Published on July 13, 2016
Slide1: By Lincoln Honts, Haley Mitchell, Chelsea Rollo, & Haley Shaw July 14, 2016 Timeline of WorldCom Fraud: Timeline of WorldCom Fraud Earnings Management vs. Fraudulent reporting : Earnings Management vs. Fraudulent reporting Earnings Management Accounting techniques to level out net income fluctuations from one period to the next Fraudulent reporting An illegal act of lying on the financial statements Two techniques WorldCom used Accrual Release (1999-2000) Capitalization of line costs (2001-2002) Motivation Behind the Fraud: Motivation B ehind the F raud To be the #1 stock on Wall Street Maintain revenue growth Pressure from upper management Compensation incentives Pressure to “Cook the Books”: Pressure to “Cook the Books” Generally Financial statement improvement Increase earnings Meet analysts’ and investors’ expectations Keep stock price high Meet debt covenants Personal motivation Own large portion of stock Greed WorldCom Poor industry conditions: High competition Saturation of the market Decrease in demand for tele-com services Pressure on the E/R ratio Ebbers unrelated businesses were dependent on WorldCom stock The Fraud Triangle: Perceived Pressure Financial pressure to meet E/R ratio Pressure from top management Personal pressure (Vinson, Ebbers, etc) The Fraud Triangle Perceived Opportunity Lack of written code and poor internal controls Poor communication with the Board of Directors Secrecy Rationalization It would save the company and jobs. Employees trusted top management. Arther Andersen’s “investment” The Corporate Culture: The Corporate Culture Disaggregated, a “hodgepodge of people and cultures” An aggressive top-down management system Emphasized that employees should do as they are told Poor ethical standards set by the top Example: Compensation by Ebbers and Sullivan Legal advice not welcome No whistleblowing hotline and lack of emphasis on the internal audit department Top Down Prepaid Capacity: “ Prepaid Capacity” allowed for the transfer of the costs of leasing fiber-optic lines from the income statement as an expense to the balance sheet as a capital asset Rounded dollar amounts 49 accounts totaling over $3.8 billion Inflated income No support for the transactions Prepaid Capacity Income Statement Revenue (Expenses) Net Income Balance Sheet Assets Liabilities SE Financial Impact: Part One: Financial Impact: Part One Accrual releases—eliminating estimated liabilities of line costs before the actual bill came; Released $3.3 billion of accruals over 7 quarters The accrual release flowed from the balance sheet to the income statement as a reduction in line expenses which increased income Slide10: Expense capitalization—excess network capacity treated as capital expenditure rather than operating expense which boosted income Used an account called “Construction in Progress” Form Filed with the SEC Reported Line-Cost Expenses ($ millions) Actual Line-Cost Expenses ($ millions) Reported Income before Taxes and Minority Interests ($ millions) Actual Income (Loss) before Taxes and Minority Interests ($ millions) Overstated Income 10-K, 2000 15,462 16,697 7,568 6,333 1,235 10-K, 2001 14,739 17,754 2,393 (622) 3,015 10-Q, 1st Qtr 2002 3,479 4,297 240 (578) 818 Total 5,068 Capital Expenditures (in millions) 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 Total As reported to board 2,648 2,418 2,235 2,033 1,786 1,785 1,250 14,155 Actual spend, not shown to board 1,691 1,473 1,044 944 462 5,614 Difference 2,648 2,418 544 560 742 841 788 8,541 Financial Impact Continued...: Financial Impact Continued... Together, these tactics helped WorldCom reach its desired E/R ratio of 42% rather than the 50% it would have had without the fraud Stakeholders Affected: Stakeholders Affected Shareholders in WorldCom lost the money from their investment Employees lost a job which included benefits like healthcare and retirement funds Competitors lost money trying to match the efficiency and numbers from WorldCom’s books Financial institutions that loaned money to WorldCom with the expectation of repayment lost a majority of that money due to WorldCom’s bankruptcy Hiding the Fraud: Hiding the Fraud Upper management split different parts of the fraud amongst a variety of managers in the company. They kept these people quiet through social engineering or even coercion. Upper management also limited the ability of auditors (internal and external) to uncover the frauds by limiting access to information. Internal Audit: Internal Audit Cynthia Cooper - head of internal audit, first started the uncovering process in 2002 Gene Morse - senior manager with internal audit, did a majority of the actual searching for evidence due to his access to financial info/records Glyn Smith - internal audit senior manager; helped toward the end, especially when confronting managers within WorldCom Cynthia Cooper Overview: Cynthia Cooper Overview Scott Sullivan tried to intimidate Cooper Cooper faced an ethical dilemma Cooper had an ethical obligation to investors Cynthia Cooper Overview: Cynthia Cooper Overview Reported directly to Scott Sullivan, CFO Two choices: To whistleblow or not to whistleblow Betty Vinson: Victim or Villain?: Betty Vinson: Victim or Villain? Victim: Evident internal struggle Overcome with guilt and planned to resign Driven by the financial well-being of family No alternative job with comparable compensation Isolation, weight loss, sleep deprivation Villain: Criminal from law perspective Guilty of one count of securities fraud and one count of conspiracy to commit securities fraud Sentenced to 5 months in prison and 5 months house arrest Ultimately a villain in the end Who to Blame?: Who to Blame? Board of Directors 4-6 meetings per year No direct contact with executives Robotic in nature Distant and detached External Auditors Under billed Worldcom for services Assessed risk as Moderate instead of Maximum Ignored absence of irregularities Did not focus on misstatements due to deliberate manipulation Shareholders Management Final Lesson & Conclusion: Final Lesson & Conclusion Don’t let emotions blur your decision-making ability Don’t hesitate to investigate Rely on your accounting expertise Sources Used: Sources Used Alvarez , Alayna. "Texas Enterprise: Big Ideas in Business from The University of Texas at Austin." Truth and Consequences: Lessons from WorldCom . University of Texas at Austin, 12 June 2013. Web. 12 July 2016. Beresford, Dennis R., Nicholas DeB. Katzenbach, and C.B Rogers, Jr. "Report of Investigation." SEC . N.p., 31 Mar. 2003. Web. 9 July 2016. < https://www.sec.gov/Archives/edgar/data/723527/000093176303001862/dex991.htm#ex991902_20 >. Colvin, Geoffrey. "The Other Victims of Bernie Ebbers's Fraud." The Other Victims of Bernie Ebbers's Fraud - August 8, 2005 . N.p., 8 Aug. 2005. Web . 11 July 2016. < http://archive.fortune.com/magazines/fortune/fortune_archive/2005/08/08/8267650/index.htm >. "Earnings Management Definition | Investopedia." Investopedia . N.p., 26 Apr. 2011. Web. 11 July 2016. <http://www.investopedia.com/terms/e / earnings-management.asp?layout=infini&v=5A&orig=1&adtest=5A>. Hancock, David. "World-Class Scandal At WorldCom." CBSNews . CBS Interactive, 26 June 2002. Web. 11 July 2016. http ://www.cbsnews.com/news/world-class-scandal-at-worldcom / Johnson, Sarah. "Should Internal Auditor Report to the CFO?" CFO. CFO.com, 13 Oct. 2006. Web. 12 July 2016 Kaplan, Robert S., and David Kiron . “Accounting Fraud at WorldCom.” Harvard Business School, 14 Sept. 2007. Web. 9 July 2016. Katz, David M. "The Big Lie." CFO . N.p., 25 Jan. 2008. Web. 08 July 2016. < http://ww2.cfo.com/accounting-tax/2008/01/the-big-lie/ >. Sources Used: Sources Used Pulliam, Susan, and Deborah Solomon. "How Three Unlikely Sleuths Exposed Fraud at WorldCom." The Wall Street Journal, 30 Oct. 2002. Web. 11 July 2016. http :// www.wsj.com/articles/SB1035929943494003751?mg=id-wsj . Romero , Simon. "WORLDCOM FILES FOR BANKRUPTCY; LARGEST U.S. CASE." The New York Times . The New York Times, 21 July 2002. Web . 11 July 2016. http :// www.nytimes.com/2002/07/22/us/worldcom-s-collapse-the-overview-worldcom-files-for-bankruptcy-largest-us-case.html "WorldCom Company Timeline." Washington Post . The Washington Post, 15 Mar. 2005. Web. 11 July 2016. < http://www.washingtonpost.com/wp-dyn/articles/A49156-2002Jun26.html >.