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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

Q1- 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.

Q2 - 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.

Q3 - 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.

Q4 - 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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Q5 - 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.

Q6 - 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.

Discussion case
Tyco International Corporate Scandal 2002

Arthur J. Rosenberg, situated in Waltham, Massachusetts, founded Tyco Incorporated in

1960. The company produces electrical and electronic components, health-care, fire and
security services. In 1992, Leo Dennis Kozlowski became the CEO and used an
aggressive approach to gain acquisitions and mergers. In choosing Tyco Inc. board of
directors, Kozlowski only picked his own crony and composed the firm’s corporate
governance system. In 1999, after a stock split, rumors began to spread about Tyco’s
accounting habits. It was said that Tyco was producing irregular financial accounts, but it
was denied by Tyco’s leaders. Throughout the years of Kozlowski’s leadership, Tyco’s
profits grow beyond $30 billion.
Tyco’s scandal taken place in 2002 when board of directors launched an investigation
about their member’s incorrect behavior. Kozlowski and his few “friends" resigned and
have been dragged to the court. Kozlowski and Swartz, the Chief Finance Officer (CFO)
of Tyco Inc were alleged for stealing $170 million from the company and fraudulently
selling an additional $430 million in stock options. Kozlowski and few Tyco’s board of
directors also been accused in embezzling of Tyco fund for their private used. This
scandal has caused the shares value decreased drastically and made the workers
breathless. After the resignation of Kozlowski, Tyco was led by Edward Breen and the
firm have been saved.
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Case Issue

The case of Tyco corporate scandal of 2002 was due to unethical business practices of
a number of its top-ranking officers, especially CEO Kozlowski. Kozlowski was involved
in numerous financial transactions that were not included in the financial reports of the
company. Kozlowski was also involved in unethical transactions with other Tyco officers
and lower ranking employees to cover up for his’s illegal financial transactions. He even
got outsiders involved in the problem when his second wife received money diverted from
the firm. Court proceedings proved that Kozlowski stole millions of dollars from Tyco, and
that his illegal financial transactions were extensive. Kozlowski and other officers from
Tyco were imprisoned. Tyco declined as investors lost confidence in the company. The
following are the issues that involved with conflict of interest that were in the discussion:

a) Conflict of interest Issues

The leaders in Tyco International were caught for involving in various unethical deeds.
While they were holding the position of trust as board of directors, they involved
themselves in issues that conflict with their positions. All the crimes they did showed
that they gave priority to self-interest rather than the interest of the shareholders of the
company. The following are the issues that involved with conflict of interest that were
in the case study. These issues are leader embezzlement of company fund, bribery
and accounting fraud.

b) Inappropriate discharge of employees

Dennis Kozlowski had discharged the employees without any notice when he found
out that some of the merged company did not perform well in producing the revenue.
Also, Jeanne Terrile, stock analyst of Tyco was fired because of giving adverse
opinion on Tyco rapid acquisitions and mergers. The CEO of Tyco International,
Kozlowski failed to follow two basic principles under discharge of employees. He fired
the employees without looking at their related job performances. Besides, he didn’t
refer to the fairness of procedures used to discharge the employees and also
contravene to the principle of due process. He failed to give the notice to the
employees and failed to make compensation and pension to the employees that have
been discharged by him. In this case, he does not treat his employees fairly and justly.

Conclusion

As a conclusion, both WorldCom and Tyco scandal was due to unethical practices. The
manipulation of accounts occurs because of lack in internal control and to show good
financial statement for the investors. A good way to avoid management oversights is to
have an environment where controls matter and business performed in accordance with
law and ethical practices. It is up to top management to send a pragmatic message to all
employees that good ethics is foundation of good business. Board of directors and
auditors need to have healthy level of scepticism to keep the controls working efficiently.