WorldCom Scam

INTRODUCTION
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”) that
grew to become the third largest
telecommunications company in the United
States due to the management of Chief
Executive Officer (“CEO”) Bernie Ebbers.
Started in 1983
Changed to 30 billion dollars company
in a decade
85000 workers
65 countries
The biggest bankruptcy of the history
The worst crime of the history
11 billion dollars – 12.8 billion dollars
Leading to
30000 jobs lost
180 billion dollars losses for investors
Bernie Ebbers

Former CEO

the main culprit and he did it by

capitalizing inflated revenues with
fake accounting entries

25 years jail sentenced

for fraud, conspiracy and filing false

documents with regulators.
Scott Sullivan
Former CFO
5 year jail sentence
pleading guilty and testifying against
Ebbers
David Myers
former director of General Accounting
of WorldCom
1 year jail sentence
after the fraud incident
Cynthia Cooper 
formerly served as the Vice
President of Internal Audit
at WorldCom
She and her team were the first
people who uncovered the major fraud
at WorldCom
Company Culture

 Top Management’s Managing Style According to Albrecht

& Albrecht (2004), to prevent fraud, the opportunity to
commit fraud should be minimal or nonexistent.
Creating a work culture of “honesty, openness, and
assistance” is key to fraud prevention (Albrecht &
Albrecht, 2004, p. 61). First, it is important to hire
honest people and train them in fraud awareness, and
to present a code of conduct or ethics that is not only
stated on a piece of paper, but is truly respected and
followed by other employees including top
management. Second, a positive work environment
must be created. Third, employees must be provided
with assistance programs (Albrecht & Albrecht, 2004).
 The growth through acquisitions “strategy” at
WorldCom was enforced and reinforced by top
management. The consistent pressures from top
management created an aggressive and
competitive culture (in re WorldCom, inc., 2003)
that did not contain any communication of the need for
honesty or truthfulness or ethics within the company
(Breeden, 2003). In fact, one former executive reports
that the pressure became “unbearable-greater than he
had ever experienced in his fourteen years with the
Company” (Zekany, Braun, & Warder, 2004). One
employee stated that WorldCom was never a happy
place to work, even when the company was doing well,
the employees were forced to work 10, 12, or even 15
hour days but it balanced out with the higher
compensation
Corporate Governance
 According to Romney & Steinhart (2008), a Board of
Directors that is active and involved within an
organization is an important internal control for the
organization. The directors at WorldCom were from
different backgrounds. While some had widespread
knowledge and experience of business and legal issues,
others were appointed due to their connections with
Embers (Breeden, 2003). The mix of the Board and the
close ties to Embers led to the Board's lack of awareness
on WorldCom's issues. The Board was inactive and met
only about four times a year, not enough for a company
growing at the rate that it was. In addition, the
directors were only given a small cash fee as
compensation, thus an appreciation of stock was the
only form of compensation available
PRESSURE

 Pressure is a person’s motivation to commit fraud. Financial, Emotional, and

Lifestyle pressures are common types of pressure.

 In WorldCom’s case, financial pressure existed for top management to meet

the expectations of analysts at Wall Street.

 Ebber was under pressure to continue to contribute as a looked upon figure of

guidance.

 Ebber was under financial pressure to pay for his extravagant lifestyle.

 Greed
Rationalization
 rationalization: a form of justification in the mind of the offenders of their illegal
behavior.

 Most offenders, as in the case of WorldCom, are first-time offenders with no criminal
background that allows them to use rationalization to hide their dishonesty.

 Due to the economic conditions that existed at the time of the fraud, the managers
who made the journal entries presumed the misstatement to be a one-time act and
the economy will get better.

 I have a reputation to maintain,I must be a proper role model for the people.

 No one will get hurt.

 Preventing fraud in the first place is the most important control, because once it
starts to grow, the damage is already done.
Opportunity

 Opportunity is the condition that allows an organization to: commit or

conceal the fraud.

 The situation at WorldCom that created the opportunity to commit the fraud
were:-

 lack of a culture that rewards integrity and honesty.

 lack of strong internal controls.

 Disintegrated accounting systems.

 Internal audits lack of access to the financial statements.

 Bod – director agree to pay a total of $25million to settle
securities class action case

 Investment t banks – City Group $2.6 billion , other Banks -

$1billion

 SEC – In Securities analysis paid a fine of $15 million and banned

for life of practice.
The Impact of the Fraud
 Shareholders - $180billion of shareholders value lost

 Debt & Preferred Stockholders - $37.5billion of debt and Preferred

Stock holder value lost.

 Company – Paid $750 million settlement to SEC.

 Employees – 1. 57,000 employee lost jobs

. 2.All current and former employees lost most of their
retirement savings

 Auditor – Arthur Andersen agreed to pay $65 million to settle securities

class action case
 Insurance Companies – Agreed to pay $36 million to settle claims against
Worldcom directors and officers
FRAUD
1. Gaining an unfair advantage over another person is considered
fraud(Romney and steinbart 2008). To be considered a fraud,the
deception must be categorised by “a false statement,represention,
disclosure”; “a material fact”, that cause the fraudster to initiate the
fraud; the “ intention to deceive” a justifiable reliance of the fraudster
on the misstatements ; and an injured party.
2. While there are different types of fraud,the most common type of fraud is
the misstatement of financial statement. The fraud is committed on the
behalf of the organization,usually through the acts of top management,as
in the case of worldcom. In management fraud, management is the
perpetrator and the company’s stock holder, lenders and other user of
financial information are the victims( Albrecht and Albrecht 2004), the
reason behind these manipulatios is usually to “increase the company”
stock price, meet cash flow neets, hide company losses and problems”
Effects on External Environment

•The largest effect on the external environment was on the investors of

WorldCom. The pension fund lost over $300 million of its investments in
WorldCom

•The New York State Common Retirement Fund is the second largest public
pension fund in the U.S. e, even the world's largest bankruptcy of the time
was unable to shake their investments.

• In terms of the banks, brokers, and accountants that knowingly or

unknowingly aided the growth of the fraud, they were punished .
Effects on Internal Environment

After the fraud was announced to

the public on June 25, 2002, new
measures were taken quickly to reform
WorldCom and restore the public's
confidence in the company.

The first big step was the removal of top

management. the company and on the
accounting issues that may signal an
irregularity

While the new implementation of controls

depicts a firm action by WorldCom to
reinvent itself.
Audit Committee

An audit committee was established to conduct

relations with Arthur Andersen, the external auditor.
In WorldCom’s case, the lack of awareness and
independence of the Board as a whole trickled down
to the audit committee. The committee’s chairman,
Max Bobbitt, was very loyal to Embers hampering the
quality of audit leading to the fraudulent
misstatements for the years 1999, 2000, and 2001.
Internal Audit

 WorldCom’s Audit Committee failed to meet with the

Internal auditors of the company, who had the liability to
provide the Audit Committee with an independent and
objective view for improving and adding value to WorldCom's
operations.
 The internal auditors were provided with limited access to
the income statements and balance sheets with only a partial
picture of the company’s financial situation that prohibited
them from properly assessing the finances of the company.
 The Internal Audit department is intended to be independent
and report directly to the Audit Committee to avoid the
influence of top management. This form of relationship was
lacking at WorldCom.
External Auditors

 Arthur Anderson served as WorldCom’s independent external

auditor for long term and had the responsibility for providing
an independent opinion of the financial situations at
WorldCom for investors and creditors. There were apparent
flaws in Anderson’s audit approach.
 Anderson limited its testing of account balances in favor of
relying on the adequacy of WorldCom’s control environment,
overlooking serious deficiencies in documentation and
controls that were in fact exploited in WorldCom’s fraud.
 Andersen appeared to have missed several opportunities that
might have led to the discovery of the capitalization of line
costs, management’s misuse of accruals, and the improper
recognition of revenue items.
Conclusion

•The causes serve as red flags that the stakeholders and auditors of a
company should look for to prevent a fraud.

•If the circumstances within the company and in its external environment
suggest a situation different than what is represented in the financial
statements.

•It should raise similar pressures persist presently as they did in the
previous fraud.
summary