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Responses by the Federal Communications Commission to Worldcom's Accounting Fraud Federal Communications Law Journal Volume 58 Issue 3 Article 21 6-2006 Responses by the Federal Communications Commission to WorldCom's Accounting Fraud Warren G. Lavey Skadden, Arps, Slate, Meagher & Flom Follow this and additional works at: https://www.repository.law.indiana.edu/fclj Part of the Administrative Law Commons, Antitrust and Trade Regulation Commons, Communications Law Commons, Legislation Commons, and the Securities Law Commons Recommended Citation Lavey, Warren G. (2006) "Responses by the Federal Communications Commission to WorldCom's Accounting Fraud," Federal Communications Law Journal: Vol. 58 : Iss. 3 , Article 21. Available at: https://www.repository.law.indiana.edu/fclj/vol58/iss3/21 This Article is brought to you for free and open access by the Law School Journals at Digital Repository @ Maurer Law. It has been accepted for inclusion in Federal Communications Law Journal by an authorized editor of Digital Repository @ Maurer Law. For more information, please contact [email protected]. Responses by the Federal Communications Commission to WorldCom's Accounting Fraud Warren G. Lavey* I. INTRODUCTION ............................................................................. 615 II. How DID THE FCC RESPOND IN THE DAYS AND WEEKS FOLLOWING WORLDCOM'S DISCLOSURE? .................. .. .. .. .. 619 A. WorldCom's Disclosure of Accounting Fraud..................... 619 B. FCC's Public Statements Responding to WorldCom's D isclosures............................................................................ 624 C. Analysis of the FCC'sImmediate Response ......................... 628 III. WHAT REGULATIONS DID THE FCC APPLY OR NOT APPLY TO WORLDCOM DURING THE ACCOUNTING FRAUD9 ....................... 631 A. Findings of Financial and Character Qualifications for WorldCom 's Licenses ........................................................... 631 1. Legal Framework for the FCC's Analysis of W orldCom's Qualifications ............................................ 631 2. Annlcation of Financial and Character Oualifications Tests to WorldCom During the Fraud ......................... 634 B. Assessment of WorldCom as a Financially Strong Competitor in Authorizing Other Carriers........................... 635 C. Audit of and Reports by WorldCom ...................................... 637 *Partner, Skadden, Arps, Slate, Meagher & Flom LLP. J.D., Harvard Law School; former Adjunct Professor, Washington University Law School and Kellogg School of Management, Northwestern University; former Assistant to the Chief, Common Carrier Bureau, Federal Communications Commission. I am grateful for the assistance of Anthony Oettinger, David Prohofsky, Joseph Hanley, James Harper, Blair Levin, Holly Rosencranz, Ruth Milkman, and Joan Summers. Errors are mine alone. FEDERAL COMMUNICATIONS LA W JOURNAL [VOL. 58 D. StatisticalReports Reflecting WorldCom's Financials......... 640 E. Enforcement Action ............................................................... 64 1 F. Regulations of Prices, Terms, and Conditions for Services Offered by Local Exchange Carriers.................................... 645 G. Analysis of the FCC's Relevant Regulations During the WorldCom Accounting Fraud............................................... 646 IV. AFTER SEVERAL YEARS, How DID THE FCC CHANGE OR NOT CHANGE ITS REGULATIONS RELATED TO WORLDCOM'S D ISCLOSURE? ........................................ .. .. .. .. .. .. .. .. 64 9 A. FCC Proceedings Triggeredby WorldCom's Disclosure .... 649 1. Discontinuance of Some Noncore Services .................... 650 2. WorldCom 's Licenses ..................................................... 651 3. Local Exchange Carriers' Protection Against U ncollectibles .................................................................. 654 B. Continuation of Other FCC Regulations Related to W orldCom 's D isclosure........................................................ 655 1. Information Filing and Accounting Requirements for Nondominant Carriers ..................................................... 656 2. License Applications ....................................................... 657 3. A udits .............................................................................. 659 4. Enforcement Actions ....................................................... 660 C. Analysis of the FCC's Maintenance of its Regulations and PracticesFollowing its Public Statements on WorldCom's Disclosure ............................................................................. 662 V. WHAT EXPLAINS THE FCC's RESPONSE TO WORLDCOM'S D ISCLOSURE? ...............................................................................663 A. ProtectingConsumers and Rooting Out CorporateFraud.. 663 B. Partial Explanations for the FCC's Stance on Financial F raud ....................................................................................668 1. Changes in Securities Laws, SEC Regulations, and Other SEC and Justice Department Actions ................... 668 2. Telecommunications Industry Downturn ........................ 672 3. Deregulation and Market Forces ..................................... 674 4. Political Accountability ................................................... 677 V I. C ONCLUSION ................................................................................ 679 NUMBER 31 WORLDCOM'S ACCOUNTING FRAUD I. INTRODUCTION The disclosure of massive financial accounting fraud at WorldCom, Incorporated ("WorldCom") on June 25, 2002,1 was a major shock to the Federal Communications Commission ("FCC"). The FCC is the principal federal agency responsible for fostering reliable, universally available telecommunications services, as well as competition and growth in the communications and related Internet services industries.2 A wide range of FCC policies, proceedings, and capabilities were implicated by the accounting fraud and resulting bankruptcy of WorldCom. At that time, WorldCom was the second largest long-distance carrier, one of the largest competitive local exchange carriers, and the largest provider of Internet backbone services.3 WorldCom held numerous FCC licenses for landline and wireless services. During the quarter century prior to the disclosure of4 fraud, advocacy by WorldCom and MCI Communications Corp. ("MCI") 1. Press Release, WorldCom, WorldCom Announces Intention to Restate 2001 and First Quarter 2002 Financial Statements (June 25, 2002), http://global.mci.conca/news/ ca_archive02.xml (follow "WorldCom Announces Intention to Restate 2001 and First Quarter 2002 Financial Statements" hyperlink) [hereinafter WorldCom Press Release]; DENNIS BERESFORD ET AL., REPORT OF INVESTIGATION BY THE SPECIAL INVESTIGATIVE COMMITTEE OF THE BOARD OF DIRECTORS OF WORLDCOM, INC. 1 (2003), http://news. findlaw.com/hdocs/docs/worldcom/bdspcomm6O903rpt.pdf [hereinafter INVESTIGATION REPORT]. The restated financials for 2000 and 2001 included impairment charges (write- downs of goodwill and certain other assets) totaling $59.8 billion and $4.8 billion of charges to pretax income to correct line costs (a category of operating expenses) that had been reduced either by improper capitalization or inappropriate reductions to reserves. Infra Part II.A. 2. See Nat'l Cable & Telecomms Ass'n v. Brand X Internet Servs., 125 S. Ct. 2688, 2695-98 (2005) (stating that the FrCC ik reponsible for nmnting the g--th of Intn-te and advanced services); Verizon Comm. v. FCC, 535 U.S. 467, 475-77 (2002) (stating that the FCC is responsible for promoting competition in local telecommunications services); Tex. Office of Pub. Util. Counsel v. FCC, 183 F.3d 393, 405-07 (5th Cir. 1999) (stating that the FCC is responsible for promoting universal telecommunications services); see generally Communications Act of 1934, ch. 652, 48 Stat. 1064 (codified as amended at scattered sections 47 U.S.C.). 3. See INDUS. ANALYSIS & TECH. Div., FCC, STATISTICS OF THE LONG DISTANCE TELECOMMUNICATIONS INDUSTRY 7, 16-17 (2003), http://www.fcc.gov/Bureaus/Common _Carrier/Reports/FCC-State Link/IAD/ldrpt103.pdf; Complaint, United States v. WorldCom and Sprint Corp. (D.D.C. filed June 27, 2000), at 4-7, http://www.justice.gov/ atr/caseslf5000505 l.pdf; J. Gregory Sidak, The Failureof Good Intentions: The WorldCom Fraud and the Collapse of American Telecommunications After Deregulation, 20 YALE J. ON REG. 207, 227 (2003). 4. WorldCom acquired MCI in 1998. See Application of WorldCom, Inc. and MCI Communications Corp. for Transfer of Control of MCI Communications Corp. to WorldCom, Inc., Memorandum Opinion and Order, 13 F.C.C.R. 18025, para. 1 (1998). At times between 1998 and 2002, the company was named "MCI WorldCom, Inc." and was renamed "WorldCom, Inc." To avoid confusion, this Article refers to the post-acquisition company as "WorldCom." FEDERAL COMMUNICATIONS LA W JOURNAL [VOL. 58 5 reshaped telecommunications regulations. The FCC's regulations did not cause, prevent, detect, or remedy the criminal conduct at WorldCom. However, the FCC's rules required WorldCom to file accurate financial information and to show that it had the financial and character qualifications necessary to hold radio and other FCC licenses. With broad statutory authority to require information filings and perform investigations of telecommunications carriers, the agency with telecommunications industry expertise might have done more to detect and protect the public against harms from financial fraud at major telecommunications carriers such as WorldCom, Qwest Communications 7 8 International, Inc. ("Qwest"),
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