Responses by the Federal Communications Commission to WorldCom's accounting fraud.

• Author: Lavey, Warren G.
• Position: Telecommunications Act of 1996: Ten Years Later Symposium

WorldCom's disclosure of billions of dollars of financial fraud on June 25, 2002 challenged the Federal Communications Commission ("FCC") in several major ways. The FCC proclaimed its commitment to enforce its rules to protect consumers against service discontinuance as well as the priority of rooting out corporate fraud. The FCC's rules required WorldCom to file accurate financial information and to show that it had financial and character qualifications necessary to hold FCC licenses. Despite numerous related proceedings and other actions in 2001 and early 2002, the FCC had not detected nor deterred WorldCom's fraud. After the disclosure, WorldCom continued its landline and other core services. Although there were allegations that WorldCom violated the FCC's rules by filing false financial information, the FCC did not take enforcement action against WorldCom and did not tighten its regulations related to such financial fraud. This article will examine the reasons for the FCC's regulatory treatment of WorldCom, its failure to prevent the WorldCom debacle, and the absence of any shift in its regulatory posture in the WorldCom aftermath. Four partial explanations for the FCC's responses involve the actions of the Securities and Exchange Commission and Justice Department, downturn in the telecommunications industry, long-range deregulation by the FCC, and political accountability.

1. INTRODUCTION II. HOW DID Tim FCC RESPOND IN THE DAYS AND WEEKS FOLLOWING WORLDCOM'S DISCLOSURE? A. WorldCom's Disclosure of Accounting Fraud. B. FCC's Public Statements Responding to WorldCom's Disclosures C. Analysis of the FCC's Immediate Response III. WHAT REGULATIONS DID THE FCC APPLY OR NOT APPLY TO WORLDCOM DURING THE ACCOUNTING FRAUD? A. Findings of Financial and Character Qualifications for WorldCom's Licenses 1. Legal Framework for the FCC's Analysis of WorldCom's Qualifications 2. Application of Financial and Character Qualifications Tests to WorldCom During the Fraud B. Assessment of WorldCom as a Financially Strong Competitor in Authorizing Other Carriers C. Audit of and Reports by WorldCom D. Statistical Reports Reflecting WorldCom ' s Financials E. Enforcement Action F. Regulations of Prices, Terms, and Conditions for Services Offered by Local Exchange Carriers G. Analysis of the FCC's Relevant Regulations During the WorldCom Accounting Fraud IV. AFTER SEVERAL YEARS, HOW DID THE FCC CHANGE OR NOT CHANGE ITS REGULATIONS RELATED TO WORLDCOM'S DISCLOSURE? A. FCC Proceedings Triggered by WorldCom' s Disclosure 1. Discontinuance of Some Noncom Services 2. WorldCom's Licenses 3. Local Exchange Carriers' Protection Against Uncollectibles B. Continuation of Other FCC Regulations Related to WorldCom' s Disclosure 1. Information Filing and Accounting Requirements for Nondominant Carriers 2. License Applications 3. Audits 4. Enforcement Actions C. Analysis of the FCC's Maintenance of its Regulations and Practices Following its Public Statements on WorldCom's Disclosure V. WHAT EXPLAINS THE FCC'S RESPONSE TO WORLDCOM'S DISCLOSURE? A. Protecting Consumers and Rooting Out Corporate Fraud B. Partial Explanations for the FCC's Stance on Financial Fraud 1. Changes in Securities Laws, SEC Regulations, and Other SEC and Justice Department Actions 2. Telecommunications Industry Downturn 3. Deregulation and Market Forces 4. Political Accountability VI. CONCLUSION I. INTRODUCTION

   The disclosure of massive financial accounting fraud at WorldCom, Incorporated ("WorldCom") on June 25, 2002, (1) was a major shock to the Federal Communications Commission ("Fee"). The FCC is the principal federal agency responsible for fostering reliable, universally available telecommunications services, as well as competition and growth in the communications and related Internet services industries. (2) A wide range of FCC policies, proceedings, and capabilities were implicated by the accounting fraud and resulting bankruptcy of WorldCom. At that time, WorldCom was the second largest long-distance carrier, one of the largest competitive local exchange carriers, and the largest provider of Internet backbone services. (3) WorldCom held numerous FCC licenses for landline and wireless services. During the quarter century prior to the disclosure of fraud, advocacy by WorldCom and MCI Communications Corp. ("MCI") (4) reshaped telecommunications regulations:

   The FCC's regulations did not cause, prevent, detect, or remedy the criminal conduct at WorldCom. However, the FCC's rules required WorldCom to file accurate financial information and to show that it had the financial and character qualifications necessary to hold radio and other FCC licenses. (6) With broad statutory authority to require information filings and perform investigations of telecommunications carriers, the agency with telecommunications industry expertise might have done more to detect and protect the public against harms from financial fraud at major telecommunications carriers such as WorldCom, Qwest Communications International, Inc. (Qwest"), (7) and Global Crossing Ltd. (8)

   The securities laws and regulations and the competence of the Securities and Exchange Commission ("SEC") were the focus of the public debate following WorldCom's disclosure. There was relatively slight attention to the FCC's enabling statute, regulations, and performance. The spotlight was instead directed at public companies' audited financial statements filed with the SEC. Perhaps this occurred because WorldCom's disclosure was preceded by disclosures of accounting fraud at Enron Corp. (9) and many other companies, (10) as well as the criminal prosecution of Arthur Andersen LLP. (11) The failures within the communications industries were largely treated as further examples of problems with the securities laws, accounting standards, and the SEC. The FCC's public response to WorldCom's disclosure focused primarily on continuity of telecommunications services to the public, with secondary concerns about punishing and preventing fraud. (12)

   WorldCom's disclosure provides an opportunity to examine certain areas of the FCC's regulations in both their direction and effectiveness. This Article analyzes WorldCom's disclosure of accounting fraud as a shock to the FCC in four parts: (1) How did the FCC respond in the days and weeks after the disclosure?; (2) What regulations did the FCC apply or not apply to WorldCom during the accounting fraud?; (3) After several years, how did the FCC change or not change its regulations related to WorldCom's disclosure?; and (4) What explains the FCC's response to WorldCom's disclosure?

   The picture that emerges shows an agency that had responsibilities and made findings related to WorldCom's financial accounts but which was unaware and unsuspecting of the criminal conduct until WorldCom's public disclosure. Following the disclosure, the FCC gave certain assurances to the American public and Congress and completed some proceedings addressing WorldCom's fraud and bankruptcy. It appears that the FCC did not reform its analysis or regulations with the goal of protecting against future occurrences of similar harmful conduct. On the contrary, as part of its efforts to decrease unnecessary regulatory burdens and promote market forces, the FCC applied streamlined requirements related to financial qualifications and accounting after WorldCom's disclosure. (13) Although WorldCom's fraud and bankruptcy was a major development for the industries regulated by the FCC and helped spur reforms in securities laws and regulations, it does not appear to be a turning point in FCC regulations.

   If indeed the FCC did not substantially reform its efforts to protect against accounting fraud and financially unstable carriers, and given that the FCC treated WorldCom's conduct as more than ordinary aggressive accounting, at least four partial explanations may apply. On the level of substantive regulation, the post-WorldCom tightening of the securities laws--the Sarbanes-Oxley Act (14)--along with changes in SEC regulations and other actions by the SEC and Justice Department may have obviated the need for changes in the FCC's analysis, regulations, and enforcement practices. In terms of the structure of the communications and Internet services industries, the downturn of the industries and other rule changes weighed against the FCC imposing penalties on or blocking opportunities for financially weak firms that were often innovators and emerging competitors. Regarding long-range regulatory philosophy, the FCC was oriented toward deregulation, competitive entry, and market forces and was reluctant to intervene in the market once the immediate threat of service disruption and financial meltdown passed. Finally, on the political level, high-profile investigations and rule changes at the FCC would have put the agency more in the spotlight of what it, rather than the SEC, could have done to prevent accounting fraud by major telecommunications carriers; the FCC needed its political credibility as an effective regulator and industry analyst to push forward deregulation.

   The Article concludes that the FCC's inactivity regarding financial qualifications and financial fraud resolved inconsistencies in the FCC's deregulation of nondominant carriers. Regulatory inactivity in these areas likely promoted the public interest, and the FCC correctly resisted various pressures to throw additional accounting, audit, and enforcement resources at determining financial qualifications and deterring financial fraud.

2. How DID THE FCC RESPOND IN THE DAYS AND WEEKS FOLLOWING WORLDCOM'S DISCLOSURE?

   WorldCom's financial scandal directly affected investors in, creditors of, and employees of WorldCom. It posed the possibility of also affecting users of WorldCom's services (both consumers and interconnecting carriers) and the telecommunications carriers that supplied services to or competed against WorldCom. The FCC was, on the one hand, the...