In the wake of the collapse of Enron, WorldCom—the telecommunications giant—collapsed and succumbed to $41 billion of debt and a corporate scandal that destroyed its access to capital. On July 19, 2002 the Company was forced to file for Chapter 11 bankruptcy and seek protection from its creditors. Amidst the string of SEC investigation into telecommunication companies, emerged a hero, Cynthia Cooper, whose careful detective work as an internal auditor at WorldCom exposed some of the accounting irregularities behind the greatest accounting fraud in U.S. history. Her effective whistleblowing highlighted the Company’s malpractices and led to the eventual resignation of WorldCom CFO, Scott Sullivan and other senior executives. Whistleblowing has emerged as a valuable tool for internal corporate monitoring, although the social repercussions often deter employees from reporting such frauds. While legislation has attempted to address the issue and encourage whistleblowers, I will argue that the motive behind whistleblowing reflects Kant’s idea of good will and thus cannot be enforced by government regulation.
- WorldCom: A Case Study
Historical Overview: The Rise of WorldCom
Few could have imagined that a company with the stature and size of WorldCom could collapse so quickly; at its peak, WorldCom had attained a market value of $180 billion, was the largest Internet carrier, and was the second largest long-distance carrier. From its humble beginnings as an obscure long distance telephone company based in Hattiesbrug, Mississippi the idea behind WorldCom emerged from a coffee shop collaboration of businessmen Murray Wladron, William Rector, and Bernie Ebbers (who would later be appointed CEO). The deregulation of telecommunications industry in the early 1980s allowed many new entrants to compete in the market and Waldron, Rector, and Ebbers planned to create a discount long distance provider called LDDS (Long-Distance Discount Service). LDDS went public through the acquisition of Advantage Companies Inc. in 1989, and began aggressively expanding regionally and internationally, prompting its name-change at the end of 1995 to WorldCom (Thornburgh, 2002).
WorldCom would be just another case of failed corporate governance, accounting abuses, and outright greed, if it weren’t for its colorful and likeable senior executive, Bernie Ebbers. The Canadian-born businessman differed from many of the other CEOs behind the string of corporate scandals in the early 2000s; dubbed the “Telecom Cowboy” Ebbers was known for his relaxed, unorthodox style, and passion for his company (Moberg & Romar, 2003). He regularly taught Sunday school and attended weekly worship with his family, donated over $1 million plus numerous information technology to the local all-black college near WorldCom’s headquarters, and continues to this day to serve meals to the homeless at Frank’s Famous Biscuits in downtown Jackson, Mississippi (Moberg & Romar, 2003).
But perhaps the most unique characteristic about CEO Bernie Ebbers, is his sincere passion in WorldCom and its success, which translated into his loading up on common stock. “Through generous stock options and purchases, Ebeers’ WorldCom holdings grew and grew, and he typically financed these purchases with his existing holdings as collateral” (Moberg & Romar, 2003). This only became a problem when WorldCom stock started to decline and Ebbers was faced with margin calls on some of his purchases. Instead of selling at the top, like most senior executives in his position would have done, Ebbers refused to sell and honestly believed WorldCom would recover. His investing strategy only made sense if he really believed in his company’s stock and its ability to appreciate in value, and thus it was his enthusiasm, not greed, that led to his personal financial demise.
The Telecommunications Industry
Since 1983, the U.S. telecommunications industry has been transformed from a monopoly to an extremely competitive marketplace. Some of the principal factors that have driven competition include: (1) the elimination and relaxation of legal and regulatory barriers to markets; (2) the advancement of new technologies and services, including data transmission and Internet services; and (3) consolidation (Thornburgh, 2002). Prior to deregulation, AT&T effectively controlled the facilities for both local and long distance service throughout the United States. The government’s breakup of AT&T enabled many new telecommunication companies to enter the market and unleashed a flood of technological advances for consumers. This “technological revolution” beginning in the mid-1980s with the introduction of the personal computer and World Wide Web created changes in product development and services across the industry.
The Telecommunications Act of 1996 and concomitant changes in the regulatory policy of the Federal Communications Commission further increased competition by removing legal barriers for long distance carriers to provide local telephone services and vice versa. The elimination of these barriers spurred the consolidation of local and long distance service providers into companies that could offer single-source local and long-distance service (Thornburgh, 2002). The “telecom” industry became characterized as fiercely competitive due to government deregulation, technological developments, and new market entrants, and provided the framework necessary for a modest reseller within a narrow geographic area like WorldCom to grow into a diversified telecommunications giant with a global presence (Thornburg, 2002).
WorldCom’s Growth Strategy
WorldCom was able to achieve its position as a significant player in the global telecommunications industry though the execution of an aggressive acquisition strategy—from 1985 to 2001, WorldCom acquired other telecommunications companies at an unrelenting pace: over 60 acquisitions in just over 15 years (Thornburgh, 2002). Regulatory filings reflect that some of these transactions constituted the largest mergers of their time in the telecommunications industry, and in the heady days of the technology bubble, Wall Street took notice. This was a company “on the move,” and Wall Street investment banks, analysts and brokers began to discover WorldCom’s value and made “strong buy recommendations” to investors (Moberg & Romar, 2003). As the stock value went up, it became easier for WorldCom to use stock as the vehicle to continue to purchase additional companies; however, this strategy also created “the need to maintain the value and attractiveness of that “currency” [WorldCom stock] and placed considerable pressure on WorldCom to achieve consistently impressive share price performance and high stock prices” (Thornburgh, 2002). By the end of 2000, WorldCom had grown into a telecommunications giant, with significant operations in all major aspects of the industry. As of December 31, 2000, the Company reported total annual revenues of over $39 billion and notes payable and long-term debt of $24.9 billion.
SEC Investigation & Chapter 11 Bankruptcy
WorldCom may have just been another story of successful growth strategy, so long as there were acquisition targets available. WorldCom’s stock price was high, and accounting practices allowed the company to maximize the financial advantages of its acquisitions while minimizing the negative. However, all of this was jeopardized when the government refused to allow WorldCom’s acquisition of Sprint in 2000, marking the end of the Company’s “acquisition-without-consolidation” strategy (Moberg & Romar, 2003). Around the same time, Fort Worth Weekly Online published an article entitled “Accounting for Anguish” and revealed reports of substantial accounting and financial reporting improprieties based on interviews with former WorldCom employees.
The Internal Audit Committee began an investigation into the Company on May 21, 2002 in response to the article and in the wake of public reports regarding numerous SEC investigations into the accounting practices of telecommunications and other companies. The report concluded that a full restatement of the financial statements of WorldCom for 2001 and the first quarter of 2002 was necessary; WorldCom responded by issuing a press release on June 25, 2002 announcing the restatement would cause an aggregate reduction of $3.8 billion in its earnings before interest, taxes, depreciation, and amortization for 2001 and the first quarter of 2002 (Thornburgh, 2002). Within four weeks of the announcement, WorldCom announced that it an substantially all of its active U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code.
The Sources Behind WorldCom’s Demise
“WorldCom did not achieve its growth by following a predefined strategic plan, but rather by opportunistic and rapid acquisitions of other companies. The unrelenting pace of these acquisitions caused the Company constantly to redefine itself and its focus” (First Interim Report of Dick Thornburgh, Bankruptcy Court Examiner).
Although public statements by WorldCom executives suggest that their acquisitions were “intended to achieve strategically broader geographic coverage of the Company’s services, more and better transmission facilities, new services and new markets” and initially appear harmless enough, WorldCom’s acquisition strategy proved to be far too aggressive to provide any sort of sustainable long-term growth. It presented significant challenges in multiple areas across the company, including: (1) management’s inability to integrate acquired assets, (2) increased pressure to report high stock prices, and (3) the use of company loans to senior executives. A chronology of important events that calls into question the ongoing viability of WorldCom is provided in Table 1. These internal challenges, combined with overly optimistic returns on acquisitions (and the telecommunications industry overall) applied excessive pressure on the senior executives to report profitability, which eventually turned into fraudulent practices.
Events indicating concern over the future viability of WorldCom
February 6, 2002:
|Concerns over aggressive accounting practices|
March 11, 2002:
|Request for information from the SEC relating to accounting procedures and loans to officers|
April 3, 2002:
|4% of overall work force to be eliminated|
April 22, 2002:
|Standard & Poor’s and Moody’s cut credit ratings|
April 30, 2002:
|Resignation of WorldCom CEO, Bernard Ebbers|
May 9, 2002:
|Standard & Poor’s and Moody’s cut credit rating to junk status|
May 21, 2002:
|Dividend payments and two tracking stocks to be eliminated|
June 4, 2002:
|Sales of assets and business units|
June 25, 2002:
|CFO fired after uncovering improper accounting of $3.8 billion in expenses over five quarters starting in 2001; 20% of overall work force to be eliminated; fraud charges filed by SEC|
July 1, 2002:
|Indication of further fraud regarding reversals of reserve accounts; lenders notify WorldCom that they could demand immediate repayment due to default|
July 19, 2002:
|Bankruptcy filings expected on the next business day|
This table briefly describes 11 major event dates that indicate some degree of concern over the future viability of WorldCom. We obtain the even dates and descriptions from Lexis-Nexis news articles on events that led up to WorldCom’s bankruptcy filing (Akhigbe, et al., 2004).
Managerial Challenges of Integrating Acquired Assets
Mergers and acquisitions present significant managerial challenges—management must integrate the acquired assets, operations, and related customer services of the new and old organizations into a smoothly functioning business. These processes are often time-consuming and require thoughtful planning and considerable oversight by senior management if the acquisition is to increase the value of the firm to both shareholders and stakeholders (Moberg & Roman, 2003). WorldCom’s rapid acquisition “binge” focused primarily on the acquisition, without giving much consideration to the integration phase. For all its talent in acquiring competitors, “the Company was not up for the task of merging them. Dozens of conflicting computer systems remained, local systems were repetitive and failed to work together properly, and billing systems were not coordinated” (Moberg & Roman, 2003).
Fraudulent Accounting Practices
Due to the increasing pressure on quarterly profits and share prices, WorldCom adopted a “liberal interpretation” of accounting principals. By the second quarter of 2001, the Company’s business revenues were decreasing, which jeopardizes its ability to meet the quarterly revenue growth targets set by Wall Street and the investing public. In an effort to make it appear that profits were increasing, WorldCom would “write down in one quarter millions of dollars in assets it acquired, while at the same time, it included in this charge against earnings the cost of company expenses expected in the future” (Moberg & Roman, 2003). This resulted in bigger losses in the current quarter, but smaller ones in the future to give the illusion that profits were improving. The company was also able to manipulate its financial statements in accounting for its acquisitions. For example, after acquiring MCI, WorldCom reduced the book value of some MCI assets by several billion dollars and increased the value of good will by the same amount—this enabled WorldCom to charge a small amount each year against earnings by spreading larger expenses over decades rather than years.
Sweetheart Loans to Senior Executives
When the value of WorldCom stock began to fall in 2000, Ebbers faced margin calls exceeding the value of his personal assets; he was forced to either sell some of his common shares to finance the margin calls, or request a loan from the company. The Board of Directors refused to let Ebbers sell his shares based on the belief that it would depress the stock price and signal a lack of confidence about WorldCom’s future and ultimately trigger a further downward spiral in share price; instead, they opted to loan Ebbers over $400 million at an interest rate slightly above 2%, which was considerably below that available to “average” borrowers, and below the company’s marginal rate of return. The policy of boards of directors authorizing loans for senior executives raised eyebrows and called into question the ethics behind such practices. Former SEC enforcement official, Seth Taube, claimed, “A large loan to a senior executive epitomizes concerns about conflict of interest and breach of fiduciary duty”. Both the size and the terms of the loan made to Ebbers, although legal, were deemed unethical by much of the investing public. The fact that Ebbers leveraged his substantial share holdings in the Company for his own private purposes put the interests of all the Company’s shareholders at risk (Thornburgh, 2002). Furthermore, by using his WorldCom shares to collateralize his massive debt obligations, Ebbers placed himself under intense pressure to support the Company’s share price.
The Whistleblower: Cynthia Cooper
At a time when dishonesty at the top of U.S. companies was dominating public attention, Cynthia Cooper, WorldCom’s former vice president of internal audit, and her team of middle managers took their commitment to financial reporting to extraordinary lengths and uncovered the largest corporate fraud in history. Cooper and her colleagues grew suspicious of a number of peculiar financial transactions and went outside their assigned responsibilities to investigate. What they found was a series of clever manipulations intended to bury almost $4 billion in misallocated expenses and phony accounting entries (Muberg & Roman, 2003).
Cooper’s curiosity was first aroused in March 2002 when senior line manager, John Stupka, complained to her that her boss, CFO Scott Sullivan, had usurped a $400 million reserve account Stupka had set aside as a hedge against anticipated revenue losses. Under accounting rules, if a company knows it is not going to collect on a debt, it has to set up a reserve to cover it in order to avoid reflecting on its books too high a value for that business, which is exactly what Stupka had done. However, Sullivan instead decided to take the $400 million away from Stupka’s division and use it to boost WorldCom’s income. She suspected fraud and inquired of the Company’s accounting firm, Arthur Andersen, who proceeded to brush her off. Cooper then decided to press the matter with the board’s audit committee, which put her in direct conflict with her boss, Sullivan, who ultimately backed down but warned her to stay out of such matters.
Knowing that Andersen had been discredited by the Enron case and that the SEC was investigating WorldCom, Cooper continued her investigation, often working late at night to avoid detection by their bosses. Ultimately, she and her team uncovered a $2 billion accounting entry for capital expenditures that had never been authorized—it appeared that the company was attempting to represent operating costs as capital expenditures in order to make the company look more profitable (Pulliam & Solomon, 2002). When Sullivan heard of the ongoing audit, he asked Cooper to delay her work until the third quarter, but she bravely declined. She went to the board’s audit committee and in June, Scott Sullivan and two others were terminated. Cooper was later recognized as one of the three “Persons of the Year” by Time magazine for her whistle-blowing efforts as depicted in Figure 1. Additionally, Cooper released her book Extraordinary Circumstances in 2008, which is a reflection on the challenges she faced to become a corporate whistleblower. Video 1 presents CNBC’s interview with Cynthia Cooper following her book release and her life after WorldCom. She mentions “misguided loyalty” as one of the reasons behind the WorldCom collapse—middle managers were hesitant to report fraud to the board of directors out of fear of losing their jobs.
Link to the CNBC interview with Cynthia Cooper on her experiences since WorldCom, the release of her new book, and the importance of corporate whistleblowing. Airdate: Tuesday, February 5, 2008
2. Corporate Whistleblowing
While globalization and technological developments have created many business opportunities, they have also introduced much malpractice. As the string of corporate scandals during the early 2000s have proven, organizations can incur considerable losses as a result of the negative publicity that accompanies the public disclosure of corporate illegalities (Chiu, 2003). Traditional corporate monitoring efforts have proved to be insufficient in preventing fraud, and whistleblowing, a form of proscoial behavior, is acquiring new significance as a mechanism of social and internal control. Whistleblowing can be defined as “the voluntary release of non-public information, as a moral protest, by a member or former member of an organization outside the normal channels of communication to an appropriate audience about illegal and/or immoral conduct in the organization or conduct in the organization that is opposed in some significant way to the public interest” (Chiu, 2003). Despite its value in corporate monitoring, whistleblowing usually brings undesirable consequences to the whistleblower, such as the loss of employment, threats of revenge, and social isolation at work—a reported 90 per cent of whistleblowers lose their jobs or are demoted (Chiu, 2003). Such repercussions deter many employees from reporting corporate misconduct, which allow frauds to continue and grow in magnitude. The most recent attempt to encourage employees to become more effective corporate mentors is the Sarbanes-Oxley Act of 2002, passed by Congress in response to corporate scandals. However, is it the role of the government to enforce internal monitoring? According to a Kantian perspective, whistleblowing can be considered a truly moral act and therefore employees should do so without outside interference.
Traditional corporate monitoring occurs through a variety of overlapping means, including: the company’s board of directors, external auditors and attorneys, and the government. “A primary advantage of these traditional corporate monitors is that they are external to the company…Independent directors purportedly provide dispassionate oversight of management” (Moberly, 2006). However, despite the advantage of external monitors, their position presents a significant challenge: monitoring the inner workings of a company from the outside. Even under the best possible circumstances, the information supplied to external monitors is likely to be incomplete and self-serving due to the information blocking and filtering by executives and middle managers. The rise of technology has only increased the complexity and secrecy of internal operations, enabling the external detection of fraud to be substantially delayed (as seen in the WorldCom case).
Corporate employees could be instrumental in solving the inherent information problems of traditional external corporate monitors due to their information advantage. The recent corporate scandals have demonstrated employees’ efficacy as monitors with accurate insider knowledge about the inner workings of their corporations. Viewed differently, however, the scandals also illustrate the difficulty of relying upon employees to function as effective corporate monitors; employees clearly have the potential to monitor corporations, but oftentimes this potential is not fully realized (Moberly, 2006). Numerous attempts have been made to pass legislature to encourage whistleblowing, but through the adoption a Kantian perspective, I believe that employees must be motivated by the desire to eliminate corporate fraud, rather than legal compliance, for whistleblowing to reach its full potential.
Philosopher Immanuel Kant is perhaps best known for his ethical theory, which has been applied to business ethics. At the base of Kant’s theory, he argued that, “the highest good was the good will. To act from a good will is to act form duty. Thus, it is the intention behind an action rather than its consequences that make that action good” (Bowie, 1999). He uses an example of a merchant to illustrate his point: if a merchant is honest so as to earn a good reputation, these acts of being honest are not genuinely moral. The merchant is only truly moral if he is honest because being honest is right. Persons of good will do their duty because it is their duty and for no other reason (Bowie, 1999). The act of whistleblowing fits into this categorical imperative of duty to do the right thing. The sole motive of the action is report corporate misconduct; there are no monetary gains or self-interested motives to “contaminate” the action.
Additionally, the proposed act of whistleblowing passes Kant’s test of morality. “Since Kant believed that every action has a maxim, we are to ask what would happen if the principle (maxim) of your action were a universal law (one that everyone acted on). Would a world where everyone acted on that principle be possible? If it can, then the decision to act would be morally permissible” (Bowie, 1999). If whistleblowing were a universal principle, all would benefit from the transparency and investor confidence would be maximized; therefore, according to Kant, the act of whistleblowing is morally permissible.
As businesses continue to grow larger and more complex, whistleblowing has emerged as a valuable tool for eliminating future corporate fraud. The case of WorldCom exemplifies the benefits of Cynthia Cooper’s effective whistleblowing, which lead to the discovery of the world’s largest corporate fraud. However, many employees are often deterred from whistleblowing due to the negative repercussions associated with whistleblowing, and fail report such incidents of misconduct. Although legislation has been passed to encourage internal corporate monitoring, I believe that effective whistleblowing is motivated within. Kant argued that the motives behind an action determine its morality, and its evident that corporate whistleblowing reflects a truly moral motivation for ethical business conduct that cannot be enforced by government regulation.
Akhigbe, Aigbe, Anna D. Martin, and Ann Marie Whyte. “Contagion effects of the world’s largest bankruptcy: the case of WorldCom.” Quarterly Review of Economics and Finance (July 2004): 48-64. LexisNexis Academic. Web. 15 Apr. 2012. <http://lexisnexis.com>.
Bowie, Norman E. A Kantain approach to business ethics: 3-16. 1999. Print.
Chiu, Randy K. “Ethical Judgment and Whistleblowing Intention: Examining the Moderating Role of Locus of Control.” Journal of Business Ethics 43 (2003): 65-74. Springerlink. Web. 15 Apr. 2012. <http://springerlink.com/content/>
Cooper, Cynthia. “WorldCom Whistleblower.” Interview by CNBC. First on CNBC. CNBC. 5 Feb. 200. CNBC Video. Web. 15 Apr. 2012. <http://video.cnbc.com/gallery/>
Heisler, Gregory. The Whistleblowers. 2002. “Persons of the Year 2002: Cynthia Cooper, Coleen Rowley, and Sherron Watkins.” By Richard Lacayo and Amanda Ripley. Time Magazine 21 Dec. 2002: n. pag. Time. N.p., n.d. Web. 15 Apr. 2012. <http://time.com>
Moberg, Dennis, and Edward Romar. WorldCom. Santa Clara University. Markkula Center for Applied Ethics, Santa Clara University. 2003. Web. 15 Apr. 2012. <http://scu.edu/ethics>
Moberly, Richard, “Sarbanes-Oxley’s Structural Model to Encourage Corporate Whistleblowers” (2006). College of Law, Faculty Publications. Paper 27. <http://digitalcommons.unl.edu/lawfacpub/27>
Southern District of New York. United States Bankruptcy Court. First Interim Report of Dick Thronburgh, Bankruptcy Court Examiner. By Dick Thornburgh. Ed. Kirkpatrick & Lockhart LLP. FindLaw. N.p., 4 Nov. 2002. Web. 15 Apr. 2012. <http://findlaw.com>.