employees that were fired. We took 17,000 head count off of our
payroll one way or the other. About 5,000 of those were not
WorldCom employees but were contractors that we were paying by
the hour or by the day, whatever. Another 4 or 5,000 were
employees of a business that we are selling, and so
theoretically the employees may go and find jobs with the new
company. About 8,000 I believe--maybe it was--and we have got
some attrition also. But 8,000 real employees are coming off
the payroll. Maybe they won't all be eliminated, but that is
the rough scale there.
The reason why we were pretty confident that we would be
able to provide ongoing service and steady service to our
customers and to be able to employ most of our employees is
because under any financing scenario, even a chapter event, a
Chapter 11 event of some sort, we believe that the company can
survive and make it through it.
Mrs. Biggert. If that were to happen and Chapter 11 would
become a reality, how would WorldCom go about protecting
investors and employees? And what about the average
shareholders? What would happen to them?
Mr. Sidgmore. Well, under that scenario the average
shareholder would get hurt badly. Okay. Employees would come
out on the other side with new stock options.
And one other thing I wanted to mention, because it has
been raised in a couple of forums, that is about our 401(k)
plan. People have asked whether this was like some of those
other situations where everyone loses everything because
everything is in stock.
Well, today only 4 percent of the 401(k) plan is in company
stock, but that is because the price is so low. But if you took
from end of the 1999 through May of this year, the average
was--would range from 20 percent to 50 percent. So most of the
employees' 401(k) plans are not in company stock but actually
in cash, and we have never forced anyone to take stock. We have
always paid them cash.
Mrs. Biggert. Thank you. Thank you both for being here.
I yield back.
The Chairman. The gentleman from Washington state, Mr.
Inslee.
Mr. Inslee. I yield to the next in line. They have been
waiting longer than I.
The Chairman. The gentleman from Kansas, Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman; and thank you,
gentlemen, for being here today.
How much is Cynthia Cooper making?
Mr. Sidgmore. How much money?
Mr. Moore. Yes.
Mr. Sidgmore. I have no idea.
Mr. Moore. Can you guess? She is not making a million
dollars a year, is she?
Mr. Sidgmore. No, 140, 150.
Mr. Roberts. She is a vice president.
Mr. Moore. She probably should be in line and get a bonus,
don't you think?
Mr. Sidgmore. She gets a bonus. She will get a bonus in
addition to that every year.
Mr. Moore. Maybe another bonus, too, as a result of what
happened here?
Mr. Sidgmore. She has done a good job.
Mr. Moore. You know, there are three television cameras
here and people out there in the country--it is a big country--
are watching what is happening here; and I can't even imagine
what I think I know, because I talked to my folks, my
constituents at home last week. People are very, very angry;
and they don't get it.
September 11, our country was hit. Three thousand people
died in a terrorist incident in New York and Washington. And
then when we think things are starting to get better and we are
getting beyond this, all of a sudden we have Enron, Global
Crossing, WorldCom, Merck, and on and on and on. People are
wondering, what is happening in our country? It just seems
greed is just taking over.
I know it is--we can't get so despondent I guess that we
think this is happening in every country--I hope to God it is
not--but I think we have got more of these coming, too; and I
am worried what is going to happen and what is going to come
out in the next several months.
I think people must think this whole situation is surreal.
They watch this hearing--and I am not talking about you. I am
talking mostly about the previous panel, but a little bit here,
too. These are people that work for a living. They are making
30, 50, 75, or $150,000 a year. And they are seeing somebody
who is borrowing $400 million when he is leaving the company,
they are seeing somebody who is getting a million and a half
dollars a year for the rest of his life after he is leaving the
company and corporate use of a corporate jet, and his wife gets
$750,000 for the rest of her life, and a 2 or 3 percent loan,
this $400 million.
And they see you selling stock, Mr. Sidgmore, $87 million.
And you earned it. You have a right to that. But, I mean,
people just don't talk in these numbers. I know a handful of
people that have money like that.
And, Mr. Roberts, you are earning a million dollars a year.
I am not begrudging you that at all. And you sold stock for $22
million.
But all I am saying is these people out here wonder, what
is going on? You know, they don't have anything like this. They
certainly maybe have $400,000 in a retirement account, but they
don't have it in their kid's college fund.
I guess my question to you gentlemen is--I am not pointing
fingers here because I really appreciate--the first thing both
of you did was to apologize and be contrite. Didn't see much of
that in the last panel. I really appreciate what you have said
and what you have done. I think you are trying to turn things
around.
But I am saying people need to understand and believe that
you are going to do something to try to save these jobs in this
company for the people who work for your company and not just
thinking about the people on the board of directors and the
corporate executives.
What can we do? You named one thing I think. But what else
happens? Should CFOs and CEOs be given sworn statements about
their belief about what the value of a company is and that
the--the things--that these statements are correct, the
financial statements, and the other reports are correct?
I see here that the Business Roundtable in this morning's
Wall Street Journal said, enough is enough. When even one CEO
betrays investors, this is one too many. I mean, when the
Business Roundtable starts saying that something is wrong, they
don't take that lightly.
The same thing that Judy Biggert I think referred to. I
have a March 7 statement from the SEC talking about information
on goodwill accounting policies and saying that WorldCom
announced on March 7th it estimated it would take a 15 to $20
billion write-down, 15 to $20 billion write-down of its
goodwill account at the end of the second quarter. Is there
more coming out here?
What is happening here? I don't get it. Can you tell me
what we here in Congress can or should do to make sure we don't
have more of these in the future?
Mr. Sidgmore. Well, let me answer for WorldCom for a
moment. I agree with almost everything you said, so we are not
trying to be argumentative. But what we have done in the last
couple of months, we fired the CEO, we have a new CEO. We will
have a new CFO. We fired the CFO. We fired our auditors and
hired new ones. We hired Bill McLucas to go do an independent
investigation.
So we are taking the steps that--the only steps we know how
to do, how to take in order to get to the bottom of this. So
that is priority one.
Right now, my priority personally and Bert's is to get this
company back on a normal business footing.
Mr. Moore. Let me stop you one minute. Can you just give me
an answer, either one or both of you, very quickly, but
everybody else on this committee would like to hear this, too.
What can we do? What should we do beyond WorldCom? Move beyond
WorldCom and look to the future to make sure in this country we
get this problem under control and this doesn't happen any
more.
Mr. Sidgmore. Well, my answer would be more controls. I
think every company should have to have a second auditor to
audit the first auditor and have them both sign off. I think
separating research and investment banking like we talked this
morning. I think a lot of these ideas that were brought up this
afternoon are the right thoughts.
The Chairman. The gentleman from Pennsylvania, Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman; and thank you,
gentlemen, for being with us today.
My first question goes back to the meeting that you
described in which Mr. Sullivan presented his white paper and
which I envision, as you have described it, to have been a
counterproposal or debate almost over the appropriate treatment
of these accounts.
On the one hand, the professional auditors were arguing the
way that they believed it ought to be done. Mr. Sullivan
defended his approach.
A couple of questions. First of all, you were both present
at that meeting; am I correct?
Mr. Roberts. I was by way of telephone.
Mr. Toomey. Did either of you find Mr. Sullivan's
presentation particularly persuasive?
Mr. Sidgmore. On the 24th now?
Mr. Toomey. Correct.
Mr. Sidgmore. No.
Mr. Toomey. From all press accounts this is a relatively
simple transaction. I am not a CPA. I am reasonably familiar
with financial statements. It seems pretty clear to me what
should have been done versus what was done. You understand
these things far better than I do. Is it pretty obvious to you
that he intentionally misallocated these accounts?
Mr. Sidgmore. You know, I don't want to say that, because I
will go back to what you asked before. When we had the same
meeting on the 20th, this is before we had gone through the
white paper exercise, Scott basically presented the same case.
It sounded more reasonable to me then because I didn't know the
accounting rules associated with operating lease
capitalization. So I wouldn't want to say exactly what the
motivations were and everything. But I can tell you that there
was no doubt in my mind when we were done with that 24th
meeting that the senior accounting team had to go and that
there was no way we could support the accounting.
Mr. Toomey. Mr. Roberts, is it your opinion that Mr.
Sullivan might very well have sincerely and genuinely believed
that he was correct and the rest of the world was just all
wrong on how this was to be accounted for?
Mr. Roberts. It is not my contention, but I believe it is
what he was trying to say during that board meeting and when we
talked to him on the 20th. I agree with what John has said,
though. After you get into the detail one level it is difficult
to see how that accounting treatment could have been made. It
is more difficult to see how Arthur Andersen would not have
picked it up, advised the audit committee, advised the board.
Mr. Toomey. It is difficult for me to see how someone can
avoid being punished for this kind of thing, because it strikes
me as a pretty clear case of fraud. I know you gentlemen don't
seem comfortable stating that, but it seems to be the case.
You both have stated, if you allow me to paraphrase, that
the board of directors is essentially at the mercy of the CFO
in terms of relying on--in combination with the outside
auditors--in relying on numbers. Do either of you believe that
that ought to be the case for CEOs as well, or do you believe
that the CEO needs to take responsibility for the financial
statements that are being generated, despite the fact that they
are being prepared by a CFO?
Mr. Roberts. Let me answer then. Two things.
First of all, many U.S. Corporations, the chairman is the
CEO of the company. So you have got one person.
Secondly, if the committee will go back and look at some of
the information that was filed and had I been CEO of the
company as I was with MCI and had I sat down with the auditors,
had I seen the presentation that they would have given in the--
you know, in the February time frame as we closed our books, I
would have had nothing to base an answer on that there was
something wrong.
You have to depend on your CFO, the veracity of the CFO,
and his accounting knowledge; and, more important, you have to
depend on your external auditors as they report to the audit
committee.
Mr. Toomey. So I am taking that to say that you believe
that the CEO is also at the mercy of the CFO for this kind of
financial information, even on this order of magnitude.
Mr. Roberts. And at the mercy of the external auditor that
is the check and balance of what should happen.
Now we fortunately had the check and balance of the
internal auditors that found this.
Mr. Toomey. Does not a CEO also have responsibility for
setting up internal procedures that would make it extremely
difficult if not impossible for someone to get away with this
sort of thing? I don't know if you have yet come to the
conclusion about how many people were involved in falsifying
these accounts, but it strikes me as unlikely that it could
have been just an individual. But, however many it was, it was
not identified by your internal procedures for five quarters.
Mr. Roberts. Right.
Mr. Toomey. Isn't a CEO ultimately responsible for setting
up a system that prevents this sort of thing from happening?
Mr. Sidgmore. I believe he or she is. I do think that
things can change in that regard. I do think, for example,
having a separation between the chairman and the CEO is a good
thing, generally speaking. I think having an internal audit
team with real teeth is a good thing, generally speaking.
Having an audit committee on the board that has real expertise
on it is a really good thing.
And we didn't mention this before, but WorldCom is out
right now. We are trying to recruit some new board members. So
we are going to wind up here shortly we think with a new team
entirely--
I just want to say one more thing about Cynthia Cooper.
This was raised before. She has a larger team than I thought
doing other process work, billing process and operations. She
actually has 24 people in total. So if I can just correct the
record.
The Chairman. The gentlelady from Ohio.
Mrs. Jones of Ohio. Mr. Roberts, Mr. Sidgmore, do both of
you have counsel, sir, in your individual capacity as well as
in your capacity as a representative of WorldCom?
Mr. Sidgmore. No. I mean, we don't have individual counsels
here today. We hired counsel to talk us through some of the
process and procedure here.
Mrs. Jones of Ohio. You don't have them here today? The
question is, do you have private counsel as well as counsel
that represents you in your capacity as a representative or
member of the board of WorldCom?
Mr. Sidgmore. We have counsel that represents the board and
the directors; and, you know, we have lots of internal counsel.
Mrs. Jones of Ohio. Do you have private counsel, sir?
Mr. Sidgmore. No.
Mrs. Jones of Ohio. Mr. Roberts?
Mr. Roberts. No.
Mrs. Jones of Ohio. Now, you both have come here, it has
been salutary that you are here, to converse with us about all
that went on. I am going to have to presume that you believe
through your counsel or through the counsel of WorldCom that
neither of you have any individual exposure for the conduct of
these two other people or three other people at WorldCom, and
that is why you are so free to testify before this committee
today. Is that a fact, sir, Mr. Sidgmore?
Mr. Sidgmore. Well, I guess I don't think I need counsel,
because I really don't think I did anything wrong.
Mrs. Jones of Ohio. Mr. Roberts.
Mr. Roberts. I don't think I need counsel, because I don't
think I did anything wrong.
Mrs. Jones of Ohio. I am a former judge and prosecutor, and
lots of people used to tell me that in my 20 years on the bench
and as prosecutor they didn't think they did anything wrong.
But I am presuming you wouldn't be sitting here telling us all
of this if you felt that you had some personal exposure. Is
that that a fair statement, sir?
Mr. Sidgmore. It is.
Mr. Roberts. It is.
Mrs. Jones of Ohio. Have either of you been granted
transactional or testimonial immunity for helping or assisting
the SEC or the Department of Justice in offering the
information that you have been offering?
Mr. Sidgmore. No. Where do you get that?
Mrs. Jones of Ohio. I am merely asking a question, sir.
Mr. Sidgmore. No, absolutely not.
Mrs. Jones of Ohio. Now, you said there were seven
independent board members who made a decision to give Bernie
this great package for him to retire. Can you tell me who they
were, either of you?
Mr. Roberts. Well, the seven independent board members are
Judy Areen, Max Bobbitt, Styles Kellett, Francesco Galesi, Jim
Allen, and Gordon Macklin. Do I have that right? Who am I
missing? Carl Aycock. That is seven.
Mrs. Jones of Ohio. From your conversations or your
responses today, you are sitting here like Bernie is a great
guy and Sullivan is a great guy. He was just managing or
mismanaging or massaging the records of the company.
But the people sitting listening across this country and
across the world don't think of them as such great guys. Are
you saying if--you even said that, well, Bernie is going to pay
us this money back. We believe that he has the intent to pay us
back. You still hold him in this high esteem after all that has
been presented here or that is being found out about your
company, sir, Mr. Roberts?
Mr. Roberts. Well, I mean, I don't think I said that.
First of all--
Mrs. Jones of Ohio. I wrote down that Bernie has an intent
to pay us back and we have an intent to get it back from him
and he has put up these farms. You did say that, didn't you?
Mr. Roberts. I did say that.
Mrs. Jones of Ohio. So maybe it is not high esteem. How do
you hold him then?
Mr. Roberts. He feels an obligation to pay back the loan. I
think that we have an obligation as a company to get the loan
paid back.
Mrs. Jones of Ohio. He feels an obligation in light of the
fact--what did you give him to leave? You gave him some amount
of money to leave WorldCom, to put him out the door; and you
say he has an obligation to pay it back.
Mr. Roberts. No, that is not quite what I said.
Mrs. Jones of Ohio. Tell me what you said then, sir.
Mr. Roberts. The $400 million loan that he has, he has an
obligation both legal and I think a personal commitment to pay
back.
Mrs. Jones of Ohio. And this man who put your company in
the position it is, right now, today, you believe that he is
going to stand by that personal obligation?
Mr. Roberts. I don't know that he put the company in the
position it is today, because I don't know that he has said or
admitted that he had a part to the accounting problems that we
have. But I do believe, irrespective of that, he does have an
obligation.
Mrs. Jones of Ohio. He did have oversight over Mr.
Sullivan, sir?
Mr. Roberts. Mr. Sullivan reported to him, yes.
Mrs. Jones of Ohio. Let me turn to you, Mr. Sidgmore. Do
you still hold Mr. Ebbers in high esteem and believe that he
has an intent to pay this company back and is personally
planning to do it so he can stand up to his personal
reputation?
Mr. Sidgmore. No. He has got a legal obligation to pay it
back, and we will go after him if he doesn't.
Mrs. Jones of Ohio. You did call him Bernie like you are
old buddies still?
Mr. Sidgmore. We are not old buddies at all. You know, I
liked Bernie when I joined the company. We have had some famous
fights over the years. But I like Bernie. But everybody calls
him Bernie. Nobody calls him Ebbers. He has been on the job for
20 years. He is known by his first name everywhere. It is just
a habit. But we are not trying to make him a hero. We don't
know of anything to accuse him of right now, and we are
planning on getting our money back.
The Chairman. The gentleman from Arizona.
Mr. Shadegg. I thank both gentlemen for being here today
and for your testimony. I appreciate your candor with this
committee, and I wish you the best in rebuilding this company.
I think that is in the best interest of the country. I hope you
are successful in that effort.
I want to ask a couple of questions that are technical, and
than to I want to follow up on some comments by Mr. Moore
earlier in the evening regarding the perception of this hearing
out across America.
First of all, our records indicate in October of 2000,
specifically October 5th, Mr. Ebbers sold I believe it is 3
million shares of stock for $84 million. Then in February of
2002, he was issued this roughly $400 million loan which is
secured, which you believe you are going to get repaid. Can you
explain to me why it was not perceived as a problem for Mr.
Ebbers to sell $3 million worth of shares in October of 2000
but perceived as a problem for that to occur in February?
Because I believe what you said was--and Mr. Roberts you
were the one that made this testimony--you thought it was a
problem for him to sell the stock in February, and that is why
the company made the loan to him; is that correct?
Mr. Roberts. Yes, that is what I said.
Mr. Shadegg. What changed between those two times?
Mr. Roberts. I don't know about that previous sale. I am
not saying it is not correct. It might have been exercise of
stock options or something that wasn't a direct sale of the
actual holdings. I would have to go back and research that. We
will get back to you.
Mr. Shadegg. I would appreciate it, because our records
show he sold 3 million shares for $84 million on October 5,
2000. Go ahead.
Mr. Roberts. But what I was going to add is that it was a
compensation committee that interacted with Bernie Ebbers and
came to the conclusion that he should not sell, perhaps, more
shares or these shares in that it would be bad for the CEO to
have--to be looked at as though he was selling shares in the
marketplace and therefore perhaps not confident in the company.
The board did ratify that decision, but it was the
compensation committee that met with him and came to the board
for the ratification.
Mr. Sidgmore. The October sale that he made was apparently
his first margin call. So he actually had a margin call and
then sold the stock to cover it.
Mr. Shadegg. Second, Arthur Andersen apparently filed a
report in February, specifically February 6, 2002, to the
WorldCom audit committee indicating that it had internal
control processes in place for preventing a material
misstatement due to line cost allocations and the
capitalization of assets and that those controls were
effective. Obviously, that was incorrect. I guess my question
is, did anybody challenge that?
And, second of all, specifically what have you done to
ensure that that type of mistake--how that mistake happened and
to make sure that it doesn't happen again?
Mr. Sidgmore. Well, the audit committee and the internal
audit department are looking at that right now. They are going
to build a new process that is much more robust in terms of not
only that piece of the accounting process but also the entire
audit process.
How Andersen could react that way in the February 6th
meeting honestly is just beyond us. We really have no
explanation for it, and they have no explanation for it today.
Mr. Shadegg. Are you contemplating pursuing them for that
error, for that malpractice or that malfeasance?
Mr. Sidgmore. I don't want to get into that here, if you
don't mind.
Mr. Shadegg. Your other answer is a perfect segue for where
I want to go. You are now doing what you can to restructure
WorldCom and to try to put in place mechanisms to prevent these
things from happening in the future and to rebuild the company.
We are required to do the same. I think my colleague from
Kansas, Mr. Moore, made an impassioned statement saying the
perception of what is going on in corporate America across
America is pretty severe. We have got a serious problem here.
As Mr. Shays, my colleague, pointed out, many of us raised
to believe very, very deeply in the free market system are now
having that faith totally shaken. One member of this Congress,
indeed a member of this committee, believes we should have the
government go in and audit every corporation in America. I have
no faith in the government to do that.
But as another one of my colleagues on the other side said
earlier tonight, I view these hearings as a chance to look
forward in a positive fashion. We have got to do something to
rebuild American confidence in this market and to put in place
some controls to ensure that doesn't happen again.
You have at least one suggestion that has been made, Mr.
Sidgmore, was that the auditor should have an auditor. There
should be a second auditor required to audit the first auditor
so that they complete against each other and maybe is a good
one that this committee should look at.
It seems to me--and I don't want to get petty about this in
terms of retirement packages--but you look at the Enron
executives that walked away with a fair amount of money, you
look at the executives here that are walking away with a fair
amount of money, maybe there should be a statutorily mandated
requirement that if there is any evidence of fraud or any
evidence of significant negligence, the compensation package,
the golden parachute that they walk away with is negated and we
can get back to all of that money.
The Chairman. The gentleman's time has expired.
Mr. Shadegg. I guess I would like to conclude by asking, do
you have, again, anything you can suggest to this committee as
to what we can do to try to rebuild the confidence of the
American people in this marketplace?
Mr. Sidgmore. Well, I already made a couple of suggestions.
But in terms of having the government audit every company in
America, I mean, I don't know if there are enough people in
America to do that. I mean, that would be a tough challenge.
But I would say that--
Mr. Shadegg. You would have to believe that the government
can do it better than the private sector.
Mr. Sidgmore. However, there could be some controls put in
place and maybe monitored by the SEC; and we would probably
require some more people there as well.
The Chairman. The gentleman from Washington State, Mr.
Inslee.
Mr. Inslee. Thank you, Mr. Chairman.
Would you explain to us and the American people why the
WorldCom Corporation is paying its former CEO under whose watch
almost $4 billion of chicanery went on, as a lifetime pension
apparently, instead of taking that million and a half dollars
and putting it into a fund for the thousands of people who lost
a good part of their life savings as a result of this
chicanery? Why isn't your corporation using that million and a
half dollars a year for the people who have been injured, who
have no ability to find that chicanery, instead giving it to
the CEO who is no longer working with you under whose watch
this took place?
Mr. Sidgmore. Well, I would say it is not voluntary. We are
under a contractual obligation right now. And, yes, I would
admit that there have been some suggestions that maybe, you
know, that can be rescinded now, given what happened. But, see,
we have no basis for trying to prove or--or even accuse Mr.
Ebbers of doing anything wrong. Until that would occur--
Mr. Inslee. Well, how about running a ship where $4 billion
in a corporate culture was allowed to exist, that was put into
an alleged capital account, when clearly it was an expenditure
by--every single human being on the face of the earth agrees to
that--and taking personal responsibility for it? What happened
with a little bit of accountability here?
People used to go down with their ship. Now they go to
Bermuda on a million and a half dollar yacht. Why doesn't
WorldCom take a position that there has got to be some personal
accountability here? Why don't you take that position?
Mr. Sidgmore. We have taken that position about personal
accountability. All I am saying is, in this particular case, we
have no way easily to get out of that contract. We are
contractually--
Mr. Inslee. Have you asked Mr. Ebbers to show a little
accountability in that regard? Have you suggested it to him?
Mr. Sidgmore. I have not spoken to Mr. Ebbers in any
substantive way since I left.
Mr. Inslee. Let me ask you a little different
accountability. In this country, if you sell 50 grams of crack,
you go to jail for 10 years--no ifs, ands or buts. It is a
mandatory minimum sentence in a Federal penitentiary.
If Mr. Sullivan is held criminally responsible for
intentionally defrauding investors due to his what I believe
clear chicanery, do you think that he ought to serve 10 years
minimum in a Federal penitentiary like a crack dealer selling
50 grams, considering the devastation that this has caused in
America?
Mr. Roberts. I don't think--first of all, he hasn't been
proven guilty of anything. I think it would be unfair for--
Mr. Inslee. Let me make sure you understand my question. I
am not asking you to say that he is guilty of anything at all.
But if he is found guilty of this, if he is found guilty of
intentionally defrauding American investors in this regard, do
you think that is a sanction that ought to be imposed?
Mr. Roberts. I have no--nothing to base on what would be a
proper guideline versus other white collar crimes on this. But
I don't think there is anything worse than people perpetuating
drugs on society.
Mr. Inslee. Mr. Sidgmore, do you think he ought to spend 10
years?
Mr. Sidgmore. I don't know about 10 years. I don't have
experience to argue about how many years are appropriate. But I
will say this. Our position as a company, I think personally,
is that, you know, we want the people that did this harm to the
company and to--
Mr. Inslee. Well, we would like to give you an opportunity
to make sure that that happens.
Let me ask you a question about your corporation's position
right now on several issues.
The Democratic position on this is that we proposed having
a truly independent public accountancy board. The Republicans
failed to join us.
We on the Democratic side proposed strong and certain CEO
certification of financial records. The Republicans refused to
join us.
We proposed on our side of the aisle that there be a strong
firewall of compensation so that analysts would not have a
conflict of interest who allegedly were independent of
analysts. The Republicans failed to join us.
We proposed requiring audit committees to require approval
of nonauditing services. The Republicans failed to join us.
Now we hope as part of these hearings that the other party
will have an epiphany, and we hope the President sends a strong
message in that regard tomorrow night. But I would like to ask
about your corporate position. Given the devastation that has
occurred here, you have a front-line seat to what has occurred.
Do you agree the four things I just talked about, that WorldCom
supports those proposals in a strong reform effort?
Mr. Sidgmore. I think we support a strong reform effort. I
don't know enough about the specifics of each of these pieces
to comment on them. But we certainly support stronger controls.
The Chairman. The gentleman's time has expired.
Mr. Inslee. I could envoke the ``Watt rule,'' but I won't
in the interests of time.
The Chairman. I thank the gentleman for that, and I thank
him for his vote for my bill in the committee and on the floor.
The gentleman from Massachusetts, Mr. Capuano.
Mr. Capuano. I guess a few minutes ago I heard that the
entire telecom industry is in trouble because of an overbuilt
capacity, and I agree with that. But I wanted to remind you
that it was overbuilt by you. It was overbuilt by the people
who financed you. It was overbuilt by you and your competitors
who have--many of whom, unfortunately, have been here before
you, all of whom have said the same thing: We didn't do it.
I feel like I am watching a complete rerun of the Simpsons.
We didn't do it. We didn't do it. We didn't do it. Who did it?
Nobody did it. Somebody else did it.
I have got to tell you, I look at the testimony, Mr.
Sidgmore, your written testimony. You say you are fully
cooperating with the SEC. Yet even Mr. Pitt is a little bit too
far in the pocket of industry. Even he wasn't satisfied. You
have since filed a restatement. All it said basically is that
we didn't do it. You say later on that WorldCom's presence
ensures competition. Yet less than 2 years ago WorldCom tried
to kill competition by buying your largest competitor.
Competition wasn't good then, but it is good now; and therefore
we have to save you.
Mr. Roberts, you asked--at the end of your written
statement you say, with your support we will meet this
challenge. I want to make it clear. You do not have my support;
and you will not have my support until you, your board and your
industry, actually does the right thing once.
Find me an independent CEO. Find me a board of directors
who actually does anything. I have yet to meet a member of the
board of directors on any company that has come before this
committee in the last year that said, we said no. Everyone has
said, well, we really didn't do anything. We really don't know
anything, but we took stock options, and we got paid. Just what
I heard today. Why bother to have a board of directors?
By the way, if you are looking for additional people on
that board, I can name at least 650,000 of my constituents who
would like to get a million dollars a year, corporate jets,
some stock options; and each one of whom will be more honest
than the members of your board. If they do something wrong,
they might be just as contrite.
I am not a priest. Your act of contrition means nothing to
me. It is your actions that mean something to me.
If you sit here and tell me you are doing it, well, great.
Prove it to the market. If you survive, great. If you don't,
the world will go on. And the truth is, one company's survival,
other than to the employees that are involved with it, is of no
importance. What is of importance is that this is repeating.
Even today you have already been knocked off the front page by
Merck. Their misstatement is three times larger than yours.
I wonder what is going to happen tomorrow? Who is it going
to be tomorrow?
My concern is that we have a Federal Government for the
last 10 years that has completely reduced governmental
oversight. If you would tell me the auditor who--who is going
to audit the auditor who is reporting to the auditor? At some
point you have to have somebody who is not paid by you. That is
called government regulation. For the last 10 years, government
regulation has been a swear word around here. It is terrible.
What have we done? For all intents and purposes, we have
dismantled the FCC--you know that better than I have, you have
taken advantage of it--to whose benefit I don't know. My cable
rates have gone up. I am actually sick and tired of getting
your phone calls in the middle of the night telling me to
switch my phone company to you, which I won't do. I don't know
what we have done.
We have made the SEC a toothless tiger. The SEC was created
after the last round of repeated corporate greed. We have made
them a toothless tiger. We have a Vice President whose own
former company is under investigation right now for accounting
questions. We have a President who made a million dollars doing
the exact same thing that Enron did, the exact same thing. And
there is no wrongdoing. Nobody did anything wrong.
I got to tell you, it is no surprise to me that as long as
we say that somehow government oversight and government
regulation is a sin, is anti-American somehow, we are not going
to get out of this mess. Because an auditor auditing the
auditor will not change a thing unless we, your government,
hold somebody accountable and establish a system that worked
for 65 years in this country to create the greatest economy in
the history of the world. We have dismantled it in 10 years to
make you rich.
The Chairman. The gentleman's time has expired.
The gentleman from Kentucky, Mr. Lucas.
Mr. Lucas. Mr. Chairman, I have listened today with a great
deal of patience; and we have had about 8 hours of testimony, I
believe, if I am accurate. It has been a real eye-opener. I
think we have thoroughly vetted this thing. Everything that
could be said has been said.
But, you know, one of the things that concerns me is we can
do some things I think to shore up some of the problems. But I
think the big problem is that we can't legislate morality. We
can't legislate the amount of greed that is out there.
And my concern is that we as a country come together,
because I do feel like one of the greatest things that is going
to happen is that everybody, in trying to cover their
backside--the accountants, the investment analysts, the
officers of the companies, the members of the board--I think
that out of all of this gloom and doom I think there will be
some great benefit to come. Because we are going to have a--
sort of a come-to-Jesus meeting here in their own professions
to protect themselves.
So being the eternal optimist that I am, I would hope that,
with all of this ugliness that has come out, that we can right
the ship of our capital markets, because this is the foundation
of our country. So I don't really have any questions, but I do
think there is going to be some good that comes out of all of
this.
The Chairman. I appreciate the gentleman's statement and
also his patience.
The gentleman from Mississippi.
Mr. Shows. We love punishment. We have been with you here
all day. Thank you, Mr. Chairman.
I want to make a suggestion. I got you some new board
members.
Hewlett Anderson in Bassfield, Mississippi. He raised eight
kids and sent six of them to Mississippi State and graduated
from college and raised them on a cotton farm. The daddy paid
for the first one to go to school, and when he graduated he
paid for the younger one coming behind him.
J.D. Sparkman raised a family on a cotton farm. Never
cheated anybody out of anything. He has passed away so he would
do just as well or better than the analysts that we have.
Alex Ramsey, a farmer in Jeff Davies County who made good
money. Never told a lie, was a good Christian man and did the
right thing.
John McNease, my father-in-law, could squeeze the last dime
out of anything he wanted to do. Very conscientious man.
Kermit Broome started with nothing. Quit school in the 7th
Grade, has become a very successful man because he is honest,
he worked hard and he didn't lie.
Howard Barnes. He is deceased. He can work--he was a court
bailiff, but he managed to save money to end up with a hundred
thousand dollars when he died on a court bailiff salary. He
watched his money. He is deceased. He can do a lot better job
than Arthur Andersen did.
Carol Holloway, he was our Farm Bureau Director. He had to
answer to a board of directors. He did a great job.
Allie McNease, Ronnie Shivers, Pete Gates and Lewis Scene.
I believe all of these men that I have named would go down
with their ship instead of watching it and themselves profit.
It just strikes me that I have seen businessmen out here--
as long as it seems to take care of themselves, they don't
really care what happens to anybody else;and I am afraid that
is what the business--I am afraid that is what people out here
are thinking about today. Who really cares about the working
guy out there, and who really cares about the investor? People
have never, ever trusted a market before in their life, and now
we think that they are going to jump back in it.
You know, this happened in my State and within--with this
company. I hope you can right the wrong, because a lot of
people are dependent on you; and I want to do everything I can
do as a Congressman to see this company make it. If you guys
can do it, more power to you. But we just need some common
people in there with some common sense and common ethics about
trying to do the right thing.
I thank you, Mr. Chairman.
The Chairman. The gentleman from New York, Mr. Crowley.
Mr. Crowley. Thank you, Mr. Chairman.
I thank both gentlemen for your testimony today and for
being willing to come before this Congress and give testimony
and know that a number of individuals have not come forward or
refused to testify before this committee today.
Being the low man on the totem pole, as Ken Lucas has said
very clearly before, every question that probably has been or
should have been raised probably has been raised already. But I
just have a couple of questions.
Mr. Sidgmore, you'd probably forgive me, but I noticed you
mentioned before, I think the American people have a real
interest in all of this, this corporate breakdown basically;
and your laundry is being exposed to a lot of people. I think
it is important to understand, you made a point before about
you sold off about $400,000 worth of stock to invest for your
nieces and nephew. I make a point. My nephew graduated from
high school a couple of weeks ago. I gave him 50 bucks. You
know, the American people just don't really get how that can
happen--all of the power to you.
But it just shows you that a Member of Congress and the
head of a major company--you mentioned that there was a $400-
some-odd million loan to Mr. Ebbers. You call him Bernie. What
was the term of that loan? How long was it for?
Mr. Sidgmore. It is now a 5-year term.
Mr. Crowley. So it is now 5 now. You say "now." was it
originally something else?
Mr. Roberts. No, it was always 5 years.
Mr. Crowley. How is Mr. Ebbers--there is a lack of
security. It is not totally unsecured, but it is not a terribly
secured loan that you made in the first place. He is expected
to pay back $400-some-odd million over a 5-year period plus 2
and a half percent interest; is that correct?
Mr. Roberts. Right.
Mr. Crowley. How do you propose that that is going to take
place, given his assets, what he has put up in terms of his
collateral? Does it reach $400-some-odd million? Is more than
that that he has available to him?
Mr. Roberts. Again, we hope the collateral is adequate.
Obviously, the part of that collateral that was stock is no
longer certainly adequate, but if you take a look at the other
assets that were pledged, particularly the Joshua Timber Farm
and the ranch in Vancouver and the boat yard, and he has other
assets that weren't pledged that presumably could be pledged
and/or sold to pay off the loan.
He has got a legal obligation to do it. We have got a legal
obligation to collect it.
Mr. Crowley. If something should happen to him, what would
happen to that loan? Who is responsible for it then?
Mr. Roberts. It would go into his estate, and from there we
would be a creditor. If you look at the terms of payback, next
year is $25 million. I think a year after that is 25. Then it
escalates from there.
Mr. Crowley. I appreciate it. Again, for a person who
represents a district where it is difficult for some people to
secure a loan for a home mortgage, these are really just
astronomical figures that you are talking about today.
I think in the broader picture what I think this committee
has attempted to do, and I think the chairman has really has
tried to do this in the legislation that was passed, is he was
trying to bring about some kind of audit responsibility and
bring some resemblance back to the economy of this country.
I just see the Dow is down 105 points, NASDAQ is down 43,
S&P is down 12. Not major numbers, given some of the ups and
downs of recent weeks. But there is really a jitteriness out
there in the public. People are concerned about the economy.
Some have estimated between 20 and 30 percent, the real value
of the market, but people aren't willing to make that
commitment right now.
Where does this all end? I mean, today it is Merck. How
many companies out there do you think are going to bust?
Do you believe people should be going to--do you believe
some people should be going to jail? If so, who should be going
to jail because of the debacle in your company?
Mr. Sidgmore. Well, I think we tried to say this before. I
guess we weren't very articulate about it. But I think that we
believe that the bad guys should be punished severely and go to
jail, whoever the bad guys turn out to be. We are not going to
convict anyone or accuse anyone here.
Mr. Crowley. Do you think that there were bad guys in your
company?
Mr. Sidgmore. I think there is some likelihood that there
were. I don't want to say that directly. But we want the bad
guys to go to jail, and we want the rest of the company to
survive. We don't think our 65,000 employees should be punished
because of the deeds of a few bad ones.
The Chairman. The gentleman's time has expired.
The gentleman from Arkansas, Mr. Ross.
Mr. Ross. Thank you, Mr. Chairman; and thank you for being
here for this hearing today.
I come from a very poor congressional district, the
southern half of Arkansas where the average household income is
$17,000 a year. It is difficult for me and for the people in my
district to comprehend these million dollar salaries and these
80 and $90 million stock deals. Do you believe people should go
to jail as a result of what has happened?
Mr. Sidgmore. If they are convicted of fraud, I think they
should go to jail.
Mr. Ross. Do you believe that there are people within
WorldCom that should go to jail?
Mr. Sidgmore. I don't know that they will be convicted of
fraud. I don't want to speculate on whether they will be.
Mr. Sidgmore. I didn't say who is responsible.
Mr. Ross. Who is responsible then?
Mr. Sidgmore. Somebody at WorldCom is probably responsible
for this, but I don't want to get involved in accusing somebody
and convicting somebody before the evidence comes out. We are
not a court. All we can do is allow the investigation to go on
and be as open and honest as we can, and point out all issues
as we know them, and we'll let the law enforcement people take
care of it.
Mr. Ross. You may not be a court, and we may not be a court
here, but I can tell you this, I've got seniors in my district
who had WorldCom stock to help them buy their medicines, to
help buy their groceries, to help them pay their rent, help
them pay their light bill. Can you tell me what that stock was
worth in July of '01?
Mr. Sidgmore. No. Not offhand.
Mr. Ross. You have a lot of folks here with you.
Mr. Roberts. Six cents.
Mr. Ross. No. July of '01.
Mr. Ross. You can be within $10.
Mr. Sandlin. $14 dollars in 2001. Six cents now.
Mr. Ross. From $14 to 6 cents. We all agree with that
assessment? And it seems like we want to blame everyone except
ourselves. No disrespect, sir, but you keep talking about how
you weren't the CEO when all this went down, but you did work
there then, correct?
Mr. Sidgmore. I didn't work there. Specifically I was on
the board. But I am not--we are not trying to push the blame on
others. We are trying to expose exactly who was involved at
WorldCom. We have had hired investigators to help. We have
worked with the SEC and all of the judicial people to get at
the facts here. We are not trying to hide anything. We are not
trying to say that we're not at fault. We already apologized.
We want to get the bad guys out and move forward with the
company.
Mr. Ross. We've got people living from paycheck to
paycheck, and I'm talking Social Security checks, and they're
subsidizing it with things like stock from WorldCom, and it's
gone from $14 to 6 cents. And I'm sorry, but apology is not
going to be enough here. When were you the chief operating
officer at WorldCom?
Mr. Sidgmore. I was never the chief operating officer. I
was the chief operations officer in 1997 and 1998.
Mr. Ross. Let me ask you this. You were on the board,
though, when all this went down, but you don't blame yourself
for that, you want to blame others.
Mr. Sidgmore. I think what we're trying to say is the board
has a certain ability to get to the bottom of these things. And
when you have potentially a financial organization that is not
giving the straight facts, when you have an auditor and one of
the major auditors that does not hit the facts when they go
through a standard audit, when the auditor comes in and tells
us they look at the specific facts that are now being exposed,
they thought everything was right, it's tough to get to the
bottom of that.
Mr. Ross. It seems like you keep wanting to blame the
auditors. And believe me, I think there are some auditors that
ought to go to jail over this too, but I also think people at
the helm of WorldCom also ought to be going to jail. I'm a
small business owner, sir. Nothing to the magnitude that you've
got. I've got 12 employees in the little town of Prescott,
Arkansas, some 3400 people. I have an accountant. I get a
financial statement every month. I also know what my cash flow
is, based on my checkbook and my bank statement. And whether
you are a little business or a big business, it looks like, to
me, you would catch on the checkbook, if nothing else, a $3.8
billion misreporting error.
Mr. Sidgmore. The 3.8 billion has nothing to do with cash.
It was moving it from one account to the balance sheet. There
was no impact on cash whatsoever and I would just point out to
you respectfully that a company of WorldCom size that operates
in hundreds of countries that you know has $30 billion in
revenue, 66,000 or 65,000 employees, sometimes that is
difficult to catch. I am not saying we shouldn't have. We are
here today because we want to figure this out with the
government, and we want the bad guys to go to jail. The only
thing I am pushing back on is I am not here to convict anyone
of being a bad guy. That's the Government's job. We will
support it 100 percent.
The Chairman. The gentleman's time has expired.
Mr. Ross. One additional--30 seconds.
The Chairman. The gentleman is recognized for 30 seconds.
Mr. Ross. What about others out there? I've always wondered
how you could do this long distance thing for 5 cents a minute
anyway. And it seems to me there has been competition going on
to try to put the other guys out, so there would be one carrier
out there so they could raise the price. Do you think the
competition is also going to find themselves where you found
yourself. You heard of Enron and Merck. And I think the Dow
reflected it today. Are there others?
Mr. Sidgmore. I think there had been others. There had been
Global Crossing. Qwest has had problems. Level 3 has had
problems. People are out of business now, Intelligent, Winstar,
and et cetera. So a lot of telecommunications companies have
gone out of business, and others are in trouble. It is a very,
very serious situation in our industry.
The Chairman. The Chair thanks the witnesses for their
testimony. Without objection, today's hearing record will open
for 45 days for members to submit questions in writing to the
witnesses. The witnesses are reminded that any answers provided
to those questions are covered by the same oath taken at the
outset of this hearing. The witnesses--
Mr. Sandlin. Mr. Chairman, could I just inquire of the
chairman. I know that the first panel remains subject to the
subpoenas of the committee. I want to make sure that when we
were going to continue to study the issue of contempt. I want
to renew my motion for contempt and ask that a show cause order
be issued asking the former witness to appear to show cause why
he shouldn't be held in contempt and we get a resolution from
this committee, doing that upon satisfactory completion of
that, that he be held in contempt of the United States Congress
and be ordered to testify.
The Chairman. We have counsel working on that very issue
now and we will report as soon as we find out all the facts and
the law that applies.
The committee stands adjourned.
[Whereupon, at 10:10 p.m., the committee was adjourned.]
A P P E N D I X
July 8, 2002
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