WorldCom, which was at one time the second biggest long-distance phone company in the United States, is now known for its world’s most prominent corporate scandal of all time. With an estimated 107 billion dollars losses in assets, the company was put into bankruptcy in 2002. Its executives who inflated the company’s assets by about 9 billion dollars through false accounting initiated the fraud that led to the downfall of the company. Its chief financial officer Scott Sullivan improperly reported expenses as investments so that the company’s financial situation could look much better than it did. More than 9 billion dollars was recorded in false accounting entries. It also exaggerated profits by around three billion dollars. The driving force of the fraud was a business strategy by the CEO, Bernie Ebbers. The CEO felt the need to show ever-increasing revenue and income, and this was made possible through financial schemes, which included recording expenses as investments. The other accelerant towards the fraudulent events at WorldCom was Ebbers’s desire to build and protect his very own financial status; this led to his continuous need to show a growing net worth to avoid marginal calls on the WorldCom stock that he had plagued to secure loans. The setting at which the fraud accounts occur is also a result of corporate governance failure given the board of directors did not do anything to stop the death spiral of the company but instead shift all the blame to the CEO citing him as the source of culture and pressure that birthed the fraudulent events.
Fraud Tree Classification
According to the ACFE’s Fraud Tree, the case of WorldCom falls under the category of financial statement fraud (Heracleous & Katrin, 2016). The facts of the duplicity by the company and its executives suggest that the net income and the net worth of the company’s capital were overstated. There was an exaggeration of reported revenues. Given the expenses are reported as investments, this indicates that there was concealing of liabilities and expenses, which the company incurred without the knowledge of its employees (Iyer & Samociuk, 2016). According to Arthur Andersen an accounting firm that conducted audits on WorldCom, the results came up short as Mr. Sullivan withheld information during the audits, this suggests there were improper disclosures where the employees and the public were made to believe the company was functioning in its full capacity (Heracleous & Katrin, 2016). Given the company was incurring debts instead of making profits, this is an indication of fictitious revenues. The financial officer Mr. Sullivan reported false reports on company finances; this is a clear depiction of improper asset valuation where the company is made to look in a positive light when in truth it is buried in debts and liabilities.
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The Fraud Detection
The fraudulent activities at WorldCom were discovered and ousted by a renowned whistleblower, Cynthia Cooper. Although the whistleblowing was the action that brought to light the mishaps of the company, the discovery stems from internal auditing of the firms accounting records. As the then vice president of internal audit, she decided to investigate anomalies in the company’s accounting entries (Iyer & Samociuk, 2016). Out of curiosity to discomfort, and suspicion, Cooper together with her team identified some irregular patterns in the accounting entries. She was explicitly asked by the CFO Mr. Sullivan to delay their capital-expenditure audit, which initiated her curiosity. Later she receives an email from the controller David Meyers telling her that she was wasting her time in auditing capital expenditures, which made her uncomfortable.
Along with her team, they worked their way up the chain of command investigating people. After a confrontation with the controller Meyers, he confessed and then they had their evidence (Iyer & Samociuk, 2016). The Securities and Exchange Commission (SEC) then launched an official wide-ranging investigation into the accounting department of WorldCom (Heracleous & Katrin, 2016). As a result of her actions, which the government got wind of, the U.S Senate responded to the revelations on fraud at WorldCom by implementing section 404 which governs assessing of internal controls through the Sarbanes Oxley Act.
Forensic Posture
The Special Investigative Committee of the Board of Directors of WorldCom Incorporated conducted the analysis of facts opinions and conclusions surrounding the case of fraud at WorldCom through internal proceedings. According to a report published by this committee on March 31, 2003, WorldCom committed an enormous fraud in a very mundane way (Iyer & Samociuk, 2016). They classify the event as one of the largest accounting frauds in history. More than nine billion dollars in false and unsupported accounting entries were made at WorldCom to achieve a desired reported financial result. However, the fraud did not involve WorldCom’s Network, its technology, or engineering departments. Most of the employees had no clue it was happening. The fraud was orchestrated by a few of the senior executives at the headquarters in Clinton, Mississippi, together with a few personnel from the accounting department (Heracleous & Katrin, 2016). The fraud continued as long as it did due to the lack of courage to blow the whistle by others, insufficient audits by the auditing firm Arthur Andersen, and a deficient financial system.
The investigation of the SIC directed by the board at WorldCom was complicated by their inability to converse with some of the central figures in the events that they examined. As a result, some of the information from the investigation was incomplete (Dennis, Nicholas, Rogers, 2003). The CEO had to be aware that the company was meeting revenue expectations through financial gimmickry (Heracleous & Katrin, 2016). The fraud was also influenced by Ebbers’s significant efforts to building and protecting his financial empire, without paying attention to the risks that those undertakings had on the welfare of the company. He presented a false picture to the company and employees because at the time the fraud was going on, he projected and reported continuous growth despite receiving internal information that was inconsistent with the reports. The committee was also unable to determine the extent to which the CEO and CFO knew or influenced the actions of the company, as they were unavailable for interviews.
The Security and Exchange Commission filed a civil action against WorldCom in 2002. In the litigation release number 17588 on accounting and auditing, the SEC charged WorldCom with 3.8 billion dollars fraud commission. It sought an injunction, money penalties, prohibitions on destroying documents and making extraordinary payments to WorldCom affiliates (Heracleous & Katrin, 2016). From the analysis of the SEC, WorldCom overstated its income before income taxes and minority interests amounting to approximately 3.055 billion dollars in 2001 and 797 million dollars during the first quarter of 2002. WorldCom also falsely portrayed itself as a profitable business during 2001 and the first quarter of 2002 by reporting earnings, it did not have. It did so by capitalizing rather than expensing (SEC, 2002). The company transferred the costs to capital accounts which are a violation of established generally accepted accounting principles. The actions of the company are taken to mislead investors and keep their earnings in line with the estimates of Wall Street analysts.
The action charged the company with a violation of antifraud and reporting provisions of the federal security laws in section 10b) and 13a) of the Securities Exchange Act of 1934(SEC, 2002). The commission sought court orders that would impose civil monetary penalties, prohibition of officers and employees from destroying altering or hiding relevant documents. The commission also ordered WorldCom under oath to file a detailed report of the specifics of the matter.
Analysis of the Fraud
The fraud was perpetrated in two ways, reduction of reported line costs and exaggeration of reported revenues. The objective of these efforts was to hold the reported line costs to about 42 percent of revenues and to report continuous double-digit revenue growth (Dennis, Nicholas, Rogers, 2003). The first instance of fraud happened when WorldCom announced that its financial personnel had improperly transferred 3.852 billion dollars from line cost to asset accounts from 2001 to early 2002. Between 1999 and 2000, the company reduced reported line costs by approximately 3.3 billion dollars (Iyer & Samociuk, 2016). This action was accomplished through improperly releasing accruals to pay anticipated bills. The events surrounding this action had an effect of offsetting against reported line costs such that reported expenses are reduced whereas reported pre-tax income increases.
The company adjusted accruals in three ways: in the first instance, some accruals were released without apparent analysis of whether the company had any excess in the accrual account. The second, when the company had excess accruals, the company failed to release them in the period stipulated (Iyer & Samociuk, 2016). Instead, they were kept for a rainy day when the company needed to report improved results. Thirdly, the company released accruals that had been established for other purposes. In all these cases line costs reduced as the pre-tax income increased. Senior members of the corporate finance section led by CFO Sullivan, Meyers and Buddy Yates, the director of general accounting directed these actions (Dennis, Nicholas, Rogers, 2003).
The second instance of fraud, WorldCom exaggerated reported revenues. Between 2000 and 2001, market conditions in the telecommunications industry deteriorated. However, WorldCom continued to post perfect results (Dennis, Nicholas, Rogers, 2003). The promise of double-digit growth in revenue resulted in pressures to maintain those numbers. The CFO and CEO were both aware of the non-recurring items to increase reported revenues (Heracleous & Katrin, 2016). Sullivan later becomes concerned as some of the revenue items were shadowing operating results. He leaves a voicemail to Ebbers, which was more than a year before the fraud was uncovered showing the scheme had been going on for so long.
The motivations for the fraud were to keep the company steady in the face of Wall Street. The company, unlike other telecommunications companies, wanted to capitalize on the line costs to the extent that they created accruals so that pre-tax income may increase and no one would notice (Iyer & Samociuk, 2016). In the end, WorldCom had violated its capitalization policy and accounting standards. The economic impact of the events leading up to the discovery of the fraud included a failed merger with Sprint Corporation due to anti-trust objections (Heracleous & Katrin, 2016). The financial gains of the CEO of the company stemmed from the CEO’s ability to manage internal operations of the large company and doing so in an industry-wide decline.
Internal Investigation
The SEC launched an investigation into the accounting and auditing departments of WorldCom. They ordered the board to file a report of the events that had happened. Given the sheer size of the company, the board of directors had to have the most extensive knowledge of the company’s proceedings. The board published an investigation report backed by counsel and accounting advisors (Iyer & Samociuk, 2016). The board of directors at WorldCom formed a special investigative committee to come up with a detailed report about the case, do analyses, and report a summary. There is no indication that the board received information before the ousting of the fraud. One could argue that the board was incompetent not to notice what was happening right under their noses. However, given the Ebbers and Sullivan were board members and had not come clean for years about their scheming, one would also argue that they were oblivious of the undertaking seeing as they were there to attend board meetings (Heracleous & Katrin, 2016). The process of developing fraud begins with a dysfunctional leadership and ineffective corporate governance and trickles down to risky strategic decisions and lax execution (Heracleous & Werres, 2016). Gradually, organizational misalignment develops.
If an internal investigation is merited, the Board of Directors will be the best suited to lead in the investigation or appoint someone. As the role of the board is to oversee the operations of the firm, they should have gotten wind of the situation earlier or made a friendly environment in which anyone who notices an anomaly would feel comfortable coming to them with the issue. A civil or criminal authority could also be an excellent choice to oversee the investigation if there is an assumption that everyone or the majority of people in the company knew about the fraudulent activity. If the board was compromised, then an external or more specifically a civil authority like the SEC would be the best choice to lead an investigation. External and other investigation firms could be given the opportunity to investigate if internal components could provide bias. In my opinion, internal investigations are better initiated by the board of directors or the shareholders given they govern how the company runs. To protect their assets, they would need to take the initiative of investigation or appointing a trusted entity that would do so on their behalf.
Investigative Steps
Several steps are crucial in every investigation. The first step should be to take immediate action. It includes preserving the area under investigation and notifying the relevant parties. According to Nigels and Samociuk (2016), investigations should begin with the collection of all relevant information based on investigative experience. Developing a hypothesis and planning the investigation follows (Iyer, & Samociuk, 2016). To gather accurate and first-hand data, an investigator, can obtain information from individuals. Information obtained from individuals can take either of two ways. The first is doing interviews of critical witnesses or subjects. Interviewing a person of interest gives you an honest depiction of their side of the story and what factors influenced their behavior. Interviews can be either self-report tests or depositions. Depositions state that whatever the individual has said is the original truth according to their perspective (Iyer, & Samociuk, 2016). Given that depositions are taken under oath and are conveyed verbally, an investigator can get the information directly from the source and observe an individual’s behavior during the exercise. For successful interviewing of individuals, it is understood that an investigator needs to gather all and necessary information before the exercise.
When conducting an investigation, forensic analysts have to be at the forefront of the exercise and ensure that what is needed remains unhampered. The documents needed for conducting interviews include internal records such as accounting audits, price and cost inventories, order reports and marketing information (Iyer, & Samociuk, 2016). External records such as invoices, payment records, and tax and bank statements can be subpoenaed. The public records including policy statements, terms and conditions, as well as court records and authentications, can all be used in the investigation to root the causal factors and accelerants. Computer forensics including logs and data entries can give a history of company activities. However, computer logs can be quickly erased and would require additional expert skill to find backlinks and user signatures.
Conclusions and resolutions reached by interested parties
The SEC’s complaint charges WorldCom with violation of antifraud and reporting provisions of the federal security laws. The commission concludes that the company falsely portrayed itself as a profitable business through reporting revenue it did not have. The actions of the company were only aimed at impressing investors and keeping up a good face with the Wall Street analysts (SEC, 2002). According to the investigation report done by the SIC directed by the board at WorldCom, numerous individuals most of whom were from the finance and accounting departments became aware of the misconduct of the senior management. However, none came forth to report the matter to human resource, internal audit, the law or public policy departments (Dennis, Nicholas, and Rogers, 2003). The downward spiral of the company is attributed to how the CEO ran the culture of the organization and the undercover operations of the accounting officials.
Recommendations
The case of WorldCom remains the biggest corporate scandals in the globe to date. There is a possibility that the same can happen today. The measures taken to prevent future similar problems can be done through outsourcing audits. An external auditing company is more likely to do a better job of identifying improper accounting and reporting it than internal audits given internal auditing may be run by the CFO or someone with the power to manipulate the results. The CEO and significant senior officials in forms should be subjected to reviews often to assess their work and decisions that could potentially influence the company. The board should take a more managerial post in running the organization rather than giving all the powers to the CEO. Policies should be implemented to organize regular reviews on company operations to fish out any suspicious activities. Regular reports on corporate functioning should be implemented to identify problems and develop interventions and recommendations for changes. The internal audit should have an expanded role equivalent to company resources and expertise. To avoid instances of fraud, it would be imperative for organizations to use budgets and financial targets as benchmarks and therefore work towards achieving these drives.
Other Issues
The unethical behaviors presented by the leading officials at WorldCom may have been caused by groupthink. Groupthink arises as a result of a group’s desire to achieve their motivations and override alternative courses of action. The pressure created at the top by the CEO to keep up appearances had a trickle effect on all other departments and employees. Ebbers demanded results he had promised yet he never rewarded ethical business practice. Through some mechanisms, the senior management controlled the financial information such that very few people knew of the nature of accounting irregularities. The few who knew the misgivings of the accounting department still blindly trusted the incompetent officials without much thought of the impending backlash that could potentially destroy them and the company when the details of the dealings surfaced.
References
Iyer Nigel & Samociuk Martin (2016) Fraud and Corruption . London Routledge
Heracleous Loizos & Katrin Werres (2016) On the road to disaster: Strategic misalignments and corporate failure. Long Range Planning , 49 (4), 491-506. https://doi.org/10.1016/j.lrp.2015.08.006
Dennis R. Nicholas K. Rogers B (2003) Report of Investigation Special Investigative Committee of the Board of Directors of WorldCom, Inc
U.S Securities and Exchange Commission (2002) Securities and Exchange Commission v. WorldCom, Inc., Civil Action No. 02 CV 4963 (JSR) Litigation Release No. 17866
