Directors asked how they failed to spot fraud

Serious and wide-ranging questions were being asked yesterday about how WorldCom's board of directors failed to detect the simple but catastrophic accountancy discrepancy which has brought the company to the verge of bankruptcy. The US Treasury Secretary, Paul O'Neill, said corporate executives who falsely certified company finances should go to jail.

The impropriety at the heart of WorldCom's finances was discovered only a few weeks ago by the company's the head of internal audit, Cynthia Cooper. When she discovered the chief financial officer, Scott Sullivan, had been using an "unorthodox" accounting technique, listing charges paid to telephone companies as capital expenditure rather than operating costs, she informed the head of the firm's auditing committee. Mr Sullivan was fired on Tuesday.

The man who ordered the audit, WorldCom's new chief executive, John Sidgmore, said he was shocked by the discovery of the accountancy fraud, which was formally revealed to the board on Monday.

Analysts demanded to know why the board had failed so completely to detect the impropriety before then. How, they asked with just a trace of dark humour, could the telecommunications company simply turn around a simply say, "Sorry, wrong number"?

Charles Elson, director of the Centre for Corporate Governance at the University of Delaware, said: "This board is certainly no stranger to corporate governance controversy, most notably the whole brouhaha over loans made to [former CEO Bernard] Ebbers."

WorldCom's board consists of 11 directors, eight of whom are considered "independent", as defined by the National Association of Securities Dealers. Its audit committee is charged with reviewing the company's financial statements.

The statement the company filed this year with the Securities and Exchange Commission (SEC), says the four-person committee met five times in 2001 to review the firm's financial statements. The company now says these statements inflated earnings before interest, taxes and depreciation by $3.8bn.

Nell Minnow, a commentator on corporate structure and editor of Corporate Library told TheStreet.com, a online financial news site, that she believed the company's directors were unqualified to understand what was happening.

The statement filed by WorldCom last May said: "The members of the audit committee are not professionally engaged in the practice of auditing or accounting and are not experts in the fields of auditing or accounting. Members of the audit committee rely without independent verification on the information provided to them and on the representations made by management and the independent auditors.

"Accordingly, the audit committee's oversight does not provide an independent basis to determine that management has maintained appropriate accounting and financial reporting principles or appropriate internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations."

With the SEC having already having filed civil fraud charges against WorldCom and with the US Justice Department said to have launched a criminal investigation, Secretary O'Neill said: "I think we've got to prosecute people to the full extent of the law. In some cases we need to strengthen the law so the government can prevent unscrupulous executives from looting their companies."

Mr O'Neill, a former chief executive of Alcoa Inc, added: "It's not possible for it to have been done by one individual. The scope of what they've done at WorldCom requires complicity of quite a few people, I think, because the numbers are so huge. The accounting technique they used is so fundamental. It's just mind-boggling."

On ABC's Good Morning America, he backed the SEC chairman Harvey Pitt's comment advocating criminal prosecution of executives who falsely certify corporate finances. "We think that's the right step," he added.

President George Bush, who said on Wednesday that he found WorldCom's behaviour "outrageous", said yesterday, before a meeting with Russia's President Vladimir Putin at the G8 summit in Canada: "If you are a responsible citizen and you run a corporation in America, you must fully disclose all assets and liabilities, and you must treat your shareholders and employees with respect."

Analysts warned that WorldCom, owner of the MCI long-distance business and one of the world's biggest internet "backbone" networks, could declare bankruptcy within a week, joining Enron as one of the most spectacular failures of the so-called new economy.

With more than $100bn in assets reported at the end of March, a WorldCom bankruptcy would be twice as large as Enron's record-setting fall last autumn and four times as big as that of Global Crossing in January.

Late on Wednesday, the SEC filed civil charges against WorldCom, partly to stop the company destroying documents, as happened in the case of Enron. Its suit said: "In a scheme directed and approved by its senior management, WorldCom disguised its true operating performance by using undisclosed and improper accounting that made the company appear more profitable than it was."