WorldCom Inc. allocated about $3.2 billion in expenses to its MCI subsidiary in the year leading up to the company's accounting scandal, raising concerns among senior MCI executives about how the bookkeeping was justified, according to company documents.
The documents show that MCI executives took their concerns to WorldCom founder and chief executive Bernard J. Ebbers and then to his successor as chief executive, John W. Sidgmore, but got no explanation for the allocations.
"We have not been able to fully understand the underlying detail up to this point in time," MCI Chief Operating Officer Wayne E. Huyard told Ebbers in a Jan. 28, 2002, e-mail. "And I don't anticipate that I would find success in this area without your explicit approval and endorsement."
Huyard is now president of MCI's mass markets unit. The company would not make him available for comment. Ebbers's lawyer, David Kaufman, declined to comment.
Some MCI executives suspected that WorldCom officials were pushing expenses onto the MCI balance sheet to improve the appearance of the parent company's financial performance, sources familiar with both companies said. MCI operates as an independent subsidiary and is covered by its own tracking stock, but WorldCom executives retain the authority to allocate certain overhead and other costs to its bottom line.
Corporations have a wide degree of latitude in assigning expenses, including those attributed to a separately traded subsidiary. But sources said that an examiner appointed by the U.S. Bankruptcy Court is looking closely at expenses that were allocated to MCI by WorldCom officials in 2001. Specifically, sources said, the bankruptcy examiner and other federal investigators are trying to determine if WorldCom executives violated the terms of the prospectus for MCI's spinoff, which stated that expenses would be "allocated to WorldCom group or MCI group based upon identification of the services specifically benefiting each group."
WorldCom spokesman Brad Burns declined to comment on the substance of the internal documents, some of which were described in a Wall Street Journal story this week.
According to a copy of a presentation prepared for Ebbers on Feb. 7, 2002, Ashburn-based MCI reported general overhead costs of about $2.7 billion in 2001. WorldCom executives at the company's headquarters in Clinton, Miss., added $3.2 billion in overhead costs to the MCI division. Although MCI executives questioned the costs, they apparently were not provided with information to justify the increase, sources said.
On April 30, 2001, Ebbers was forced to step down in a controversy over WorldCom's decision to lend him $408 million to cover personal stock losses. Ebbers was replaced by Sidgmore, who had been the company's vice chairman.
Some MCI executives viewed Sidgmore's elevation to chief executive as a new opportunity to present their case about costs they believed had been improperly allocated to their division. In May 2002, they prepared a presentation for Sidgmore that included another detailed description of the allocations.
That presentation noted that WorldCom publicly reported that MCI's overhead expenses -- generally referred to as sales, general and administrative costs -- increased by $457 million in 2001. Internally, however, MCI reported it cut costs by $415 million.
"In particular, the $457 million increase in attributed SG&A delivered a $900 million 'reality gap' " in MCI's balance sheet, the presentation said.
Sidgmore said this week that he does not remember discussing the matter.
"I really honestly don't remember anything about this," Sidgmore said. "It doesn't even ring a bell."
Edward Soule, a professor of business ethics at Georgetown University, said it is common for subsidiaries to complain about expenses attributed to their bottom lines by parent companies. "That's life in corporate America," he said.
However, Soule, who is a certified public accountant, said MCI executives should have been able to get an explanation of how the costs were calculated. "To the extent they couldn't get an explanation, that's a strong indication that it was not justified," Soule said.
WorldCom officials noted yesterday that the allocations in question were made before the company revealed its accounting problems in June 2002. They also said several key executives, including Ebbers and Chief Financial Officer Scott D. Sullivan, have left the company.
Sullivan, who was responsible for allocating costs at WorldCom and MCI, has been charged with fraud for his alleged participation in a scheme to improperly account for $9 billion in capital expenses and reserve accounts from 1999 to early 2002. He has pleaded not guilty.
The company has said the total amount of improper accounting will probably be more than $9 billion. Sources said the figure may swell to $11 billion. The $3.2 billion in costs questioned by MCI executives are not included in the improper accounting already reported by the company.
At the time WorldCom was allocating billions of dollars in expenses to MCI Group, many top WorldCom executives held large amounts of WorldCom stock and far smaller amounts of MCI shares. Ebbers owned about 27 million WorldCom shares, compared with 700,000 MCI shares in April 2002. Sullivan owned 3.3 million WorldCom shares and just 223 shares of MCI.
In addition, 10 senior MCI executives were offered new WorldCom stock option rights, a practice that some corporate governance experts say can create mixed allegiance for executives.
Beth M. Young, director of special projects for the Corporate Library, a public-interest group that follows corporate governance issues, said there have been growing concerns about the potential misuse of options granted to executives who run subsidiaries represented by tracking stocks. "It can create a perverse situation where executives in one company are benefiting from decisions that actually hurt their company," Young said.
In MCI's case, WorldCom stock-option rights were offered to several executives who had questioned expenses that WorldCom had assigned to their division. Under the plan, the executives' WorldCom stock options, which had become essentially worthless because of falling share prices, would be repriced lower. In theory, the new lower price would make it easier to sell the WorldCom stock at a profit. The repriced options were not made available to other MCI employees.
Burns, the WorldCom spokesman, confirmed that the 10 executives, including Huyard, were offered the repriced options for WorldCom stock. Burns declined to comment further. "We can't speculate on the compensation decisions of past executives."
WorldCom filed for bankruptcy protection before the stock options were scheduled to be repriced, effectively rendering all WorldCom stock and options worthless.