1. Advanced Forensic Accounting TONE AT THE TOP Max P. Liphart CPA/ CFF, CMA, CFE 1Copyright 2011 PCG Consultants

2. Advanced Forensic Accounting TONE AT THE TOP: HOW MANAGEMENT CAN PREVENT FRAUD IN THE WORKPLACE PRESENTED BY THE ASSOCIATION OF CERTIFIED FRAUD EXAMINERS and THE AICPA 2Copyright 2011 PCG Consultants

3. Advanced Forensic Accounting What is the “Tone at the Top”? ◦Tone at the top refers to the ethical atmosphere that is created in the workplace by the organization's leadership. ◦Ideally whatever tone management sets will have a trickle- down effect on employees of the company. ◦If the tone set by managers upholds ethics and integrity, employees will be more inclined to uphold those same values. ◦However, if upper management appears unconcerned with ethics and focuses solely on the bottom line, employees will be more prone to commit fraud because they feel that ethical conduct is not a focus or priority within the organization. ◦Employees pay close attention to the behavior and actions of their bosses, and they follow their lead. In short, employees will do what they witness their bosses doing. 3Copyright 2011 PCG Consultants

4. Advanced Forensic Accounting Tone at the Top and Treadway Commission The National Commission on Fraudulent Reporting (called the Treadway Commission) released a groundbreaking study in 1987 that reported the casual factors that lead to fraudulent behavior and financial statement fraud. According to the Commission, the tone at the top plays a crucial and influential role in creating an environment in which fraudulent financial reporting is ripe to take place. 4Copyright 2011 PCG Consultants

5. WorldCom Background WorldCom For a time, WorldCom was the United States' second largest long distance phone company (after AT&T).United phone companyAT&T WorldCom grew largely by aggressively acquiring other tele-communications companies, most notably MCI Communications.MCI Communications It also owned the Tier 1 ISP UUNET, a major part of the Internet backbone.Tier 1 ISPUUNETInternet backbone 5Copyright 2011 PCG Consultants

6. WorldCom Background Bernie Ebbers Co-founded the telecommunications company WorldCom in 1983 and is the former chief executive officertelecommunicationscompany WorldComchief executive officer In 2005, he was convicted of fraud and conspiracy as a result of WorldCom's false financial reporting, and subsequent loss of US $100 billion to investors.fraud conspiracy US $100 billion The WorldCom scandal was, until the Madoff schemes came to light in 2008, the largest accounting scandal in United States history.MadoffUnited States 6Copyright 2011 PCG Consultants

7. WorldCom Background Bernie Ebbers (continued) Currently serving a 25-year prison term at Oakdale Federal Correctional Complex in LouisianaLouisiana CNBC named Ebbers as the fifth-worst CEO in American history CNBC Time magazine named him the tenth most corrupt CEO of all time. Time magazine WorldCom Background In the year 2000, the telecommunications industry entered a downturn and WorldCom’s aggressive growth strategy suffered a serious setback when it was forced by the US Justice Department to abandon its proposed merger with Sprint in mid 2000. 7Copyright 2011 PCG Consultants

8. WorldCom Background WorldCom Background (continued) By that time, WorldCom’s stock was declining and Ebbers came under increasing pressure from banks to cover margin calls on his WorldCom stock that was used to finance his other businesses (timber and yachting, among others). margin calls During 2001, Ebbers persuaded WorldCom’s board of directors to provide him corporate loans and guarantees in excess of $400 million to cover his margin calls. 8Copyright 2011 PCG Consultants

9. WorldCom Background WorldCom Background (continued) The board hoped that the loans would avert the need for Ebbers to sell substantial amounts of his WorldCom stock, as his doing so would put further downward pressure in the stock's price. Ebbers was ousted as CEO in April 2002 and replaced by John Sidgmore, former CEO of UUNet Technologies, Inc.John SidgmoreCEOUUNet Technologies, Inc. Beginning modestly in mid-year 1999 and continuing at an accelerated pace through May 2002, the company (under the direction of Ebbers (sentenced to 25 years), Scott Sullivan CPA (CFO) – (sentenced to 5 years), David Myers (Comptroller) – (sentenced to 1 year) and Buford "Buddy" Yates (Director of General Accounting – sentenced to 1 year) used fraudulent accounting methods to mask its declining earnings by painting a false picture of financial growth and profitability to prop up the price of WorldCom’s stock.Scott SullivanComptroller 9Copyright 2011 PCG Consultants

10. WorldCom Background The Fraud The fraud was accomplished primarily in two ways: ◦Underreporting ‘line costs’ (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them.capitalizingexpensing ◦Inflating revenues with bogus accounting entries from "corporate unallocated revenue accounts". (the “Cookie Jar”) 10Copyright 2011 PCG Consultants

11. WorldCom Background The Fraud (continued) ◦In 2002, a small team of internal auditors at WorldCom worked together, often at night and in secret, to investigate and unearth $3.8 billion in fraud. ◦Shortly thereafter, the company’s audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, Myers resigned, Arthur Andersen withdrew its audit opinion for 2001 and paid $65 million to settle allegations it failed to protect investors from WorldCom's historic accounting fraud.Arthur Andersen ◦The U.S. Securities and Exchange Commission (SEC) launched an investigation into these matters on June 26, 2002.U.S. Securities and Exchange Commission ◦By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion. 11Copyright 2011 PCG Consultants

12. WorldCom Background Story of a Convicted Criminal: Walt Pavlo ◦Walt Pavlo- ex-senior manager is a convicted white-collar criminal who claims that he was pressured by his bosses to commit financial statement fraud at MCI/WorldCom. ◦In January of 2001, Pavlo received a 41-month federal prison sentence for money laundering, wire fraud, and obstruction of justice. 12Copyright 2011 PCG Consultants

13. WorldCom Background Story of a Convicted Criminal: Walt Pavlo (continued) ◦He was a Senior Manager in Billing & Collections at MCI/WorldCom and dealt with customer payments, credits and reconciliations of accounts. He felt pressure from upper level management at MCI/WorldCom to constantly achieve revenue growth in the company. Employees were pressured to meet or exceed these projections. ◦As Pavlo watched his bosses manipulate the company’s financial records, he soon began to manipulate them himself. Soon after, Pavlo’s own employees would learn to conduct fraudulent activity under their boss. Pavlo and his supervisors met to devise ideas on how to cook the company’s books. Financial records were manipulated by Pavlo, his superiors, and his colleagues in a widespread effort to fraudulently make the company look like it was meeting revenue growth projections, even though it wasn’t. ◦Pavlo learned how to conceal uncollectible debt, which boosted the company’s assets and profits. ◦Auditors eventually found unusual journal entries made by Pavlo and confronted him about it. It was then that he confessed to his fraudulent behavior. 13Copyright 2011 PCG Consultants

14. Advanced Forensic Accounting Fraud and Tone at the Top A DVD Presented by the ACFE and the AICPA 14Copyright 2011 PCG Consultants