Case 2-1
WorldCom
The WorldCom fraud was the largest in U.S. history, surpassing even that of Enron. Beginning
modestly during mid-year1999 and continuing at an accelerated pace through May 2002, the
company, under the direction of Bernie Ebbers, the CEO, Scott Sullivan, the CFO, David Myers,
the controller, and Buford Yates, the director of accounting, “cooked the books” to the tune of
about $11 billion of misstated earnings. Investors collectively lost $30 billion as a result of the
fraud.
The fraud was accomplished primarily in two ways:
1. Booking “line costs” for interconnectivity with other telecommunications companies as
capital expenditures rather than operating expenses;
2. Inflating revenues with bogus accounting entries from “corporate unallocated revenue
accounts.”
During 2002, Cynthia Cooper, the vice president of internal auditing, responded to a tip about
improper accounting by having her team do an exhaustive hunt for the improperly recorded line
costs that were also known as “prepaid capacity.” That name was designed to mask the true
nature of the costs and treat them as capitalizable costs rather than as operating expenses. The
team worked tirelessly, often at night and secretly, to investigate and reveal $3.8 billion worth of
fraud.
Soon thereafter, Cooper notified the company’s audit committee and board of directors of the
fraud. The initial response was not to take action, but to look for explanations from Sullivan.
Over time, Cooper realized that she needed to be persistent and not give in to pressure that
Sullivan was putting on her to back off. Cooper even approached KPMG, the auditors that had
replaced Arthur Andersen, to support her in the matter. Ultimately, Sullivan was dismissed,
Myers resigned, Andersen withdrew its audit opinion for 2001, and the Securities and Exchange
Commission (SEC) began an investigation into the fraud on June 26, 2002.
In an interview with David Katz and Julia Homer for CFO Magazine on February 1, 2008,
Cynthia Cooper was asked about her whistleblower role in the WorldCom fraud. When asked
when she first suspected something was amiss, Cooper said: “It was a process. My feelings
changed from curiosity to discomfort to suspicion based on some of the accounting entries my
team and I had identified, and also on the odd reactions I was getting from some of the finance
executives.”
Cooper did exactly what is expected of a good auditor. She approached the investigation of
line-cost accounting with a healthy dose of skepticism and maintained her integrity throughout,
even as Sullivan was trying to bully her into dropping the investigation.
When asked whether there was anything about the culture of WorldCom that contributed to
the scandal, Cooper laid blame on Bernie Ebbers for his risk-taking approach that led to loading
up the company with $40 billion in debt to fund one acquisition after another. He followed the
same reckless strategy with his own investments, taking out loans and using his WorldCom stock
as collateral. Cooper believed that Ebbers’s personal decisions then affected his business
decisions; he ultimately saw his net worth disappear, and he left owing WorldCom some $400
million for loans approved by the board. Ebbers was sentenced to 25 years in jail for his offenses.
Betty Vinson, the company’s former director of corporate reporting, was one of five former
WorldCom executives who pleaded guilty to fraud. At the trial of Ebbers, Vinson said she was
told to make improper accounting entries because Ebbers did not want to disappoint Wall Street.
“I felt like if I didn’t make the entries, I wouldn’t be working there,” Vinson testified. She said
that she even drafted a resignation letter in 2000, but ultimately she stayed with the company.
Vinson said that she took her concerns to Sullivan, who told her that Ebbers did not want to
lower Wall Street expectations. Asked how she chose which accounts to alter, Vinson testified:
“I just really pulled some out of the air. I used some spreadsheets.”
Her lawyer had urged the judge to sentence Vinson to probation, citing the pressure placed on
her by Ebbers and Sullivan. “She expressed her concern about what she was being directed to do
to upper management, and to Sullivan and Ebbers, who assured her and lulled her into
believing that all was well,” he said. In the end, Vinson was sentenced to five months in prison
and five months of house arrest.
Questions
1. What is the difference between accrual earnings and cash earnings? In addition to
the effect on accrual earnings of capitalizing the line costs, how might the treatment
mask the true nature of operating cash flows?
Cash earnings account for revenue with cash inflows and for expense with cash outflows.
Cash earnings then are a recording of true cash flows. This method has timing differences
between cash for revenue is received and when it is earned. There are also timing
For example, consider accounting for leases. Accounting rules on leases proscribe which
leases qualify as an operating lease (a current expense), and which qualify as a
In WorldCom scandal, Scott Sullivan explained that the prepaid capacity was fiber optic
lines leases that were being capitalized, instead of expensed. The revenues on the leased
fiber lines had declined, so the leases were being capitalized to better match the expense
2. Identify the stakeholders in the WorldCom case and how their interests were
affected by the financial fraud.
The stakeholders in the WorldCom case are top management (i.e., Ebbers and Sullivan), Cooper,
Vinson, the owners, employees, investors, creditors, the accounting firm (Andersen), the audit
committee of the board of directors and the public. The owners, investors, and creditors lost their
3. Use ethical reasoning to compare the actions of Cynthia Cooper in the WorldCom
case to those of Sherron Watkins in the Enron case, discussed earlier in this
chapter.
Cooper and the internal auditors used objectivity and skepticism in looking at the prepaid
capacity costs. They did not accept glib answers after being stonewalled on questions and
requests for support and documentation. Their actions relate to the Rest’s four-
component model of morality: moral sensitivity, moral judgment, moral motivation, and
Watkins knew the company falsified its financial information and did not go beyond Ken
Lay, who was partly to blame, in taking her concerns further in the organization. She
knew it was wrong but only took limited action to correct the matter. She also seemed