Tech Q & A
Chapter 11: Laundering Fraud?
By REBECCA BLUMENSTEIN and ALMAR LATOUR
Staff Reporters of THE WALL STREET JOURNAL
William Barr, the general counsel of Verizon Communications Inc., and Michael H. Salsbury, MCI's general counsel, have sparred for years from opposite sides of the telecommunications industry. Neither minces words. Mr. Barr, 53 years old, is a former U.S. attorney general, and Mr. Salsbury, also 53, fought the legal battles for MCI that led to the breakup of the original Bell monopoly. Now, the Verizon counsel is arguing that the former WorldCom, which bought MCI in 1998 and has since renamed itself MCI, shouldn't be allowed to emerge from bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. MCI's lawyer strongly disagrees. The two responded to questions posed by The Wall Street Journal in separate interviews.
WSJ: Is WorldCom different from other companies that have filed for bankruptcy and attempted to emerge and compete again?![[William Barr]](http://interactive.wsj.com/public/resources/images/Barr_William-GC66005142003221231.gif)
Mr. Barr: Reorganization doesn't apply when the assets are the product of crime. If I go out and lawfully acquire trucks for my business and I go bankrupt, I might be able to keep the trucks. If I go out and steal trucks for my business, I can't keep those trucks by claiming bankruptcy.
Bankruptcy is not a mechanism for laundering stolen goods. It doesn't provide a safe harbor for proceeds of crime. So the fundamental difference between companies like the airlines and the steel industry and WorldCom/MCI is that the latter is responsible for the largest corporate fraud in American history, and clearly a substantial part of its business is the fruit of its fraud.
Mr. Salsbury: This is not a company that was built or created by fraud. MCI is a company that was around for 30 years and was built by hard work, innovation and providing services to customers. UUNet is the same thing, WorldCom and WorldCom International the same thing. The actions of a few people to restate some revenue over a two- or three-year period should not be used to color the heritage of these companies.
The bankruptcy process is not a picnic. People don't volunteer for it. We have made tremendous changes. We have a new CEO, a new CFO and a new board of directors. All the people associated with the fraud are gone. This is an unprecedented effort to reform the situation that allowed the actions of a few to cause damage to the company.
Further, the people that were defrauded here by the misstatement of earnings are the creditors of the company. Those are the creditors that are behind the reorganization and the re-emergence of the company.
WSJ: The government is prosecuting the individuals associated with the fraud, which could reach as high as $11 billion. What does that have to do with bankruptcy?
Mr. Barr: This falls squarely within the framework of bankruptcy law because the bankruptcy law specifically recognizes that law enforcement needs have to take precedence, and that the government has latitude to do what's necessary to rectify criminality. And any relief that's ultimately granted in bankruptcy has to conform with an appropriate enforcement resolution. So there is no right to reorganization when you are dealing with assets that are tainted by fraud.
Mr. Salsbury: I think that the Chapter 11 case here is no different than any other Chapter 11 case. There are the fraud elements that in this case were handled outside the bankruptcy process. The airlines and steel companies didn't face those other investigations and proceedings that we did. It is interesting that we don't see Verizon expressing shock and outrage over companies like Adelphia that have committed fraud and are trying to emerge from bankruptcy. This is a competitive issue for them. Monopolies don't like competition. Therefore, they react the way they have.
WSJ: How did WorldCom benefit from the fraud?
Mr. Barr: You have massive fraud over a three-year period, at least. Clearly, that resulted in the company acquiring assets and customers it wouldn't have had but for the fraud. Its books during this period were showing swings of $3 billion.
These were not rounding errors in their financial statements. These were massive. They doubled their debt over that three-year period. But for the fraud, they wouldn't have had that money and they wouldn't have been able to acquire those assets and customers. So part of their business is ill-gotten gain. So what happens if you allow a company like that to reorganize? The reorganization actually completes the crime and perfects the crime, and it puts them in a better position than they were in before the crime was detected.
Mr. Salsbury: This is a company that has suffered terribly because we discovered the fraud, we exposed it and have gone to extraordinary lengths to cooperate. We are also the ones, along with the creditors of the company, who have paid the price for that. More than 90% of the creditors have signed onto the reorganization plan, and these are the people that Verizon is saying are wrong. We have suffered tremendously. Our employees have lost their retirement accounts and many of them their jobs, and it will take us years to rebuild our name. This company was not built on fraud.
WSJ: Why isn't it enough that prosecutors are pursuing criminal charges against the individuals within WorldCom who committed the fraud?
Mr. Barr: If organized crime sets up a corrupt company, a trucking firm, and it steals trucks and it engages in all kinds of criminal activity to build up that firm, there are two sets of victims. There are the people that they steal the trucks from, and there are the honest trucking companies that they're stealing business from, customers from and value from. Now what would the government do if it found out that there was this entity set up by organized crime that was involved in fraud?
Would it be enough just to punish an individual or individuals, and then leave the company to operate? Would the government say let's get this guy's cousin to run it, he's a good guy? That situation would result in the continuing victimization of honest trucking firms because that company is still a criminal enterprise.
This argument is not about punishment. It is about removing the effects of the crime and rectifying the crime, which is another important objective of the criminal justice system -- which so far the enforcers in WorldCom/MCI's case seem to be ignoring.
Mr. Salsbury: The illegal acts were committed by individuals, and those individuals have been separated from the company.
The bankruptcy laws favor reorganization because it is better for the economy. People don't lose their jobs, and customers don't lose their service.
We believed right from the beginning that we should cooperate. We have cooperated more than any other company in that situation. Further, the SEC has gone to tremendous lengths in this case. They insisted that a corporate monitor be installed to oversee all activities. No other company has faced that. The SEC took very aggressive action, and Richard Breeden, the corporate monitor, has reported that we have in fact made tremendous strides in reforming the company.
We reached a partial settlement last fall with the SEC. We have had ongoing discussions with them about that. No other company has ever had a corporate monitor sitting within the company, a former chairman of the SEC. He has access to every single element of our business.
WSJ: Isn't there a third group of victims, the employees, who would be further victimized by liquidation -- or breaking WorldCom into pieces that would be sold?
Mr. Barr: Liquidation doesn't mean that the company is vaporized. Liquidation means that the assets continue in the marketplace and are deployed in the market, but they do so under new ownership. That ownership has a cost basis in the assets that is based on honest economics and therefore results in honest competition.
And the employees, presumably, will keep jobs with the new entity that is deploying these assets. The alternative of allowing reorganization means that there will be employees that will lose their jobs, but it will be employees of the honest companies that are being confronted by a company that has artificial advantages in the marketplace and efficiency in the marketplace that has been dictated by government fiat, not by real economics.
Mr. Salsbury: When the plan of reorganization comes up for confirmation, one of the decisions the creditors make is whether the company is worth more liquidated than as an ongoing concern. Clearly, the creditors believe the company is worth far less in liquidation.
I am sure Verizon would rather we be liquidated because they would be able to raise prices and have less competition. None of the employees would retain their jobs in liquidation. Why don't you ask them how they feel about it?
This is a company that has a viable ongoing business. There are many companies that go into Chapter 11 that can't emerge. We have 20 million plus customers, 55,000 employees. Our customers and our creditors want us to emerge. Why should our creditors be forced by Verizon to accept a smaller amount?
WSJ: So is there something wrong with bankruptcy law? What about companies like the former Sunbeam, now called American Households Inc., that have been accused of fraud and emerged from bankruptcy?
Mr. Barr: Bankruptcies in capital-intensive infrastructure industries, like airlines and like telecom, are as a matter of economic policy very damaging. And there is a school of thought that bankruptcy should not be permitted in that kind of industry. But that's not the argument I'm making here. I'm arguing that whatever may be said of a law-abiding company stumbling into bankruptcy, bankruptcy reorganization should not be available to a company whose business has been significantly built on fraud. Bankruptcy is meant to forgive stupidity, not reward criminality.
The Sunbeam case shows that not every instance of accounting fraud necessarily taints a company. It is a matter of degree -- how large, how sustained, how far it contributed to building the business. At Sunbeam the company had been solid for 100 years and an outsider swooped in using specious accounting for less than two years. MCI presents a far different situation.
Mr. Salsbury: The first set of victims in the bankruptcy are the creditors. They are the ones who are voting in favor of us. They believe [reorganization] is the proper outcome.
Customers make a choice every day what service providers they want to use. Unlike Verizon or the Bell companies, we don't have monopolies. Every single customer of our company made a decision to come with us. There is nothing to prevent Verizon from winning back these customers. They realize now that we will emerge this fall, and this is not something they had anticipated. I think they did not anticipate that our customers would stick by us and that we would be able to put our house in order as quickly as we have.
WSJ: Arthur Andersen LLP was indicted and later convicted as a company for obstruction of justice after being accused of destroying documents. What are the differences here?
Mr. Barr: I think the problem is that some people, mostly at political levels, maybe made uninformed decisions, or at least had an uninformed view that enforcement shouldn't do anything that can be viewed as destroying a company. What was being done at Andersen was the punishment of a company by indicting the company. Here I am not talking about punitive measures that should be taken against WorldCom. I haven't said anything about that. What I'm saying is that effective enforcement action requires liquidation, not reorganization.
Mr. Salsbury: We have been told that our ongoing cooperation is the best assurance that there won't be anything like that. There is nothing pending like that now.
Write to Rebecca Blumenstein at rebecca.blumenstein@wsj.com and Almar Latour at almar.latour@wsj.com