How Unethical Practices Almost Destroyed WorldCom

WORLDCOM LEADERSHIP

CEO Bernard Ebbers CFO Scott Sullivan

Overview

•WorldCom Inc. began as a small Mississippi provider of long distance telephone service called LDDS.• 1996: Acquired MFS Communications (internet

backbone)• 1998: Acquired MCI• 2000: Dotcom Bubble Burst (rapid decline in

telecom stock values)• 2002: Accounting Fraud uncovered • 2002: Filed for Bankruptcy Protection

How it started?WorldCom and other telecommunications firms have faced reduced demand as the dot–com boom ended and the economy entered recession.

Revenues fall short of expectations, while debt remains.

With failure of sprint merger it faced a severe setback.

Shareholder’s expectation

Profits

Market value of the company’s common stock plunged from about $150 billion in January 2000 to less than $150 million as of July 1, 2002.

Fraud

First, WorldCom's accounting department

underreported 'line costs’

Second, The company inflated revenue by $ 1

billion.

What WorldCom did?Reduced the amount of money held in reserve by $2.8 billion and moved this money into the revenue line of its financial statements.

In 2000, classified operating expenses as long-term capital investments ( $3.85 billion).

These changes turned WorldCom's losses into profits to the tune of $1.38 billion in 2001. It also made WorldCom's assets appear more valuable.

How discovered?

Then Securities and Exchange Commission (SEC) launched an investigation.

Firstly by WorldCom's own internal audit department- uncovered $3.8 b. of the

fraud.

Consequences

• Stock • Mid 1999 -$64.50 a share • After announcement - below $1 a share• Price fell below $1 a share ($.06) upon news that there might be further accounting irregularities.

• Employees• Those who hold the company’s

stock in their retirement plans. (ESOP)• 17,000 employees lost their jobs.

Consequences

• Shareholders

$180 Billion of shareholder value lost.• Future of the company•Their customers switch to other telecommunications carrier.• WorldCom was disqualified from further federal government contracts.•How bankruptcy would affect service to

Customers retaining WorldCom contracts is

Another issue.

Why it Happened?• Corporate Culture• Autocratic style of management and followed a top

down approach. • Lack of courage of employees to communicate the

fraudulent activates – believed it would have cost them their jobs• A financial system in which controls were extremely

deficient• The BOD and Audit Committee did not appear to have

had an adequate understanding of the company and culture• Inadequate audits by independent auditors

Ethical Values Violated

• Unethical Work Culture• Pressuring employees to manipulate accounts• Employees who played along were rewarded; others were

threatened.• Fudged up the accounts; mislead the various stakeholders.

Present condition

The company emerged from Chapter 11 bankruptcy during 2004 with about $5.7 billion in debt and $6 billion in cash.

On August 7, 2002, the exWorldCo 5100 group was begun. It

On February 14, 2005, Verizon Communications agreed to acquire MCI for $7.6 billion.

December 2005, the Microsoft announced that MCI will join it by providing Windows Live Messenger customers "Voice Over Internet Protocol" (VoIP) service.

This was MCI's last new product—- called "MCI Web Calling".

After the merger, this product was renamed "Verizon Web Calling".

Legal trials

Bibliography

• Kaplan, R. S., and Kiron., D. (2007) Accounting Fraud at WorldCom. Harvard Business School Case 104-071, September 2007. (Revised from original April 2004 version.)

• Lyke, B. (2002). “WorldCom: The Accounting Scandal.” CRS Report for Congress, August 2002.http://www.law.umaryland.edu/marshall/crsreports/crsdocuments/RS21253_08292002.pdf

• Romar, E., and Calkins, M. (2006) WorldCom Case Study Update. University o Massachusetts-Boston http://www.scu.edu/ethics/dialogue/candc/cases/worldcom-update.html

• American Institute of Certified Public Accountants (2005) The Worldcom Fraud http://www.aicpa.org/InterestAreas/AccountingEducation/Resources/DownloadableDocuments/worldcom.ppt

• WorldCom: The Case Against Bernard Ebbers (2011)https://www.youtube.com/watch?v=DW03eVMtOY4

• WorldCom – What Went Wrong (2008)https://www.youtube.com/watch?v=7g_d-phoUrU

Big expectations-bigger frauds

The Blame Game

•Arthur Anderson was external auditor of WorldCom since 1989.•They denied any involvement in the Fiasco.•Arthur Anderson missed opportunities where they could have disclosed the fraud. They have been criticized for their way of handling WorldCom accounts books and policies.

Corporate Whistleblowing Cynthia Cooper and her team were the first people who uncovered the major

fraud at Worldcom. The voluntary release of non-public information, as a moral protest, by a

member or former member of an organization outside the normal channels of communication to an appropriate audience about illegal and/or immoral conduct in the organization or conduct in the organization that is opposed in some significant way to the public interest.

Traditional corporate monitoring occurs through a variety of overlapping means, including: the company’s board of directors, external auditors and attorneys, and the government.

“The highest good was the good will. To act from a good will is to act form duty. Thus, it is the intention behind an action rather than its consequences that make that action good” – Immanuel Kant.

As businesses continue to grow larger and more complex, whistleblowing has emerged as a valuable tool for eliminating future corporate fraud.

A reported 90 per cent of whistleblowers lose their jobs or are demoted.

THE FINANCIAL MESS

SEC revealed the fact that WorldCom had a debt of 5.75 billion dollar.WorldCom has also signed a deal with 26 banks according to which It has to pay 2.65 billion dollar per year.Banks agreed to give the loans without any collateral.WorldCom manipulated the value of its total assets

Summary• WorldCom is not only about “greed”• Corporate fraud is the result of how a

corporation is led, how employees are motivated, the nature of the work, and the degree of individual autonomy• Ethics training and compliance programs

don’t work in a culture that is exclusively materialistic and that devalues the dignity of work and workers• The basic assumptions about how

corporations are organized and run need to be rethought• Corporate executives must re-learn how to

lead• Leadership training must be holistic,

emphasizing free will, personal responsibility and transparency i.e.: continuous, open, information-sharing

Why ‘good’ managers make bad ethical choicesFour Rationalizations To Justify Questionable Conduct• 1. Believe that the activity is not “really illegal”• Top execs. seldom ask their subordinates to do things that both of them know are against the

law or imprudent. But company leaders sometimes leave things unsaid or give the impression that there are things they don’t want to know about….often lure ambitious lower level managers by implying rich rewards await those who can produce certain results.

• WorldCom – top exec. Comp and benefits were extremely generous. (First Interim Report page 63). Large subjective cash bonuses were paid. Sullivan made personal payments to staff out of large bonus he was paid (Second Interim Report page 150).

• 2. That it is in the individual’s or corporation’s best interest.• Need to value the “how” results are achieved not just the “results” itself. If not, individuals will

assume that borderline actions will be overlooked or at least interpreted charitably if noticed.• WorldCom – employees feared loss of job over blowing the whistle.• 3. That it will never be found out.• A major factor in the WorldCom fraud. Hoped that Sprint deal would close so they could re-fuel

reserves. Then hoped demand would pick up to use up excess capacity and could bleed off overcapitalization against future growth. Then hoped that could take a restructuring charge – and blame it on overall market conditions.

• 4. Believe that the company will condone actions that are taken in its interest and will even protect the managers responsible.

• Classic case of this in WorldCom. When accounting staff began to bulk at making improper entries. Sullivan and Myers assured them that it was ok and not to abandon the ship during the storm.

• Need an environment of transparency that – do not shoot the messenger – that people are not afraid to speak up – that do not hid things or problems.

21

ConclusionA good way to avoid management oversights is to subject the

control mechanisms themselves to periodic surprise audits…The point is to make sure that internal audits and controls are

functioning as plannedIt is a case of inspecting the inspectors and taking the

necessary steps to keep the controls working efficientlyIt is up to Top Management to send a clear & pragmatic

message to all employees that good ethics is still the foundation of good business

• First and foremost need a proper “Tone from the Top” – without it no system of controls will be effective.

• Need an environment where controls matter and doing business in accordance with the law and ethically is said and practiced.

• Need to have healthy level of skepticism• A great quote from Bankruptcy Court Report on Corporate Governance For The

Future of MCI, Inc.• “Power tends to corrupt, and absolute power corrupts absolutely” Lord Action

1887

Key Take Aways• No job is worth breaking the law or committing

unethical acts for your personal integrity is your most important asset – you own it and control it

What will it profit a man if he gains the world but loose

his own soul? (Mark 8:36)Jesus Christ