The case
WorldCom
On 9 June 2003, the US Bankruptcy Court of New York issued an
interim report (Thornburgh, 2003) which expanded on the Court’s
earlier find- ings (Thornburgh, 2002) of lack of corporate gov-
ernance, mismanagement and concern regarding the integrity of
WorldCom’s accounting and fi- nancial reporting functions. Amongst
the numer- ous incidents of mismanagement, corporate gov- ernance
failure and accounting irregularities, the most salient related to
the overstatement of re- ported profitability by inappropriately
capitaliz- ing very significant elements of operating costs. In
June and August 2002, WorldCom restated its previously filed
financial figures by $3.8 and $3.3 billion, respectively, primarily
in relation to this failure to charge operating costs to the profit
and loss account appropriately. The trigger for these re-
statements in part was an internal audit investiga- tion into the
capitalization of operating costs – al- though this only took place
after the departure of WorldCom’s dominant CEO and the replacement
of Andersen as the external auditor by KPMG. Indeed, an internal
audit of capital expenditure a year previously had become aware of
the existence of $2.3 billion of ‘corporate accruals’ in relation
to
capital expenditure, but had made no attempt to verify the
nature and propriety of these ‘accruals’. Internal audit at
WorldCom was an in-house department first set up in a small way in
1993,
but which had subsequently grown in numbers –
although it was never heavily resourced relative
to internal audit departments in other companies
of a similar size. Formally it had a dual report-
ing responsibility – reporting to both the Chief
Financial Officer (CFO) and the audit committee,
although the bankruptcy examiner had no doubt
that its functional reporting responsibilities were
to the CFO and that its existence and role were
3
very much at the behest of senior management. This perceived
dependence upon executive man- agement for resources led to the
work programme concentrating almost exclusively on operational
aspects, focusing on audits and projects that would be seen as
adding ‘value’ to the company, and seeking to identify ways to
maximize revenues, reduce costs and improve efficiencies. It did
not involve itself in financial auditing per se, and even when it
did check accounting entries to subsidiary ledgers it did not
normally follow these through to the general ledger – apparently to
avoid the perception of the duplication of work with the external
auditors Andersen.
The report of the bankruptcy examiner (Thorn- burgh, 2004)
also provides evidence of lack of uniform procedures within the
internal audit department relating to the conduct of audits,
preparation of reports, review of management responses and
follow-up procedures; a lack of co- operation with internal audit
by line management; limited access by internal auditing staff to
the com- pany’s computerized accounting and reporting systems;
unwarranted influence by management in the preparation and
negotiation of the internal audit reports; and a lack of a
systematic approach in relation to highlighting serious internal
con- trol weaknesses and tracking of management responses and
corrective action taken.
Another aspect of the corporate governance paradigm
highlighted by the WorldCom case re- lates to the cooperation and
liaison, or rather lack of it, between the internal auditors, the
external auditors and the audit committee. WorldCom had an audit
committee constituted in accordance with the requirements of the
Blue Ribbon Committee (1999) and, over the relevant period,
consisting of
four non-executive directors with varying degrees
of business experience and expertise. The commit-
tee met three to five times a year and at each meet-
ing would, inter alia, receive an information pack
prepared by the Director of Internal Audit and
on occasion would receive presentations from her.
Formally, internal audit reported to the audit com-
mittee but as the report notes: ‘while most mem-
bers of the Audit Committee perceived the Inter-
nal Audit Department as reporting to the Audit
Committee, that was not the case, functionally or
practically’. The audit committee only received executive summaries
of the actual audit reports, rarely the full reports. Perhaps more
importantly, the members of the audit committee appear to have
assumed there to be a much greater degree of co- ordination between
internal audit and external au- dit than actually took place, and
were not aware that Andersen did not receive copies of the internal
audit reports. In fact, communication between internal audit and
external audit was very limited, being largely restricted to joint
attendance at the meetings of the audit committee. The lack of
communication between the two is highlighted in relation to the
ability of the external auditor to provide annual reassurance to
the audit committee on the absence of material weaknesses in the
company’s systems of internal control, notwithstanding the
existence of internal audit reports, some of which documented
significant such weaknesses. It also appears to have been a factor
in the failure referred to above of internal audit to conduct
meaningful financial audit, even when aware of circumstances which
might have been expected to prompt further investigation.
Questions
1) Based on the paper identify four(4) coperate governance
weaknesses of WorldCom
2) Adduce respective recommendations to address each weakness
identified, to ensure compliance with corporate governance
principles.
3) Based on the paper and the corporate governance principles
set out in the preamble above, identify and explain the
following:
i. Four (4) actions that the board chairmen of the firm should
have taken in order to meet corporate governance requirements for
the firm.
ii. Four (4) actions that the chief executive officer of the
firm should have taken in order to meet corporate governance
requirements for the firms.
iii. Four (4) actions that the non-executive directors on the
management boards of the firm should have taken in order to meet
corporate governance requirements for the firm.
iv. Six (6) actions that the audit committee boards of the
firm should have taken in order to meet corporate governance
requirements for the firm.
v. Three (3) actions that the risk management committee of the
firm should have taken in order to meet corporate governance
requirements for the firm.
vi. Two (2) actions that the remuneration committee of the
firm should have taken in order to meet corporate governance
requirements for the firm.
vii. Four (4) actions that the internal auditors of the firm
should have taken in order to meet corporate governance
requirements for the firm.