Current Events - Week 5 - Values & Ethics

MCI: Is Being Good Good Enough? Mike Capellas has his plate full cleaning up MCI. That's just a start.

By Stephanie N. Mehta

October 27, 2003

(FORTUNE Magazine) – On a recent fall morning, 50 MCI employees gathered in a windowless training room at the company headquarters in Ashburn, Va., to debate a hypothetical scenario: A would-be supplier walks out of an important contract negotiation and leaves behind a folder containing potentially juicy information. The session leader asks the MCIers whether they'd peek. One manager suggests the folder may have been left behind as a test "to see if you have what it takes to get the deal done." Another is more cynical. "You'd all look," he cajoles, drawing titters from around the room. "You're just doing your job, and you've gotta be thinking about putting food on the table."

About halfway through the 20-minute discussion, a hand shoots up: "I think we're going to be held to a higher standard than other companies," the khaki-clad man in his mid-40s says softly. "And the higher standard is to not look."

It's no accident that such introspection permeates the offices of MCI, the company known until recently as WorldCom. Huge banners plugging the company's ten guiding principles bromides exhorting employees to REPORT RESULTS ACCURATELY and AVOID CONFLICTS OF INTEREST festoon the open, cavernous hallways at headquarters. CEO Michael Capellas, who arrived last December, peppers speeches to employees with principle No. 10: "Do the right thing because it's the right thing to do." All 55,000 MCI workers must complete an online ethics-training course. More than 2,000 MCI managers and finance employees have gone through full-day ethics seminars like the recent session FORTUNE observed in Ashburn. And to make sure someone is always bird-dogging the company's morals, Capellas in mid-October announced the appointment of a chief ethics officer who will report directly to him: Nancy Higgins, former ethics vice president at Lockheed Martin.

The posters, the slogans, the ethics czar they all seem, well, sort of Pollyanna-ish, even in today's world of Sarbanes-Oxley governance rules and anticorruption crusades. That is, until you consider the magnitude of Capellas's challenge. He's taken on the unenviable task of restoring credibility to a company that has admitted to the largest financial fraud in U.S. history. Even today, 16 months after the scandal broke, the numbers are still jaw-dropping. Beginning at least as early as 1999 and continuing into 2002, financial officers of WorldCom allegedly booked billions of dollars of routine business costs as capital expenditures, which contributed to an overstatement of income by at least $9 billion. The board of directors granted $400 million in loans to then-CEO Bernie Ebbers. And acquisitions, the foundation of the company's growth, received scant scrutiny. In just a few years WorldCom erased $200 billion in market value and shed thousands of jobs. By July 2002, the fraud and lax supervision forced WorldCom into bankruptcy.

Now Capellas is trying to take the company through the looking glass: If WorldCom was a top symbol of corporate greed and neglect, MCI must be a paragon of integrity. And "must" is no understatement. Failing to pull off MCI's ethical transformation could carry a steep pricetag. The General Services Administration in late July suspended MCI from winning new government business historically an important revenue source and said it may bar the company from future contracts with the Feds unless it tightens internal financial controls and bolsters its ethics training. Competitors are closely watching MCI's actions and will use anything that hints at an ethical lapse to lure its customers. And as MCI prepares to exit from bankruptcy at presstime, a court hearing was scheduled for mid-October, setting the stage for the company's stock to resume trading by early next year potential shareholders and short-sellers will be scrutinizing every earnings call and financial filing to see if MCI really has come clean.

To make Capellas's job even harder, he must pull off all that without the wide range of discretion CEOs normally have. Closely watching his every move is Richard Breeden, the former chairman of the SEC who since July 2002 has served as the "corporate monitor" for MCI. The U.S. district court judge the guy overseeing the SEC's case against MCI initially wanted Breeden to make sure management didn't destroy documents or give itself juicy bonuses. But Breeden has built the role into one where he can create a governance blueprint not just for MCI but for the entire corporate world. In August he released a 115-page report outlining dozens of changes covering everything from CEO pay to the number of meetings the governance committee should hold that will make MCI, by many accounts, the most strictly governed company in America.

Dealing with Breeden and cleaning up MCI is only the beginning of the CEO's task. Capellas's moves are, in his parlance, "table stakes" the ante the company must pay in order to play telecom poker. To win, he and his team need to figure out a way to fix the business of MCI as well—integrating various units that his predecessor bought, keeping the still-cutthroat competitors at bay, and aligning MCI's costs with the those of top rivals. While AT&T's operating margins are about 12%, MCI's are closer to 9%. And even as Capellas tries to shield his firm from further government scrutiny, he also needs to keep winning federal and state business. In 2002, MCI inked $772 million in multiyear federal prime contracts, up 50% from the previous year, according to trade magazine Washington Technology. Today, government business represents about 6.5% of MCI's $25 billion in revenue; corporate customers make up the bulk of its sales.

Yes, MCI has lots of incentive and is under lots of pressure to do the right thing. This is also likely its last chance to shape up. One ethical slip by anyone from Capellas on down, and the company could be toast. "The thing that scares everybody to death is, What if it happens again?" says Brandt Allen, an associate dean at the University of Virginia's Darden School of Business, which helped design MCI's ethics course. "It won't happen at the top, but what if it happens at a business-unit level or with a country manager? There are no degrees of freedom left for MCI."

What Capellas is trying to accomplish has little precedent. Business historians are hard-pressed to name corporations that have transformed themselves into shining examples of virtue in areas in which they were once prime practitioners of vice. Sure, Exxon cleaned up its act after the Exxon Valdez debacle, but no one equates the oil company with environmental friendliness. Many other damaged companies, such as Arthur Andersen, go out of business before they have a chance to reinvent themselves.

If the challenge daunts Capellas, he doesn't show it. In a recent series of meetings he seemed more relaxed and upbeat than when FORTUNE visited him last November, just days after he'd agreed to become CEO. Sitting in his modest office, eating soup and sandwiches fetched from the company cafeteria, Capellas maintains that the problems at the company were caused by a few bad actors. "It was a group of people that was divorced and out of touch with the rest of the company," he says. "I don't think they represented the culture of the company."

Maybe not, but management's detachment certainly enabled financial fraud and other unsavory practices to flourish. Ebbers disdained traditional corporate structure: He wanted to approve all sorts of minute initiatives, such as commission structures for the sales staff, yet current and former executives insist he was nearly impossible to get on the phone. And when he did meet with executives, it was often to berate them about spending. Jerry Edgerton, who heads the MCI group that sells to federal and state governments, remembers meeting with Ebbers during a particularly good year for his division. Ebbers looked up from a spreadsheet and admonished Edgerton, "I see you spent $3,000 taking customers to a Cubs game."

To avoid Ebbers's fixations, executives either didn't question him and other senior managers or, as in Edgerton's case, bypassed them altogether. Edgerton maintained his own information-technology team and engineering group that sometimes duplicated the efforts of the corporate IT and engineering folks. It wasn't efficient, he says, but it was the only way he knew to get things done without seeking Ebbers's approval. Ebbers's style, he says, was "intimidation." He adds, "I found it personally insulting."

One of the most enduring symbols of WorldCom's dysfunctional management was its total lack of a home base. Ebbers lived in Brookhaven, Miss., a 60-minute drive from WorldCom's Clinton offices. CFO Scott Sullivan lived in Florida, and vice chairman John Sidgmore lived in a suburb of Washington, D.C.

Shortly after Capellas arrived at MCI from Hewlett-Packard (which had been acquired by Compaq, where he was CEO), he began to centralize management operations. He shifted the headquarters from rural Clinton to more centrally located northern Virginia and consolidated many of the finance functions there. He spent a single Saturday house hunting and purchased a home in D.C. suburb Great Falls, Va. The message was clear: Senior management would be expected to follow suit and live where they worked.

Capellas had more to deal with than finding a center for the company. He quickly realized he had many internal and external constituencies to please and appease. There was the SEC, which settled its case with the company for $750 million and mandated ethics training and stringent accounting controls. There were also creditors and bondholders to satisfy (debt buyer David Matlin, who recently agreed to join the MCI board, had clamored to make Rudy Giuliani chairman); regulators and investigators to meet (two law firms have produced investigative reports on MCI, and more are to come); and dispirited employees to cheer up (the bankruptcy had financially wiped out many).

Yet it became clear right away that one of Capellas's most important audiences would be Breeden, the garrulous corporate monitor who had arrived at the company almost six months earlier. As SEC chairman under the first President Bush, Breeden had overhauled U.S. proxy rules. He wasn't shy about wielding court-appointed authority with MCI, either. In his role he had the power to approve and amend or veto major employment costs and contracts.

That included Capellas's pay package. Capellas at one point sought $1.5 million in annual salary plus $18 million in stock for guiding MCI out of bankruptcy. Breeden knocked down the stock award to $12 million, said Capellas would need to win Breeden's and the board's approval to get the additional $6 million, and tied the entire pay package to upholding an ethics pledge the CEO had to sign.

It could have marked the beginning of a rocky relationship, but instead the two men have forged an unlikely alliance: Breeden says it isn't unusual for them to hold gab sessions on governance and other matters that stretch into the wee hours of the morning. Board member Dennis Beresford says Capellas deserves credit for accepting Breeden's recommendations and criticisms with aplomb. "Richard is one of the company's biggest assets, but he has also been a real pain in the butt," says Beresford, a University of Georgia accounting professor who used to head the Financial Accounting Standards Board. Capellas shrugs it off: "It would have been natural for there to be conflict, but there was never any competition. He does what he does, and I do what I do."

Capellas and Breeden have a common goal of making MCI a model of corporate governance, but their motives seem to differ. Breeden says he hopes his report on MCI, which he entitled "Restoring Trust," will become part of of the governance dialogue that many corporate boards are now holding. Already shareholder activist Bob Monks praised Breeden's recommendations on his website, and many corporate directors are forwarding the report to their peers. "Some members of the legal profession say the report is too ambitious," Breeden says. "I hope people won't reject all of it, or accept all of it, but think about all of it."

While Breeden is focused on big changes, Capellas has a company to save. One of his first moves as CEO was to ax the old WorldCom board. Last fall Sidgmore, who served as interim CEO, brought in Beresford, as well as Jack Rogers, former chairman of Equifax, and former U.S. Attorney General Nicholas Katzenbach. Capellas kept them and recently recruited five additional independent directors, including former deputy attorney general Eric Holder. And earlier this year he fired dozens of employees, including finance workers who allegedly had stood by while others cooked the company's books.

Many of those moves seem like no-brainers, of course he's going to get rid of the finance team on watch during the fraud, or were prescribed by outsiders. But Capellas insists that they are the start of a shift in MCI's attitude. (He points out that he has long been an ethics stickler. At Compaq he forbade people to drive if they consumed even one alcoholic drink at company functions.) Even the most skeptical employees say the CEO has set a tone of openness and accessibility in sharp contrast to the atmosphere during the Ebbers years. "Executives here are taking their cues from Michael, and Michael's style is to put everything on the table," says Vint Cerf, an Internet pioneer who worked at the old MCI in the '80s and rejoined WorldCom in 1994. He now serves as senior vice president of technology strategy.

Other MCI executives say that the company is not merely "checking a box" or doing the minimum mandated by settlements and reports. To satisfy the SEC's ethics-training requirements, for example, some people inside MCI suggested the company buy an "off the shelf" course; Capellas insisted on having one custom-built and attended several meetings with the University of Virginia and New York University professors who created the classes. Capellas and the board also demanded the resignation of general counsel Michael Salsbury, whose conduct had been questioned in a report by bankruptcy examiner Richard Thornburgh. Thornburgh felt Salsbury had failed to keep the board of directors apprised of key transactions involving the company. Most MCI executives believe Salsbury wasn't the bad guy that Ebbers had kept him in the dark on a number of issues, and that in fact Salsbury had ably guided MCI through its settlement with the SEC. Still, Capellas couldn't risk appearing unresponsive to Thornburgh's criticism. He asked Salsbury to leave the company in June.

Several MCI executives cite that move as an example of how Capellas has acted well beyond the demands of the SEC or some other outside agency. Yet his decisions also point to the unparalleled level of formal and informal scrutiny he must operate under. Among other CEOs who have stepped into the hot seat, few face his challenges: not Ed Breen at Tyco, which doesn't have to deal with a bankruptcy court; not Stephen Cooper at Enron, which is expected to come out of bankruptcy as a boring old energy utility; not even John Reed at the New York Stock Exchange. "When I took the job, I thought there was a fairly defined set of things to deal with, like the bankruptcy and the accounting," Capellas admits. "But when you look at the complexity of the issues, it's impossible to imagine having a broader, more diverse set of constituencies to deal with."

Keeping constituencies satisfied is one thing, fending off competitors another. Telecom rivals say that all of Capellas's do-gooding is merely window-dressing, and that the company still has plenty of housecleaning left. (They have other reasons to be mad: MCI will compete against them post-bankruptcy with a clean balance sheet. It will also be able to use retroactive tax benefits granted thanks to the operating losses MCI should have been reporting during the years of fraud.) Their most recent finger-pointing has to do with MCI's alleged attempts to avoid the fees that long-distance companies typically pay to local telcos for originating or terminating their phone calls.

SBC and Verizon have told the U.S. Attorney's office in New York that as recently as this year MCI has employed various schemes, such as changing the coding of calls to make MCI long-distance calls look like local ones. AT&T has filed a lawsuit accusing MCI of dumping calls onto an AT&T line, forcing Ma Bell to pay the access charges. For its part, MCI says it hasn't turned up evidence of any wrongdoing, and finding cheap ways to route calls is common practice in the industry.

That "everybody does it" reaction is hardly the response of a company that has zero tolerance for inappropriate behavior, critics say. And MCI's decision to hire a law firm to investigate the charges drew jeers from some networking experts. "Everybody in the industry laughed at that," says a telecom consultant who declined to be named. "You're dealing with one of the most complex, multifaceted aspects of the telecom network, and MCI hires lawyers?"

To competitors, MCI seems interested only in rooting out financial fraud, at best or perhaps in simply keeping one step ahead of the government's demands. For example, the company had been in talks this spring to hire accounting firm Deloitte & Touche to develop financial controls. But it was only after the General Services Administration scolded MCI for continued weaknesses in its control processes that 600 Deloitte accountants descended on the company's Ashburn offices. "Did the GSA drive things faster? Sure," concedes Capellas. "But it wasn't like we were lacking a sense of urgency before that."

One of MCI's most vocal critics, AT&T general counsel Jim Cicconi, argues that Capellas is taking a narrow view of what he needs to fix one that ignores plenty of potential lapses. "The danger is that management sees this as an accounting problem, so they've gone in and cleaned out the accounting department and brought in new auditors," he says. "But many more people in the company knew they were making up numbers and didn't say anything. They grew up in a culture in which it was okay to operate in all sorts of gray areas—and I'm not sure that's a fact that the new management is confronting."

With all the executive changes and investigations grabbing headlines at MCI, it is sometimes easy to forget that Capellas also has a business to run. He insists that the governance and ethics requirements don't tie his hands, yet there are plenty of requirements that a business manager trying to execute a huge turnaround might not necessarily submit to voluntarily. Most notably, Breeden's report calls for MCI to distribute a dividend to shareholders he suggests 25% of net income. He also wants MCI to come up with new forms of cash flow reporting to enhance the information shareholders already receive. Under the SEC settlement, the company will meet certain internal-control requirements spelled out in the Sarbanes-Oxley legislation a full nine months before any other American corporation.

With all these rules in place, it's no wonder that Capellas is eager to steer conversations toward his big-picture plans for MCI. The former computer programmer and onetime chief information officer lights up when he talks about a future in which computing and telecom converge: "Somewhere between those two worlds there's a new kind of company, and that's what we can be," he says. In the meantime he's pushing data-oriented services, such as one that delivers telephone calls over Internet networks, and "managed services," in which corporate customers hire MCI to run their phone and data operations.

Yes, competitors are trying to do exactly the same things, but Capellas thinks MCI has a couple of advantages. One is its UUNet Internet backbone, which his predecessors spent $38 billion to build and which carries much of the world's Internet traffic. He also says MCI is starting to push partnerships with other companies an initiative that stagnated even before the Ebbers years. "The company always felt it could build everything itself," he says. "Post-bankruptcy, the opportunities for partnering are huge."

Of course, for MCI to build meaningful alliances, it must prove itself a trustworthy partner, which brings us back to values and ethics. Internally, the CEO's message on ethical conduct does seem to be getting through. During the session FORTUNE observed, the instructor closed the case study by asking, "What would MCI want you to do?" One participant, the same employee who had argued that everyone in the room would succumb to temptation and look inside the supplier's folder, could hardly contain himself. He deadpanned, "Do the right thing." Capellas couldn't have said it better himself.

http://money.cnn.com/magazines/fortune/fortune_archive/2003/10/27/351664/index.htm

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