Cynthia Cooper details her trials and tribulations about her experiences at WorldCom in the book Extraordinary Circumstances: The Journey of a Corporate Whistleblower.
The following excerpts from the book describe the actions she took to uncover the fraud at WorldCom and reactions of key players in the accounting department, top management, the audit committee, and the external auditors.
Cooper was first alerted to the fact that there may have been a problem with capital expenditures when she read an article called “Accounting for Anguish” that appeared in the Fort Worth (Texas) Weekly on May 16, 2002. It described the ordeal of Kim Emigh, a former WorldCom financial analyst who was laid off from the company after complaining for many years about potential abuses related to capital spending. Glyn Smith, a senior manager in internal audit, suggested to Cooper that they do an internal audit of capital expenditures immediately. Cooper agreed. The first sign of a problem was when one of the finance directors provided capital spending schedules for the audit and two of them disagreed in amount. The director said the difference was due to something called “prepaid capacity.’ When asked to explain, the director couldn’t and said that David Myers, the controller of WorldCom, provides the data to record.
Later on a member of the internal audit team with technology knowledge, Gene Morse, was asked to examine the system and see if there was anything designated as prepaid capacity. Morse found prepaid capacity amounts “jumping all over the place, from account to account.” There were numerous examples of items moved from account to account apparently to mask the true nature of the expenditures.
As news spread of the internal audit of capital expenditures, Myers suggested that the team was wasting its time on the audit and that their time would be better spent to find ways to save money in operating cost. The reaction of Myers only made Cooper more suspicious of what really was going on.
Cooper then approached Farrell Malone, the external audit partner at KPMG, the firm that replaced Andersen after its collapse following the Enron audit. Cooper explained about the movement of amounts to different accounts and unexplained prepaid capacity designations. Farrell recommended not going to the audit committee at that time. Still, Cooper decided to take a closer look. Morse downloaded thousands of entries searching accounts with more than 300,000 transactions each month spread across a hundred legal entities.
Cooper learned that Scott Sullivan, the CFO, had found out about the audit. He questioned Morse about the work. This increased Cooper’s suspicion since Sullivan rarely took such a direct interest in an internal audit matter. She asked her staff what they thought about Morse’s discovery. Most believed there was a good explanation. But Cooper knew as auditors they were obligated to stay with leads and keep reviewing the issues. In her book, Cooper states her philosophy of internal auditing as: “At times, it is a slow, plodding process of checking and re-checking facts, developing theories, trying to find connections, and thinking through the issues until you get it right.”
On June 10, Morse found several entries labeled “prepaid capacity.” They appeared to be moving large amounts from the income statement to the balance sheet—$743 million in the third quarter of 2001, $941 million in the fourth quarter of 2001, and $100 million in the first quarter of 2002.
The auditors went about tracing the amounts from account to account through the system to see where they landed.
The next morning Cooper received a message that Sullivan wanted to speak to her right away. He talked about becoming more involved in internal audit matters, an unusual step for him. Cooper also overheard a conversation while in Sullivan’s office that Max Bobbitt, the chair of the audit committee, would be leaving the committee. This was of concern to Cooper since she reported functionally to the audit committee and administratively to Sullivan. The audit committee provided internal audit with independence from management.
She worried that the conversation may have been for her benefit to inform her that Bobbitt may not be there to support her.
At the meeting with Sullivan, Cooper bluntly asked about prepaid capacity. He explained that it represented costs associated with no or low-utilized Sonet Rings and (telecommunication)
lines that were being capitalized. He stated:
“While revenues have declined, the costs related to certain leases are fixed, creating a matching problem.” Although not clear at the time, Cooper came to realize that the amounts represented costs related to the company’s leased fiber (optic) lines that had little or no customer usage because of the implosion of telecommunications in the late 1990s and early 2000s. The company continued to pay for the leased capacity but they brought in little, if any, value. Instead of expensing the lease costs as they were incurred, the company reclassified the amounts as capital assets and expensed them over a longer period of time allowing it to stretch out the deduction to company earnings, buying time for revenue to catch up. Sullivan told her he was aware of the issues with the accounting treatment but they “will be cleared up in the second quarter of 2002.” At that time he said a restructuring charge related to prepaid capacity would be recorded effectively writing off most of the amounts that had been capitalized.
After that, the company would no longer capitalize line costs as prepaid capacity, “instead allocating these costs between a restructuring charge and an expense.” Sullivan asked Cooper to postpone the audit until the third quarter of 2002.
Cooper thought about what had transpired in her meeting with Sullivan. She realized that some aspects of accounting depended on judgment. She thought, maybe the prepaid capacity was aggressive, but perfectly legal, accounting.
She was uncomfortable with the matter in light of Farrell’s admonition not to go to the audit committee. Cooper called Bobbitt to discuss the matter. She thought even though he was coming off the audit committee, that he would be interested in her findings. She told Bobbitt that her staff had identified accounting entries made in the third and fourth quarter of 2001 and the first quarter of 2002 that totaled $2.5 billion, and she was concerned about the accounting. Bobbitt told her to meet with Farrell, the KPMG partner, to discuss the issues.
The next day Bobbitt came to town for an audit committee meeting and asked Cooper to meet with her and Farrell. At first, a stressed-out Bobbitt chastised Cooper for discussing the matter with anyone else until after they could meet to discuss the entries. Cooper felt she needed to have Bobbitt focus on the real issue. However, Bobbitt had already decided not to discuss the matter with the whole committee and he was supported by Farrell.
At this point Cooper and Smith decided to interview Betty Vinson, the accounting director who entered some of the amounts into the accounting system. She asked for support for the prepaid capacity entries. Vinson admitted to making the entries but stated she did not know what they were for and had no support. Cooper asked where the amounts for the entries came from. Vinson said David Myers, the controller, or Buddy Yates, the director of general accounting. Cooper and Smith went to see Yates who told them to see Myers.
Incredulously, she asked: “Can a person reporting to you book a billion-dollar journal entry without your knowledge?”
Yates told her that Myers called people who report to him all the time to book entries. Besides, “most of the accounting is done in the field and not in my group.” She thanked him for his answer but was in a state of disbelief. Cooper then went to see Myers who told her while he could construct support for the entries, he wouldn’t do it. She asked him if there are any accounting standards to support the entries. He stated there aren’t and that “we probably shouldn’t have capitalized the line cost. But once it was done the first time, it was difficult to stop.” He professed to be uncomfortable with the entries from the first time they were recorded. Smith wondered whether this was some sort of aggressive accounting technique.
She asked Myers whether he was aware of other companies in the telecommunications industry who were using the same accounting treatment. He answered no, but offered that other companies must have been doing the same thing to keep their cost structure low.
Cooper decided to inform Bobbitt of what had transpired.
Bobbitt suggested she should update Farrell and call him back after that. Farrell seemed surprised by the situation but said he would contact Bobbitt and Myers. Cooper called Myers to give him a heads-up. Later in the day, Bobbitt asked her to fly to Washington, DC, to meet with him and Farrell the next morning. At the meeting Cooper expressed her concern that only one member of the audit committee knew about the entries. Bobbitt cautioned that they had to be sure before going further and suggested it was now an external audit issue for KPMG, not an internal audit matter. Cooper offered that she didn’t care “whose issue it [was] as long as it [was] addressed appropriately.” They agreed that Farrell would meet with Scott Sullivan, the CFO, who was the mastermind behind the accounting and give him an opportunity to explain his rationale. Farrell told Cooper that Sullivan’s explanation may have made sense from a business perspective, but not an accounting perspective.
By June 20, over $3 billion of improperly classified costs had been found. It had been eight days since Cooper first called Bobbitt about the audit findings and she was growing increasingly concerned that others on the audit committee were kept in the dark. She told Farrell that if Bobbitt didn’t call a meeting of the audit committee immediately, she would. Later in the day Bobbitt called Cooper and told her there would be an audit committee meeting and she and Smith could attend if they wanted to. She asked why he seemed so agitated. Bobbitt remarked: “Do you have any idea what I’m about to have to do? I’m about to blow up this company!”
Farrell admitted at the meeting that he was not aware of any provision in GAAP that would support the line-cost entries. Sullivan defended the transfers by stating:
Starting in 1999, WorldCom invested heavily in assets to expand the telecom network, anticipating enormous future demands in customer traffic. WorldCom not only purchased equipment and fiber, but aiso signed a significant number of long-term fiber leases with third parties to carry the expected telecom traffic. But when the telecom industry imploded, starting in 2000 and continuing through 2002, the customer usage anticipated never materialized. Now, large pieces of both owned and leased portions of the telecom network had no or very little customer traffic.
Sullivan had business reasons but no accounting rationale for the entries. He tried to use the matching principle to justify the accounting. However, it applied only if the original journal entries to account for the leases were correct. He also talked about taking an impairment charge in the second quarter of 2002, to write off the line cost amounts booked as capital assets. He insisted the entries weren’t made to meet earnings; that the accounting for line costs required judgment and the transfers were made using estimates.
Following the audit committee meeting, Cooper’s team found 49 prepaid capacity accounting entries, totaling $3.8 billion, recorded over all four quarters of 2001 and the first quarter of 2002. She concluded after reviewing the entries that they were sinister in intent. The pattern of movement between accounts changed from one quarter to the next but the entries had the same end result. She concluded: “It was a spider-web of amounts moving as many as three times and finally spread in smaller dollar increments across a multitude of assets, mostly telecom fiber and equipment. If the amounts are funneled through enough accounts and then spread out, someone seems to have thought, they’d come out on the other end less detectable by the external auditors.”
On June 24, Cooper and Smith met with Troy Normand, the mid-level accounting director, who claimed to have relayed his concerns to Sullivan about another matter—the drawing down of “rainy-day” line-cost reserves, thereby reducing expenses. This occurred in 2000 when Normand observed that Sullivan was “forced” to manipulate these amounts to meet the earnings guidance he had provided to Wall Street. Sullivan drew on the business purpose of the transactions and assured Normand everything would be okay.
Normand felt he didn’t know enough to refute Sullivan’s explanation so he went along with it. He shared with Cooper that he had considered resigning and never told internal or external audit about any of the entries because he was concerned for his job and had a family to support. He concluded, “In hindsight, I wish I had.”
Questions 1. What are the rules in accounting for determining whether to expense certain costs against revenue versus capitalizing and amortizing the costs? How do the different treatments affect earnings? Explain the reasons given by Scott Sullivan for capitalizing line costs. Why did Cooper believe the treatment did not conform to GAAP?
2. Analyze Cooper’s use of professional judgment in the WorldCom case. How do her actions relate to Rest’s four stages of moral development?
3. What do you think motivated the behavior and actions of the following key people in this case:

a. Max Bobbitt, chair of the audit committee

b. Farrell Malone, the KPMG partner

c. Scott Sullivan, the CFO

d. David Myers, the controller

e. Betty Vinson and Troy Normand, members of the accounting department staff