WorldCom's

(WCOME)

disclosure of a massive $3.8 billion accounting fraud Tuesday once again turns an uncomfortable spotlight on the failure of outside corporate directors to zealously guard shareholder interests.

As was the case with other recent, high-profile corporate blowups -- including

Enron

,

Adelphia

(ADLAC)

,

ImClone Systems

(IMCL)

and

Tyco International

(TYC)

-- investors are now wondering, what exactly was WorldCom's board of directors doing for the last five quarters as the books were being cooked?

"This board is certainly no stranger to corporate governance controversy, most notably the whole brouhaha over loans made to

former CEO Bernard Ebbers," said Charles Elson, director of the Center for Corporate Governance at the University of Delaware.

WorldCom's board consists of 11 directors, eight of whom are considered "independent," as defined by the National Association of Securities Dealers. Like all publicly traded companies, WorldCom's board has an audit committee, which is charged with reviewing the company's financial statements, communicating with its outside auditors and reviewing internal accounting controls.

WorldCom's four-person audit committee met five times in 2001, according to its 2001 proxy statement, filed on May 20, with the

Securities and Exchange Commission

. It's at these meetings, presumably, that the committee reviewed and approved the company's financial statements for the past five quarters. The company now says these statements inflated earnings before interest, taxes, depreciation and amortization -- a measure of cash flow -- by $3.8 billion by improperly identifying routine maintenance costs as long-term capital costs.

The inability of WorldCom's audit committee to catch this accounting trick doesn't surprise Nell Minow one bit. A frequent commentator on corporate governance and editor of the

Corporate Library

, Minow said the report of the audit committee, contained in WorldCom's May 20 proxy statement, paints the picture of unqualified directors who couldn't understand accounting.

"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," the report stated. "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."

The report continued: "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."

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Minow said WorldCom, particularly the audit committee report, has become her "bad example" of corporate governance when speaking to institutional investors. She gave one such presentation Wednesday in Chicago.

"I've seen disclaimers in parking lots that are better than that," she said, calling the language a major red flag. "I'd love to meet the lawyer who drafted that in order to protect the directors from liability, because it's just not going to work."

Culpable or Gullible?

As the WorldCom fiasco plays out, questions will be raised about the culpability of management and directors. Wednesday, WorldCom said the first evidence of the fraud was detected soon after the ouster of longtime chief executive Ebbers in April. WorldCom then turned the matter over to its audit committee and newly hired auditors,

KPMG LLP

, who deemed the issue serious enough to alert the SEC. KPMG replaced

Arthur Andersen

as WorldCom's outside auditing firm in May.

"Our senior management is shocked by these discoveries," said CEO John Sidgmore, who recently took over from Ebbers. "We are committed to operating WorldCom in accordance with the highest ethical standards."

Shareholder lawsuits have already been filed against WorldCom, Arthur Andersen and several WorldCom directors, including audit-committee Chairman Max Bobbitt, a consultant; John C. Allen, general partner of Meritage Private Equity Fund; and Francesco Galesi, chairman and CEO of Galesi Group. The suits allege violation of securities law stemming from other accounting irregularities, as well as the board's role in rubber-stamping sweetheart loans to Ebbers.

"We have to find out what

directors knew and when they knew it," said Elson. "Were there red flags that they missed? Capitalizing expenses is certainly one of the oldest accounting tricks in the book, and it's something that auditors look for."

But parsing significant blame to outside directors is just not realistic, said Ben Hermalin, interim dean of the Haas School of Business at the University of California, Berkeley. He believes directors who sit on auditing committees rely on management and independent auditors providing real numbers, something that apparently didn't happen at WorldCom.

"As a practical matter, I think you'd be hard-pressed to find any director at a board meeting get up and ask whether a company is taking operating expenses and treating them as capital expenditures," said Hermalin.

Deserving or not, it seems clear that heat under WorldCom directors will surely be turned up to full blast after Tuesday's disclosures, and it will add further weight to the calls for reform. Unfortunately, the body of law dealing with corporate governance can be murky, which makes it difficult to predict just how much will change. (A topic

examined by TheStreet.com in a recent story.)

This isn't likely to sit well with investors, who are, once again, being offered up another reason to distrust corporate directors who are supposed to look out for their best interests.

Headed For Hot Seat

Max Bobbitt, a WorldCom director since 1992, chairs the company's audit committee. Currently a telecommunications consultant, he served as president and CEO of Metromedia China from March 1997 until July 1998. He still sits on Metromedia China's board of directors.

Metromedia China is a subsidiary of

Metromedia International Group

(MMG)

, a troubled communications firm that was put on a watch list by the California Public Employees Retirement System (CalPERS) in 2000 because of poor financial and corporate governance performance. At its recent price of 11 cents a share, Metromedia has lost more than 99% of its market value since hitting an all-time high of $19.50 in 1995.

Bobbitt owns about 434,000 shares of WorldCom stock, according to the company's proxy statement. He could not be reached for comment.

The other members of WorldCom's audit committee are:

James C. Allen, a director since 1998. Allen is currently an investment director and general partner of Meritage Private Equity Fund, a venture capital firm specializing in the telecommunications sector. Prior to that, Allen was vice chairman and CEO of Brooks Fiber Properties, a Nasdaq-listed firm that was sold to WorldCom in January 1998 in a deal valued at $3.3 billion, including the assumption of debt. Allen owns just under 413,000 shares of WorldCom stock.

Judith Areen, a director since September 1998. Since 1989, Areen has been the dean of Georgetown University's law school. She owns just under 114,000 shares of WorldCom stock.

Francesco Galesi, a director since 1992. Galesi is the chairman and CEO of Galesi Group, a privately held, diversified company active in real estate, oil and gas and telecommunications. In June, Galesi was forced to sell 5,000 shares of WorldCom stock pledged as collateral for personal loans, according to an SEC filing. He now owns a little more than 1 million WorldCom shares. Galesi is also known as the owner of a 55,000-square-foot "castle" located in tony Southhampton on the Eastern fork of Long Island. The mansion is for sale, with a price tag of $37.5 million, reduced from $45 million, according to several media reports.

Allen, Areen and Galesi did not return phone calls seeking comment.