1.

Introduction

Accounting scandals are business scandals which arise from intentional manipulation of financial

statements with the disclosure of financial misdeeds by trusted executives of corporations or
governments. There are two types of fraud such as Misappropriation of assets and fraudulent
financial reporting. Misappropriation of assets often called defalcation or employee fraud occurs
when an employee steals a company's asset, whether those assets are of monetary or physical
nature. Typically, assets stolen are cash, or cash equivalents, and company data or intellectual
property. 

Fraudulent financial reporting is also known as earnings management fraud. In this context,
management intentionally manipulates accounting policies or accounting estimates to improve
financial statements. Public and private corporations commit fraudulent financial reporting to
secure investor interest or obtain bank approvals for financing, as justifications for bonuses or
increased salaries or to meet expectations of shareholders. The Securities and Exchange
Commission has brought enforcement actions against corporations for many types of fraudulent
financial reporting, including improper revenue recognition, period-end stuffing, fraudulent post-
closing entries, improper asset valuations, and misleading non-GAAP financial measures.

The story of WorldCom began in 1983 when businessmen Murray Waldron and William Rector
sketched out a plan to create a long-distance telephone service provider on a napkin in a coffee
shop in Hattiesburg, Miss. Their new company, Long Distance Discount Service (LDDS), began
operating as a long distance reseller in 1984. Early investor Bernard Ebbers was named CEO the
following year. Through acquisitions and mergers, LDDS grew quickly over the next 15 years.
The company changed its name to WorldCom, achieved a worldwide presence, acquired
telecommunications giant MCI, and eventually expanded beyond long distance service to offer
the whole range of telecommunications services. WorldCom became the second-largest long-
distance telephone company in America, and the firm seemed poised to become one of the
largest telecommunications corporations in the world. Instead, it became the largest bankruptcy
filing in U.S. history at the time and another name on a long list of those disgraced by the
accounting scandals of the early 21st century.

1
 2. WorldCom Scandal (2002)

WorldCom began operations in 1983 as a small provider of long distance telephone service. It
became a publicly traded company in 1989. During the 1990s, WorldCom began a series of
acquisitions of other telecommunications companies, most notably being MCI Communications.
As a result, it became the second largest long distance telephone company after AT&T.

In November 1997, WorldCom and MCI merged to form MCI WorldCom, making it the largest
corporate merger in US history. In six years, WorldCom completed successfully 65 acquisitions.
However, since funds had to be found to finance these mergers and acquisitions, the company
rang up debts totaling US$40 billion. It was therefore necessary for WorldCom to maintain an
income stream to enable it to maintain its day-to-day operations and to service these debts.
Acquisitions, however, were not without its problems for WorldCom, the chief being managerial
especially as regards the integration of the old with the new, each having different systems and
procedures, among others.

At the beginning of 2000, WorldCom and other telecommunications companies began to see
their revenues decline due largely to the oversupply in telecommunications capacity and over-
optimistic projection of internet growth. The economy was also entering recession. This,
combined with the forced abandonment of the proposed merger with Sprint Corporation (which
would have made MCI WorldCom larger than AT&T) was a serious setback for the company’s
aggressive growth strategy.  In January 2002, the market value of the company’s common stock
was US$150 billion. By July 2002, it plummeted to US$150 million.

In order to maintain its stock price, from mid-1999 onwards, the company used accounting
chicanery and other fraudulent methods to disguise its decreasing earnings and to give the
impression that the company was growing and was profitable. This effort was led by CEO
Bernard Ebbers, Chief Financial Officer Scott Sullivan, Controller David Myers and Director of
General Accounting Buford Yates.

2
Discovery of the scandal

In May 2002, Cynthia Cooper, WorldCom’s internal auditor, and a small team of auditors
worked secretly at nights and discovered inappropriate accounting treatment amounting to
US$7.6 billion for certain transactions in order to inflate profits and hence the performance of the
company .

Two main methods were used:

 Charging interconnection expenses with other telecommunications companies as capital

expenditure in the balance sheet i.e. treating them as assets instead of operating expenses,
thereby under-reporting expenses; and

 Inflating revenues with bogus accounting entries from “corporate unallocated revenue
accounts” i.e. inappropriately transferring from reserves to revenue to boost profits.

By the end of 2003, the company had inflated its assets by an estimated US$11 billion.

Sullivan, who was Cooper’s boss, tried his best to dissuade the latter from auditing capital
expenditure. She, however, got more suspicious and persevered. Cooper discussed the
misclassification of the accounting entries with Sullivan and Myers. She was told to ignore the
problem and turn her attention elsewhere, and was even threatened in various ways. Cooper then
reported the matter to the Audit Committee which in turn asked the external auditors KPMG to
mount an investigation. In May 2002, KPMG had replaced Arthur Andersen who had been the
auditors since 1989.

Sullivan failed to provide adequate justification for the accounting treatment and was dismissed
on 25 June 2002. Myers resigned the same day. Prior to the announcement of the results of the
investigation, WorldCom’s stock price had fallen from as high as US$64.50 in mid-1999 to less
than US$2. With the announcement, the price fell to less than US$1.

Earlier, Ebbers had persuaded WorldCom’s board to approve a US$400 million loan to assist
him with his private investments. This was in the hope that he would not find it necessary to sell
a substantial part of his stock in WorldCom, which would have further decreased to value of the

3
company’s stock. The strategy failed, as the stock price continued to decline. In April 2002,
Ebbers was forced to resign as CEO and was replaced by John Sidgmore. As in the case of
Enron, senior executives held significant amounts of shareholdings in WorldCom. There was
therefore every incentive to manipulate the accounts to show higher profits in order to boost the
share price. Therein, lies a conflict of interest.

In June 2002, WorldCom announced that it had overstated earnings in 2001 and the first quarter
of 2002 by more than US$3.8 billion and that it had manipulated its reserve accounts in recent
years in the sum of an additional US$3.8 billion.

Given these revelations, Arthur Andersen withdrew its audit opinion for 2001. However,
Andersen’s work as the external auditors was seriously called into question. The auditing firm
defended its position by stating that it was not informed of the inappropriate accounting
treatment referred to above. However, Andersen had a professional duty to evaluate the internal
controls of the organization and to design tests to detect material errors which can result in a
misstatement of the financial statements. To this extent, Andersen had failed in its duty.

The SEC began its investigation in June 2002, and in July 2002, WorldCom filed for Chapter 11
bankruptcy protection, the largest at the time. Smarting from the Enron scandal, the SEC
obtained a court order barring the company from destroying financial records, limiting payments
to current and past executives and requiring an independent monitor for the company.

WorldCom File for Bankruptcy

WorldCom did not have the cash needed to pay $7.7 billion in debt, and therefore, filed for
Chapter 11 bankruptcy protection on July 21, 2002. In its bankruptcy filing, the firm listed $107
billion in assets and $41 billion in debt. WorldCom’s bankruptcy filing allowed it to pay current
employees, continue service to customers, retain possession of assets, and gain a little breathing
room to reorganize. However, the telecom giant lost credibility along with the business of many
large corporate and government clients, organizations that typically do not do business with
companies in Chapter 11 proceedings.

4
In 2001 WorldCom created a separate “tracking” stock for its declining MCI consumer long-
distance business in the hopes of isolating MCI from WorldCom’s Internet and international
operations, which were seemingly stronger. WorldCom announced the elimination of the MCI
tracking stock and suspended its dividend in May 2002 in the hopes of saving $284 million a
year. The actual savings were just $71 million. The S&P 500 reduced WorldCom’s long-term
and short-term corporate credit rating to “junk” status on May 10, 2002, and NASDAQ de-listed
WorldCom’s stock on June 28, 2002, when the price dropped to $0.09.

In March 2003, WorldCom announced that it would write down close to $80 billion in goodwill,
write off $45 billion of goodwill as impaired, and adjust $39.2 billion of plant, property, and
equipment accounts and $5.6 billion of other intangible assets to a value of about $10 billion.
These figures joined a growing list of similar write-offs and write-downs as companies in the
telecommunications, Internet, and high-tech industries admitted they overpaid for acquisitions
during the tech boom of the 1990s.

Aftermath of the scandal

At the end of 2000, some US$642.3 million of retirement funds were held in stocks. After the
revelations of fraudulent transactions, the value fell to less than US$18.7 million. In addition,
after 25 June announcement, WorldCom stated that it would cut 17,000 out of 85,000 of its
workforce.  WorldCom emerged from Chapter 11 bankruptcy in 2004 with about US$5.7 billion
in debts and as at 2007, its creditors, who had waited several years, were yet to be paid.

In March 2005, Ebbers was convicted of fraud, conspiracy and filing false documents with
regulators. He was sentenced to 25 years in prison and had agreed to relinquish his US$40
million Mississippi mansion and other assets to settle a lawsuit brought by investors who had lost
billions of dollars in the scandal.  Sullivan received five years after he entered a guilty plea in
March 2004 and surrendered his US$11 million mansion in Florida. Myers had pleaded guilty in
September 2002 and received a one year and one day sentence.

5
Lesson learned from the scandal

The internal problems at WorldCom were its lack of a competitive strategy, weak
internal controls, an aggressive culture that demanded high returns, and the failure to look out
for what was best for the stock holder as well as the stake holder of the company. The
competitive culture at WorldCom was characterized by loyalty to management with no regards
to ethics, honesty, or integrity.

So, there should be needed a strong competitive strategy and internal control and healthy
corporate culture of the company. It can build a strong, honest, ethical integrated management.

3. Conclusion
 The story of WorldCom began in 1983 when businessmen Murray Waldron and William
Rector sketched out a plan to create a long-distance telephone service provider on a
napkin in a coffee shop in Hattiesburg, Miss.
 WorldCom which was at one time the second-largest telecommunication company in the
U.S is perhaps best known for a massive accounting scandal that led to the company
filing for bankruptcy protection in 2002. WorldCom executives effectively fudged the
company's accounting numbers, inflating the company's assets by around $12.8 billion
dollars. The swift bankruptcy that followed led to massive losses not only for investors
but also for retailers and employees. The WorldCom scandal is regarded as one of the
worst corporate crimes in history, and several former executives involved in the fraud
were held responsible for their involvement.
 In 2002, just a year after the Enron scandal, it was discovered that WorldCom had
inflated its assets by almost $11 billion, making it by far one of the largest accounting
scandals ever.
 The company had underreported line costs by capitalizing instead of expensing them and
had inflated its revenues by making false entries. The scandal first came to light when the
company’s internal audit department found almost $3.8 billion in fraudulent accounts.
The company’s CEO, Bernie Ebbers, was sentenced to 25 years in prison for fraud,
conspiracy, and filing false documents. The scandal resulted in over 30,000 job cuts and
over $180 billion in losses by investors.
4. Reference
 https://Wikipedia.org,wiki,accounting scandals.
 https://www.academia.edu, WorldCom accounting scandal.
 https://corporate finance institute.com

6
7