In the wake of the Senate’s historic vote to put corporate wrong-doers behind bars for up to ten years, a suggestion to change the reporting line of internal auditors seems sort of minor.
The suggestion tends to carry a lot more weight, though, when it comes from an internal auditor who helped uncover the biggest accounting error — perhaps the biggest accounting fraud — in U.S. corporate history.
Glyn Smith, a senior manager in WorldCom’s internal audit department, worked closely with Cynthia Cooper, the vice president of audit, in the investigation of that company’s capital expenditures and capital accounts. The duo’s probing eventually unearthed the telco’s treatment of line charges as capital investments. As a result of their work, WorldCom was forced to increase its previously stated expenses for 2001 by $3.01 billion and increase expenses for the first quarter of 2002 by $800 million.
In an exclusive interview with CFO.com late last week, however, the WorldCom employee voiced strong general views about the need for internal auditors to pursue their work without ties to finance executives or heads of operating units.
Indeed, by Smith’s lights, an internal auditor’s primary allegiance should be to the audit committee of the board of directors. “In the post-Enron, post-Andersen environment,” he says, “internal audit really needs to function independently of either the CEO or the CFO.”
At the Center of the WorldCom
According to sworn public documents filed by WorldCom, the telco’s internal audit team seems to have demonstrated why such a setup may be preferable.
On June 11, after Cooper discussed her investigation with then-CFO Scott Sullivan, Sullivan asked the head of WorldCom’s audit team to delay their review. But Cooper and Smith pressed on with the audit.
The next day, the two internal auditors called Max Bobbitt, the chairman of the audit committee, to discuss “questionable transfers” the company made during 2001 and the first quarter of 2002, according to the sworn statement. The two auditors apparently discovered that the company had begun accounting for its line costs (payments for network services and the use of third-party facilities) as capital expenditures — and not as expenses.
That treatment was out of whack with industry practice. It also didn’t jibe with GAAP.
The WorldCom SEC filing indicates that, during the call to the audit committee chairman, Smith himself told Bobbitt about the key points Scott Sullivan made in his discussion with colleague Cooper. The points included the CFO’s request for a delay of the audit review, and his claim that the capitalization issues would be cleared up in the second quarter of 2002.
Along with Cooper, Smith also interviewed WorldCom senior vice president and controller David Myers (who later resigned without severance). In addition, Smith attended the June 20 audit committee meeting where the expense transfers were described, according to the company’s sworn statement.
On June 26, WorldCom management announced the discovery of the expense transfers, along with the firing of Sullivan. The telco’s management also noted that the company would be forced to restate its earnings for the time in question.