ACCOUNTING FRAUD AT WORLDCOM

Introduction
WorldCom, US second largest telecommunication company shocked the world
byfiling bankruptcy at 21 July2002. The WorldCom filing surpassed Enron and
became thelargest bankruptcy filing in United States history. Due to its rapid
growth, WorldCom is also heavily in debt as they finance the company growth
with debt. The collapse of WorldCom did not just affect their employees,
retailers, the government but also bankers. WorldCom was a multi-billion dollar
telecommunications company that was founded in1983.The company starts
their business under the name 'Long Distance Discount Services' (LDDS),
providing long distance telecommunication services. The venture was profitable
right from the start. In 1985, Bernie Ebbers became the company's CEO. The
company changes its name to WorldCom in 1995.During the 1990s, the
company starts to grow through series of successful acquisition and merger.
However, during the late 1999, the companys performance begins to slip due to
heightened competition, overcapacity and reduced demand for
telecommunication services at the onset of the economic recession and the
aftermath of the dot-com bubble collapse. Other than that,
falling telecommunications companies and new entrants were drastically
reducing their prices leads WorldCom. All these pressures caused WorldCom to
involve in accounting fraud. Scott Sullivan, WorldCom's CFO, begins the
process of misallocating as capital expenditure what should have been normal
expenses, thus turning losses into profit, creating a smokescreen that the
company is performing well. Things start to come under light at June 2002 and
the companys stock price plunged. Investigations were carried out. On June 25,
WorldCom admits that it had inflated its earnings by $3.8 billion --the largest
accounting fraud in history. After series of investigation, the total amount
discovered from improper accounting procedures raised to $9 billion causing
WorldCom to file bankruptcy in July. Several top management personnel were
held responsibilities for the fraud.
2. What are the pressures that lead executives and managers to cook the
books?

The main pressures were coming from the economic recession and the
aftermath of dot-com bubble collapse which then causes the
industry conditions began to deteriorate in 2000. The competition among
existing company and the new entrants were becoming more heightened; the
company became overcapacity and the demand for telecommunication services
reduced significantly. And the pressure to maintain a 42% of expense-to-
revenue ratio (E/R ratio) had also becoming one of the forces that lead the
executives and the manager to cook the books in order to make it looked good
at the publics eyes.
From the perspective of the executives, the main pressure would be to ensure
that the investor or the shareholder to keep on trusting the company and
continue to keep their investment or inject more investment into the company.
This is so much important as the shareholders trust greatly depending on the
company performance. When the performance indicator shown not a good
result, the shareholder will most probably take off their investment and this will
impacted the companys stock price. Besides that, the executives were also
surrounded by their self-interest. Having a good position, good title in the
company with a good salary, had made them comfortable with current situation.
If they choose to reveal the actual company performance, then it is just like
digging for their own grave. They would lose everything that they had.
Therefore, they prefer to cook the books or to cover the real performance by
doing some improper accounting practices. For example, in the first quarter of
2000, WorldCom was having revenue, pricing and its highly committed line
costs pressures that making it hard to maintain an E/R ration of 42%. This was t
hen lead to Ebberss emotional speech to the senior staff about how he and the
other director will lose everything if the company did not show good
performance. From the perspective of the managers, the employee benefits that
they had receive was all because of the great companys performance. If the
company did not improve, then many of them will be fired or loss their job as a
way of saving the companys cost. And due to preventing this thing from
happened, the employee had no other choice other than to obey the senior
managements command of cooking the books, or to not engage with the fraud
by quitting the job. For example, Betty Vinson, who was previously a manager
in the international accounting division, was having a dilemma after she done
her first fraud of releasing an $ 828million of line accruals. She was wondering
whether she was at the right action or not. However, after being compromise by
the director, David Myers, she and her colleague, Troy Normand feel at ease
and decided to do the transfer. But at last, the same things happen and they keep
on releasing accruals and capitalizing expense. Troy Normand at last decided to
resign while Vinson was rethinking her plan of resigning as the family was at
that time depending at her and its hard to find a company that give good
employee benefits like WorldCom. Thus, she decided to keep working in
the company and do whatever being told by the top management. It
was clearly shown that sometimes the pressures came from the surrounding and
forced one to commit fraud in order to survive.

3. What is the boundary between earnings smoothing or earnings

management and fraudulent reporting?
The earnings management or earnings smoothing is about the use of accounting
techniques to show produce financial reports that may shows an overly positive
picture of a companys business activities and financial position which
is considered to be normal for the company. It is deemed as not an illegal act but
if the earnings management gone to be abusive (material and intentional
misrepresentation), then the action became illegal and the SEC may issue fines.
Basically, income smoothing is the reduction of the variance in periodic profit
overtime to the extent allowed by accounting and management principles.
Usually, by smoothing the earnings, the net income fluctuations from one period
to the next will be less.
Companies practice this because of the investor that prefers to get premium paid
(dividend) for stocksthat are stable in their earnings. The earnings smoothing
can be about changing the accounting methods, recognizing one-time items, or
deferring expenses or accelerating revenues to bring about desired short-term
earnings result. The main reasons managers doing income smoothing are to
maximize companys wealth, reducing the perceived riskiness of the firm,
enhancing companys value, meeting debt covenants, reducing tax and political
costs and enhancing the reliability of financial forecasts. On the other hand,
fraudulent reporting is about the deliberate action of issuing misleading
financial statements in an effort to avoid negative impacts on the financial
stability of a business. And the most important, it is an illegal act as the
action was intentional to hide and misreport the actual companys financial
figures and information to the public. As from the case, we can see so clear that
the management were not doing income smoothing, instead, they are making
fraudulent reporting. The top management such as Scott Sullivan and David
Myers were forcing the subordinates to cooks the book in order to show
a positive and maintained performance.

For example, they had released a total of $ 3.3billions throughout year 1999
until 2000.Then, instead of recognizing the unused excess network capacity as
expense, it capitalizes it and recognized as asset. Besides that, Sullivan
intentionally asking Cynthia Cooper to delay the capital expenditure audit until
the next quarter as he need the time to prepare for the fictitious transactions. In
order to conceal the truth, the top management told the employees on what they
can and cant share with the outsiders especially with the auditor Arthur
Andersen. Moreover, Sullivan manipulated the information related to capital
expenditures and line costs presented to the board by showing a steady
decrease as the board were expecting some cuts on the capital expenditure.
However, the actual capital expenditure incurred was far lower than reported.
This means, WorldCom were capitalizing the expense as assets more than it
should. Furthermore, the board meeting was handled by Ebbers instead of the
chairman of the board, Mr. Bert Roberts, which simplifies the process of
committing fraud among the top management and hid it properly from the board
and the auditor.

4. Why were the actions taken by WorldCom managers not detected

earlier? What processes or systems should be in place to prevent or detect
quickly the types of actions that occurred in WorldCom?
Firstly, the main reason would be from the WorldComs corporate culture itself.
The corporate culture did not encourage employees to come forward and voice
out their opinions, instead, they were taught to simply listened to the superiors
and do what they were told.
There were no official written policies or code of conduct. Because of this
culture, employees felt that they did not have an independent outlet for
expressing concerns about company policies or behavior. Whereas, the good
employee will be favoured by the top management and receive promotion or get
more employee benefits. This was what happened to Betty Vinson, the loyal
manager at the international accounting division that willing to do anything she
was told, and voluntarily worked over time and even while at home or on
vacation. Due to the pressures given from the top management, she was forced
to carry out the fraud. She was one of the big roles in releasing the accruals and
capitalizing unnecessary capital expenditures. Besides that, the culture that
created by Ebbers was setting the legal function aside from the management,
causing it to be less influential and becoming totally useless. The head
department was tabulated all over the countries. For example, the department of
human resources was in Florida, while the legal department was in Washington,
D.C. This far away departments and having different types of management style
creating an environment that was not synchronized and it was hard to
communicate each other. In addition, due to the environment that was totally
controlled by the top executives management, the internal audit function
becoming useless and several employees dont even knew their existence. The
internal audit reported directly to CFO Scott Sullivan for most purposes and
they were not allowed to speaking the truth to the external auditor. Secondly, the
next reason would be the distant relation of the board of directors. The board
composition was made up of 50% non-executive directors and it included
experts in law, finance and the telecommunication services. However, to some
extent, the board was just like puppet of the executives. They got power but
they didnt/cant use it. Even the board meetings were presided by Ebbers. The
same goes with the audit committee and the compensation committee. This was
then leading the investigative committee to conclude that the board played far
too small a role in the life, direction and culture of the company; the Audit
Committee did not engage to the extent necessary to understand and to address
the financial issues presented by WorldCom; and the Compensation Committee
dispensed extraordinarily generous rewards without adequate attention to the
incentives they created and presided enormous loans to Ebbers. Third and lastly,
was the auditor; Arthur Andersen. The Andersen, as the external auditor had
carried out various type of audit on WorldCom, starting from the old-fashioned
way until a more sophisticated and efficient audit procedures. In 1999 to 2000,
the risk management software program carried by Andersen had rated
WorldCom as a high risk of committing fraud client. However, Andersen did
not modify its approach and despite of that, it continued to audit WorldCom as a
moderate risk client.
The processes or systems that should be in place in order to prevent or detect
quickly the types of actions that occurred in WorldCom would be as following.
First, the corporate culture should encourage whistle-blowing or in other words,
encourage employees to stand up and voice out their opinions regarding any
matters that they felt important. A transparent and forthright corporate culture
should be implemented. The corporate culture should encourage and expect
ethical conduct, and exemplified by the Companys Code of Ethics which had
been signed by the senior management in order to show their commitment
towards implementing it. The culture should also make the legal function
influential by giving them space to help in decision making process and in the
management of the company. Second, a formalized and well-documented
accounting policies and procedures should
also be carried out including setting up a robust internal control in the process o
f reporting thefinancial data. As we can see in the case, due to there is lack of
controls, the superiors can easily pact with the employees in committing fraud
or threat the employees to do the fraud. This control will actually prevent fraud
or alliances among the superiors and the subordinate in misrepresenting the
actual data to the public.
Third, there should be open and luminous dealings with the external auditor,
which will reflect the critical role they played. External auditor played a
significant role in helping companies making a right decision. However, if the
auditor is not allow or prevented to know the real condition of the company, or
were not disclosed enough, were provide with the wrong information, then the
auditors roles will diminished as they will analyse it and get the inaccurate
result. Nonetheless, still it will be the auditor fault if they had knew that the
client is a high-risk of committing fraud but it still insisted to carry on the audit
without reporting it to related authorities.

5. Were the external auditors and board of directors blameworthy in this

case? Why or why not?
Yes, they should be blame. The board of directors who should actually monitor
the executives, helping in the direction of the company; instead was just like
leaving everything to the management itself to do whatever they feel right.
None of the outside directors had regular communications with the top
management or with other employee outside of board or committee meetings
and prior to April 2002, they were never met by themselves to discuss matter
related with WorldCom. They were taking everything easy, did not do anything
except attending the board meeting which was presided and decided by Ebbers,
and as are turn, get the dividend annually. This shows how distant they were
from the management of the company. As the board of directors, they had
significant role in driving the company performance towards better and higher,
not to just waiting for the returns. On the other side, the external auditors should
also blame. As an external auditor, they should be independent and unbiased in
their decision.
Just because WorldCom was its flagship and its most highly coveted client,
didnt means that Arthur Andersen should cover for them. Instead of
recognizing WorldCom as highly fraud committed client, they change it to only
moderate risk client. This shows how bias they are in order to please the
customer. Even though, they were restricted in gaining access to the company
information, still they manage to perform audit that shown the clue of fraud
committing. It can be clearly seen that the auditor was a part of the fraud as they
rated WorldCom as fair and it was actually release information that the
company was in a good condition.

6. Betty Vinson: victim or villain? Should criminal fraud charges have been
brought to her? How should employees react when ordered by
their employer to do something they do not believe in or
feel uncomfortable doing?
As from my opinion, Betty Vinson is actually a victim of the situation. For
someone who was in a difficult situation like her, for sure they would also do
the same. However, it was not an excuse of doing fraud. Vinson was a loyal
employees and she cooks the book on behalf of the superior, the CFO Scott
Sullivan and the director David Myers. Something to note that, Vinson was
actually known from the beginning that the things she was asked to do was
something wrong. However, she and Troy Normand were later persuaded with
the words from Myers, and at last they were swallowed by his words. Being
convinced that it will be the first and the last, Vinson and Normand make the
release of accruals. Nonetheless, things did not end up. There had always the
second, the third time and more, until the total releases of accruals was summed
up to be around $ 3.3 billion? She had once decided to resign
but because of the interdependence of family financial sources lies on her shoul
der, so she did not quit her job and keep obeying her superiors commands. For
the things that she had done, of course criminal fraud charges should be put on
her no matter what excuses it is. Nevertheless, she had pleaded guilty for
conspiring in committing fraud together with the others and she was released on
a bond secured by $ 25,000 of equity in her home instead of carrying the
sentence of 15 years in prison. I think this is best enough for her and the
experience should be a lesson for her in the rest lifetime to not ever commit
fraud again. Absolutely when one employee was asked to does something
uncomfortable or something wrong, they should directly reject it. However,
things were not as easy as we think. When employee rejects an employer
request, then there should be a consequence, whether they will be fired or they
would be discriminate than other loyal colleague. Everything was actually
depending on ones principles and determination. If the employees really hold
to ethical values and he/she always believe in God, believe that God will give a
better return if she do the right things, then they should just not do it. If it was
hard to quit job as it is harder to get
a better job, then they need to gather up some courage and report it to higher su
periors or report to other professional body, which in other word means, be a
whistle-blower for the company.