Cynthia Cooper’s new book on WorldCom details inside story of firm’s historic fall

Cynthia Cooper would not buckle under the pressure. In 2002, Cooper was Vice President of Internal Audit at WorldCom when she uncovered company officials’ use of something other than generally accepted accounting principles. Time magazine named Cooper one of its “Persons of the Year 2002.”

Following is an excerpt from her new book, “Extraordinary Circumstances: The Journey of a Corporate Whistleblower” (Wiley). The excerpt from Chapter 23, “The Confrontation,” revolves around an audit committee meeting with CFO Scott Sullivan, Cooper and others on June 20, 2002:

“Scott arrives almost an hour late, trailed by a large entourage: David Myers; John Sidgmore; Ron Beaumont, the COO; Mike Salsbury, the general counsel; and a team of high-powered attorneys from Simpson, Thacher, & Bartlett, a prestigious New York firm with an office in Washington.

A few people awkwardly shake hands. Passing behind me, Scott briefly rests his hand on my shoulder, but doesn’t say anything and keeps walking. I have no idea whether he means it as a friendly gesture. I’ve had no interaction with him for six days.

Farrell takes a seat at the head of the conference table, facing an attorney representing WorldCom, while the rest of us line the sides. Around 5:00 pm, Max opens the meeting, handing out several of the charts Internal Audit has put together summarizing the accounting entries. Calmly and fluently, he presents the findings.

‘‘Internal Audit has discovered some questionable transfers from line-cost expense accounts to asset accounts beginning in the second quarter 2001 and continuing through the first quarter 2002,’’ he says. ‘‘The cumulative total of the transfers is $2.24 billion in 2001 and $818 million in 2002.’’ Max adds that the impact to WorldCom’s financial statements is to increase reported earnings each quarter by the amount transferred. He then turns to Scott, asking him to explain his rationale for the entries.

‘‘I would like to get KPMG’s comments on this issue first,’’ interjects one of the outside attorneys.
Farrell is calm but firm. He explains that he’s not aware of any provision in generally accepted accounting principles that would support these entries.

Scott adamantly defends the transfers. He first gives the business rationale for the journal entries. He explains that 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 also 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 either have no or very little customer traffic. Scott has provided his business reason for the entries, but he hasn’t provided an accounting rationale for why he moved these lease amounts from an expense on the income statement to an asset on the balance sheet.

Next, Scott launches into accounting shop talk—usually the point at which non-accountants’ eyes begin to glaze over, but not today. Today every person is hanging on his every word, aware that the company’s future hinges on the validity of what he says. Scott deflects the discussion to the ‘‘matching principle’’—an age-old accounting convention that delays expensing costs so that they are much more aligned with the future benefit an asset will generate. But the ‘‘matching principle’’ only holds if the original journal entries to account for the leases were correct.

Scott again deflects by throwing out a second accounting issue—‘‘impairment’’ of the company’s asset base. He argues that based on the economic downturn in telecom, and the decline in WorldCom’s first quarter revenue, it is now apparent the company’s capital assets, including the telecom network and amounts he transferred from line-cost expense to assets, are of less value than the amounts currently on the books. Therefore, he wants to take an ‘‘impairment charge’’ in the second quarter 2002, effectively writing off the line-cost amounts booked as capital assets. Scott has again moved the discussion away from whether the original journal entries were proper, to whether an impairment charge should be taken, presuming the original entries were correct.

Scott continues to sidestep the real issue, insisting the entries weren’t made to meet earnings; that accounting for ‘‘line costs’’ requires judgment; and that the transfers were made using estimates. He also says he didn’t see the need to consult anyone from Arthur Andersen on these matters.

Scott adds that David can provide support. I’m wondering if he knows David has already told me there is none. David is listening blankly from the end of the table. Scott asks the Audit Committee if they will give him some time to provide support for his claims.

Max decides to take the meeting into an executive session. Ron, Scott, David, Glyn and I are asked to leave. The CEO, general counsel, outside counsel and external audit partners stay.

Those of us who leave the room go to a small conference room to wait ... After what seems to be an hour or more, Max finally comes out. KPMG hasn’t made a final decision on the accounting. Scott is given the weekend to support his position with evidence from accounting literature. The Committee will meet again on Monday to listen to his argument.

Max tells Scott and David that they can leave. I watch as they walk out the door. ‘‘Cynthia, now I want you and Glyn to go on back home,’’ Max says in a fatherly tone, huddling us both together, his hands on our shoulders. ‘‘You’ve done your job and you need to go home now. You can continue working on your capital expenditure audit, but I don’t want you working on this prepaid capacity anymore. This is an issue between KPMG and management. KPMG will handle it from here’’...

For the first time in what seems an eternity, I feel relief—the issue is finally being looked into by the Audit Committee. But my mind eventually goes back to Scott’s arguments in the meeting. Was it all just one big smokescreen? I don’t believe Scott can support the entries, and my relief quickly fades when I think about the likely consequences—for employees, shareholders, the company.

Exhausted, Glyn and I head to the airport to board a plane.

Scott is in the office this weekend, working feverishly with one of his staff to compose a white paper defending his position. Like his arguments at the Audit Committee meeting, it will rely heavily on the ‘‘matching principle.’’

Since the Audit Committee meeting, we’ve fished out even more suspicious entries. I now have a full view of 49 prepaid capacity accounting entries, totaling $3.8 billion, recorded over all four quarters in 2001 and the first quarter of 2002.

The more I stare at the entries, the more sinister they seem. They’re different from each other, the pattern of movement between accounts changing from one quarter to the next. Still, the entries all have the same end result. While some are described as prepaid capacity, others are labeled, simply, ‘‘SS entry.’’ Mark Abide will later testify that he keyed in Scott’s initials because he was told by another accounting director that the entries were coming from David and Scott.

It’s 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.

The entries are ‘‘on-top’’ (made at the Corporate level) and ‘‘post-close’’ (made after the books are closed). As management will later admit, it compared company results to the earnings guidance that had been given to Wall Street and then made adjustments to make up the difference. Because this was done at the Corporate level, employees within the business units whose numbers were being manipulated didn’t have access to the entries.

Based on the user IDs we see in the system, employees in two different accounting groups—General Accounting and Property Accounting—physically made the entries. Sometimes mid-level managers—Mark Abide and Betty Vinson—made the entries. Sometimes lower-level staff reporting to them keyed in the figures, perhaps without understanding their significance.

It’s Mark Abide and one of his staff who divided amounts in smaller increments. In one quarter, Mark made 10 entries, each for $54.4 million and all to the same ‘‘fiber optic cable’’ account. In another quarter, Mark instructed one of his employees to make 12 entries, this time to different accounts, and in descending round dollar amounts—$52 million, $51 million, $50 million, and so on.

While Mark sent us the article ‘‘Accounting for Anguish,’’ the allegations in it would not have led to the prepaid capacity entries. If we hadn’t already had a capital expenditure audit on our plan, we likely would have just tested the article’s allegations, but the wider net we cast uncovered much more.”

Reprinted with permission of John Wiley & Sons Inc.