Corporate Con Man

In the age of Sarbanes-Oxley, the biggest danger to your company is not a fierce rival but a trusted lieutenant gone bad. I was that bad lieutenant. For the first time in my own words, here’s how I embezzled $6 million from MCI and became a party to the biggest accounting fraud in U.S. history — and how you can protect yourself from a similar fate.

by Walter Pavlo Jr.

The worst moment on the worst day of my life, March 14, 2001, came when I kissed my wife and two young sons goodbye and headed out the door, bound for prison. My younger brother, Chris, was waiting in the driveway. Our destination was the Federal Correctional Institution in Jesup, Georgia, two hours south of my Savannah home.

I was dressed in gray Wal-Mart-issue sweatpants, white socks, a T-shirt and white sneakers that met Federal Bureau of Prisons regulations. The last thing I wanted was for my street clothes to be mailed home in a box marked jesup federal prison. For nearly four years, I had pulled every legal trick I could imagine, and plenty of illegal ones, to try to avoid this day. I had burned through hundreds of thousands of dollars mounting my legal defense, turned on friends and felt the sting of friends turning on me.

Now my fate was sealed. I was about to get locked up with a bunch of street thugs and drug pushers. Part of me felt a cut above. Another felt lower than the lowest of them. More than anything, I was scared to death. Chris managed a wan smile. Good thing he was behind the wheel, I thought. Drive? Hell, I was having trouble breathing. Without a word, Chris fished a fresh pack of Marlboro Lights from his pocket and offered it to me. “Ah, a condemned man’s last wish!” I said. I lit up and silently watched the trees go by. “So,” Chris finally asked, “How’d we ever get here?”

In that moment, for the first time, I realized how hard it must be to chauffeur your big brother to prison. Chris and I were from a working-class family. I had been the first to go to college, go to graduate school and achieve white-collar success. Now I was going to be the first to go to prison, too. Chris’s question was my question as well. How, I asked myself for the 100,000th time, had I gone from trusted fast-tracker, rapidly ascending the corporate-finance ladder, to convicted felon on his way to serve 25 months for wire fraud, money laundering and obstruction of justice? First and foremost, I knew, the fault was mine. I’d had choices and chances along the way from the corporate suite to the courthouse. I’d blown them. But I also knew there was more to the story than my own misdeeds. There was more because I had joined my former employer, MCI Communications, some years earlier with the best of intentions and nary a clue about how to perpetrate the sort of financial crimes for which I was ultimately convicted. It was a journey down the proverbial slippery slope. As I settled into my prison routine, I discovered that stories like mine were depressingly common. The prison was filled with once-respected guys who, like me, had rationalized unethical and ultimately illegal behavior. The discussions I had with fellow inmates were a form of soul-searching for all of us. For chief executives and chief financial officers, covering the same ground is often a matter of survival. Under Sarbanes-Oxley, their reputations, careers and financial well-being can be made, or broken, based on the internal controls and other measures they take to minimize temptations like the ones to which I succumbed. Industry data paint a sobering picture of the cost of white-collar wrongdoing. Economic crimes — especially accounting fraud, corruption and bribery — remain among the most problematic issues for global businesses today. In fact, 43 percent of companies have suffered one or more significant economic crimes in the past two years, according to a recently released survey by PricewaterhouseCoopers. Among 4,000 U.S. workers, 74 percent said they had witnessed corporate misconduct over the past year, according to a 2005 KPMG survey. Over half of those who had observed wrongdoing characterized it as so severe that it would cause a “significant loss of public trust” if discovered. All told, fraud — financial-statement fraud, embezzlement, identity theft and other misdeeds — costs American business more than $650 billion a year, the Association of Certified Fraud Examiners estimates. It would be a simple matter to stamp out such rampant wrongdoing if it were perpetrated by people who stood out from their peers. Unfortunately, there is no fail-safe method to screen out executives who might be prone to going bad. Instead, like me, they usually look like everyone else and, if anything, are assisted in their crimes by the high degree of trust granted them by their colleagues. What does follow a pattern is the environment in which white-collar crime takes place. Almost without exception, it involves what forensic accountants and investigators refer to as the Fraud Triangle. It consists of three points: pressure (I’ve got to make my numbers); opportunity (lax internal controls); and rationalization (everyone else is playing it fast and loose, so why not me?). When it comes to the Fraud Triangle, I’m a textbook case.

My spirits soared as I cruised to my new job in Atlanta in July 1992. I wasn’t necessarily on track to become a millionaire when I turned 30 that September, but I had arrived as a corporate player, having been hired into a very sexy business by a major player: MCI Communications. Salesmanship coursed through the company’s veins. It built long-distance market share with compensation that was sometimes 100 percent commission-driven, and in its early years it grew rapidly. For me, the only imperfection seemed to be the department that had hired me: Financial Services. Accounts receivable, credit and collections. I was going to be a bill collector. Things went along fine for a few years. I earned three quick promotions, traveling the country clearing up billing disputes and collecting money from the likes of WorldCom, Cable & Wireless and Sprint. As competition stiffened in the long-distance market and prices plunged, however, my world changed. My bosses started lowering their standards for the sort of wholesale customers we let use MCI’s network. Some of the new customers sold calling cards in inner cities. Others provided erotic, caller-pays chat lines. Many were serious credit risks. The worst of them probed for creative ways to exploit MCI’s accounting system and perpetrated “bust-out” scams. Those often involved selling calling cards for cash at per-minute rates far below what they were supposed to be paying MCI. By the time we got around to asking for MCI’s money, many of these customers were into it for millions of dollars. Then, instead of trying to negotiate down their bills, the resellers would bust out by going bankrupt or simply disappearing. The scam was so lucrative that it quickly attracted attention from organized crime. Many otherwise legitimate long-distance resellers, meanwhile, had decided to cope with tumbling rates by “cramming,” or padding, bills with bogus minutes. Some billed twice for the same call. Others foisted charges on people who had never used their service. Unfortunately, the harsh reality of telecom was that once the product — a phone call — was sold, there was no way to repossess it. That meant that cutting off customers was almost guaranteed to push them over the brink into bankruptcy and leave nothing for anyone to collect. When we couldn’t squeeze any cash out of delinquents, my boss and I turned to MCI’s accounting department for guidance. Accounting was under pressure from the executive suite, which was, in turn, under pressure from the board of directors and Wall Street, to report earnings each quarter that supported the company’s lofty share price. The pressure to perform — and cut corners — mounted further when rumors began flying that MCI was a buyout candidate. The higher the price we sold for, the more it would enrich me and thousands of other employees. In my collections department, the way to do our part was to keep delinquent customers alive. Through persistence and minor accounting sleights of hand, my boss and I managed to stay within our bad-debt budget. But we knew we would have to pull ever-larger rabbits out of our hats to continue making our numbers.

That task became ever more difficult.

On a trip to New York, I walked into the “accounting department” of a calling-card customer that eventually stiffed MCI for $55 million. The room was protected by armed guards and consisted of a large table covered by a mound of cash. A woman was separating and stacking the bills by denomination. Two others carried the stacks to counting machines, which bundled them in wrappers marked $1,000 each. The bundles were then stuffed into duffel bags, which were spread around the room. A kid with a broom stood nearby sweeping up the currency that fell to the floor. When I tried to work out payment terms, I was told the customer could not afford to pay us.

Former Major League pitcher Denny McLain, baseball’s last 30-game winner (he won 31 games for the Detroit Tigers in 1968), was also a customer. His company, too, was soon deeply in debt to MCI, and McLain was on his way to fending off an indictment with John Gotti Jr. for his role in a telecom scam. McLain beat the rap but did a stint in prison for defrauding a pension fund.

Despite the ever-growing list of deadbeat customers that the sales department was bringing onto MCI’s network, MCI Corporate held my collections department to the same low bad-debt targets we’d had in previous years with far more legitimate clients. Under pressure, I began taking ever more license with our accounting. With my boss, I encouraged customers to sign promissory notes we had little chance of ever collecting on. I began posting one customer’s payments to another’s account to keep our bad-debt balance down, and crediting accounts even before money arrived.

My bosses never explicitly ordered me to do anything unsavory. They merely set the targets and left it to functionaries like me to make our numbers. As one later put it, under oath, employees’ reward was that they “got to keep their jobs.”

After four years on the job, now 33, I was crisscrossing the country constantly and personally trying to collect debts from MCI’s nastiest customers. I was the day-to-day master of its carrier portfolio, overseeing more than $2 billion in annual revenues. My office walls were plastered with photos of me doing the grip-and-grin at golf outings and yacht races in the company of telecom muckety-mucks. Eighty mostly young, bright, ambitious men and women reported to me and sought my sage counsel, just as I had my former boss’s.

I was, by most measures, a success. But I hated it. I had become an accounting alchemist: Hit my numbers, and everyone loved me. Miss them, and . . . I didn’t want to go there. Too many people above and below me — and at home — were counting on me.

I should have quit, but I’d been raised Catholic and acquired an inner voice that whispered in my ear anytime I thought about bailing: “Always finish whatever you start.” I rationalized that quitting would be disloyal to my wife and sons. And then there were the stock options and buyout rumors. If I left, I might miss out on a big payday.

Besides, there was one other thing: the seed planted in my mind by one of my former customers. “I’ll make it worth your while” to stick around, he had told me. The customer, a phone-porn entrepreneur, and I had become buddies. He was no saint, I knew, but he was charismatic, fun and the kind of person who made things happen by sheer force of will. I could learn a few things from him, and maybe make some real money for a change. Judging by the way he lived, his business ventures minted the stuff.

One day my friend suggested a way we could divert hundreds of thousands of dollars from MCI’s deadbeat customers. The ruse was simple: I was to threaten to disconnect a few delinquent telecom resellers unless they paid MCI pronto. My friend would then present himself as a wealthy investor willing to pay off their debts in exchange for payments over time to a finance company in the Cayman Islands. Instead of my friend paying off the MCI debts as he promised, however, I would tap some of the same sorts of accounting tricks that I’d formerly cooked up to bury bad debt on its behalf. Only now I would be using them to rip off my employer.

“What you’re suggesting is, you know . . . wrong,” I said. I couldn’t say the word out loud: criminal.

“Spare me the sermon,” my friend said. “Your customers are out-and-out deadbeats. You guys at MCI aren’t any different. Everybody cheats. That’s the way the world works. Your problem is that you haven’t figured out how to make money at it.”

At the moment, his twisted logic made perfect sense to me. Money, tons of it, was being manipulated, lied about, misused, misplaced, stolen. By everybody. I knew the whole world didn’t work that way, but mine did. The scheme my friend was describing, I told myself, was no worse than what MCI’s customers were doing to MCI, or what my bosses were doing to our shareholders. Embezzlement was the legal term. But it wasn’t like we were going to trick old ladies out of their savings or bash anyone over the head. It was victimless embezzlement — unless you counted my hustler-clients as victims. I had no trouble drawing a straight line, through all the self-serving spin, from my misery to my friend’s solution.

The scheme worked with amazing ease. Improbable a savior as my friend was, seven of my desperate customers jumped at the chance to do deals with him. Over six months, we stole away with a $6 million Cayman stash. My life changed. I was rolling in dough and rushing off on private jets to far-off vacations, renting huge yachts and buying baubles for my family.

At MCI, I remained a respected, and trusted, young executive. Despite it all, I was miserable. I knew I was a phony betraying my colleagues and leading a dishonest double life. My conscience tore at me. I was also constantly looking over my shoulder, regretting the path I had taken but too far along to turn back. I was haunted by where it all might lead me and my family. I began drinking heavily and became addicted to prescription drugs. I put on 20 pounds and took up smoking.

Just as MCI was selling itself to WorldCom, my scam came unwound. MCI Accounting caught on to my questionable transactions. With nowhere else to turn, I quit MCI, hoping and praying that my misdeeds would just go away amid the confusion and hoopla of the historic buyout. Instead, an internal investigation led to a federal probe and indictments. I was irreversibly on my way to life as a convicted felon.

I appeared at the federal courthouse in Atlanta for my sentencing in January 2001. “Are we prepared for me to render a sentence?” the judge asked. “Your honor, my client would like to make a statement for the record prior to sentencing,” my lawyer said. “Proceed.” “Thank you, Your Honor,” I said, approaching the podium. I read a statement expressing love for my family, acknowledging both what I had done and my willingness to accept the consequences. “It has been said that the road to a righteous life is narrow, but it is nonetheless a road and not a tightrope,” I said in closing. “I should have known better, and I vow to do better.” The judge sentenced me to three years and five months of prison time and ordered me to pay $5.8 million in restitution. “It was an ingenious plan, I’ll give you that,” my lawyer said when it was over. “But I’ve gotta ask: Why? Why, with so much going for you, did you do it?” I paused and lit his cigarette. “I started out hating my crooked customers. Then I hated MCI. Then I hated myself. After that, greed took over. I figured that even if MCI caught me, it would keep quiet because it was doing far worse. What I didn’t count on was all the stuff they dredged up. But I really did hate the bastards. All of ’em.” “That much is obvious, my friend.” CL

Protecting Yourself
It takes a thief to catch a thief. I am thus at once the ideal person to warn of the dangers of internal corporate fraud and the last one in possession of the moral authority to do so. That said, since leaving prison in 2003, I have traveled the country telling my cautionary tale to accounting groups, corporations and universities. While I hesitate to hold myself out as an authority on corporate ethics, I believe my experiences have given me a framework for what top managers need to do to minimize the danger that corporate crime will strike their organizations. 1. Set the right tone at the top. The guidelines and incentives you give employees will be taken to heart. If the edict, or implication, is “make your numbers — or else,” the results will be predictable. Here, actions speak louder than words. On paper, after all, Enron had an outstanding code of ethics. 2. Establish strict internal controls, and rigorously implement them. Think hard about where weaknesses exist in your organization’s controls and the temptations people face. As Ronald Reagan said, trust but verify. 3. Carefully structure performance-based compensation so that it never rewards employees for doing the wrong thing. If you give workers financial incentives to act unethically, some will. 4. Create an environment that encourages people to report suspected wrongdoing without fear of reprisal. 5. Be skeptical of news that sounds too good to be true. It usually is.