Infectious Greed (64 page)

On August 6, 2001—at almost exactly the same time an Enron employee,
Sherron Watkins, was warning Ken Lay about the firm's accounting practices—Olofson sent a five-page letter to James Gorton, Global Crossing's 39-year-old general counsel and “Chief Ethics Officer,” warning him that the firm had engaged in misleading accounting practices.
²⁸
The letter closely resembled Sherron Watkins's letter to Ken Lay, and even discussed similar issues.

After consulting with Global Crossing outside counsel, Gorton responded that the company already knew of these accounting practices and then resigned a few days later, citing “personal reasons.”
²⁹
Apparently, Global Crossing's top managers did not send the letter to its auditors or board of directors. Olofson was fired from Global Crossing in November 2001.

According to a February 4, 2002, press release by Global Crossing, the firm did not inform Arthur Andersen or its audit committee about the contents of the letter until January 29, 2002, the day after it filed for bankruptcy, when the
Los Angeles Times
reported the existence of Olofson's letter.

Global Crossing later dismissed Olofson's allegations as the rantings of a disgruntled former employee, notwithstanding the fact that Olofson was not fired until three months after he sent his pivotal letter. It was true that Olofson was embroiled in a legal battle with Global Crossing and Gary Winnick related to his dismissal. But you didn't need to believe Olofson to spot Global Crossing's accounting machinations. Congressional investigators and prosecutors were uncovering the same facts, and much of what Olofson alleged was plain from Global Crossing's public disclosures. All you needed to do was read Global Crossing's most recent annual report.

Anyone looking carefully at Global Crossing's annual financial filing for 2000 would find $350 million of revenue on page 29 listed under “Sales Type Lease Revenue,” the term Global Crossing used for swaps of fiber-optic capacity. There was no corresponding line item for the expenses associated with these revenues. Instead, on page 32, there was this statement: “In addition, depreciation and amortization includes non-cash cost of capacity sold resulting from capacity sales that meet the qualifications of sales-type lease accounting.” In other words, in 2000, Global Crossing was recognizing revenue up front from these transactions and spreading the associated expenses over time. This accounting treatment matched Roy Olofson's allegations.

Global Crossing apparently was concerned about continuing to follow
these accounting practices, because it changed its reporting in 2001 in a way that made the firm's quarterly filings look like financial reports from Wonderland. Suddenly, no “Sales Type Lease Revenue” was listed at all. Instead, Global Crossing downplayed the firm's
actual
revenues and expenses—which were plummeting, along with those of the rest of the telecommunications industry—and encouraged investors and analysts to focus, instead, on something it called “Cash Revenue,” which was defined as the firm's actual revenue plus “revenue” from IRU swaps. In other words, “Cash Revenue” was neither cash nor revenue. The additions were substantial: $551 million for the second quarter of 2001.
³⁰

The firm then used the “Cash Revenue” number to calculate another accounting fiction, “Adjusted EBITDA,” a manufactured number that included EBITDA—the measure of accounting earnings—plus the “non-cash cost of capacity sold” and the “cash portion of the change in deferred revenue,” terms that referred to IRU swaps. In other words, Global Crossing's “Adjusted EBITDA” was a measure of the firm's income that included up-front revenue from the IRU swaps, but spread expenses over time. This also matched Olofson's allegations.

The securities analysts covering the telecommunications industry were aware of the bizarre accounting practices related to IRUs.
³¹
They shouldn't have cared whether Global Crossing recorded the costs up front or spread them over time, or whether the firm wanted to use make-believe terms such as “Adjusted EBITDA.” As long as they knew what the firm actually was doing, they should have been able to figure out what it was worth, and then either recommend the stock to investors, or not. In an efficient market, sophisticated investors would trade Global Crossing's stock until its price was accurate, selling if uninformed investors had driven up the price. However, the market for Global Crossing stock did not seem to be an efficient one; it was dominated by investors who loved the idea of Global Crossing, but did not understand IRUs and did not even bother to read Global Crossing's financial filings. They overestimated Global Crossing's value, and their frenetic buying drove the price of the stock. An informed investor who tried betting against Global Crossing's stock might be correct, but she was stepping in front of a speeding train.

Meanwhile, Global Crossing's executives were stumbling over each other to sell stock before reality struck, and the firm was awarding unprecedented pay packages to a rapid succession of short-lived CEOs.
³²
First, Gary Winnick paid Jack Scanlon 3.6 million stock options to take
the top job in April 1998. Then, Robert Annunziata, a former AT&T executive, took over in February 1999, with a $10 million signing bonus and 4 million options.
³³
Then Leo Hindery was CEO for seven months, and received 2 million options. In October 2000, Winnick promised new CEO Thomas J. Casey, an investment banker from Merrill Lynch, an $8 million loan (which later was forgiven), in addition to a seven-figure salary and bonus, plus options on 2 million shares of Global Crossing stock. Casey lasted less than a year in the job, and so Winnick enticed John J. Legere with the same terms
plus
a $3.5 million signing bonus, an additional $7 million of loans, and an extra 3 million options. Interestingly, these executives were so eager to sign pay packages that they neglected to check the details of when their stock options would become available. Casey's employment agreement omitted one of the option payment dates; as a result, he was not entitled to receive 440,000 options, with a value of millions of dollars at the time they were granted.
³⁴
It is unclear whether anyone at Global Crossing spotted this mistake. Whatever happened to Casey's extra options, it was incredible that, throughout this period, with five CEOs, individual investors nevertheless remained interested in Global Crossing.

The fictitious gains from IRU swaps could not continue indefinitely without real profits to replace them, and on October 4, 2001—less than three weeks before Ken Lay's fateful conference call with Enron's analysts and investors—Global Crossing announced that it would not meet analysts' earnings estimates. As word spread about the way the firm had recorded revenues and expenses from IRU swaps, investors abandoned the stock. Enron's collapse was a bad precedent, and investors watching Enron nervously sold their Global Crossing stock. The end was sudden, and Global Crossing filed for bankruptcy on January 28, 2002—less than two months after Enron. The firm had had a short life as a public company under Gary Winnick—just four years from IPO to bankruptcy. In the end, as in the beginning, the firm took care of its insiders. In addition to forgiving $18 million in loans to its last two CEOs,
³⁵
Global Crossing—like Enron—arranged for its top employees to be paid millions of dollars just before its bankruptcy filing.
³⁶

Gary Winnick wasn't suffering too much. In 1999, the
Los Angeles Business Journal
had named Winnick “Los Angeles' richest man,” worth $6 billion. He was no longer worth that much, but he was still on the Forbes 400 list of the wealthiest U.S. citizens, behind Bill Gates but ahead of Donald Trump. And he still lived in a $40 million mansion in Beverly
Hills, down the street from Barbra Streisand, where he was considering plans for a new 100-car parking garage. He was active with his favorite charities, although he no longer could use Global Crossing's resources for contributions, as he had, repeatedly, as chairman, even offering use of Global Crossing's marine-services division to assist in the rescue of the Russian submarine Kursk in 2000.
³⁷
It seemed likely that Winnick would avoid civil liability and criminal charges. The leaders of C. W. Post still cherished his support, and “Winnick House”—unlike Enron Field—kept its name.

 

 

S
ince Bernard Ebbers was a child in Edmonton, Alberta, he had wanted to be a basketball player.
³⁸
He played for his high school team in Canada during the late 1950s, but didn't receive any major scholarship offers. He enrolled at the University of Alberta, but after spending a year practicing his jump shot more than studying, he flunked out. Ebbers did odd jobs in Edmonton, including one summer at Edmonton Telephones
³⁹
and a stint driving a milk-delivery truck.
⁴⁰

After a few years, he finally found a place where he could play basketball: Mississippi College, a small school affiliated with the Mississippi Baptist Convention, which was consistently listed in the top 100 “character-building” colleges in the United States. Mississippi College was just the kick in the pants Ebbers needed, and he graduated in 1967 with a degree in physical education.
⁴¹

Unfortunately, a Mississippi College degree didn't do much more for Bernie Ebbers at first than a diploma from C. W. Post had done for Gary Winnick. Ebbers coached high school basketball in Mississippi for a year, and then ran a small garment factory.
⁴²
He eventually persuaded some friends to invest with him in a motel and restaurant in a small town in Mississippi. He kept costs low, and over time bought a few more motels.
⁴³
But sixteen years after graduation, he was a long way from becoming a multibillionaire.

One day in 1983, as Ken Lay was ascending the corporate ladder in Houston, Ebbers was sitting in a coffee shop in Hattiesberg, Mississippi, discussing the recent breakup of AT&T with his friends Murray Waldron and William Rector. The men decided they might be able to make money by purchasing long-distance services from the major phone companies and then selling it to small, local companies. Their waitress was
listening to their conversation, and suggested Long Distance Discount Services as a name. The men started LDDS, and Ebbers abandoned his hotels to become CEO of the company in 1985.
⁴⁴

Like Gary Winnick, Ebbers was an aggressive salesman. But unlike Winnick, Ebbers also was frugal, and his penny-pinching attitude appealed to companies interested in reducing their long-distance bills. During the next decade, LDDS acquired a portfolio of residential and business customers, and expanded by buying a handful of small long-distance companies, just as Ebbers previously had acquired hotels. By 1995, LDDS had become a substantial provider of discount long-distance services, and Bernie Ebbers decided that the waitress from Hattiesberg hadn't been thinking big enough; he changed the company's name to WorldCom.

Like Gary Winnick, Ebbers built up WorldCom, piece by piece, by acquiring dozens of companies. And like Gary Winnick, Ebbers befriended Jack Grubman and Salomon Brothers, relied on Grubman for advice, and used Salomon as his firm's primary investment bank. Grubman had an unusually close relationship with WorldCom's top managers, and even attended three board meetings, where he discussed deals the company was considering (securities analysts typically were not permitted to attend board meetings).
⁴⁵
With Grubman's help, WorldCom's stock price soared, and Ebbers began considering acquiring larger companies. In all, WorldCom paid Salomon $80 million in fees for these deals and other investment-banking work.
⁴⁶

In 1997, at Grubman's urging, WorldCom offered to buy MCI in the highest-profile deal of Ebbers's career, one of the biggest mergers in U.S. history. The media closely followed the deal, and sophisticated fund managers—including Long-Term Capital Management—bet on whether it would succeed. When MCI agreed to terms, WorldCom instantly became the second-largest provider of long-distance telephone services—and a household name.
⁴⁷
By the late 1990s, investors knew more about WorldCom than they did about AT&T, the dominant telecommunications firm from the prior decade. WorldCom was the fifth most widely held stock in the United States, and its shares were worth $115 billion, double the value of AT&T's shares. Twenty million residential customers used WorldCom as their long-distance carrier.

And yet, looking at the upper management of WorldCom, it was hard to believe this was a major multinational company. WorldCom was a creation of Wall Street, in the same way Britney Spears was a creation of
the entertainment industry. Jack Grubman might as well have propped up a cardboard cutout of a CEO. Ebbers still didn't understand WorldCom's finances and relied extensively on Grubman. Ebbers also depended almost exclusively on Scott D. Sullivan, his chief financial officer, to “see if the numbers work.”
⁴⁸
Sullivan was bright—a straight-A student at the State University of New York at Oswego—and was knowledgeable about accounting and mergers, but he lacked Andy Fastow's training and experience in complex financial engineering. In contrast to Enron, which had been featured in Myron Scholes's Nobel laureate address, WorldCom's approach to its finances was straight out of
The Complete Idiot's Guide to Finance and Accounting.

In many ways, WorldCom's simplistic approach to its finances was superior to Enron's. WorldCom had invested three times as much as Enron in Rhythms NetConnections before that firm's Initial Public Offering.
⁴⁹
That $30 million investment bought 8.6 percent of the company, worth almost a billion dollars at the peak. In 2001, WorldCom bought most of the assets of Rhythms NetConnections, and those assets appeared on WorldCom's financial statements. Investors knew about WorldCom's involvement in Rhythms NetConnections, and WorldCom didn't use elaborate partnership transactions to hide its gains—or, later, its losses.