Good Deal

Defending the SEC’s settlement with MCI.

At first blush, the settlement that the company formerly known as Worldcom tentatively reached with the Securities and Exchange Commission appears rather straightforward. To resolve charges that the company illegally inflated revenues and earnings by $11 billion, the bankrupt firm (which now goes by MCI) will pay a $500 million fine. As per the mandates of the Sarbanes-Oxley law, the cash will be distributed to investors. The SEC will cease pursuing MCI, while continuing to focus on former Worldcom executives who may have perpetrated the fraud.

William Barr, the former attorney general and the aggrieved general counsel of Verizon, finds the fine insulting. He has been lobbying for the imposition of the death penalty on Worldcom’s rump because he believes its assets, customers, and contracts are ill-gotten gains. And, as Barr put it, “Bankruptcy is not a mechanism for laundering stolen goods.”(Even worse, from Barr’s perspective, if MCI emerges from Chapter 11 this fall with less debt and aggressive expansion plans, it could prove a formidable competitor.)

The justice in this case is plainly more symbolic than retributive. The $500 million is only a small chunk of the bankrupt company’s current cash hoard. Based on MCI’s recent monthly operating reports, the fine represents about one week’s worth of revenue. And while elements of MCI’s bankruptcy are troubling, Barr’s reasoning doesn’t hold up. The bankruptcy system recognizes a different form of justice than that meted out by prosecutors, and it refuses to grant victim status to the competitors of failed companies—regardless of why or how they failed. Besides, continuing to punish MCI would be a little like keeping sanctions on Iraq even after Saddam Hussein’s regime has ended.

Barr’s brief goes as follows: By falsely claming to have made profits on its services in the past few years, Worldcom forced those who used honest accounting to engage in self-destructive discounting. And if MCI emerges from bankruptcy this fall, shorn of its once-onerous debt load, the second-largest long-distance company will be able to compete aggressively for new business. Because he believes Worldcom won many of its existing contracts by guile or fraud, Barr compares MCI to an organized crime enterprise. “If I go out and steal trucks for my business, I can’t keep those trucks by claiming bankruptcy,” he says.

But by any definition, today’s MCI bears comparatively little relation to the Worldcom of a few years ago. And none of the people who are alleged to have stolen the trucks at Worldcom are keeping them.

Chapter 11 is a means of transferring ownership from debtors to creditors. It’s also a re-branding experience. The company has changed its name from the scandal-ridden Worldcom to the more romantic MCI. (MCI, of course, was the upstart that took on Ma Bell back in the early 1970s, when offering competitive long-distance service was essentially illegal.) The company is moving its headquarters from the ethical swamp of Clinton, Miss., to the comparatively salubrious climate of suburban Washington. And it has a new chief executive, former Compaq head Michael Capellas, who has no link to the ancien régime.

Worldcom was run like a private piggy bank for CEO Bernard Ebbers and a selected coterie of officials. Today’s MCI is run as a trust for its creditors, who, upon the company’s emergence from Chapter 11, will become its new shareholders. In the future, there will be no way for the disgraced Ebbers to benefit from any of the competitive advantages MCI may have reaped under his leadership. His options and stock are worthless. His pension has been cut off. And because Ebbers has missed payments on loans made to him by Worldcom, MCI is starting to sell his assets. Meanwhile, both the SEC and the Justice Department are continuing to build cases against senior Worldcom officials. (Ebbers hasn’t been charged. Yet.) Levying a giant fine on bankrupt Worldcom would take cash out of the pockets of people who have legally recognized claims on the company’s assets.

MCI may be receiving some special treatment in Washington. Enron was barred from bidding on federal contracts after it went into Chapter 11. But MCI, which provides services to more than 75 government agencies and is a huge government contractor, continues to receive them. Still, MCI isn’t the only telecommunications company to benefit from such favoritism. Verizon, to take one example, reaps enormous benefits by virtue of its favored regulatory position in the local telephone business.

In the end, the settlement was less a product of blind justice than of cold calculation. The SEC angled for an attention-grabbing headline number. The financial types at MCI, after consulting their spreadsheets and cash-flow matrixes, figured out what price the recovering firm could reasonably pay for the sins of its previous owners.

Chapter 11 is always a dissatisfying, zero-sum game. Creditors generally settle for pennies on the dollar. Even the SEC isn’t getting what it had hoped. The settlement actually requires MCI to pay a civil penalty of $1.51 billion. But because the company is bankrupt, the agency agreed to accept the $500 million on behalf of defrauded investors. In bankruptcy, even the Feds have to take a haircut.