Business Ethics-Worldcom Scandal
Topic Page No
Key Players Involved in Scam 5-7
Company Culture 8-9
Corporate Governance 10-14
How Fraud Happened ? 15-22
Discovery-Whistler Blower 23
Audit Committee 24-27
Effect of Scam 28-29
SOX Act 30-31
Impact of the Fraud 32
Proposed US Governance Principle 33-34
Q & A 35-37
After Scandal 38-40
Lessons Learned and Reference 41
WorldCom was a provider of long distance phone services to businesses and residents. It started
as a small company known as Long Distance Discount Services (“LDDS”) that grew to become the third
largest telecommunications company in the United States due to the management of Chief Executive
Officer Bernie Ebbers. It consisted of an employee base of 85,000 workers at its peak with a presence in
more than 65 countries. LDDS started in 1983. In 1985, Ebbers was recruited as an early investor of the
company and became its CEO. It went public four years later. Ebbers helped grow the small investment
into a $30 billion revenue producing company characterized by sixty acquisitions of other telecomm
businesses in less than a decade. On June 25, 2002, the company revealed that it had been involved in
fraudulent reporting of its numbers by stating a $3 billion profit when in fact it was a half-a-billion dollar
loss. After an investigation was conducted, a total of $11 billion in misstatements was revealed.
On June 25, 2002, WorldCom announced that it intended to restate its financial
statements for 2001 and the first quarter of 2002. It stated that it had determined that certain
transfers totaling $3.852 billion during that period from “line cost” expenses (costs of
transmitting calls) to asset accounts were not made in accordance with generally accepted
accounting principles (“GAAP”).
Less than one month later, WorldCom and substantially all of its active U.S.
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy
Code. WorldCom subsequently announced that it had discovered an additional $3.831 billion in
improperly reported earnings before taxes for 1999, 2000, 2001 and first quarter 2002. It has
also written off approximately $80 billion of the stated book value of the assets on the
Company’s balance sheet at the time the fraud was announced.On June 26, 2002, the
United States Securities and Exchange Commission filed a lawsuit captioned Securities and
Exchange Commission v. WorldCom, Inc., No. 02-CV-4963 (JSR).
On July 3, the Honorable Jed S. Rakoff, of the United States District Court for the Southern District
of New York, appointed Richard C. Breeden, former Chairman of the SEC, as Corporate
Monitor, with the consent of WorldCom. This Committee was established by the Board of Directors
On July 21, 2002. The Board directed to conduct a full and independent investigation of the
accounting irregularities that gave rise to the announced intention to restate, and such other matters
as we concluded should be considered, without any limitations. The members of the Committee
were new to the Board of WorldCom at that time.
Key Players Involved in WorldCom Scandal
1. Bernard Ebbers-Chief Executive Officer in the company.
2. Scott Sullivan-The chief financial officer and secretary of WorldCom.
3. David Myers-The controller and senior vice president of WorldCom.
4. Cynthia Cooper-Chief Internal Auditor of WorldCom.
5. Buford Buddy Yates – He was the former director of accounting at WorldCom.
6. Betty Vinson – She was the former director of corporate accounting at WorldCom.
7. Arthur Anderson LLP – Kenneth M. Avery and Melvin Dick were the primary
auditors representing their firm in the WorldCom scandal.
Who was mainly responsible for the downfall of
I. Board of Directors: As they were involved in fraudulent and cheat.
II. Non-Executive Directors: As they were involved with Board of Directors in
III. Internal Audit Team: As they were bribed by Board and Management to show
their audit report clean.
People Who were Affected ?
Company Culture- Top Management’s Managing Style
The growth through acquisitions “strategy” at WorldCom was enforced and reinforced by
top management. The consistent pressures from top management created an aggressive and
competitive culture that did not contain any communication of the need for honesty or truthfulness
or ethics within the company.There was a large focus on revenues, rather than on profit margins
and the lack of integration of accounting systems allowed WorldCom employees to move existing
customer accounts from one accounting system to another. The lack of a code of ethics at
WorldCom shows that no training on awareness of fraud or ethics was conducted. Therefore, it is
very possible that when the employees reported existing customers as new ones, they were not
aware of the obdurate consequences that may occur.
The lack of an ethical code and an outlet for concerns was the concept of
employee compensation with stock options. Employees at WorldCom received a lower
salary than their counterparts at competitors such as AT&T and Sprint. Most of the
information was not fully available to employees, furthering this secrecy. Even some who
had the need to know the information such as the internal auditors, were able to view only
some of the journal entries in the income statement and the balance sheet but never the
entire documents. Ebbers created an individualistic culture where loyalty to a person was
more important than loyalty to the company. This created an environment where the boss
was not to be questioned.
Corporate Governance- Board of Directors
The Board was inactive and met only about four times a year, not enough for a company
growing at the rate that it was. In addition, the directors were only given a small cash fee as
compensation, thus an appreciation of stock was the only form of compensation available. The
directors also depended on company growth and stock appreciation for compensation, as did the
employees and management. Due to the Board’s lack of active participation, there was a lack of
awareness about WorldCom’s matters. Management aided that lack of awareness by presenting the
directors with very limited information about the company and its acquisitions. The discussions did
not involve the Board at all and at other times no documents were even presented concerning the
terms of the transactions
Toxic Culture of Senior Management Team
Believed that their actions were not “really” illegal.
Unrealistic financial targets and inability to meet them.
Recording of a/c entries without any evidence.
Company was capitalizing its line costs. Line costs were operatingexpenses but
WorldCom classified as capital expenditure.
In 2000 and 2001, WorldCom claimed pre tax revenue of 7.6 and 2.4Bn $ respectively.
Later discovered as loss of 49.9 and14.5 Bn $ forthe respective years.
Reserve accounts were manipulated to increase figures.
Two versions of accounts the actual version and the Final version for investors.
What are the key factors for the collapse in the
view of Corporate Governance?
The following key factors resulted the company to a collapse:
i)Senior Executives were encouraged to lie, cheat and manipulate records by providing them
high margin of profits.
ii)Executives were interested in their personal reward structure ignoring the stakeholders’
iii)Board members were mostly highly rewarded and consist of the friends, who did not
raise questions on any doubtful and ambiguous records.
iv)Non-Executive Directors were also highly rewarded and they worked independently.
v)Audit Team was bribed, so that the team will produce a clean audit report.
vi)Illegal profits were generated and it was shown that all the policies and rules
implemented from the top were for the benefit of the company and shareholders, and
hence, were ethical.
vii)The cost of heavy machinery purchased in a particular period was not spread by the
company in the next coming financial years.
Loans to Ebbers
Ebbers had made several purchases for which he had acquired loans and used his WorldCom
stock as collateral. The price of WorldCom stock fell, Ebbers was required by the banks to fill in the
margins 12 between the value of his loans and the fallen value of his stocks.Instead of selling his stock,
which he thought would further cause a decline in stock price on Wall Street, Ebbers requested the
Board to approve personal loans to fill in the margins. Ebbers took advantage of the lack of
independence of the board members who were loyal to him such as Stiles Kellett, chairman of the
Compensation Committee, and Max Bobbitt, chairman of the audit committee. Not only did the two
allow the loans to grow to more than $400 million, but also when the Board found out about these loans,
they failed to take any action and allowed the loans to carry on.
How Fraud Happened ?
The fraud was characterized mainly by the improper reduction of line costs and false adjustments to
report revenue growth.
The Misstatement of Line Costs
Capitalizing Line Costs
The Misstatement of Line Costs
Line costs are the costs associated with carrying a voice phone call or data
transmission from the call’s origin to its destination. If a WorldCom customer made a call
from New York City to London, the call would first go through the local phone company’s
line in New York City, then through WorldCom’s long distance, and finally through the local
phone company in London. WorldCom would have to pay both the local companies in New
York City and London for use of the phone lines,these costs are considered line costs. Not
only were line costs WorldCom’s biggest expense but were also approximately half of
WorldCom’s total expenses. Especially after the collapse of the dot com bubble in early 2000,
cost savings became extremely important, so important that line cost meetings were the only
meetings with regular attendance by top management.
WorldCom’s top management strived to achieve a low line cost to revenue ratio because
a lower ratio meant better performance whereas a higher ratio meant poorer performance. To report
better performance and growth, Sullivan implemented two improper accounting methods to reduce
the amount of line costs, release of accruals from 1999-2000 followed by the capitalization of line
costs in 2001 through early 2002.
The end of each month, during the fraud period at WorldCom, was characterized by the
estimation of costs that were associated with using the phone lines of other companies. The actual
bill for the services was usually not received for several months. This meant that some entries made
to the payables could be 27 overestimated or underestimated. In the case that the liability was
overestimated, when the actual bill was received there would be a surplus of liabilities that when
released would result in a reduction of the line costs.
Accounts Payable 1,000,000
Cash Paid to Suppliers 900,000
Line Cost Expense “release” 100,000
WorldCom adjusted its accrual in three ways:
Some accruals were released without even confirming if any accruals existed in the first
Second, if WorldCom had accruals on its balance sheet it would not release them for the
proper period and instead keep them as “rainy day” funds for future uses.
Lastly, some of the accruals released were not even established for line costs, thereby
violating GAAP by using one expense type to offset.
Capitalizing Line Costs
The 4% utilization of the fiber optic cables meant that WorldCom was still paying
for the leases on the cables even though it was generating no revenue on them. According
to Morse 29 WorldCom had leased the lines in a 2-5 year agreement that could not be
canceled. However, the costs associated with the lines were causing the line cost E/R ratio
to increase. Thus, when no more accruals could be released, Sullivan turned to capitalize
these costs, another violation of GAAP.
By the time the fraud was discovered, Sullivan had managed to improperly
reduce the line costs by approximately $3.883 billion.Capitalizing the expenses resulted in
shifting the items from the income statement onto the balance sheet, allowing the
overstatement of income as well as the overstatement of assets.
A process called “closing the gap” was utilized to achieve the falsified
growth. First, Ebbers and other top management received the “MonRev” report that
provided a picture of the company‟s revenue for a given period. The report was
available exclusively to top management and its access was closely guarded. At the end
of each quarter, top management would meet to close the gap that existed between the
actual revenue number and the expected number. Usually the journal entries involved
large round numbers, in millions or even tens of millions of dollars, and were booked
to an account called Corporate Unallocated revenue account. In reality, this account
had no relation to the operating revenues of WorldCom. A total of approximately $958
million in revenue was improperly recorded by WorldCom during Q1 1999 – Q1 2002.
What is interesting about the inflated earnings is that WorldCom was able to acquire a lower cost
of capital in terms of borrowing because the banks assumed WorldCom could cover its loans. The
reduction in cost of capital was one of the reasons WorldCom was able to make the multiple
acquisitions, paying for the acquisitions with its own inflated stock. From December 1996 to July
2001, WorldCom spent a total of $65 billion in acquisitions. If the Sprint acquisition had been
approved, it would have spent a total of $195 billion
When Cooper, the Vice President of the Internal Audit, questioned about capital
expenditures audit resulted in a large variance due to entries to an account called prepaid capacity.
no one appeared to give a answer. When she asked Sullivan about it, he explained they were line
costs that had been capitalized and told her to delay the audit until the third quarter of
2002.Cooper did not consider his request and continued with the audit. She asked Gene Morse, a
Manager in the Internal Audit department to look into the entries. Morse states it did not take him
long to find the journal entries, especially because they were large round-dollar entries even
though his access to the full view of both the balance sheet and income statement was limited.
On June 17, 2002, Cooper and Glyn Smith, another internal auditor in the
department, went to Betty Vinson in the General Accounting department to further inquire
about the prepaid capacity entries. She informed them that she had indeed made those journal
entries but only upon the request of top management. They next went to Buddy Yates,
Director of General Accounting, who directed them to Controller David Myers who
confessed to the fact that he indeed did not have any support for the journal entries and that
once top management had started making those entries it was difficult to stop making
them.June 25, 2002 marked the public release of the fraud.
An Audit Committee was established to conduct relations with Arthur Andersen, the external
auditor. In WorldCom’s case, the lack of independence and awareness of the Board as a whole
trickled down to the audit committee. The committee’s chairman, Max Bobbitt, was very loyal to
Ebbers. Hence, the members of the committee, including Bobbitt, were either unaware or had
known about the fraudulent misstatements for the years 1999, 2000, and 2001 and choose to ignore
WorldCom’s Audit Committee failed to meet with the Internal Auditors of the company, who
had the duty to provide the Audit Committee with an independent and objective view on how
to improve and add value to WorldCom’s operations.
The internal auditors were provided with limited access to the income statements and balance
sheets with only a partial picture of the company’s financial situation that prohibited them
from properly assessing the finances of the company
The Internal Audit department is intended to be independent and report directly to the Audit
Committee to avoid the influence of top management. This form of relationship was lacking at
The external auditor, Arthur Andersen, was the one responsible for providing an
independent opinion of the financial situation at WorldCom for investors and
creditors. The auditing firm also failed to carry out its duties properly.
Arthur Andersen’s failed to detect the fraud was due in part to negligence and in
part to the tight control top management kept over information.
Andersen failed to bring this problem to the attention of the Audit Committee
Effects on Internal Environment
After the fraud was announced to the public on June 25, 2002, new measures were taken quickly to
reform WorldCom and restore the public’s confidence in the company. The entire Board of Directors was
replaced with a new Board to guarantee independence and objectivity about management’s decision.
While more than four hundred new finance and accounting personnel were hired, 17,000 of the existing
85,000 employees at WorldCom were let go. A new independent auditor was 40 brought in to re-audit the
financial statements for the fraudulent period. The overstated assets were evaluated for impairment and
the goodwill from the previous acquisitions was written down. The use of stock options was also
abolished and restricted stock with full expensing value of equity grants was implemented A new ethics
program was implemented with training programs for employees to educate them on the manner of their
responsibility at the company and on the accounting issues that may signal an irregularity.
Effects on External Environment
The largest effect on the external environment was on the investors of WorldCom. The New York
State Common Retirement Fund is the second largest public pension fund in the U.S. It invested
the assets of the New York state and local employees retirement system and of the New York
State and Local Police and Fire retirement system. The pension fund lost over $300 million of its
investments in WorldCom.
Sarbanes & Oxley Act
WorldCom’s failure in June 2002, Congress quickly passed the Sarbanes & Oxley Act about a month later
on July 30, 2002 .The purpose of the act is to protect the investors by improving the accuracy and
reliability of the disclosures made by the publicly traded companies.
Section 301 that gives Audit Committees more responsibility to strengthen the committee’s role. Not only
does the act advise the committee to oversee the auditor’s work, but also requires the members of the
committee to be independent to ensure conflicts of interest do not arise. Additionally, the external auditors
are required to report directly to the Audit Committee and not top management to ensure independence
Lastly, Section 404 of the Act requires the SEC to assess the internal controls of financial reporting giving
the company responsibility to strengthen the controls and exclude the requirement of having the external
auditors assess management’s process of assessing the internal control system.
The Response of President and Parliament
President Bush called for tough new legislation to restore faith in American business.
Mr.Bush said those guilty of corporate fraud should be sent to jail for the sake of US
capitalism. He argued that people guilty of such abuses should be prevented from holding
high-level business positions again.
SOX: Sarbanes-Oxley act 2002, was precipitated by Enron, Arthur Andersen, Tyco,
Global Crossing and WorldCom. WorldCom was seen as the last straw in driving through
Impact of the Fraud
Shareholders: $180B of shareholder value lost (based on peak stock price)
Debt & Preferred Stock holders: $37.5B of debt and preferred stock holder value lost
Company: $750M settlement paid to SEC
Employees: 57,000 employees lost jobs
Board of Directors: 12 Directors agreed to pay (out of pocket) a total of $25M to settle
securities class action case
Proposed US Corporate Governance Principles
Select a chief executive officer and to oversee the CEO and senior management in the competent and
Establish a culture of legal compliance and integrity.
Develop and implement the corporation’s strategic plans, and to identify, evaluate and manage the
risks inherent in the corporation’s strategy.
Oversight of the audit committee and the board, to produce financial statements that fairly present the
financial condition and results of operations of the corporation.
Engage an independent accounting firm to audit the financial statements prepared by management and
issue an opinion that those statements are fairly stated in accordance with Generally Accepted
Through its corporate governance committee, to play a leadership role in shaping the
corporate governance of the corporation and the composition and leadership of the
Compensation committee, to adopt and oversee the implementation of compensation
policies, establish goals for performance-based compensation, and determine the
compensation of the CEO and senior management.
Deal with its employees, customers, suppliers and other constituencies in a fair and
What are something's that world com executives could
have done to prevent the accounting scandal ?
The main problem is not following the accounting principles . They should have followed the
Courage should have been developed by the employees and should not feel insecure to highlight
the issue to the internal audit team . Whistle blowing with third party audits.
Executives should have changed the autocratic culture during a small mistake or data fudging
Accounting executives should do cross –internal audit among the employees within the same
department , instead of a formal audit
How could corporate ethics have played a part in this failure ?
How could they help to bring a new and successful world com
Corporate culture is the main reason for this failure. World com has followed an autocratic culture , it
means a top down approach. It made all employees to accept the fraud and every one were given
targets to run over that
Corporate ethics should be adopted as follows to bring a successful company
Bottom Up Approach
-Specific and analytic approach
-Executives set directions and define mission
-Tangible and lasting results
Participative Management – pressure should be made to realize to employees through
town hall meeting and by being a transparent management in all policies
Improve Employee self ethics by frequently posting Fraud case studies a knowledge in
Strong Confidentiality in whistle blowing policies
The company emerged from Chapter 11 bankruptcy during 2004 with about $5.7 billion in debt and
$6 billion in cash.
On February 14, 2005, Verizon Communications agreed to acquire MCI for $7.6 billion.
On December 2005, the Microsoft announced that MCI will join it by providing Windows Live
Messenger customers "Voice Over Internet Protocol" (VoIP) service.
This was MCI's last new product called "MCI Web Calling".
Lessons Learned-Ethical Values Violated
Unethical Work Culture.
Pressurising employees to manipulate accounts.
No productive outlet for employee dissent.
Employees who played along were rewarded; others were threatened.
Fudged up the accounts mislead the various stakeholders.