Bankruptcy examiner: WorldCom avoided state taxes

WorldCom engaged in a questionable program to reduce the state taxes it paid by millions of dollars between 1998 and 2001, according to a final bankruptcy examiner’s report released Monday

The 542-page report, released by examiner Dick Thornburgh, also accuses WorldCom and former Chief Executive Officer Bernard Ebbers of maintaining “improper” relationships with investment bankers, including Citigroup Global Markets.’s Smith Barney group. Thornburgh accuses Smith Barney, formerly known as Salomon/SSB, of offering Ebbers “extraordinary” shares in initial public offerings (IPOs) between 1996 and 2000, allegedly to influence Ebbers to give his company’s investment banking business to Smith Barney.

“It is obviously difficult to prove, with certainty, that the Salomon/SSB IPO allocations to Mr. Ebbers were made for the purpose of obtaining WorldCom’s investment banking business, especially since Salomon/SSB has denied that there was any connection …,” Thornburgh wrote in the report. “Nevertheless, the Examiner concludes that the evidence strongly supports the conclusion that the extraordinary allocations to Mr. Ebbers were made to obtain and then to keep WorldCom as an investment banking client.”

Ebbers gained $12.8 million from stock shares given him by Salomon/SSB in 22 IPOs between June 1996 and August 2000, according to the Thornburgh report. Ebbers steered $106.8 million worth of business to Salomon/SSB between August 1996 and February 2002, the report adds.

Neither a Citigroup representative nor Ebbers’ lawyer Reid Weingarten, were immediately available for comment.

WorldCom filed for bankruptcy in July 2002, about a month after the company disclosed that a group of former employees had altered accounting records to conceal losses and inflate earnings. The company plans to emerge from bankruptcy next month.

The first 100-plus pages of Thornburgh’s report, which follows reports released in November 2002 and June 2003, focuses on WorldCom’s “state tax minimization” program, recommended to the company by KPMG Peat Marwick. Under the program, WorldCom classified the “foresight of top management” as an intangible asset, and licensed that foresight to subsidiaries for royalties. The subsidiaries then counted the royalties as business expenses deductible on state taxes.

But Thornburgh wrote that management foresight is not an asset that WorldCom could charge royalties for. In September 2003, nine states filed paperwork with the U.S. Bankruptcy Court for the Southern District of New York asking for time to conduct audits on taxes owed by WorldCom. Thornburgh suggested in his Monday report that WorldCom may have a claim of malpractice and negligence against KPMG for interest and penalties WorldCom may owe to states.

KPMG issued a statement Monday calling Thornburgh’s conclusions about the tax program “simply wrong.”

“The tax strategy employed by WorldCom and still in effect today is commonly used by companies with subsidiaries in many jurisdictions to simplify their state tax structure,” the KPMG statement said. “The vast majority of companies with multi-state subsidiaries pursue similar strategies to shift income among states, transferring tax obligations to lower-taxed jurisdictions.”

WorldCom has already reviewed the KPMG tax program and found it was appropriate, said Stasia Kelly, WorldCom executive vice president and general counsel. “As a result, the company has no plans to pursue claims against KPMG,” Kelly said in a statement.

Thornburgh’s report leaves the decision of lawsuits up to WorldCom, but he suggests the company could also have causes of action against Ebbers for awarding banking business to Salomon/SSB in return for IPO stock options and for accepting more than $400 million in loans from WorldCom. Thornburgh also suggests WorldCom could have claims against former Chief Financial Officer Scott Sullivan and other former employees for fraud and breaches of the fiduciary duties of loyalty and good faith for actions related to accounting irregularities.

WorldCom will invite Thornburgh to present his findings to its board of directors “as part of our ongoing efforts to ensure that what happened in the past will never happen again,” Kelly said in her statement.

WorldCom is considering potential lawsuits against outside parties discussed in Thornburgh’s report, she added. The company will take actions when they are appropriate, are a prudent use of company resources and have a “strong likelihood” of winning, Kelly said in the statement.

WorldCom is working to become a new kind of company, Kelly said. “The company has put in place procedures and resources to ensure that the highest standards of business ethics are maintained,” she added in her statement. “We have worked together to build a culture at MCI where integrity and honesty are valued above all else. As MCI approaches its emergence from Chapter 11, we remain focused on MCI’s future as a leader in the convergence of telecommunications and computing. Somewhere between those two worlds is a new kind of company, and that’s what we’ll be.”