course outline.docPHONEI prefer to be contacted via ema.docx

course outline.doc
PHONE:
I prefer to be contacted via email.
TEXT:Rittenberg, Johnstone, and Gramling, Auditing – A
Business Risk
Approach, 9th
edition
PLEASE DO NOT PURCHASE THE INTERNATIONAL
EDITION
COURSE DESCRIPTION:
This course is the second in a two course sequence. It contains
lectures on auditing procedures (compliance and substantive)
for cash, receivables, inventory, payables, long-term debt,
equity balances and related income statement accounts. Topics
also include writing of auditor's reports, including special
reports, and review/compilation reports in accordance with
AICPA standards.
LEARNING OUTCOMES:
Upon successful completion of this course, students will be able
to:
1. Assess and resolve deficiencies that may be present in
financial statement audit reports and other types of reports
commonly prepared by CPAs.
2. Analyze one or more cases that involve the evaluation of

internal control
3. Analyze one or more cases that involve risk assessment and
resolution of client issues.
4. Analyze one or more cases that involve accounting fraud,
litigation and auditor liability.
5. Analyze one or more cases that involve the assessment of
information technology controls.
6. Research a topic related to the audit of financial statements
or management fraud relating to financial reporting, and writes
a paper with appropriate content and format.
D. RESEARCH PAPER ( CLO 6) due on or before Saturday of
the 4th week, 11:00 PM PT
During week one each student is to notifiy me as to their chosen
topic. Your topic should be related to an integrated audit of
financial statements with respect to management fraud. Please
find a true life case where management fraud actually existed
and report on it utilizing at least 15 resourses dealing with the
issues in your paper. This assignment requires the use of the
Library/Internet research to locate and study reference
materials, preferably journal articles. The paper should be APA
6th edition style, minimum 1,500 words,12 pt. font, double
spaced, Times New Roman) . The objective of this activity is
for you to be aware of what is happening in the real world that
relates to auditing and to practice your writng skills and make
the study of auditing more meaningful. Post the assignment
under the RESEARCH PAPER Assignment Link as a Word Doc.
attachment. You may call the library for assistance in locating
articles for your references. Wikipedia is not an acceptable
article reference—not reliable. PLEASE LOOK UNDER
“COURSE RESOURCES” to find Research Paper Guidelines in
Bb.
OTHER COURSE REQUIREMENTS AND INFORMATION:
PROFESSIONAL ASSOCIATIONS:
American Institute of CPA’s

Institute of Internal Auditors
California State Society of CPA’s (CALCPA.org)
Institute of Management Accountants
WEB SITES:
Directory of acctg. Web site resources:
http://www.rutgers.edu/accounting/raw
Financial Accounting Standards Board (FASB):
http://www.fasb.org
Government Accounting Standards Board (GASB):
http://www.gasb.org
American Institute of CPA’s (AICPA):
http://www.aicpa.org
Institute of Management Accountants (IMA)
http://www.imanet.org
Financial information on public companies:
http://www.sec.gov/edgar
Federal tax code research:
http://www.tns.lcs.mit.edu:80/uscode/
NU Library System:
http://www.nu.edu/library
Annual Reports:

http://reportgallery.com
http://www.bloomberg.com
Financial Analysis:
http://marketguide.com
PAGE
1
Research Paper Guidelines.docx
Research Paper Guidelines
Paper is to address the following in good writing format. Use
this as an outline.
Separate these things into paragraphs in the paper. Write a
conclusion.
1)Introduce the company where the fraud occurred. Give the
background and where the company is place in the world.
2)Who are the players? Who committed the fraud, how, why,
over what time period. HOW DID THEY DO IT AND WHAT
WAS THE MOTIVATION? What was the monetary damage?
Address the farad issues that you have learned in classes. Were
the 3 elements of fraud there?
3)Who discovered it?
4)What was the reaction by the company?
5)What happen with respect to internal control? Did it fail? Was
it ever in place etc.?
6) What happened to the person/people who committed the
fraud?
7)Who were the attorneys?
8)What changed in the company after the fraud…if there were

any changes?
If you find any additional information that we should know, add
it.
worldcom research.docx
EUROPEMEDIA-21 July 2002-Extent of WorldCom audit
problems unknown (C)2002 Van Dusseldorp & Partners - http://
www.vandusseldorp.com/
The disgraced telecoms group, WorldCom, may not know the
scale of its audit problems before the end of the year, its
president and CEO has said. The "best guesstimate is by the end
of the year, but that could slip," said CEO John Sidgmore. "We
really have no idea what the magnitude is at this time." The
news came just hours after WorldCom applied for bankruptcy
protection following its USD3.85bn (E3.82bn) accounting
debacle. The bankruptcy filing will not be affecting the
European operations of the company.
Sidgmore stated that WorldCom's first priority is to stabilise the
company financially. USD2bn (E1.99bn) has been sourced by
the company to keep it going during restructuring, according to
reports. The firm stressed that the filing will not apply to its
non-US operations. Mr Sidgmore said the company will look at
selling some of its non-core assets, and which "potentially
includes some of our Latin American facilities" and wireless
resale business.
The main question facing investigators and investors is whether
the accounting fraud was an aberration, or a sign of a diseased
company. There is also concern as to whether or not holders of
WorldCom's USD30bn (E29.82bn) in bonds will be able to swap
their debt for shares in the restructured firm. Bankruptcy had
been hoped to be avoided by the firm, which was valued at
USD175bn (E173.99bn) at its height in 1999. Today's Chapter
11 filing by WorldCom eclipses that of collapsed energy trader
Enron as the largest bankruptcy in US history. ((Distributed via
M2 Communications Ltd - http://www.m2.com))

Word count: 272
(Copyright M2 Communications Ltd. July 21, 2002)
It took a routine internal audit to uncover one of the biggest
suspected corporate frauds ever perpetrated. But just why
billions of dollars of suspect costs had gone unnoticed before is
something that will hang over WorldCom, its auditor Andersen,
and some of Wall Street's most prominent banks for a long time.
The scandal that could sink one of the world's biggest
telecommunications companies came to a head last weekend,
after an internal auditor employed by WorldCom had discovered
something strange.
The amount WorldCom had spent on capital investment since
the beginning of last year appeared to have been boosted by
substantial amounts that did not look like capital spending at
all. Instead, some $3.8bn had simply been transferred out of the
company's normal operating expenses and classified instead as
capital investment - something that kept it off WorldCom's
profit and loss account.
On Monday, as the company's board was told of the problem,
WorldCom's internal investigation went into high gear and a
powerful outside legal team was brought in. On Tuesday, the
Securities and Exchange Commission was told - just as
WorldCom's technology workers were working to cut the access
that Scott Sullivan, the company's chief financial officer, had to
the company's internal computer network. By that evening, Mr
Sullivan had been sacked and the fraud was laid bare.
Yesterday, the company was investigating whether Mr Sullivan
had ordered the money in question to be transferred to capital
expenditures from operating expenses. And it added that it
would not know who else - including Bernie Ebbers, former
chief executive - knew about the accounting irregularities until
its investigation was completed.
The breath-taking simplicity and apparent brazenness of it all
was brushed aside by a WorldCom spokesman yesterday.
"Unfortunately you cannot audit every journal entry every
quarter," he said. But for many people at the company, or close

to it, the questions may not be brushed away so lightly.
High on that list is Andersen, the audit firm that has already
been laid low by the collapse of Enron. Andersen, which had
approved the company's 2001 accounts and reviewed its figures
in the first quarter of this year, sought to lay the blame squarely
on Mr Sullivan, accusing him of having failed to disclose the
transfers that are at the centre of the investigation.
Though Andersen did not perform internal audit work at
WorldCom, it had the sort of close involvement across a wide
range of advisory roles that has prompted questions about the
independence of auditors to some of the biggest US companies.
Of the $16.8m in fees that WorldCom paid Andersen last year,
only $4.4m was in connection with the annual audit.
WorldCom's independent directors - particularly those on its
audit committee, and its chairman Bert Roberts - are likely to
come under scrutiny in the months ahead. None could not be
reached or did not return calls to comment yesterday.
"What they knew, and when they knew it, are very important
questions," said Charles Elson, professor of corporate
governance at the University of Delaware.
Many of the board members had close ties to Mr Ebbers - either
as WorldCom executives or as officers of other telecoms
companies that had been acquired by WorldCom over the years.
The chairman of the audit committee is Max E. Bobbitt, an old
friend of Mr Ebbers with long experience in the industry.
Mr Bobbitt, a consultant who has been involved in numerous
telecoms start-ups, joined the board in 1992 after WorldCom
took over another company where he was a director, Advanced
Telecommunications.
The audit committee also includes James Allen, a Denver-based
telecoms industry venture capitalist, who has sat on
WorldCom's board since 1998; Francesco Galesi, a real estate,
oil and telecoms magnate and a board member since 1992; and
Judith Areen, dean of the Law Center at Georgetown University
and a board member since 1998.
Also in the spotlight yesterday was Jack Grubman, the Salomon

Smith Barney analyst who had been WorldCom's biggest Wall
Street cheerleader and who only withdrew his "buy"
recommendation on the stock earlier this year. Mr Grubman had
put out a note as recently as Friday sounding a caution about
WorldCom and its precarious finances - something that
prompted speculation about whether he had an inkling of what
was to come.
In an interview with CNBC, the analyst said: "Nobody saw this
coming. I am as shocked about this as everyone else."
Salomon's work in helping Mr Ebbers assemble WorldCom
through a string of acquisitions has already brought it extensive
unwanted attention since the company's decline set in, while a
string of other banks are set to come under scrutiny for their
role in helping the company with a giant bond issue a year ago -
a time when it may have been in the midst of perpetrating a
giant fraud, it has now emerged. Copyright Financial Times
Limited 2002. All Rights Reserved.
Word count: 817
Copyright Financial Times Information Limited Jun 27, 2002
x Prosecutors had no comment on whether they plan to arrest
ousted WorldCom chairman Bernard J. Ebbers or indict
WorldCom as a corporation. They also declined to comment on
widespread speculation that they hope to get [Scott D. Sullivan]
or [David Myers] to provide incriminating information against
Ebbers, who grew WorldCom from a no-name Mississippi long-
distance reseller into a dominant global telecom provider
through a string of 60 deals over 17 years. Many of the biggest
deals were engineered by Sullivan.
An internal WorldCom auditing memo filed with court papers
yesterday gave some details of how Sullivan and Myers shifted
operating expenses known as "line costs" over to capital
accounts where they could be written off over years, improving
WorldCom's reported cash flow.
1. Scott D. Sullivan (center), former chief financial officer of
bankrupt telecommunications giant WorldCom, and former
controller David Myers (not shown) surrendered to federal

agents yesterday to face securities fraud, conspiracy, and false-
statement charges. The two allegedly shifted $3.9 billion in
operating expenses to capital accounts in order to post more
than $1 billion in bogus profits. E2. Photo ran on Page A1. /
REUTERS PHOTO 2. Ex-WorldCom controller David Myers
sitting in a car after surrendering to federal authorities
yesterday in New York. / AP PHOTO
Full Text
· TranslateFull text
·
Material from Globe wire services was used in this report.
WorldCom's former top two financial executives were arrested
yesterday on fraud charges related to the bankrupt
telecommunications giant's $3.9 billion accounting scandal and
were paraded handcuffed past television crews for the latest
"perp walk" in the government's crackdown on corporate
abuses.
Scott D. Sullivan, 40, WorldCom's former chief financial officer
and master merger strategist, and David Myers, 44, the
company's former controller, surrendered to the FBI in New
York early yesterday morning to face securities fraud,
conspiracy, and false- statement charges that could send them to
prison for as long as 65 years each and cost them millions of
dollars in fines.
The spectacle of Sullivan and Myers being led to court from the
FBI's New York headquarters came a week after federal agents
brought former Adelphia Communications chairman John Rigas
and two of his sons in handcuffs past a phalanx of television
cameras. The Rigases were indicted on charges they looted
hundreds of millions of dollars from Adelphia, driving the cable
television company to bankruptcy and costing investors and
creditors $60 billion.
Reacting to yesterday's arrests, Attorney General John D.
Ashcroft said: "With each arrest, indictment and prosecution,
we send this clear, unmistakable message: Corrupt corporate
executives are no better than common thieves."

Sullivan was released on $10 million bail secured by the
waterfront mansion he is having built in Boca Raton, Fla. Myers
posted $2 million bail. US Magistrate Judge Richard Francis
ordered both men to surrender their US passports to prevent
them from fleeing the country. Their lawyers said they will
plead not guilty to charges.
Federal authorities allege Sullivan and Myers shifted $3.9
billion in operating expenses to WorldCom capital accounts in
order to enable the number two long-distance company to post
more than $1 billion in bogus profits during 2001 and the first
quarter of this year. They are accused of filing false statements
with the Securities and Exchange Commission five times in the
last two years.
They were fired in June, hours before WorldCom chief
executive John W. Sidgmore disclosed the accounting moves to
Wall Street and triggered a SEC civil fraud complaint against
WorldCom.
Prosecutors had no comment on whether they plan to arrest
ousted WorldCom chairman Bernard J. Ebbers or indict
WorldCom as a corporation. They also declined to comment on
widespread speculation that they hope to get Sullivan or Myers
to provide incriminating information against Ebbers, who grew
WorldCom from a no-name Mississippi long-distance reseller
into a dominant global telecom provider through a string of 60
deals over 17 years. Many of the biggest deals were engineered
by Sullivan.
Ebbers, in a statement issued by his lawyers, said he knew
nothing of the accounting moves and called Sullivan and Myers
"competent, ethical, and loyal employees, devoted to the
welfare of WorldCom."
Ebbers became a lightning rod for WorldCom investor outrage
after revelations the Clinton, Miss., company's board loaned
him $408 million to buy company stock that has lost 99 percent
of its value in the last three years and closed yesterday at 15
cents a share. Last month he and Sullivan refused to answer
questions at a congressional hearing, invoking their Fifth

Amendment rights against incriminating themselves.
WorldCom filed for Chapter 11 bankruptcy protection 11 days
ago, the largest filing in US history. It listed $41 billion in debt
and assets of $107 billion. Besides long-distance carrier MCI,
WorldCom operates key Internet facilities such as UUNet that
handle an estimated half of all US Net traffic.
WorldCom spokeswoman Julie Moore said the company was
cooperating fully with the government probe.
"Nobody wants to get to the bottom of this quicker than
WorldCom," she said.
An internal WorldCom auditing memo filed with court papers
yesterday gave some details of how Sullivan and Myers shifted
operating expenses known as "line costs" over to capital
accounts where they could be written off over years, improving
WorldCom's reported cash flow.
"David [Myers] acknowledged that the line costs should
probably not have been capitalized and stated that it was
difficult to stop once started. David indicated that he has felt
uncomfortable with these entries since the first time they were
booked," the internal auditors' memo said.
A WorldCom staff accountant who began raising questions
about the moves, Cynthia Cooper, was urged this spring by
Sullivan to delay completing an audit of the line costs until this
summer.
Sullivan's attorney, Irv Nathan, accused federal prosecutors of
turning the "honest and honorable" Sullivan into a scapegoat.
"We deeply regret the rush to judgment and the political
overtones involved," Nathan said.
Noting that the men were the subject of a criminal complaint,
not a formal indictment, Nathan said, "All of this suggests this
is a lot of politics. Unfortunately, politics are intruding into the
criminal justice system."
Reid Weingarten, the attorney representing Ebbers, said the
made- for-TV arrests of Sullivan and Myers may have been
"good theater." But Weingarten said prosecutors have yet to
"prove that Sullivan and Myers ever acted with criminal intent,

an essential element we doubt the government will ever be able
to prove in this case."
Emphasizing the public-relations value of the WorldCom arrests
in the wake of President Bush's signing a new law toughening
penalties for white-collar crime, White House spokesman Ari
Fleischer said the president is "determined that people who
break America's laws and engage in corporate practices that are
corrupt will be investigated. [They] will be held liable, will be
held accountable and will likely end up in the pokey, where
they belong."
Ashcroft said, "When financial transactions are fraudulent and
balance sheets are falsified, the invisible hand that guides our
market is replaced by a greased palm. Information is corrupted,
trust is abused and the . . . ruthless and corrupt profit at the
expense of the truthful and law-abiding."
But Senator Tom Daschle of South Dakota, the Democratic
majority leader, said, "There hasn't been anyone in handcuffs
from Enron, and we don't know the reason why."
Executives of the Houston energy giant, which filed for Chapter
11 bankruptcy protection in January, had been key political
patrons of Bush in Texas. Enron collapsed amid questions about
phony profits and elaborate accounting ruses to hide debt.
Also yesterday, the Justice Department nominated former US
Attorney General Richard Thornburgh to serve as its
independent examiner in the WorldCom bankruptcy
proceedings, charged with investigating mismanagement and
fraud.
If approved by federal bankruptcy judge Arthur J. Gonzalez,
Thornburgh would have 90 days to file a report detailing what
caused WorldCom to fall into bankruptcy.
Peter J. Howe can be reached at [email protected]Abstract
(summary)
TranslateAbstract
WorldCom is under investigation by the Justice Department and
the Securities and Exchange Commission. Scott Sullivan,
WorldCom's former chief financial officer and Ms. [Cynthia

Cooper]'s boss, has been indicted. He has denied any
wrongdoing. Four other officers have pleaded guilty and are
cooperating with prosecutors. Federal investigators are still
probing whether Bernard J. Ebbers, the company's former chief
executive, knew about the accounting improprieties. Since the
initial discoveries, WorldCom's accounting misdeeds have
grown to $7 billion.
Behind the tale of accounting chicanery lies the untold detective
story of three young internal auditors, who temperamentally
didn't fit into WorldCom's well-known cowboy culture. Ms.
Cooper, 38 years old, headed a department of 24 auditors and
support staffers, many of whom viewed her as quiet but
strongwilled. She grew up in a modest neighborhood near
WorldCom's headquarters and had spent nearly a decade
working at the company, rising through its ranks. She declined
to be interviewed for this story. Mr. [Morse], 41, was known for
his ability to use technology to ferret out information. The third
member of the team was Glyn Smith, 34, a senior manager
under Ms. Cooper. In his spare time he taught Sunday school,
took photographs and bicycled. His mom had taught him and
Ms. Cooper accounting at Clinton High School.
The confrontations put Ms. Cooper in a sticky position. Mr.
Sullivan was her immediate supervisor. Plus, her vague
discomfort with the way WorldCom was handling its accounting
led her into areas that were not normally her bailiwick.
Although her department did a small amount of financial
auditing, it primarily performed operational audits, consisting
of measuring the performance of WorldCom's units and making
sure the proper spending controls were in place. The bulk of the
company's financial auditing was left to Arthur Andersen. But
neither of those things dissuaded Ms. Cooper from following
her nose to the root of the ill-defined problem.Full Text
·
CLINTON, Miss. -- Sitting in his cubicle at WorldCom Inc.
headquarters one afternoon in May, Gene Morse stared at an

accounting entry for $500 million in computer expenses. He
couldn't find any invoices or documentation to back up the
stunning number.
"Oh my God," he muttered to himself. The auditor immediately
took his discovery to his boss, Cynthia Cooper, the company's
vice president of internal audit. "Keep going," Mr. Morse says
she told him.
A series of obscure tips last spring had led Ms. Cooper and Mr.
Morse to suspect that their employer was cooking its books.
Armed with accounting skills and determination, Ms. Cooper
and her team set off on their own to figure out whether their
hunch was correct. Often working late at night to avoid
detection by their bosses, they combed through hundreds of
thousands of accounting entries, crashing the company's
computers in the process.
By June 23, they had unearthed $3.8 billion in misallocated
expenses and phony accounting entries. It all added up to an
accounting fraud, acknowledged by the company, that turned
out to be the largest in corporate history. Their discoveries sent
WorldCom into bankruptcy, left thousands of their colleagues
without jobs and roiled the stock market.
At a time when dishonesty at the top of U.S. companies is
dominating public attention, Ms. Cooper and her team are a case
of middle managers who took their commitment to financial
reporting to extraordinary lengths. As she pursued the trail of
fraud, Ms. Cooper time and again was obstructed by fellow
employees, some of whom disapproved of WorldCom's
accounting methods but were unwilling to contradict their
bosses or thwart the company's goals.
WorldCom is under investigation by the Justice Department and
the Securities and Exchange Commission. Scott Sullivan,
WorldCom's former chief financial officer and Ms. Cooper's
boss, has been indicted. He has denied any wrongdoing. Four
other officers have pleaded guilty and are cooperating with
prosecutors. Federal investigators are still probing whether
Bernard J. Ebbers, the company's former chief executive, knew

about the accounting improprieties. Since the initial
discoveries, WorldCom's accounting misdeeds have grown to $7
billion.
Behind the tale of accounting chicanery lies the untold detective
story of three young internal auditors, who temperamentally
didn't fit into WorldCom's well-known cowboy culture. Ms.
Cooper, 38 years old, headed a department of 24 auditors and
support staffers, many of whom viewed her as quiet but
strongwilled. She grew up in a modest neighborhood near
WorldCom's headquarters and had spent nearly a decade
working at the company, rising through its ranks. She declined
to be interviewed for this story. Mr. Morse, 41, was known for
his ability to use technology to ferret out information. The third
member of the team was Glyn Smith, 34, a senior manager
under Ms. Cooper. In his spare time he taught Sunday school,
took photographs and bicycled. His mom had taught him and
Ms. Cooper accounting at Clinton High School.
Frightened that they would be fired if their superiors found out
what they were up to, the gumshoes worked in secret. Even so,
their initial discrete inquiries were stonewalled. Arthur
Andersen, WorldCom's outside auditor, refused to respond to
some of Ms. Cooper's questions and told her that the firm had
approved some of the accounting methods she questioned. At
another critical juncture in the trio's investigation, Mr. Sullivan,
then the company's CFO, asked Ms. Cooper to delay her
investigation until the following quarter. She refused.
Ms. Cooper's first inkling that something big was amiss at
WorldCom came in March 2002. John Stupka, the head of
WorldCom's wireless business, paid her a visit. He was angry
because he was about to lose $400 million he had specifically
set aside in the third quarter of 2001, according to two people
familiar with the meeting. His plan had been to use the money
to make up for shortfalls if customers didn't pay their bills, a
common occurrence in the wireless business. It was a well-
accepted accounting device.
But Mr. Sullivan decided instead to take the $400 million away

from Mr. Stupka's division and use it to boost WorldCom's
income. Mr. Stupka was unhappy because without the money,
his unit would likely have to report a large loss in the next
quarter.
Mr. Stupka's group already had complained to two Arthur
Andersen auditors, Melvin Dick and Kenny Avery. They had
sided with Mr. Sullivan, according to federal investigators.
But Mr. Stupka and Ms. Cooper thought the decision smelled
funny, although not obviously improper. Under accounting
rules, if a company knows it is not going to collect on a debt, it
has to set up a reserve to cover it in order to avoid reflecting on
its books too high a value for that business. That was exactly
what Mr. Stupka had done. Mr. Stupka declined to comment.
Ms. Cooper decided to raise the issue again with Andersen. But
when she called the firm, Mr. Avery brushed her off and made it
clear that he took orders only from Mr. Sullivan, according to
the investigators. Mr. Avery and Mr. Dick declined to comment.
Patrick Dorton, a spokesman for Andersen, said his firm thought
that the $400 million wireless reserve was not necessary.
"That was like putting a red flag in front of a bull," says Mr.
Morse. "She came back to me and said, `Go dig.' "
Some internal auditors would have left it at that and moved on.
After all, both the company's chief financial officer and its
outside accountants had signed off on the decision. But that was
not Ms. Cooper's style. One favorite pastime among the auditors
who reported to her was applying the labels of the Myers-Briggs
& Keirsey personality test to their fellow staffers. Ms. Cooper
was categorized as an INTJ -- introspective, intuitive, a thinker
and judgmental. "INTJs," according to the test criteria, are
"natural leaders" and "strong-willed," representing less than 1%
of the population.
And so Ms. Cooper decided to appeal the decision. As head of
auditing, it was her responsibility to bring sensitive issues to
the audit committee of WorldCom's board. She brought the
reserves question to the attention of the committee's head, Max
Bobbitt. At a committee meeting at the company's Washington

offices on March 6, she and Mr. Sullivan presented their cases,
according to minutes from the meeting. Mr. Sullivan backed
down, according to people familiar with his decision.
The next day he tracked down Ms. Cooper. Unable to reach her
immediately, Mr. Sullivan called her husband, a stay-at-home
dad to their two daughters, to get her cellphone number. He
finally caught up with her at the hair salon. In the future, she
was not to interfere in Mr. Stupka's business, Mr. Sullivan
warned, according to people familiar with the reserves question.
The confrontations put Ms. Cooper in a sticky position. Mr.
Sullivan was her immediate supervisor. Plus, her vague
discomfort with the way WorldCom was handling its accounting
led her into areas that were not normally her bailiwick.
Although her department did a small amount of financial
auditing, it primarily performed operational audits, consisting
of measuring the performance of WorldCom's units and making
sure the proper spending controls were in place. The bulk of the
company's financial auditing was left to Arthur Andersen. But
neither of those things dissuaded Ms. Cooper from following
her nose to the root of the ill-defined problem.
On March 7, a day after Ms. Cooper had visited with the audit
committee, the SEC surprised the company with a "Request for
Information." While WorldCom's closest competitors, including
AT&T Corp., were suffering from a telecom rout and losing
money throughout 2001, WorldCom continued to report a profit.
That had attracted the attention of regulators at the SEC, who
thought WorldCom's numbers looked suspicious.
But investigators had grown frustrated as they combed through
public filings looking for evidence of wrongdoing, according to
people familiar with the inquiry. So they asked to see data on
everything from sales commissions to communications with
analysts.
Concerned about why the SEC was sniffing around, Ms. Cooper
directed her group to start collecting information in order to
comply with the request.
She also was growing concerned about another looming

problem. Andersen was under fire for its role in the Enron case,
which soon would lead to the accounting firm's indictment. It
was clear that WorldCom would have to retain new outside
auditors.
Ms. Cooper set off on an unusual course. Her own department
would simply take on a role that no one at Worldcom had
assigned it. The troubles at Enron and Andersen were enough to
warrant a second look at the company's financials, she
explained to Mr. Morse one evening as they walked out to
WorldCom's parking lot. Her plan: her department would start
doing financial audits, looking at the reliability and integrity of
the financial information the company was reporting publicly.
It was a major decision, which would necessitate a lot more
work for Ms. Cooper and her staffers. Still, Ms. Cooper took on
financial auditing without asking permission from Mr. Sullivan,
her boss, according to investigators and a person familiar with
Ms. Cooper's decision.
"We could see a strain in her face," recalls her mother, Patsy
Ferrell, about that time period. "She didn't look happy. We
knew she was working late and some of the other people were
working late. We would call and say, `Can we bring some
sandwiches?' and her father would bring them sandwiches."
Several weeks later, Mr. Smith, a manager under Ms. Cooper,
received a curious e-mail from Mark Abide, based in
Richardson, Texas, who was in charge of keeping the books for
the company's property, plants and equipment.
Mr. Abide had attached to his May 21 e-mail a local newspaper
article about a former employee in WorldCom's Texas office
who had been fired after he raised questions about a minor
accounting matter involving capital expenditures. "This is worth
looking into from an audit perspective," Mr. Abide wrote. Mr.
Smith, who declined to be interviewed, forwarded the e-mail to
Ms. Cooper, according to investigators and a lawyer involved in
the case.
The e-mail piqued Ms. Cooper's interest. As part of their initial
foray into financial auditing, Ms. Cooper and her team had

already stumbled on to the issue of capital expenditures, a
subject that would prove to be crucial to their quest.
The team had run into an inexplicable $2 billion that the
company said in public disclosures had been spent on capital
expenditures during the first three quarters of 2001. But they
found that the money had never been authorized for capital
spending.
Capital costs, such as equipment, property and other major
purchases, can be depreciated over long periods of time. In
many cases, companies spread those costs over years. Operating
costs such as salaries, benefits and rent are subtracted from
income on a quarterly basis, and so they have an immediate
impact on profits.
Ms. Cooper and her team were beginning to suspect what was
up with the mysterious $2 billion entry: It might actually
represent operating costs shifted to capital expenditure accounts
-- a stealthy maneuver that would make the company look vastly
more profitable.
When Ms. Cooper and Mr. Smith asked Sanjeev Sethi, a director
of financial planning, about the curious adjustment, he told
them it was "prepaid capacity," a term they had never heard
before. Further inquires led them to understand that prepaid
capacity was a capital expenditure. But when they asked what it
meant, Mr. Sethi told them to ask David Myers, the company's
controller, according to Mr. Morse and a person familiar with
Ms. Cooper's situation. Mr. Sethi did not return phone calls.
Ms. Cooper and Mr. Smith opted instead to call Mr. Abide, who
had pointed out a capital expenditures problem in his e-mail.
When they asked him about "prepaid capacity," he too answered
very cryptically, explaining that those entries had come from
Buford Yates, WorldCom's director of general accounting.
While perusing records looking for accounting irregularities
later that same day, May 28, Mr. Morse made the big discovery
of the $500 million in undocumented computer expenses. They
also were logged as a capital expenditure. "This stinks," Mr.
Morse recalls thinking to himself. He immediately went to Ms.

Cooper to tell her what he'd found. She called a meeting of her
department. "I knew it was a horrific thing and she did too,
right off the bat," says Mr. Morse.
Several days later, Ms. Cooper and Mr. Smith met to try to
make sense of their growing list of clues. Particularly puzzling
were the cryptic comments made by Mr. Sethi and Mr. Abide.
Finally the two auditors came up with a plan of action to test
their sense that when it came to the booking of capital
expenditures, something was very wrong at WorldCom. Ms.
Cooper would send Mr. Smith an e-mail saying she wanted to
know more about prepaid capacity as soon as possible, and
asking how much harder they should press Mr. Sethi. They
would copy Mr. Myers on the e-mail.
Mr. Myers shot back an e-mail. Mr. Sethi should be working for
him and did not have time to devote to Ms. Cooper's inquiries,
he wrote. Ms. Cooper had been stonewalled yet again.
Ms. Cooper and Mr. Smith didn't know it, but they had stumbled
onto evidence that some executives were keeping two sets of
numbers for the then-$36 billion company, one of them
fraudulent.
By 2000, WorldCom had started to rely on aggressive
accounting to blur the true picture of its badly sagging business.
A vicious price war in the long-distance market had ravaged
profit margins in the consumer and business divisions. Mr.
Sullivan had tried to respond by moving around reserves,
according to his indictment. But by 2001 it wasn't enough to
keep the company afloat.
And so Mr. Sullivan began instructing Mr. Myers to take line
costs, fees paid to lease portions of other companies' telephone
networks, out of operating-expense accounts where they
belonged and tuck them into capital accounts, according to Mr.
Sullivan's indictment.
It was a definite accounting no-no, but it meant that the costs
did not hit the company's bottom line -- at least in the version
of the books that were publicly scrutinized. Although some
staffers objected, the scheme progressed for the next five

quarters.
Ms. Cooper, Mr. Smith and Mr. Morse didn't know this. They
only knew that accounting entries had been hopscotching
inexplicably around WorldCom's balance sheets and that nobody
wanted to talk about it. To put all the pieces together, they
would need to plumb the depths of WorldCom's computerized
accounting systems.
Full access to the computer system was a privilege that
normally had to be granted by Mr. Sullivan. But Mr. Morse, a
bit of a techie, had recently figured out a way around that
problem.
Without explaining what he was up to, Mr. Morse had asked
Jerry Lilly, a senior manager in WorldCom's information
technology department, for better access to the company's
accounting journal entries. Mr. Lilly was testing a new software
program and gave Mr. Morse permission to road test the system,
too.
The beauty of the new system, from Mr. Morse's perspective,
was that it enabled him to scrutinize the debit and credit sides
of transactions. By clicking on a number for an expense on a
spreadsheet, he could follow it back to the original journal entry
-- such as an invoice for a purchase or expense report submitted
by an employee, to see how it had been justified.
Sifting through the data for answers to still-vague questions
about capital expenditures amounted to a frustrating task, Mr.
Morse says. He combed through an account labeled
"intercompany accounts receivables," which contained 350,000
transactions per month. But when he downloaded the giant set
of data, he slowed down the servers that held the company's
accounting data. That prompted the IT staff to begin deleting
his requests because they were clogging and crashing the
system.
Mr. Morse began working at night, when there was less demand
on the servers, to avoid having his work shut down by the IT
department. During the day, he retreated to the audit library -- a
windowless, 12-by-12 room piled with files from previous

projects and tucked away in the audit department -- to avoid
arousing suspicion.
By the first week of June, Mr. Morse had turned up a total of $2
billion in questionable accounting entries, he says.
Having found the evidence they were looking for, the sleuths
were suddenly faced with how serious the implications of their
endeavor really were.
Mr. Morse grew increasingly concerned that others in the
company would discover what he had learned and try to destroy
the evidence, he says. With his own money, he went out and
bought a CD burner and copied all the incriminating data onto a
CD-Rom. He told no one outside of internal audit what he had
found.
Mr. Morse even kept his wife, Lynda, in the dark. Each night,
he'd bring home documents he was studying. He instructed his
wife not to touch his briefcase. His wife thought the usually
gregarious father of three looked drained.
Ms. Cooper had begun confiding in her parents, with whom she
was especially close. Without going into detail, she told her
mother that she was worried about what her team was finding,
and that it was definitely a very big deal, according to a person
close to Ms. Cooper.
Meanwhile, Mr. Sullivan began to ask questions about what Ms.
Cooper's team was up to. One day the finance chief approached
Mr. Morse in the company cafeteria. When Mr. Morse saw him
coming, he froze. The auditor had only spoken to Mr. Sullivan
twice during his five-year tenure at WorldCom.
"What are you working on?" Mr. Morse later recalled Mr.
Sullivan demanding. Mr. Morse looked at his shoes.
"International capital expenditures," he says he replied,
referring to a separate, and less-threatening auditing project. He
quickly walked away.
Days later, on June 11, Ms. Cooper got an unexpected phone
call from Mr. Sullivan. He told her that he would have some
time later in the day, and invited her to come by and tell him
what her department was up to, according to a person familiar

with Ms. Cooper's situation.
That afternoon, Ms. Cooper, Mr. Smith and another auditor
arrived at Mr. Sullivan's office. They talked about pending
promotions and other administrative matters, according to
lawyers involved in the case.
As the meeting was breaking up, Ms. Cooper turned to Mr.
Smith and suggested that he tell Mr. Sullivan what he was
working on. It was meant to seem like a casual comment. In
fact, the two auditors had planned it out beforehand, so that
they could gauge Mr. Sullivan's reaction, according to a person
familiar with Ms. Cooper's situation.
Mr. Smith briefly described the audit, without going into the
explosive material they already had found.
Mr. Sullivan urged them to delay the audit until after the third
quarter, saying there were problems he planned to take care of
with a write-down, according to several people familiar with the
meeting.
Ms. Cooper replied that no, the audit would continue. Mr.
Sullivan didn't respond, and the meeting ended in a stalemate.
Concerned now that Mr. Sullivan might try to cover up the
accounting improprieties, Ms. Cooper and Mr. Smith appealed
to Mr. Bobbitt, the head of WorldCom's audit committee. Mr.
Bobbitt had to travel to Mississippi from his home in Florida for
a board meeting scheduled for June 14, so the day before he met
with Ms. Cooper and Mr. Smith at a Hampton Inn in Clinton.
The two auditors told Mr. Bobbitt what they had found. He
asked Ms. Cooper to contact KPMG, the company's new outside
auditors, and brief them on what was happening. Mr. Bobbitt
did not raise Ms. Cooper's suspicions at the board meeting the
next day, according to a document WorldCom later submitted to
the SEC. James Sharpe, Mr. Bobbitt's lawyer, declined to
comment.
Farrell Malone, the KPMG partner in charge of the WorldCom
account, urged Ms. Cooper to make sure she was right.
On June 17, Ms. Cooper's team began a series of informal
confrontations meant to convince themselves that there was no

legal explanation for the accounting entries.
That morning, Ms. Cooper and Mr. Smith went to the office of
Betty Vinson, director of management reporting, and asked her
for documentation to support the capital-expense-accounting
entries. Ms. Vinson told the two that she had made many of the
entries but did not have any support for them, according to an
internal memo prepared by Ms. Cooper and Mr. Smith. Ms.
Vinson's lawyer did not return phone calls.
Next they walked a few feet to Mr. Yates's office. He said he
was not familiar with the entries and referred Ms. Cooper and
Mr. Smith to Mr. Myers.
The duo then paid a call on Mr. Myers. When confronted, he
admitted that he knew the accounting treatment was wrong,
according to the memo. Mr. Myers said that he could go back
and construct support for the entries but that he wasn't going to
do that. Ms. Cooper then asked if there were any accounting
standards to support the way the expenses were treated,
according to the memo, which was later made public by a
Congressional committee.
Mr. Myers answered that there were none. He said that the
entries should not have been made, but that once it had started,
it was hard to stop.
Mr. Smith asked how Mr. Myers planned to explain it all to the
SEC. Mr. Myers replied that he hoped it wouldn't come to that,
according to the memo.
An hour or so later, Ms. Cooper returned to her department to
brief Mr. Morse and her other auditors. "They have no support,"
she told them, according to Mr. Morse.
It was clear to Ms. Cooper's team that their findings would be
devastating for the company, and the prospect of going before
the board with their evidence was sobering. They worried about
whether their revelations would result in layoffs and obsessed
about whether they were jumping to unwarranted conclusions
that their colleagues at WorldCom were committing fraud. Plus,
they feared that they would somehow end up being blamed for
the mess.

Ms. Cooper's staffers began to notice that she was losing
weight. Mr. Morse's wife noticed he was preoccupied and short
tempered.
During the third week in June, Mr. Smith called his mother, who
was vacationing in Albuquerque, according to a person familiar
with the conversation. Without providing specifics, he told her
that he was about to take actions at WorldCom that were not
going to make people happy. He asked his mother, Ms. Cooper's
former high school accounting teacher, to remember him in her
prayers and to pray for him to be strong.
Ms. Cooper prepared for several meetings with the audit
committee. At one, on June 20, Mr. Sullivan was scheduled to
defend himself.
One evening, as Ms. Cooper worked late with accountants from
KPMG, she suddenly dropped her head into her arms on the
conference-room table. Mr. Malone of KPMG led her onto a
balcony, put his arm around her and showed her the sunset,
according to a person familiar with the meeting.
Ms. Cooper, Mr. Smith and Mr. Malone headed to Washington
to brief the board's audit committee. At the meeting on
Thursday, June 20, Mr. Malone described the transfer of line
costs to capital accounts and told the audit committee that, in
his view, the transfers didn't comply with generally accepted
accounting principles, according to a document WorldCom later
submitted to the SEC.
Mr. Sullivan tried to give an explanation for the accounting
adjustments but asked for more time to support the line-cost
transfers. The committee gave Mr. Sullivan the weekend to
explain himself. He got to work constructing what he called a
white paper that argued that the accounting treatments he used
were proper, according to the document.
It didn't work. On June 24, the audit committee told Mr.
Sullivan and Mr. Myers they would be terminated if they didn't
resign before the board meeting the next day. Mr. Sullivan
refused and was fired. Mr. Myers resigned.
The next evening, WorldCom stunned Wall Street with an

announcement that it had inflated profits by $3.8 billion over
the previous five quarters.
Afterward, Ms. Cooper drove to her parents' house, which was
near WorldCom's headquarters. She sat down at the dining-room
table without saying anything, says Ms. Ferrell, her mother.
"She was deeply, deeply pained. She was grief stricken that it
was true and that all these people would feel the consequences
of having gone astray," Ms. Ferrell says. "We were all so proud
of WorldCom and it's just been the saddest, most tragic thing."
Mr. Morse worked late that night, and his wife phoned after she
watched the news. The anchors were calling the company
World-Con, she reported. Did he know anything about it?
The SEC on June 26 slapped the company with a civil fraud
suit, and trading of WorldCom's stock was halted. Ultimately
the company was delisted by the Nasdaq Stock Market.
Mr. Sullivan is preparing to go to trial. "We will demonstrate at
the appropriate time that a number of the negative points that
WorldCom's internal auditors have recently suggested about Mr.
Sullivan are not accurate," says Irvin Nathan, a lawyer for Mr.
Sullivan. "The fact is that he was always supportive of internal
audit and was instrumental in the promotion of Cynthia Cooper
and securing resources for her staff."
Mr. Myers, Mr. Yates, Ms. Vinson and Troy Normand, the
director of legal entity accounting, have all pleaded guilty to
securities fraud and a variety of other charges. David Schertler,
an attorney for Mr. Yates, says that while his client pleaded
guilty, "all the evidence would suggest he was acting under the
orders of supervisors."
Ms. Cooper and her team have continued to work at
WorldCom's Clinton headquarters and are responding to
requests related to the various investigations of the company.
Ms. Cooper, Mr. Smith and Mr. Morse have been interviewed by
FBI agents in connection with the Justice Department's
investigation.
Some WorldCom employees have told the auditors that they
wish they had left the accounting issues alone.

---
Journal Link: See further coverage of the WorldCom scandal,
including bios of key players, in the Online Journal at
WSJ.com/WorldCom.Abstract (summary)
TranslateAbstract
The report, which also criticized the company's outside auditors
and Salomon Smith Barney's former telecommunications analyst
Jack Grubman, hints that the extent of the improper accounting
at WorldCom, this time relating to revenue, could be more
extensive than the $7.2 billion restatement the company already
has said it will make. Now, the report indicates, WorldCom also
is under fire for accounting methods used in recording revenue,
an entirely new avenue for investigators. Those investigators
also are looking at what the report refers to as "fraudulent
journal entries and adjustments" made by WorldCom executives.
The report also provides new details about Mr. [Bernard
Ebbers]'s $1 billion in borrowings and makes the argument that
the leverage Mr. Ebbers placed on his huge WorldCom holdings
put the interests of WorldCom shareholders at risk since the
company's shares could plummet if he tried to sell the stock.
"Furthermore by using his WorldCom shares to collateralize
massive debt obligations, Mr. Ebbers placed himself under
intense pressure to support WorldCom's share price," the report
says.
The report also points to Mr. Ebbers's role in determining
bonuses and other compensation for WorldCom executives.
Though WorldCom's disclosure documents suggest that bonuses
were paid to top executives based on performance, the report
says that Mr. Ebbers could adjust performance bonuses received
by individual employees. "Some individuals, even at lower
ranks, were paid massive performance bonuses equal to many
times their base salaries, while others received bonuses equal to
only a small percentage of their salaries." Mr. [Richard
Thornburgh] intends "to inquire whether these bonuses were
indeed based on quantitative performance factors or were used
instead for some improper or other purpose."Full Text

·
WorldCom Inc. is in talks with the Securities and Exchange
Commission are in talks to settle SEC fraud charges against the
company amid rapid developments in the case, according to
people familiar with the talks.
The broad outlines of an agreement in the massive accounting-
fraud case, hammered out a week ago, would include a court
injunction barring WorldCom from violating securities law.
WorldCom would also agree to a consent decree of those terms,
under terms of the settlement. The SEC is also expected to
settle charges against several individuals. The individuals'
names aren't known, but people close to the situation say they
are low- to mid-level executives who wouldn't be subject to
charges by federal prosecutors who are also conducting an
investigation. Some of those people have already worked out or
are working out plea agreements.
The amount of the fines against WorldCom -- and potentially
against individuals as well -- under the settlement terms is
unclear. One of the considerations the SEC is said to be looking
at is how potential fines would affect shareholders and creditors
of WorldCom.
A deal could be announced within the next week or so.
A WorldCom spokesman declined to comment.
On a separate front yesterday, a special bankruptcy-court
examiner accused WorldCom of a "smorgasbord" of fraudulent
accounting adjustments and disclosed that ousted Chief
Executive Bernard Ebbers personally guaranteed or pledged
WorldCom stock in order to receive $1 billion in loans -- an
amount considerably higher than previously believed.
In a highly critical report that is the most sweeping to date of
WorldCom's massive accounting problems, former U.S.
Attorney General Richard Thornburgh describes a company
culture rife with conflicts of interest and lacking proper
controls. Mr. Thornburgh, appointed in August by the
bankruptcy court to examine wrongdoing, mismanagement and

incompetence at WorldCom, found some of each.
The "report indicates a trifecta," he said in an interview after
releasing his 118-page preliminary document. Many details
were excised from the report so that it doesn't compromise
continuing inquiries by the Justice Department and Securities
and Exchange Commission, Mr. Thornburgh said.
The report, which also criticized the company's outside auditors
and Salomon Smith Barney's former telecommunications analyst
Jack Grubman, hints that the extent of the improper accounting
at WorldCom, this time relating to revenue, could be more
extensive than the $7.2 billion restatement the company already
has said it will make. Now, the report indicates, WorldCom also
is under fire for accounting methods used in recording revenue,
an entirely new avenue for investigators. Those investigators
also are looking at what the report refers to as "fraudulent
journal entries and adjustments" made by WorldCom executives.
Details from the report also imply that Mr. Ebbers's financial
condition is greatly weakened. At the end of 2001, Mr. Ebbers's
net worth was $295 million while his stock holdings were
valued at $286.6 million. Now that stock is worthless, leaving
him with a net worth of $8.4 million, if all his other assets
remained the same. Mr. Ebbers couldn't be reached for
comment.
The report also provides new details about Mr. Ebbers's $1
billion in borrowings and makes the argument that the leverage
Mr. Ebbers placed on his huge WorldCom holdings put the
interests of WorldCom shareholders at risk since the company's
shares could plummet if he tried to sell the stock. "Furthermore
by using his WorldCom shares to collateralize massive debt
obligations, Mr. Ebbers placed himself under intense pressure to
support WorldCom's share price," the report says.
In all, the report said, Mr. Ebbers personally guaranteed or
pledged WorldCom stock as security for more than $1 billion in
personal and business loans. The company itself lent Mr. Ebbers
$415 million, which contributed to his ouster. Though the
money was intended to help him cover margin calls on bank

loans that he had collateralized with WorldCom stock, Mr.
Ebbers, according to the report, used $27 million of the
proceeds for other personal reasons.
According to the report, those personal uses included "payments
of $1.8 million for the construction of his new house, $2 million
to a family member for personal expenses, approximately $1
million in loans to his family, his friends, and a WorldCom
officer, and payments of $22.8 million to his own business
interests." At the same time, the report notes, the company gave
him loans before they were "reduced to writing" and some loan
documentation may have been backdated.
In a statement, John Sidgmore, the current CEO, said: "We are
working to create a new WorldCom. We have developed and
implemented new systems, policies and procedures," including
doubling the internal-audit staff, to correct the company's past
problems and to ensure that they don't recur.
Mr. Thornburgh portrays WorldCom, a telephone and data-
services concern bloated by its speedy acquisition of more than
70 companies, as a company where management and internal
controls couldn't keep pace. He says the company's board of
directors and audit committee were ineffective while the
compensation committee "seemed to abdicate its responsibilities
to Mr. Ebbers." Arthur Andersen LLP, the company's external
auditor, was too lackadaisical given WorldCom's risk category,
the report says, and one of its bankers, Salmon Smith Barney
had a relationship so close that it is "potentially problematic."
By the second quarter of 2001, WorldCom's revenue was
declining, hurting its ability to meet quarterly revenue-growth
targets, the report says. "Accordingly, the company undertook
an analysis of ways to boost the company's quarterly revenues.
Ultimately, it appears that improper additions to revenue were
later booked in connection with this process," the report says.
The report also describes a series of false internal reports that
were generated at WorldCom to support the doctored financial
reports that would later be given to Wall Street. The report said
Mr. Thornburgh -- who conducted interviews with employees

and reviewed internal company documents -- would present his
findings on the false entries later, "in deference to governmental
investigations."
Meanwhile, other lawyers in the case have described the
preparation of what amounted to a second set of books that were
prepared for David Myers, controller, and Scott Sullivan, chief
financial officer. At the end of each quarter, Buford Yates,
director of general accounting, would prepare two charts, with
one showing accurate results from operations. Next to those
numbers would be a series of accounting adjustments necessary
to hit Wall Street estimates. Mr. Yates would then prepare a
second chart with doctored results after the adjustments had
been made, these lawyers say. Those doctored results would
then be presented to the public each quarter, they say.
The report also provides insight into the company's
"manipulation of reserve accounts" to meet Wall Street earnings
estimates. Reserves are typically set up to meet certain
expected, but not yet realized, costs. If reserves are determined
to be in excess of what is needed, companies are allowed, under
accounting guidelines, to "release" those reserves into earnings.
Mr. Thornburgh is continuing to investigate the company's
accounting practices regarding the establishment of reserves for
seven financial items, including reserves for taxes, depreciation,
legal costs and bad debts, among others, the report says. The
release of reserves added particularly heavily to the company's
earnings before interest, taxes, depreciation and amortization,
or Ebitda, during 2000. In that year, the release of reserves
added between $374 million and $661 million each quarter to
the company's reported Ebitda.
The Thornburgh report also chastises the company for limiting
the role of its internal auditors to audits of the company's
operations. At the same time the report applauds three internal
auditors who first investigated the company's fraudulent
accounting and brought the matter to light with the board and
outside auditors.
The report also raises questions about whether Arthur Andersen,

WorldCom's auditors before its collapse, "should have done
more to determine whether the risks of abuses were adequately
taken into account" by the company. Arthur Andersen,
according to the report, had identified WorldCom as a
"maximum risk client." It doesn't appear, the report says, that
Andersen took measures that were appropriate for the risk
profile it ascribed to the company.
The report also points to Mr. Ebbers's role in determining
bonuses and other compensation for WorldCom executives.
Though WorldCom's disclosure documents suggest that bonuses
were paid to top executives based on performance, the report
says that Mr. Ebbers could adjust performance bonuses received
by individual employees. "Some individuals, even at lower
ranks, were paid massive performance bonuses equal to many
times their base salaries, while others received bonuses equal to
only a small percentage of their salaries." Mr. Thornburgh
intends "to inquire whether these bonuses were indeed based on
quantitative performance factors or were used instead for some
improper or other purpose."
In his report, Mr. Thornburgh also discusses the relationship
between WorldCom and former Salomon Smith Barney analyst
Jack Grubman. The report reiterates much of the allegations
previously leveled against Mr. Grubman and his former
company: That Salomon granted Mr. Ebbers and WorldCom
directors lucrative shares in initial public offerings in exchange
for investment-banking business, which generated fees of $107
million for 23 deals between October 1997 and February 2002.
Vowing to investigate further, Mr. Thornburgh noted that Mr.
Grubman routinely rated WorldCom stock as a buy and urged
investors at one point to "load up the truck" with the company's
stock. He didn't change his "risk factor" rating until a week
after the SEC initiated an inquiry, the report said.
A spokeswoman for Citigroup, parent of Salomon, said that "in
light of ongoing discussions with the various regulators, we are
declining to comment." A lawyer for Mr. Grubman couldn't be
reached.

Word count: 1588
Copyright Dow Jones & Company Inc Nov 5, 2002Abstract
(summary)
TranslateAbstract
WorldCom filed for Chapter 11 bankruptcy protection in July
after acknowledging an initial $3.7 billion fraud. The bulk of
the fraud so far involved booking billions of expenses in line
costs, the fees that telephone companies pay to use local
landline networks, as capital expenditures instead of operating
expenses, thereby boosting profits. WorldCom also boosted
revenue with so-called cookie-jar accounting in which it used
reserves for bad accounts.Full Text
·
The accounting fraud at WorldCom Inc. is likely to reach
approximately $11 billion as the company's auditors and
investigators continue to pore over financial statements that
already detail the biggest case of accounting fraud in U.S.
history, according to people familiar with the situation.
The exact amount of the fraud hasn't yet been determined
because the company doesn't expect the investigation to be
completed until the summer. The actual losses WorldCom will
have to restate could be smaller if they are offset by tax credits
or other factors.
Already, WorldCom has said it expects the fraud to exceed $9
billion. "We won't have the restatement process complete until
this summer," said WorldCom spokesman Brad Burns. "At this
point, it is not possible to know what the final number will be."
WorldCom filed for Chapter 11 bankruptcy protection in July
after acknowledging an initial $3.7 billion fraud. The bulk of
the fraud so far involved booking billions of expenses in line
costs, the fees that telephone companies pay to use local
landline networks, as capital expenditures instead of operating
expenses, thereby boosting profits. WorldCom also boosted
revenue with so-called cookie-jar accounting in which it used
reserves for bad accounts.

The additional $2 billion in overstated profits, reported by
Bloomberg News yesterday, relates to a number of different
accounting issues, a person close to the situation said.
So far, two dozen employees of WorldCom, Clinton, Miss., the
nation's second-largest long-distance company, have been
dismissed or resigned over the fraud, including its chief
financial officer, Scott Sullivan. Mr. Sullivan and four other
former executives have been indicted or charged by New York
prosecutors in connection with the probe. All have pleaded
guilty, except for Mr. Sullivan.
Word count: 284
Copyright Dow Jones & Company Inc Apr 1, 2003Abstract
(summary)
TranslateAbstract
Seven years of attempted deregulation of telecommunications in
the US yield several lessons. First, the transaction costs of the
regulatory process have grown since enactment of the
Telecommunications Act of 1996. Second, despite its
micromanagement of competition in local telecommunications,
the FCC missed WorldCom's fraud and bankruptcy. WorldCom's
accounting fraud may have destroyed billions of dollars of
shareholder value in other telecommunications firms. In
addition, WorldCom's misconduct may have been intended to
harm competition by inducing exit (or forfeiture of market
share) by the efficient rivals. Chapter 11 reorganization of
WorldCom would further distort competition in the long-
distance and Internet backbone markets. The FCC has a unique
obligation to investigate the harm that WorldCom caused the
telecommunications industry. If WorldCom is unqualified to
hold its FCC licences and authorizations, that legal conclusion
would promptly, and properly, propel WorldCom toward
liquidation.Full text
·
Headnote
Seven years of attempted deregulation of telecommunications in

the United States yield several lessons. First, the transactions
costs of the regulatory process have grown since enactment of
the Telecommunications Act of 1996. Second, if the Federal
Communications Commission ("FCC") had used a consumer-
welfare standard rather than a competitor-welfare standard when
interpreting the Act, the agency's regulations on mandatory
unbundling of local telecommunications networks would have
been simpler and more socially beneficial. Third, despite its
micromanagement of competition in local telecommunications,
the FCC missed WorldCom 's fraud and bankruptcy. WorldCom
's false Internet traffic reports and accounting fraud encouraged
overinvestment in longs-distance capacity and Internet
backbone capacity. Because Internet traffic data are proprietary
and WorldCom dominated Internet backbone services, and
because WorldCom was subject to regulatory oversight, it was
reasonable for rival carriers to believe WorldCom 's
misrepresentation of Internet traffic growth. WorldCom 's
shareholder value in other telecommunications firms. In
addition, WorldCom 's misconduct may have been intended to
harm competition by inducing exit (or forfeiture of market
share) by the efficient rivals. Chapter 11 reorganization of
WorldCom would further distort competition in the long-
distance and Internet backbone markets. The FCC has a unique
obligation to investigate the harm that WorldCom caused the
telecommunications industry. If WorldCom is unqualified to
hold its FCC licenses and authorizations, that legal conclusion
liquidation.
Introduction
The United States has spent seven years trying to deregulate
telecommunications. We are not in the "transition" any longer.
It is time to take stock. In this Article, I address three topics.
The first, addressed in Part I, is the administrative cost of
deregulation under the Telecommunications Act of 1996.1 Next,
I examine in Part II the consequences of the Federal

Communications Commission's ("FCC's") use of a competitor-
welfare standard when formulating its policies for local
competition, rather than a consumer-welfare standard.
Beginning in Part III, I address at greater length my third topic.
I offer an early assessment of the harm to the
telecommunications industry from WorldCom's fraud and
bankruptcy. I explain how WorldCom's misconduct caused
collateral damage to other telecommunications firms,
government, workers, and the capital markets. WorldCom's false
Internet traffic reports and accounting fraud encouraged
overinvestment in longdistance capacity and Internet backbone
capacity. Because Internet traffic data are proprietary and
WorldCom dominated Internet backbone services, and because
WorldCom was subject to regulatory oversight, it was
reasonable for rival carriers to believe WorldCom's
misrepresentation of s Internet traffic growth. WorldCom's
shareholder value in other telecommunications firms and eroded
investor confidence in equity markets. Using event-study
analysis, I estimate the harm to rival carriers and
telecommunications equipment manufacturers resulting from
WorldCom's restatement of earnings. WorldCom's false or
fraudulent statements also supplied state and federal
governments with incorrect information essential to the
formulation of telecommunication policy. State and federal
governments, courts, and regulatory commissions would thus be
justified in applying extreme skepticism to future
representations made by WorldCom.
Part IV explains how WorldCom's fraud and bankruptcy may
have been intended to harm competition, and in the future may
do so, by inducing exit (or forfeiture of market share) by the
company's rivals. WorldCom repeatedly deceived investors,
competitors, and regulators with false statements about its
Internet traffic projections and financial performance. At a
minimum, WorldCom's fraudulent or false statements may have
raised rivals' costs by inducing inefficient investment in

capacity or inefficient expenditures for customer acquisition
and may have artificially reduced WorldCom's cost of capital
and thus facilitated its long string of acquisitions.
During the pre-bankruptcy period, WorldCom's business
strategy may have been designed to harm rival providers of
Internet backbone or long-distance services. Because
WorldCom's real costs were unknown, its pricing of Internet
backbone services bore no relation to cost. Recoupment of
losses was unnecessary as a condition for plausible predation by
WorldCom because its management had other ways to profit
personally. The coordinated actions of WorldCom's
management, its investment bankers, and its auditors may have
injured competition in the telecommunications industry. Part V
argues that the FCC has a unique obligation-distinct from the
mandate of the bankruptcy court or the Securities and Exchange
Commission-to investigate the effect of WorldCom's misconduct
on the telecommunications industry.
For WorldCom, Chapter 11 bankruptcy can be a means to distort
competition m the long-distance and Internet backbone markets.
Because Chapter 11 bankruptcy is not designed to eradicate
anticompetitive business models or to establish policy for the
telecommunications infrastructure, the FCC is uniquely
empowered to defend the competitive process. After Chapter 11
reorganization, WorldCom's freedom from debt would enable
the firm to underprice rivals that are as, or more, efficient than
WorldCom. Economic efficiency would suffer because
consumers would pay less than the true social cost required to
supply the services offered by WorldCom. Moreover, the
competitive advantage conferred upon WorldCom by the U.S.
bankruptcy court's elimination of WorldCom's debt (in whole or
in part) could constitute state aid in violation of Article 87 of
the European Community Treaty.
In Part VI, I argue that WorldCom's exit from the market would
not carry significant social costs. WorldCom's value as a going
concern is dubious, and other carriers could readily absorb
WorldCom's Internet and long-distance; customers. The FCC

should investigate the ramifications of WorldCom's fraud for
telecommunications policy. The outcome of that investigation
may include the finding that WorldCom is unqualified to hold
its FCC licenses and authorizations. That legal conclusion
liquidation.
I. The Administrative Cost of Deregulation
My first point is a simple one: deregulation has actually
increased regulation. That is not a reason to reject deregulation,
but it may be a useful indicator of whether we are on the right
trajectory for true deregulation. Consider first the growth of
regulatory inputs.
Figure 1 shows the FCC's annual budget in inflation-adjusted
dollars. Real expenditures quickly rose by about one-third after
enactment of the Telecommunications Act of 1996, from $158.8
million to $211.6 million, and they have stayed at that higher
level. The increase is thirty-seven percent if one includes 1995
in the post-deregulation period-perhaps on the rationale that the
FCC both saw new legislation coming and sought to get an early
jump on some of the expected regulatory detail. What happened
to regulatory output? The FCC, of course, produces many
regulatory products. Some, such as inaction, are particularly
difficult to quantify. But a simple, albeit imperfect, measure of
output is the number of pages per year of the FCC Record, the
official compendium of all FCC decisions, proposed
rulemakings, adjudications, and the like. As Figure 2 shows, the
number of pages per year nearly tripled in the post-1996 period.
During that period, the FCC Record averaged 23,838 pages per
year.
So, at a very crude level of analysis, it would appear that
deregulation permanently increased the inputs and outputs of
the FCC. Indeed, on the back of the envelope, it appears that a
one percent increase in real expenditures for the FCC would
produce about a nine percent increase in output.
How did the near tripling of the FCC's output in the post-1996
period affect the transactions costs that private firms incurred in

connection with telecommunications deregulation? This
question is hard to answer because the relevant data are by
definition private rather than public. One anecdotal measure
that is publicly available is the number of lawyers who belong
to the Federal Communications Bar Association. As Figure 3
shows, this measure of the number of telecommunications
lawyers grew seventy-three percent between December 1994 and
December 1998. If one assumes (very conservatively) that the
average income of an American telecommunications lawyer is
$100,000, then the current membership of the FCBA represents
an annual expenditure on legal services of at least $340 million.
Of course, some of these telecommunications lawyers may have
been laid off by now, and others may have redeployed their
talents in more promising specialties-such as bankruptcy,
securities litigation, and white-collar criminal defense. But the
raw data do suggest that the stock of telecommunications
lawyers experienced a substantial and enduring shift upward
after 1996 that tracked the increase in the FCC's real budget and
the increase in its annual output as measured by the size of the
FCC Record.
I have analyzed the growth in the FCC's inputs and outputs, as
well as in its attorney constituency, as proxies for transaction
costs. One might object that my time horizon coincided with
dramatic growth in the telecommunications industry, and that
these data might look quite different if one considered instead a
measure of transactions costs per revenue dollar (or transactions
costs per bit of data transmitted). I have not attempted such a
calculation in the belief that it is reasonable to expect the
transactions costs of telecommunications regulation to exhibit
some increasing returns to scale. One would not expect the costs
of regulatory compliance and strategy to be twice as high for a
carrier with twice the revenues of another.
Regardless of whether one considers particular FCC policies to
be good or bad, there can be no dispute that the public and
private transactions costs of implementing the
Telecommunications Act of 1996 have been significant.

II. Mandatory Unbundling Under the Competitor-Welfare
Standard
What about the substance of deregulation? The centerpiece of
the Telecommunications Act of 1996 was the opening of the
local network. My second major point is this: Following a
consumer-welfare model would have made unbundling policy
simpler and more socially beneficial. Unbundling means that the
owner of a network will offer competitors the use of pieces of
the network on a disaggregated, wholesale basis.2 The principal
policy questions that arise under unbundling are "What shall be
unbundled?" and "How shall the unbundled network element be
priced for sale to competitors?" Through its mandatory
unbundling policies, the FCC affirmatively promoted preferred
forms of market entry. Those modes of entry-and the business
models predicated upon them-might have been immediately
rejected in a truly deregulated marketplace rather than one that
was subject to managed competition. It would not be credible to
lay all the blame at Congress's feet by saying that the
Telecommunications Act of 1996 compelled the FCC to follow
an unbundling rule that ensured perverse economic
consequences. Writing in his memoir in 2000, former FCC
Chairman Reed Hundt said the following about the
congressional compromises made to pass the
Telecommunications Act of 1996:
The . . . compromises had produced a mountain of ambiguity
that was generally tilted toward the local phone companies'
advantage. But under principles of statutory construction, we
had broad . . . discretion in writing the implementing
regulations. Indeed, like the modern engineers trying to
straighten the Leaning Tower of Pisa, we could aspire to
provide the new entrants to the local telephone markets a fairer
chance to compete than they might find in any explicit
provision of the law.3
Mr. Hundt's stratagem worked. By a 7-1 margin in Verizon
Communications Inc. v. FCC,4 the FCC's lawyers successfully
convinced the Supreme Court in 2002 of the reasonableness of

the agency's pricing rules for unbundled network elements
("UNEs").
Those rules are predicated on the novel concept of total element
long-run incremental cost ("TELRIC").5 The TELRIC concept
was so nuanced that the FCC devoted more than 600 pages to
explaining it. Even if the FCC's TELRIC pricing model was not
the best possible interpretation on economic grounds, it was
deemed by the Court to deserve deference on review under the
Chevron doctrine.6 How much leeway did that imply? A great
deal, for Justice David Souter wrote for the Court that the
Telecommunications Act of 1996 created a "novel ratesettmg
designed to give aspiring competitors every possible incentive
to enter local retail telephone markets, short of confiscating the
incumbents' property."7
And what if those incentives led to a trillion dollars or more of
wasted investment? That was not the Supreme Court's problem.
With the exception of Justice Stephen Breyer, the Court would
defer to any method, even one never contemplated by Congress
in the Telecommunications Act of 1996, that the FCC might
devise for pricing UNEs-that is, as long as the Court did not
think that the method constituted a government taking of private
property. And the Court signaled in the same opinion that it had
no appetite for deciding that constitutional question anytime in
the foreseeable future.8
The Court confirmed what the FCC's leadership had believed
since 1996: That the agency had the wisdom to devise, and the
authority to impose, the means to promote competition in local
telephony. But those same officials and their successors were
slow to acknowledge that the FCC correspondingly possessed
the power to distort competition and investment in the
telecommunications industry.
On the question of wasted investment, there is a puzzle. There
currently exists excess capacity in the telecommunications
industry despite FCC policies that created an incentive for
underinvestment by both incumbent local exchange carriers
("ILECs") and competitive local exchange carriers ("CLECs").9

The answer to this puzzle lies in the data. Eventually, research
by empirical economists may give us a definitive autopsy. It
will be necessary to examine the level of investment in local
network facilities (including cable television systems and
wireless systems) versus the level of investment in Internet
backbone facilities, undersea cables, and other long-haul fiber-
optic networks. For some investments, unrealistic predictions of
demand may have more explanatory power than regulatory
distortions.
A powerful factor contributing to excess capacity in long-
distance telecommunications was the unexpected degree of
improvement in dense wave division multiplexing. At first, a
given strand of fiber was split into two channels. The
technology rapidly advanced to where a given strand of fiber
now has over 100 channels, with the possibility of over 1000
channels in the future. Thus, as companies installed new long-
distance networks, technology improved so dramatically that
capacity outpaced growth in demand, even with the Internet's
rapid growth. The connection between this fact and the
WorldCom bankruptcy will be apparent later in this Article.
It bears emphasis, however, that this excess capacity exists at
the long-distance level, which is virtually unregulated in the
United States. At the local level, relatively little new facilities
investment by CLECs took place. Indeed, when Rhythms and
Northpoint (the second and third largest CLECs offering DSL
service) went bankrupt, their networks sold for under $50
million each. Similarly, Global Crossing's worldwide fiber optic
network, which consumed $15 billion in financing to construct
in the late 1990s, was implicitly valued in March 2003 at only
$406.5 million.10 Thus, we observed overinvestment in long-
distance networks with no regulation, and underinvestment in
regulated local networks, where the FCC (and state regulators)
set prices for unbundled elements and wholesale services.
For the sake of argument, suppose that those policies were
lawful but foolish. What should the FCC have done? Under
Chairman Michael Powell's leadership, the FCC in 2002

undertook a "Triennial Review" of its policies on mandatory
unbundling of local exchange networks. At that time, the agency
continued to embrace the proposition that, in its words, "access
to UNEs would lead to initial acceleration of alternative
facilities build-out because acquisition of sufficient customers
and necessary market information would justify new
construction."11 This is a testable hypothesis. After seven years
of implementing the Telecommunications Act of 1996, does
empirical evidence support it? What would the FCC have to find
empirically to continue to make this hypothesis the basis for its
UNE rules? Empirical research by Robert Crandall of the
Brookings Institution12 suggests that CLECs that built their
own facilities were more likely to produce what the FCC calls
"sustainable competition."13 In New York and Texas, for
example, where CLEC market share is higher than elsewhere, is
there any empirical evidence that there was a greater rate of
reliance on UNEs by CEECs? Answers to such questions are
essential to knowing whether, as the FCC assumes, mandatory
unbundling at regulated TELRIC-based prices achieves its
intended purpose.
And what exactly is that purpose? Section 251(d)(2) of the
Telecommunications Act requires an incumbent local exchange
carrier to unbundle at a regulated price any network element
which, if not offered on an unbundled basis at the regulated
price, would "impair" the CLEC's ability to compete.14 The
meaning of "impairment" is critical. Not surprisingly, the
definition was litigated in the Supreme Court after the FCC
essentially said that any UNE that can be unbundled must be
unbundled. The Supreme Court concluded that such a definition
had no limiting principle, and it therefore remanded the
rulemaking to the FCC.15 The FCC then decided to use the
phrase "materially diminishes" to limit the scope of the
statutory phrase "impairs."16
In May 2002, in U.S. Telecom Association v. FCC, the FCC's
impairment rule was again struck down on judicial review, this
time by the U.S. Court of Appeals for the District of Columbia

Circuit in an opinion by Judge Stephen F. Williams.17 At that
time, the FCC was already in the midst of its Triennial Review
of its unbundling rules. The FCC thus already had a proceeding
underway to answer the following kinds of questions that would
give economic content to the definition of "impairment." If FCC
regulation succeeded in reducing the CLECs' level of
"impairment," what variable would we observe changing:
Prices? Output? Investment? CLEC profit? Sales of
complementary hardware and software? The FCC said that it
wanted to review its UNE policies "in light of [its] experience"
since 1996.18 Experience implies empiricism, and unless the
FCC clearly states its hypothesis concerning the predicted
effects of its particular unbundling policies, such as the
impairment test, it cannot know what changes to expect or the
method by which to measure them.
The standard economic metric is consumer welfare, yet that is
the one conspicuous variable that the FCC excluded from its
laundry list of five factors that were supposed to unpack the
phrase "materially diminishes."19 I submit that no reasonable
understanding of "the public interest" can be reconciled with the
FCC's exclusion of consumer welfare from the list of relevant
considerations. A cynic might speculate that the reason for the
omission is that consideration of consumer welfare would
vitiate many of the FCC's conclusions on the essentiality of
unbundling particular network elements. Consideration of
consumer welfare would undo the competitor-welfare standard
by which the FCC hoped to straighten the Leaning Tower of
Pisa.
In this sense, the unbundling debate illustrates the potential
circularity of regulation. "Impairment" cannot be defined
without reference to the price regulation to which UNEs are
subject. Impairment is thus endogenously determined by UNE
price regulation. Moreover, impairment is endogenously
affected by the allowed duration of the lease. Under existing
TELRIC pricing, would a CLEC be impaired if it were required
to lease a UNE for its useful life (more precisely, for the

duration of its depreciable life for regulatory purposes), instead
of being free to lease the UNE for a period that is terminable at
will by the lessee and capped by regulators?
Furthermore, what is the fundamental economic characteristic of
"impairment?" Increasingly, the bottleneck of the
telecommunications network is regarded as the trench in the
street. The costliness of digging holes is a breathtakingly
unpersuasive justification for mandating the unbundling of
telecommunications networks, especially next-generation
services. It is regrettable that only a fraction of regulatory
energy was devoted to the coordination of the actual trenching
and sizing of conduit as was devoted to estimating the forward-
looking cost of an unbundled loop in a hypothetical network. A
CLEC faces no barrier to entry with respect to the provision of
a service if the ILEC itself is overlaying existing facilities or if
it is building new facilities or totally rehabilitating previous
facilities. The ILEC faces the same sunk cost that a CLEC
would. This analysis would seem to answer the FCC's central
question in its Triennial Review: should the FCC "modify or
limit incumbents' unbundling obligations going forward so as to
encourage incumbents and others to invest in new
construction[?]"20
The FCC would clarify the meaning of "impairment" if it
assessed the magnitude of the real option conferred on the
CLEC by mandatory unbundling of a particular network element
at a TELRIC-based price.21 The value of the real option held by
the CLEC increases with three factors: uncertainty concerning
technology, consumer demand, and regulation; the duration of
the lease; and the degree to which the leased assets are
investments by the ILEC that are sunk rather than salvageable.
The real option view of mandatory unbundling meshes neatly
with two of the five factors that the FCC had been using to
determine the scope of unbundling-that is, before the D.C.
Circuit's May 2002 decision in the U.S. Telecom Association
case.22 The first factor is, in the FCC's words, "whether the
[unbundling] obligation will promote facilities-based

competition, investment, and innovation," and the second, again
in the FCC's words, is "whether the unbundling requirements
will provide uniformity and predictability to new entrants and
market certainty in general."23 With respect to the second
factor, a lack of uniformity and predictability will increase the
standard deviation of returns for the ILEC, which increases the
value of the real option that the ILEC is implicitly forced by the
FCC to confer on CLECs. That increased value of the real
option represents the value to the CLEC of waiting to see
whether the ILEC's investments in new technologies pan out
before the CLEC commits itself to making sunk investments in
the acquisition of particular UNEs. The real option has the
effect of discouraging ILEC investment. To the extent that
innovation flows from investment, innovation is jeopardized by
a rising value of the real option inherently conveyed to CLECs
through mandatory unbundling.24
In contrast to such economic analysis, the FCC's definition of
"impair" as meaning "materially diminishes" does nothing to
reduce the regulatory risk that drives the value of the real
option that the ILEC must give CLECs when the FCC mandates
unbundling at TELRIC-based prices. A "materiality" standard
places enormous discretion in the hands of the regulator, which
increases regulatory risk for those making decisions on
investment in network infrastructure. That greater risk increases
the value of the real option that the FCC forces the ILEC to
confer on CLECs.
To its credit, the FCC in 2002 proposed what it called a "more
granular statutory analysis" of the unbundling requirements in
Section 251 of the Telecommunications Act. That
recommendation is consistent with the proposal that Jerry
Hausman and I made in 1999.25 In our article, we advocate an
impairment standard that is product-specific, geographically
specific, and limited in duration. In essence, a competitive
analysis of each desired network element is required, with an
antitrust-style examination of competition in the relevant
product and geographic market over the relevant time horizon.

This approach, incidentally, is consistent with the new
regulatory framework that the European Union has adopted for
telecommunications. In that framework, competition law
principles (of which consumer welfare maximization is the most
elemental) are supposed to guide decisions about what and how
to regulate on a sector-specific basis.
Under the Hausman-Sidak test, once the CLEC has
demonstrated that the network element meets the basic
requirements of the essential facilities doctrine, it would then
need to show also that an ILEC could exercise market power in
the provision of telecommunications services to end-users in the
relevant geographic market by restricting access to the
requested network element. Thus, the regulator would mandate
unbundling of a network element if, and only if, all of the
following conditions exist:
* It is technically feasible for the ILEC to provide the CLEC
unbundled access to the requested network element in the
relevant geographic market;
* The ILEC has denied the CLEC use of the network element at
a regulated price computed on the basis of the regulator's
estimate of the ILEC's total element long-run incremental cost;
* It is impractical and unreasonable for the CLEC to duplicate
the requested network element through any alternative source of
supply;
* The requested network element is controlled by an ILEC that
is a monopolist in the supply of a telecommunications service to
end-users and that employs the network element in question in
the relevant geographic market; and
* The ILEC can exercise market power in the provision of
telecommunications services to end-users in the relevant
geographic market by restricting access to the requested
network element.
In its practical application, this test would replace the FCC's
current competitor-welfare standard with a consumer-welfare
standard.
The Hausrnan-Sidak analysis also answers the FCC's request in

its Triennial Review for an unbundling framework that
incorporates what the Commission calls "intermodal
competition."26 The test would consider the effect of declining
prices and growing subscribership for wireless as a factor
bearing on the extent to which wireless-wireline displacement,
rather than unbundling rules, have impaired CLECs.27 The
FCC's own statistics show that the number of wired access lines
in the United States fell by two million between 2000 and
2001.28 In August 2002, Forbes magazine reported on the
competitive implications of that fact,29 and the New York
Times reported that wireless was displacing wireline telephone
access.30 By early 2002, nearly eighteen percent of Americans
considered wireless service to be their primary means of voice
communication.31 Figure 4 shows the growth of wireless
subscribership relative to local access lines. Figure 4 shows that
the growth of wireless subscribers exceeded the growth of
access lines between 1985 and 2002. Also, between 2000 and
2002, the growth rate of access lines was negative, whereas the
growth rate of cellular subscribers remained positive. It would
seem inescapable, therefore, that the wireless industry has
stolen customers from the wireline industry. In other words, the
local loop bottleneck is not a bottleneck.
Competition occurs on the margin. So why does the FCC not
acknowledge that cell phones now substitute for landlines for
significant numbers of consumers? Even the Interstate
Commerce Commission, the whipping boy of deregulators,
managed to acknowledge intermodal competition between
railroads, barges, and pipelines in the 1980s, when it revised its
policy on rate regulation for railroads serving captive
shippers.32
Of course, intermodal competition between wireless and
wireline telephony depends critically on the FCC's allocation of
sufficient spectrum to accommodate the shift in demand. This
dependency on government spectrum allocation is another
example of the regulation-induced endogeneity of perceived
market failure. Without enough spectrum allocated, the local

loop looks like a bottleneck. That appearance of market failure
is then considered evidence of the continued need for
regulation. In the United States, we have never permitted the
necessary counterfactual to come into existence, so as to assess
without regulatory endogeneity whether the local loop really is
a natural monopoly or an essential facility. If the FCC were to
acknowledge the actual and potential displacement of wireline
access by wireless, the exercise of mandating the unbundling of
incumbent local exchange networks would sooner or later fade
away.
* * *
On February 20, 2003, as this Article was going to press, the
FCC announced its decision in its Triennial Review on
unbundling policy. In a 3-2 vote in which Chairman Powell and
Commissioner Kathleen Abernathy strenuously dissented from
the majority led by fellow Republican, Commissioner Kevin
Martin, the FCC announced a new impairment standard to be
administered by the state PUCs. The procedure by which the
FCC announced this new policy was bizarre, as the agency did
not actually have an order to issue at its meeting. Evidently,
because of the last-minute negotiations among the
commissioners, the FCC voted on a "term sheet" for an order,
not an actual draft order. Commissioner Michael Copps said in
his separate statement: "Although the bottom lines have been
decided, the devil is more often than not in the details. I am
unable to fully sign on to decisions without reservations until
there is a final written product."33 Clearly, changing a "shall"
to "may" here and there in an order running several hundred
pages could escape notice but have a substantial impact on the
order's practical meaning.
Given, for purposes of administrative procedure, the absence of
the text of an order at the time of the February 20, 2003
meeting, it is fair to ask whether the FCC actually issued an
order that day. If it did not, the old unbundling rules expired on
February 20, 2003, pursuant to the lifting of the stay by the
D.C. Circuit in the U.S. Telecom Association case.34 From that

day until the FCC ultimately publishes the text of its Triennial
Review order in the Federal Register, only the bare statutory
language of Section 251 of the Telecommunications Act defines
the government-created rights of CLECs and the government-
created obligations of ILECs. Similarly, if the devil is truly in
the details, then the commissioners' final agreement on the
language of the Triennial Review order would seem to be a
different "meeting" for purposes of administrative law, separate
from their decision to reduce to writing their broad-brush
agreement on "the bottom lines." If so, then this subsequent
meeting would trigger the usual public notice and ex parte
procedures.
The high school civics rendition of administrative law would
posit that Congress, a political body, established the FCC to be
an expert independent agency to set telecommunications policy.
Because of such agency expertise and independence, the
Supreme Court has instructed the D.C. Circuit and other federal
appellate courts to defer, through the Chevron doctrine, to the
reasoned analysis of an agency like the FCC. The FCC's
decision in the Triennial Review, however, plainly was not
based on reasoned analysis, as there was no document
explaining why various lines were being drawn in one place and
not another. The decision exhibited neither expertise nor
independence. The commissioners could not be sure what they
were voting for, and their statements accompanying the decision
radiated politics. The possible dimensions of political struggle
in the Triennial Review are multiple: There are the economic
interests of the RBOCs in conflict with those of AT&T and the
other CLECs; the personal ambitions of Commissioner Martin
versus those of Chairman Powell; and, even though they seem
far fetched, White House concerns about the ramifications of
unbundling and TELRIC pricing for the 2004 presidential
election.35
Given so much politics surrounding what can only be fairly
characterized as a desiccated matter of pricing regulation, it is
worth asking why Congress needs the FCC at all. Why should

Congress delegate the making of transparently political
decisions concerning telecommunications to a body whose
comparative advantage is not supposed to be politics? Why not
leave political decisions with the elected federal legislature? If
the FCC's review of mandatory unbundling policy ultimately
will turn on politics, why should Congress permit the FCC to
waste more than a year compiling a record by which the agency
might pretend to have reached its decision by a more
disinterested means?
The Triennial Review also incidentally suggests how Chevron
can cheapen the constitutional role of the judiciary with respect
to oversight of the administrative state. Agencies and the
litigants before them engage in highly strategic use of the
administrative process in which the sustainability of regulations
on appeal is a major component. If the purpose of appellate
review is to determine whether a supposedly expert independent
agency has managed to produce one "reasonable" reading of its
statute, then how much is really left for appellate judges to do
in administrative law? It does not require a penchant for judicial
activism to believe that Chevron can diminish the proper role of
the Judiciary as the interpreter of acts of Congress. How much
deference is due an agency decision like the Triennial Review,
which mocks the administrative process?
Turning to the substance of the FCC's decision, the
Commission's press release redefined "impairment" such that
"[a] requesting carrier is impaired when lack of access to an
incumbent LEC network element poses a barrier or barriers to
entry . . . which are likely to make entry into a market
uneconomic."36 This analysis, the FCC said, "specifically
considers market-specific variations, including considerations
of customer class, geography, and service."37 The only UNE
that the FCC removed from the unbundling list was switching
for high-capacity loops (which principally serve business
customers), and even that national finding may be rebutted by
individual states.38 With the exception of high-capacity
switching, the new status quo would seem to be that all UNEs

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