The case

WorldCom

On 9 June 2003, the US Bankruptcy Court of New York issued an interim report (Thornburgh, 2003) which expanded on the Courts earlier find- ings (Thornburgh, 2002) of lack of corporate gov- ernance, mismanagement and concern regarding the integrity of WorldComs 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 WorldComs 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

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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- panys 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 companys 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.