WORLDCOM

1
WORLDCOM

• Presented by
• Eric Barr
• Stephanie Jenkins
• Robert Provost
• Adam Wear

2
WorldCom

• What are the facts?
• Ebbers (CEO) had used his company stock as
  collateral for both professional and personal
  loans
• Ebbers and Sullivan (CFO/CPA) frequently made
  the decision to grant excessive compensation
• Line Costs were capitalized as Prepaid Capacity
• A long time ensued before Cynthia Cooper came
  forward with the inaccurate accounting practice

3
What are the Ethical Issues?

• Was capitalizing line costs ethical?
• Was going along with the capitalization ethical?
• Was using company stock as collateral for loans
  ethical?
• Was having a no-question culture ethical?
• Should Andersen have questioned treatment of
  capitalization more?

4
Alternatives

• Ebbers could have changed his business strategy
• Sullivan could have refused to go along with
  accounting practices
• External Auditors could have questioned more
• Internal employees could have come forward
• Internal Audit could have had stronger presence

5
Stakeholders

• Employees (Including Upper Management)
• External Auditors
• Shareholders of Stock
• Competitors
• Lenders
• Customers

6
Practical Constraints

• Ebbers would have gone bankrupt
• Company would suffer large losses
• Employees could lose job
• External Audit Firm could lose client
• Internal Audit kept busy away from auditing

7
Did the Top Executives Act Ethically?

• Bernard Ebbers, CEO
• Participated in improper lowering of expenses and
  inflating revenues.
• Had continued to acquire companies and put
  WorldCom into debt and had used WorldCom stock as
  collateral for his own investments
• Scott Sullivan, CFO
• Also participated with Ebbers in improper
  accounting
• Made sure the internal auditors time was spent on
  operational audits almost exclusively
• Pushed employees to make entries with no evidence
  and meet numbers no matter what

8
Did the Top Executives Act Ethically?

• David Meyers, Controller
• Pressured along with Sullivan for reduced line
  costs in whatever way possible
• Made entries to falsify financial reports with no
  documentation or justification
• Ronald Lomenzo, Sr. VP Financial Operations
• Prepared MonRev and Corporate Unallocated
  Schedule reports
• Booked entries on the schedule and restricted
  distribution

9
Did the Top Executives Act Ethically?

• Buford Yates, Director General Accounting
• Participated in and encouraged the improper
  accounting even though he saw no justification
  for it
• Cynthia Cooper, VP Internal Audit
• Uncovered the accounting fraud and blew the
  whistle
• Steven Brabbs, Europe Asia Executive
• Questioned unjustified entries to top exectutives
  and Arthur Anderson
• Refused to make the entry, but eventually did
  record it through a management company adjustment

10
Did the Top Executives Act Ethically?

• Delores DiCicco, VP Wireless Finance
• Refused make an entry with no support despite
  heavy pressure
• Troy Normand Betty Vinson
• Felt uneasy about some of the entries but did
  nothing to stop them
• Normand says he was scared of losing his job and
  putting his family in financial jeopardy

11
Why Record False Entries?

• Bonuses/Perks dealt with bottom line performance
• Mandated to make false entries by upper
  management
• Assumed it was correct, no support asked for
• Fear for Job
• Raise Company Stock Price

12
What would you have done?
13
What are the facts?

• Steven Brabbs
• Vice President of International Controls in
  London
• One of first to notice accounting irregularities
• Notified Senior executives at WorldCom
• Notified Arthur Andersen auditors
• Refused to make the entry on the international
  companies books

• Troy Normand
• Director of Legal Entity Accounting
• Warehoused balance sheet accruals
• No documentary support for any of the entries
  posted to these general accounts
• Initially questioned the entries
• Later thought about resigning

14
What are the Ethical Issues?

• Steven Brabbs
• Should he make the entry without backup?
• Does the entry fairly represent company events?
• Who should he inform about the issue?

• Troy Normand
• Are the accruals appropriate?
• Should he have taken a stronger stance?
• Who should he inform about the issue?

15
What are the Alternatives?

• Steven Brabbs
• Follow corporate orders and make the entry
• Make the entry on separate books
• Refuse the entry
• Report the incident
• Resign

• Troy Normand
• Follow corporate orders and make the entry
• Make the entry on separate books
• Refuse the entry
• Report the incident
• Resign

16
Who are the Primary Stakeholders?

• WorldCom Employees
• Family Members
• Stockholders
• Creditors
• Arthur Andersen Auditors

17
What are the Practical Constraints?

• Disobeying could prevent future promotions
• Difficult to identify when your boss is wrong
• Need to support a family
• Difficult to blow the whistle on something that
  you are involved in

18
Who Was More Ethical?

• Steven Brabbs
• Notified Arthur Andersen on at least two
  occasions
• Refused to make entries to international books
• Set up a non-legal entity to make the entry

• Troy Normand
• Never contacted auditors
• Made non-GAAP entries to his account
• Ignored initial reservations

19
Internal Auditing

• Portray the firms financial situation as
  accurately and truthfully as possible.
• Maintain the highest standards of ethical
  conduct.
• Disclose fully all relevant information that
  could reasonably be expected to influence an
  intended users understanding of the records,
  comments, and recommendations presented.
• Maintain an appropriate level of knowledge and
  skill (competency).
• Refrain from disclosing confidential information
  except when authorized or required by law
  (confidentiality).
• Avoid conflicts of interest (integrity).
• Communicate information fairly and objectively
  (objectivity).

20
Independent Auditing

• Must Follow GAAS which includes both field work
  and reporting standards.
• Cohen Commission
• Primary Role Serve as intermediate between the
  financial statement and the users of those
  statements.
• Determine whether the judgments of managers in
  the selection and application of accounting
  principles were appropriate or inappropriate for
  use in the matter at hand.
• Express an opinion on internal accounting
  control.
• Detect and report errors, irregularities, and/or
  fraud.

21
Independent Auditing

• Judge Burger (Arthur Young Case, 1984)
• Examine the corporations books and records.
• Determine whether the financial reports of the
  corporation have been prepared in accordance
  wither generally accepted accounting principles
• Issue an opinion as to whether the financial
  statements, taken as a whole, fairly present the
  financial position and operations of the
  corporation for the relevant period.
• Maintain total independence from the client at
  all times.
• Maintain complete fidelity to the public trust.

22
Operating Audit vs. Financial Audit

• Purpose of Audit
• Emphasizes effectiveness and efficiency concerns
  operating performance for the future
• Distribution of Reports
• Reports are intended primarily for management.
• Inclusion of nonfinancial areas
• Cover any aspect of efficiency and effectiveness
  in an organization and involve a wide variety of
  activities.

• Emphasizes whether historical information was
  correctly reported oriented to the past
• Report typically goes to many users of financial
  statements.
• Limited to matters that directly affect the
  fairness of financial statement presentations.

23
WorldComs Internal Auditors and Audit Committee

• Internal auditors performed mainly operational
  audits.
• Avoided financial audits that might overlap with
  the work of external auditors on the grounds of
  cost savings.
• Internal Auditors only reported to audit
  committee at year-end.
• Reported to Scott Sullivan the rest of the year,
  who controlled their promotions, salary
  increases, bonuses, stock options, and more.
• Assignment of special projects with no audit
  purpose, which consumed most of the time of the
  Internal Audits staff.
• Audit committee accepted proposed Internal Audit
  Plan that focused on operational effectiveness
  and efficiency, systems, and internal controls.

24
What are the Facts?

• Salomon Smith Barney offered 1 million shares of
  IPOs to WorldCom CEO
• Salomon Smith Barney gave WorldCom positive
  reports despite suspect financials
• WorldCom CEO eventually made more than 11
  million from trading

25
What are the Ethical Issues?

• Bankers were selectively doling out IPO shares to
  individual executives instead of the public
• Financial reviews were being completed by the
  same company that depended lucrative banking
  business from the client

26
What are the Alternatives?

• Require that clients purchase their stock shares
  through public forum
• Set guidelines for selling IPO shares to clients
• Disclose financial relationships of clients
  during reviews
• Require holding period for IPO purchases for
  clients

27
Who are the Primary Stakeholders?

• Salomon Smith Barney
• WorldCom CEO and IPO holder
• The general public
• The company offering the IPO
• Analysts in charge of reviewing WorldCom

28
What are the Practical Constraints?

• Trying to maintain practical professional
  relationships
• Competitive environment pressures institutions to
  provide incentives

29
What Actions should be Taken?

• IPOs should not be given out selectively by the
  bank to clients
• Analyst reviews of clients should declare that
  relationship

30
WorldCom

• 2002 saw an unprecedented number of corporate
  scandals Enron, Tyco, Global Crossing.
• WorldCom went from being the nations second
  largest long distance carrier to the brink of
  bankruptcy as a result of massive fraudulent
  accounting practices.
• WorldCom is another case of failed corporate
  governance, accounting abuses, and outright
  greed.