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Worldcom - Executive Summary Company Background

WorldCom grew rapidly in the 1990s through acquisitions but saw slowing growth in 1999. To meet earnings expectations, WorldCom's management improperly transferred $3.8 billion in operating expenses to capital expenditures over 5 quarters. Arthur Andersen, the auditor, failed to catch this due to lost independence. When irregularities were discovered in 2002, WorldCom admitted to the inflation and filed for bankruptcy, with the CEO and CFO charged for securities fraud.

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Yosafat Hasvandro Hadi
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1K views3 pages

Worldcom - Executive Summary Company Background

WorldCom grew rapidly in the 1990s through acquisitions but saw slowing growth in 1999. To meet earnings expectations, WorldCom's management improperly transferred $3.8 billion in operating expenses to capital expenditures over 5 quarters. Arthur Andersen, the auditor, failed to catch this due to lost independence. When irregularities were discovered in 2002, WorldCom admitted to the inflation and filed for bankruptcy, with the CEO and CFO charged for securities fraud.

Uploaded by

Yosafat Hasvandro Hadi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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WorldCom – Executive summary


Company background
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”)
during 1983 based in Jackson, Mississippi. In 1985, LDDS selected Bernie Ebbers to be
its Chief Executive Officer. The company become traded publicly as a corporation in
1989 as a result of a merger with Advantage Companies Inc. The company name was
changed to LDDS WorldCom in 1995, and relocated to Clinton, Mississippi. The
company grew rapidly and become the third largest telecommunications company in the
United States The company acquires over half a dozen communication companies
during the year 1988- 1994. In November 1997, WorldCom and Microwave
Communication Inc. (MCI) merged for US$37 billion and become MCI WorldCom,
making it the largest corporate merger in US history.

WorldCom Scandal
In 1999, WorldCom’s revenue growth slowed and stock price began to fall. WorldCom’s
expenses increased as its earnings growth rate dropped. This meant WorldCom’s
earnings might not meet Wall Street analyst’s expectations. In order to increase
revenue, the company reduced the amount of money it held in reserve by $2.8 billion to
cover liabilities for the acquired companies and moved this money into the revenue line
of its financial statements. In 2000, Ebbers began to classify operating expenses as
long-term capital investments for $3.85 billion. With the alliance of WorldCom’s Chief
Financial Officer, Accounting Department Director, Management Reporting Department
Director, Controller and Legal Entity Accounting Director, Ebbers made entries to falsify
financial reports with no documentation or justification. These changes turned
WorldCom’s losses into profits and made WorldCom’s assets appear more valuable.

How it was discovered


In 2002, the Securities Exchange Commission requested for more information as
accounting irregularities were spotted in WorldCom’s books. The SEC was suspicious
because WorldCom was making so much profit, while another huge communication
company, AT&T was having losses. Internal auditor, Cynthia Cooper had found the
improper accounting and questionable entries amounted $2 billion. The controller of
WorldCom, David Meyers admitted to internal auditors that they didn’t follows
accounting standards. WorldCom admitted to inflating their profits by $3.8 billion over
the previous five quarters. The company filed for bankruptcy on the same year. As a
results, WorldCom was renamed to MCI after it emerged from bankruptcy in 2004.
Former CEO, Ebbers and Former CFO, Sullivan were charged with fraud and violating
securities laws. Ebbers found guilty and sentenced to 25 years in prison while Sullivan
pleaded guilty and requested for lenient sentences.
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Case Study Answers

1. Describe the mechanisms that WorldCom’s management used to transfer


profit from other time periods to inflate the current period
WorldCom manipulated their profits using the infamous ‘cookie jar’ accounting
technique where the company build up reserves of expenses in one period and take
advantage of them in another period. The company created excess revenues for future
expenses. WorldCom falsely portrayed itself as a profitable business when it was not,
and concealed large losses suffered by improperly released certain reserves held
against operating expenses. The company also improperly classify operating expenses
as capital expenditures. WorldCom transferred the amounts in order to keep earnings in
line with the analyst’s projected earnings. This fraudulent accounting practices
materially understated the company’s expenses and materially overstated its earnings.

2. Why did Arthur Anderson go along with each of these mechanisms?


We think that Arthur Anderson, external auditor for WorldCom had lost its independence
when conducting audit. Both Sullivan (CFO) and Myers (Controller) had worked for
Anderson before joining WorldCom. Also, Andersen’s close relationship with Ebbers,
resulted in lack of professional scepticism. They had conflict of interest whereby they
felt more responsible for their client rather than upholding their fiduciary responsibility.
Moreover, maybe Arthur wanted to maintain WorldCom as their client because of
WorldCom’s high reputation.

3. How should WorldCom’s board of directors have prevented the


manipulations that management used?
Good managers make bad ethical choices because of the rationalization that the
manipulation is for company’s best interest and will never be found out. WorldCom’
board of directors should have prevented the manipulations that management used by
establishing standard code of ethics. This could have been done by reviewing and
comparing the financial statements carefully and demanded for actions to be taken if
there were mistakes. Board members should question management when needed
which results in failure to protect the interest of shareholders of the company. Moreover,
the board of directors should have implemented better internal control procedure to
prevent fraud.

4. Bernie Ebbers was not an accountant, so he needed that cooperation of


accountants to make his manipulations work. Why did WorldCom’s
accountants go along?
WorldCom hired Sullivan and Myers which both had worked for Andersen. With knowing
this, WorldCom’s accountants were motivated to make sure that profits looked good
regardless if it was unethical or not. They were seeking to present a profit resulted
financial report to maintain the reputation of the company. Besides, they might get more
financial benefits if liaise in this unethical practices. Also, it might be that the
accountants were sacred to lose their jobs.
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5. Why would board of directors approve giving its Chair and CEO loans of
over $408 million?
The board of directors approved giving its Chair and CEO loans of over $408 million
clearly because they felt the money was used for buying shares back into the company.
Also, it was described in company’s records as helping Ebbers to meet margin calls on
personal loans secured by his own WorldCom’s stock holdings. The mix of the Board
and close ties to Ebbers led to the Board’s lack of awareness on WorldCom’s issues.
The Board was inactive and met only about four times a year which was not enough for
a growing company at that time.

6. How can a board ensure that whistleblowers will come forward to tell them
about questionable activities?
The board can ensure that whistleblowers will come forward to tell them about
questionable activities in order to help the company prevent financial losses caused by
fraud by creating ethical atmosphere. Board can encourage whistle blowers to come
forward by informing them that doing so will not hurt their employment or allow them to
be victimized. Board must ensure that whistle blower will be protected from revenge as
a result of good efforts to expose unethical activities. Moreover, they can be offered
some sort of incentives for whistle blowing in a company.

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