Running head: CASE ANALYSIS OF THE ACCOUNTING FRAUD AT WORLDCOM

Case Analysis of the Accounting Fraud at WorldCom

Angela Crossley
Troy University
October 27, 2008
History
The origin of WorldCom can be traced back to 1983. The CEO, Bernard J. Ebbers, of WorldCom had very
interesting beginnings. He invested in Long Distance Discount Services (LLDS) with eight other investors, and
believed that the telecommunications industry was a very good business venture. In the beginning the lack of
technical experience of the LLDS proved to be detrimental by creating a great deal of debt. The company enlisted
Bernard J. Ebbers to create a sound and solid business. Ebbers proved himself to the company and others in the
industry that he was a force to be reckoned with and turned the business profitable in less than a years time. Ebbers
did not have a degree in business from any elite school. He had a very humble beginning with cost cutting at the
forefront and a desire to make change within the industry. In 1995, the company publicly became known as
WorldCom. By 1998, Ebbers and his Chief Financial Officer, Scott Sullivan, who was the brains behind the MCI
merger, received accolades and were recognized by analysts as industry torch bearers. As the years progressed and
the company grew larger, problems began to arise. The problems that WorldCom encountered could not have been
predicted by any of the stockholders. In 1999, WorldCom tried to attain Sprint, but the merger was terminated, which
led to the beginning of the end for WorldCom. On July 21, 2002, WorldCom Group filed bankruptcy, which was due
to deliberately overstating tax income.
The Culture
WorldComs company culture was extremely oppressive. The advent of expanding the company led to pitfalls
that management did not address. WorldCom acquired different companies and continued to manage the
companies that they obtained as separate entities. The disconnection of the departments within the company
impeded the performance and governance of the WorldCom. Ebbers attitude towards corporate governance
spearheaded the less than favorable climate of the company. Upper management only wanted to dictate the
employees. The employees did not have any way of reporting grievances. The chain of command only flowed
downward. Employees did not feel at liberty to disclose inadequacies within the company, because the lack of the
code of conduct that Ebbers felt was a waste of resources to pursue. If Ebbers had fostered a culture where
employees at all levels followed a chain of command when reporting issues, several problems could have been
alleviated or at least Ebbers would have had knowledge of all of the inadequacies of the firm. Sullivan, CFO, took
advantage of the lack of a direct chain of command and ran the business how he wanted to do so. Upper
management used intimidation and scare tactics to gain what they wanted from employees. The threats and
language that Buddy Yates, director of WorldCom General Accounting, used when speaking to the Gene Morse,
senior manager at WorldComs internet division, was not professional neither ethical. Threats should have been
reported and dealt with accordingly.

Employees that were loyal and did what they told, especially the ones that worked in accounting, finance, and
investment departments received compensation for their duties. Compensation to those employees in those
departments equated to hush mouth money. Ebbers and Sullivan were both aware of the downward turn the
company was taking and wanted to make sure to keep the employees that were privileged to the financial
information, was kept happy. Often times people will keep quiet for the right price.
The Beginning of the End
The external environment that WorldCom faced during 1999-2001 was grim. The telecommunications industry
had taken a nosedive. The competition was fierce and the demand for telecommunications declined. Sullivan, CFO,
apparently felt that desperate times called for desperate measures. Sullivan and his staff used accounting strategies
to realize targeted performance for the company. Executives were pressured by the numbers. The pressures of Wall
Street were an increasing concern of executives. The executives wanted to make sure that stock prices were not
affected by the companies unspoken hardships. Top level executives did everything in their power to snow
everyone that had some type of interest in the company.
Betty Vinson and Troy Normand from the general accounting department were enlisted to make transfers by their
boss Yates. They were opposed to following the orders of top-level management, but eventually they conceded to
the pressures. Like good employees, they did what they were told. Yates told his employees that the orders were
given by Myers and Sullivan. Sullivan insured them that nothing was wrong and he would take full responsibility for
their actions. Interestingly enough, Ebbers heard about the accountants apprehension and reportedly told Myers
not to put the accountants in that position. This is another example of the breakdown of communication within the
company. This led me to believe that Ebbers was not all knowing of the financial woes of WorldCom. Sullivan called
many of the shots that led the company into its detriment. Ebbers should have tightened his grip on the company
and conducted his own investigations about the numbers. Ebbers should have insisted on his approval before any
major business decisions were made. Ebbers had the title of CEO, but Sullivan was the financial brains behind the
company. Ebbers admitted to not knowing about the numbers, and relied heavily on Sullivan to make important
financial decisions about the business.
Betty Vinson was a victim. She had a reputation of following orders as directed. Upper-level management used
Bettys weakness to their advantage. Betty was the bread winner of her family and needed her job and did not want
to be insubordinate and lose her job by not complying. Betty Vinson was caught in a very difficult situation as many
of the employees at WorldCom that needed their jobs to support their families.
Smoothing earnings is not an illegal act; it levels out peaks and valleys from normal earnings. Fraudulent
financial reporting is an aggressive act taken by executives within a company to intentionally conceal financial
information about the company and to deceive others about the wealth of the company.
(http://www.investopedia.com/ask/answers/191.asp) WorldCom committed fraudulent activities. Now, Ebbers is
serving time in prison for delegating the responsibility of being the CEO to the CFO.
The internal auditors of WorldCom reported to CFO. The internal auditor should have reported to the CEO and
the audit committee. In 2001, Cynthia Cooper headed the internal audit department. Gene Morse, at that time,
worked for the audit department. Cynthia Cooper and Gene Morse was a matched made for the demise of the
WorldCom. Although a few years had passed, Gene Morse, surely, did not forger about the threats that were made
to him by Yates. Morse wanted justice and wanted the executives to be exposed for who they really were. Morse

coupled with Coopers inquisitive nature and a desire to accurately report financial information went through extreme
measures to get to the root of WorldComs finances.
External auditors serve a vital role in our economy. They ensure that companies are employing good business
practices and disclosing accurate records to shareholders. External auditors are the hub of our economy. Arthur
Andersen was WorldComs independent external from 1990 to 2002. Initially, he and his team audited WorldCom the
conventional way, up until the massive expansion of the company. With the increased mergers, Andersen adopted
what he thought was a more efficient way to audit the company. He focused his audits primarily on analytic reviews
and risk assessment. There was a checks and balances system. Andersen trusted the company to supply him with
accurate financial records. Andersen may have been suspicious about the records. But, he really did not want to
find out too much because the success of the company was important to him too. Andersen should not have been
WorldComs auditor because there were conflicts of interests. Andersen violated the competence, integrity, and
credibility ethical practices. He lacked competence because he did not provide accurate information about the
results of the risk management software, which indicated that WorldCom was a maximum-risk client. Despite
Andersens findings, his audit reports continued to depict WorldCom as moderate-risk client. Andersen had a special
interest in the company. He even reduced his fees for auditing the company. He lacked integrity by doing so, and felt
compelled to keep the corporate conglomerate afloat by not doing thorough investigations. Surely, Andersen was
receiving massive amounts of money for auditing the company and not to mention the notoriety he received for being
associated with the company. He did not really want to risk his social standing to be a corporate whistleblower. He
could have asked more questions and probed a little more, but he wanted the company to thrive. The high-level
executives went to extreme measures to ensure that Andersen received records that were not accurate. They
prepared special reports for him, which was out right blatant fraud at the executive level. Andersen lacked creditability
because he did not disclose to the audit committee about his restrictive access to financial records. Andersen did not
actively adjust the numbers, but he was a major part of the problem that led to companys downfall. He should have
been unbiased and reported the findings to the audit committee. He did not act professionally and should have
received prison time and should have had to pay restitution because he did not uphold ethical standards. He put
many peoples livelihood at risk by simply not doing the job he was hired to do.
Conclusions
Ebbers should have received prison time for his involvement and being the CEO of the company. Ebbers
unethical behavior trickled down to all of his subordinates. He violated practically all of the professional ethics.
Although he was the not the CFO, he should have established an environment where he had oversight of all of the
important financial business decisions. His defense of not being a numbers man was not sufficient. He is paying
dearly for the lack of not knowing the numbers and trusting his CFO, which in turn, sold him out.
Ebbers approach to business was too broad. He acquired too many businesses when he could not control the
one that should have been the most lucrative. He was irresponsible for using WorldCom to back his other personal
business ventures. Although Ebbers may not have known of all of Sullivans poor business decisions, he made
plenty of poor decisions himself, in which he was responsible. Ebbers knew exactly what he was doing when he
decided to own his many businesses, and that too affected WorldCom.

Sullivans sentence was not just. He should have received more time in prison because he orchestrated a great
deal of the financial transfers. He acted alone on several occasions, but was not held as accountable for his efforts in
the collapse of the company.
Ultimately, the crisis could have been averted by establishing professional standards for managers and
employees alike. When there are effective measures implemented to ward off unethical behaviors, employees at all
levels are less likely to engage in behaviors that are not becoming of their profession. There should have been
professional development at every level of the company to ensure that all employees knew how and to whom to
report activities that could be less than favorable to the company, its reputation, management, and employees.
References
Accounting Fraud at WorldCom. Retrieved October 21, 2008 from Harvard Business Online Website:
https://harvardbusinessonline.hbsp.harvard.edu/b01/en/courseplanning/student/student_course_detail.jhtml?
courseId=c23431
Horngren, T. C., Sundem, L. G., Stratton, O. W., Burgstahler, D., & Schatzberg, J. (2008). Introduction to
Management Accounting Chapters 1-17 (14th ed.).
What is earnings management? Retrieved October 25, 2008, from Investopedia Website:
http://www.investopedia.com/ask/answers/191.asp

Abstract:

The case discusses the accounting frauds

committed by the leading US telecommunications
giant, WorldCom during the 1990s that led to its
eventual bankruptcy. The case provides a detailed
description of the growth of WorldCom over the
years through its policy of mergers and
acquisitions. The case explains the nature of the
US telecommunications market, highlighting the
circumstances that put immense pressure on
companies to project a healthy financial position
at all times. The case provides an insight into the
ways by which WorldCom manipulated its
financial statements. The case also describes the
events that led the company to file for
reorganization under Chapter 11 of the U.S.
Bankruptcy Court in 2002.
The role of the company's top management in the scandal has also been discussed. Finally, the case
explores the initiatives being taken by the company to change its management structure, improve its
performance and restore investor confidence.

Worldcom 2002: Yet Another Corporate Scam

On June 26, 2002, the US-based telecommunications major WorldCom received unprecedented media
coverage all over the world. Not for good reasons though. The company had earned the dubious
distinction of being involved in the largest accounting scandal ever to hit the US corporate history.
WorldCom had reportedly misrepresented its financial statements to an extent of around $ 4 billion.

The company admitted that it had resorted to

fraudulent accounting practices for five quarters
(four quarters of 2001 and the first quarter of
2002). Soon after, WorldCom terminated the
services of some of its top executives including
Scott Sullivan (Sullivan), the Chief Financial
Officer and David Myers, the Senior Vice
President and Controller.
The company's auditors held Sullivan responsible
for the accounting mess and Sullivan was soon
arrested on charges of fraud and
misrepresentation. Adding fuel to the fire was the

fact that Arthur Anderson was WorldCom's

auditor while the inappropriate accounting was
taking place.2
However, Arthur Andersen tried to wash its hands off the crisis stating that it was not aware of the
accounting discrepancies. They accused Sullivan for withholding crucial information about bookkeeping practices followed at WorldCom.

With the sudden appearance of a $ 4 billion hole

in its balance sheet, WorldCom was in an acute
financial crisis. A severe cash crunch forced the
company to layoff 17000 workers, which
constituted 20% of its global workforce.
Eventually, the financial crisis forced WorldCom
to file for reorganization under chapter 113 of the
Bankruptcy Code in July 2002., In August 2002,
WorldCom shocked company observers and
stakeholders yet again by reporting an additional
improper reporting in its financial statements. This
time around, the amount involved was $ 3.3
billion, carried out by manipulating the
EBITDA4during 1999-2001, and the first quarter
of 2002. By late 2002, the extent of
misappropriation by WorldCom was estimated to
be well over $ 9 billion...
From being one of the world's most valuable companies (valued over $ 100 billion at its peak),
WorldCom came to be known as one of the biggest instances of the 'fraud wave' sweeping the global
corporate world since the late 1990s. The company's downfall from WorldCom to 'WorldCon' is a story
of a corporate feeding its greed through financial and accounting manipulations.