If I had to explain, what the leading cause of the WorldCom scandal in one word, I would say because of megalomania. Megalomania means a person has an exaggerated attitude about his qualities and displays excessive pride and an excessive ambition.
In 1984, a motel operator with a few other people formed a company titled Long Distance Discount Service. The main activity of the company was to obtain transmission capacity on telephone lines and then resell it to the business owners and individuals. The initiator of the business was Bernie Ebbers who had no prior experience in telecommunication. His concept of business was: bigger is clearly better.
In 1985, the small company started developing outside of Mississippi State. In a matter of 15 years, the company bought over 60 companies. In 1995, the name of the company had been changed to WorldCom. Every investment that Bernie Ebbers made required a lot of money, and because the company did not have enough cash he had to buy the companies through the company's stocks. As long as the prices of the stock would go up he was able to get more and more. By October of 1997, Ebbers would have already bought MCI, one of the largest telecommunication companies. This cost the company 40 billion in stock. For two years, the company had a sizeable profit.
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In 1990, Ebbers and WorldCom have invested hundreds of million of dollars in a lot of luxury "investments"; a 500,000-acre cattle ranch in British Columbia for $65 million, 540,000 acres of Timberland in different states for 600 million, a mine-sweeping company for $14 million, a luxury yachts for $25million. Bernard Ebbers bought all these properties only because he had the money, and not because they were large investments.
One of the responsibilities of directors of WorldCom was to check Ebbers management of the company,because he had many successful acquisitions the board of directors stopped to control his activity. After the collapse, a court-appointed examiner presented two examples where the board of directors renounced to their responsibility to oversee the acquisitions. In 1999, the company bought Skytel communication for $2 billion. The board of directors approved the deal after a 15 minutes presentation of the WorldCom management. In 2000 WorldCom management buys Intermedia for $6 billion the presentation was less than 90 minute.
In April 2000 Steven Brabbs who used to be the leader of international finance and control for WorldCom for operations for Africa, Europe and Middle East discovered a journal entry that was not appropriate for an accountant. The value of the wrong journal entry was about $33.6 million.
The fact that the cost of the cost per minute rate of renting third-party phone lines were fluctuating and the WorldCom would not know for several months what is the real price for the current month, usually they had to estimate the price and sometimes the prices were wrong. Therefore, Brabbs like any other accountants made an "accrual" or a reserve fund in their accounting books to make up for the difference. What happened on Brabbs department was that the Mississippi headquarters moved the Accrued Capital Expenditure from the expenses accounts and put them into Capital Investments, therefore, the profit would become larger, and that would look attractive for the investors. After Braggs saw the error and he started calling and asking his superiors, Yates and Meyers, for an explanation of the journal entry. Despite repeated requests, he had not received an explanation for the journal entry. He continued raising his concerns about the matter. Braggs did not stop there and informed the independent auditors of the WorldCom. He had not received a clarification neither from Arthur Andersen Audit Company, nor from WorldCom management. The fraud became larger until the internal auditors examined the books in 2002 and they found that the 3.8 billion fraud which brought the collapse of the company.
Cynthia Cooper, one of the WorldCom's internal auditors, has become the heroine of the scandal. After Bernard Ebbers's resignation, Cynthia Cooper began the traditional management control and she discovered quarter after quarter the writing methods of routing odd financial entries of Scott Sullivan, the financial director of WorldCom.
WorldCom dismissed him and then in 2004 he had been sent to prison for five years and three years probation. WorldCom accepted the resignation of David Myers, senior vice president in charge of auditing and he had been sentenced for a year and a day. Bernard Ebbers the CEO of WorldCom had been sentenced to prison for 25 years, and he lost all his personal assets. Buford Yates the accounting director had been sentenced and received one year and a day in prison.
Always on Time
Marked to Standard
Arthur Andersen, previous independent auditing company, had been replaced by one of the competitors KPMG; the new independent audit firm had an extremely difficult task to take on a comprehensive audit of financial accounts for 2001 and 2002.
The WorldCom sink was enormous and a high impact on everyone life. The investors after filling a lawsuit they were able to recuperate 6.1 billion from different sources including investments banks. About 300,000 telecommunication workers have lost their jobs. Telecommunications equipment manufacturers suffered at the end with layoffs, and decline of the share prices. In June 1999 at the height of his fame, WorldCom showed a value about 115.3 billion dollars, the share price to 62 dollars. In 2002 at NASDAQ, the price of a share was no more than 0.83 for a valuation of about 2.5 billion. Financial markets did not actually need another scandal. The environment was already negative on international stock exchange, and a new financial disaster as WorldCom had revitalized fears of investors burned by Enron.
In our country they were 95 million American shareholders in pension funds. The stock ownership was no longer protected,and therefore the entire population was concerned and outraged by the financial scandals. The American citizens asked the Congress and the other governamental organizations to try to find a solution to the problems of our society. Security and Exchange Commision enforced some regulations and introduced the Sabanes Oxley Act in 2002.
SOX came up with a major changes,on making internal controls and legal and criminal responsibility on the CEO and CFO (chief financial officers and managing directors) for the quality and effectiveness of internal controls within the organization. This change has a major responsibility on the shoulders of management companies listed at the Stock market and therefore they must take all necessary measures to ensure the implementation of a system of internal controls and the effectiveness of the system. Section 404 of the Sarbanes Oxley act presented the interest the most and it contains 11 titles including additional responsibilities of the Board of directors, independent auditors, corporate governance, internal controls assessment and improvement of the presentation of financial documentation.