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Lies My C.F.O. Told Me, Act XIII

By: Floyd Norris
New York Times, June 30, 2002

HO says big has to be complicated?

The latest, and biggest, claim of accounting fraud — the overstatement of profits by nearly $4 billion at WorldCom — is easy to understand. If Enron's accounting manipulations sometimes were reminiscent of Rube Goldberg, WorldCom's maneuvers were elegantly simple.

At bottom, nearly all accounting frauds are designed to raise profits in one of two ways: by overstating revenues or understating expenses. Since profits are simply revenues minus expenses, either has the desired effect.

At Enron, the ploys were overlapping and complex, and performed with an audacious flair that has impressed connoisseurs of corporate trickery. Enron created a series of partnerships that made often baffling trades, some involving Enron stock. It also juggled numbers so that a failed deal with Blockbuster yielded instant profits. So some tactics hid expenses and some produced nonexistent revenues.

WorldCom's sleight-of-bottom-line is also impressive, but in a completely different way. Over 15 months, $3.8 billion of expenses — money that it paid to other phone companies for the use of their lines to complete calls — were hidden in plain sight.

No off-balance sheet partnerships were needed. WorldCom simply classified the spending as capital expenditures, as it would if it had spent the money to build a new plant or buy a new computer. Fewer expenses meant the ledger showed more assets, more profits and more operating cash flow than it really had. Probably not by coincidence, the hidden expenses were just enough to let it meet earnings expectations.

That sum is more than seems to have been involved at Enron, and larger than the amounts of revenue that Xerox arbitrarily moved from one period to another to make its numbers. The amounts at all three companies dwarf the more than $500 million in overstated profits at the former CUC International, which only two years ago was being described as the largest accounting fraud ever.

One thing the WorldCom fraud shows is the value of a fresh set of eyes on the books. Arthur Andersen, WorldCom's old auditors, says it was misled about what was going on, and never would have approved the accounting if its chief financial officer, Scott Sullivan, had explained what he was doing. But the maneuver was quickly uncovered by a WorldCom inside auditor who had been asked to review the company's capital spending by the company's new chief executive.

That is similar to other accounting frauds. The CUC fraud, which involved reporting nonexistent revenues, went unnoticed for years by CUC's auditors from Ernst & Young, but were quickly found after the company merged into the Cendant Corporation. Another of this year's scandals, involving Peregrine Systems, a software company, was revealed within weeks of that company replacing Andersen.

Accounting irregularities come in all flavors, from the complex to the simple, and there is no assurance that auditors will find them. One obvious remedy would be to require the periodic changing of auditing firms, but companies and auditors are strongly opposed, and the idea is not included in either the bill passed by the House or the one pending in the Senate.

The Securities and Exchange Commission is, however, about to require that chief executives and chief financial officers at the 1,000 largest companies formally certify that their books are accurate. Whether that will reassure investors remains to be seen.

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