IT Management Reference Guide

This is the second of a two-part article on business ethics and corporate scandals. In part one I discussed the issues of personal and business ethics, and then described two recent corporate scandals involving RadioShack and Tyco International. In this segment part two I look at two even larger recent scandals involving WorldCom and Enron.

The WorldCom Case

On November 10, 1997, WorldCom and MCI Communications merged to form the US$37 billion company of MCI WorldCom, later renamed WorldCom. This was the largest corporate merger in United States history. The company's subsequent bankruptcy in 2003 arising from accounting scandals was symptomatic of the dotcom and Internet excesses of the late 1990s.

After its merger in 1997, MCI WorldCom continued on with more ambitious expansion plans. On October 5, 1999 it announced a US$129 billion merger agreement with Sprint Corporation. This would have made MCI WorldCom the largest telecommunications company in the United States, eclipsing AT&T for the first time. But the US Department of Justice and the European Union (EU), fearing an unfair monopoly, applied sufficient pressure to block the deal. On July 13, 2000 the Board of Directors of both companies acted to terminate the merger; later that year MCI WorldCom renamed itself WorldCom.

The failure of the merger with Sprint marked the beginning of a steady downturn of WorldCom's financial health. Its stock price was declining, and banks were pressuring CEO Bernard Ebbers for coverage of extensive loans that had been based on over-inflated stock. The loans financed WorldCom expansions into non-technical areas such as timber and yachting that never proved to be profitable. As conditions worsened, Ebbers continued borrowing until finally WorldCom found itself in an almost untenable position. In April 2002 Ebbers was ousted as CEO, and replaced with John Sidgmore of UUNet Technologies.

Beginning in 1999 and continuing through early 2002, the company used fraudulent accounting methods to hide its declining financial condition by presenting a misleading picture of financial growth and profitability. In addition to Ebbers, others who perpetuated the fraud include CFO David Sullivan, Controller David Myers and the Director of General Accounting Buford Yates.

In June 2002 internal auditors discovered some $3.8 billion of fraudulent funds during a routine examination of capital expenditures and promptly notified the WorldCom board of directors. The board acted swiftly: Sullivan was fired, Myers resigned and Arthur Anderson (WorldCom's external auditing firm) was replaced with KPMG. By the end of 2003, it was estimated that WorldCom's total assets had been inflated by almost $11 billion.

On July 21, 2002 WorldCom filed for Chapter 11 bankruptcy protection in the largest such filing in United States history. The company emerged from bankruptcy as MCI in 2004 with approximately $5.7 billion in debt and $6 billion in cash. On February 14, 2005 Verizon Communications bought MCI for $7.6 billion. In December 2005 Microsoft announced MCI would join them by providing Windows Live Messenger customers with voice over the Internet protocol (VoIP) service for calls around the world. This had been MCI's last totally new product called "MCI Web Calling," and has now been renamed "Verizon Web Calling." It continues to be a promising product for future markets.

CEO Bernard Ebbers was found guilty on March 15, 2005 of all charges and convicted of fraud, conspiracy and filing false documents with regulators. He was sentenced to 25 years in prison. He began serving his sentence on September 26, 2006 in Yazoo City, Mississippi. The other executives who co-conspired with Ebbers all pled guilty to various charges and were given slightly reduced sentences.

There are many lessons to be learned from this case, but two elements especially stand out. One is that the fraudulent accounting was found during a routine examination of company records, indicating a fair degree of arrogance on the part of the conspirators as little was done to conceal the irregularities. Second, it marked a rare instance of a reputable external accounting firm being involved, at least peripherally, with suspicious activities. But the tarnishing of Arthur Anderson's reputation was only beginning as we will see in the next section.

The Enron Case

The most famous case of corporate fraud during this era was that of the Enron Energy Corporation headquartered in Houston, Texas. It resulted in itself and its external auditing firm both being put out of business. Never before in United States business have two major corporations fallen more deeply or more quickly. This case epitomizes how severe the consequences can become as a result of unethical business practices.

Enron enjoyed profitable growth and a sterling reputation during the late 1990s. It pioneered and marketed the energy commodities business involving the buying and selling of natural gas, water and waste water, communication bandwidths and electrical generation and distribution, among others. Fortune magazine named Enron "America's Most Innovative Company" for six consecutive years from 1996 to 2001. It was on Fortune's list of the "100 Best Companies to Work for in America" in 2000.

But by 2001 Enron's global reputation was becoming undermined by persistent rumors of bribery and strong-armed political tactics to secure contracts in Central America, South America, Africa, and the Philippines. In July 2001 Enron admitted to incurring a $102 million loss and in November of the same year Enron admitted to hiding hundreds of millions more. By the end of 2001 the financial collapse of Enron as a corporation was in full effect and its stock price plummeted to less than one dollar.

In 2002 a complex network of suspicious offshore partnerships and questionable accounting practices surfaced. The mastermind behind these activities was Enron CFO Andrew Fastow. He was indicted on November 1, 2002, by a federal grand jury in Houston on 78 counts including fraud, money laundering and conspiracy. He and his wife Lea Fastow, former assistant treasurer, accepted a plea agreement on January 14, 2004. Andrew Fastow agreed to serve a ten-year prison sentence and pay $23.8 million and his wife agreed to a five-month prison sentence. In exchange, both would testify against other Enron corporate officers.

Federal prosecutors issued indictments against dozens of Enron executives. Key among these were Kenneth Lay, the former Chairman of the Board and Chief Executive Officer and Jeffrey Skilling, former Chief Executive Officer and Chief Operating Officer. They were served in July 2004 with a 53-count, 63-page indictment covering a broad range of financial crimes. Among these was bank fraud, making false statements to banks and auditors, securities fraud, wire fraud, money laundering, conspiracy and insider trading.

Lay pled not guilty to his eleven criminal charges claiming he had been misled by those around him. His wife, Linda Lay, also claimed innocence to a bizarre set of associated circumstances. On November 28, 2001, Linda Lay sold approximately 500,000 shares of her Enron stock (when its value was still substantial) some 15 minutes before news was made public that Enron was collapsing at which time the stock price sunk to under one dollar.

After a highly visible and contentious trial of Lay and Skilling, the jury returned its verdicts on May 25, 2006. Skilling was convicted on 19 of 28 counts of securities fraud and wire fraud and acquitted on the remaining nine, including insider trading. He was sentenced to 24 years, 4 months in prison which he began serving on October 23, 2006. Skilling was also ordered to pay with his own money $26 million to the Enron pension. Lay was convicted of all six counts of securities and wire fraud and sentenced to 45 years in prison. On July 5, 2006, Lay died at age 64 after suffering a heart attack the day before.

The Arthur Andersen Case

Corporate officers from Enron were not the only ones to suffer the consequences of the scandal. On June 15, 2002, Arthur Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron. On May 31, 2005, the Supreme Court of the United States unanimously overturned Andersen's conviction due to flaws in the jury obstructions. Despite this ruling, it is highly unlikely Andersen will ever return as a viable business.

Arthur Andersen was founded in 1913 and enjoyed a highly regard reputation for most of its history. But the firm lost nearly all of its clients after its Enron indictment, and there were over 100 civil suits brought against it related to its audits of Enron and other companies, including WorldCom. From a peak of 28,000 employees in the United States and 85,000 worldwide, the firm now employs roughly 200 people, most of who are in Chicago handling the various lawsuits. Andersen was considered one of the "Big Five" large international accounting firms, shown in Listing 1, which has since become the "Big Four."

Figure 1 Big Five Accounting Firms in 2002

• Arthur Andersen
• Deloitte & Touche
• Ernst & Young
• KPMG
• PricewaterhouseCoopers

Summary

This concludes the second part of the two-part series on Ethics and Scandals. In this final segment I discussed the issues of personal and business ethics, and then described two of the largest corporate scandals in U.S. history: WorldCom and Enron. In subsequent sections of this Reference Guide I will present some of the recent legislation that was enacted in direct response to these scandals, and point out the impact these new laws have on the management of IT organizations.

References

• http://en.wikipedia.org/wiki/Worldcom
• http://en.wikipedia.org/wiki/Enron