Accounting Fraud at WorldCom

Requirements

Read the case study, Accounting fraud at WorldCom, and answer the questions. Apply concepts from class! In preparing your paper, you may read outside articles and books on the topic of the WorldCom scandal. In doing so, you will likely read other people’s opinions and analysis of what happened and why. This analysis will likely apply concepts that we have not covered. These concepts will probably not help you write your paper. Your assignment is not simply to analyze the case; it is to use concepts from this course to analyze the case. You will be graded on how well you explain and apply concepts from class. If your paper is based heavily on other people’s analysis of the situation, you will likely fail to cover concepts of class adequately and will likely introduce foreign concepts that are not meant to be part of this assignment. The paper should be 11-pt font, 1-inch margins

Solution

Accounting plays a critical role in any given organization. Among others, it gives insights on how the organization can be able to increase its revenues and how the financial resources available to the organization can be put into good use. Indeed, it can be explained that in situations where the accounting aspect is not well taken care of in a given organization, the chances of the organization not being effective are very high. That is the case because the organization might have money been spent to cover unnecessary expenses for the business while accounting personnel could also be involved in accounting fraud that could have a devastating impact on the organization. This paper focuses on accounting fraud in WorldCom, which left the company in bankruptcy.

Normative Analysis

The fraud that took place at WorldCom was indeed unethical since it was not ethical for the company to post misleading financial results that gave the impression that the company was doing very well while, in a real sense, the company was not doing good.  On the other hand, the reasons behind the organization’s leaders orchestrating the fraudulent accounting prices are totally unethical; hence, anyone involved in the scandal can be considered to have violated a fiduciary duty.

As discussed by Frankel (2010), fiduciary duty implies that one has to take the highest level of care specifically because the person owes the duty to the principal, who is also referred to as the beneficiary. For the leaders of WorldCom, they had the duty of care since they are put in charge of ensuring that they lead the organization in a manner that it will serve the interests of all the stakeholders better.  However, by reading the case study by Kaplan and Kiron (2007), it is obvious that the leaders of WorldCom failed in their fiduciary duty. That is the case because the various stakeholders that had trust in the company suffered from the fraud. For instance, the financial institutions that loaned money to the company, the investors who had invested in the company, and even the employees who were employed by WorldCom were all negatively impacted by the fraud.

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Another duty that the leaders of WorldCom failed can be explained as the duty of loyalty since this duty had banned them from ensuring that they do not have any personal interest conflict. However, what happened at WorldCom was the opposite of that since the leaders carried out the fraud for their selfish interests without considering the devastating impacts their actions would have on the organization and various stakeholders.  For example, Ebbers, the CEO at the time, was aware of what was happening in the organization and encouraged it since he wanted to take responsibility for the impressive performance posted by WorldCom. 

In view of the accounting employees who are ready to engage in fraudulent practices, they were also in pursuit of their interests since they know that they would get bonuses by posting impressive financial results that were not genuine. However, if the CEO, the other leaders, and the accounting staff had been loyal to the company enough, there is no way that they would have been involved with the fraud since their selfish interests would not have directed them to be involved with the fraudulent activities. Due to the failure of leaders of WorldCom to adhere to fiduciary duty and duty of loyalty, the employees working for the company lost their job, investors who had invested in the company saw their investments decline to unprecedented levels, and confidence in the telecommunications and the technology sector also declined.

Even though the position that WorldCom was at after the scandal had been discovered meant that the company couldn’t take responsibility of the impacts that the fraud had on the various stakeholders, it can be explained that WorldCom should have been held responsible since it means that the company cannot only focus on how to increase its profits without serving the interests of other stakeholders. The culture in place at the organization was also not ideal since the fact that decisions made by the superiors could not be questioned resulted to the fraud having far more reaching impacts.

 As far as the debate between Friedman and Mackey is concerned, I am in support of Mackey’s view since even though Friedman is of the view that social responsibilities can result in a company not being able to focus on making profits solely, I am fully convinced that if companies only focus on the profit, they can have devastating impacts to various stakeholders. Indeed, if the leaders at WorldCom had also taken into consideration the social responsibilities of WorldCom, there is a high chance that the fraud would not have occurred.

Causal Analysis

To carry out a causal analysis of the case study, foot-in-the-door technique, informational social influence, and normative social influence. The reason for opting for these concepts is that they can be used to show why the fraud at WorldCom happened.

In view of informational social influence, it can be explained that it comprises of a situation where people be predisposed to presume the behaviors as well as actions of others in an attempt to establish the ideal actions in a given situation. Thus, in this situation, some people tend to suppose or be of the view that they are wrong since some people are of the view that they are indeed wrong and cannot agree with them. In that perspective, it can be explained that it is for this specific reason that majority of the junior employees at WorldCom did what they were asked to do by their bosses, specifically Sullivan and Myer. Actually, Sullivan and Myer demanded that the juniors modify the books by showing them that the accrued amounts will be covered in the subsequent quarters.  Similarly, that was the same reason that made the external auditor Arthur Andersen overlook the warning signs on WorldCom, as the senior managers had noted that the techniques they were applying were indeed legal and accepted in the accounting world. Moreover, when some employees noticed the change and raised the issue, they were requested to do nothing since accounting practices had been suggested and actually approved by the Chief Finance Officer.

The other concept entails the foot-in-the-door technique. This concept expounds that conformity entails having someone to concur to most of the requests by initially setting them up and having them concur to a lawful and humble demand. In the case of WorldCom, it can be explained that at the start, Scott Sullivan was hired specifically due to his experience and past achievements and actually played a major role in the company as it enhanced its profitability.  Nevertheless, as time passed, Ebber, the Chief Executive Officer, continued promoting him as he was ready to do anything that would make the company appear more profitable.

Normative social influence can be explained as the type of social influence whose outcome is compliance. From another perspective, this type of influence can be explained as the type of influence that makes people obey the existing rules, resulting in them being liked and even accepted by others.  Thus, it can be noted that the fact that people now need to survive, do well, and even be successful in life in a highly competitive world, people have learned to conform to the rules enacted by those in power as they pursue success. Thus, when some senior managers ask an employee to make some exceptions to existing rules,  the chances of the employee not following the directive of the senior manager are very low since the employee knows that by following such a directive, he or she will be rewarded later on either through promotion or bonuses.  

This can be applied in WorldCom since Sullivan, who was the Chief Finance Officer at the time of the fraud, applied unethical approaches to ensure that the E/R ratio of WorldCom was maintained at 42%. To prove that this performance was achieved, “accrual releases in 1999 and 2000, and capitalization of line costs in 2001 and 2002” (p.4). As a matter of fact, Sullivan used the accountants to release the accruals. These changes, among other changes that were done by Sullivan, were only possible because the CFO had asked the accountants to do so, and they had to comply with these orders since failure to do so could have resulted in the accountants losing their jobs.  They simply had no option apart from complying with the directives by the CFO. However, a number of the employees refuted the social influence of the senior managers. For instance, Cynthia Cooper, who was a the time the vice president of the company’s internal audit department, exposed the accounting fraud and questioned the controller and as well as the audit committee though Sullivan ordered here to “stay away from the wireless business unit” (p. 8). That did not, however, deter her since she eventually expose the fraud that was taking place at the company.

Recommendations

Taking into account the events that took place at WorldCom, it was only a matter of time before the fraud was exposed.  Indeed, those given the mandate to lead the company felt that they had to do anything to ensure that WorldCom was successful and profitable irrespective of whether it was ethical or unethical. Nevertheless, these leaders, and in particular Ebber, Sullivan, and Myers, should have upheld ethics and reported the actual numbers rather than inflating the numbers to send the message that while other telecommunication companies were struggling, WorldCom was making impressive profits.  Moreover, the company’s leaders had contracted an external auditor that they could easily manipulate since if the company had hired an auditor who could not be compromised, the fraud would not have happened. Thus, the external auditors could have been hired regularly, with an external auditor not being allowed to work for the company for a period exceeding three years.

In view of the Board of Directors, it can be explained that it should have ensured that the senior employees hired by the company are of good character and are highly ethical. Indeed, if thorough background checks of Ebbers, Sullivan, and even Myers were carried out before the three were hired, there is a high chance that the three could not have been hired since the background checks would have given indications that the three are likely to do anything irrespective of whether it is ethical or unethical to prove that they are successful leaders.  

 Apart from that, the Board of Directors could also have been more keen on monitoring the company’s internal operations. For example, they could have overseen the implementation of various strategies and also monitored the reporting in place at the company. The senior managers should have gotten the impression that the Board of Directors would keep them in check though the impression they got from the Board of Directors is that they were in total control of the business.  The Board of Directors should have made it clear that they had to approve the management strategy before any strategy can be implemented and thoroughly reviewed various company financial statements. Moreover, the Board of Directors should have also interacted regularly with the internal and external auditors as that would have ensured that the auditors were not compromised in any way.

 In conclusion, it can be noted that the fraud at WorldCom was caused by three main reasons:

1. Laxity of the Board of Directors to undertake its duties – If the Board of Directors had demanded regular reporting from the senior managers, the fraud would not have taken place or would have been identified at the time when it was beginning to take place.
2. Attachment from the accountants and auditors – Workers and auditors felt they had to comply with the unethical accounting practices or be sacked. However, if the company had clear ethics policies that had to be complied with, there is a low chance that those involved with the fraud would have taken part in the fraud since they would be assured that their jobs were safe as long as they acted ethically.
3. Lack of ethics – From the case study, it is obvious that there lacked ethics in the company. Thus, the company could have developed a clear code of ethics that made it clear that all employees were expected to act ethically at all times, irrespective of the outcome. That is the case because even if the three senior leaders had plans to implement their unethical accounting practices, the junior accountants would have declined to comply with their orders, which would have resulted in the fraud not taking place.

The bottom line is that the fraud happened due to laxity in the code of ethics. Thus, having a code of ethics in place and ensuring that it is fully complied with will avoid similar frauds in the future.

References

Bazerman, H. M., Loewentesin, G., Moore, D. (2002). Why Good Accountants Do Bad Audits. Retrieved from: https://hbr.org/2002/11/why-good-accountants-do-bad-audits

Frankel, T. (2010). Fiduciary Law. Oxford: Oxford University Press

Kaplan, R., Kiron, D. (2007). Accounting Fraud at WorldCom. Harvard Business Review.