Internal Control and Shady Accounting Practices
Group 3 1. Why did accounting fraud occur at WorldCom? Fraud occurred at WorldCom for a variety of reasons. The senior executives had unchecked power because the board of directors were only figure heads, the ethics hot-line was nonfunctional, and in internal audit department did report to the appropriate link in the corporate chain to minimize fraud.
These reasons, combined with a poor company culture, created the environment where fraud was able to become an acceptable business process. The senior executives at WorldCom had a “do it or else” attitude that was unchecked by any external force.
That external force should have been the board of directors. Unfortunately the board of directors were being directed by the senior executives, given information about WorldCom that was disorganized to hide highly controversial and aggressive accounting techniques. These directors should have recognized they were being used and realized their agency to the stock holders to administer the oversight they were compensated to provide. The ethics hot-line, according to the case, while existed, was not known or trusted by the general population of employees at WorldCom.
While many employees were aware of unethical activity, no of them felt that using this channel was a viable solution to addressing problems at WorldCom. Finally, the Internal audit department reported to the senior executive who ultimately steered their activity. If the executive was informed that internal audit was close to uncovering the unethical acts of managers, he directed their internal activity to other areas of the firm and blocked access to their department to the files that could expose the problem.
If the internal audit department reported to the board of directors, better policing of executive activity would have been possible. All of these reasons had an element of poor culture in their makeup. Allowing senior executives to bullying their subordinates, inattentive directors, allowing for the ethics channel to be nonfunctional, and accepting the unethical actions of seniors as the way things get done, ultimately doomed WorldCom to a spiral of actions that had the momentum of everyone’s livelihood at stake, with no system in place to automatically apply the brakes to protect the shareholders. . What is the difference between earnings management (or earnings smoothing) and accounting fraud? What are the relevant criteria to use in distinguishing ethical from unethical accounting practices? I don’t think there is a difference between earning smoothing and accounting fraud. Both practices intentionally mislead investors to alter their opinion of their holdings. Even if altering earning to smooth it out is mean only to put investors at ease, the underlying goal of smoothing is to change the perception of risk and volatility, which demand premiums in the market.
Relevant criteria for distinguishing ethical from unethical accounting practices are if the accounting practice materially changes what the average investor values the company at and items addressed in GAAP and other accounting standards that are against conventional accounting guidelines actively used and unchallenged in the business landscape. 3. What internal processes or systems do you recommend to prevent fraudulent practices such as those present at WorldCom?
Why were these practices not detected sooner? It appears WorldCom’s fraudulent activities was uncovered by the companies own internal accounting department, indicating that at least one of five internal controls – “monitoring of controls” was functional. However, I believe if there were to have been periodic external auditing from impartial entities outside of WorldCom, the fraudulent activities would have been uncovered sooner than it occurred in 2005.
Other internal control processes that could have prevented WorldCom’s fraudulent activities and demise are; hiring competent, reliable and ethical personnel, particularly in leadership positions that the company’s board of trustees failed to accomplish, or perhaps were oblivious and complacent with the “red flag warnings” – falsely professed financial growth and profitability to increase the price of WorldCom’s stock, and underreporting line costs (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them.
In addition to inflating revenues with bogus accounting entries from corporate unallocated revenue accounts. I also believe there was failure with “assignment of duties”, or separation of duties if you will. Because, Mr. Ebber’s seems to have been in control of his CFO – Sullivan, Controller – Myers, and Director of General Accounting – Yates. All of whom were unethical leaders at WorldCom that helped concoct “shady” accounting practices that led to the demise of WorldCom. It is my opinion that the above mentioned practices were not detected early enough due to micro management of lower taff employees by unethical leadership through autocratic style leadership, and environment that instilled fear in employees for fear of losing their jobs if any concerns were raised. An unfortunate reality that sadly exist in many big corporations, and even in governments. 4. What external processes or systems do you recommend to prevent and detect fraudulent practices such as those present at WorldCom? Were the directors on the board or the external auditors to be blamed?
External auditing is an effective process that can in many ways prevent fraudulent activities within organizations, as the respective auditing teams have no “loyalty” to management or leadership within the company undergoing review by the external auditors. Retrospectively, I believe that the board of trustees of WorldCom at the time of the scandal would have wished that they had carefully looked into the background and leadership style of Mr. Ebber’s and his co-conspirators to have checked for any signs of unethical behavior that many companies continue to blindly ignore.
Barely about a year ago, Yahoo’s former CEO was publicly humiliated, and subsequently fired by the company for “embellishing his academic credentials”. A very minor issue that could have been easily prevented, had the board of trustees of Yahoo looked thoroughly into Thompson’s background by doing their due diligence. Unfortunately, the board of trustees of Yahoo failed at this task, much like what happened back in the late nineties with WorldCom and Ebber’s. 5. You are a representative from the SEC.
Briefly describe any sections of Sarbanes-Oxley Act of 2002 that you would cite to either Mr. Sullivan or Mr. Ebber’s when they refuse to comply with your request for information. Under the federal regulations and securities Section 3(a)(47) of the Securities Exchange Act of 1934 (15 U. S. C. 78c(a)(47)), refusal of any individual(s), or company(s) to conform to set accounting practices including external auditing by appropriate personnel (entities) will be liable to punitive actions set forth by federal legislations – up to or more than 25-years imprisonment and fines.
Additionally, accounting and auditing practices by firms and individuals associated with a particular entity, or provide other services to any or such entities are prohibited to prevent conflict of interest, and accurate reporting of accounting practices. All of which were corporate infractions engaged in by Mr. Ebber’s and his co-conspirators at WorldCom. 6. The E/R ratios of other telecommunications companies during the late 1990’s hovered around 50% or at best high 40%. If you were an investor, would you have invested in WorldCom? I probably would have.
Despite the fact that WorldCom’s E/R ratio seems to have been lower than its competitors , which should have raised a red flag in any potential investors mind. However, like my decision to still invest in WorldCom despite its “too good to be E/R ratios”, many investors back then may have ignored what was obvious because WorldCom’s “cooked books” from previous years all “seemed financially sound”, thanks to Ebber’s and his co-conspirators great efforts at evading external auditors, fooling the public and its shareholders, and “muscling” junior employees to cover up its “shady accounting practices”.
So naturally, any potential investor would probably back then have made the same mistake of investing in WorldCom. Obviously, not expensing largest operating expense “line costs” – incurred to gain access to other carriers networks to allow WorldCom to complete customers calls, as reported in its SEC filings will make its E/R ratio lower compared to WorldCom’s competitors, resulting in an “inflated performance” – overstatement of earnings and understatement of operating expenses. 7. Contrast the roles of Vinson and Cooper in the case.
Should Vinson have been charged with committing crime? According to the section “Resolution of Ethical Conflict” in the Institute of Management Accountants’ Code of Ethics, how should employees proceed when under pressure by senior managers to engage in unethical behavior? As stated by James Comey, the U. S. attorney that prosecuted Ms. Vinson’s case, “just following orders” is not an excuse to break the law. Why? Because, like many accounting professionals, Ms. Vinson knew right from wrong as it pertains to the prescriptive law of accounting ethical practices.
In her own statement and admissions to prosecutors during the initial stages of her prosecution, and attempt to become a witness for the prosecution to gain leniency. (Pulliam, 2003). She (Ms. Vinson) stated that “each time she was ordered to “cook” or cover unethical accounting practices, she thought and hoped it will be the last time she caved in for such unscrupulous activities. Unfortunately, she kept on caving for years till the scandal was uncovered”. In light of the facts, and Ms.
Vinson and Cooper’s knowledge of right and wrong concerning the ethical practices of their chosen professions, it is appropriate for both of them to have been held liable for conspiring and engaging in such fraudulent activities as purported by WorldCom. As outlined by the IMA, accounting professionals in any company that are micro-managed, “muscled”, or coerced to engage in any fraudulent activities or witness any such improprieties, should first report the issue to an immediate supervisor that is not involve in such activities.
In the event such option does not exist, one should then report the issue to a higher management staff that is not involved in such impropriety. it’s also advisable for one to seek legal counseling with a private attorney about how to proceed in such matters n the event that reporting to an external body is imminent. Reference:PULLIAM, S. , Staff Reporter of THE WALL STREET JOURNAL Online, June 23, 2003| |