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. Located at the 515 East Amite
Street Jackson, Mississippi 39201-2702 U.S.A. WorldCom Group operates data, internet,
hosting, international and commercial voice businesses. The Company operates a global
facilities-based communications network that provides international, data, and internet services.
It consisted of an employee base of 85,000 workers at its peak with a presence in more than 65
countries. LDDS started in 1983.
In 1985, Ebbers was recruited as an early investor of the company and became its CEO. It
went public four years later. Ebbers helped grow the small investment into a $30 billion revenue
producing company characterized by sixty acquisitions of other telecom businesses in less than a
decade. In 1999, Ebbers was one of the richest Americans with a $1.4 billion net worth. From the
outside, WorldCom appeared to be a strong leader of growth. In reality, the appearance was
nothing more than a perception.

Companies Acquired by WorldCom

The executive and strategic decisions at WorldCom were characterized by rapid growth
through acquisitions such as:

1989: LDDS becomes public through the acquisition of Advantage Companies Inc.

1992: LDDS merges in an all-stock deal with discount long distance service provider Advanced
Telecommunications Corp.

1993: LDDS acquires long distance providers Resurgens Communications Group Inc and
Metromedia Communications Corp. in a three-way stock and cash transaction that creates the
fourth-largest long-distance network in the United States

1994: LDDS acquires domestic and international communications network IDB

Communications Group Inc. in an all-stock deal.
1995: LDDS acquires voice and data transmission company Williams Telecommunications
Group Inc. for $2.5 billion and changes its name to WorldCom Inc.

1996: WorldCom merges with MFS Communications Company Inc. and UUNet Technologies
Inc.

1998: WorldCom completes three mergers: with MCI Communications Corp. ($40 billion)—the
largest in history at that time—Brooks Fiber Properties Inc. ($1.2 billion) and CompuServe Corp
($1.3 billion).

1999: WorldCom and Sprint Corp. agree to merge but blocked by European and U.S. regulators

2001: WorldCom merges with Intermedia Communications Inc., a provider of data and Internet
services to businesses

Causes
Internal Environment
 Strategy (or lack thereof)
The executive and strategic decisions at WorldCom were characterized by rapid growth
through acquisitions (In re WorldCom, inc., 2003). “Growth, growth, growth…” (G. Morse
personal communication, October 22, 2010). By 1998, WorldCom had been involved in mergers
with sixty companies. Together, these transactions were valued at more than $70 billion, the
largest of which, MCI Communications Corporation (“MCI”), was completed on September 14,
1998, and was valued at $40 billion (In re WorldCom, 2003).
According to Smith & Walter (2006), WorldCom was motivated by the low interest rates
and rising stock prices during the 1990s. From the beginning, it committed itself to the high-
growth strategies that relied on aggressive corporate actions that often involved “creative”
accounting practices. Dick Thornburgh‟s investigation of WorldCom (2003) revealed a lack of
strategic planning, often depicted by nonexistent “proper corporate governance protocols.” While
documents called “strategic plans” were found, they only consisted of an overview of the
company’s financial outlook in the event that WorldCom stopped the aggressive acquisitions.
They did not contain any realistic strategic plans (Thornburgh, 2003). There was no strategic
committee and the decision makers mainly consisted of the Chief Executive Officer
("CEO")Bernard John Ebbers, Chief Financial Officer (“CFO”) Scott Sullivan, and Chief
Operations Officer (“COO”) John Sidgmore (Thornburgh, 2003).

Once WorldCom acquired the new companies, it failed to properly integrate the systems
and policies that not only led to very high levels of overhead in proportion to the revenues but
also to an extremely weak internal control environment (Breeden, 2003). Due to the fast pace of
the acquisitions as well as management’s neglect, the accounting systems at WorldCom were
unable to keep up with integration and efficiency. The lack of internal controls allowed manual
adjustments to be made in the system without the emergence of any red flags, thereby
minimizing any chance of detection (Breeden, 2003). To further this acquisition problem, the
MCI merger caused WorldCom to take on a huge debt load. In addition, MCI had a residential
customer base with slower growth rates while WorldCom had historically served business
customers, a customer base consisting of high margins and less turnover. (Katz & Homer, 2008).

The beginning of WorldCom’s fall came with its attempt to merge with the second largest
telecommunication company at the time: Sprint (WorldCom being the third largest). The plan
was terminated by the U.S. Department of Justice due to the lack of anti-competitiveness it
would create within the telecommunications industry. With no other companies to merge with,
WorldCom’s growth through acquisitions strategy came to a screeching halt (Clikeman, 2009).
According to Porter (1985), a competitive strategy searches for a favorable competitive position
in a company’s industry, aiming to establish a position in which the company is profitable and
sustainable against its competitors. The management at WorldCom was so determined to grow
that it not only failed to create a competitive strategy, but also did not see that with growth
comes “the need to maintain” to prosper. In the end, that lack of strategy prevented it from
effectively planning and determining a position to acquire that prosperity.

 Corporate 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.
However, when the stock dropped, the employees were still required to work the long hours even
when compensation was all but gone (L. Jeter, personal communication, October 17, 2010).

There was a large focus on revenues, rather than on profit margins and the lack of
integration of accounting systems allowed WorldCom employees to move existing customer
accounts from one accounting system to another. This allowed the reporting of higher revenues
for WorldCom through which employees pocketed extra commissions that amounted to almost
$1 million (in Re WorldCom, Inc., 2003). According to the Beresford, Katzenbach, & Rogers
(2003), efforts made to establish a corporate Code of Conduct received Ebbers disapproval. He
often described the Code as a “colossal waste of time.” Implementing a code of ethics and
having employees read and sign it periodically can reinforce ethical conduct as well emphasize
that it is important to the company (Albrecht & Albrecht, 2004). The lack of a code of ethics at
WorldCom shows that no training on awareness of fraud or ethics was conducted. Therefore, it is
very possible that when the employees reported existing customers as new ones, they were not
aware of the obdurate consequences that may occur.

The employees at WorldCom did not have an outlet to express concerns about company
policy and behavior either. Special rewards were given to those employees who showed loyalty
to top management while those who did not feel comfortable in the work environment were
faced with obstacles in their need to express their concerns (Panday & Verma, 2004). Due to the
multiple acquisitions, WorldCom’s business units were spread across the eastern United States.
Hence, if an employee working at headquarters in Clinton, Mississippi was facing a problem,
he/she would have to contact the Human Resources department in either New York, N.Y. or
Boca Raton, Florida. This autonomous structure complicated matters further and discouraged
most employees from saying anything at all (Beresford, Katzenbach, & Rogers, 2003). The lack
of an outlet to express concerns was not only problematic for regular employees, but also for the
upper level employees who were asked to participate in the fraud. Betty Vinson and Troy
Normand, managers in Clinton’s Accounting Department, were told to make journal entries on
the instructions of the Director of General Accounting Buddy Yates (Beresford, Katzenbach, &
Rogers, 2003). They followed his orders. However, they both wrote a letter of resignation after
they felt uncomfortable with the falsified journal entries they made. The two never submitted
their resignation letter due to their dependence on their jobs to support their families (Cooper,
2008).

A low fraud environment could have been created if WorldCom’s culture consisted of
positive work environment elements such as employee assistance programs that make it easier
for the employees to not only report fraud, but decrease their own likelihood of committing it.
Open door policies, positive personnel, and operating procedures could have been implemented
to diminish the barrier between employees and upper management (Albrecht & Albrecht, 2004).
Unfortunately, in the case of WorldCom, the personnel themselves were involved in the fraud.
Yet, if the personnel were the ones to implement the positive work environment, they might not
have been involved in the fraud in the first place. On top of the lack of an ethical code and an
outlet for concerns was the concept of employee compensation with stock options. Employees at
WorldCom received a lower salary than their counterparts at competitors such as AT&T and
Sprint (J. Chalmers personal communication, October 21, 2010). According to Chalmers, a
lawyer who dealt with many WorldCom employee cases after the fraud, the gap between the
competitors‟ compensation and WorldCom employee compensation was filled through stock
options which further enforced management’s ideology of focus on revenues. The higher the
revenues, the better the company appeared to Wall Street which in turn led to a higher stock
price and higher compensation for both employees and management. However, when WorldCom
fell, so did the stock price, leaving its employees with worthless stock options. Gene Morse
(personal communication, October 22, 2010), one of the internal auditors who helped discover
the accounting fraud, had been given the senior level director’s stock options package. If the
stock had returned to its high and WorldCom had not fallen, his options would have been worth
over $900,000. Morse stated that he never sold the options because he too, like most of other
employees and stakeholders, believed in Ebbers’s optimism about WorldCom.

Ebbers played a huge part in turning LDDS into a “global telecom giant,” WorldCom, with
the goal of acquiring the position as the “number one stock on Wall Street” (Panday & Verma,
2004). Ebbers had started out by managing hotels in 1974 (Clikeman, 2009). He continued his
“hands on” managerial style throughout his involvement in WorldCom even when the company
had revenues amounting to billions of dollars (in re). He was known for taking risks (Katz &
Homer, 2008) no matter how aggressive, towards making WorldCom’s stock a highly
demandable one. According to Panday & Verma (2004), Ebbers created an individualistic culture
where loyalty to a person was more important than loyalty to the company. This created an
environment where the boss was not to be questioned. Therefore Ebbers plan was the company’s
plan.

Sullivan was Ebbers’s right hand man. He and Ebbers had the same managing style.
Sullivan was known as a “whiz kid” who enjoyed the reputation of “impeccable integrity.” He
was a leader that, like Ebbers, was not to be questioned. The loyalty that existed at WorldCom
was very important to keep the fraudulent activities that occurred bottled up. Most of the
information was not fully available to employees, furthering this secrecy. Even some who had
the need to know the information (Zekany, Braun, & Warder, 2004), such as the internal
auditors, could view only some of the journal entries in the income statement and the balance
sheet but never the entire documents (G. Morse Personal Communication, October 22, 2010).
The combined management allowed the creation of a culture that was more suitable for a sole
proprietorship than for a billion-dollar corporation. The aggressive nature of the managing style
such as the plethora of acquisitions as well as the failure to integrate them properly created an
environment where employees were pressured to report high growths quarter by the quarter.
There was no emphasis or encouragement of honesty and integrity with those demands.
According to Romney & Steinbart (2008), a work environment that emphasizes “integrity and
commitment to both ethical values and competence” depicts good business, yet it all has to start
at the top. Management that required and rewarded integrity and honest behavior (Romney &
Steinbart, 2008) may have prevented what occurred at WorldCom. Furthermore, if management
had envisioned a more stable and long-term outlook for the company, the quick paced
acquisitions may not have occurred. Unfortunately, they did. The approval for these acquisitions
was given by the Board of the Directors.

 Corporate Governance
 Board of Directors

According to Romney & Steinbart (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
Ebbers (Breeden, 2003). The mix of the Board and the 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, 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. The directors also depended on company growth and stock appreciation
for compensation, as did the employees and management. They had a large amount of influence
on the approval or disapproval of company decisions. Their approvals of the acquisitions allowed
WorldCom’s growth to an increase that led to a higher stock price and a large amount of
compensation. Directors dependent on this type of “large issuances of equity” not only conveyed
an unhealthy practice, but also created a conflict of interest where their goal became more
focused on the growth of the stock than on what was in the best interests of the company
(Breeden, 2003). Another conflict of interest arose for those board members that had strong ties
to Ebbers. Their closeness to Ebbers hurt their duty to be independent from the company and its
management.

Due to the Board’s lack of active participation, there was a lack of awareness about
WorldCom’s matters. According to Thornburgh (2003), management aided that lack of
awareness by presenting the directors with very limited information about the company and its
acquisitions. Thornburgh (2003) states multibillion dollar transactions were approved by Board
of Directors with the limited information. At times, they were approved with discussions that
lasted less than half an hour. Sometimes these discussions did not involve the Board at all and at
other times no documents were even presented concerning the terms of the transactions. In
addition, no risk assessment was performed on these acquisitions (Breeden, 2003). Romney &
Steinbart (2008) recommend that the Board of Directors of a company should be responsible for
overseeing management and inspect its “plans, performance, and activities” (p. 208). The
directors should also approve the company’s strategy, review its financial statements, and
evaluate security policy. They should also always interact with the auditors, both external and
internal.

 Loans to Ebbers

“We stand by our accounting.” Ebbers made this statement during an earnings conference
call with analysts in February of 2002 (in Re WorldCom, Inc., 2003). However, what was
unknown at the time was Ebbers’s personal financial situation. Ebbers had made several
purchases for which he had acquired loans and used his WorldCom stock as collateral. The
purchases were quite extravagant and included the largest ranch in Canada, a yacht construction
firm and yard, a marina, motels, a hockey team, and even a yacht Ebbers named “Acquisition.”
Once the price of WorldCom stock fell, Ebbers was required by the banks to fill in the margins
between the value of his loans and the fallen value of his stocks (Panday & Verma, 2003).

Instead of selling his stock, which he thought would further cause a decline in stock price
on Wall Street, Ebbers requested the Board to approve personal loans to fill in the margins
(Breeden, 2003). To ease the process, Ebbers took advantage of the lack of independence of the
board members who were loyal to him such as Stiles Kellett, chairman of the Compensation
Committee, and Max Bobbitt, chairman of the audit committee. Not only did the two allow the
loans to grow to more than $400 million, but also when the Board found out about these loans,
they failed to take any action and allowed the loans to carry on (Breeden, 2003). A strong Board,
that included directors who were more focused on the shareholders rather than on what Bernie
recommended, could have avoided the multimillion dollars in loans that further deteriorated
WorldCom’s financial situation. This shows that it is important to inform the directors about
company policies, mission, and ethics since they are not a part of the company’s daily life and
culture.
  The Compensation Committee

One main reason Ebbers’s loans were approved was the Compensation Committee. The
Committee’s authority was stated in a charter from 1993 that listed a vague description of its
power to supervise the compensation of the officers (Beresford, Katzenbach, & Rogers, 2003).
However, in the company’s proxy statements, the committee had the power to determine the
“salaries, bonuses, and benefits” of the officers (p. 270). The Committee approved the loans to
Ebbers without confirming with the Board and asked for the Board’s approval after the loans had
already been paid out (Beresford, Katzenbach, & Rogers, 2003). The Committee was the only
one at WorldCom that met regularly: seven to seventeen times per year during the fraud period
of 1999-2001. Similar to the Board of Directors, the Compensation Committee failed to properly
conduct its role in placing appropriate pay programs that not only supported the company’s
mission and strategy but were also in the best interests of the company. The approval of Ebbers’s
loans does not qualify as an action in the company’s best interests, but only in the best interests
of Ebbers and the board members who were loyal to him.

 Lessons in Corporate Governance

Corporate governance involves the protection of shareholders by the Board of Directors (P.
Roush, personal communication, 2011). The approval of Ebbers’s personal loans was not in the
best interests of the stakeholders. Breeden (2003) mentions that there are no “checklists” of
achieving “good” governance. There is, however, a need of a Board that contains individuals
who not only possess business knowledge and skills but also have “healthy sensitivity to norms
of proper behavior” (p. 23). The focus then turns to the creation of value for the company rather
than to simply avoid wrongdoing and to have a good code of ethics (Breeden, 2003).

Breeden further emphasizes “doing the right thing,” stating that every Board whether at a
national, business, or university level will at some point be faced with tough decisions and
challenges. The key to the success of the Board is to take action and resolve any problems with
competency (Breeden, 2003). Unfortunately, with WorldCom, when the Board was presented
with the challenge of approving Ebbers’s loans, among other large acquisition decisions, it failed
to take action and limit Ebbers’s power on the Board. Perhaps the Board did not realize the
consequences that could occur as a result of those actions committed against their long-time
friend nor did it have the competency to take control of the board and take a strong position
against the decisions.

 Auditing: to detect or to neglect

 Audit Committee

A director’s independence from management is a key factor in a successful company. At

WorldCom, an Audit Committee was established to conduct relations with Arthur Andersen, the
external auditor. An Audit Committee consists of a selected number of Board members who are
to meet from time to time with the company’s auditing firm and discuss the progress of the audit,
the findings, and resolve any conflicts that may occur between management and the firm
(Louwers, Ramsay, Sinason, & Strawser, 2008). However, in WorldCom’s case, the lack of
independence and awareness of the Board as a whole trickled down to the audit committee. The
committee’s chairman, Max Bobbitt, was very loyal to Ebbers. Hence, the members of the
committee, including Bobbitt, were either unaware or had known about the fraudulent
misstatements for the years 1999, 2000, and 2001 and choose to ignore it. According to
Breeden(2003), the Committee oversaw the $30 billion revenue company when it met for about
three to six hours once a year.

While the Committee was represented positively, the accounting controls within were
“virtually non-existent” (in Re WorldCom, Inc., 2003). It appears the lack of activity was more
of a “going through the motions” as opposed to the Committee sitting down and understanding
the policies, the internal controls, and the audit programs that were a necessity to the company‟s
core structure (Breeden, 2003). Even though Arthur Andersen acknowledged WorldCom as a
“maximum risk” client and mentioned to the Committee that WorldCom had “misapplied GAAP
(Generally Accepted Accounting Principles) with respect to certain investments,” the committee
chose to ignore it and in the end Arthur Andersen gave WorldCom a clean, unqualified opinion
(Zekany, Braun, & Warder, 2004).

The audit committee’s negligence depicts another weakness in WorldCom’s internal

controls. Therefore, it is very important to have members in the committee that fulfill their duties
by overseeing the corporation’s internal control structure as well as making sure that the
company complies with “laws, regulations, and standards” (Romney & Steinbart, 2008). The
members should also periodically meet with the firm’s internal and external auditors to ensure
the audit process is efficient and be aware of the company’s operations. The fulfillment of these
duties is now a requirement due to Section 301 of the Sarbanes-Oxley Act discussed later.

 Internal Audit

WorldCom’s Audit Committee failed to meet with the Internal Auditors of the company,
who had the duty to provide the Audit Committee with an independent and objective view on
how to improve and add value to WorldCom’s operations (Louwers, Ramsay, Sinason, &
Strawser, 2008). Not only were the personnel in the internal audit department not enough for a
large company, but they also lacked the proper training and experience to conduct the testing of
the company’s controls.

According to Thornburgh (2003), Ebbers or Sullivan would have the department work on
“special projects” that were very time consuming and would normally not be part of the audit
function. Thornburgh states that there were times when the auditors would work on the projects
during the day and then stay late at night to complete the audits that were often delayed. Cynthia
Cooper, the Vice President of the Internal Audit function and the individual whose department
discovered and reported the fraud, stood by the intense work in the hopes that top management
would see her department as important and add the personnel and resources needed to efficiently
maintain the internal audit function (Thornburgh, 2003). Gene Morse (personal communication,
October 22, 2010) adds that 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 (Louwers, Ramsay, Sinason, & Strawser,
2008). This form of relationship was lacking at WorldCom. Furthermore, Ebbers wrongly
associated the duties of an internal auditor with those of an external one. In reality, an internal
auditor does little work on the financial statements and focuses more on “improving the
organization’s operations” (Louwers, 2008, p. 629), rather than conducting the actual operations.
The department must try to reduce or eliminate risks that could create losses and improve the
efficiency of operations. Lastly, the department should help ensure compliance with
management, laws and regulations as this would add value to the company (Louwers, 2008).

 External Auditors

At WorldCom, it appears there were no checks and balances in auditing. The internal
auditors were not sufficiently staffed to work on the internal controls and the audits of the
company which prevented them from correctly reporting to the Audit Committee about the
operational and financial situation of WorldCom. The Committee itself did not meet on a regular
basis either and was unable to properly take actions to fix the situation. Yet, the external auditor,
Arthur Andersen, was the one responsible for providing an independent opinion of the financial
situation at WorldCom for investors and creditors. The auditing firm also failed to carry out its
duties properly.

According to Beresford, Katzenbach, & Rogers (2003), Arthur Andersen’s failure to detect
the fraud was due in part to negligence and in part to the tight control top management kept over
information. A flaw in Andersen’s approach was that it limited its testing of account balances,
relying on WorldCom’s perceived strong internal control environment (Beresford, Katzenbach,
& Rogers, 2003). Unfortunately, WorldCom’s internal control environment was inefficient in
many ways, and therefore allowed Andersen to overlook “serious deficiencies” that existed in the
internal environment (p. 223). If the external auditors had performed their work properly, the
fraud could have been discovered long before 2002. Moreover, even though the top
management’s control over the information was suspicious, Andersen failed to bring this
problem to the attention of the Audit Committee (Beresford, Katzenbach, & Rogers, 2003).

Speaking at an event at Baylor University, David Myers, former comptroller at WorldCom,

stated that the WorldCom audit was Arthur Andersen’s largest audit in the region, and that
Arthur Andersen wanted to keep WorldCom as a client (Acc guest 2009). Unfortunately, the
retaining of WorldCom as a client was due to the consulting revenue that it brought in to Arthur
Andersen. The auditors spent more time selling those consulting services and less time
conducting analytical reviews and testing controls. According to Roush (personal
communication, 2011), this situation created a conflict of interest because the auditors would
first consult a company about how to increase performance or efficiency and then go back to the
same company and independently audit it. Top management at WorldCom was aware of this and
made the journal entries in the way they would be tested by Arthur Andersen. In addition, Myers
notes that Arthur Andersen may not have overlooked the details purposely but rather the auditors
were pressured to have the job completed as soon as they could. It appears that the relationship
with WorldCom was more valued than performing appropriate audit work. Andersen’s close
relationship with Ebbers, in the end, resulted in a lack of professional skepticism: the questioning
attitude an auditor must have when in the field.
External Environment

The external environment during the fraud period also served as a basis for WorldCom’s
growth during the Internet bubble. When the bubble burst in early 2000, WorldCom’s share price
plummeted along with most of the volatile Internet and telecommunications companies.

 Double Bubble
 Dot-Com Bubble

In 1996, UUNet, the technology and Internet sector of WorldCom, announced that Internet
traffic was doubling every 100 days. According to Odlyzko (2003), while the statement may
have been true from 1996-1997, when Internet was indeed growing, the growth failed to be
carried on towards the later years when it was most often cited. This statement was not only
made by Internet and telecommunications companies to boost investment in their companies, but
also, by scientists trying to demonstrate the need for research within this new technology
(Odlyzko, 2003). Hence, people believing in the evolving myth started to invest rapidly into the
volatile stocks of Internet and telecommunication companies. Most of these companies were not
even making a profit. Odlyzko emphasizes that people did not stop to think about how something
could grow so fast and that the myth was repeated enough times that it became a reality. He
states that in order for the traffic to keep on increasing, within a year every person would have
had to be using the Internet twenty-four hours per day, a scenario that was not plausible at the
time. In his most recent paper, Odlyzko (2010) mentions the cause of bubbles like the Internet
and telecommunications one is gullibility. This “beautiful illusion” of enormous profits and a
better lifestyle block one’s ability to think objectively. In the end, the growth is empowered by
this gullibility. Essentially people end up “drinking their own Kool-Aid” (Odlyzko, 2010). These
actions later turn into anger and disbelief once the bubble is gone and reality becomes apparent.
  Telecom in Trouble

During the false growth of the Internet, the Telecommunications Act of 1996 was passed.
The act allowed long distance companies such as WorldCom to compete in the local market and
allowed the local phone companies to compete in the long-distance market. Therefore, it opened
the various parts of the telecommunications industry to fierce competition and lowered the price
of telecom services (Economides, 1998). As more and more Internet companies came into the
market, an increased demand in broadband services appeared. Consequently, WorldCom started
leasing fiber optic cables to support the demand (Gene Morse, personal communication,
February 8, 2011). According to Morse, when the hype of the internet stocks diminished, the
Internet companies went out of business and canceled their services with WorldCom.
Unfortunately for WorldCom, the leases it had made were two to five-year agreements that could
not be canceled. To make matters worse, companies like Cisco introduced switches that at first
doubled the capacity the cable could carry, then soon gained the ability to carry thirty two-times
capacity.

WorldCom had bought and invested a vast amount of capital into a transatlantic cable that
when leased to other companies had only 4% utilization. The switches allowed the companies to
lease only a small amount of the cables and acquire more capacity (Morse, personal
communication, February 8, 2011). Morse refers to the idea of a restaurant with a hundred tables,
but that only four of the tables are used on any given day. The problem here is that there was no
return on the investment, yet WorldCom still had to incur the expenses for purchasing the cables.
The timing of the situation was characterized by optimism, expansion, and opportunity so it was
hard for anyone to predict anything other than growth. Jack Grubman, an analyst on Wall Street,
stated “build it and they will come” when referring to the fiber optic cable expansion (The wall
street fix, 2005).

 Greed at Wall Street

The perceived unlimited growth the Internet and telecommunication bubbles were creating
led to a significant flow of capital to WorldCom and other telecommunications companies
(Thornburgh, 2002). The capital flow allowed the share prices of the telecom industry as a whole
to increase vastly. WorldCom’s share price was in the $20 range in early 1995 and rose to more
than $90 during 1999. WorldCom stock during the 90s was characterized by six different stock
splits. On the other hand, when the new millennium started, WorldCom’s stock faced a
continuous decline until it became worthless. It was also delisted from the Nasdaq market once
the misstatements were made public (Thornburgh, 2002).

The scenario was reminiscent of other telecommunications companies who also saw a large
downfall in their stock prices. What differentiated WorldCom stock was that WorldCom was
deceiving the public through the misstated financial statements and through Jack Grubman’s
repetitive “buy” ratings of the stock (in re WorldCom, inc., 2003). Jack Grubman was an analyst
for Salomon Smith Barney (“SSB”), an investment firm that was often involved in underwriting
WorldCom’s acquisitions. He was one of the most powerful men on Wall Street. What he said
about a stock significantly affected its status on Wall Street. He was so close to Ebbers that when
he was invited to his wedding, SSB‟s investment banking department covered all his expenses
(in re WorldCom, Inc., 2003). After the fraud was revealed, it was discovered that from June
1996 through August 2000, Ebbers received IPO allocations through Grubman that allowed him
to make profits totaling $11.5 million (Exchange hearing 03-72, 2003). The question that arises
is why was this loyalty so important to Grubman?

The economic environment at the time permitted investment banks to have their analysts
rate companies that were a part of their own clientele base, due to the repeal of the Glass-Steagall
Act during the 1990s (Katz & Homer, 2008). This created a conflict of interest similar to how the
accounting firms were offering their clients both consulting and auditing services. In essence,
when Grubman gave WorldCom’s stock a “buy” rating, the public trusted him and bought more
stock, thereby increasing its price. When the price went up, top management at WorldCom was
able to use the appreciation to engage in more acquisitions which required underwriters such as
SSB. Thereby, SSB was able to charge large fees for performing the underwriting services. From
1996 until 2000, SSB acquired a total of almost $76 million in fees from WorldCom (Exchange
hearing 03-72, 2003).

Perhaps unknowingly or even knowingly, Grubman fulfilled the desire of top management
at WorldCom, who found that the stock appreciation allowed WorldCom to keep the fraudulent
activities a secret for that much longer. Grubman was pressured by his own management to
maintain positive ratings for the clients of his company and prevent any form of action that
would make those clients take their multi-million dollar fees elsewhere (Exchange hearing 03-
75, 2003). When then New York State District Attorney General, Eliot Spitzer, launched an
investigation into SSB, Grubman left SSB. The agreement he signed with SSB included
compensation of about $19.5 million, plus $13 million in deferred compensation from previous
years, which unfortunately did not serve as a lesson to analysts. Rather, it showed them that the
worst that can happen to them as an analyst is that they retire earlier with a lower net worth than
they would have otherwise. There is a dire need for standards and punishments for wrongdoing
in the financial markets. Some efforts have been made to create a more stable economic
environment such as the Dodd-Frank Wall Street Reform and Consumer Protection Act that was
passed on July 21, 2010 (FDIC Law, 2010). The act included the Volcker Rule, proposed by
former Federal Reserve Chairman, Paul Volcker, and restricts US banks from making certain
investments if they are not on behalf of the banks‟ customers. Yet, continuous efforts are needed
to ensure future stability.

Causes Conclusion

What lessons can we learn from the causes of the WorldCom fraud?

WorldCom’s internal environment was a mess waiting to happen. It appears that even
without the fraud, the company would have collapsed anyways, yet perhaps sooner than it really
did. The fraud was similar to a piece of gum patching a hole in a dam. The external environment
was the storm that caused the gum to lose its stickiness. Lastly, the lack of proper personnel to
detect and fix the hole was the auditing failure.

The internal problems at WorldCom were its lack of a competitive strategy, weak internal
controls, an aggressive culture that demanded high returns, and the failure to look out for what
was best for the stock holder as well as the stake holder of the company.

While the growth of a company is necessary for its sustainability, it is also important for the
company to focus on the long term rather than only on the next quarterly report. By doing so, the
company emphasizes that it creates value not only for Wall Street, but also for its customers that
are the drivers of the company.
 Employees of a company are also drivers for its growth and success. However, the
competitive culture at WorldCom was characterized by loyalty to management with no regards
to ethics, honesty, or integrity (“doing the right thing”).

The Board of Directors served as an internal control that was a failure on its own part. The
duty of the Board was to correct the weakness of the company that management was unable to
see due to its lack of the independence from the company. However, the Board appeared to be
barely independent as most of the members were Ebbers’s friends. Due to this friendship, the
Board started to look out for pleasing management rather than fulfill its duty to protect the
stakeholders.

Within the Board was the Audit Committee that had the obligation to communicate with the
internal and external auditors. Since it only met three to six hours a year, it did not fully
communicate with either of the auditors. Although, Arthur Andersen did inform the Committee
that WorldCom had misapplied GAAP, the committee members chose to ignore it.

The external environment was a storm moving into an already deteriorated structure. The
collapse of the Internet and Telecom bubbles led to a continuous decline in the company’s stock
price. This decline was only slowed due to Jack Grubman’s continuous “buy” ratings for
WorldCom.

In the end, the lessons learned from these causes is that when a company appears to be
doing well within an external environment that is very bleak, it is the internal auditor’s duty to
investigate. In addition, the external auditor is the one that must come in with an objective,
unbiased mind set and audit the company with integrity, honesty, and independence.

In an organization, when carrying out an objective, one must plan, design, implement, and
evaluate. Throughout the research process, the information collected suggests that there are very
useful guidelines that exist that provide a detailed outline of running and maintaining an
organization. Unfortunately, while the planning and designing of a good ethical work culture, for
example, already exists in these guidelines, their implementation is what companies fail to do.
FRAUD TRIANGLE

Fraud is a crime that is more costly than most people realize. According to the FBI, non-
healthcare related fraud alone is estimated to cost the U.S. over $40 billion a year! Yet fraud and
other unethical behavior does not happen randomly. Certain factors must be present to allow
most individuals to commit these crimes.
American criminologist Donald Cressey developed a theory – known as the Fraud
Triangle – that explains the factors that lead to fraud and other unethical behavior. When
businesses and organizations understand the Fraud Triangle, they can more effectively combat
criminal behavior that negatively impacts their operations.

Understanding the Fraud Triangle

The three factors that make up the fraud triangle are:

1. Pressure. Most individuals require some form of pressure to commit a criminal act. This
pressure does not need to necessarily make sense to outside observers, but it does need to be
present. Pressures can include money problems, gambling debts, alcohol or drug addiction,
overwhelming medical bills. Greed can also become a pressure, but it usually needs to be
associated with injustice. “The company has not been paying me what I am really worth,”
for instance.
2. Opportunity. An opportunity to commit the act must be present. In the case of fraud, usually
a temporary situation arises where there is a chance to commit the act without a high chance
of being caught. Companies that are not actively working to prevent fraud can present
repeated opportunities to individuals who meet all three criteria of the fraud triangle.
3. Rationalization. The mindset of a person about to commit an unethical act is one of
rationalization. The individual manages to justify what he or she is about to do. Some may
think they are just going to borrow the stolen goods, or that they need the money more than
the “big” company they are stealing from.

Using the Fraud Triangle

The fraud triangle provides a useful framework for organizations to analyze their
vulnerability to fraud and unethical behavior, and it provides a way to avoid being victimized.
Almost universally, all three elements of the triangle must exist for an individual to act
unethically. If a company can focus on preventing each factor, it can avoid creating fertile
ground for immoral behavior.

 Relieve Pressure
Companies only have so much impact on the personal lives of customers and employees.
Identifying any possible pressures that the company could have an impact on – such as money
problems, substance abuse, etc. – can be helpful. Working to relieve these issues can help
prevent criminal behavior.

 Minimize Opportunity
Companies should always be looking to minimize the opportunity for fraud and unethical
behavior. Brumell Group can assist with this. Working as a Fraud Consultant, Brumell Group
can help companies analyze operations, review internal controls and address any current or
future vulnerabilities. It is a worthwhile investment for any organization that wants to remain
secure against the hazards of fraud.
 Target Rationalization
One way to prevent fraud is to keep individuals from ever being able to rationalize the
behavior in the first place. Companies can create a “zero tolerance” policy towards fraudulent
behavior, and remind employees and customers of this policy on a regular basis. Companies can
also make certain that individuals know the cost of fraud to other customers and other
employees. Letting individuals know that there are heavy consequences makes it more difficult
to minimize the unethical behavior.
Auditing: to Detect or to Neglect (Audit Committee)

An Audit Committee consists of a selected number of Board members who are to meet
from time to time with the company’s auditing firm and discuss the progress of the audit, the
findings, and resolve any conflicts that may occur between management and the firm (Louwers,
Ramsay, Sinason, & Strawser, 2008).

However in WorldCom’s case, the lack of independence and awareness of the Board as a
whole trickled down to the audit committee. The committee’s chairman, Max Bobbitt, was very
loyal to Ebbers. Hence, the members of the committee, including Bobbitt, were either unaware or
had known about the fraudulent misstatements for the years 1999, 2000, and 2001 and choose to
ignore it.

Even though Arthur Andersen acknowledged WorldCom as a 15 “maximum risk” client

and mentioned to the Committee that WorldCom had “misapplied GAAP (Generally Accepted
Accounting Principles) with respect to certain investments,” the committee chose to ignore it and
in the end Arthur Andersen gave WorldCom a clean, unqualified opinion (Zekany, Braun, &
Warder, 2004).

The audit committee’s negligence depicts another weakness in WorldCom’s internal

controls. Therefore, it is very important to have members in the committee that fulfill their duties
by overseeing the corporation’s internal control structure as well as making sure that the
company complies with “laws, regulations, and standards” (Romney & Steinbart, 2008). Vice
President of Internal Audit Cynthia Cooper states that The controller had intentionally cut her
team's system access to try and keep them from finding the fraudulent accounting entries in the
Worldcom.

Internal Audit
WorldCom’s Audit Committee failed to meet with the Internal Auditors of the company,
who had the duty to provide the Audit Committee with an independent and objective view on
how to improve and add value to WorldCom’s operations (Louwers, Ramsay, Sinason, &
Strawser, 2008).
 Cynthia Cooper, the Vice President of the Internal Audit function and the individual
whose department discovered and reported the fraud, stood by the intense work in the hopes that
top management would see her department as important and add the personnel and resources
needed to efficiently maintain the internal audit function.

External Auditors
The Committee itself did not meet on a regular basis either and was unable to properly
take actions to fix the situation. Yet, the external auditor, Arthur Andersen, was the one
responsible for providing an independent opinion of the financial situation at WorldCom for
investors and creditors. The auditing firm also failed to carry out its duties properly.
According to Beresford, Katzenbach, & Rogers (2003), Arthur Andersen’s failure to detect the
fraud was due in part to negligence and in part to the tight control top management kept over
information.
While there are different types of fraud, the most common type of fraud is the
misstatement of financial statements. The fraud is committed on 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 stockholders, lenders, and other users of
financial information are the victims (Albrecht & Albrecht 2004).The reason behind these
manipulations is usually to “increase the company’s stock price, meet cash flow needs, or hide
company losses and problems” (Romney & Steinbart, 2008, p.146).
WorldCom made major accounting misstatements that hid the increasingly perilous
financial condition of the company. As enormous as the fraud was, it was accomplished in a
relatively mundane way: more than $9 billion in false or unsupported accounting entries were
made in WorldCom's financial systems to achieve desired reported financial results.
 FRAUD
was accomplished in two main ways:

Inflated Revenues by
Capitalization of accounting entries that
revenue expenditure does not adhere to
GAAP

The Misstatement of Line Costs

What is Line Cost?
 According to Beresford, Katzenbach, & Rogers (2003), line costs are the costs associated
with carrying a voice phone call or data transmission from the calls origin to its
destination.
 WorldCom paid outside service providers to carry some portions of its calls. WorldCom
paid the outside service providers for carrying WorldCom customers’ calls on their lines
 Line cost are important to WorldCom because it accounted for roughly half of
WorldCom’s total expenses. It is a key measurement of line costs to analysts is the ratio
of line costs expense to revenue.

The end of each month, during the fraud period at WorldCom, was characterized by the
estimation of costs that were associated with using the phone lines of other companies. The
actual bill for the services was usually not received for several months (Breeden, 2003). This
meant that some entries made to the payables could be overestimated or underestimated. In the
case that the liability was overestimated, when the actual bill was received there would be a
surplus of liabilities that when “released” would result in a reduction of the line costs:
Sullivan tried to find different ways to reduce expenses. He directed General Accounting to
reduce the line cost expense for the Wireless division by $150 million. The Wireless division
saw this and told Sullivan that there was no support to the entry and he was forced to reverse it.
He then ordered the managers of the General Accounting department to make large “round-
dollar” journal entries that weren’t related to the Wireless division without any documentation.

Capitalizing Line Costs

The 4% utilization of the fiber optic cables meant that WorldCom was still paying for the
leases on the cables even though it was generating no revenue on them. According to Morse 29
(personal communication, February 8, 2011), WorldCom had leased the lines in a 2-5-year
agreement that could not be canceled. However, the costs associated with the lines were causing
the line cost E/R ratio to increase. Thus, when no more accruals could be released, Sullivan
turned to capitalize these costs, another violation of GAAP. GAAP requires these costs to be
recognized immediately. A Line Cost to Revenue report was generated for top management to
which round number adjustments were made a week or so before the numbers were announced
to the public
In April 2000, even after market conditions had started to deteriorate, he stated that he
was still comfortable with a revenue growth of 13.5%-15.5%. The increasing growth allowed an
increasing stock price that resulted in higher compensation and currency for the numerous
acquisitions WorldCom made.
Capitalizing the Line cost makes the operating expenses to be understated, hence,
overstating revenue.

How was fraud uncovered?

On May 21, 2002, a WorldCom employee sent a featured article from the May 16 edition
of Fort Worth Weekly Online to an internal auditor, indicating that the issues raised in the article
might warrant investigation. The article was based upon interviews with a former WorldCom
employee who was allegedly fired for whistle blowing. When the 2001 capital expenditures audit
resulted in a large variance due to the entries to an account called “prepaid capacity”, the internal
audit department began an investigation concerning the capitalized line costs. On June 12, 2002,
Sullivan asked the internal audit department to delay its review of the capital expenditures
account until third quarter of 2002. But Cooper refused to stop the audit and the Internal Audit
team contacted Max Bobbitt, the Chairman of the Audit Committee of the Board of Directors.
On June 13, Smith and Cooper met with Bobbitt about their concerns because they thought that
Sullivan would try to block them. When Cooper asked Myers about the capitalization of line
costs, Myers admitted that they capitalized line cost because if not, the company would probably
go bankrupt. KPMG met with Sullivan and Myers to ask for a justification for the accounting
treatment of the expenses. Sullivan explained that because WorldCom wasn’t receiving any
revenue for the payments, he defers the costs of leasing the phone lines until they were able to
generate a revenue for WorldCom. But according to KPMG, the costs of operating leases could
not be recognized in a future period. Sullivan asked for more time when he failed to give support
for the transactions. On June 24, 2002, Sullivan, again failed to produce a valid support for the
transactions. The Audit Committee told Sullivan and Myers that they would be fired if they
would not resign before June 25, Tuesday morning. Myers resigned but Sullivan refused, so he
was terminated. Also on June 25, the fraud was released to the public.

Cynthia Cooper: The Whistleblower

Cynthia Cooper stated on her interviews the revelations on how she discovered the fraud
in WorldCom. According to her statement there was this instance when the CFO Scott Sullivan
asked her to delay the capital expenditure unit and the controller e-mailed her that she was
wasting her time auditing capital expenditures. The suspicious entries she and her team identified
and the odd reactions she got from finance executives changed her feelings from curiosity to
discomfort. For Cynthia believed that it is important to be able to dig down and find your
courage which isn’t always easy when she was asked by time magazine how she tried to cultivate
that conviction on her own daughters. As her suspicions grew big Cynthia Cooper along with
Sherron Watkins and Coleen Rowley and the team began working at night and behind closed
doors because she did not want to be detected. She and her team conducted door-to-door
confrontation especially in the accounting department and this is when David Meyers initially
confessed.
 Scott Sullivan had considerable influence on Bernie Ebbers as he is the one who
convinced Ebbers to take over MCI along with Jack Grubman and Salomon Smith Barney. It is
Bernie’s personal propensity for taking risk contributed to both the rise and the fall of the
company. He loaded it with some $40 billion in debt to fund one acquisition after another. He
followed the same strategy with his own investments, taking out loans and using his WorldCom
stock as collateral. His personal decisions then affected his business decisions, because he
ultimately saw his net worth disappear, and he was left owing WorldCom some $400 million for
loans approved by the board.

Consequences of Bad Ethical Accounting Practices

Accounting rules and regulations exist to ensure that financial statements are useful to
their end users in their financial decision-making. For financial statements to be useful, the
information presented therein must be accurate, faithful to the financial circumstances and be
produced in time to help the decision-making process. Poor ethics in accounting result not only
in increased incidences of criminal activities, but also hurt the business through harming its
reputation and rendering their financial statements untrustworthy and thus useless.
Unethical accounting practices motivated by bonus incentives, pressure to obtain
financing or a desire to appear successful are not always illegal, but they almost always have an
adverse effect on your business. The common theme of these practices is that they sacrifice the
short-term gain of apparent financial viability for long-term negative consequences.
 Misappropriation of Assets
A business owner might think he's only using his own assets when he takes business
goods for personal use, such as a ream of copy paper or a pizza at the end of the night, but an
employee might see things differently. The employee may see the use or appropriation of
business goods for personal needs as a benefit of being an employee. Before long, the employee
who witnessed the owner's borrowing has become a borrower himself and others are seeing this
employee's behavior as acceptable.

 Civil and Criminal Penalties

If company management is unethical to the point of financial fraud, the company could
be subject to civil and criminal penalties. For publicly traded companies, the Sarbanes-Oxley Act
prescribes fines and prison time for knowingly falsifying financial information. Further,
investors of the company may be able to successfully sue the company and its owners for civil
damages. Small-business owners should exercise caution, as not understanding accounting
practices and standards is not a defense for fraudulent reporting. If a reasonable person believes a
manger should have known about fraud in the business, this may be enough to allow the jury to
side with the plaintiff.

Poor ethics amongst a business' accountants means that those persons are more willing to
break the rules to benefit either themselves or their business illegally. For example, an unethical
accountant granted too much control and too little oversight from superiors can embezzle from
the business and conceal the evidence. In contrast and comparison, an unethical accountant
working at the behest of the business can manipulate the data to commit a number of crimes
including fraud and tax evasion

 Loss of Reputation
If you operate your small business in an unethical manner, word will eventually get out.
This is especially true for small businesses in tight-knit communities. In general, customers
would rather shop at businesses that operate ethically, take care of their employees and support
their communities. If your company does not operate ethically, this can affect the willingness of
customers and suppliers to conduct business with you. Over time, this may destroy your
business.

Poor ethics can also inflict damages on the business' reputation and trustworthiness of its
stakeholders, such as customers and business partners. The absence of trust ensures that the
business finds it difficult to conduct business with others. This damage to a business' reputation
is particularly devastating to accounting firms who rely heavily on that reputation to remain in
business. Arthur Andersen LLP effectively perished as a business because of its poor conduct in
the Enron scandal.

 Loss of Human Capital

Many good employees do not want to work for a company that is unethical. Accounting
professional standards require that accounting work is performed ethically and with integrity. If
you pressure company accountants to behave unethically, these accountants can't uphold the
standards of their profession, and they might risk loss of their license or credentials. Reputable
accountants will not work for an employer who expects unethical behavior.
  Personal Consequences

Once caught and tried, accountants so unethical as to commit crimes related to their
profession are punished. Depending on the specific circumstances of the case, this can result in
prison time, financial costs and other legal punishments to the accountants found guilty. Not only
is this devastating for said accountant, it is also devastating on both friends and family,
particularly the family.

 Usefulness of Financial Statements

Each time that an unethical accountant deliberately breaks the rules and regulations to
manipulate the information presented on the financial statements to illegal advantage, those
financial statements become less and less useful. Since financial statements must remain accurate
and truthful to help end users in making their financial decisions, financial statements tainted
deter the decision-making process. Erroneous figures cast all other figures into doubt and end
users simply become unable to trust the information presented.

How the Sarbanes-Oxley Act of 2002 Impacts the Accounting Profession

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The
Act-which applies in general to publicly held companies and their audit firms-dramatically
affects the accounting profession and impacts not just the largest accounting firms, but any CPA
actively working as an auditor of, or for, a publicly traded company. The basic implications of
the Act for accountants are summarized below.

Public Company Accounting Oversight Board.Moving to a different private sector regulatory

structure, a new Public Company Accounting Oversight Board (the Board) will be appointed and
overseen by the SEC. The Board, made up of five full-time members, will oversee and
investigate the audits and auditors of public companies, and sanction both firms and individuals
for violations of laws, regulations and rules.

4. Board Composition.Two of the five Board members must be or must have been CPAs. The
remaining three must not be and cannot have been CPAs. The Chair may be held by one of the
 CPA members, but he or she must not have practiced accounting during the five years
preceding his/her appointment.
5. Funding. The Board will be funded by public companies through mandatory fees. Accounting
firms that audit public companies must register with the Board ("registered firm"), and pay
registration and annual fees.
6. Standard Setting. The Board will issue standards or adopt standards set by other groups or
organizations, for audit firm quality controls for the audits of public companies. These
standards include: auditing and related attestation, quality control, ethics, independence and
"other standards necessary to protect the public interest." The Board has the authority to set
and enforce audit and quality control standards for public company audits.
7. Investigative and Disciplinary Authority. The Board is empowered to regularly inspect
registered accounting firms' operations and will investigate potential violations of securities
laws, standards, competency and conduct. Sanctions may be imposed for non-cooperation,
violations, or failure to supervise a partner or employee in a registered accounting firm. These
include revocation or suspension of an accounting firm's registration, prohibition from auditing
public companies, and imposition of civil penalties. During investigations, the Board can
require testimony or document production from the registered accounting firm, or request
information from relevant persons outside the firm. Investigations can be referred to the SEC,
or with the SEC's approval, to the Department of Justice, state attorneys general or state boards
of accountancy under certain circumstances.
8. International Authority. Foreign accounting firms that "prepare or furnish" an audit report
involving U.S. registrants will be subject to the authority of the Board. Additionally, if a
registered U.S. accounting firm relies on the opinion of a foreign accounting firm, the foreign
firm's audit workpapers must be supplied upon request to the Board or the Commission.

New Roles for Audit Committees and Auditors. The relationship between accounting
firms and their publicly held audit clients is different under the new law. The basic
implications are outlined below.

 Auditors Report to Audit Committee. Now, auditors will report to and be overseen by a
company's audit committee, not management.
 Audit Committees Must Approve All Services. Audit committees must preapprove all services
(both audit and non-audit services not specifically prohibited) provided by its auditor.
 Auditor Must Report New Information to Audit Committee. This information includes: critical
accounting policies and practices to be used, alternative treatments of financial information
within GAAP that have been discussed with management, accounting disagreements between
the auditor and management, and other relevant communications between the auditor and
management.
 Offering Specified Non-Audit Services Prohibited. The new law statutorily prohibits auditors
from offering certain non-audit services to audit clients. These services include: bookkeeping,
information systems design and implementation, appraisals or valuation services, actuarial
services, internal audits, management and human resources services, broker/dealer and
investment banking services, legal or expert services unrelated to audit services and other
services the board determines by rule to be impermissible. Other nonaudit services not banned
are allowed if preapproved by the audit committee.
 Audit Partner Rotation. The lead audit partner and audit review partner must be rotated every
five years on public company engagements.
 Employment Implications. An accounting firm will not be able to provide audit services to a
public company if one of that company's top officials (CEO, Controller, CFO, Chief
Accounting Officer, etc.) was employed by the firm and worked on the company's audit during
the previous year.

Criminal Penalties and Protection for Whistleblowers. The law creates tough penalties for those
who destroy records, commit securities fraud and fail to report fraud.

 Failure to Maintain Workpapers. It is now a felony with penalties of up to 10 years to willfully

fail to maintain "all audit or review workpapers" for at least five years. The SEC will establish
a rule covering the retention of audit records and the Board will issue standards that compel
auditors to keep other documentation for seven years.
 Document Destruction. It is a felony with penalties of up to 20 years to destroy documents in a
federal or bankruptcy investigation.
 Securities Fraud.Criminal penalties for securities fraud have been increased to 25 years.
 Fraud Discovery. The statute of limitations for the discovery of fraud is extended to two years
from the date of discovery and five years after the act. It was previously one year from
discovery and three from the act.
 Other Provisions. Other provisions protect corporate whistleblowers, ban personal loans to
executives, and prohibit insider trading during blackout periods.

Financial Reporting and Auditing Process Additions. Issuers of public stock and their auditors
must now follow new rules and procedures in connection with the financial reporting and
auditing process.

 Second Partner Review and Approval of Audit Reports. The new regulatory board will issue or
adopt standards requiring auditors to have a thorough second partner review and approval of
every public company audit report.
 Management Assessment of Internal Controls. Management must now assess and make
representations about the effectiveness of the internal control structure and procedures of the
issuer for financial reporting.
 Audit Reports Must Contain Description of Internal Controls Testing. The new regulatory
board will also issue or adopt standards that will require every audit report to attest to the
assessment made by management on the company's internal control structures, including a
specific notation about any significant defects or material noncompliance found on the basis of
such testing.

Areas for CPAs to Watch. The ramifications of some of the provisions in the Sarbanes-Oxley
Act will become known only as the SEC and the new Public Company Accounting Oversight
Board begin implementing the bill.

 Consulting Services. The Act lists eight types of services that are "unlawful" if provided to a
publicly held company by its auditor: bookkeeping, information systems design and
implementation, appraisals or valuation services, actuarial services, internal audits,
management and human resources services, broker/dealer and investment banking services,
and legal or expert services related to audit services. It also has one catch-all category
authorizing the board to determine by regulation any service it wishes to prohibit. Other non-
 audit services-including tax services-require pre-approval by the audit committee. Pre-
approved non-audit services must be disclosed to investors in periodic reports.
 Implications for CPAs with Tax Practices. "Expert" services are not defined in the Act and we
do not know how broadly the board or the SEC will define this term. It is conceivable that
some tax services we view as traditional may be construed as "expert" services, and not
permitted by any firm providing audit services to publicly held audit clients. We will
encourage the Board or the SEC to understand the importance of auditors providing tax
services for publicly held audit clients. In addition, tax services performed by an auditor for a
publicly held company would require pre-approval by the client's audit committee.
 Cascade Effect. Of particular concern is the cascade effect that the scope of services
restrictions could have on small businesses and accounting firms. Our major concern is that the
new legislation by Congress may become the template for parallel federal and state legislative
or rule changes that directly affect both non-public companies that are subject to other
regulations and the CPAs that provide services to them. The AICPA and the state CPA
societies are monitoring this situation closely and will continue to keep you informed.

Additional Burdens for CPAs in Business and Industry. CPAs working in the financial
management areas of public companies are directly impacted by the Act. These CPAs need to be
aware of the new responsibilities of CEOs and CFOs, who are now required to certify company
financial statements. They also have a greater duty to communicate and coordinate with
corporate audit committees that are now responsible for hiring, compensating and overseeing the
independent auditors. There are new requirements regarding enhanced financial disclosures as
well. The AICPA is working to develop additional resources specifically tailored for members in
corporate practice as they implement these new requirements.

Other Information Related to WorldCom

 AT&T
AT&T is multinational telecommunication conglomerate and is located in Dallas, Texas.
After inventing the phone in 1876 Alexander Graham Bell founded the Bell Telephone Company
and one of its subsidiaries was American Telephone and Telegraph Company (AT&T). On
December 31 1899 AT&T acquired Bell Telephone Company and became the main company.
AT&T established a network of subsidiaries in the United States and Canada that held a
government-authorized phone service monopoly throughout most of the twentieth century. This
monopoly was known as the Bell System. In 1982 US regulators break up the monopoly making
its subsidiaries an individual company. As a result of the break up, AT&T was faced with
competition with new competitors such as Sprint and MCI, also it Southwestern Bell emerged.
Southwestern Bell acquired several telecommunications company and in 2005 Southwestern Bell
acquired AT&T and adopted the name and brand of AT&T.
Even when competition arise AT&T prove itself and became one of the largest
telecommunication company and up until now AT&T is the largest telecommunication company
in the world by revenue

 Klynveld Peat Marwick Goerdeler (KPMG)

KPMG is a global network of accounting firms providing audit, tax, advisory, special
interest and industry-specific services. It employs approximately 189,000 professionals working
together to provide quality service in 155 countries around the world. KPMG earned $25.4
billion in 2016.

The organization was formed in 1987 through the merger of Peat Marwick International
and Klynveld Main Goerdeler (KMG)

The Big 4 used to be known as Big 8 made up of (1) Arthur Andersen, (2) Arthur Young
& Co., (3) Coopers & Lybrand, (4) Ernst & Whinney, (5) Deloitte, Haskins & Sells, (6) KPMG,
(7) Touche Ross, and (8) Price Waterhouse. It was after a series of mergers and dissolutions that
brought about the elite four: Deloitte, PricewaterhouseCoopers(PwC), Ernst & Young, and
KPMG
Source:

https://en.m.wikipedia.org/wiki/AT%26T
http://about.att.com/sites/company_profile
http://www.encyclopedia.com/science-and-technology/computers-and-electrical-
engineering/computers-and-computing/att-inc
http://etd.fcla.edu/CF/CFH0003811/Ashraf_Javiriyah_201105_BSBA.pdf

http://www.washingtonpost.com/wp-dyn/articles/A49156-2002Jun26.html

http://www.brumellgroup.com/news/the-fraud-triangle-theory/

http://ww2.cfo.com/human-capital-careers/2008/02/worldcom-whistle-blower-cynthia-cooper/

http://content.time.com/time/arts/article/0,8599,1709695,00.html

https://books.google.com.ph/books?id=Jb8gAQAAQBAJ&pg=PA435&lpg=PA435&dq=what+h
appened+on+june+12,+2002+on+worldcom?&source=bl&ots=zwDU7QMgTL&sig=-
u5qZp6im5u-
Zsxq6LeMGuHcsyc&hl=en&sa=X&ved=0ahUKEwi2wNS704PVAhWKU7wKHdLvBGEQ6A
EIUTAJ#v=onepage&q=what%20happened%20on%20june%2012%2C%202002%20on%20wo
rldcom%3F&f=false

http://yourbusiness.azcentral.com/consequences-bad-ethical-accounting-practices-7750.html
http://smallbusiness.chron.com/effects-poor-ethics-accounting-37750.html

http://www.dgm.com/information-center/sarbanes-oxley-information/how-the-sarbanes-oxley-
act-of-2002-impacts-the-accounting-profession

http://www.ecommercetimes.com/story/45542.html

http://money.cnn.com/gallery/news/2015/10/14/biggest-corporate-scandals/2.html

http://www.fraud-magazine.com/article.aspx?id=210
http://faculty.som.yale.edu/shyamsunder/FinancialFraud/WorldCom%20-
%20A%20Bunch%20of%20Dirty%20Fraudsters.ppt

http://answers.google.com/answers/threadview?id=524376

https://www.thebalance.com/worldcom-s-magic-trick-356121

http://www.slu.edu/departments/accounting/keithleyj/Spring%202008/614/PPSlides/WorldCom
%20(A)%20-%20student%20team%20No.%201.ppt

http://etd.fcla.edu/CF/CFH0003811/Ashraf_Javiriyah_201105_BSBA.pdf

http://www.accountingverse.com/articles/big-4-accounting-firms.html

http://www.investopedia.com/terms/c/corporate-culture.asp

https://www.tinypulse.com/blog/six-management-styles

https://www.cleverism.com/management-styles/
WorldCom: Accounting

Scandal
Group 2
BSA 3-5

Amandy, Karl Marcelo, Louise Dianne

Ermac, Daizyrie Onia, Anne Kristine

Espiritu, Harold Pelayo, Jennifer

Garlitos, Michelle Perez, Rosemarie

Japlos, Angela Nicole Pergis, Rossel

Javier, Louise Lloyd Perlas, Abegail Joy

Leecon, Prince Pornillos, Robert

Macabago, Joralyn Quibral, Joana Dennise

Maclang, Jhoan Joy

Prof. Maria Luisa U. Oliveros.