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ACCOUNTING FRAUD AT WORLDCOM Corporate Governance Assignment

Group-6 (Akshay Goyal, Jitesh Agarwal, Tarun Bansal, Ashutosh Pandey, Puneet Khanna, Gaurav Gumber)

1. What are the pressures that lead executives and managers to cook the books? There are several situations that lead the executives and managers cook the books. Enron, Tyco, Global Crossing, Adelphia, WorldCom, and HealthSouth - the list continues to grow. While Enron is perhaps the most complicated fraud in the recent string of business failures, WorldCom was the most simple to perpetrate. WorldCom is a for profit organization that specialized in local, long distance and international plans, high cable internet, prepaid cards, and provided telecommunications to customers nationwide with business corporations making up the majority of the 20 million customers they served. Fraud is becoming increasingly prevalent and also public. Two of the largest corporate frauds in U.S. history, Enron and WorldCom, occurred in this decade, inspiring increased attention from both the financial press and government regulators. If overconfidence is the reason, does that mean systematically biased decision makers dominate the executive ranks? A lot of executives exhibit the characteristic of overconfidence in which their expectations are higher than what might be suggested, Overconfidence is a human characteristic that exists in the general population for certain types of people, and it is more prevalent in executives. It is pointed out that research in psychology, along with entrepreneurial and management studies, shows that people who get promoted to the top levels of a corporation are typically those with enough confidence to take chances. In addition, executives are in top positions because of past successes, and these experiences can cause them to be overly confident. Just because overconfidence might lead to bad decisions in particular circumstances, it should not be the only, or even primary, consideration when evaluating executives, adding that a growing body of literature indicates that confident and optimistic leaders might make what would be viewed as bad decisions in certain circumstances, but overall, they also have assets that any firm needs to succeed. "Given that the firm has to hire the whole person, you might actually want somebody who exhibits this bias. But, you should recognize that the overconfidence, which has its positive aspects, can also have a downside. 2.What is the boundary between earnings smoothing or earnings management and fraudulent reporting? Earnings Management may be defined as reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results. Earnings Management is not to be confused with illegal activities to manipulate financial statements and report results

that do not reflect economic reality. These types of activities, popularly known as cooking the books or fraudulent earnings, involve misrepresenting financial results. Both involve the intent, by reporting management, to distort their company's earnings picture, but fraudulent accounting does so by violating generally accepted accounting standards (GAAP) while earnings management does so within GAAP. Many executives face a lot of pressure to cross the line from earnings management to fraudulent earning. Some researchers believe it is a legal act and totally different from fraud because it is within the boundaries of GAAP, while others see a very tiny line between earnings management and fraud, and view it as an unethical act that needs to be fought by external auditors. The debate on earnings management and fraud will continue unless there is a proper way to help auditors identify the difference between them. 3. Why were the actions taken by WorldCom Managers not detected earlier? WorldComs company structure and corporate culture were the roots that prevented the fraud by the WorldCom managers from being detected earlier. There existed no written policies or code of conduct and each department had it own management style. A culture was created that made legal function less influential and less welcome. There existed distant relations between the WorldComs external auditor and the board of directors. Employees did not have an independent outlet for expressing concerns. The internal audit team was also rendered useless and several employees did not even know of its existence. The company encouraged a corporate culture that employees should not question their superiors, but simply do what they were told. The employees had incentives to follow top managements demand or were crumbled by threats that were commonplace to employees who did not obey orders. As we see in the case of Betty Vinson who had flawed under pressure from her bosses. Another major cause was WorldComs departments were spread out across the country, which made it difficult for the different departments to fully coordinate and realize what was occurring in other departments. 4. What processes or systems should be in place to prevent or detect quickly the types of actions that occurred in WorldCom? Several systems should have been in place to both prevent and detect the types of actions that occurred in WorldCom. Firstly, WorldCom should not focus on just one performance indicator, the E/R ratio. Just focusing on one indicator gives managers incentive to do whatever they can to reach the target ratio. By having several performance indicators, managers would have a harder time usingfraudulent practices to maintain all indicators, and the multiple indicators would give a better, overall view of the companys health.

Secondly, the external audit system should work correctly to ensure that no fraudulent practices occur. Several times a year the external auditor should audit the old fashioned way by testing thousands of random individual transactions, giving the auditor a better chance of catching fraud, instead of just testing the same summaries each quarter. The external auditorshould also not permit clients like WorldCom to deny turning over important financialinformation or deny meetings or phone conversations; if a client continues to deny financialinformation or meetings, the external auditor should report the company to the SEC for closerinvestigation. Lastly, the board of directors should more directly interact with the company to oversee alloperations and make sure everything is running smoothly and legally. The board shouldpersonally check out the accountant department financial statements at random to see the truefinancial situation, instead of just accepting financial packets created by the CEO. The Board of Directors should also be in closer contact with different managers and lower level staff members to get a better picture of true operations, not the picture painted by the CEO. 5. Were the external auditors and board of directors blameworthy in this case? Why or why not? Yes, the external auditors and board of directors were blameworthy in this case of accounting fraud at WorldCom. Mr Ebbers, CEO of WorldCom always tried to maintain a distance from the lawyers and ethical and legal procedures. Apart from his job as CEO of WorldCom, he was also owner of several other businesses and he drew financial help from WorldCom for those businesses without providing any significant collateral option by using his position in WorldCom. CEO and CFO were trying to show consistent revenue growth at WorldCom by manipulating accounts. Manipulating tactics included mainly two actions releasing accruals and capitalization of line costs. CFO Mr Sullivan forced other employees to change the account entries to meet the illogical forecasts of CEO. Board of directors and external auditors never had access to the correct information of WorldCom accounts. It was a tough time for telecom industry and there were enough doubt raising facts and figures but Board of directors and external auditors of WorldCom ignored them. Their job was to raise question, which they didn't do. Not interruption or scrutiny by them made them blameworthy. 6. Betty Vinson Victim or villain? Should criminal fraud charges have been brought against her? How should employees react when ordered by their employer to do something they do not believe in or feel uncomfortable doing? Betty Vinson had pleaded guilty to the court and was indeed cooking the books at the behest of her employers. However, it would be unfair to take an extreme position and label her a villain, as she was put in a difficult position, although she was definitely not without blemish. She had complete knowledge of the wrongness of what she was doing right from the beginning when she was asked to do it for the first time. What mitigated her concerns must be the assurances from her employer that she was not doing anything illegal and that he took full responsibility.

Although she had planned to resign she never did, in fact, she continued to cook the books, to keep the job holding the knowledge that it was illegal. Perhaps, the handsome salary and the position of Director provided further incentive. Although ethically incorrect, the criminal charge of conspiracy was not deserved as she was not a part of the conspiracy but was following orders and was under much pressure. However the eventual punishment that she received was not a very harsh one and at par with her fault as she should have refused to do what she did the very first time. Whenever an employee is in a position, where his principles are in conflict with his work at the job, he should do what he believes in and not something that causes internal conflict. He should refuse the order and quit the job if need be. If quitting job is difficult due to lack of another opportunity, he/she should perhaps turn into a whistleblower.