VIET NAM NATIONAL UNIVERSITY

HO CHI MINH CITY

UNIVERSITY OF ECONOMICS AND LAW

Case 5:
Accounting Irregularities at
Worldcom
Teacher: Mai Thị Phương
Thảo Student:
Nguyễn Thị Hồng Nhung K164052243 25%

Đặng Thị Nguyên Hạnh K174050567 25%

Nguyễn Nhật Hoàng K174050568 25%
Nguyễn Gia Linh K174050572 25%


1. Introduction about WorldCom
1.1. Background

- WorldCom, US second largest telecommunication company shocked the

world by filing bankruptcy at 21 July2002. The WorldCom filing
surpassed Enron and became the largest 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

change sits name to WorldCom in 1995.

- During the 1990’s, the company starts to grow through series of

successful acquisition and merger.

- During the late 1999, the company’s 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 steril in accounting fraud. Scott

Sullivan, WorldCom's CFO, begins the process of misallocating as capital
expenditure what should have 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 company’s 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.
 1.2. Leaders
1.2.1. WorldCom CEO: Bernie Ebbers
- CEO was Bernie Eves who's also named "Telecom Cowboy" by Business
Week Magazine after a bold bid to buy MCI in 1997.
- Co-founded WorldCom in 1995, named chief executive officer
- In April 2002, he announces his resignation from WorldCom amid SEC
investigation
1.2.2. Chief Finance Officer: Scott Sullivan
- Began his career with WorldCom in 1992
- He rose to CFO of WorldCom through a close-knit relationship with
Bernie Ebbers by helping with acquisitions and mergers
- A leading executive, who was one of the most well-paid in his field with
more than $19 million in earnings in 1998 Fired in June 2002 after the
accounting fraud discovery
- May have been considered the mastermind behind the WorldCom scheme
manipulating numbers
1.2.3. VP of Internal Audit: Cynthia Cooper
- 1994 was the year that began her journey with the company
- Led her team to the discovery of WorldCom's accounting fraud in 2002
- Raised suspicion about the anomalies of WorldCom's capital expenditures
after advised by CFO to delay audit
Worked her way up the chain of command to get her questions answered
2. WorldCom Scandal
2.1. What happened ?
- On June 25, 2002, WorldCom, the Nation’s second largest long distance
telecommunications company, announced that it had overstated
earnings in 2001 and the first quarter of 2002 by more than $3.8 billion.
The announcement stunned financial analysts and, coming on top of
accounting problems at other corporations, had a noticeable effect on
the financial markets.
- The accounting maneuver responsible for the overstatement –
classifying payments for using other companies’ communications
networks as capital expenditures – was characterized by the press as
scandalous, and it was immediately asked why Arthur Andersen, the
company’s outside auditor at the time, had not detected it.
- WorldCom filed for bankruptcy protection on July 21st. On August 8th,
the company announced that it had also manipulated its reserve
 accounts in recent years, affecting an additional $3.8 billion
- On June 26th, the U.S. Securities and Exchange Commission (SEC)
charged the company with massive accounting fraud and quickly
obtained court order barring the company from destroying financial
records, limiting its payments to past and current executives, and
requiring an independent monitor.
- Hearings were held by the House Committee on Financial Services on
July 8th and by the Senate Committee on Commerce, Science, and
Transportation on July 30th. Several company officials have been
indicted.
- The fundamental economic problem confronting WorldCom is the vast
oversupply in the Nation’s telecommunications capacity, a byproduct of
overly optimistic projections of Internet growth. WorldCom and other
telecommunications firms faced reduced demand as the dot–com boom
ended and the economy entered recession. Their revenues have fallen
short of expectations, while the debt they took on to finance expansion
remains high. As the stock market value of these firms has plunged,
corporate management has had a powerful incentive to engage in
accounting practices that conceal bad news.
2.2. How they did it ?

- In its June 25th statement, WorldCom admitted that the company had
classified over $3.8 billion in payments for line costs as capital
expenditures rather than current expenses. Line costs are what
WorldCom pays other companies for using their communications
networks; they consist principally of access fees and transport charges
for messages for WorldCom customers. Reportedly, $3.055 billion was
misclassified in 2001 and $797 million in the first quarter of 2002.
According to the company, another $14.7 billion in 2001 line costs was
treated as a current expense.

- By transferring part of a current expense to a capital account, WorldCom

increased both its net income (since expenses were understated) and its
assets (since capitalized costs are treated as an investment). Had it not
been detected, the maneuver would have resulted in lower net income in
subsequent years as the capitalized asset was depreciated (depreciation
is an expense that reduces net income). Essentially, capitalizing line
costs would have enabled the company to spread its current expenses
into the future, perhaps for 10 years or even longer.

- On July 1, 2002, WorldCom announced that it was also investigating

possible irregularities in its reserve accounts. Companies establish these
accounts to provide a cushion for predictable events, such as future tax
liabilities, but they are not supposed to manipulate them to change
reported earnings. On August 8th, WorldCom admitted that it had
improperly used its reserves in recent years. The indictments issued
 August 28th charged that reserve accounts were reduced in order to
provide credits against line expenses.
2.3. How they got caught ?
- Cynthia Cooper, a strong-willed, 38-year-old, nine-year WorldCom
veteran, headed WorldCom’s24-member internal audit department.
Cooper had grown up in Clinton, Mississippi, WorldCom’sheadquarters
since 1998. Her high school teacher of accounting was the mother of one
of her senior auditors. Gene Morse (Manager internal audit) also was
working in Internal Audit, as a senior manager; he had transferred after
Yates( threatened him, in October 1999, about speaking to external
auditors. Internal Audit reported directly to CFO Sullivan for most
purposes. It conducted primarily operational audits to measure business
unit performance and enforce spending controls. Arthur Andersen,
WorldCom’s independent auditors, performed the financial audits to
assess the reliability and integrity of thepublicly reported financial
information. Andersen reported to the audit committee of the
company’s board of directors.

- In August 2001, Cooper began a routine operational audit of WorldCom’s

capital expenditures.Sullivan instructed Myers to restrict the scope of
Cooper’s inquiry: “We are not looking for acomprehensive Capex audit
but rather very in depth in certain areas and spending.” Cooper’s
auditrevealed that Corporate had capital expenditures of $2.3 billion. By
way of comparison, WorldCom’soperations and technology group, which
ran the company’s entire telecommunications network, hadcapital
expenditures of $2.9 billion. Internal Audit requested an explanation of
Corporate’s $2.3 billion worth of projects. Cooper’s team received a
revised chart indicating that Corporate had only $174 million in
expenditures. A footnote reference in this chart indicated that the
remainder of the$2.3 billion included a metro lease buyout, line costs,
and some corporate-level accruals.

- In March 2002, the head of the wireless business unit complained to

Cooper about a $400 million accrual in his business for expected future
cash payments and bad-debt expenses that had been transferred away to
pump up company earnings. Both Sullivan and the Arthur Andersen
team had supported the transfer. Cooper asked one of the Andersen
auditors to explain the transfer, but he refused, telling her that he took
orders only from Sullivan. Morse recalled: “That was like putting ared
flag in front of a bull. She came back to me and said, ‘Go dig.’

- Cooper brought the issue to WorldCom’s audit committee but was told
by Sullivan, after the audit committee meeting, to stay away from the
wireless business unit. Cooper recalled Sullivan screamingat her in a
way she had never been talked to before, by anyone.
 - Also in March 2002, SEC investigators sent WorldCom a surprise
“request for information.” The SEC wanted to examine company data to
learn how WorldCom could be profitable while other telecom companies
were reporting large losses.Cooper decided, unilaterally and without
informing Sullivan, to expand Internal Audit’s scope byconducting a
financial audit. Cooper asked Morse, who had good computer expertise,
to access thecompany’s computerized journal entries. Such access was
granted only with Sullivan’s permission,which they definitely did not
have. But Morse, anticipating a need for unlimited access to
thecompany’s financial systems, had previously persuaded a senior
manager in WorldCom’s ITdepartment to allow him to use the systems
to test new software programs.The software enabled Morse to find the
original journal entry for virtually any expense. Morseworked at night,
when his activities were less likely to clog the network.

- By day, Morse examined his downloaded materials in the audit library, a

small windowless room. He copied incriminatingdata onto a CD-ROM so
that the company could not subsequently destroy the evidence. Morse,
agregarious father of three, was so concerned with secrecy that he did
not tell his wife what he was doing and instructed her not to touch his
briefcase.

- It’s time that everything revealed.

2.4. Consequence
2.4.1. Company

- Prior to the June 25th announcement about accounting problems,

WorldCom stock had fallen from a high of $64.50 a share inmid-1999 to
less than $2 a share. The price fell below $1 a share immediately after the
announcement and then to pennies a share upon news that there might be
further accounting irregularities. While much and perhaps most of this er
described above is likely to have hurt investors who continued to hold the
shares or even bought more in anticipation of a rebound.

- WorldCom employees who hold the company’s stock in their retirement

plans have also suffered losses. At the end of 2000, about 32%, or $642.3
million, of WorldCom retirement funds were in company stock; those
investment have fallen to less than 4%, or less than $18.7 million, of the
funds. WorldCom does not require employees to own company stock in
their retirement plans, and they are permitted to sell the shares they do
have.

- WorldCom filed for Chapter 11 bankruptcy protection on July 21 st. (The

goal of a Chapter 11 bankruptcy is to keep the firm in business under a
court-supervised rehabilitation plan.) While the company reported $103.8
billion in assets as of the end of March 2002, it also has $41 billion in
 debt on which it must make payments. The WorldCom bankruptcy is the
largest in U.S. history; in comparison, Enron listed assets of $63.4 billion
when it filed for bankruptcy in December, 2001.

- One factor affecting WorldCom’s future is whether its customers switch

to other telecommunications carriers. On July1 st, the Bush Administration
announced that it was considering disqualifying WorldCom from further
federal government contracts. (The Federal Aviation Administration has
rejected WorldCom’s bid to modernize its communications systems.)
How bankruptcy would affect service to customers retaining WorldCom
contract sis an issue the Federal Communications Commission is
monitoring.

- Immediately after the June 25th announcement, WorldCom stated that it

would cut 17,000 of its 85,000 employees. The extent to which these
dismissals would have occurred in the absence of the firm’s accounting
problems is not clear.

2.4.2. Leaders
CEO Bernard Ebbers
- On July 13, 2005, federal judge Barbara S. Jones, of the United States
District Court for the Southern District of New York, sentenced Ebbers
to 25 years in a federal prison in Louisiana. He was imprisoned on
September 26, 2006 .In December 2019, Ebbers was released from
Federal Medical Center, Fort Worth due to declining health, having
served 13 years of his 25-year sentence, and he died just over a month
later.
CFO Scott Sullivan
- In 2002, WorldCom learned of improper accounting at the company.
Sullivan was asked to resign by the company's board of directors; he
refused, and was fired. In August of that year, Sullivan was arrested and
charged with seven counts related to fraud at WorldCom
- Sullivan entered a guilty plea and was sentenced to five years in prison
as part of a plea agreement in which Sullivan testified against former
WorldCom CEO Bernard Ebbers, who received a 25-year sentence (the
maximum sentence that Sullivan could have received if he had not
accepted the plea agreement and was found guilty).
- Sullivan was released from jail in August 2009, after serving four years
of his sentence. He was required to be on home confinement for another
three years. He returned to Boca Raton, but not to his mansion, which
had been sold
3. Answer some questions
Question 1: What are the pressures that lead executives and managers to
“cook the books”
 When 1990, revenue growth slowed and the stock price began falling.
WorldCom's expenses as a percentage of its total revenue increased because
the growth rate of itsearnings dropped. This also meant WorldCom's
earnings cant Wall Street analysts'expectations. These situation pressures
WorldCom to cook the books

 In an effort to increase revenue, Ebbers put pressure his employees that he

wanted by the number one stock in Wall Street. He demanded his
employees to increase the revenues that focused on building revenues and
acquiring capacity sufficient to handle expected growth even if the long-
term cost exceeds the short-term profit. Revenue growth was a key to
increasing the company's market value. As a result of this demand by
Ebbers,executives and managers needed to show increasing in the revenues
that they started cooking

 He also put pressure the senior managers by saying that they will lose
everything if the company did not improve its performance. This has
actually encouraged the managers todo whatever it takes in order to boost
the revenues and remain in their jobs.Consequently, Sullivan decided to
entries to achieve targeted performance. Sullian fined that the only way,
which he and his two staff used main accounting tactics that accrualreleases
and capitalization of line costs to manipulating with the figures in order to
showthat company is in a better position.

 The telecommunication industry began to fall apart as a result of the high

competitionalong with the low demand at the onset of the economic
recession and the aftermath of the dot-com bubble collapse. As new entrants
began to enter the market, this led the prices to decrease further and
WorldCom forced to match. Due to this, WorldCom faced a higher pressure
to increase its revenues

 They are facing pricing pressures and its high committed line costs.
Moreover, WorldCom was faced by that the company may not be attractive
to investors anymore

Question 2: 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 ofactions that occurred in WorldCom?
Analysis of Issue

- There are quite a handful reasons that actions taken by WorldCom

managers were notdetected earlier. These reasons are divided into internal
and external factors.
Internal Factors:
- Top management is the heart of a company. They are the one who runs the
company andmaking the best decisions for the company. In the case of
 WorldCom, persons whoinvolved in fraud were the ones from the top
management such as the CEO, CFO and controller. If the top management
were involved in fraud, most likely they would use their influence in the
company or abusing their power in order to achieve their personalinterest
and cover up their tracks. Furthermore, if the top management is involved
infraud, there are limited channels for the subordinates to report about the
fraud.
- Corporate culture of WorldCom is one of the contributing factors. The
organizationculture in WorldCom is flawed and induces fraud to happen. In
WorldCom, itsemployees are prohibited to question their supervisors and
require them to follow everyinstruction given. Other than that, the
operation in every department is not uniformed.Every department has its
own rules and management style.
- Communication is important for a company. Through communication,
departments couldexchange information, getting new updates and
decisions can be made through thereporting. Poor and lack of
communication is what that happened in WorldCom. We cansee that
through the relationship between the employees and their supervisor,
betweendepartments, between internal and external auditor and between
boards of director.
- Information was limited and being blocked causing the true picture of the
company staysin the dark.
- Last but not least, the mindset and awareness of the employee. The mindset
of employeesin WorldCom is to follow their supervisor’s instruction, do not
question the instructiongiven and mind their own business. They do not
challenge their supervisor or reportabout anything suspicious because they
are afraid if there are any inevitableconsequences. Besides that, their
awareness about fraud is low. The employees do notknow how to handle
the situations when there is fraud happening in the company and being
victimized by the management.
External Factors:
- External auditor plays an important role in a company. Their job is as a
watchdog andexpresses their opinion of the financial report. An auditor also
upholds principles such asindependence, objectivity, integrity and
competency and due care, confidentiality, professional behavior and
technical standard. However, most the principles mentionedabove weren’t
seen in WorldCom’s auditor, Arthur Anderson. In the case of
WorldCom,there were signs and symptoms of fraud, however, the auditors
failed to detect any fraudand issued unqualified audit report for years. This
shows the ignorance and incompetenceof Arthur Anderson while
conducting audit work.
Question 3: How should employees react when ordered by their employer to do
something they do not believe in or feel uncomfortable doing
The employees should know the steps to resolve any dilemmas that confront
with the ethical values when they feel inconvenienced of doing something that
ordered by their employer. Meanwhile, employees should be aware and follow
up with the enforcement of rules and regulations such as whistle-blowing as it is
not in the matter of ignorance. Firstly, employees should consider the future
assured action in confronting with an ethical dilemma is by abiding with the
code of ethics as a form of guidelines. Even, in the WorldCom case however,
there were no in written policies for the management practices and rules itself
yet the code of ethics. Therefore, employees in WorldCom had no formal
guidance to lead them to an ethical decision in abiding or disobeying their
superiors such as Sullivan, Myers and Yates. As a fact, The IFAC's Code of
Ethics (2006) is developed eventually after the WorldCom corporate scandal in
order to provide clear guidelines on how a professional accountant should
comply with the following principles: integrity, objectivity, professional
competence and due care, confidentiality and professional behavior . In addition,
employees should make an ethical decision which entails a "right-versus-wrong"
decision as the one in which there are a right (ethical) choice and a wrong
(unethical or illegal) choice. When a person makes a decision that’s
unmistakably unethical or illegal, then person committed an ethical lapse. For
example, Betty Vinson had an ethical lapse or dilemma when she caved in to her
superior’s pressure to cook the WorldCom books. Apart from that, the
employees may determine themselves with the alternative actions that are
available to them in that situation. After that, they should weigh up the benefits
and costs of the alternatives to themselves as well as to others who might be
affected by the action taken. The alternatives that produce the greatest benefits
then should be chosen. Taking Betty Vinson as an example in which she should
not only consider about her personal matters besides the company’s sake, but she
also should consider the consequences towards the company’s shareholders and
stakeholders before performing the fraud. The steps as listed below indicate how
employees can avoid ethical dilemma by making a better ethical decision:
 Is the action is illegal
 Is it unfair to other parties
 If I take it, what I feel about it
 Will I be ashamed to tell my family members, co-workers
 Will I be embarrassed with if my action is written up in the local
newspaper?
Whereas, employees may use whistle-blowing as a legitimate channel to expose
the misconduct, alleged dishonest or illegal activity occurring in an organization.
The alleged misconduct may be assigned to various ways. For example, a
violation of a law, rule, regulation and a direct threat to public interest such
fraud, health and safety violation and corruption. Whistle blowers may make
their allegations internally (to other people within the organization) or externally
 (to regulators, law enforcement agencies, to the media or to groups concerned
with the issues). For example, from what we can see in the WorldCom corporate
scandal, the misdeeds of Betty Vinson and her accomplices at WorldCom didn’t
go undetected. They caught the eye of Cynthia Cooper, the company’s director
of internal auditing who could have looked the other ways, but instead she
summoned up the courage to be a whistle-blower or an individual who exposes
illegal or unethical behavior in an organization. The following fest the
involvement of authorities to enforcements whistle-blowing in order to
safeguard employee’s interest and information

4. Conclusion
- Pressures such as meeting market expectation, economy recession and
intensecompetition within the industry has lead executives and managers to
“cook the books”.

- The reason is that actions taken by manager are unable to be detected earlier
is because ofthe top management was acting in collusion with the auditor in
concealing the act offraud. The flawed company culture, the mindset and
awareness of the employees and poor communication were also part of the
contributing factors.

- Actions such as enhancing and complyingcorporate governance, implement

andencourage whistle blowing policy, enhancing communication, annually
reviewingauditor’s performance and conducting proactive audit would
prevent or detect quickly thetypes of actions that occurred in WorldCom

5. Team Recommend
- Inculcation of ethical values into the work culture
- Embracing a bottom top approach
- Stringent auditing, both interal and external, procedures
- Divesting control in a larger number of hands
- Comparing companies in the same industry and sector based on
performance indicators
- Keeping various stakeholder’s interests in mind