Believing that he was being asked to commit tax fraud, Emigh pressed his concerns up the chain of command, notifying an assistant to WorldCom chief operating officer Ron Beaumont.
[2] The Fort Worth Weekly article was eventually read by Glyn Smith, an internal audit manager at WorldCom headquarters in Clinton, Mississippi.
After examining it, he suggested to his boss, Cynthia Cooper, that she should start that year's scheduled capital expenditure audit a few months early.
[3]: 220–221 During a meeting with the auditors, corporate finance director Sanjeev Sethi explained that differing amounts in two capital spending expenditures were related to "prepaid capacity," something Cooper had never heard of.
When pressed for an explanation, Sethi claimed that he did not know what the term meant, despite his division approving capital spending requests.
Cooper asked Glyn Smith for an auditor with technical skills in order to locate the entries in the accounting system.
Smith returned with Eugene Morse, an accountant who had been working at WorldCom since 1997 and who had helped with some reports on the wireless allowance audit.
[3]: 225 With starting points in hand, Cooper told her "techie" Morse to peruse the accounting system and look for any references to prepaid capacity.
Not totally satisfied with the results, Cooper asked Morse to try and find another prepaid capacity entry that moved around in similar fashion.
[3]: 233–237 That night, Cooper and Smith called Max Bobbitt, a WorldCom board member and the chairman of the Audit Committee, to discuss their concerns.
Bobbitt was concerned enough to tell Cooper to discuss the matter with Farrell Malone of KPMG, WorldCom's external auditor.
She first asked Kenny Avery, who had been Andersen's lead partner on the WorldCom account before KPMG took over, if he knew about prepaid capacity.
Avery had never heard of the term, and knew of nothing in Generally Accepted Accounting Principles (GAAP) that allowed for capitalizing line costs.
In response, Sullivan, Myers, Yates, and Abide scrambled to find amounts that were expensed when they should have been capitalized in hopes of offsetting the prepaid capacity entries.
By this time, Cooper's team had discovered over $3 billion in questionable transfers from line cost expense accounts to assets from 2001 to 2002.
Sullivan claimed that WorldCom had invested in expanding the telecom network from 1999 onward, but the anticipated expansion in customer usage never occurred.
He argued that the entries were justified on the basis of the matching principle, which allowed costs to be booked as expenses so they align with any future benefit accrued from an asset.
All told, the internal audit unit had discovered a total of 49 prepaid capacity entries detailing $3.8 billion in transfers spread out across all of 2001 and the first quarter of 2002.
KPMG discovered that Sullivan had moved system costs across a number of property accounts, allowing them to be booked as capital expenditures.
They concluded that the amounts were transferred with the sole purpose of meeting Wall Street targets, and the only acceptable remedy was to restate corporate earnings for all of 2001 and the first quarter of 2002.
It had been facing a separate SEC investigation into its accounting that had started earlier in the year, and was laboring under $30 billion in debt.
[8] The federal government had already begun an informal inquiry earlier in June, when Vinson, Yates, and Normand secretly met with SEC and Justice Department officials.