WorldCom's accounting fraud and violation of GAAP principles

¶ … WorldCom

Prior to the corporate financial scandal, WorldCom was one of the largest long distance telephone companies (Reuters, 2003). Initially headquartered in Mississippi it later moved to Virginia. The company grew fast by acquiring other companies such as MCI Communications in 1998 and UUNET technology in 1996. Other companies acquired included, Metromedia in 1992, Resurgens Communications Group in 1993. In the course of this acquisition spree, WorldCom undertook two complex takeovers. The first was the 1998 acquisition of CompuServe from H&R Block where it retained the network division, sold off the online service to American Online (AOL) and the second, the acquisition of Digex in 2001, and disposed of all Digex assets to Allegiance Telecom (Kaplan & Kiron, 2004). With these acquisitions, it gained a favorable reputation in the market as a company with a solid foundation.

Facts of the WorldCom Case

The WorldCom fraud case is one of the largest corporate fraud and accounting scandal in the United States history. It inflicted billions of dollars worth of damage to the investors and resulted in the greatest bankruptcy in America. Senior directors, officers and external auditor Arthur Andersen and investment banking agency Salomon Smith Barney Incorporated brought about the fraud case (Kaplan & Kiron, 2004). This syndicate was in violation of securities act of 1993, and the securities and exchange act of 1934. WorldCom gained more than $3.8 billion in ordinary costs as capital expenditure; a gross violation of the Generally Accepted Accounting Principles (GAAP) (The Securities and Exchange Commission, 2002).

WorldCom inflated their stock and bond prices to meet Wall Street's estimates, a plan that enabled the company and principal underwriters to defraud investors by misguiding them to purchasing more that $17 billion investment notes contrary to the company's financial status. The senior executives involved in the swindle manipulated reserves to cover bad debts by setting high figures to compensate for projected and real profits.

Violation of GAAP Concept

WorldCom largely violated the GAAP. Under the GAAP, the company was required to approximate monthly line costs and expenses. To estimate these costs, WorldCom created a liability account. The company reduced the bills in the same margin as the income. Expenses according to GAAP are estimates that needed revision to make sure their genuineness (Ryerson, 2009). In cases whereby the expenses are lower than estimates, they are revised to match with revenues and expenses; which WorldCom did not do. The management involved in the fraud manipulated the figures to give unrealistic values.

The Fraud from Accounting Aspects of the Case

From the beginning of the first half of 1999 to the first half of 2002, WorldCom under Bernard Ebbers management used fraudulent and unscrupulous accounting practices to cover declining revenues. They did this by portraying an inaccurate image of the company's financial growth and profitability to stabilize and strengthen the stock value. The fraud carried out by the company was primarily in two major phases; placing line costs as capital in the balance sheet instead of expenses and inflating the revenue earned with inaccurate accounting entries from non-allocated revenue accounts (The Securities and Exchange Commission, 2002).

The company's employees released inaccurate and manipulated financial statements in order to give a picture of financial stability to the stakeholders. They did this by setting unrealistic revenues targets set up by the chief finance officer Mr. Scott Sullivan and the chief executive officer Mr. Bernard Ebbers. WorldCom decreased line costs by improperly releasing altered reserves set aside for other expenses unrelated to line costs. These changes done quarterly without any proper supporting evidence made the company cut expenses and increase reported before-tax revenue to help the perpetrators of the phishing fraud.

Victims of the fraud

The trading of WorldCom securities were efficient before the scandal and attracted many investors into the company. The WorldCom fraud scandal rocked the financial foundations of several shareholders and stakeholders within the company. The investors in shares of WorldCom who suffered grievous losses include the county of Fresno, HGK Asset Management Inc. among others.

The main loser from the share trade was New York State Common Retirement Fund (NYSCRF), which purchased WorldCom securities during the class period and suffered from fine based on the federal securities law violations (The Securities and Exchange Commission, 2002, p. 3). NYSCRF invests in assets of New York State and Local Employees' Retirement System and because of WorldCom's share purchases suffered losses amounting to $315 million.

The other victim of the fraud was Fresno County Employees Retirement Association (FCERA), California that bought WorldCom shares and was fined for violating federal securities laws. The association investing in funds for provision of retirement compensation and disability benefits to participants in the pension system suffered losses of $12 million from investing in WorldCom (The Securities and Exchange Commission, 2002, p. 15).

Finally, the last victim of the phishing scandal was HGK Asset Management Incorporation. HGK; an investment advisor serving clients under the Employee Retirement Income Security Act of 1974 was fined and suffered damages for federal securities law violation following share acquisition during the Class Period. Because of the firm's purchases of WorldCom securities, it suffered losses of more than $28 million.

Beneficiaries of the Fraud Scandal

The fraud could not have been successful without the collaboration of Salomon Smith Barney Limited. They were the main underwriters of the public offerings of WorldCom notes that generated $17 billion for WorldCom in the stock market in the first year (Ryerson, 2009). The major beneficiaries of the fraud deal included the former Chief Executive Officer (CEO) Mr. Bernard Ebbers, Mr. Scott Sullivan the former Chief Finance Officer (CFO), Director of General Accounting (DGA) Mr. Buford Yates Junior, former controller Mr. David Myers and outside auditor Mr. Arthur Andersen LLP of investment banking agency Salomon Smith Barney Incorporation (Ryerson, 2009).

Sarbanes-Oxley Act

The Sarbanes-Oxley Act put a recommendation for businesses to hire second accounting or business advisory company to offer non-audit services, "including internal assessment co-sourcing and out sourcing" (United States Congress, 2002). Additionally, the Act provides for independent lawyers and accountants to help firms identify and process ethical responsibilities. So far, this Sarbanes-Oxley tool has been highly ranked as a key deterrent of fraud.

In the case of WorldCom, the Act could have created a set of understandable, brief and well-ordered protocols that recognizes prior risk generated from weaknesses in the internal audit. It could be used as a controls measure for business activities and other executions.

Under the Act, CEO and CFO are held accountable for manipulated accounts statements. It also prescribes suitable penalties such as forfeiture of bonuses and any benefit resulting from the sale of company securities. CEOs must also personally vouch for their companies' statements and give well-documented evidence that their internal control systems are in order.

The Sarbanes-Oxley Act Provides a structural foundation that incorporates workflow, document management and account publishing to establish compliance processes in order to manage businesses effectively.

The Current Status Of World

WorldCom currently is called Verizon communications, an American communication company headquartered in Ashburn, Virginia. The company was formerly a subsidiary of WorldCom using the name MCI WorldCom before finally using Verizon in April after emerging from the parent company's fraud scandal. The company offers several products and services including wired and wireless telecommunications, wireless voice over internet protocols and data services among others. With gross revenue of approximately $110 billion and employing more than 30,000 employees, Lowell C. McAddam as the chair, Francis J.Shammo the chief financial officer and Trinidad Aguirre as the area president of south and western regions manage the company.