What Happened At Worldcom Accounting Essay


WorldCom, now named MCI, recently emerged from bankruptcy protection after reporting accounting irregularities of $11 billion. These accounting irregularities have resulted in many of WorldCom's previous executives being prosecuted on securities charges. In the past 18 months MCI formerly known as WorldCom has fired the CEO, COO, CFO, controller, general counsel, the entire board of directors and over 400 finance and accounting employees. In addition, to establishing a code of conduct and guiding principles; MCI's current CEO, has established an ethics office, hired a Chief Ethics Officer, and require all MCI employees to have extensive ethics training. However, it remains unclear if these actions are enough.

As part of their emergence settlement, MCI paid the Securities and Exchange Commission fines totaling $750million and former bondholders received 36cents on the dollar in stock in the new company. These accounting irregularities have resulted in many of WorldCom's previous executives being prosecuted on securities charges. On 2nd March 2004, Bernie Ebbers, WorldCom's ex-Chief Executive Officer, was charged with conspiracy to commit securities fraud, securities fraud, and falsely filling with the sec and on 24th 2004 six additional counts were filed against him. On 15th March 2005 Ebbers was found guilty on all nine counts and faces a maximum penalty of 85years in prison and an $8.25 million fine. On the same day the additional charges were filed against Ebbers, Scott Sullivan, WorldCom's ex-Cheif Financial Officer, according to a television stated that "as CFO at WorldCom I participated with other members of WorldCom to conspire to point a false and misleading picture of WorldCom's financial results."

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It was posited that much of WorldCom's unethical behaviors may have been caused by groupthink. Groupthink is caused when concurrence seeking becomes paramount in team decision-making. Also, it was defined groupthink is a "mode of thinking that people engage when they are deeply involved in a cohesive in-group, when the member's strivings for unanimity override their motivation to realistically appraise alternative courses of action". The characteristics of groupthink include a feeling of invulnerability, ability to rationalize events and decisions, moral superiority within group, group pressure on dissenters, use of stereotypes, self-censorship within group, and unanimity. While groupthink may have contributed to the number of people involved in the unethical behaviors as well as the length of time over which WorldCom's fraud occurred, groupthink does not resolve the ethical concerns with the senior level executives or the board of directors responsible for creating the culture which led to these events.

WorldCom has been just one of many companies caught in ethical quandaries and predicaments over the past few years. It appears that while some companies and their executives have maintained a strong focus on ethical behavior regardless of economic conditions, others have not.

What happened?

WorldCom was a major telecommunications company that was worth billions of dollars. It has business interest in more than 65 countries, and a network that stretches over almost 150, 000 kilometers. WorldCom gobbled up several pioneering internet firms such as UUNET, MCI and CompuServe, which created the first email services in the late 1970s. Unfortunately, the large sum of money that this company was earning were not being monitored in the correct manner and eventually it collapses because of major accounting fraud, and leaving the fate of its more than 80,000 employees across the world hangs in the balance.

In March 2002, the U.S. Securities and Exchange Commission (SEC) sought information from WorldCom about its accounting procedures and about loans it had extended to its officers. In April the company announced that it was cutting 3,700 jobs. Soon after, Standard & Poor's, Moody's and Fitch downgraded WorldCom's credit ratings. The U.S. Justice Department has launched an independent probe into the WorldCom scandal.

In April 2002, Bernard J. Ebbers the CEO of WorldCom resigned after an SEC probe revealed that WorldCom had lent $339.7 million to him to cover loans that he took to buy his own shares. In May, Standard & Poor's reduces WorldCom's credit rating to junk status and WorldCom was removed from the prestigious S&P 500Index. On June 25, the company announced that improper accounting of $3.8 billion in expenses had covered up a net loss for 2001 and the first quarter of 2002. The company also announced that is planned to shed 17,000 jobs, more than 20 percent of its workforce. The Nasdaq halted trading in WorldCom's stocks of WorldCom Group and MCI Group. In four months, ending of April, the share price fell by over 80 percent. On June 26, the SEC filed a suit alleging "securities fraud" against WorldCom is a district court in New York. It alleged that WorldCom's top management "disguised its true operating performance" and "misled investors about its reported earnings".

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Even as the company was sliding, it announced on June 25 that it was "restating" its income for 2001 and the first quarter of 2002. It said that an internal audit had revealed that earlier financial statements of the company had deviated from accounting principles, resulting in an over-statement of its revenues and profits for 2001 and the first quarter of 2002 to the tune of $3.8 billion. The company had used a simple trick in its balance sheet to boost revenues and profits while hiding expenditures. By classifying ordinary day-to-day expenses as investments and long-term expenses associated with the acquisition of capital assets, on which companies enjoy certain tax advantages, WorldCom was able to hide expenses to the tune of nearly $4 billion and instead show this as profit. One of WorldCom's major operating expenses relates to its "line costs", the fees that it pays to third party telecom network providers for the right to access their networks. In effect, WorldCom capitalized these fees, terming them as investments, when in fact; they were one of the most important day-to-day expenses. The SEC, in its complaint in court, stated that WorldCom's top executives did this in order to keep Wall Street happy. The shock turned anger as it became known that Arthur Anderson, who was WorldCom's auditor.

Major Personnel Involved

The driving factor behind this fraud was the business strategy of WorldCom's CEO, Bernie Ebbers. In the 1990s, Ebbers was clearly focued on achieving impressive growth through acquisitions. By using the stock of WorldCom to accomplish this buying spree, the stock had to continually increase in value.

WorldCom pursued scores of increasingly large acquisitions. The strategy reached its climax with WorldCom's acquisition in 1990 of MCI Communications, a company with more than two-and-a-half times the revenue of WorldCom. Bernie Ebbers acquisition strategy largely came to an end by early 2000 when WorldCom was forced to abandon a proposed merger with Sprint because of antitrust objections.

Bernie Ebbers felt the need to show ever-increasing revenue and income. His only recourse to achieve this end was financial gimmickry. The problem is that the more one resorts to this sort of dishonesty, the more complicated it becomes to continue it. Dishonesty is jus not sustainable in the long run. Complicating Ebbers situation was an industry-wide downturn in telecommunications. During that time, Wall Street had continued expectation of double-digit growth for WorldCom. After all, they had achieved so much in such a relatively short period of time.

However, WorldCom needed time for its management to catch up to its newly acquired companies and learn how to run and manage them. Unfortunately, Ebbers did not have the courage to tell Wall Street that WorldCom needed time for the consolidation and digestion of its acquisitions. In order to satisfy Wall Street's expectations, Ebbers had to examine his company's books. If he had the courage to tell them what was really needed, WorldCom would be alive today and Ebbers would not be facing the prospect of spending the rest of his life in prison.

Moreover, another major factor driving to the fraud in WorldCom was Bernie Ebbers very apparent desire to build and protect his personal financial condition. For this reason, he had to show continually growing net worth in order to avoid margin calls on his own WorldCom stock that he had pledged to secure loans.

Other than him, there are few senior personnel involved in the manipulations at WorldCom included such as Scott D.Sullivan, the CFO, Buford Yates Jr, Director of General Accounting, David F. Myers, Controller; Betty L. Vinson, Director of Management Reporting, from January 2002 and Troy M. Normand, Director of Legal Entity Accounting, from January 2002.

Flaws in corporate and professional accounting governance exposed

The flaws in terms of corporate governance in WorldCom are, where all the WorldCom's board members approved nearly everything Bernie Ebbers suggested, mainly because Ebbers showered them with benefits. Half of WorldCom's director were associates of Ebbers and had large personal stakes in the company. In addition, the board's wealth was tied to the stock and therefore it was in the board's interest to allow management to do whatever they wanted to keep the stock price up. WorldCom's directors were so tied to management financially that they had little incentive to question management's decisions, for fear of losing their wealth. The close relationship between management and the board made management believe that they would not get caught or fired because the board would not investigate decisions aggressively. Thus, management believes there was a low probability that they would get caught committing fraud.

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Moreover, the flaws in professional accounting governance are where Arthur Anderson who was the external financial auditor or WorldCom took the incentive to keep his mouth shut about the problems. Management was able to exploit this problem and get its auditors to agree to the fraud it was committing. Because of the close relationship between auditor and company, management was under the impression that their auditors would not report their fraud. The complexity if financial accounting and disclosure rules allowed management to commit fraud with the thought that it was hidden from the eyes of other. Accounting is supposed to be based on the principle that it is looks like it, and then it should be recognized as such. However, this uncertainty has caused a need for further defined rules. The level of transparency within the financial statement is derived from lack if full disclosure. Management at WorldCom exploited the complexity and lack of disclosure by hiding their problems. In additions, because of the lack of disclosure, management felt they could hide their problem sufficiently to prevent them from getting caught committing fraud.

Improvements of the flaws in corporate governance & professional accounting governance

One of the improvements on the flaws that resulted such accounting scandals to happen is that Sarbanes-Oxley (SOX) Act was implemented. In the SOX Act, it states that the Public Accounting Oversight Board is responsible to monitor public accountants, make changes in the auditing rules and to authorized and increase in criminal penalties for more white-collar crimes. This is to further prevent similar cases from happening again.

Besides that, the New York Stock Exchange (NYSE) and the National Association of Securities Dealers also play a part in this improvement of the accounting scandal. Major additions and alterations in the rules for accounting, auditing and also corporate governance had been passed on. Those are all necessary conditions for listing of a corporation's stock for trade on the exchange.

Standard and Poor's which is one of the three major credit-rating agencies, has developed a new concept of "core earnings" with the assistance from the financial and investment communities. This "core earnings" is a measure of earnings from a company's core business operations which includes the production and marketing line. The S&P measure excludes gains and losses from a variety of financial transactions such as gains and losses from the sale of a company's assets and goodwill. This is different compared with the earnings as defined by the generally accepted accounting principles (GAAP). S&P has planned to report this measure of earnings for all publicly held U.S. companies to provide investors with a standardized and a more transparent way to compare companies' earnings.

Not only that, the audit committee should meet with shareholders, portfolio managers and analysts at least once annually to solicit input and suggestions to improve the quality of the company's disclosure. Meeting should be conducted at least once annually with the management and advisors together with the audit committee specifically to review revenues in order to improve transparency in public disclosures.

Besides that, the other corrective actions taken under SOX laws is that auditors are not allowed to offer both audit services and consulting services to the same company at the same time. This would results in self-evaluation and therefore the auditors would no longer be independent. The auditors of the company should be independent so that the auditors can make sure that the financial statements are of true and fair view and issue out an auditor's report accordingly and not influenced by the cozy relationship the auditors had established with the company.

All the improvements are taken with the hope that no such scandals would reoccur. In addition, the number of corrective steps taken that will strengthen the governance practices at the companies in the future to safeguard and protect the interests of investors, and the larger public interest in the functioning of one of the country's largest corporations.

The impact of WorldCom on the accounting profession

The accounting fraud involving WorldCom has indirectly and directly impacted the accounting profession significantly. The public had lost trust towards the auditors since the aftermath where the auditors are supposed to be independent and carry out their responsibilities to make sure the financial report is of true and fair view on behalf of the shareholders and to the public. However, as for the WorldCom case, the auditors had neglected their duties to do so.

A Gallup poll indicated that the accounting profession's positive ratings dropped after the collapse of the accounting scandals while on the other hand the negative ratings had increased. The implications of such low positive ratings and high negative

ratings have had a dramatic impact on the profession.

The WorldCom scandals which had caused the investors billions of dollars when the share prices of affected companies collapsed, public's confidence in the nation's securities markets has been shaken. Shareholders should be given protection against scandals like WorldCom and Enron that left most of them almost penniless. The major impact after the scandal is the increased regulation with the passage of the Sarbanes-Oxley Act (SOX) of 2002. The intention of the SOX is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. It not only improves the independence of corporate boards, as well as the independence of the auditors, but it also imposed on more severe penalties for those who shred documents or violate the security laws. Not only that, chief executive officers and chief financial officers now had to vouch that the company's financial reports are free from material misstatements. In addition, the demand for accountants has dramatically increased with the passage of the Sarbanes-Oxley Act. The new law has increased the demand for accounting firms to help companies to comply with the law.

It is necessary for the accounting profession to come out with more laws and regulations of the accounting system in order to prevent such infamous scandals to reoccur. Not only that, the authorities should also enforce the existence laws and regulations. The accounting bodies are responsible to play a part in building back the trust and confidence of the shareholders. Their confidence and trust towards the profession had been decreased significantly since the occurrence of such scandal. Maintaining the public's trust is essential for accountants to meet their obligation to the society. Positive perceptions of the accounting profession are important if accountants want to continue in their role as providers of quality assurance in corporate statements.

In the accounting scandals' aftermath, individual accountants and their associations have also placed renewed emphasis on traditional professional themes such as integrity, accountability, independence, and objectivity to try and convince the public the profession remains trustworthy and committed. This is to prevent future corporate failures due to poor accounting or auditing practices. All those efforts done are to make sure that the public could once again have faith and confidence in the profession.