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“WorldCom could not have failed as a result of the actions of a limited number of individuals. Rather, there was a broad breakdown of the system of internal controls, corporate




responsibility, all of which worked together to create a culture in which few persons took responsibility until it was too late�.

Richard Thornburgh, Former U.S. Attorney General


CONTENTS 1. Executive Summary


2. Methodology


3. Introduction


4. Key Players in the Scandal


5. Timeline


6. Analysis


6.1 The Accounting Scandal



Line Costs



Revenue Manipulation


6.2 A Failure of Corporate Governance



Management & Board of Directors



Audit Committee



Internal Audit



External Audit: Arthur Andersen



Financial Analyst: Jack Grubman


6.3 Comparison with other Corporate Scandals


6.4 The Fraud Triangle


6.5 Regulation and Reforms: Sarbanes-Oxley Act (2002)



Conclusion and Further Recommendations





8.1 WorldCom Organisation Structure


8.2 WorldCom Board of Directors, 2001


8.3 List of WorldComâ€&#x;s Key Acquisitions/ Mergers


8.4 WorldCom Reported Operating Results and Consolidated Balance Sheet



8.5 WorldCom Share Price Fluctuation, 1998 – 2003


8.6 Corporate Governance Rules By SEC and NYSE


8.7 Examples of businesses personally acquired by Ebbers


8.8 Minutes of Group Meetings





1. EXECUTIVE SUMMARY We present an analysis of the WorldCom scandal, and the unethical management and business conduct of WorldCom and its CEO, Bernard Ebbers. Specific accounting aspects of the scandal are presented, including the capitalisation of expenses and exaggeration of revenues. The failure of Corporate Governance at WorldCom is analysed. The report finishes with an in-depth examination of reforms such as the Sarbanes-Oxley Act (SOX) and provides our recommendations for future regulation. Key Words: WorldCom, Scandal, Ebbers, Corporate Governance, Sarbanes-Oxley Act, Audit, Arthur Andersen, Line Costs, Revenue Manipulation



By combining theories such as the fraud triangle and the corporate governance „mosaicâ€&#x; with empirical evidence and secondary data from the case itself, we offer an in-depth analysis into the scandal. We utilised numerous online journals to familiarise ourselves with the background and the technical area of the case. The internet formed the major resource we used to compile this report due to its unparalleled accuracy and precision to time nature. The report itself is available from:



WorldCom was once the second largest telecommunications provider in the world, with revenues of $30 billion and over 60,000 employees (Kaplan & Kiron 2007). However, on the 21st July 2002, WorldCom filed for chapter 11 bankruptcy. WorldComâ€&#x;s collapse was the largest corporate bankruptcy of all time, an undesirable title it retained until September 2008, when the collapse of Lehman Brothers triggered the recent banking crisis. WorldComâ€&#x;s collapse caused collateral damage to other telecommunications firms, government, workers, and the capital markets (Sidak, 2003). The effects of large corporate bankruptcy are widespread, significant, long felt and are certainly not a thing of the past. With this in mind, we write a report to understand and analyse the causes of such events, the legislation which has arisen from them, and what could be done in the future to prevent repetition in other companies.


4. KEY PLAYERS IN THE SCANDAL Table 1: Key Players

Bernie Ebbers

Scott Sullivan


Role in scandal


Former Chief Executive Officer (CEO) and founder of WorldCom

Guilty of fraud, conspiracy, and filing false documents with regulators

Forced to resign in March 2002. Found guilty on nine counts of fraud; in July 2005, he was sentenced to 25 years in prison

Former Chief Financial Officer (CFO) at WorldCom

Guilty to three counts of securities fraud and conspiracy charges that he deceived the public, the SEC1, securities analysts, and others about WorldCom's true financial condition

Sentenced to 5 years in prison (in 2005), after agreeing to plead and testified against Ebbers

David Myers

Former Senior VicePresident and Controller at WorldCom

Budford Yates

Former Director of Accounting at WorldCom

Betty Vinson

Former Accounting Department Manager at WorldCom

Former WorldCom Accounting Department employee Troy Normand

Guilty to three felony charges: securities fraud, conspiracy to commit fraud, and making false filings with the SEC1

Securities fraud; conspiracy to commit securities fraud

Resigned and sentenced to 1 year and 1 day in prison

Forced to resign and sentenced to 1 year and 1 day in prison

Securities fraud; conspiracy to commit securities fraud

Forced to resign and sentenced to 5 months in prison. Currently working as an accountant for a large Kentucky Fried Chicken franchise

Securities fraud; conspiracy to commit securities fraud

Forced to resign and given 3 years probation


Cynthia Cooper

Former Director of WorldComâ€&#x;s internal audit department

Pursued the morally right course of action by blowing the whistle on the accounting fraud

Received accolades from outside organizations for her actions; was ostracised at WorldCom/MCI and eventually compelled to resign

Arthur Andersen

Former external auditors of WorldCom

Failing to detect the fraud and settled for $65m

Replaced by KPMG as a result of the scandal

Analyst at investment bank - Solomon Smith Barney

Urged investors to accumulate telecom stocks even when reports were contradictory (downgraded the shares only after they'd fallen almost 90% from their 1999 peak)

Fined $15m and given a lifetime ban from working in the securities industry for his involvement

Board of Directors of WorldCom

Lied about company finances before a large bond issue

Shareholders brought a class-action law suit against the directors, settled for a $54m payment

Chairman of the Audit Committee

Failed to manage the Internal Audit department (VicePresident, Cynthia Cooper), the external auditors (Arthur Anderson), and managementâ€&#x;s financial reporting


Primary overseer and regulator of the US securities markets

Launched an investigation of WorldCom due to suspicions over its apparently great performance whilst their biggest rivals were struggling in the downturn


Jack Grubman


Max Bobbitt


SEC1 - Securities and Exchange Commission (SEC)

Source: AGS Group 4 (2009)


5. TIMELINE (Year 2002) April

3rd - With the additional $65 million loan, Ebbers agrees stocks as collateral for the total of $408 million company loan. 29th - Ebbers resigns as CEO and Sidgmore is appointed.


9th - A world-record number of WorldCom shares, 670 Million, are traded and AXA ends up owning 11% of the company and KPMG replaces Arthur Anderson as an independent auditor. 28th - Internal auditor Gene Morse discovers $500 million in fraudulent computer expenses.


Grubman downgrades WorldCom stocks to “underperform”. Stocks plunge 20% in after hours trading, Myers resigns, Sullivan is fired and 17,000 employees are made redundant.


12th - Ebbers, Sullivan, Grubman and Anderson are under investigation. 25 banks file lawsuit and request $2.65 billion on WorldCom assets. 21st - WorldCom files the largest bankruptcy in the world. 30th - Sarbanes-Oxley Act 2002 is signed into law.

August September October

An additional $3.3 billion in accounting fraud totaling $7.68 billion. 11th - Sidgmore resigns as CEO; Myers pleads guilty and testifies against Ebbers . Buford Yates, Betty Vinson and Troy Normand plead guilty to charges of conspiracy and fraud.


4th -An additional $3billion is added to the tally of fraud. 5th- SEC chairman Pitt resigns and the SEC files additional fraud charges saying the company inflated earnings over $2 billion. 26th -WorldCom strikes a deal with SEC to settle the fraud suit against the company.


10th- WorldCom lays off 3,000 employees and six board members resign the day after two judges approve Capellas‟ (CEO) pay package, and Capellas‟ turnaround plan begins in earnest.

Source: Jeter (2003)



6.1 The Accounting Scandal Through fraudulent reporting, WorldCom maintained an Expense to Revenue (E/R) ratio at a level of 42%, when in reality it was above 50% (Beresford et al, 2003). This Key Performance Indicator (KPI) directly affected the share price. It was essential for Bernie Ebbers (CEO) that WorldCom‟s share price did not fall, as his stock financed his personal businesses (O‟ Donnell and Backover, 2002). In late 1990s, demand for WorldCom‟s services dropped, resulting in a fall in prices (Kaplan & Kiron, 2007). When performance failed to improve, two fraudulent accounting methods were employed: improper line cost adjustments and revenue manipulation. 6.1.1 Line Costs WorldCom‟s largest expense was line costs; costs of carrying a voice call or data transmission from its starting point to its ending point. Line costs were improperly adjusted in two ways. Firstly, the release of accruals was made at the request of Scott Sullivan (CFO) to the value of $3.3bn. Accruals are amounts set aside on the balance sheet to pay estimated future bills. “Releasing” an accrual is proper when it turns out that the actual expense is lower than estimated. It has the effect of providing an offset against reported line costs in the period when the accrual is released, thus reducing reported line costs (Beresford et al, 2002). In 1999-2000 WorldCom, accruals for line costs were released having no matching reduction in estimated costs. By the end of 2000, WorldCom had exhausted all available accruals, leaving Sullivan to search for other ways to boost reported performance (Kaplan & Kiron, 2007). The second improper adjustment of line costs was the capitalization of such expenses on the balance sheet. Sullivan reasoned that line costs could be recognised as capital expenditure, and therefore as an asset on the balance sheet under the heading “pre-paid capacity”, rather than as an operating expense on the income statement (Kiron & Kaplan, 2007). Under US Generally Accepted Accounting Principles (GAAP), operational costs must be reported as an expense in the income statement. The consequence was a reduction in reported expenses. Figure 1 summarises how this capitalization was done. 10 | P a g e

Figure 1: How WorldCom might have mishandled expenses

Source: Gelles (2002) The improper capitalisation of lines costs was conducted between the third quarter of 2000 and the 1st quarter of 2002. Table 2 shows the difference between reported and actual line costs over these periods and the resulting impact on pre-tax profit. Table 2: Quarter (Q)

Line Cost Expenses reported (1)

Line Cost Expenses Actual (2)

Variance 3=(2-1)

Reported Income before taxes (4)

Actual Income before taxes (5)

Variance 6=(4-5)

3rd Q.2000 2000 1st Q.2001 2nd Q.2001 3rd Q.2001 2001 1st Q.2002

3.867 15.462 4.108 3.730 3.745 14.739 3.479

4.695 16.697 4.879 4.290 4.488 17.754 4.297

0.828 1.235 0.771 0.560 0.743 3.015 0.818

1.736 7.568 0.988 0.159 0.845 2.393 0.240

0.908 6.333 0.217 -0.401 0.102 -0.622 -0.578

0.828 1.235 0.771 0.560 0.743 3.015 0.818

Source: Adapted fillings SEC in forms 10Q and 10K Figure 2 demonstrates the combined impact of accrual releases and expense capitalisation of line costs. 11 | P a g e

Figure 2: Reductions to Line Costs by Accrual Releases, Capitalisation and Other Adjustments

Source: (Beresford et al, 2003). The significance of the reductions is far better demonstrated in the graph below (figure 3). The blue line indicates that following the series of capitalisation and accrual releases, the E/R ratio was held around 42% for 6 consecutive quarters, whilst the genuine ratio soared above 50%. Figure 3: Line Cost E/R Ratio

Source: (Beresford et al, 2003). 12 | P a g e

Tables 3 and 4 highlight the monetary impact of the expense capitalisation on the financial statements, which include the capitalisation of $500m in computer expenses on top of the line costs.

Table 3 - Income Statement Manipulation

Revenues COGS

xxx xxx

(no change) (no change)

xxx xxx

(-$3.35 billion) (-$0.5 billion)


(+$3.85 billion)

Operating Expenses: *Fees paid to lease other companies phone networks: *Computer Expenses NET INCOME * Removed from Income Statement

Table 4 - Balance Sheet Manipulation Assets: **Computer Assets **Leasing Assets

xxx xxx

(+$0.5 billion) (+$3.35 billion)



(no change)



(+$3.85 billion)

** Added to the Balance Sheet

Source: (AICPA, 2005).

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6.1.2 Revenue Manipulation WorldCom‟s consistent double-digit revenue growth led to high performance of the WorldCom stock. Continued revenue growth was a strategy instilled by Ebbers that was “In every brick of every building”. When WorldCom failed to meet his expectations, accounting entries were made in a process named “close the gap” (Beresford et al, 2003 pp13). WorldCom inflated revenues by taking money from reserve accounts, initially set up to pay for potential losses from specific predictable events. They then showed it as revenue from operations. This process was against accounting policies specified under US GAAP. This enabled the company to add $2.8bn to the revenue line (AICPA, 2005). Tables 5 and 6 show how this exaggeration of revenues was achieved. This manipulation again helped maintain the E/R ratio at 42%. Table 5 - Income Statement (extract) Manipulation Revenues

(+$2.8 billion)



(no change)

Operating Expenses


(no change)



(+$2.8 billion)

Table 6 - Balance Sheet (extract) Manipulation

Financed by: Retained Earnings


(+$2.8 billion)

Reserve a/c


(-$2.8 billion)

Source: (AICPA, 2005).

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6.2 A Failure of Corporate Governance Corporate governance is “rigorous supervision of the management of a company…ensuring that business is done competently, with integrity and with due regard for the interests of all stakeholders” (Institute of Directors, 2009). The WorldCom scandal had many corporate governance issues along with accounting abuses and plain “outright greed” (Moberg & Romar, 2006). We address the failings in corporate governance with regard to each party involved in the „corporate governance mosaic‟ shown in figure 4. Figure 4: Corporate Governance Mosaic and Financial Reporting Quality

Source: Cohen et al (2004), Journal of Accounting Literature, p. 89

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6.2.1 Management and the Board of Directors. The board of directors played a small role in the life, direction and culture of the company and significantly, no-one on the board knew of the improper accounting practices other than Sullivan and Ebbers (Beresford et al, 2003). The relationship that existed between Ebbers, Sullivan and the board was not synonymous with good corporate governance. Ebbers was a dominant CEO. He controlled the board‟s agenda, its discussions and decisions. He had a strong desire for the hubris of building as big an empire as possible, both through WorldCom and his own personal businesses. Within the company, he failed to consider how acquisitions would add value to WorldCom‟s business, and with a board made up mainly of independent directors who had Ebbers to thank for their wealth, there was little resistance to Ebbers‟ strategy of multiple acquisitions without proper integration. Moberg & Romar (2006) believe the authorisation of Ebbers‟ loans was peculiar and raise ethical concerns. The board effectively rubber stamped Ebbers‟ decisions and requests, perhaps most notably in regard to the $480m worth of personal loans made from WorldCom to Ebbers, which he used to finance his personal business empire. Aside from the point that running these businesses must have vastly impacted on Ebbers‟ ability to be a suitable CEO, making personal loans to Ebbers on favourable terms was clearly not the most effective use of WorldCom capital. Ebbers also amounted large debts from other sources, and used his WorldCom stock as collateral on these loans. It was when Ebbers was faced with the prospect of having to sell large quantities of his stock to repay debts that the board agreed to make the loans in order to avoid any fall in share price. Ebbers claimed that WorldCom's aim was "not to capture market share or be global…our goal is to be the No. 1 stock on Wall Street" (Charan et al, 2002). To fulfil this goal, it became necessary to manipulate accounting figures. His incentive to raise the share price differs from those at Enron, the other large accounting scandal being investigated at that time; Ebbers orchestrated the fraud to raise the share price as his shares were collateral for his loans. However, at Enron, Jeff Skilling and Ken Lay‟s motivation to fraudulently raise the share price was so they could cash in on their personal share of the company.

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According to Beresford et al (2003), Sullivan regularly forced WorldCom managers to find ways to reduce line costs that had no basis in US GAAP. Several employees became suspicious, but feared that objecting to conduct that was directed by Sullivan would cost them their jobs. This is another corporate governance issue, as there was clearly a lack of protection for whistle-blowers.

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6.2.2 Audit Committee Audit Committees have been required for companies listed in the US since 1978 and were recommended in the UK in the Cadbury Report (1992). Audit Committees should be mainly or wholly composed of Non Executive Directors. The Audit Committee has several roles; they monitor the effectiveness of the Internal Audit function, they recommend a selection of external auditors to the board and monitor the appointed auditor, they deal with whistleblowers, hold meetings with the internal and external auditors which are away from management, and they are responsible for overseeing managements‟ financial reporting (Beresford et al, 2003). WorldCom‟s Audit Committee was chaired by director Max Bobbitt and consisted of four members, who had no knowledge of the improper accounting at WorldCom. This is not surprising given how little time they devoted to their role, meeting three to five hours per year. They didn‟t engage to the extent necessary to understand and address the financial issues presented by this large and extremely complex business. They were given false but plausible information by management and there were no red flags that should have led the Audit Committee to become aware of the fraud. However, as Beresford et al (2003) point out, they didn‟t operate effectively. The most suspicious information was that WorldCom's ratio of line cost expense to revenues stayed at 42%, which was striking in a fluctuating business environment (Hamilton & Micklethwait, 2006). This should have been suspicious to the Audit Committee. Further to this, their role in internal audit‟s activities was very limited; they did not play a substantial role in setting priorities or in the follow-up on problems found in the course of its audits.

However, despite the inadequacy of the Audit Committee, once advised of the improper accounting issues by Internal Audit, they took it very seriously and directed prompt attention to it (Beresford et al, 2003). In a meeting they held on June 24, 2002, Sullivan and Myers were ordered to resign. Myers resigned and after Sullivan refused to, he was fired.

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6.2.3 Internal Audit The Internal Audit structure had four serious weaknesses according to Beresford (2003):

1) They reported to Sullivan, who was the mastermind behind the fraud and hence disregarded any concerns they showed. 2) Their role as internal auditors was primarily concerned with operational auditing, with Arthur Anderson dealing with financial auditing. This would have made it difficult for them to detect any fraudulent activity. 3) There was very little communication between the internal auditors and the audit committee 4) The internal audit department was understaffed and under budgeted, because Ebbers viewed investment in internal audit functions as a waste of resources. Despite these weaknesses, the fraud was eventually uncovered by Cynthia Cooper, VicePresident of internal audit. When Cooper raised concerns to Sullivan, he told her to drop her enquiry. Evidence shows that internal controls were very weak (Jeter, 2003). Cooper assembled her team of internal auditors and they worked through the night to gather evidence. When they had uncovered sufficient evidence, Cooper presented it to the audit committee.

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6.2.4 External Audit: Arthur Andersen The purpose of the external audit is to overcome the “agency problem”; shareholders own the company but management run the company. The shareholders want to know that the company is being run in their best interests and that the financial statements presented to the shareholders by the directors are true and fair. An external auditor is therefore hired to give an opinion on the financial statements. This opinion must consider whether or not the statements are complete and presented correctly, whether all assets recorded do actually exist and are owned by the client and whether all items are valued correctly and recorded accurately. Audit techniques include substantive testing, controls testing and analytical reviews. An appropriate mix of these three techniques will increase the likeliness that the audit is of good quality; „audit quality‟ is the probability that an auditor will not issue an unqualified report for statements containing material errors (Watkins et al, 2004). Watkins et al have draw up an Audit Quality Framework, as shown in figure 5.

Figure 5: Audit Quality Framework

Source: Watkins et al (2004)

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As can be seen above, „auditor independence‟ plays a part in the framework. Having auditors who are completely independent of the company gives credibility to the audit. Such independence may be compromised by the provision of non-audit services; auditors who also provide non-audit services to a client may be reluctant to give a qualified opinion in fear of being replaced and losing much revenue. If an auditor goes on to become employed by the client they were auditing, this too may reduce independence; the ex-auditor will have too close a relationship with the auditors, who were once his or her colleagues. No evidence was found that Andersen was aware of the capitalisation of line costs or revenue manipulation (Beresford, 2003). The failure of Andersen to detect the fraud was the fault of both WorldCom and Andersen. WorldCom maintained inappropriately tight control over information Andersen needed. For example, Andersen could have identified the fraudulent accounting entries from a review of the company‟s general ledger. However, WorldCom repeatedly refused Andersen access to the computerised general ledger (Kaplan & Kiron, 2007). Access to speak to key personnel at WorldCom was also rejected, including Ronald Lomenzo, Senior Vice-President of Financial Operations, who oversaw international line-cost accruals. When information was given to Andersen, it was often altered to mislead the auditors (Kaplan & Kiron, 2007). In this situation, where Andersen knew they were receiving less than full co-operation from the client, it is Andersen‟s responsibility to overcome such obstacles and to inform the Audit Committee of the difficulties it faced (Beresford, 2003). However, Andersen did not draw these restrictions to the attention of the Audit Committee. Other failures in audit practice occurred too. Andersen placed too much reliance on senior management and did not conduct substantive tests to back up the information received in many areas (Beresford, 2003). Also, Andersen‟s analytical review procedures were not properly performed; they should have triggered concerns when WorldCom reported revenue growth and a stable line cost expenseto-revenue ratio during a period of severe decline in the telecommunications industry, where competitors were performing poorly (Kaplan & Kiron, 2007). Instead of wondering how WorldCom maintained a 42% E/R ratio, Andersen appeared comforted by the absence of variances. Auditor independence issues were also present; Andersen‟s income from WorldCom was $64m between 1999 and 2001. $50m of this was for non-audit services (Hamilton & Micklethwait, 2006). Andersen had developed a close relationship with WorldCom for over twenty years. This may have influenced their willingness to confront management. 21 | P a g e

6.2.5 Financial Analyst: Jack Grubman Ebbers‟ close relationship with Jack Grubman, the analyst at investment bank Solomon Smith Barney (SSB), has been criticised as one of the key reasons why WorldCom were able to conceal their downturn in performance for as long as they did. According to Elliot Spitzer (2002), the Attorney General of the State of New York, Grubman has admitted to issuing “Buy” ratings for WorldCom‟s stock in order to retain their investment banking business, even when he knew they were struggling financially in the downturn in the telecommunications industry. WorldCom appointed SSB as their investment bankers, knowing that their stock would secure high ratings from Grubman. Spitzer points out that sixteen of the stocks that Grubman rated went bankrupt. Yet, Grubman never issued any Sell ratings and assigned only two Underperform ratings. Investment bankers at SSB discouraged Grubman from downgrading investment banking clients as they slid into bankruptcy in fear that their clients would move their business to another investment bank. Grubman‟s stock ratings on WorldCom since June 2000 are shown on table 7. Table 7: Date

Share Price

SSB's Rating

June 30, 2000



January 4, 2001



June 1, 2001



January 2, 2002



March 18, 2002



April 21, 2002



June 24, 2002



July 21, 2002

Filed for bankruptcy

N/A Source: E. Spitzer (2002)

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6.3 Comparison with other Corporate Scandals We believe there are certain characteristics of the WorldCom scandal that were also present in other large corporate scandals. Table8 summarises our comparisons. Table 8: Comparison among WorldCom, Enron, Shell, Parmalat and L&C Securities L&C Characteristic/Company



Revenue Manipulation



Cash Flow Manipulation Expense Capitalisation Non-prudent Estimates of Future Earnings



Securities⁴ X







Concealed Debts



Concealed Losses







Artificially Boosted Share Price



Cash Embezzlement Loans to Directors


Dominant Individuals






Weak Internal Controls






External Audit Failures








Aggressive Acquisition Strategy



Source: AGS Group 4 (2009) 23 | P a g e

Enron¹ - Stewart (2006) Shell² - Pfeifer (2008) Parmalat³ - Melis (2005) L&C Securities⁴ - Matthews (2005) Whilst certain characteristics were specific to the individual scandal, factors such as dominant individuals, weak internal controls and external audit failures appear in all five scandals. Importance should therefore be placed on these characteristics when new reforms are considered. It is important to point out that a certain characteristic being present in a scandal does not necessarily imply that it is a significant cause. Agrawal and Chadha (2005) conducted an econometric analysis of 159 US companies that manipulated earnings in 2000 or 2001 and found that certain governance mechanisms are related to the incidence of an earnings restatement by a firm, whilst others are statistically insignificant. Table 9 summarises their findings.

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Table 9: Econometric Analysis

Statistically Significant Statistically Insignificant Low Probability of Earnings

High Probability of Earnings



Independence of Boards and audit committees

Boards or audit committees have an independent director with

Provision of nonaudit services by auditor

financial expertise

Chief executive officer belongs to the founding family.

Use of Arthur Andersen Use of other Big 5 audit firm

Surprisingly, the use of Andersen as external auditors and the provision of non-audit services are statistically insignificant to the probability that earnings will be manipulated. This is because the use of Andersen as WorldComâ€&#x;s auditors was not what caused the fraud to occur, rather Andersen were at fault for failing to detect the fraud and confront management.

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6.4 The Fraud Triangle

No single person can be held entirely accountable for the fraud, as a plethora of factors were involved. The „Fraud Triangle‟ model (Choo & Tan, 2007) can help us to summarise the key drivers behind this scandal, allowing us to identify the main influences of the fraud. The fraud triangle states that corporate fraud is a function of incentives, opportunities and rationalisations. Firstly, employees may be under pressure to achieve targets, creating an incentive to commit fraud. Secondly, the absence of effective controls, or the ability of management to override controls provides opportunity for fraud. Thirdly, those involved are able to rationalise commiting a fraudelent act. Some individuals posses an attitude that allows them to knowingly and intentinoally commit a dishonest act (Cohen et al, 2008). At WorldCom, the key behavioural motivations are presented in table 10. Table 10: WorldCom’s behavioural motivations Incentive/Pressure


Company‟s performance – Ever growing revnenue and

Management hides the truth.


Personal enrichment (shares of the company)

income. To meet analysts‟ forecast. Weak internal controls

Complicity between the CEO and the CFO.

To maintain the share price.

Table 10 suggests that the scandal at WorldCom included all three elements, with more weight in the incentive/pressure and rationalization factors. We can present these key behavoural motivations in the fraud triangle model: Fig.6 – WorldCom’s key drivers for fraud Incentive/Pressure WorldCom



Source: AGS Group 4 (2009) 26 | P a g e

6.5 Regulation and Reforms: Sarbanes-Oxley Act (SOX)

SOX was implemented in 2002 following the Enron and WorldCom scandals and seeks to increase auditor independence, add additional responsibilities for the board, increase criminal penalties for fraudulent activities and provide whistleblower protection for employees. In this section, we will discuss the main provisions of SOX in relation to WorldCom and future scandals. Table 11 summarises the key provisions of SOX and highlights how each provision could have prevented the WorldCom scandal.

SOX would have increased auditor independence at WorldCom, improved the effectiveness of the audit committee, prevented Ebbers from taking loans from WorldCom and improved the internal audit function and internal controls. The fraudulent activities at WorldCom may be described as a form of „earnings management‟. A common definition of earnings management is the “purposeful intervention in the external financial reporting process with the intent of obtaining private gain” (Jackson & Pitman, 2001). Had SOX been in place sooner, earnings management may not have occurred at WorldCom; McEnroe (2007) found some evidence that earnings management has fallen since SOX was introduced.

Since SOX came into place, scandals have still occurred. Cullinan (2004) argues that SOX doesn‟t address auditor competence; we have highlighted in the previous section that Andersen were inadequate as WorldCom‟s auditors. This clearly needs addressing to prevent future scandals, and unfortunately SOX alone will not achieve this. Further to this, despite the role of the audit committee in recommending external auditors, management still remain the biggest influence on their appointment. In light of these criticisms, we will discuss further potential reforms in the next section.

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Effect on WorldCom scandal

Details Table 11:

Section 201: “Services Outside the Scope



Andersens‟ income from WorldCom was $64m between 1999

of Practice of Auditors”

auditors providing non-

and 2001 (Hamilton & Micklethwait, 2006). Two thirds of

audit services for the same

this was non-audit income, which would not now be allowed

clients, e.g. consulting

under SOX. Therefore, there was a lack of independence, and


SOX would have improved this. Section 203: “Audit Partner Rotation”

Lead partner to be rotated

Andersen was WorldCom‟s auditors for over 20 years. There

every 5 years

were no signs of partner rotation, which reduced auditor independence.

Section 204: “Audit Reports to Audit




must to


There was a lack of communication between Andersen and


WorldCom‟s audit committee. Andersen failed to tell the



audit committee that they had been denied access to WorldCom‟s general ledger. This section would have required Andersen to timely report to the Audit Committee.






Prohibition on personal

Ebbers loans from WorldCom would not now be allowed

Interest Disclosures”

loans to executives

under SOX

Section 404: “Management Assessment


for Internal Controls”

establish, regularly


There were weak internal controls at WorldCom as Ebbers



believed maintaining them was a waste of resources which



could be used elsewhere.

internal control structure Section 802: “Criminal Penalties for



No effect – Ebbers knew he faced 25 years in prison and still

Altering Documents”

imprisonment for altering,

committed the act. This section would therefore not have

destroying, concealing or

deterred him from committing the fraud.






documents Sections





Protection against whistle-

Cooper did not have any whistleblower protection and so was


hesitant to report her findings earlier. Now there is 10 years imprisonment for retaliating against a whistle-blower, e.g. by firing them. Cooper was reluctant to stand up to Sullivan as she feared she would lose her job, but had SOX been in place, her job would have been safe.

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7. Conclusion and Further Recommendations Since the WorldCom scandal, International Financial Reporting Standards have become more widely implemented, corporate governance codes have been reviewed and the Companies Act 2006 has set out clearer duties for directors. The results have been positive; audit committees and internal auditors have been functioning more effectively in recent years. However, several areas still need to be addressed, which we will discuss in turn.

There are concerns over the usefulness of the audit report; there is little useful information for the users of financial statements, especially if the opinion is unqualified. To make the audit report more useful, it could report on the issues such as topics which the auditors discussed with the audit committee. This would encourage more involvement from the audit committee, something which was lacking at WorldCom. Principle judgements made by the auditor during the audit could also be included. We believe it is very easy for an auditor to sign off on an unqualified report, however if they were forced to justify the principle judgments made, it would make the public more confident in the auditors competence.

Should companies be able to choose their own auditors? If the SEC had been given the responsibility for allocating auditors to listed companies before the WorldCom scandal, there is a chance that a different firm would have audited WorldCom; a firm which may have been willing to stand up to management and therefore uncover the fraud. The fact that WorldCom were able to choose their own auditors meant that they were able to retain Andersen for over twenty years knowing that they would willingly sign an unqualified opinion. Audit firms could be forced to sell off all non-audit business. SOX prevents audit firms from providing certain non-audit services to audit clients however auditor independence could be increased further if audit is the only service the firm is able the provide their client. As discussed, Andersen received the majority of their WorldCom fees from non-audit services and so as a result were less willing to stand up to management or sign a qualified report in fear they would lose a large client. Compulsory training, emphasising on business ethics for all company directors is also an idea which we support. Such training could provide education on the responsibilities of internal and external auditors and the role of audit committees. If all directors at WorldCom had been aware of the importance of internal auditors, they may have been willing to commit more 29 | P a g e

resources to the department. If the directors who sat on WorldCom‟s audit committee were made more aware of their role, they may have decided to commit more than 3 to 5 hours per year meeting. Table 7 Difficulty of Implementation High 4 2

High Potential Impact

Low 3 5 1





A more detailed Audit report, including discussions between auditors and the audit committee, and the principle judgments used


SEC should allocate auditors to listed companies


Establish incentives and protections for corporate whistle-blowers


Audit firms should be forced to sell off all non-audit business


Require accountants to take continuing education courses in business ethics, so it enhances board awareness of important developments inside and outside the company Source: AGS Group 4 (2009)

It is important to point out that fraud was not the cause of WorldCom‟s downfall, it was the cover-up. The real cause of WorldCom‟s downfall was a combination of both the downturn in the telecommunications industry, along with the failure to fully integrate the collection of companies that Ebbers had built up. Ebbers over paid for some acquisitions, leaving the company struggling under a burden of debt. The fraud occurred because WorldCom did not want to admit the truth; management at the company had grown to appreciate the standard of living that the high share price had brought them. World Count: 3932 30 | P a g e

8. Appendices 8.1 WorldCom Organisation Structure

Source: Beresford (2003)

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8.2 WorldCom Board of Directors, 2001 Bernard J. Ebbers, 59, was the CEO of WorldCom since 1985 and a board member since 1983. Bert C. Roberts Jr., 58, was the CEO of MCI from 1991-1996 and served as chairman of the MCI board beginning in 1992. He stayed on in this capacity after the WorldCom merger with MCI in 1998. Carl J. Aycock, 52, was an initial investor in LDDS and a director since 1983. He served as secretary of WorldCom from 1987 until 1995. Clifford L. Alexander Jr., 67, joined the board after the merger with MCI in 1998. He was previously a member of the MCI board. Francesco Galesi, 70, became a director in 1992. He was the chairman and CEO of the Galesi Group of companies involved in telecommunications, and oil and gas exploration and production. Gordon S. Macklin, 72, became a director in 1998 after having served as chairman of White River Corporation, an information services company. He sat on several other boards and had formerly been chairman of Hambrecht and Quist Group and the president of the National Association of Securities Dealers, Inc. James C. Allen, 54, became a director in 1998 through the acquisition of Brooks Fiber Properties where he served as the vice chairman and CEO since 1983. John W. Sidgmore, 50, was the vice chairman of the board and a director at WorldCom beginning in 1996. Also, from 1996 until the MCI merger, he served as COO of WorldCom. He had previously been president and COO of MFS Communications Company, Inc. and an officer of UUNET Technologies, Inc. Judith Areen, 56, joined the board after the merger with MCI in 1998. She had previously been a member of the MCI board. Arren was appointed executive vice president for Law Center Affairs and dean of the Law Center at Georgetown University in 1989.

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Max E. Bobbitt, 56, became a director in 1992 and served as chairman of the Audit Committee. He was president and CEO of Metromedia China Corporation from 1996-1997 and president and CEO of Asian American Telecommunications Corporation, which was acquired by Metromedia China Corporation in 1997. Ronald R. Beaumont, 52, was COO of WorldCom beginning in 2000 and had previously served both as the president and CEO of WorldComâ€&#x;s Operations and Technology unit and as the president of WorldCom Network Services, a subsidiary of WorldCom, Inc. Prior to 1996, Beaumont was president and CEO of a subsidiary of MFS Communications. Scott D. Sullivan, 39, became a director in 1996 after he was named CFO, treasurer, and secretary in 1994. Source: Adapted by case writer from WorldCom 2001 Proxy Statement, pp. 137-139. Stiles A. Kellet Jr., 57, became a director in 1981 and served as chairman of the Compensation and Stock Option Committee. Source: Adapted from USA Today (2002)

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8.3 List of WorldCom’s Key Acquisitions/ Mergers

Source: ICMR

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8.4 WorldCom Reported Operating Results and Consolidated Balance Sheet

Source: WorldCom Annual Report (2000) 35 | P a g e

8.5 WorldCom Share Price Fluctuation, 1998-2003

Source: (2009)

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8.6 Corporate Governance Rules By SEC and NYSE

Source: Adapted from The Economist (2003)

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8.7 Examples of businesses personally acquired by Ebbers Angelina Plantation - 21,000-acre farm in Monterey, Louisiana of which Ebbers was a coowner with his brother. Acquired in 1998. Douglas Lake Ranch - 500,000-acre ranch in British Columbia. Invested as “general partner� in 1998 with approximately $65 million. Joshua Holdings/Joshua Timberlands/Joshua Timber - 540,000 acres of timber in Mississippi, Tennessee, Louisiana, and Alabama majority owned by Ebbers. Acquired in 1999 with approximately $600 million. Pine Ridge Farm - Ebbers was the owner of this livestock and crop farm in Mississippi as of 1997. Columbus Lumber - High-tech lumber mill in Mississippi acquired by Ebbers in 1996. BCT Holdings, owner of Intermarine - Ebbers was the primary owner of this yacht building and repairs facility in Georgia. Acquired Intermarine in 1998 for approximately $14 million. Hotels in Mississippi and Tennessee - Ebbers acquired nine hotels over a period of several years. KLLM - Trucking firm in Mississippi of which Ebbers was the director. Acquired with partner in 2000 for approximately $30 million. Jackson Bandits - Minor League hockey team in Jackson, Mississippi 50% owned by Ebbers. Source: Adapted from USA Today (2002)

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8.8 Minutes of Group Meetings [15:30 – 16:30, 25th September 2009] Present:

[Dharni Patel; Callum Sellar; Miguel Amaro; Owen Liu; James Howie]

Next meeting: [27th September, 2009], [10:00 – 12:00], [Callum‟s house)



After the initial lecture we formed for a group meeting in the same group we had worked in on previous projects. Owen and Miguel advised to invite 2 more members to have a group of 7. Dharni recommended Sucheet Shah; Callum and James recommended Shaan Morzaria


Key discussions

Module Outline was examined; Key points were discussed from the section „Module Assessment – Group Project‟. We also discussed listed scandals on appendix 1 from the module outline. Furthermore, we debated on the pros and cons of each scandal from the list and analysed their level of relevancy to our course contents and group project


Tasks for next meeting

We agreed to hit the ground running and do extensive research over the first weekend of term, whilst general workload was at a minimum. Members were required to do extensive research on scandals and come up with 3 scandals of their choice. Members must explain their reasons behind their chosen scandals and show how it may relate the scandal to the module content. Dharni, Callum and James to inform Sucheet and Shaan regarding to the meeting and the tasks for next meeting.

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[27th September, 2009], [10:00 – 12:00], [Callum‟s house) Present:

[Dharni Patel; Callum Sellar; Miguel Amaro; Owen Liu; James Howie; Sucheet Shah; Shaan Morzaria]

Next meeting: 25th September [13:00 – 15:00], [Jubilee Exchange]




Key discussions

Each member were required to present their research and findings from the task, and here are the results: Dharni:

WorldCom, Tyco and Royal Mail Group.

Owen: Xerox, Daiwa Bank and WorldCom. Miguel:

AIG, WorldCom and Xerox.


WorldCom, Tyco and MG Rover.

James: WorldCom, AIG and Siemens. Sucheet:

SunBeam, Tyco and Xerox.

Shaan: Xerox, WorldCom and Allied Irish Banks. To summarise, WorldCom and Xerox were the most popular chose among us. We further discussed these two scandals and finally selected WorldCom. We identified 5 main areas to work on with WorldCom. (Also listed in Appendix 2 in Module Outline), allocated members to each topic listed in Appendix 2.


Tasks for next meeting

Members are required to do extensive research on WorldCom base on the 5 main areas discussed. To inform module convenor regarding our group members and the chosen scandal.

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[5th October], [13:00 – 15:00], [Jubilee Exchange] Present:

[Dharni Patel; Callum Sellar; Miguel Amaro; Owen Liu; James Howie; Sucheet Shah; Shaan Morzaria]

Next meeting: [16th October], [16:00 – 19:00], [Jubilee Exchange]



James announced that he had informed Mark Billings of our choice of scandal, and that Mark Billings had agreed we could proceed with WorldCom.


Key discussions

The main discussion was to identify the main aim of our coursework – Should we focus on a specific question, such as „Who was to blame for the WorldCom scandal?‟ or to do a literature review on the case. We presented our work on the 5 key areas from the last meeting; we compiled all the research and findings into 1 report. We also shared our findings on WorldCom articles, books and journals. However, we realised the report was not coherent enough and might not meet convenor‟s expectations.


Tasks for next meeting

Arrange a meeting with Mark Billings to discuss how to approach the report. Members are required to continue with their work from last meeting.

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[11:00 – 14:00, 10th November, 2009] Present:

[ Callum Sellar; James Howie; Shaan Morzaria; Miguel Amaro]

Next meeting: [17th November, 2009], [11:00 – 14:00], [Hallward Library]



We received apologies from Owen and Dharni. Owen is away for a football tournament in Loughborough and Dharni is away for a dancing competition.


Key discussions

Over google-docs, a structured report was beginning to emerge, and members agreed to allocate specific sections for each group member to work on that week. By this point in the term, we had now attended 7 lectures on the module, and were therefore able to draw on the information taught in lectures. Shaan reminded other group members to apply theory learnt in class to the WorldCom scandal, not only from the AGS module, but also from other modules such as AFR. Miguel mentioned that he had found the module “introductory econometrics” particularly interesting last year, and James volunteered to look for any econometric research that had been published in relation to corporate governance failure.


Tasks for next meeting

Each group member to concentrate on the section of the report allocated to them at the meeting. Owen and Dharni to be briefed on the outcome of the meeting by James.

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[17th November, 2009], [11:00 – 14:00], [Hallward Library] Present:

[Dharni Patel; Callum Sellar; Miguel Amaro; Owen Liu; James Howie; Sucheet Shah; Shaan Morzaria]

Next meeting: [27th November], [16:00 – 19:00], [Jubilee Exchange]



Dharni apologised again for her previous absence, but also announced that she had won her dancing competition, and the group congratulated her for this.


Key discussions

The report on google docs was now looking very detailed, but James pointed out that as a result of splitting the work into different sections to be completed by different people, continuity was becoming an issue. Miguel added that the word count was well over 4000 words, and this was before a conclusion had even been written. The group discussed the best way to tackle these issues, and it was decided that working together in a group room on a smart board would be more efficient than operating individually. Shaan pointed out that Google-Docs was also causing some compatibility issues, in particular when combining graphs and tables into the project. The decision was made to stop using google-docs.


Tasks for next meeting

Copy the report so far from Google-Docs into a word document, and book regular smartboard sessions in Hallward library at mutually convenient times.

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9. References 

Agrawal, A. & S. Chadha (2005): “Corporate Governance and Accounting Scandals”, Journal of Law and Economics, Vol. 48, October 2005.

AICPA (2005) The WorldCom Fraud

Bakarak,M., (2003), “Reports Detail WorldCom Execs‟ Domination,” AP Online, June 9, 2003.

Beresford, DR., Katzenbach, N. & CB. Rogers (2003): “Report of Investigation by the Special Investigative Committee of the Board of Directors of WorldCom Inc”, FindLaw, March 31.

Charan, R., Useen, J. & A. Harrington (2002): “Why Companies Fail,” Fortune (Asia), May 27, 2002, pp.36-45.

Choo, F. and K. Tan (2007), „An “American Dream” Theory of Corporate Executive Fraud‟, Accounting Forum, Vol. 31, No. 2, June, pp. 203-215.

Coffee, J (2005): “A Theory Of Corporate Scandals: Why The USA And Europe Differ”, Oxford Review of Economic Policy, Vol.21, No.2, p202.

Cohen, J., Ding, Y., Lesage, C. & H. Stolowy (2008): “The role of managers‟ behaviour in corporate fraud”, Carroll School of Management at Boston College, USA, China-Europe International Business School (CEIBS), Shanghai, China, „HEC School of Management, Paris, France, pp.12-16, 46.

Cullinan, C (2004): “Enron as a Symptom of Audit Process Breakdown: Can Sarbanes-Oxley Act Cure the Disease”, Critical Perspectives on Accounting, Vol. 15, No. 6-7, pp.853-864.

Gelles, K., “Accounting Fraud” USA Today, June 27, 2002

Hamilton, S. & A. Micklethwait (2006) Greed and corporate failure: the lessons from recent disasters, Basingstoke : Palgrave Macmillan.

Jackson, S. & M, Pitman (2001): “Auditors and Earnings Management”, The CPA Journal, Vol. 71, No.7, pp.39-44.

Jeter, L (2003), Disconnected: Deceit and Betrayal at WorldCom, John Wiley & Sons, Inc., Hoboken, New Jersey.

Kaplan, R.S. & D. Kiron (2007): “Accounting Fraud at WorldCom”, Harvard Business School Case Study, No. 9-104-071, Rev. September 14, 2007. Boston, MA: Harvard Business School Publishing.

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Matthews, D. (2005): “London and County Securities: A case study in audit and regulatory failure”, Accounting, Auditing & Accountability Journal, Vol. 18, No. 4, pp. 518-536.

Melis, A. (2005), “Corporate Governance Failures: To What Extent is Parmalat a Particularly Italian Case?”, Corporate Governance, Vol. 13, No. 4, July, pp. 478-488.

Moberg, D. & EJ. Romar (2006): “WorldCom”, Santa Clara University. Downloaded from at 17/11/2009 as at November 14, 2009.

O‟Donnell, J. and Backover, A.(2002), “Ebbers‟ high-risk act came crashing down on him,” USA Today, December 11, 2002.

Pfeifer, S. (2008): “Final settlement draws line under Shell scandal”, Financial Times, March 7, 2008. Downloaded from on November 20, 2009.

Sidak, JG. (2003): “The Failure of Good Intentions: The WorldCom Fraud and the Collapse of American Telecommunications After Deregulation”, Yale Journal on Regulation, Vol. 20, No. 2, pp.207-268.

Spitzer, E. (2002): “State of New York v. Anschutz, Ebbers, Garofalo, McLeod and Nacchio,” FindLaw, 30th September. Downloaded from as at November 3, 2009.

Stewart, B. (2006), 'The Real Reasons Enron Failed', Journal of Applied Corporate Finance, Vol. 8, no. 2, pp. 116-119.

The Economist (2003), “Corporate Governance Rules By SEC and NYSE”, downloaded from on November 26, 2009.

U.S. Securities and Exchange Commission securities fraud report, (2002), filed against WorldCom, June 26, 2002. From website,, accessed November 2009

US Today (2002), “Accounting Fraud”. Downloaded from on December 2, 2009.

Watkins et al. (2004), Journal of Accounting Literature, p.157

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Report written by Group 4: Callum Sellar Dharni Patel James Howie Luis Amaro Owen Liu Shaan Morzaria Sucheet Shah

University of Nottingham Module: Auditing, Government and Scandals Module Code: N13505 Module Convenor: Mark Billings

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