Case Study - Accounting Fraud at Worldcom

Case Study - Accounting Fraud at WorldCom

1. In the 1980 and 90’s WorldCom became a major player in the telecom industry through numerous acquisitions which increased their revenues and stock prices. After an attempt to acquire Sprint was blocked, by the U.S. Justice Department, WorldCom realized that the era of revenue growth via large-scale mergers was over. The company seemed to lose strategic direction at this point.

During the growth and acquisition phase there was a great deal of waste and in inefficiency in the business. As the dot com bubble burst many telecom companies began to fail and new entrants to the industry were drastically reducing their prices and WorldCom was forced to match. As business operations continued to struggle and performance marks were not being reached, CFO Sullivan decided to start entering different numbers and altering reports to show that WorldCom was reaching performance marks and the situation spiraled out of control.

2. The conflict between smoothing earnings and fraudulent activity is a complicated argument that continues today. More commonly known as generally accepted accounting principles (GAAP) is the preferred method for financial reporting and is gauged as the best practice to understand and comprehend a business. However, adjusted or smoothing earnings can also be used, as it is not considered an illegal or non-compliant act, and can often help favorably bias a company with public and private equity investors as well as creditors. Through earnings adjustments, fluctuations are removed and one-time costs deducted allowing for more smooth net income fluctuations from period to period. Without considerable legislation to dictate otherwise smoothed earnings can help propel a company forward.

While no direct line can be drawn to indicate one activity as fraudulent versus a non-fraudulent act, it seems that a preponderance of evidence pointing to direct intent as the divisor. The intent to hide and misreport the company’s financial figures and information or misreporting financial cash flow amounts or disclosing false financial information, most notably during governmental audit is considered fraudulent.

Regarding the case, WorldCom’s intent to prevent disclosure was fraudulent. Worldcom ceased recognizing expenses for unused network capacity and capitalized $771 million of non-revenue generating line expenses into an asset account. Subsequently, WorldCom reversed $227 million of capitalized expenses to make accrual release from liability. Moreover, when audited, Worldcom did not provide all the necessary information to the internal audit department, warned employees not to disclose the information asked for by external auditors and intentionally altered accounts, transferring millions in account balances to deceive the auditing firm.

3. WorldCom did not have a healthy corporate culture. WorldCom nurtured a corporate culture in which employees did not questions superiors, and only did as they were told. Each department had its own rules and management style as there was no written policies or corporate code of conduct, of which Ebbers was told to create, but thought the project was a “colossal waste of time.” Selected or favored employees received salaries and bonuses approved by Ebbers and Sullivan that were outside company guidelines. These aspects of the company culture left employees feeling that they could not express concerns about company policies or witnessed behaviors.

Additionally, Ebbers’ created a culture in which the legal function was “less influential and less welcome than in a healthy corporate environment.” Because of acquisitions WorldCom had offices spread all over the country. The department of human resources was in Florida, while the legal department was in Washington, D.C. Failure to consolidate departments under one corporate headquarters let to inconsistencies in management styles and poor interdepartmental communicates. Furthermore, many operations were controlled by top executives and the internal audit function became impractical and numerous employees did not even know it existed. The internal audit reported directly to CFO Scott Sullivan for most resolutions and they were not allowed to be truthful to the external auditor.