When Good Employees Go Bad

Posted on Wednesday, December 14, 2016

What makes an apparently ideal employee turn into a white-collar criminal? Companies can learn from the case of Walt Pavlo, who served two years in federal prison for money laundering, wire fraud and obstruction of justice, in the MCI WorldCom scandal.

A New Career

These days, Walt Pavlo has a new career on the lecture and consulting circuit. In his lectures, he speaks of the pressure he was under and how easily one ethical slip can lead to another and to the eventual destruction of a career.

He insists there must be an ethical roadmap in corporate life and is now an advocate for strict standards.

And, perhaps most importantly, he criticizes the "go along to get along" philosophy where colleagues needlessly become enmeshed in a downward spiral. He encourages people to speak out about ethical and legal workplace violations.

Along with other famous convicted fraudsters such as Frank Abagnale, whose life inspired the film "Catch Me If You Can," Pavlo's ethical and legal missteps can serve as a cautionary tale for business executives and future corporate leaders.

Pavlo's story has been turned into a training video and report called "Fraud and the Tone at the Top," which is used by the Association of Certified Fraud Examiners (ACFE) and the AICPA.

In the 1990s, Pavlo was a senior billings collection manager at MCI WorldCom. He was responsible for reconciling customer accounts and dealing with customer payments and debt. Pavlo says he felt extreme pressure to live up to revenue projections set by upper management. According to him, the company refused to alter its budget allowance of $15 million for bad debt -- even when the company had accumulated $180 million in bad debt one year.

Cooking The Books

The pressure, Pavlo says, drove him to start cooking the books to conceal uncollectible debts and make it appear that the company had higher net assets. Given time, he hoped, the company's revenues would sufficiently grow to cover his financial manipulations.

He also claims that upper management encouraged his actions and was well aware of what he and other colleagues were doing. Among Pavlo's unethical accounting techniques:

Allowing customers with large debt to sign promissory notes, an accounting shift that rendered the debt a short-term asset.
Routinely redating invoices.
Developing a complicated payment code system that would indicate that a customer was due to make a payment in a week when, in reality, that payment was not promised for a month.
Using money from customers who paid on time to make it appear as if customers with months or years of bad debt were making regular payments.

Where Were The Auditors?

Aiding Pavlo in his criminal activities was his strong control over the company's internal auditors and the primary audit procedures that he set up. In the current era of corporate accountability, it would be much more difficult to accomplish what Pavlo managed, but in the mid-1990s, before Sarbanes-Oxley, the only accountability were standards the company itself set.

At the time, the company's external auditors tended to conduct cursory reviews of MCI WorldCom's books. And in the end, the corporation wrote off $650 million in bad debt through fraudulent machinations, aided by the rapid rise of the telecommunications industry at the time with little regulation and few internal controls. The company's internal auditors were contractors trained by Pavlo, who reported to him. That gave him the advantage of being able to direct them to focus only on the aspects of the operation he wanted seen and allowed him to create audit procedures that focused on the aspects of the business that seemed legitimate. If the internal auditors had questions, he conveniently explained them away. The internal auditors were never encouraged to meet as a group or compare notes.

An Ethical Slippery Slope

However, Pavlo's transgressions didn't benefit just the company. He established a complex fraudulent scheme for his own gain that his superiors and colleagues knew nothing about.

With the help of a friend who didn't work at MCI WorldCom, Pavlo set up a plan to tag team customers with large amounts of bad debt. Pavlo approached those customers and threatened to disconnect them if they didn't pay in full immediately.

Pavlo's partner would pose as a potential investor and contact each customer, saying he was aware of the debt problem and offered a solution. He offered to pay off the debt and the customer could repay him in installments. The payments were made to a bank account in the Cayman Islands.

The Final Downfall

Once again, Pavlo would cook the books to make it appear as if the customer had paid the debt. The fraud netted Pavlo and his partner $6 million. The carefully crafted deceptions started to crumble when two events occurred nearly simultaneously:

An accountant uncovered paperwork that tracked Pavlo's system of covering bad debts with funds from paying customers.
A suspicious customer tipped off the FBI.

When Pavlo realized his schemes were falling apart, he confessed to his part in the accounting deceptions.

His story is used by the AICPA and the ACFE to train business professionals about the problems that can occur without strong ethical management. "The tone at the top" was what made MCI Worldcom different from many companies, according to ACFE Chairman Joseph Wells.

"People in the company got the message and that message was to find creative ways to make the numbers," Wells said.

(In a future article, we'll explain some of the reasons why employees don't report unethical behavior and what you can do to protect your organization.)

Posted in Fraud & Forensics Group

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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