Walt1 Pavlo joined MCI in 1992 and rapidly became second in command at the company’s finance or long-distance collections unit, as is documented in the ethics case “Manipulation of MCI’s Allowance for Doubtful Accounts” in Chapter 5.

Walt left MCI in 1996 and ultimately resigned in early 1997. During the four years and just afterward, he participated in several frauds on MCI and on customers who were dealing with MCI.

The frauds against MCI are detailed in the case noted earlier, and the frauds he perpetrated against others are detailed here. Walt’s motivation, opportunity for, and rationalization of these frauds are analyzed in the illustration in Figure 7.3.

Walt initially became caught up in an attempt to cover up the fact that many of the accounts receivable from companies that resold MCI’s telephone connection time to consumers were far past due and collection ultimately unlikely. Senior executives at MCI were reluctant to show the true state of MCI’s bad debts2 because they wanted to isolate the company’s earnings and assets in order to attract a favorable takeover bid buyout of shares that would make them rich. Consequently, although total bad debts approached

\($120\) million, upper management encouraged MCI finance staff to use a number of techniques to minimize the visibility of the problem and limit the annual write-off of bad debts to only \($15\) million. The minimization techniques included the following:

• Restructuring a \($55\) million account receivable into the form of a promissory note—but one without collateral—so that the amount would not appear old in an aging analysis.

• Restructuring other bad debts into notes in a similar fashion.

• Lapping—applying checks from one creditor to the account of another to make it appear that bad accounts were being paid. The accounting system was notorious for its delays and inaccuracies, so if a customer complained about his account, it was “fixed” by a transfer from another customer’s account with only a few accounting staff knowing what was going on.

• Disappearing an account—an extension of lapping where the balance on an account is eliminated by spreading it into the accounts of others through lapping.

• Recording “cash in transit” and using it to reduce problem accounts receivable—large payments of \($50\) million to \($60\) million per month from WorldCom, for example, were picked up by a clerk, faxed in, and recorded as a debt to cash in transit with the credit to a problem account. When the real check arrived, the entries would be reversed and proper entries made, but the interval of a few days allowed some “management” of accounts receivable.

• Misapplying vagabond payments—

millions of dollars per month were sent in, and MCI’s inefficient accounting system could not figure out which account the money belonged.

Walt was encouraged to “make his bad debt aging numbers,” as he says in his own words: “Instead of gaming the system, MCI Finance had turned the system into a game, going so far as to send around a monthly internal report, grading departments on how well they did in sticking to their ‘aging’ numbers. Pavlo got a hearty pat on the back from his superiors, and he passed on the favor by praising his staff for their heroism in battle.”3 Walt was seen—

and saw himself—as a “solutions provider”

for MCI in managing the exposure to and of its bad debts.

One of Walt’s customers, Harold Mann, introduced him to Mark Benveniste, the owner of a company called Manatee Capital, who had a proposal for

“factoring” MCI’s accounts receivable—

paying MCI up front for a portion of certain receivables and collecting the entire receivable when it was paid. MCI would get their money much faster in return for a factoring discount or fee. It sounded great except that Manatee would not do the deal unless MCI guaranteed any accounts that proved to be uncollectible.4 In Walt’s terms, Manatee would, in effect, advance or loan money to MCA’s clients to allow them to pay early, provided that MCI guaranteed these loans—and Walt was sure that MCI would not do so.........

Questions:-

1. What aspects of the schemes described in this case were

a. unethical?

b. illegal?

c. fraudulent?
2. When would a healthy skepticism by senior management or professional skepticism by an accounting or legal professional have been useful in combating the opportunities faced by Walt?
3. Was the Hilby caper a victimless crime and therefore okay?
4. What ethical issues should have occurred to Walt and MCI in regard to the schemes described?
5. What governance measures might have protected MCI if they had been in place and enforced?
6. What is the role of internal auditors in regard to such schemes?