WorldCom was part the Telecommunication Company prior to its being eventually named to MCI in 2003, Inc. after several events. One significant event its life was its merger with LDDS and later with MCI Communications. MCI, Inc, which was later, bought by Verizon Communication and now forms part of Verizon Division. This consequent renaming of company may be viewed as part of the company plan to arise from bankruptcy caused by the scandals that the company went through (Venison, 2008).
As far as incentive/pressures/motivations are concerned in case of WorldCom, it could be asserted that the perpetrators wanted become rich taking advantage of their knowledge of accounting and the related decision that was made with the leadership of the company’s CEO and other officers by increasing price of their shareholdings and eventually selling the same. This kind of fraud implies knowing accounting principles and practices and manipulating the same to their advantage.
The taking advantage has to do with the timing when people or various investors were looking for ways to earn without these latter people accepting the reality of the situation that they are being fooled. The start of the fraudulent accounting for WorldCom was found in 1999 when the company wanted to paint a good financial condition contrary to what was actually happening after the downturn in the telecommunication industry in 1998. By painting a different picture, investors allowed themselves to be plainly deceived into investing.
The timing to deceive people was most appropriate because its investors just wanted to earn and they did not want to accept the downhill trend in telecommunication industry as a reality. The practice was plain greed of management, which also capitalized on the greed of investors who refused to see the truth about the industry where the company operated. The incentives or motivations appear to be the most influential factor in the fraud commission.
The causes of fraud at WorldCom could be looked into the possible motives on why its people had resorted to fraud commission. The company’s stocks were used as means to create more wealth for its chief executive officer (CEO) Ebbers and other officers. These people incidentally came from finance and accounting departments, who had come together to act at the expense of many investors. The accounting fraud that they commit could be viewed as making the company to look more profitable than what is real to attract investors to buy stocks.
They therefore created simulated profitability for WorldCom and this caused the price of the company’s stock to rise significantly and such was intended encourage more investors to invest more with the eventual purpose of selling the stocks by perpetrators when it is time to profit more. The clear causes of fraud show the greed of these people for more wealth. As far as opportunities are concerned, it is believed to be present in the case of WorldCom as there appears to a lack of good internal control in the organization.
The laxity of the system of controls or accounting rules that allowed things to happen so easily and this can be proved by the nature of fraud committed. The two fraudulent practices committed in the case of WorldCom could be classified into two. The first type was the underreporting of “line costs” by capitalizing them rather than recording them as expenses for the period. The second type was the deliberate inflating or overstating the revenues without basis.
As profitability is measured by the excess of revenues over expenses every period, the management of WorldCom postponed he recognition of the expense. This made the company to look more profitable that what was real. The second fraud on revenue overstatement produced the same effect as the first since this caused the company’s profitability to look better as well. In examining both types of frauds for WorldCom, investigators found about the perpetrators’ overall objective, which was to keep reported line costs to approximately 42% of revenues.
The result was to reduce the actually levels in excess of 50%, and to help management maintain in its report to investors about the double-digit revenue growth when the truth was that actual growth rates were so much lower substantially (Beresford, et al, 2003). It may be asked, why has management not stopped the opportunities to commit fraud? It would appear that the CEO was in control in what happened at the company. The officer who was given the power to give direction to the organization was the very leader who was telling his finance and accounting people to do what they do by making them believe that investors would be earning money.
Some employees may have noticed something wrong, but it took quite a considerable time before the fraud was discovered and stopped. The extent of control of CEO may be appreciated to the nature and extent for the deliberate means in the underreporting of line costs in the form of interconnection expenses with other telecommunication companies. Perpetrators accomplished the fraud by capitalizing these costs on the balance sheet rather than properly expensing them.
The reduction of reported line costs, representing the company largest category of expenses, was converted into company assets instead of causing to be reported as expenses for the meantime. Double the effects could be considered evident that manifest intention to commit fraud. The first happened in understating expenses and the other in overstating assets, which are both favorable to the company by looking better to investors. Had the fraud not discovered after sometime, greater damage might have resulted to investors.
Fortunately, WorldCom’s internal audit personnel acquired some knowledge about what was happening and they alerted the other member of board and about improper transfer of $3. 852 billion from line cost expenses to capitalized accounts during 2001 and the first quarter of 2002. If the said amount of fraud were combined with the first $ 3. 8 billion, the staggering total at $6. 412 billion in improper reductions to line costs would result. These and other manipulations of line cost caused fraudulent overstatement of pre-tax income by over $7 billion (Beresford, et al, 2003).
The fact that the internal audit personnel discovered the same would show that a good internal control like having an internal audit could really help prevent fraud. According to report made to the SEC, the fraud actually started as line cost adjustments in the form of accruals in 1999 and 2000 but when it was not possible to make more large accruals, the next scheme was to capitalize or defer 2001 and 2003 operating line cost as assets (Beresford, et al, 2003). Such a situation indicated an utter lack of check and balance that almost entrenched the perpetrators to their thing.
To understand the nature of fraud, there is need to understand what are line costs, which the investigators have defined as charges for carrying a voice call, or data transmission from one point to another point, which represents the company’s largest single expense from 1999 to 2001. Being the largest , it was about more than 50% of total expenses of the company, the extent of manipulation of the figures would necessarily produce easily the desired effects in income level by perpetrators. Investors were easily hooked by their greed.
It is expected that company’s management and other parties particularly outside analysts to desire to find out the trends by the use of ratio of line cost expense to revenue (E/R ratio) as a way to measure the trend of behavior of the cost to revenues (Beresford, et al, 2003) as way of evaluation of an investment’s desirability. A taking advantage of knowledge in accounting principles by focusing on big amounts that could substantially increase income would necessarily appear evident and which is again a strong evidence of motivation or incentive to commit fraud.
On another aspect, the WorldCom’ management manipulated its accrual of expenses as could be found in releasing the same with the required analysis even if found to be in excess of the amount required to be accrued. With the excess accruals, the perpetrators caused them not to be effected at the time of identification. Instead, they delayed them at the most opportune time. Obviously, investigators found that certain line cost accruals were in effect kept as rainy day funds and managers caused only their release when needed.
With an overwhelming evidence that everything was really in the control of the perpetrators who knew how to manipulate the accounting information for their selfish purposes when there was a felt need to improve results (Beresford, et al, 2003), the investors who became victim could only be pitied for their ignorance of what was then happening in the company. Perpetrators intended to make the stock price of the company to behave consistent with manipulated profitability results.
Malice as evidence of moral perversion or corruption for this kind of behavior is noticeable since accounting information is supposed to be reported because standards require them to be such. However, the manipulators found a way to go around the requirement. In addition, manipulated accrual was found by investigators in the case of the release of accruals that were applicable for other purposes, which could be considered a variation in understating the expenses to attain the targeted level of profitability as promised to the investors by the manipulators (Beresford, et al, 2003).
Investigators found Chief Finance Officer Sullivan, Controller Myers, and Accounting Yates who were incidentally part of the finance organization in the company to have directed in common the inappropriate releases of accruals. Astonishingly, release was discovered to have occurred not during ordinary or normal day-to-day operations but during adjustment periods after the end of each quarter. Since documentations too were not complete, and that employees involved have commonly raised concerns at time due to their knowledge of what was indeed happening to the company (Beresford, et al, 2003), fraud could only be concluded from them.
The other fraud of inflating revenues with fake accounting entries arose from corporate unallocated revenue accounts. ’ With the company wanting to appear better than actual, it was needed to paint itself as well in the market as high-growth Company, and had its revenues continuously growing. Such a scheme was management plan to convince investors what the company was doing well even if market conditions throughout the telecommunications industry were not that good during the years 2000 and 2001.
It is was obvious also that investors normally preferred earnings than to accept the reality of declining market, thereby cheating them into believing that the company could sustain growth while the opposite was true. Having claimed to manage successfully industry trends, which on contrary were already hurting all of its competitors, perpetrators at WorldCom superbly deceived people with the promises of double-digit growth rates (Beresford, et al, 2003).
Sometime in 1999, involved people in the fraud from the company made efforts to blow up revenues after the end of every reporting quarter to confirm what was told to investors made to believe. Basically, they made adjustments between the differences of actual and “targeted revenues” and leveling the same as corporate unallocated revenue accounts (Beresford, et al, 2003) the perpetrators attained much success in manipulation.
To put it simple, management announced a target in revenues that would be attained when reporting period comes. Management accomplished this by preparing needed adjusting entries, which the investors did not know or have not bothered to investigate earlier. Investigators indeed revealed the questionable revenue entries found under the Corporate Unallocated accounts, which have reached millions or tens of millions of dollars. Thus, the obviously bloated profitability.
That revenues appeared generally only in the quarter-ending month which was recorded weeks after the quarter has ended (Beresford, et al, 2003) as another evidence of that fraud which caused Sullivan to become concerned later since revenues recorded were already masking the result of the company’s operation, yet Ebbers remained unfettered (Beresford, et al, 2003). As for rationalization, what could be seen is the fact the since management was making the stockholders wealth, why not make the officers and managers become rich as well since they could also be as stockholders next time.
The event was therefore an utter collapse of the requirements of agency theory in finance where the agents must act to the best interest for their principals. 2. 3. 2 The case of Enron Enron operated as engineering company and became a world leader in various industries such as electricity, pulp paper, and natural gas and communication companies with revenue reaching to billion dollars in 2000 before 2001 bankruptcy proceedings (Barreveld, 2002).
Fraud relating to securities or accounting fraud was believed to have occurred and perpetrated to certain a great extent when the company entered into joint venture arrangements, while the company assuming as a limited and minority partner at same time. From these arrangements, Enron did not disclose the extent of company’s contingent liabilities related to those partnerships, which is contrary to the existing federal securities laws where Enron is required to have at least listed these matters in its footnotes to financial statements (Morgenson, 2001). The non-disclosure could be therefore viewed as a clear act of fraud.
The incentives to enrich themselves are again very evident in case of Enron. The reason why corporations practice the use off-balance sheet liabilities or non-disclosure of said liabilities could be traced to have been evidently caused also by greed by managers, investors and the investment banks. From a management perspective, a corporation desiring to increase its stock price, would naturally or inherently resort to window dressing their assets accounts and revenue accounts or understating expense accounts and liability accounts to make these companies to appear more profitable, more liquid or more solvent than they actually are.
What else could best describe the events other than greed and which feeds on deception since the two could normally go together as investors as much as possible would want above average rates of returns. Under normal circumstance however, ordinary investors deserve to be informed accurately on what are the real scores or accurate and accurate or reliable information about the companies where investments could be made.
They are interested to know companies in terms of profitability, liquidity, solvency, and efficiency to assure them under the Securities Act of 1933 the better chances in their decisions to make good returns, as they are free to choose. The victims of Enron scandals although informed can be considered treated as they are deliberated misled or ill informed. As to what will ensure reliability and accuracy of information could be a function of accounting standard and willingness or readiness of the corporation to comply honestly with these accounting standards.
But the Enron officials who greedily committed errors could only disregard the means to control the opportunities for fraud in the form of accounting standards. In fact, the officers defeated the control that what supposed to be there. Thus, no issue could be raised as to non-recognition of these off-balance sheet liabilities or contingent liabilities by Enron since they are not actual liabilities under criteria set by existing accounting standard. However, this is where the taking advantage for committing fraud was effected because of the failure of accounting rules to address the intricacies of financial reporting.
But such act of Enron’s failure to disclose surrounding conditions of the arrangements, in a deeper sense, actually mislead investors into believing that the company has a good capital structure and the that company was more solvent than what it actually was had these contingent liabilities been included and factored in assessing the company’s financial information for purposes of investment. The opportunities for fraud were also found to have existed in Enron since the accounting fraud is on the practice of off-balance sheet reporting where items need not be reported because the accounting standards may be lax on the matter.
In the case of Enron, there was an evidence of intentional non-disclosure of their contingent liabilities, which made it fraudulent (Morgenson, 2001). The case of Enron included great losses for many investors due to the eventual decline of its stock value as result of development of events that included sudden fall in the stock price, which could not have happened if proper disclosures of off-balance sheet items were made earlier.
It is difficult to contradict the strong evidence of fraud against perpetrator because of the conviction for conspiracy and fraud of Enron’s officers (Hays, 2006). Thus, conclusive fraud in the cases of Enron and of WorldCom since both resulted to criminal convictions of the key officers involved in the fraud (Hay, 2006, CBC News, 2008). What facilitated the commission of fraud by Enron is management’s creation of offshore entities that the management used to plan and avoid taxes and raise profitability.
Some of the special purpose entities include those of Jedi, Hawaii and Bob West Treasure. By providing ownership and movement, Enron was able to appear more profitable than actual as they did not report and disclose material information that would have affected their assets and liabilities (Guardian, 2008). As to rationalization factor, it could be viewed as that attitude by the same way as that used by the management headed by the CEO in the case of WorldCom.
It would seem to dwell on the idea that since investors or stockholders deserve to get wealthy, why not make the directors and officers who are at the same time stockholders to become rich as well by all means. It is survival-of-the-fittest thing as may have been encouraged by capitalism so that they have reasons to justify their ways because of the demand of their lifestyles. While getting rich for these officers may be valid, the same must not be at the expense of the rest of the stockholders who had less knowledge than management about important information and definitely should be free from fraud and deception.