The accounting scandal enveloping WorldCom Inc. grew out of a scheme so simple and brazen that top executives for the telecom giant should have known it would eventually collapse of its own weight, experts in corporate finance said yesterday.
But the pressure to meet Wall Street's earnings expectations, coupled with a culture of permissiveness among internal and external auditors, may have fed a misguided belief that the improper shifting of $3.8 billion in expenses could be covered long enough for the company to revitalize its slumping earnings.
"The only reason they live is to make their returns," said John F. Smith, a corporate finance expert and senior partner with Morris, Manning and Martin in Atlanta. "I don't think even the [chief financial officer] and his team thought any one decision would catch up with them."
The scheme was not complicated: The company's financial officers recorded routine maintenance expenses totaling $3.9 billion as capital expenditures, which can be written off over decades rather than booked as immediate expenses.
The misclassification inflated the company's profits and lowered its borrowing costs over a period of five quarters.
WorldCom says the fraud was discovered by its internal auditors, but outsiders question whether top officials were unaware of what was happening.
The same criticism was leveled at Arthur Andersen, the company's former external auditor.
"It's inconceivable that they didn't know about it at the top levels," said John P. McAllister, accounting department chairman at Kennesaw State University in Kennesaw, Ga. "Unlike with Enron, this is not bells and whistles with lots of risk and derivatives and complicated contracts. Every basic accounting student knows this stuff."
The fraud would have been easy to get past industry analysts and outside observers, experts said.
But the company's internal and external auditors should have spotted it or called it into question months ago.
"It's just amazing that anybody would think they could do this," McAllister said. "I think they must think they're not going to get caught."
It's not uncommon for companies to try to "manage" their earnings through a variety of accounting gimmicks designed to give the illusion of steady growth, analysts said.
In WorldCom's case, there was plenty of incentive.
The telecommunications company's true cash flow was dropping steadily over the past few years - something that would have alarmed investors and sent its shares plunging.
By recording certain expenses as long-term investments, Chief Financial Officer Scott D. Sullivan, who was fired Tuesday, made it look as though cash generated from operations was increasing at a comfortable pace.
But with billions of dollars being shuffled around, experts said, it was only a matter of time before the fraud came to light.
Constance Bagley, an associate professor at Harvard Business School and a former securities lawyer, said the WorldCom case is reminiscent of the insider trading scandals of the 1980s.
Similarly, a rash of corporate scandals in the past year has brought to light a new culture of permissiveness on Wall Street that is driving executives to make questionable decisions, Bagley said.
The WorldCom scandal comes after Enron Corp., Xerox Corp. and a number of other companies have restated earnings after similar revelations.
Bagley listed statistics showing that U.S. corporations were forced to restate earnings 270 times in 2001, up from an average of about 49 a year in the early to mid-1990s.
The increase comes despite a drop in the number of publicly traded companies.
"Frankly, you have auditors who aren't being the watchdogs they need to be and are instead being almost co-conspirators," she said.
"There's a significant element of arrogance and a sense of entitlement ... and not enough people with saner heads saying, 'Look, at some point the music is going to stop and there are not going to be enough chairs to jump into.' "