JANINE MAE H.
GABOR
ACCTG27 CN: 20019
The WorldCom Scandal
The Rise and Fall of WorldCom
WorldCom’s story began in the 1980s when Bernard Ebbers, a former
motel owner, co-founded a small long-distance phone company called LDDS
(Long Distance Discount Services). By 1985, Ebbers became CEO. He was
not a technical expert, but he had a talent for business expansion. His
strategy was simple: instead of growing slowly, he acquired other
telecommunications companies.
Throughout the 1990s, Ebbers bought more than 60 companies,
including the major purchase of MCI Communications in 1998, which made
WorldCom one of the largest telecom companies in the world. Investors and
Wall Street praised the company for its growth, and its stock price soared. On
the surface, WorldCom seemed unstoppable.
However, the aggressive acquisition strategy had a downside. By the
late 1990s, the telecommunications industry began to slow down. Competition
increased, demand weakened, and WorldCom’s profits started to fall. This
was dangerous for Ebbers, who had borrowed millions of dollars using
WorldCom stock as collateral. If the stock price fell, Ebbers would personally
lose a fortune. Instead of admitting to investors that the company was
struggling, Ebbers and his CFO, Scott Sullivan, decided to hide the truth.
How the Fraud Began and Grew
The fraud started when Scott Sullivan, with Ebbers’ support, changed
how expenses were recorded. Normally, expenses such as line rental fees
(money WorldCom paid to use other companies’ networks) should reduce
profits. Sullivan instead treated these expenses as “capital investments,”
which appear on the balance sheet as assets instead of costs. This made the
company look like it was still making large profits.
For example, if WorldCom spent billions maintaining its phone lines, it
should have reported those as expenses that lowered profits. By recording
them as assets, Sullivan made it seem like the money was used to expand
the business, not just maintain it. This simple accounting trick hid billions of
dollars in losses.
In addition, the company also inflated revenues by recording income
that did not exist. Employees in accounting were pressured to follow these
instructions, and many feared losing their jobs if they refused. Some
employees noticed the fraud but kept quiet because the corporate culture
discouraged honesty.
By 2002, the fraud had grown to about $11 billion. On paper,
WorldCom looked like a thriving company. In reality, it was deeply in debt and
losing money.
Who Failed to Stop the Fraud?
Several groups of people and institutions failed to prevent the
WorldCom scandal:
1. Senior Leadership – CEO Bernard Ebbers and CFO Scott Sullivan created
a culture where financial dishonesty was encouraged. They cared more
about stock prices and personal gain than about honesty and
responsibility.
2. Board of Directors – The board of directors, whose job was to oversee
management, trusted Ebbers too much. Many board members lacked
financial expertise and did not ask tough questions about the company’s
accounting practices.
3. Auditors – WorldCom’s external auditor, Arthur Andersen, failed to detect or
report the fraud. This was the same firm involved in the Enron scandal,
and its failure in both cases destroyed its credibility. The internal audit
team was weak and lacked authority until Cynthia Cooper took the risk of
investigating secretly.
4. Financial Reporting System – The system lacked transparency, and there
were no strong protections for whistleblowers. Employees who wanted to
expose wrongdoing were afraid of retaliation.
The Discovery and Collapse
The fraud began to unravel when Cynthia Cooper, the Vice President
of Internal Audit at WorldCom, and her team started investigating unusual
accounting entries. Because they feared being stopped by executives, they
often worked late at night in secret.
In June 2002, Cooper’s team discovered that WorldCom had wrongly
classified about $3.8 billion in expenses. Further investigations showed the
fraud was much bigger around $11 billion.
In July 2002, WorldCom filed for bankruptcy, which was the largest in
U.S. history at the time. Thousands of employees lost their jobs, and investors
lost billions of dollars. Bernard Ebbers was later convicted of fraud and
conspiracy and sentenced to 25 years in prison. Scott Sullivan, who
cooperated with investigators, received a lighter sentence of five years. The
scandal also led to the downfall of Arthur Andersen, once one of the “Big Five”
accounting firms.
Governance Reforms to Prevent Similar Failures
The WorldCom scandal showed how dangerous weak corporate
governance can be. To prevent similar failures, organizations must adopt
stronger reforms. One of the most important reforms is the creation of an
Independent and Empowered Audit Committee within the board of directors.
This committee should:
Be made up only of independent members with financial expertise.
Directly supervise both internal and external auditors.
Ensure that company reports follow strict accounting standards and are
transparent.
Provide strong protections for whistleblowers, so employees feel safe
reporting misconduct.
Another important reform is to align executive compensation with long-
term performance. In WorldCom, executives were motivated to manipulate
earnings because their wealth depended on short-term stock prices. If pay is
tied to long-term stability, leaders will have less reason to cheat and there
must be an emphasis on ethical leadership and corporate culture. Executives
should be trained and reminded that their duty is not only to shareholders but
also to employees, customers, and the public. Creating an honest culture can
prevent dishonesty from spreading inside the company.
