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The WorldCom, Inc., bankruptcy was the largest in history. The company improperly overstated its income by approximately $11 billion, improperly overstated its balance sheet by approximately $75 billion, and caused losses to shareholders of as much as $250 billion. In November the company’s former chief executive officer, Bernard Ebbers, is set to go on trial for fraud. While the accounting irregularities behind these overstatements received the most press, as the court-appointed bankruptcy examiner and counsel, the three reports that we issued identified many other transgressions as well. These included absence of checks on the CEO, breach of fiduciary responsibility by the board, ineffective internal controls, and a state tax minimization program that allowed WorldCom to evade payment of hundreds of millions of dollars of income tax in multiple states. It is impossible to create a system that will prevent all corporate fraud. But companies, led by their general counsel, can take steps to minimize the risk of fraud. The issues identified during our investigation of WorldCom provide important lessons for any chief legal officer. Six of the more significant ones are discussed below. 1. CONTROL A DOMINANT CEO. The examiner’s three reports — released in November 2002, June 2003, and January 2004 — noted that Ebbers was a domineering force at WorldCom. In addition to setting the company’s course, he also controlled the board’s agenda, discussions, and decisions. In one situation, Ebbers got board approval to buy Intermedia Communications, Inc., a telecommunications and Internet company, for $6 billion, based on nothing more than 90 minutes of due diligence and a 35-minute telephonic board meeting — for which some directors received no more than two hours’ notice. When WorldCom had an opportunity six months later to abandon the proposed transaction, Ebbers did not even notify the board. Instead he had the transaction finalized. The value of Intermedia ultimately dropped to a small fraction of what was paid for it, resulting in huge losses for WorldCom shareholders. It is often difficult for a CLO to “control” a dominant CEO, particularly since the CLO job typically works at the pleasure of the CEO, and the CEO sets the CLO’s compensation. If, however, the CLO believes that the CEO is not acting in the shareholders’ best interests, then the CLO must register his objections. They should first be raised with the CEO. If that is unsuccessful, the CLO should bring the matter to the board. In extreme cases, and subject to privilege issues, the CLO may want to notify the Securities and Exchange Commission or other appropriate regulator. 2. KEEP THE BOARD OF DIRECTORS FULLY INFORMED. In the Intermedia acquisition described above, the examiner found that the board was not fully informed of all relevant facts. At the very least, the CLO must determine whether the board has the information necessary to fulfill its fiduciary duties. Moreover, there may be situations where the interests of the CEO and the board are not aligned. If the CLO believes that the board either does not have sufficient information or is in potential conflict with the CEO on a critical issue, it may be appropriate for the CLO to recommend that the board retain separate counsel. While the board may not want to retain separate counsel for each of its actions, that may be advisable for the more significant ones. 3. CONTROL YOUR LAW DEPARTMENT COMPLETELY The former CLO of WorldCom has not been accused of violating the law. A close look at the company’s law department, however, yields some useful insights. WorldCom grew through a series of acquisitions, and so did its legal department. The resulting department was geographically dispersed and lacked a unifying culture. Lines of authority within the department were not always clear. At least one lawyer reported directly to Ebbers, not to the CLO. The result was that the CLO was not always aware of what all of the lawyers were doing. In large companies, it is not uncommon for lawyers to work in different states and countries. No matter how far-flung the lawyers are, however, the CLO must retain ultimate supervisory responsibility, either directly or indirectly. Without this, the legal department simply cannot operate effectively. Moreover, the CLO must establish clear lines of authority and responsibilities within the department so that the lawyers can understand their roles. The senior members of the department should communicate regularly about current and potential issues facing the company. 4. DESIGNATE A SENIOR LAWYER TO TRACK SIGNIFICANT MATTERS. In 1998 relatively junior members of the WorldCom legal department hired an accounting firm to assist in analyzing whether WorldCom should realign its corporate structure. This analysis resulted in the adoption of a state tax minimization program that we believe caused WorldCom to evade payment of hundreds of millions of dollars in state income taxes. Despite the magnitude of this program, our examination found no evidence that senior members of the legal department — including the CLO and the chief tax counsel — were involved in determining its appropriateness or were even aware of its existence. It is unclear whether WorldCom’s CLO would have taken different actions if he had been more involved. But the lesson is obvious: A CLO best serves the client only if he is adequately informed of matters that have a high degree of economic or reputational risk to a company. A CLO cannot be deeply involved in all important matters, but he should delegate such responsibilities either to a senior lawyer within the department or to outside counsel. The CLO should stay informed of any developments related to these matters and advise management as appropriately. 5. BE AWARE OF OTHER CORPORATE GOVERNANCE GATEKEEPERS. Every company should have a number of “gatekeepers” who have a role in promoting proper corporate governance. While some companies consider the CLO to be the ultimate gatekeeper, other departments, such as internal audit, should also serve in a gatekeeping capacity. Our examination found that WorldCom’s internal audit department was not serving as a gatekeeper, but was instead focused on ways to increase the company’s profits. The WorldCom CLO never objected to this limited function and may not even have been aware of it. While the internal audit department was ultimately involved in unraveling the accounting fraud at WorldCom, it did so only by acting outside of its assigned responsibilities. Obviously the CLO cannot be responsible for every department and function within a company. The CLO or his designee should, however, survey the various corporate governance gatekeepers to ensure that they have both the mandate and the resources necessary to fulfill these important responsibilities. 6. PROMOTE A CULTURE OF COMPLIANCE. The corporate culture at WorldCom was one of greed. WorldCom’s many acquisitions were paid for with company stock. Its “currency” was its stock price. One way to keep it at a high level was to meet or exceed research analysts’ expectations. Senior management promoted illegal accounting practices so that analysts’ projections could be beaten. A number of employees at WorldCom were either aware of the fraudulent accounting or strongly suspected it, yet not one of them came forward. To prevent this kind of corrupt corporate culture, the CLO must promote a culture of compliance. The company should institute a policy of zero (or very little) tolerance for the transgression of corporate governance policies and impose stiff sanctions on violators. Managers should regularly remind employees that complying with applicable laws and regulations is mandatory. The company should offer continuing education on regulatory developments and encourage senior management to express their support for compliance. Regular discussion of these matters will help ensure that employees feel secure in making complaints about improper behavior. The culture of compliance must come from the top. Dick Thornburgh and Michael J. Missal are counsel and partner, respectively, in the Washington, D.C., office of Kirkpatrick & Lockhart. Thornburgh, a former attorney general of the United States, was appointed the examiner in the WorldCom bankruptcy proceedings in August 2002. Missal, a former staff member of the Securities and Exchange Commission, was his chief counsel and headed the examiner’s investigation.

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