Thanks to Aaron Parker for providing a copy of Dick Thornburgh's speech. 


Thornburgh is former Attorney General and now partner at Kirkpatrick & Lockhart.  He was a court appointed examiner to review what went wrong at Worldcom.


He also points out some of the lessons Board members need to learn.


What do YOU think?

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“WorldCom: Lessons in Corporate Governance”

Remarks by

Dick Thornburgh


Counsel, Kirkpatrick & Lockhart LLP

Former Attorney General of the United States


Court-Appointed Examiner in the

WorldCom Bankruptcy Proceedings



To Conferences in

San Francisco and Los Angeles




Tuesday and Wednesday, October 28 and 29, 2003


Today the American business and financial communities are pre-occupied as seldom before with the consequences of a flurry of investigations into allegations of corporate wrongdoing. The “Hall of Shame” of significant American businesses involved in these proceedings now includes the likes of Enron, WorldCom, Tyco, Global Crossing and Health South – all discredited by illegalities and improper accounting practices. Numerous members of the management teams of these companies have had to face criminal prosecution or regulatory sanction that have effectively ended their careers.  Meanwhile, the venerable accounting firm of Arthur Andersen, involved in a number of these debacles and once the “gold standard” of the accounting profession, has been forced from the field, and more investigations appear to be in the offing. 


            Certainly the spate of corporate scandals with which we must deal today is not unique.  It is only the latest of those which have, from time to time, posed threats to our free enterprise system and its long-established record of efficient allocation of resources within our economy. Nonetheless, these episodes are of significant consequence to the American business and financial communities in these opening years of the 21st century.


            Today I would like to share with you some insights gained from my service as the court-appointed Examiner in one of these matters, that involving the bankruptcy of WorldCom, the largest such proceeding in American history.


            The WorldCom case has, in effect, become a kind of poster child for corporate governance failures in this new century. WorldCom, the world’s second largest telecommunications company, filed for bankruptcy in the federal court in Manhattan in the summer of 2002 after the disclosure of massive accounting irregularities. I was appointed as Examiner by the bankruptcy court in August, 2002, filed my first interim report last November, a second interim report in June of this year and expect to file a final report before the end of the year. My remarks today will, understandably, reference only the results of our completed investigations which have been made public. But even the public story told thus far provides a genuine case study in the failure of corporate governance and suggests a number of lessons in how to avoid its repetition.



            What happened in the WorldCom case?  Most of the deviations from proper corporate behavior resulted from the failure of directors to recognize, and deal effectively with, abuses reflecting what our reports identified as a “culture of greed” within the corporation’s top management.  Others resulted from an abject failure of other responsible persons within the company to fulfill their fiduciary obligations to shareholders. In the final analysis, what we saw was a complete breakdown of the system of corporate governance – the checks and balances designed to prevent these types of wrongdoing simply failed to operate. As one of my colleagues noted: “The checks didn’t balance and the balances didn’t check!”


            While WorldCom has not finished restating its financials, it is clear that the company overstated its income by approximately $11 billion, overstated its balance sheet by approximately $75 billion and, as a result, caused losses in shareholder value of as much as $250 billion.


            Given the size of the fraud, the prominence of the company and the numerous opportunities seemingly available to directors and others in authority for discovering this type of wrongdoing, it is worthwhile, I believe, to analyze the components of this debacle in more detail.


            Some of the questions raised by even this summary review remain unanswered even as of this date.  We hope to provide some further conclusions in our upcoming final report and more will no doubt come from the completion of investigations being carried out by the Department of Justice, the SEC and others with whom we have closely cooperated.  But enough has already been learned to suggest some very real remedies for not only the WorldCom situation, but others displaying similar patterns of disregard of good corporate governance practices and inadequacies in the oversight of financial reporting.




            As stated in our Reports, the WorldCom story is not limited to the massive accounting fraud that has been publicly reported. Our observations reflect a broad breakdown of the system of internal controls, corporate governance and individual responsibility, all of which worked together to create a culture in which all too few individuals took responsibility until it was too late. 


            Our investigation reflects that WorldCom was dominated by Bernard Ebbers and Scott Sullivan, the former Chief Executive Officer and Chief Financial Officer of the Company, respectively, with virtually no checks or restraints placed on their actions by the Board of Directors or other management.  Significantly, although many present or former officers and directors of WorldCom told us that they had misgivings at the time regarding decisions or actions by Mr. Ebbers or Mr. Sullivan during the relevant period, there is no evidence that any of these officers and directors made any attempts to curb, stop or challenge the conduct that they deemed questionable or inappropriate.  Instead, as described in our Reports, it appears that the Company’s officers and directors went along with Mr. Ebbers and Mr. Sullivan, even 4under circumstances that suggested corporate actions were at best imprudent, and at worst inappropriate and fraudulent. 


            There are many specific corporate governance failings identified in our First and Second Interim Reports.  I will highlight only a few examples for you this afternoon.  First, as stated in our Reports, WorldCom’s dramatic rise in stock value throughout the fifteen years preceding its bankruptcy was the currency fueling the numerous acquisitions that caused the Company to grow tremendously in both size and complexity in a relatively short amount of time. We observed, however, no meaningful deliberative processes related to many of the most important of the Company‘s significant acquisitions. The Company’s approach to such acquisitions was ad hoc and opportunistic.  Acquisitions were completed with little meaningful or coherent strategic planning.  WorldCom management routinely provided the Company’s directors with extremely limited information regarding many of those acquisitions.  In fact, several multi-billion dollar acquisitions were approved by the Board of Directors following discussions that lasted for 30 minutes or less and without the directors receiving a single piece of paper regarding the terms or implications of the transactions.  Significantly, although persons involved with the Board’s consideration of some of these matters informed us that they were disturbed at the time, no director or anyone else voiced any objection to these often cursory considerations by the Board.


            Second, the Company’s lack of internal controls infected its debt offerings and use of credit facilities.  Indeed, there is no evidence that WorldCom management or the Board of Directors reasonably monitored the Company's debt level and its ability to satisfy its outstanding obligations. Messrs. Ebbers and Sullivan had virtually unfettered discretion to commit the Company to billions of dollars in debt obligations with virtually no meaningful oversight.  WorldCom issued more than $25 billion in debt securities in the four years preceding its bankruptcy.  With respect to such offerings, Messrs. Ebbers and Sullivan comprised the entirety of the Company’s Pricing Committee.  The Board passively “rubber-stamped” proposals from Messrs. Ebbers or Sullivan regarding additional borrowings, most often via unanimous consent resolutions that were adopted after little or no discussion. 


            It seems clear that WorldCom’s ability to borrow monies was facilitated by its massive accounting fraud, which allowed the Company to falsely present itself as creditworthy and “investment grade.”  It also seems clear that the Company’s ability to borrow vast sums allowed it to perpetuate the illusion of financial health created by its accounting fraud.  As late as a few weeks before it disclosed its massive accounting irregularities, WorldCom used false financial statements to access all of a $2.65 billion line of credit, the proceeds of which it used for cash flow and to pay down another credit facility.  As the Company’s Treasurer told us in an interview, WorldCom merely “robbed Peter to pay Paul.” 


            Third, our investigation raised significant concerns, particularly from a corporate governance perspective, regarding the circumstances surrounding the Company’s loans of more than $400 million to Mr. Ebbers.  As detailed in our Reports, the Compensation and Stock Option Committee of the Board of Directors agreed to provide enormous loans and a separate guaranty for Mr. Ebbers without initially informing the full Board or taking appropriate steps to protect the Company.  Further, as the loans and guaranty increased, the Committee failed to perform appropriate due diligence that would have demonstrated that the collateral offered by Mr. Ebbers was grossly inadequate to support the Company’s extensions of credit to him, in light of his substantial other loans and obligations.  Our investigation reflected that the Board was similarly at fault for not raising any questions about the loans and merely adopting, without meaningful consideration, the recommendations of the Compensation Committee.


            From a corporate governance perspective, I believe the loans to Mr. Ebbers are troubling for an additional reason.  These extraordinary loans highlighted the extent of Mr. Ebbers’ business activities that were not related to WorldCom.  In my view, the Board should have questioned whether these non-WorldCom business activities were consistent with the need for Mr. Ebbers to devote his time and attention to managing the business of such a large and complex company as WorldCom.  However, it appears that the Board did not even raise questions, much less do anything, to attempt to persuade Mr. Ebbers to divest himself of his other businesses or otherwise limit his non-WorldCom business activities.  To the contrary, the Compensation Committee and the Board provided the massive funding that facilitated Mr. Ebbers' personal business activities.


            Fourth, as to the accounting irregularities themselves, they were, on large part, responses – desperate responses – to the end of the company’s acquisition spree, caused by the disapproval by the U.S. Department of Justice of the proposed further combination of WorldCom with Sprint in 1999, and the simultaneous winding down of the boom in the telecommunications industry which had dominated much of the 1990s. 


            Because WorldCom and its management had relied heavily on an ever-increasing stock price to sustain its acquisitions and to provide lucrative stock-option cash-outs for its executives, the prospect of this double threat to its modus operandi caused considerable consternation in the executive suites.  The seemingly perpetual rise in the price of WorldCom stock had been the result of constantly increasing revenues and its seeming ease in meeting earnings targets set by investment analysts on Wall Street.  With the prospect of lowered earnings and the threat of an inability to “make the numbers” in the offing, either of which would have negatively impacted WorldCom’s stock price, management began to search the catalog of aggressive accounting techniques to milk every last bit of earnings out of their declining prospects.


            When permissible techniques failed and when actual earnings still threatened to fall short of projections, the Company began to resort to improper topside adjustments in monthly accounting figures to shore up its eroding financial picture.  This began with the improper drawing down of reserves accumulated from its acquisition program and other sources to generate what could masquerade as genuine earnings in its quarterly reports.  When allocations of more than $3 billion exhausted those reserves, the Company took the brazen step of capitalizing some $3.8 billion of line costs which should properly have been expensed and applied against earnings.  As a result, while the Company reported making its earnings targets in each of the last 13 quarters prior to bankruptcy, in fact it missed those targets in 11 out of those 13, and actually should have reported losses in four of the last five quarters prior to bankruptcy.  This house of cards finally collapsed in May, 2002 when internal auditors finally fingered a number of the improprieties and, in short order, top officials were fired or resigned, earnings were restated, SEC and criminal investigations were initiated, and bankruptcy ensued.


            Fifth, Arthur Andersen, the outside auditors, notwithstanding its designation of WorldCom as a “maximum risk” client, was insufficiently attentive to the company’s financial reporting. Most seriously, the auditors failed to work in tandem with the Audit Committee or the Internal Audit Department to create a seamless web of audit capability. As a result, these entities were effectively neutralized as a source of oversight or inquiry into improprieties that were occurring during this period. On the contrary, our Reports found, “the audit committee, the Internal Audit Department and Arthur Andersen allowed their missions to be shaped in ways that served to conceal and perpetuate the Company’s accounting fraud.”


            Sixth, another source of independent critical oversight was largely lacking as well. To the contrary, a major contributor to the substantial losses suffered by WorldCom shareholders (including many of its employees’ 401(k) plans) were financial analysts who failed to “call ‘em as they saw ‘em” during the company’s slide into bankruptcy. In particular, prominent analyst Jack Grubman of Solomon Smith Barney (SSB) continued to give exuberant forecasts up to the very edge of the abyss as the company hurtled toward disaster.  His relationship to the company and that of SSB, a major investment banker for WorldCom, raise significant questions. SSB reaped substantial financial rewards during its relationship with WorldCom and many have questioned whether Grubman’s consistent euphoria in forecasting earnings was in any way connected with SSB’s prospects for more and more investment banking business.  SSB also awarded allocations of initial public offerings (IPOs) of go-go stocks in seeming disproportionate quantities to Ebbers (who netted a reported $11.5 million in profits from such transactions) and others at WorldCom, once again raising questions of connectivity. 


            As an aside, it is perhaps worth noting some of the numbers alleged to be involved here.  According to a recent article in The New Yorker magazine, between 1996 and 2001, Jack Grubman helped SSB generate more than a billion dollars in investment banking fees, while earning for himself an average of $20 million a year, making him the highest paid stock analyst ever.  When he resigned in 2002, he was, the article reports, provided with a severance payment of more than $30 million!


            Finally, the fact that WorldCom’s accounting irregularities went undetected for so long provides further testament to the inadequacy of the Company’s systems of internal controls.  In fairness, it appears that the Audit Committee of the Board of Directors and the Internal Audit Department were not seized with actual notice of these irregularities.  To their considerable credit, they took significant and responsible steps once accounting irregularities were discovered in the spring of 2002.  Nonetheless, it seems abundantly clear that the Audit Committee over the years barely scratched the surface of any potential accounting or financial reporting issues.  Moreover, the Internal Audit Department adopted an operational audit function; that is, it focused its efforts on efficiency and cost-savings concerns, rather than acting as WorldCom’s “internal control police.” 


            All told, we believe that WorldCom's conferral of practically unlimited discretion upon Messrs. Ebbers and Sullivan, combined with passive acceptance of management’s representations and proposals by the Board of Directors and its constituent committees, and a culture that diminished the importance of internal checks, forward-looking planning and meaningful discussion or critical analysis formed the basis for the Company’s descent into bankruptcy.  In many significant respects, WorldCom appears to have represented the polar opposite of model corporate governance practices during the relevant period.  Its culture was dominated by a strong Chief Executive Officer, who was given virtually unfettered discretion to commit vast amounts of shareholder resources and determine corporate direction with only minimal scrutiny or meaningful deliberation or analysis by senior management or the Board of Directors.  The Board of Directors appears to have embraced suggestions by Mr. Ebbers without question or dissent, even under circumstances where its members now readily acknowledge they had significant misgivings regarding his recommended course of action. Indeed, even Mr. Ebbers’ requests for massive personal loans from Company assets evoked no critical discussion, much less dissent.  


            Next only in importance to the absence of internal controls as a cause of this debacle was the lack of transparency between senior management and the Board of Directors at WorldCom. While the latter does not directly translate to the massive accounting fraud committed by the Company, I believe that this failing helped to foster an environment and culture that permitted the fraud to grow dramatically.  A culture and internal processes that discourage or implicitly forbid scrutiny and detailed questioning are   breeding grounds for fraudulent misdeeds.  They also can beget ill-considered and wasteful acquisitions, improperly managed and unchecked debt and poor credit management, a lack of sensitivity to conflicts and diligence regarding the massive personal loans made by the Company to its Chief Executive Officer, and an effective neutering of other gatekeepers, such as the Audit Committee, the Internal Audit Department and the Company’s outside auditors.  In tandem with the accounting irregularities, these shortcomings fostered the illusion that WorldCom was far more healthy and successful than it actually was during the relevant period.  Ultimately, as noted, they also produced massive investor losses, the largest bankruptcy in the history of the United States and a profound loss of confidence in our financial markets and economic system.




            As might be expected, WorldCom and the other corporate debacles which followed the burst of the speculative bubble of the 1990s have produced a flood of legislative and regulatory responses. What kinds of challenges are posed by these new requirements?

            Among the dictates of the Sarbanes-Oxley Act of 2002 and/or accompanying SEC regulations are those that compel corporate CEOs and CFOs to certify as to the accuracy of financial statements filed with the SEC; that require companies to disclose in their annual reports whether they have adopted a code of ethics covering top officials; that forbid publicly-held corporations to extend credit to their directors or officers; that provide for forfeiture of bonuses and profits from the sale of company stock if restatements have been made as a result of “misconduct” in financial reporting; that require audit committee members be “independent” and to disclose whether at least one member is a “financial expert”; and that impose stricter supervision over outside auditors. The New York Stock Exchange and NASD now explicitly require that a majority of board members in listed companies be “independent;” that nominating and auditing committees be composed solely of “independent” directors and that shareholder approval is required for all equity compensation plans. Many of these requirements, incidentally, were anticipated by the core recommendations of the Blue Ribbon Commissions of the National Association of Corporate Directors.


            Sarbanes-Oxley also promises to change vastly the relationship between corporations and their counsel. The Act requires that the SEC set minimum standards requiring that attorneys for publicly traded companies report “evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company” to the chief legal officer or the CEO and, failing to receive “an appropriate response,” to the audit or other independent committee of the board.  Rules adopted or under consideration by the Commission under this section raise a whole raft of questions regarding these “up the ladder” reporting requirements. Even more important, the American Bar Association has adopted changes to its Model Ethical Rules to permit disclosure of client confidences where lawyers’ services have been used to perpetuate an ongoing fraud and the SEC is considering an even broader “noisy withdrawal” rule for counsel to public companies.


             More authority in the form of regulatory response and increased budgets for the SEC and other investigative agencies will no doubt produce much closer scrutiny of corporate practices and, if history is a guide, will likely uncover new and even more sophisticated schemes designed to defraud the public.


            The consequences of these changes are already becoming apparent:


1.      Compliance costs are estimated to increase by as much a $2.5 million per year as a result of new burdens placed on corporations and their officials.

2.      Compensation for directors will no doubt have to be increased due to the greater burdens and increased cost of compliance on their parts. The corporate monitor in the SEC proceedings against WorldCom, for example, recommended annual compensation of not less than $150,000 for directors of the reorganized company.

3.      As a practical matter, it is my personal view that the days of one individual serving on as many as 8 to 10 corporate boards at a time are over, due to increased time demands and exposure. Credentials for directors henceforth will more likely, as one observer noted, “rest on substance and not celebrity.” Equally significant, my sense as well is that boards will be increasingly wary about permitting their CEOs to serve on other board of publicly held companies.

4.      Liability for corporate directors is still a developing field, to be sure, but recent court decisions have already pointed to an expanded potential for directors’ liability in connection with approvals of excess salaries and other compensation and perquisites for top management.

5.      The “Big Eight” accounting firms have now become “The Big Four,” or as some would have it, “The Final Four,” and these firms will have to be much more constrained in serving today’s corporate clients. They will have to be on the lookout for conflicts in the providing of unrelated services.  Many clients of the major accounting firms paid them substantially more for consulting rather than for auditing during this boom period. What one would hope is resurrected is the traditional concept of the certified public accountant as the flinty-eyed independent watchdog with a green eye shade who strikes fear into the heart of those tempted to play fast and loose with the company’s financial records; not the lap dog which is tempted “to go along to get along” for fear of losing significant consulting revenue when improper aggressive accounting strategies are proposed by management. As indicated, outside accountants should regularly confer with internal audit personnel, independent directors and the board’s audit committee to insure that all are “singing from the same sheet music” on accounting issues.  No doubt, the Public Company Oversight Accounting Board established under the Sarbanes-Oxley Act will prescribe more specifics to ensure the independence of auditing firms and the rigor of their auditing procedures

            The cure for many of the ills already identified, in this as in previous eras of corporate wrongdoing is, in my view, a strong dose of leadership which emphasizes honesty, integrity, character and transparency in the conduct of corporate affairs. I agree with what one observer noted:

“The tragedy which has befallen millions of shareholders of public corporations both within and without the United States might have been avoided had the independent board members remained independent and exercised the fiduciary duties imposed upon them by federal and state laws.”

            Such duties clearly require that:


1.      Directors must insist on a relationship of transparency between management and the board, i.e. adequate information presented in understandable form (with a minimum of computer runs, for example) with adequate time before meetings for review. Management should know that the board will take a dim view of surprises – whether related to business or to regulatory matters.

2.      Directors should insist on adequate meeting time for critical deliberation of important issues. Management should expect and prepare for a healthy dose of professional skepticism from the board.

3.      Directors should not hesitate to seek and utilize independent expertise and assistance concerning, e.g., financial and technical evaluation, compensation and legal, regulatory and other significant matters. In some cases, regular retention of accounting or legal experts to attend board or committee meetings may even be appropriate.

4.      Most important of all, the independent directors, not management, should have the final say in selecting new independent directors by succession or addition to the board.

            In the final analysis, a culture which emphasizes ethical conduct will make more difference than all the laws and regulations promulgated by various governmental agencies. This is the opportunity presented to the membership of groups such as the National Association of Corporate Directors – to renew the belief of all Americans in the integrity of corporate governance and the free enterprise system upon which our financial well being and quality of life ultimately depends.


Last year, prior to my appointment as the WorldCom Examiner, I made an instructional film for distribution to corporate America, dealing with today’s legal and ethical challenges. Its message was a simple one: “Do the right thing.” At bottom, when all is said and done, this is the basic lesson taught by recently disclosed shortcomings in corporate governance. And it is a message that must be taken to heart within America’s business and financial communities if they are to continue to prosper and maintain the confidence of the investing and taxpaying public.

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