TCS Daily


End the Outrage

By James K. Glassman - June 10, 2003 12:00 AM

Editor's note: The following is a speech given this week in New York by TCS Host James K. Glassman to the New Democracy Project.

I feel a little out of place here today. Mark Green, Congressman Meeks, Rev. Chase - a distinguished group, but I doubt we share the same viewpoint on most political and economic matters. I am a guy who voted for George W. Bush and his father and for Ronald Reagan. I work for a think tank, the American Enterprise Institute, that is generally considered as right-leaning. I am an enthusiastic supporter of free-market capitalism - the more vigorous, the better. And I am host of a website, TechCentralStation.com, whose motto is "where free markets meet technology."

But I do share the outrage of the others on this panel about the events since the disclosure, almost precisely a year ago, that WorldCom had perpetrated what we now know is the worst corporate fraud in American history - $9 billion is admitted, and the final figure could go higher - some say to $11 billion. We are still awaiting two important reports on the extent and nature of the fraud, but we know that shareholders have lost over $100 billion and bondholders a huge amount as well.

The outrage is that WorldCom is still alive. Oh, the company changed its name to MCI. But it is still the same company. WorldCom - and I will call it by its more notorious name - does not deserve to live.

What has happened since the disclosure of fraud? WorldCom has filed for bankruptcy. Its stock is practically worthless. There have been management changes.

Yet WorldCom lives. It was recently awarded a $45 million contract by the federal government to provide cellular phone service in Iraq and another $7 million contract for the government for satellite data service for weather forecasting.

A recent tally by Washington Technology, a trade newspaper, found that WorldCom last year ranked eighth among all government technology contractors in 2002 - the first year it cracked the top 10. Overall, sales to the government were $772 million. WorldCom sells to 75 separate federal agencies.

Meanwhile, last month, WorldCom agreed to pay a fine of $500 million. It was the largest ever imposed by the SEC on a non-Wall Street company. But, according to an excellent article last week by Brock Meeks on MSNBC.com, "the amount was widely regarded throughout the industry as a slap on the wrist, given the nature of the company and its historic bankruptcy finding."

"It doesn't take an accounting whiz to figure out that WorldCom comes off pretty well in the deal," said an editorial May 21 in USA Today. "The $500 million fine equals just one week's worth of revenue. Lone junk-bond guru Michael Milken ended up paying more in fines ($600 million) for his crimes in the 1980s."

Jim Cicconi, general counsel to AT&T was quoted in the Washington Post as saying: "A $500 million payment for the largest corporate fraud in history is certainly not commensurate with the scale and scope of the fraud and represents only a paltry fraction of the hundreds of billions of dollars in losses suffered by innocent shareholders, honest competitors and debt holders."

So let's get this straight....

Perpetrate a gigantic fraud. Win government contracts. Get an easily manageable fine. And get tax refunds in addition. Instead of dying or at least being chastened, MCI has been reborn as a company with swagger.

Yes, according to a report in the Wall Street Journal, WorldCom is "in the process of collecting or filing for tax refunds or credits from the Internal Revenue Service because of tax payments on billions of dollars [WorldCom] falsely claimed to have earned."

Now, that's chutzpah, as we say in New York. It's like a kid shooting his parents and asking for restitution because he's an orphan.

Here is what is happening: MCI's executives are saying that, we didn't really make all those profits that we reported, but we paid the taxes anyway as part of the cover-up, so we demand a tax refund from the American people. Not only that, but according to a report in Business Week, MCI plans to carry forward its newly recognized losses - "at least $6.6 billion" - from prior years in order to shelter further earnings from taxes.

This is nuts. Where is Congress? Where is the media? Where is the outrage?

After the Enron and WorldCom scandals broke, there was an appropriate uproar. The main result was the Sarbanes-Oxley legislation. I was not an enthusiast of this approach. Making accounting rules more complicated and forcing honest corporate executives to spend more time and more of their shareholders' money jumping new regulatory hurdles - that was a waste, in my view. Though it was understandable politically.

But the best way to prevent future wrongdoing is to punish past wrongdoing with swiftness, certainty and brutality. Americans need to see corporate villains, and villainous corporations, pay a high price.

"A general disillusionment with Wall Street and corporate America...has continued to grow," said William Donaldson, the new chairman of the SEC, in a speech last month. Yes, and no wonder.

Sen. Susan Collins, Republican of Maine, asked recently for an explanation from the General Services Administration: "The massive accounting fraud by WorldCom has been well documented," she wrote to Stephen A. Perry, administrator of the GSA, which manages the federal procurement system.

As a result of the fraud, WorldCom misrepresented its true financial condition to the government and was able to get financing on far better terms than if the truth were known. "Despite all of this," Sen. Collins wrote, "WorldCom continues to remain eligible for, and receive, federal government contracts."

By contrast, GSA quickly suspended Enron and Arthur Andersen, the accounting firm, from getting federal contracts. But "no similar action...has been undertaken in regard to WorldCom." Sen. Collins wanted to know why.

Perry wrote back on May 30, citing a memorandum by the GSA's general counsel, Raymond J. McKenna, who wrote: "In order for a federal contractor to be suspended, there must first be a showing of 'adequate evidence' of infractions that affect the present responsibility of the firm or individual to conduct future business with the government."

Adequate evidence! What does the GSA want? Sen. Collins was unhappy with the GSA answer, and she should be.

But it is of a piece with other government actions - equally disturbing.

On Friday, the SEC told Judge Jed Rakoff of the U.S. District Court in New York that its proposed settlement with WorldCom is indeed harsh. In fact, the SEC went out of its way to praise WorldCom for its cooperation.

Why should WorldCom's activity be tolerated?

My guess, though no one involved will say so, is that there is fear - at the SEC, at the Federal Communications Commission and perhaps in the loftier levels of the Bush administration - that if WorldCom is harshly punished it will disappear, and the telecom infrastructure of the United States will suffer a severe blow; customers may be inconvenienced.

A hint came from Michael Powell, the FCC chairman, who said last year, "This is a significant company whose assets are critical components of the entire network. It would be messy if they became unavailable."

This is utter nonsense - the result, in part, of a concerted campaign by WorldCom to exaggerate its own importance. In fact, WorldCom handles only about 15 percent of all Internet traffic in North America, according to RHK, Inc., a San Francisco research firm.

Why would the assets become "unavailable," as Powell put it? In a proper liquidation, the assets are sold to the highest bidder. WorldCom's market share of Internet infrastructure could easily be absorbed by current telecom providers. Ditto, its long-distance business.

The disappearance of WorldCom, in fact, would make the market healthier, both ethically and competitively.

The FCC, as my colleague Gregory Sidak of the American Enterprise Institute has clearly shown, has within its own authority the ability to revoke WorldCom's licenses, or at the very least require the company to show cause why they should not be revoked. The company clearly does not meet the statutory "good character" test.

To sell off WorldCom's assets won't mean that thousands of jobs, millions of customers and billions of dollars' worth of equipment will disappear into thin air. To the contrary. In a free market system, the valuable assets of a failed firm (human and physical) move from weak to strong hands. The great economist Joseph Schumpeter called this process "creative destruction." Zombies like WorldCom are a drag on any economy.

But forget the economics. Think of the ethics.

As reporter Meeks wrote:

"Critics say it's an irresponsible waste of taxpayer money to artificially prop up a bankrupt and scandal-ridden company and that continuing to hand MCI contracts sends the wrong signal to future corporate crooks."

The contract to provide services for the National Oceanic and Atmospheric Administration, NOAA, came on the very day that the half-billion-dollar settlement with the SEC was announced. Tom Schatz, head of Citizens Against Government Waste, called it a "stunningly ill-conceived and mistimed move." Schatz added, "This kind of thinking, this kind of reasoning and the continued flow of contracts give the appearance of a hidden bailout of MCI by the federal government."

What is to be done?

First, Judge Rakoff should send the SEC back to the drawing board, with a demand for a serious fine - what about $9 billion, the amount of the fraud itself? Second, the GSA should bar WorldCom from future government contracts. After all, when the GSA barred Enron and Arthur Andersen, it said that the companies "had engaged in misconduct and committed internal control irregularities that seriously affect their suitability to receive government contracts." Third, the IRS should take WorldCom to court to fight the company's effort to win billions in tax refunds. Fourth, the FCC should immediately initiate proceedings to revoke the company's licenses.
The result of these actions will be to put WorldCom out of business - which is what it should be put out of.

Some will argue that, after all, WorldCom as a company is not guilty. Only the people who perpetrated the fraud are guilty. This argument might be valid if only a couple of officers were involved, but even the SEC admits that the fraud "was perpetrated by members of WorldCom's senior management and required the acquiescence of dozens of WorldCom employees to remain undetected for more than three years." In a widespread fraud like this, there is no difference here between the people and the company.

And the effect on the public - encouraging the kind of cynicism that Donaldson says he deplores - is undeniable if the company exists and, indeed, thrives. Most people don't know about those dozens of employees at WorldCom. They know the company. WorldCom. MCI. Whatever you want to call it.

As a conservative who believes in free markets, I do not want the government propping up any company - much less the worst miscreant in corporate history.

And one warning to an administration that I greatly admire: Let the WorldCom scandal fester and persist like this, and you will be making an issue for your opponents in the next election.

But forget politics. Forget economics. In the name of simple decency, it is time for the federal agencies that have been coddling WorldCom to do the right thing: kill it.
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