The Regents - University of California | Office of The President

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The Regents of the University of California (“The Regents”), as and for its
complaint, alleges as follows upon information and belief based, inter alia, upon
investigation conducted by Plaintiff and its counsel, except as to those allegations
pertaining to Plaintiff personally, which are alleged upon knowledge:
I. OVERVIEW OF COMPLAINT
1. This action involves one of the largest financial frauds in history. For
years, the Defendants sued herein represented that WorldCom, Inc.
(“WorldCom”), a global communications company, was a thriving and growing
company. In reliance of these representations, Plaintiff was induced to purchase
WorldCom stock.
2. Since 1994, WorldCom had been a house of cards waiting to collapse.
It had financed its growth through a series of mergers and acquisitions which
allowed it to manipulate its financial statements and inflate revenues. Rather than
having true growth, WorldCom only appeared to be successful because of the
Defendants’ scheme to defraud. With the assistance of Defendants, WorldCom
accomplished this scheme by overvaluing assets, including goodwill, improperly
recording extraordinary charges, shifting revenues from the quarter before a
merger occurred to the quarter after the merger had been completed, engaging in
sham barter transactions, booking the same sales twice, improperly capitalizing
certain expenses, including line costs, and engaging in other accounting
irregularities. As a result of this scheme to defraud, WorldCom’s financial
statements for these periods were false.
3. On June 25, 2002, WorldCom announced that it intended to restate
its financial statements for 2001 and the first quarter of 2002 because it had
improperly capitalized expenses of $3.055 billion in 2001 and $797 million in first
quarter 2002 for a total write-down of over $3.8 billion. These improprieties
resulted in an overstatement of WorldCom’s earnings and meant that for these
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reporting periods, WorldCom has a staggering loss rather than a profit as it had
reported.
4. The market’s reaction was immediate and devastating. Trading of
WorldCom’s stock was halted. Its market value plummeted to $2.7 billion from a
high of $125 billion in mid-1999. Its stock dropped to almost nothing. The
Securities and Exchange Commission (“SEC”) announced that WorldCom’s
“accounting proprieties [were] of unprecedented magnitude.”
5. On August 8, 2002, WorldCom announced that it had discovered an
additional $3.3 billion in improperly reported earnings for 1999, 2000, 2001 and
the first quarter of 2002 and that the company would be again restating its
financial statements for 2001 and the first quarter of 2002. WorldCom also
announced that it expected that it would record further write-offs of other assets,
including goodwill and other intangible assets which were currently recorded as
$50.6 billion.
6. On November 5, 2002, WorldCom announced that it will likely report
another $1.8 billion in fraudulent accounting as a result of further internal
investigations based upon past transactions.
7. Congress, the SEC, the United States Attorneys’ office, a Bankruptcy
Court examiner and others are investigating this fraud. Four WorldCom
executives have already pled guilty to securities charges and more pleas and/or
convictions are expected.
8. The impact of this financial fraud to The Regents has been enormous.
Between 1998 and 2000, it purchased 10.2 million shares of stock including
purchasing stock through defendant Salomon Smith Barney, Inc. on April 2, 1998,
April 17, 1998 and December 2, 1999 in reliance on Defendants’ representations.
They bought shares from other sources all based upon the false representations.
The Regents sold off all of its nearly worthless WorldCom holdings in June and
July 2002 - - taking a loss of more than $353 million.
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COMPLAINT

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9. A fraud of this magnitude, which occurred for years, was not and
could not be committed by WorldCom and its executives alone. They were
assisted by professionals including the defendants sued herein. Then Treasury
Secretary Paul O’Neill explained in the June 28, 2002 Boston Globe: “It’s not
possible for it to have been done by one individual. . . The scope of what they’ve
done at WorldCom requires complicity of quite a few people, I think, because the
numbers are so huge. The accounting technique they used is so fundamental – it’s
just mind-boggling.” It is clear to everyone now that all the Defendants were
directly involved in a scheme to defraud the public.
II. JURISDICTION AND VENUE
10. Between 1998 and 2000, plaintiff, The Regents, purchased 10.2
million shares of Worldcom in San Francisco, California. Plaintiff Regent is an
agent and instrumentality of the State of California, and therefore, is not a citizen
of any state. Moor v. County of Alameda (1973) 411 U.S. 693; Hamilton v.
Regents (1934) 293 U.S. 245 citing Williams v. Wheeler (1913) 23 Cal.App. 619,
623 and Wallace v. Regents (1925) 75 Cal.App. 274, 277.
11. Each Defendant has sufficient minimum contacts with California, is a
citizen of California, or otherwise purposefully avails itself of benefits from
California or doing business in California so as to render the exercise of
jurisdiction over it by the California courts consistent with traditional notions of
fair play and substantial justice.
12. The amount in controversy exceeds the jurisdictional minimum of this
Court.
13. This action is not preempted by the federal Securities Litigation
Uniform Standards Act of 1998 15 U.S.C. §§ 78bb(f)(1,2) because this action is
not a class action, but is brought by one institutional plaintiff who is seeking
damages.
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III.
THE PARTIES
A. Plaintiff
14. Established in 1868, the University of California is one of the premier
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universities in the world. As a public institution, it is governed by a 26-member
board, the Regents of the University of California (“the Regents”) pursuant to its
authority under Article IX, § 9 of the California Constitution. The Regents is an
agent and instrumentality of the State of California. The Regents manage an
investment portfolio comprised of endowment funds, pension and retirement
funds, and defined contribution funds. The fund’s assets are $49.9 billion.
Between February 21, 1998 and February 2, 2000, the Regents purchased 10.2
million shares of WorldCom stock, including purchasing WorldCom stock through
defendant Salomon Smith Barney, Inc. on April 2, 1998, April 17, 1998 and
December 2, 1999. In June of 2001, the Regents exchanged their shares of stock
for shares of stock in WordCom group stock and MCI group stock for different par
values pursuant to an amendment of WorldCom’s charter. The Regents sold off
all of its nearly worthless WorldCom holdings in June and July 2002 - - taking a
loss of more than $353 million.
B. Defendants
1. The Bank Defendants
15. Defendant Salomon Smith Barney Inc. (“Salomon”) is a full service
financial firm which is a leader in the securities industry. It provides
underwriting, advisory and investment services internationally, including in
California. Salomon is a subsidiary of defendant CitiGroup, Inc. (“Citigroup”).
Salomon and its predecessor firms received more engagements from WorldCom
than any other investment banking firm earning millions of dollars in the process.
Since 1997, it has collected over $800 million in underwriting telecom stocks and
bonds and $178 million from providing merger advice, according to Thomson
Financial. According to a September 30, 2002 lawsuit filed by the Attorney
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General of New York, between October 1997 and February 2002, Salomon
advised WorldCom on about 23 investment banking deals for which it earned over
$100 million. Its chief telecommunications analyst, Jack Grubman, had a close
and improper relationship with WorldCom, including attending Board of
Directors’ meetings where he provided investment advice and obtained
confidential, non-public information. At the times of the acts and omissions
alleged herein, Grubman was an agent and/or employee of Salomon and acting
within the course of scope of his agency/employment.
16. Defendant CitiGroup, Inc. (“Citigroup”) is an international financial
services company offering asset management, banking, investment services and
investment banking. It is the parent of Salomon and does business in California.
There is a unity of interest and ownership between CitiGroup and Salomon such
that the acts of the one are for the benefit and can be imputed as the acts of the
other. Citigroup through its division, CitiBank, loaned millions of dollar to
WorldCom.
2. The Accounting Defendant
17. Defendant Arthur Andersen, LLP (“Arthur Andersen”) is a multiinternational
accounting, auditing and consulting firm which does business in
California. Until 2002, Andersen was one of the largest accounting firms in the
world, also formerly known as one of the “Big 5" accounting firms.
18. Andersen operates as an integrated entity throughout the world, and is
including Defendant Andersen Worldwide Organization (“AWO”); the AWO
member firms; the partners of the firms. AWO and Arthur Andersen set the
policies and procedures governing all member firms and offices worldwide.
19. Except where otherwise indicated, these entities are referred to in this
Complaint as “Andersen.”
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20. From October 1993 until May of 2002, Andersen was WorldCom’s
auditors and Andersen provided unqualified audit opinions for the fiscal years
ending on December 31 st for 1994, 1995, 1996, 1997, 1998, 1999, 2000 and 2001
and it reviewed interim statements. Andersen also provided tax and consulting
advice to WorldCom during this time period, including advice on how to structure
mergers to maximize revenues. Andersen was paid millions of dollars for its
work. For example, according to WorldCom’s 2002 Proxy Statement, Andersen
received over $16 million for professional services it performed during 2001
including: audit fees of $4.4 million; $7.6 million for tax services; $1.6 million for
non-financial statement audit services; and $3.2 million for all other services.
Andersen consented for its unqualified opinions on WorldCom’s financial
statements to be included in WorldCom’s 10-K filings with the SEC, proxy
statements and other documents from 1994 to 2002. Representatives from
Andersen attended annual meetings of WorldCom.
21. In May of 2002 as a result of Andersen’s criminal conviction for
obstruction of justice, the Board of Directors replaced Andersen with KPMG, LLP
as its auditors. In the Proxy Statement (8-K) filed by WorldCom advising of the
change, WorldCom and Andersen both represented that: “During the fiscal years
ended December 31, 2001 and 2000, and in the subsequent period through the date
of dismissal, there were no disagreements with Arthur Andersen on any matters of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedures which, if not resolved to the satisfaction of Arthur
Andersen, would have caused it to make reference to the matter in connection with
their report on the financial statements.”
3. Doe Defendants
22. The true names and capacities, whether individual, corporate,
associate or otherwise of Defendants Does 1 through Does 50, inclusive, are
unknown to Plaintiff who therefore sues said Defendants by such fictitious names
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pursuant to Code of Civil Procedure § 474. Plaintiff further alleges that each of
said fictitious Doe Defendants are in some manner responsible for the acts and
occurrences hereinafter set forth. Plaintiff will amend this Complaint to show
their true names and capacities when the same are ascertained, as well as the
manner in which each fictitious Defendant is responsible for the damages
sustained by Plaintiff.
4. Agents and Co-Conspirators
23. At all relevant times, each Defendant was and is the agent of each of
the remaining Defendants, and in doing the acts alleged herein, was acting within
the course and scope of such agency. Each Defendant ratified and/or authorized
the wrongful acts of each of the Defendants.
24. Defendants, and each of them, are individually sued as participants
and as aiders and abettors in the improper acts, plans, schemes, and transactions,
to induce Plaintiff to purchase the stock that is the subject of this Complaint.
25. Defendants, and each of them, have participated as members of the
fraud or acted with or in furtherance of it, or aided or assisted in carrying out its
purposes alleged in this Complaint, and have performed acts and made statements
in furtherance of the violations and conspiracy.
5. Unnamed Participants
26. Numerous individuals and entities participated actively during the
course of and in furtherance of the conspiracy to recognize false revenues for
WorldCom, and conceal such information from the public. There was a
conspiracy and many acts were done in the course of and in furtherance of the
conspiracy by statements, conduct, and intent to defraud. The individuals and
entities acted in concert by joint ventures and by acting as agents for principals, in
order to advance the objectives of the conspiracy to increase false revenues. The
acts were intended to promote the conspiratorial objectives.
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IV.
BACKGROUND OF WORLDCOM
A. The Early Years
27. In 1983, Murray Waldron and William Rector started a long distance
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reseller company called LDDS-Long Distance Discount Service (“LDDS”).
28. In 1983, Bernie Ebbers (“Ebbers”), an early investor and former bar
bouncer, and three others bought LDDS. In 1985, Ebbers became CEO and he
remained in that position until he resigned in April of 2002. Ebbers was a handson
manager who emphasized motivating employees to meet sales goals. In an
August 28, 1996 USA Today article, he was referred to as “irascible, garrulous and
charismatic.” In an August 31, 1996 USA Today article, Jack Grubman, defendant
Salomon’s key telecommunications analyst, gave his opinion on Ebbers:
“He’s organically very smart. He’s very shrewd,” says
Jack Grubman, an analyst at Solomon Bros. who advises
Ebbers. “He does not believe in management by
committee. He trusts his instincts and then has the guts
to act on them. Anyone in this industry who dismisses
Bernie Ebbers will find him eating their lunch.”
29. LDDS changed its name to WorldCom in 1995 (and hereinafter the
company will be referred to as WorldCom).
B. WorldCom Goes Public and Engages in a Strategy of Growth
Through Acquisition or Merger
30. In August of 1989, WorldCom went public through its acquisition of
Advantage Companies, Inc., a long distance reseller. There was no exchange of
cash in the deal; the deal occurred through a stock conversion.
31. After the Advantage acquisition, WorldCom then embarked on a
series of over 60 mergers and acquisitions over the next 12 years.
32. From 1990 to 1995, WorldCom experienced enormous growth. It
went from being a long distance telephone company serving Mississippi to serving
27 states in the Southeast, Southwest and Midwest by the end of 1992. It
continued to expand through acquisitions, and by 1995, it was an international
company with reported revenues of about $3.9 billion (and long-term debt and
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notes payable of $3.4 billion). From 1992 and for the next eight years, WorldCom
made at least one significant acquisition each year.
33. In 1996, after the enactment of the Telecommunications Act of 1996
which allowed long distance telephone carriers to provide local telephone service,
WorldCom, through more acquisitions, moved into the local telephone markets
and increased its Internet services. WorldCom reported revenues of about $4.8
billion that year along with about $4.8 billion in long-term debt and notes payable.
C. 1998: The MCI Merger
34. In 1998, WorldCom culminated its merger strategy by completing
three multi-billion dollar mergers: MCI Communications Corporation (“MCI”),
Brooks Fiber Properties, Inc., and CompuServe Corporation.
35. WorldCom’s bid for MCI was considered a “surprise” bid because
MCI had entered into a merger agreement with British Telecommunications to be
purchased for $42 billion. However, when MCI announced in August of 1997,
that it would have unexpected losses of $800 million, MCI’s stock plunged 18%
and, in order to complete the merger with British Telecommunications, MCI
agreed to a 22% decrease in its purchase price. MCI’s stock plunge had a negative
effect on Salomon because it held an $100-$500 million arbitrage position.
Salomon needed to find another merger partner to turn-around its losses and it
went to WorldCom because it knew that WorldCom was always looking for
merger partners so that it could manipulate its financial statements. Thus, in
October of 1997, WorldCom announced its intention to commence an exchange
offer to acquire all of MCI’s stock. On November 9, 1997, WorldCom and MCI
entered into a merger agreement. WorldCom offered to pay $30 billion, $7 billion
more than British Telecommunications’ revised bid. At the time, the MCI-
WorldCom merger was touted as the largest merger in history and had a value of
$40 billion. On March 11, 1998, the shareholders of WorldCom and MCI
approved the merger and the merger was completed later that year.
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36. Defendant Salomon played a critical role in completing the merger.
Salomon was one of the key advisors in the deal and earned $32 million in fees,
according to Thomson Financial. As set out in more detail, infra, Salomon’s
Grubman issued many reports touting the stock and the merger. Salomon saw the
deal as trendsetting. Philip Keevil, managing director of Salomon in London, in
the April 1998 issue of Corporate Finance commented about the merger:
“WorldCom stole MCI from under the nose of British Telecom. It was
trendsetting because it was a hostile equity transaction funded by a company
whose equity was very highly valued. Many more people are looking at hostile
equity transactions as a result of that.”
37. Defendant Andersen played a critical role in providing accounting,
tax and consulting advice to WorldCom about the merger.
38. Andersen’s role was more than one of a financial advisor. It also
touted WorldCom to the public. For example, in April of 1998, Andersen’s
Global Communications & Entertainment Group suggested that WorldCom’s next
merger could be with Nextel because it could give WorldCom a nationwide
wireless network. The Atlanta Journal and Constitution, April 8, 1998.
39. Without the significant assistance of Salomon and Andersen in
advising about the merger and their representations which kept WorldCom’s stock
price high enough to pay for the merger, the merger could not have happened.
40. In reliance on Defendants’ representations, Plaintiff purchased
WorldCom stock during the period February through May, 1998 and in November
of 1998.
41. Unbeknownst to the public, until 2002, WorldCom needed the
revenue from this merger to meet analyst’s expectations and Salomon needed the
merger to avoid huge losses. Both would have been forced to incur huge losses if
the merger had not occurred. The MCI-WorldCom merger was a key part of
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Defendants’ scheme to defraud and to maintain the illusion that WorldCom was a
thriving company.
D. 1999: The Proposed Sprint Merger
42. In 1999, WorldCom announced an agreement to merge with
telecommunications giant Sprint (the two companies approved the merger
agreement on October 5, 1999). Andersen provided accounting, tax and
consulting advice to WorldCom about the Sprint merger. Salomon acted as
financial advisor to WorldCom in connection with the Sprint merger and received
millions of dollars in fees. It stood to gain even more if the deal had been
approved. The merger was touted by Grubman at Salomon.
43. From December 1999 through February 2000, Plaintiff purchased
WorldCom stock in reliance on the statements by Defendants concerning the
WorldCom/Sprint merger. The merger was stopped by the Department of Justice
because of antitrust concerns.
44. Unbeknownst to the public, until 2002, WorldCom was depending on
this merger to provide it with much needed revenue. The failure of the merger to
go through posed significant problems for WorldCom and it needed to find
another source of revenue to continue its scheme to defraud.
E. 2001: Intermedia/Digex Merger
45. In 2001, WorldCom acquired Intermedia Communications, Inc.
including an interest in Digex, Inc., a leading provider of managed Web and
application host services. The reported purchase price was $5.8 billion in stock
and WorldCom assumed debt obligations of $2.4 billion
46. By 2000, as a result of engaging in each of these acquisitions,
WorldCom was the second largest long-distance telephone service carrier in the
world. According to the First Interim Report of Dick Thornburgh, Bankruptcy
Court Examiner of November 4, 2002, page 6:
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WorldCom did not achieve its growth by following a
predefined strategic plan, but rather by opportunistic and
rapid acquisitions of other companies. The unrelenting
pace of these acquisitions caused the Company
constantly to redefine itself and its focus. The
Company’s unceasing growth and metamorphosis made
integration of its newly acquired operations, systems and
personnel much more difficult. This dramatic growth
and related changes also made it difficult for investors to
compare the Company’s operations to historical
benchmarks.
V. WORLDCOM’S FINANCIAL STATEMENTS
A. Financial Statements Must Be Prepared According to GAAP
47. As a publicly traded company, WorldCom was required to file
reports, including financial statements, with the SEC. The SEC requires that these
financial statements be prepared according to Generally Accepted Accounting
Principles (“GAAP”). See Regulation, S-X, 17 C.F.R. § 210.01(a)(1) (annual and
quarterly financial statements filed with the SEC must comply with GAAP).
GAAP are recognized and used by the accounting profession in order to define
acceptable accounting practices at a particular time. Statements of Financial
Accounting Standards (“FAS”) are the highest authority in GAAP and are created
by the Financial Accounting Standards Board. GAAP provides other authoritative
pronouncements, including Accounting Principles Board Opinions (“APB”) and
Statements of Position (“SOP”) of the American Institute of Certified Public
Accountants (“AICPA”).
48. If SEC filings do not comply with GAAP, they are presumed to be
misleading and inaccurate, despite footnote or other disclosures.
49. According to WorldCom’s filings with the Securities and Exchange
Commission, press releases and Annual Reports, WorldCom represented to the
investing public that it was a profitable, growing company. In SEC filings, press
releases and in Annual Reports, WorldCom represented that it had net income
applicable to common shareholders of $3,941,000,000 in 1999; $4,088,000,000 in
2000; and $1,384,000 in 2001.
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B. 1997 Year End Statements
50. In its March 27, 1998 filing with the SEC for the year ended
December 31, 1997, WorldCom made the following representations about its
operations, including revenues and income:
MCI WORLDCOM. INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (In Thousands, Except Per Share Data)
For the Years Ended December 31,
1997 1996 1995
Revenues $7,351,354 $4,485,130 $3,696,345
Operating expenses:
Line costs
SG&A
3,791,599
1,540,428
2,457,102
828,673
2,030,635
677,895
Deprec. & amort.
Prov. to reduce carrying
920,721 303,301 312,671
value of certain assets
Restruc. & other charges
–
–
402,000
198,148
–
–
In-process R&D
and other charges – 2,140,000 –
Total 6,252,748 6,329,224 3,021,201
Operating income (loss)
Other income (expense):
1,098,606 (1,844,094) 675,144
Interest expense
Miscellaneous
(319,748)
20,415
(221,801)
6,479
(249,216)
11,801
Income (loss) before inc. taxes
& ext. item 799,273 (2,059,416) 437,729
Provision for inc. taxes 415,621 129,528 171,458
Net income (loss) before ext. item
Ext. item (net of inc. taxes of
383,652 (2,188,944) 266,271
$15,621 in 1996) – (24,434) –
Net income (loss)
Preferred dividend req.
383,652
26,433
(2,213,378)
860
266,271
18,191
Spec. dividend pay. to Series 1
preferred shareholder – – 15,000
Net income (loss) appl. to
common shareholders $ 357,219 $(2,214,238) $ 233,080
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51. On February 19, 1998, Andersen provided an unqualified opinion on
the consolidated financial statements, including the Statements of Operations:
We have audited the accompanying consolidated balance
sheets of WorldCom, Inc. (a Georgia corporation) and
Subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations,
shareholders’ investment and cash flows for each of the
years in the three-year period ended December 31, 1997.
These financial statements are the responsibility of the
Company’s management. Our responsibility is to
express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require
that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free
of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also
includes assessing the accounting principles used and
significant estimates made by management, as well as
evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial
position of WorldCom, Inc. and Subsidiaries as of
December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in
the three-year period ended December 31, 1997, in
conformity with generally accepted accounting
principles.
Our audit was made for the purpose of forming an
opinion on the basic financial statements taken as a
whole. The schedule listed in the Index to Financial
Statements and Financial Statement Schedule is
presented for purposes of complying with the Securities
and Exchange Commission’s rules and is not a required
part of the basic financial statements. This schedule has
been subjected to the auditing procedures applied in our
audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial
data required to be set forth therein in relation to the
basic financial statements taken as a whole.
52. On March 26, 1998, Andersen gave its written consent for its report
being included in WorldCom’s 10-K, Registration Statements and other
documents filed with the SEC.
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C. 1998 Year End Statements
53. In its March 30, 1999 filing with the SEC for the year ended
December 31, 1998, WorldCom made the following representations about its
operations, including revenues and income:
MCI WORLDCOM. INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (In Millions, Except Per Share Data)
For the Years Ended December 31,
1998 1997 1996
Revenues $17,678 $7,384 $4,449
Operating expenses:
Line costs
SG&A
8,416
4,312
3,764
1,626
2,397
867
Deprec. & amort.
In-process R&D
2,200 976 320
and other charges
Total
3,725
18,653
–
6,366
2,740
6,324
Operating income (loss) (975) 1,018 (1,875)
Other income (expense):
Interest expense (637) (395) (253)
Miscellaneous 41 40 25
Income (loss) before income taxes,
min. ints.& extraordinary items (1,571) 663 (2,103)
Provision for income taxes 876 416 130
Income (loss) before min. ints. &
extraordinary items (2,447) 247 (2,233)
Minority interests (93) – –
Income (loss) before
extraordinary items (2,540) 247 (2,233)
Extraordinary items (net of inc.
taxes of $78, $0 and $16, resp.) (129) (3) (24)
Net income (loss) (2,669) 244 (2,257)
Dist. on subs. trust mand.
redeemable pref. securities 18 – –
Pref. dividend requirements 13 26 1
Net income (loss) appl. to
common shareholders $ (2,700) $ 218 $(2,258)
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54. On February 10, 1999, Andersen provided an unqualified opinion on
the consolidated financial statements, including the Statements of Operations:
To the shareholders of MCI WorldCom, Inc.:
We have audited the accompanying consolidated balance
sheets of MCI WORLDCOM, Inc. (a Georgia
corporation) and subsidiaries as of December 31, 1998
and 1997, and the related consolidated statements of
operations, shareholders’ investment and cash flows for
each of the years in the three-year period ended
December 31, 1998. These financial statements are the
responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the
financial statements of Brooks Fiber Properties, Inc., a
company acquired during 1998 in a transaction
accounted for as a pooling-of-interests, as discussed in
Note 2, as of December 31, 1997 and 1996, and for each
of the years in the two-year period ended December 31,
1997. Such statements are included in the consolidated
financial statements of MCI WORLDCOM, Inc. and
reflect total assets and total revenues of two percent and
five percent, respectively, of the related consolidated
totals in 1997 and one percent and four percent,
respectively, of the related consolidated totals in 1996.
These statements were audited by other auditors whose
report has been furnished to us and our opinion, insofar
as it relates to amounts included for Brooks Fiber
Properties, Inc. is based solely upon the report of the
other auditors.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require
that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free
of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also
includes assessing the accounting principles used and
significant estimates made by management, as well as
evaluating the overall financial statement presentation.
We believe that our audit and the report of the other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the
other auditors, the financial statements referred to above
present fairly, in all material respects, the financial
position of MCI WORLDCOM, Inc. and subsidiaries as
of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in
conformity with generally accepted accounting
principles.
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55. On March 26, 1999, Andersen also gave its written consent for its
report being included in WorldCom’s 10-K, Registration Statements and other
documents filed with the SEC.
D. 1999 Year End Statements
56. In its March 30, 2000 filing with the SEC for the year ended
December 31, 1999, WorldCom made the following representations about its
operations, including revenues and income:
MCI WORLDCOM. INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (In Millions, Except Per Share Data)
For the Years Ended December 31,
1999 1998 1997
Revenues $37,120 $18,169 $7,789
Operating expenses:
Line costs
SG&A
15,951
8,935
8,534
4,563
3,887
1,854
Deprec. & amort.
In-process R&D
4,354 2,289 1,066
and other charges
Total
(8)
29,232
3,725
19,111
–
6,807
Operating income (loss) 7,888 (942) 982
Other income (expense):
Interest expense (966) (692) (450)
Miscellaneous 242 44 46
Income (loss) before income taxes,
min. ints., cum. effect of acct
change & extraordinary items
Provision for income taxes
7,164
2,965
(1,590)
877
578
393
Income (loss) before min. ints.,
cum. effect of acct change &
extraordinary items 4,199 (2,467) 185
Minority interests (186) (93) –
Income (loss) before cum. effect
of acct change &
extraordinary items
Cum. effect of acct change
4,013 (2,560) 185
(net of income taxes of $22 in 1998)
Extraordinary items
– (36) –
(net of income taxes of $78 in 1998) – (129) (3)
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Net income (loss) 4,013 (2,725) 182
Distributions on sub trust
mandatorily redeemable
preferred securities
Preferred dividend req.
63
9
18
24
–
39
Net income (loss) applicable to
common shareholders $ 3,941 $(2,767) $ 143
57. On March 24, 2000, Arthur Andersen provided an unqualified
opinion of the consolidated financial statements, including the Statements of
Operations:
We have audited the accompanying consolidated balance
sheets of MCI WORLDCOM, Inc. (a Georgia
corporation) and subsidiaries as of December 31, 1999
and 1998, and the related consolidated statements of
operations, shareholders' investment and cash flows for
each of the years in the three-year period ended
December 31, 1999. These financial statements are the
responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the
financial statements of Brooks Fiber Properties, Inc., a
company acquired during 1998 in a transaction
accounted for as a pooling-of-interests, as discussed in
Note 2, as of and for the year ended December 31, 1997.
Such statements are included in the consolidated
financial statements of MCI WORLDCOM, Inc. and
reflect total revenues of two percent of the related
consolidated totals in 1997. These statements were
audited by other auditors whose report has been
furnished to us and our opinion, insofar as it relates to
amounts included for Brooks Fiber Properties, Inc. is
based solely upon the report of the other auditors.
We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those
standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting
principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audit and the
report of the other auditors provide a reasonable basis for
our opinion.
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In our opinion, based on our audit and the report of the
other auditors, the financial statements referred to above
present fairly, in all material respects, the financial
position of MCI WORLDCOM, Inc. and subsidiaries as
of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in
the three-year period ended December 31, 1999, in
conformity with accounting principles generally
accepted in the United States.
58. On March 29, 2000, Andersen also gave its written consent for its
report being included in WorldCom’s 10-K, Registration Statements and other
documents filed with the SEC.
E. 2000 Financial Statements
1. First Quarter 2000
59. On April 27, 2000, WorldCom issued a Press Release reporting its
First Quarter 2000 financial results. The Company represented it had:
[S]trong profitability gains in first quarter 2000 driven by robust data,
Internet and international revenues and declining access and
technology costs. For the quarter ending March 31, 2000, earnings
before goodwill amortization (cash earnings) increased 59 percent
year-over-year to $1.6 billion, or $0.54 per common share. Net
income increased 80 percent to $1.3 billion, or $0.44 per common
share.
The Press Release also provided Management’s Comments on the First
Quarter Results:
“WorldCom continues to enjoy success in its focus
markets. On an annualized basis, data, Internet and
international services represent more than $18 billion of
annualized revenues growing at 32 percent,” said
Bernard J. Ebbers, president and CEO of WorldCom.
“We are clearly leading the communications industry
into a new era dominated by data- and Internet-based
services, and our newly announced generation d
initiatives leverage our existing strengths.”
60. In its May 15, 2000 filing with the SEC for the First Quarter of 2000
ended March 31, 2000, WorldCom made the following representations about its
operations, including revenues and income:
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WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For the Three Months Ended March 31,
2000 1999
Revenues $ 9,978 $ 9,122
Operating expenses:
Line costs 4,092 4,137
Selling, general & admin
Depreciation and amort.
2,299
1,147
2,374
1,101
Total 7,538 7,612
Operating income 2,440 1,510
Other income (expense):
Interest expense (218) (272)
Miscellaneous 111 (26)
Income before income taxes &
minority interests 2,333 1,212
Provision for income taxes 953 547
Income before
minority interests 1,380 665
Minority interests (79) 65
Net income
Distributions on subsidiary trust
1,301 730
and other mandatorily
redeemable preferred securities 16 16
Preferred dividend requirement 1 2
Net income applicable to
common shareholders $ 1,284 $ 712
2. Second Quarter 2000
61. On July 27, 2000, WorldCom issued a Press Release for its Second
Quarter 2000 financial results. WorldCom represented that it had “solid
profitability gains in the second quarter ended June 30, 2000, driven by revenue
increases in data, Internet and international services, combined with declining
access and technology costs.” WorldCom also recognized in the quarter a “onetime
after tax charges of $55 million associated with the termination of its merger
agreement with Sprint.” WorldCom further represented that for “comparative
purposes, the discussion of [financial] results excludes this non-recurring charge.”
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62. In its August 14, 2000 filing with the SEC for the Second Quarter of
2000 ended June 30, 2000, WorldCom represented its operation, including
revenues and income:
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For the Three Months
For the Six Months
Ended June 30, Ended June 30,
2000 1999 2000 1999
Revenues $10,193 $9,065 $20,171 $18,187
Operating expenses:
Line costs 4,152 3,956 8,244 8,093
SG&A
Depreciation & amortization
2,442
1,186
2,241
1,086
4,741
2,333
4,615
2,187
Total 7,780 7,283 15,318 14,895
Operating income 2,413 1,782 4,853 3,292
Other income (expense):
Interest expense (236) (248) (454) (520)
Miscellaneous 109 48 220 22
Income before income taxes
and minority interests 2,286 1,582 4,619 2,794
Provision for income taxes 930 654 1,883 1,201
Income before minority interests 1,356 928 2,736 1,593
Minority interests (65) (45) (144) 20
Net income 1,291 883 2,592 1,613
Distributions on subsidiary trust
and other mandatorily
redeemable preferred securities
Preferred dividend requirement
16
-
15
3
32
1
31
5
Net income applicable to
common shareholders $ 1,275 $ 865 $ 2,559 $ 1,577
3. Third Quarter 2000
63. On October 26, 2000, WorldCom issued a Press Release reporting its
Third Quarter 2000 financial results. WorldCom represented that it had “solid
results in the third quarter ended September 30, 2000, driven by strength across
the Company's digital and international businesses. This quarter WorldCom
recognized after tax charges of $405 million associated with specific domestic and
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international wholesale accounts that are no longer deemed collectible due to
bankruptcies, litigation and settlements of contractual disputes that occurred in the
third quarter. For comparative purposes, the discussion excludes these charges.”
Under Financial Highlights, WorldCom represented:
Consolidated revenues for the third quarter increased 12
percent over last year's comparable quarter, reflecting
continued growth from global broadband services.
Operating income increased by $360 million or 16
percent from the third quarter of 1999 to $2.6 billion.
WorldCom's commercial services achieved revenue
growth of 19 percent over third quarter 1999.
Cash earnings (earnings before goodwill amortization)
per share increased 21 percent year-over-year to $0.57
per common share.
Net income applicable to common shareholders
increased 26 percent to $1.4 billion, or $0.47 per
common share, up from $0.37 per share in the third
quarter of 1999.
64. In its November 14, 2000 filing with the SEC for the Third Quarter of
2000 ended September 30, 2000, WorldCom represented its operations, including
revenues and income:
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For the Three Months
For the Nine Months
Ended September 30, Ended September 30,
2000 1999 2000 1999
Revenues $10,047 $8,996 $29,483 $26,586
Operating expenses:
Line costs 3,867 3,593 11,376 11,089
SG&A
Deprec. & amort.
3,069
1,237
2,125
1,079
7,810
3,570
6,740
3,266
Total $ 8,173 $6,797 $22,756 $21,095
Operating income 1,874 2,199 6,727 5,491
Other income (expense):
Interest expense (245) (228) (699) (748)
Miscellaneous 107 31 327 53
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Income before income taxes
and minority interests
Provision for income taxes
1,736
697
2,002
793
6,355
2,580
4,796
1,994
Income before min. ints. 1,039 1,209 3,775 2,802
Minority interests (72) (112) (216) (92)
Net income
Distributions on sub. trust
967 1,097 3,559 2,710
& other mandatorily
redeemable preferred sec. 16 16 48 47
Preferred dividend req. - 2 1 7
Net income applicable
to common shareholders $ 951 $1,079 $ 3,510 $ 2,656
4. Fourth Quarter and Year End 2000
65. On February 8, 2001, WorldCom issued a Press Release announcing
its Fourth Quarter 2000 earnings. WorldCom represented:
The solid results posted by WorldCom meet the
performance expectations the Company announced on
November 1 when it declared its intention to separate the
Company's financial structure into two distinct groups: a
high-growth unit focused on data, Internet and
international operations and a high cash flow unit
focused on mature businesses.
For the consolidated WorldCom year end results (both WorldCom and
MCI), World Com represented that:
Full year consolidated WorldCom, Inc. revenues were $39.1 billion,
up from $35.9 billion in 1999. [] Full-year consolidated EBITDA
was $13.8 billion before charges, up from 1999 EBITDA of $12.2
billion. [] Full-year 2000 cash earnings were $5.8 billion or $2.00
per share, versus $5.1 billion or $1.74 per share in 1999.
Consolidated net income before charges, was $4.6 billion or $1.59 per
share.
The Press Release quoted Ebbers for management comments:
“Since announcing our intention to separate the
Company's businesses into growth and mature segments,
WorldCom has made excellent progress. We are
addressing those areas of our business that are mature
and already have begun to manage them more
appropriately -- focusing on cash returns," said Bernard
J. Ebbers, president and CEO of WorldCom, Inc.
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The management outlook for full-year 2001 was positive:
The Company expects full-year 2001 WorldCom Group
revenue growth of between 12 and 15 percent with
quarterly growth increasing through the year. The
Company expects WorldCom Group cash earnings of
between $1.25 and $1.35 per share for the year.
Because of the Company's intention to manage the MCI
Group for cash profitability and its intention to deemphasize
unprofitable business segments, we expect
declining, but stabilizing sequential revenues in the MCI
Group. The Company expects MCI Group cash earnings
of between $0.25 and $0.30 per share in 2001. In
addition, the Company fully expects the MCI Group to
generate sufficient cash flow in 2001 to service its
dividend and debt requirements.
WorldCom, Inc. currently expects that full-year 2001
consolidated cash earnings will be in the Company's
previous $1.55 to $1.65 per share guidance range.
66. In its 10-K for year end December 31, 2000, filed with the SEC on
March 30, 2001, WorldCom represented its operations, including revenues and
income:
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (In Millions, Except Per Share Data)
FOR THE YEARS ENDED DECEMBER 31,
1998 1999 2000
Revenues $17,617 $35,908 $39,090
Operating expenses:
Line costs
SG&A
7,982
4,563
14,739
8,935
15,462
10,597
Deprec. & amort.
In-process R&D &
2,289 4,354 4,878
other charges
Total
3,725
$18,559
(8)
$28,020
–
$30,937
Operating income (loss) (942) 7,888 8,153
Other income (expense):
Interest expense
Miscellaneous
(692)
44
(966)
242
(970)
385
Income (loss) before income taxes,
min. ints., cumulative effect
of accounting change
and extraordinary items (1,590) 7,164 7,568
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Provision for income taxes 877 2,965 3,025
Income (loss) before min. ints.,
cumulative effect of
accounting change and
extraordinary items (2,467) 4,199 4,543
Minority interests (93) (186) (305)
Income (loss) before cumulative
effect of accounting change
and extraordinary items (2,560) 4,013 4,238
Cumulative effect of accounting
change (net of income taxes of
$22 in 1998 and $50 in 2000) (36) -- (85)
Extraordinary items (net
of income taxes of $78 in 1998) (129) -- --
Net income (loss) (2,725) 4,013 4,153
Distributions on subsidiary
trust mandatorily redeemable
preferred securities 18 63 64
Preferred dividend requirement 24 9 1
Net income (loss) applicable
to common shareholders. $(2,767) $3,941 $4,088
67. On March 30, 2001, Defendant Andersen provided an unqualified
audit opinion on these financial statements:
We have audited the accompanying consolidated balance
sheets of WorldCom, Inc. (a Georgia corporation) and
subsidiaries as of December 31, 1999 and 2000, and the
related consolidated statements of operations,
shareholders' investment and cash flows for each of the
years in the three-year period ended December 31, 2000.
These financial statements are the responsibility of the
Company's management. Our responsibility is to express
an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those
standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.
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An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial
position of WorldCom, Inc. and subsidiaries as of
December 31, 1999 and 2000, and the results of their
operations and their cash flows for each of the years in
the three-year period ended December 31, 2000, in
conformity with accounting principles generally
accepted in the United States. As discussed in Note 1 to
the consolidated financial statements, effective January
1, 2000, the Company changed its method of accounting
for certain activation and installation fee revenues and
expenses. Additionally, effective January 1, 1998, the
Company changed its method of accounting for start-up
activities.
68. On April 25, 2001, Andersen also gave its written consent for its
report being included in WorldCom’s 10-K, Registration Statements and other
documents filed with the SEC.
F. 2001
1. First Quarter 2001
69. On April 26, 2001, WorldCom issued a Press Release announcing its
First Quarter 2001 earnings. WorldCom represented:
In the first quarter, WorldCom recognized after-tax
charges of $76 million for domestic severance packages
and other costs associated with previously announced
workforce reductions. Of these charges, $47 million and
$29 million were attributable to the WorldCom group
and the MCI group, respectively. In addition, the
Company incurred $94 million of expenses resulting
from the impact of foreign currency exchange on
Embratel, WorldCom's Brazilian communications
company. The discussion in this release excludes these
items.
For the Consolidated Worldcom, Inc. results, WorldCom represented:
First quarter 2001 consolidated revenues were $9.7
billion, up from $9.6 billion in the same period of 2000.
Consolidated EBITDA was $2.9 billion, representing an
EBITDA margin of 30 percent.
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First quarter 2001 cash earnings were $1.0 billion, or 35
cents per share. Consolidated net income, after goodwill
amortization, was $729 million or 25 cents per share in
the quarter.
For management's comments, the Press Release stated:
“This quarter was an excellent start to what will be a
pivotal year for WorldCom. These results show that
WorldCom is on track to deliver strong growth and solid
performance throughout the year,” said Bernard J.
Ebbers, president and CEO of WorldCom, Inc. [] “On
the WorldCom group side we achieved our growth
targets, adding $237 million in revenues since the fourth
quarter -- the largest sequential increase we've delivered
in a year.”
70. In its April 15, 2001 filing with the SEC for the First Quarter 2001
ended March 31, 2001, WorldCom represented its operations, including revenues
and income:
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For the Three Months Ended March 31,
2000 2001
Revenues
Operating expenses:
$ 9,612 $ 9,720
Line costs
SG&A
3,733
2,308
4,108
2,868
Depreciation & amort. 1,147 1,463
Total $ 7,188 $ 8,439
Operating income
Other income (expense):
2,424 1,281
Interest expense
Miscellaneous
(218)
111
(297)
4
Income before income taxes,
min. ints & cumulative effect
of accounting change 2,317 988
Provision for income taxes 947 389
Income before min. ints. & cumulative
effect of accounting change 1,370 599
Minority interests (82) 11
Income before cumulative effect
of accounting change 1,288 610
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Cumulative effect of
accounting change (net of
income tax of $50 in 2000) (85) --
Net income 1,203 610
Distributions on subsidiary
trust and other mandatorily
redeemable preferred securities
Preferred dividend requirement
16
1
16
--
Net income applicable to
common shareholders $ 1,186 $ 594
2. Second Quarter 2001
71. On June 27, 2001, the shareholders, at WorldCom’s request, had
approved a Plan of Recapitalization which allowed WorldCom Group to be
tracked separately from MCI. Shareholders, including the Regents, exchanged
their stock for WorldCom group stock and MCI group stock at different par
values.
72. On July 26, 2001, WorldCom issued a Press Release announcing its
Second Quarter 2001 earnings. WorldCom represented:
Internal cash flows at the WorldCom group improved
over $600 million during the quarter and were achieved
through increased cash from operations as well as less
cash used in investing activities.
WorldCom group reported revenues of $5.4 billion, a 12
percent increase from the same period in 2000. This
strong result was driven by 22 percent year-over-year
revenue growth in data and Internet services.
73. For the consolidated WorldCom results, WorldCom reported:
Second quarter 2001 consolidated revenues were $8.9
billion. Consolidated EBITDA was $2.7 billion,
representing an EBITDA margin of 30 percent. Second
quarter 2001 cash earnings were $917 million.
Consolidated net income, after goodwill amortization,
was $623 million.
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74. In management's comments, Ebbers stated:
I'm also extremely pleased with the results of our
heightened focus on cash flow. The $600 million
sequential improvement in internally generated cash flow
this quarter is a result of good business fundamentals:
solid growth, more stable pricing, efficient cost control
and effective balance sheet management.
Management's Outlook was:
In spite of the uncertain global economic environment, at
this point the Company expects full-year 2001
WorldCom group revenue growth of between 12 and 15
percent and expects WorldCom group EBITDA to be
between $7.8 and $8.3 billion. WorldCom group's cash
earnings are expected to be between $1.05 and $1.10 per
share for the year.
75. In addition, the Press Release stated that for the three and six-month
periods ended June 30, 2001 and 2000, WorldCom, for comparative purposes,
excluded some non-recurring items.
76. In its August 14, 2001filing with the SEC for the Second Quarter
2001 ended June 30, 2001, WorldCom represented its operations, including
revenues and income:
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited, In Millions, Except Per Share Data)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2000 2001 2000 2001
Revenues $ 9,807 $ 8,910 $ 19,419 $ 17,735
Operating expenses:
Line costs 3,776 3,730 7,509 7,426
SG&A
Deprec. & amortiz.
2,458
1,186
3,389
1,407
4,766
2,333
5,986
2,742
Total $ 7,420 $ 8,526 $ 14,608 $ 16,154
Operating income 2,387 384 4,811 1,581
Other income (expense):
Interest expense (236) (348) (454) (653)
Miscellaneous 109 123 220 223
Income before income taxes,
min. ints. & cumulative
effect of accounting change 2,260
Provision for income taxes 919
159
62
4,577
1,866
1,151
444
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Income before min. ints &
cumulative effect of
accounting change 1,341 97 2,711 707
Minority interests (68) -- (150) –
Income before cumulative
effect of accounting change 1,273 97 2,561 707
Cumulative effect of
accounting change (net of
income tax of $50 in 2000) -- -- (85) --
Net income
Distributions on
1,273 97 2,476 707
mandatorily redeemable
preferred securities 16 16 32 32
Preferred dividend req. -- -- 1 --
Net income applicable
to common shareholders $ 1,257 $ 81 $ 2,443 $ 675
3. Third Quarter 2001
77. On October 25, 2001, WorldCom issued a Press Release announcing
its Third Quarter 2001 earnings. WorldCom represented that its third quarter 2001
consolidated revenues were $9 billions with EBITDA of $2.7 billion. The cash
earnings were $797 million with consolidated net income, after goodwill
amortization of $493 million. Under Management’s Comments, WorldCom
represented:
“WorldCom delivered excellent growth this quarter,
while substantially improving the free cash flow of our
business,” said Bernard J. Ebbers, president and CEO of
WorldCom, Inc. “Our data, Internet and international
businesses continue to perform well in spite of the very
difficult economic environment. We still expect our
growth businesses to gain market share profitably during
this period of global economic uncertainty.”
In Management’s Outlook, WorldCom forecasted its cash earnings for 2002 to be
between $.05 and $1.05 per share for the year.
78. In its November 14, 2001filing with the SEC for the Third Quarter
2001 for period ended September 30, 2001, WorldCom represented:
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WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
2000 2001 2000 2001
Revenues
Operating expenses:
$ 10,037 $ 8,966 $ 29,456 $ 26,701
Line costs
SG&A
3,867
3,081
3,745
2,517
11,376
7,847
11,171
8,503
Deprec. & amort. 1,237 1,524 3,570 4,266
Total $ 8,185 $ 7,786 $ 22,793 $ 23,940
Operating income
Other income (expense):
1,852 1,180 6,663 2,761
Interest expense
Miscellaneous
(245)
107
(442)
107
(699)
327
(1,095)
330
Income before income taxes,
min. ints & cumulative
effect of accounting change 1,714 845 6,291 1,996
Provision for income taxes 688 329 2,554 773
Income before min. int. &
cumulative effect of
accounting change
Minority interests
1,026
(75)
516
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3,737
(225)
1,223
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Income before cumulative
effect of accounting change
Cumulative effect of
951 536 3,512 1,243
accounting change (net of
income tax of $50 in 2000) -- -- (85) --
Net income 951 536 3,427 1,243
Distributions on
mandatorily redeemable
preferred securities &
other preferred
dividend requirements 16 43 49 75
Net income applicable
to common shareholders $ 935 $ 493 $ 3,378 $ 1,168
4. Fourth Quarter and Year End 2001
79. On February 7, 2002, WorldCom issued a Press Release announcing
its fourth quarter and full year 2001 earnings. WorldCom represented that its
fourth quarter consolidated revenues were $8.5 billion with $570 million in cash
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earnings; $295 million applicable to common shareholders. For the year,
revenues were $35.2 billion, cash earnings were $3.3. billion and consolidated net
income applicable to common shareholders was $2.1 billion. These numbers
decreased from 2000. For Management Comments, WorldCom represented:
“As with others in the industry, MCI group was
negatively impacted by a weak economy and on-going
effects of wireless substitution,” said Bernard J. Ebbers,
WorldCom present and CEO. “Despite all of these
impacts, we remain encouraged by our continued
progress on key growth initiatives that we expect will
stabilize MCI revenue in the quarters ahead.”
80. In its Consolidated Statement of Operations for fiscal year end
December 31, 2001, WorldCom represented the following in filings with the SEC:
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For Years
Ended
December 31
1999 2000 2001
Revenues
Operating Expenses:
$35,908 $39,090 $35,179
Line Costs
SG&A
14,739
8,935
15,462
10,597
14,739
11,046
Depreciation &
amort.
4,354 4,878 5,880
Other Charges (8)
28, 020
–
30,937
–
31,665
Total
7, 888 8,153 3,514
Operating Income
Other income (expense)
Interest expense
Misc.
(966)
242
(970)
385
(1,533)
412
Income before taxes, min.
ints. & cumulative effect
of accounting change
7,164 7,568 2,393
Provision for income taxes 2,965 3,025 927
Income before min. ints. &
cumulative effect of
accounting change
4,199 4,543 1,466
Minority interests (186) (305) 35
Income before cumulative
effect of accounting change 4,013 4,238 1,501
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Cumulative effect of
accounting change (net of
income tax of $50 in 2000) – (85) –
Net income 4,013 4,153 1,501
Distib. on mandatorily
redeemable pref. Sec. &
other preferred div. req. 72 65 117
Net income applicable to
com. shareholders $ 3,941 $ 4,088 $ 1,384
81. Defendant Andersen provided an unqualified audit opinion as to
WorldCom’s financial statements for 2001, which includes the Consolidated
Statement of Operations. Andersen represented:
We have audited the accompanying consolidated balance
sheets of WorldCom, Inc. (a Georgia corporation) and
subsidiaries as of December 31, 2000 and 2001, and the
related consolidated statements of operations,
shareholders’ investment and cash flows for each of the
years in the three-year period ended December 31, 2001.
These financial statements are the responsibility of the
Company’s management. Our responsibility is to
express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those
standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting
principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial
position of WorldCom, Inc. and subsidiaries as of
December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the years in
the three-year period ended December 31, 2001, in
conformity with accounting principles generally
accepted in the United States.
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As discussed in Note 1 to the consolidated financial
statements, the Company changed its method of
accounting for certain activations and installation fee
revenues and expenses.
82. On March 7, 2002, Andersen also gave its written consent for its
report being included in WorldCom’s 10-K, Registration Statements and other
documents filed with the SEC.
83. According to the footnotes accompanying the audited financial
statements, the accounting change of $85 million in 2000 was a one-time expense
which was incurred because during the fourth quarter of 2000, WorldCom
implemented Staff Accounting Bulletin No. 101, “Revenue Recognition in
Financial Statements” which required “certain activation and installation fee
revenues to be amortized over the average life of the related service rather than be
recognized immediately. Costs directly related to these revenues may also be
deferred and amortized over the customer contract life.”
84. WorldCom also disclosed in footnote 16 a related party transaction
with Ebbers related to Ebbers’ loans from certain financial institutions which were
secured by WorldCom stock. According to the footnote:
WorldCom made aggregate payments of approximately
$198.7 million to Bank of America pursuant to the
guaranty, in addition to the deposit collateralizing the
letter of credit. That amount, together with any amounts
paid or costs incurred by us in connection with the letter
of credit, plus accrued interest at a floating rate equal to
that under one of our credit facilities, is payable by Mr.
Ebbers to us on demand. The amount of such interest
accrued through February 28, 2002, is approximately
$875,000 and the interest rate as of that date was 2.15%
per annum.
G. First Quarter 2002
85. On April 25, 2002, WorldCom issued a Press Release announcing its
First Quarter 2002 results. WorldCom represented that its first quarter
consolidated revenues were $8.1 billion with consolidated net income of $130
million, including a $90 million after-tax charge associated with the disposition of
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investments. Without this charge, consolidated net income would have been $220
million.
86. The Management Comment’s represented:
“Despite very difficult performance this quarter
WorldCom was able to generate free cash flow from
operations and reduce net debt by $903 million,” said
Bernard J. Ebbers, WorldCom president and CEO. . .
Assuming no further economic or market deterioration,
WorldCom group currently expect full-year 2002
revenues of $21 billion to $21.5 billion and EBITDA
(earnings before interest, taxes, depreciation and
amortization) of $7 billion to $7.5 billion.
87. According to WorldCom’s 10-Q for the first quarter of 2002 (which
ended March 31, 2002) filed on May 15, 2002, the company had net income for its
consolidated operations of $610 million on $8,825,000,000 revenues. WorldCom
represented that Consolidated Statement of Operations (reported in millions of
dollars except for per share data) was as follows:
Revenues $8,825
Operating Expenses:
Line Costs
SG&A
3,696
2,597
Total
Depreciation & amort. 1,335
7,628
Operating Income 1,197
Other income (expense)
Interest expense (305)
Misc. 100
Income before taxes & minority int. 992
Provision for income taxes 382
Income before minority interests 610
Minority interests --
Net income 610
Distribut. on mand. redeemable
pref. sec. & other pref. sec. 16
Net income applicable to
common shareholders 594
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VI.
WORLDCOM’S STOCK
88. Until its collapse in 2002, WorldCom appeared to the markets to be a
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thriving company. In the late 1990s, analysts thought that the telecommunications
industry had the potential for unlimited growth and investors invested significant
monies into telecom companies. For many years, the telecommunications industry
as a whole did very well.
89. During the 1990s, WorldCom was one of the best performing stocks
in the Standard & Poor’s 500 index. WorldCom’s stock had high of $96.77 per
share on June 30, 1999. Stock analysts touted the stock, none more than defendant
Salomon’s analyst Jack Grubman.
90. Since it appeared to be a thriving company, WorldCom’s executives
were highly compensated. For example, as CEO of WorldCom, Ebbers received
an extremely generous compensation package. From 1999 through 2001, he
received in excess of $77 million in total compensation. According to
WorldCom’s 10-K’s filed with the SEC, Ebbers received the following
compensation:
1999: $36 million total compensation, including $935,000 in salary; $7.5
million in a performance bonus; $60,000 in other compensation; and 1,857,420
stock options worth $27,694,123 on December 31, 1999.
2000: $31.8 million total compensation, including $1 million in salary; $10
million in a retention bonus; $50,000 in other compensation; and 1,238,280 stock
options worth $20,790,721 on December 31, 2000.
2001: $9.1 million total compensation, including $1 million in salary;
$48,000 in other compensation; and 1,238,280 stock options worth $8,058,968 on
December 31, 2001.
During the 1990s, Ebbers borrowed in excess of $1 billion, including loans
from CitiGroup, using his WorldCom stock as collateral. WorldCom guaranteed
the loans and also loaned him over $400 million at below market rates. Ebbers
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often obtained the loans first and only later would obtain Board of Directors’
approval. The loans were not properly disclosed in WorldCom’s financial
statements.
91. Also Scott D. Sullivan, the CFO, received lucrative compensation
packages. Sullivan, a C.P.A., joined WorldCom in late 1992 or early 1993 as a
result of WorldCom’s merger with Advanced Telecommunications Corporation
where he had been Vice President and Treasurer. His first title at WorldCom was
that of Assistant Treasurer. In 1994, he became Chief Financial Officer, Treasurer
and Secretary of WorldCom, and in 1996, he became a Director of the Company.
According to filings with the SEC, in 1998, he received a salary of $500,000 and a
bonus of $2,000,000; in 1999, in received a salary of $600,000 and a bonus of
$2,760,000. In 2000, he received a salary of $700,000 and a retention bonus of
$10,000,000. According to WorldCom’s proxy statements for its 2002
shareholder meeting, Sullivan beneficially owned 3,264,438 shares of stock.
92. Even as the Internet bubble burst in early 2000, WorldCom continued
to show profits although its stock value did decline. Until the third quarter of
2000, WorldCom’s reported earnings consistently met or nearly met analyst’s
predictions. In subsequent quarters, WorldCom claimed non-repeating charges
which stopped it from meeting targets. In the first six months of 2001,
WorldCom’s stock was generally trading in the $18-$21 range. After that, it
continued to decline, but its decline appeared to be consistent with other declines
in the industry which was suffering problems in the long-distance and Internet
business.
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VII.
THE FRAUDULENT SCHEME
93. While the Defendants were representing to the public that WorldCom
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was a profitable company, in fact, it was an illusion based on fraudulent
accounting practices accomplished with the assistance and knowledge of the
Defendants that allowed the fraud to flourish. WorldCom and the Defendants
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misrepresented the financial condition of WorldCom through filings with the SEC,
annual statements, press releases, analyst statements, and other documents
provided to the public.
94. As the Defendants knew from their close relationship with
WorldCom, WorldCom was always an aggressive company that engaged in illegal
activity. For example, according to a July 8, 2002 article in Time, the Mississippi
Attorney General investigated WorldCom and discovered that its employees, at
Ebbers direction, made a series of campaign contributions which were illegally
reimbursed by the company. In 1995, WorldCom pled guilty to a felony charge
and paid a $120,000 penalty.
95. From WorldCom’s beginnings through 2002, WorldCom manipulated
its financial statements to show increasing revenues. Its purported extraordinary
growth was a fraud and its financial statements were false.
96. The Defendants accomplished the scheme to defraud through mergers
and acquisitions which allowed revenues to be inflated and expenses minimized.
From at least 1994 through 2002, financial manipulations rather than real growth
made WorldCom appear to be a successful company.
97. For example, through the mergers from at least 1994 through 2002,
WorldCom, with the substantial assistance of Defendants, was able to improperly
record extraordinary charges or capitalized expenses that it could hide through
mergers. As a result, WorldCom’s expenses on its financial statements were
understated. WorldCom, with the substantial assistance of Defendants during the
period from at least 1994 through 2002, overvalued assets, including goodwill.
WorldCom, with the substantial assistance of Defendants, shifted revenue.
Revenues which should have been recorded in a quarter before a merger were
improperly booked in the quarter after the acquisition so that WorlCom could
claim the revenue and make it appear as if the acquisition had real benefits to
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shareholders. As a result of the scheme to defraud during the years from at least
1994 through 2002, WorldCom’s financial statements were false.
98. Additionally, WorldCom’s sales people engaged in unethical
practices from at least 1994 until 2002 that caused the financial statements to be
misstated. For example, WorldCom’s sales force routinely double-booked sales to
boost earnings. See Mississippi Business Journal. April 1, 2002. The SEC is
looking into all documentation regarding customer accounts, accounts receivables,
billing and contract disputes, employee commissions and, sales and marketing.
One customer, who claimed he was over-billed, complained to Andersen about his
over-billing problems. See Miami Herald, March 21, 2002.
99. WorldCom also engaged in improper barter transactions which
allowed it to improperly recognize revenue. For example, in February of 1999,
WorldCom and Electronic Data Systems entered into a transaction where each
company agreed to purchase goods or services from one another at inflated prices.
Electronic Data Service agreed to purchase $8.5 billion of communications
services from WorldCom over 10 years and to purchase a WorldCom unit for $1.6
billion. WorldCom agreed to hire Electronic Data Service to oversee its billing
and other services for about $7 billion over the same 10-year period. WorldCom
improperly recognized all the revenue from the transaction in one year in violation
of accounting standards thereby inflating its revenues on its financial statements.
WorldCom entered into other improper barter transactions from 1994 through
2002 which allowed it to show higher revenues on its financial statements.
100. In about 1999, WorldCom could not generate sufficient revenues to
meet analysts’ expectations from mergers. Defendants knew that if WorldCom did
not meet analysts’ expectations, WorldCom’s stock price and market value would
decline. The Defendants knew that if WorldCom’s value declined, they would
lose their lucrative fees and, Citigroup would not be repaid its loans.
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101. Beginning in 1999, the Defendants began another type of financial
manipulation in its scheme to defraud so that its fraud could continue. WorldCom,
with the substantial assistance of Defendants, began to improperly use reserve
accounts to boost profits to meet analysts’ expectations. This scheme to defraud
was a continuation of the original scheme of financial manipulation. By 2001,
WorldCom had fraudulently depleted its reserves to a level where the reserves
could no longer be used to boost profitability. The company then began to hide
expenses to manage profitability to meet analyst’s expectations. The primary
method to hide the expenses was to reclassify them as investment costs which
allowed the company to capitalize the costs over several years rather than
deducting the costs as expenses in the year they were incurred. As a result, the
profits were inflated.
A. Improper Accounting for Reserves
102. Companies establish reserves when it is doubtful that they will
recognize an asset or it is probable that they will incur a liability. Statement of
Financial Accounting Standards (FAS) No. 5, Accounting for Contingencies
provides that reserves may only be recorded when they are probable and the
amount of loss can be reasonably estimated:
8. An estimated loss from a loss contingency (as defined
in paragraph 1) shall be accrued by a charge to income if
both of the following conditions are met:
a. Information available prior to issuance of the
financial statements indicates that it is probable that an
asset has been impaired or a liability had been incurred at
the date of the financial statements. It is implicit in this
condition that it must be probable that one or more future
events will occur confirming the fact of the loss.
b. The amount of the loss can be reasonably
estimated.
FAS 5 defines “probable” as: “The future event or events are likely to occur” as
contrasted with reasonably possible or remote contingencies.
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103. If a company maintains reserves which are not probable and
reasonably estimable exposures, then the reserves are not recorded in conformity
with GAAP.
104. Beginning in or about 1999, WorldCom improperly used reserve
accounts as a slush fund. WorldCom took reserves for potential losses for bad
debt, court judgments and other contingencies, and improperly drew down those
reserves and used the money to inflate profits. In 2000 and 2001, WorldCom
improperly reduced their reserve levels to generate an artificially high level of net
income. WorldCom had been able to increase its reserves because of its mergers
and acquisitions.
B. Improper Accounting for Line Costs
105. By the first quarter of 2001, WorldCom was not able to convert
sufficient amount of reserves to income and thus the executives at WorldCom
looked for another way to inflate income. They decided, with the agreement and
assistance of the Defendants, on a scheme to capitalize Line Costs which were a
significant portion of WorldCom’s operating expenses on its Consolidated
Statements of Operations. Line Costs represent the various fees WorldCom paid
to third-party telecommunications carriers for WorldCom's right to access the
third-party's network facilities in order to serve customers.
106. Under GAAP, these fees must be reported as an expense in the year in
which they were incurred because they are a cost. See FASB Statement of
Concepts No. 5, 85.
107. Until approximately the first quarter of 2001, WorldCom reported
Line Costs as an expense. Beginning in or about the first quarter of 2001, in order
to manage earnings to meet analyst’s expectations, WorldCom began capitalizing
the Line Costs rather than recording them as an expense. The following chart
shows the amount of Line Costs that WorldCom reported in its financial
statements compared with its actual line costs:
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Financial
Statement
Representation
of Line Cost
Expenses
(in millions)
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Actual Line
Cost Expenses
(in millions)
Difference
(in millions)
2000 $15,462 $16,697 $ 1,235
2001 $14,739 $17,754 $ 3,015
1 st Quarter
2002
$ 3,696 $ 4,297 $ 601
Total $33,897 $38,748 $ 4,851
108. According to a June 28, 2002 New York Times article which quoted a
person close to the company: “[T]his started with the desired profit margin and
then backed into the expense number.”
109. The effect of this fraudulent scheme was to reduce WorldCom’s
expenses which increased its net income. Correspondingly, the entries increased
WorldCom’s capital asset accounts and had a material effect on the Balance Sheet
and Cash Flow Statements, and had the effect of fraudulently inflating
WorldCom’s income.
C. Other Accounting Irregularities
110. According to the First Interim Report of Dick Thornburgh of
November 4, 2002 and other published sources, it appears that WorldCom also
fraudulently increased its revenues by engaging in accounting irregularities in the
areas of inter-company balances, goodwill, improper billing and capitalized labor.
VIII. THE FRAUD IS DISCOVERED AND THE COMPANY RESTATES
ITS FINANCIAL STATEMENTS
111. In March of 2002, the Securities and Exchange Commission launched
a probe into WorldCom’s loans to Ebbers and other matters. On March 11, 2002,
WorldCom reported that the Securities and Exchange Commission had requested
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that the company voluntarily produce documents including: its third quarter 2000
pre-tax charge associated with wholesale accounts; disputed customer bills and
sales commissions; its accounting policies for goodwill and implementation of
FAS 142; loans by WorldCom to officers or directors; WorldCom's tracking and
review of analysts' earnings estimates. WorldCom stated “it is not aware of any
information that would give rise to the Commission's inquiry.”
112. In April, the Company laid off 3,700 workers and Ebbers resigned.
The Press Release announcing these events provide no reasons for either.
A. Internal Audit and Audit Committee Meetings
113. During May of 2002, the Vice President of Internal Audit, Cynthia
Cooper, one of Time magazine’s “Persons of the Year” in 2002, began an
investigation of WorldCom’s accounting for capital expenditures and capital
accounts. According to WorldCom’s own July 8, 2002 filing with the SEC, she
determined that “a number of questionable transfers had been made into the
Company’s capital accounts during 2001 and the first quarter of 2002.” “The
transfers involved a portion of the costs associated with network services and
facilities provided by third parties, designated ‘line costs’ by the Company, that
previously had been treated as expenses in the Company’s financial statements.”
114. She then discussed her findings with Scott Sullivan, the Chief
Financial Officer, and David Myers, Senior Vice President and Controller.
Sullivan asked her to delay her review until the third quarter, but she refused.
Sullivan represented to Cooper that the “line cost transfers began in the third
quarter of 2001, and that previously these costs had been expensed.” See July 8,
2002 Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange
Act, page 2 attached as Exhibit “A.”
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115. Cooper continued her investigation and brought her findings to the
Chairman of the Audit Committee of the Board of Directors, Max Bobbitt. The
Chairman did not believe that the matter needed to be brought to the attention of
the Audit Committee.
116. On June 13, 2002, Sullivan represented to the CEO of the company,
John Sigmore, that “SG&A [selling, general and administrative] and capital
expenditure reduction measures planned for the second quarter of 2002 may not
have the desired impact on net income due to writedowns that were planned for
that quarter.” Id., page 3
117. On June 14, 2002, Sullivan, who was also a director of WorldCom,
represented at the regularly scheduled board meeting:
[T]he financial report for second quarter 2002 would be
complex, including the previously announced $15-$20
billion goodwill impairment charge, severance charges,
and charges for cancelled capital projects, discontinued
operations, and other items.
Ibid. “Mr. Sullivan indicated that he would continue to examine the Company’s
line cost commitments.” Ibid.
118. On June 17 or 18, 2002, Myers “indicated that large transfers were
made in 2001 and the first quarter of 2002 and that there was no directly
applicable accounting support for the transfers.” Ibid.
119. On June 20, 2002, WorldCom’s Audit Committee met to review the
capitalization of Line Costs. An auditor from the newly engaged audit firm of
KPMG,
described the circumstances underlying the transfer
of line costs to the Company’s capital accounts at the
end of each of the second, third, and fourth quarters
of 2001 and the first quarter of 2002. Mr. Malone
[the KPMG auditor] stated that the transfers, in his
view, did not comply with generally accepted
accounting principles (GAAP), and, in particular, Mr.
Malone noted the absence of documentation
supporting the transfers.
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Id., page 4 (Emphasis added, bracketed material added). Sullivan admitted that
the Line Costs had been capitalized and provided his explanation for the
accounting treatment. Sullivan also stated that there may have been a “transfer of
line costs to capital accounts in the first quarter of 2001 as well.” Id., page 5. In
preparation for the meeting, Sullivan had prepared a White Paper setting forth his
justification for capitalizing the Line Costs.
120. On June 21, 2002, “Sullivan confirmed that the capitalization of lines
costs extended back into the first quarter of 2001.” Ibid. The company realized
that it would have to restate its financial statements for 2001 and the first quarter
of 2002.
B. The Internal Audit Discovers that WorldCom Executives
Intentionally Inflated the Revenues
121. Cooper and others continued the investigation and discovered further
information about the fraudulent scheme.
122. According to Internal Audit Correspondence dated June 24, 2002,
WorldCom accountant Troy Normand, “stated that he believed the reason line
costs began being capitalized in 2001 is that there was no more room to further
reduce the liability account. Troy stated that he believed the relief of the line cost
liability account was aggressive accounting and contemplated resigning in 2000.
He also stated that he believed the prepaid capacity entries were wrong and went
beyond aggressive accounting.”
123. The memo states that Normand went to his superiors at WorldCom
who told him that everything was proper. Specifically, in the third quarter of
2000, Normand went to Sullivan to express his concerns relating to the Line Cost
accruals and that Sullivan assured him that everything would be okay. He also
went to David Myers in 2001 about the prepaid capacity and also expressed these
concerns to Betty Vinson and Buddy Yates.
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124. A series of e-mails, discovered by the internal audit which are
attached as Exhibit “B,” demonstrates how the scheme may have been hatched and
that the accounting was done to meet analysts’ expectations.
125. In an July 25, 2000, e-mail from Accounting Department member
Tony Minert to David Myers, WorldCom’s Controller and Senior Vice President
and Bufford Yates, WorldCom’s Director of General Accounting, Minert asks
whether they can capitalize costs for excess capacity based on an e-mail that he
had received advising that “if we could capitalize that piece [excess capacity] and
draw down against it like spare parts inventory, we would make the income
statement look great.”
126. On July 25, 2000, Yates e-mailed Myers:
I might be narrow minded, but I can’t see a logical path
for capitalizing excess capacity.
127. That same day, Yates responded to Minert:
David and I have reviewed and discussed your logic of
capitalizing excess capacity and can find no support
within the current accounting guidelines that would
allow for this accounting treatment. I think our efforts
should shift back to our gross margin analysis and the g/l
and essbase structural changes needed to support the
analysis.
128. Notwithstanding the knowledge that it was wrong to capitalize these
expenses, both Myers and Yates approved and participated in the capitalization of
the expenses.
129. The e-mails also show that WorldCom employees were willing to do
whatever it took to get the numbers the company needed to meet expectations. On
March 5, 2001, Myers e-mailed Tom Bosley with a cc to Sullivan regarding
“Telco.” (Telco is another term for line costs.)
Pls see the attached Gross Margin analysis which
highlights the need for immediate attention to Telco
and Margins.
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Scott [Sullivan] relayed a conversation you had with
him at dinner when you volunteered to do whatever
necessary to get Telco/Margins back in line. This was
a dinner with Scott, Ron and Bernie prior to the
announcement of last quarter.
As you can see, margins have declined significantly and
your immediate attention is appreciated. We need to
address this during the quarter and not at the end of the
quarter. Just so you know, I fully realize the impact that
declining pricing to our customers has had on margins
but I hope you feel like me that it is impossible to accept
declining margins given the significant capex (over $16
billion over the past 2 years), access reform and the
fastest growing part of our business being Telecom
(more capex with lower variable line cost). (Emphasis
added).
Bosley responded the next day in an e-mail:
Actually I asked Scott what numbers he wanted and I
would see what could be done to get them. But . . .
obviously gross margins is very important and we will
put several projects in place to get this moving back
where it was. The first quarter is pretty well cast at this
point but we will define what we can do to reverse the
trend. (Emphasis added).
130. During the internal investigation, the participants once again showed
they had knowledge that there was no support for the entries (or unconvincingly
professed ignorance of the accounting methods). In internal audit correspondence
dated June 17, 2002, accountant Betty Vinson, who posted the prepaid account
entries, had no support for the entries and stated that she obtained the entry
amounts from Buddy Yates and David Myers. Yates claimed to have no
knowledge of the entries. Myers admitted that there was no support for the
prepaid capacity and that they were “booked based upon what they thought the
margins should be.”
Next we went to David Myers’ office and requested
support for the entries. David stated that he did not
have support for the entries and the amounts were
booked based upon what they thought the margins
should be. David said that there were no accounting
pronouncements to support these entries.
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David acknowledged that the line costs should probably
have not been capitalized and stated that it was difficult
to stop once started. (Emphasis added).
June 17, 2002 Internal Audit Correspondence.
C. Andersen States 2001 Financials Not Prepared in Accordance
with GAAP and Cannot Be Relied Upon
131. From June 21-24, 2002, WorldCom briefed partners at Arthur
Andersen about the inappropriateness of the accounting.
132. On or about June 24, 2002, Andersen partners met with Sullivan
about the transfers. (See Exhibit “A”). On June 24, 2002, the Audit Committee
had another meeting which was attended by attorneys, representatives from
KPMG and Andersen (who appeared by telephone). Andersen admitted to the
Committee that the 2001 financial statements could no longer be relied upon
because they were not prepared in conformity with GAAP:
Id., at pages 5-6.
Andersen informed the Company that in light of the
transfers of line costs during 2001 and the first
quarter of 2002, Andersen’s opinion regarding the
Company’s 2001 financial statements could no longer
be relied upon. They stated that Andersen had not
known of the transfers, but declined to respond to
questions regarding how Andersen’s audit activities
could have failed to discover the transfers. Mr. Rodgers
and Mr. Howell [the Andersen representatives] indicated
that they had not seen Mr. Sullivan’s memorandum [his
White Paper], but that it had been read to them and they
did not accept it as compliant with GAAP. While noting
that KPMG had neither audited nor formally
reviewed any of the financial statements in question,
Mr. Malone and Teresa Iannaconi of KPMG
observed that they agreed with Andersen’s conclusion
that the transfers in question could not be supported
by GAAP. (Emphasis added).
133. The Audit Committee concluded that WorldCom would have to
restate its financial statements for 2001 and the first quarter of 2002. By restating
its financials, WorldCom was admitting that its publicly-issued financial
statements for each of the restated period were not prepared in conformity with
GAAP, and that WorldCom materially misstated its financial condition and results
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of operations. Under GAAP, the restatement of previously issued financial
statements is reserved for circumstances where no lesser remedy is available.
Under Accounting Principles Board Opinion No. 20, Accounting Changes,
restatements are only permitted, and are required only to correct material
accounting error or irregularities that existed at the time the financial statements
were originally prepared and issued.
134. WorldCom concluded that the amount of improper transfers were:
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First Quarter 2001
Second Quarter 2001
Third Quarter 2001
Fourth Quarter 2001
First Quarter 2002
Total
$771 million
$610 million
$743 million
$931 million
$797 million
$3.852 billion
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Ibid. As a result of the restatement, WorldCom’s reported earnings would be
reduced to $6.339 billion for 2001 and $1.368 billion for first quarter 2002, and
the company, rather than having a profit, would have a net loss for 2001 and the
first quarter of 2002.
D. June 25, 2002 Announcement of Restatement
135. In a June 25, 2002 Press Release, WorldCom announced it would be
restating its financial statements for 2001 and the first quarter of 2002 because of
improper recognition of Line Costs which improperly inflated revenues:
[I]t [WorldCom] intends to restate its financial
statements for 2001 and the first quarter of 2002. As a
result of an internal audit of the company's capital
expenditure accounting, it was determined that certain
transfers from line cost expenses to capital accounts
during this period were not made in accordance with
generally accepted accounting principles (GAAP). The
amount of these transfers was $3.055 billion for 2001
and $797 million for first quarter 2002. Without these
transfers, the company's reported EBITDA would be
reduced to $6.339 billion for 2001 and $1.368 billion for
first quarter 2002, and the company would have reported
a net loss for 2001 and for the first quarter of 2002.
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136. In June of 2002, the SEC sought civil injunctive relief against
WorldCom (the SEC amended its complaint on November 5, 2002), and on July 2,
2002, the federal court appointed a monitor to have oversight over all
compensation paid by WorldCom.
137. On July 8, 2002, the House Financial Services Committee held
hearings into the WorldCom scandal. Ebbers and Sullivan exercised their 5 th
Amendment right not to testify. Melvin Dick, former Andersen partner on the
WorldCom engagement, and Jack Grubman, Salomon analyst, did testify.
138. On July 21, 2002, WorldCom and almost all its United States
subsidiaries filed for bankruptcy. The bankruptcy court approved the appointment
of an examiner and Dick Thornburgh was appointed on August 6, 2002. He is
charged with investigating the fraud and filing reports with the court. His First
Interim Report was filed on November 8, 2002.
139. On July 29, 2002, WorldCom’s stock delisted from NASDAQ.
E. August 8, 2002 Announcement of Additional Restatement
140. On August 8, 2002, WorldCom announced an additional restatement
of its financial statements because it had improperly reported earnings of $3.3
billion for 1999, 2000, 2001 and the first quarter of 2002. The company’s Press
Release provided:
WorldCom, Inc. today announced that its ongoing internal
review of its financial statements has discovered an additional
$3.3 billion in improperly reported earnings before interest,
taxes, depreciation and amortization (EBITDA) for 1999, 2000,
2001 and first quarter 2002. This amount is in addition to the
previously reported $3.8 billion in overstated EBITDA in the
year 2001 and first quarter 2002. As a result, WorldCom
intends to restated its financial statements for 2001 and first
quarter 2000.
* * *
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WorldCom also announced it expects to record further
write-offs of assets previously reported, including the
likelihood that it may determine all existing goodwill
and other intangible assets, currently recorded as $50.6
billion, should be written off when restated 2000, 2001
and 2002 financials are released. The company will also
reevaluate the carrying value of existing property, plant
and equipment as to possible impairment of historic
values previously reported. However, until the
company’s audit of previously reported asset values is
complete it cannot determine with certainty the amount
of its ultimate write-offs.
141. The Press Release also included the following chart which
summarized the changes to the financial statements:
Reductions to WorldCom’s Pre-Tax Income
(in millions of dollars)
1999 2000 2001 1Q
2002
Total
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June 25, 2002
reported EBITDA
reductions
August 8, 2002
EBITDA
reductions
Total reduction in
EBITDA
August 8, 2002
non-EBITDA pre
tax adjustments
$ $ $3,055 $ 797 $3,852
$ 217 $2,864 $ 161 $ 88 $3,330
$ (8) $ 393 $ 166 $ (50) $ 501
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Total pre tax
income reductions
$ 209 $3,257 $3,382 $ 835 $7,683
142. These write-downs occurred because WorldCom made transfers from
the reserve accounts and used the money as if it were revenues from operations to
inflate profits at just the amount to meet Wall Street’s expectations.
143. The effect of the misstatements was to decrease the net revenues and
profits of WorldCom changing what had purportedly been successful years when
WorldCom was one of the most highly valued companies in the country and
considered a model for telecommunications companies into years of loss.
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F. Criminal and SEC Charges Against WorldCom Executives
144. On June 24, 2002, the Audit Committee told Scott Sullivan, the Chief
Financial Officer and Director of WorldCom, that he would be terminated if he did
not resign before the board meeting the next day. When Sullivan refused,
WorldCom terminated him. In August of 2002, Sullivan was charged with
conspiracy to commit securities fraud, filing false statements with the SEC and
other criminal violations. Sullivan has pled not guilty to the charges.
145. In September of 2002, David F. Myers, Controller and Senior Vice
President of WorldCom from August of 1995 until June 25, 2002, was charged
with, and has pled guilty to, one count each of securities fraud, conspiracy to
commit securities fraud and filing false statements with the SEC. He had reported
directly to Sullivan and was responsible for tax, general accounting, accounts
receivable, accounts payable, payroll, property accounting, budgeting, foreign
controllers’ group and management reporting. He and his group were responsible
for consolidating the financial statements from the company’s different operations
and providing underlying information to the Financial Reporting Group.
According to a September 27, 2002 Washington Post report:
In court today, Myers acknowledged the central elements
of the government’s case and, without identifying the
other executives by name, described a wide circle of
company employees who were involved in the scheme.
“I was instructed on a quarterly basis by senior
management to ensure that entries were made to
falsify WorldCom’s books to reduce WorldCom’s
actual reported costs and therefore to increase
WorldCom’s reported earnings,” he told Judge
Casey.
“Along with others who worked under my
supervision, and at the direction of WorldCom senior
management, such accounting adjustments were
made for which I knew there was no justification or
documentation and were not in accordance with
generally accepted accounting principles,” he said.
(Emphasis added).
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146. In October of 2002, Buford Yates, Jr., former Director of General
Accounting at WorldCom, was charged with, and has pled guilty, to securities
fraud, conspiracy to commit securities fraud and filing false statements with the
SEC. He supervised the closing of WorldCom’s book at the end of financial
reporting periods and also had responsibility in preparing WorldCom’s
consolidated financial statements. According to an October 8, 2002 article in the
New York Law Journal:
judge that:
Mr. Yates admitted his role in the multi-billion dollar
accounting scandal, telling Southern District Magistrate
Judge Andrew J. Peck that he was part of a scheme to
conceal spiraling costs on the company’s balance sheet
in a failed effort to boost WorldCom’s stock price.
“I came to believe that the adjustments I was being
directed to make in WorldCom’s financial statements
had no justification and contravened generally
accepted accounting principles,” Mr. Yates told
Magistrate Judge Peck. “I concluded that the
purpose of these adjustments was to incorrectly
inflate WorldCom’s reported earnings in order to
meet the expectations of securities analysts and
mislead the investing public.” (Emphasis added).
147. According to the November 8, 2002 Montreal Gazette, Yates told the
[H]e was first directed to misreport WorldCom’s
finances in October 2000, when it became clear that the
company’s expenses were far higher than in previous
quarters and higher than analysts had expected. []
Starting in April 2001, Yates said, he was also instructed
to report large amounts of operating expenses as capital
expenses. He said he had “serious concerns” about this
practice, which vastly increased WorldCom’s reported
earnings, and said he expressed those concerns to his
supervisor, Myers.
148. In October of 2002, Betty L. Vinson, the former director of
management and reporting, and Troy M. Normand, director of legal entity
accounting, both CPAs in the General Accounting Department under Yates, pled
guilty to conspiracy and securities fraud charges for participating in the illegal
scheme. The SEC has also filed charges against Vinson and Normand.
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149. In November of 2002, WorldCom, Myers and Yates entered into a
settlement agreement with the SEC.
G. Other Restatements Probable
150. On November 5, 2002, WorldCom announced that it will likely report
another $1.8 billion in fraudulent accounting which could bring its total
restatements to more than $9 billion. WorldCom’s Press Release stated:
In settlement discussions with the Securities and
Exchange Commission (SEC), WorldCom advised the
agency that, based on very preliminary reviews of past
accounting, it expects an additional restatement of
earnings which, when added to WorldCom's past
restatements, could total in excess of $9 billion.
151. WorldCom did not disclose the reasons for the additional restatement.
Based upon the findings of First Interim Report of Dick Thornburgh, Bankruptcy
Court Examiner of November 4, 2002, it appears that the restatements are the
result of further improper accounting by WorldCom of its reserves. Additionally,
it appears that WorldCom improperly handled currency exchange issues from its
foreign subsidiaries.
152. On November 11, 2002, WorldCom filed with the Bankruptcy Court
its September 2002 Monthly Operating Report which shows a net loss from
continuing operations of $108 million. In connection with the report, WorldCom
stated: “Until WorldCom completes a thorough balance sheet evaluation,
including reviews of goodwill, property and equipment, accrual balances and
allowances for doubtful accounts, the Company will not issue a balance sheet or
cash flow statement as part of its monthly operating report.”
IX.
ROLE OF ARTHUR ANDERSEN
A. Andersen Earned Millions of Dollars in Fees By Providing Audit,
Tax and Consulting Advice to WorldCom for 8 Years
153. Andersen was the purportedly independent auditor for WorldCom
from October 7, 1993 until May 14, 2002. According to WorldCom’s 10-K405 for
year end December 31, 1994 filed on March 30, 1995 with the SEC, WorldCom
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hired Andersen to be its “auditor and certifying accountant.” During that time,
Andersen provided unqualified audit opinions on the consolidated financial
statements for fiscal year end 1994, 1995, 1996, 1997, 1998, 1999, 2000 and 2001
and reviewed interim statements, as well as providing tax and audit advice.
Andersen consented to having its unqualified opinion included with SEC filings,
including Proxy Statements. Andersen earned millions in dollars in fees from the
engagements. As the purported independent auditor for WorldCom, Andersen
created a conflict of interest by accepting consulting and tax fees and should have
divested itself of all non-audit services to maintain its professional independence.
B. Responsibilities of an Independent Auditor
154. The independent auditor had the duty to make sure that the financial
statements, upon which it expresses an unqualified audit opinion, are presented
fairly in accordance with GAAP. The AIPCA Auditing Standards (“AU”) 110.01
and 110.02 explain this responsibility.
The objective of the ordinary audit of financial statements by the
independent auditor is the expression of an opinion on the fairness with
which they present, in all material respects, financial position, results of
operations and cash flows, in conformity with generally accepted
accounting principles. (AU 110.01)
The auditor has a responsibility to plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement, whether caused by error or fraud. (AU 110.02)
155. The independent auditor must also comply with professional training
and proficiency rules, including the following:
AU 110.04 requires that auditor to have the proper qualifications: “The
professional qualifications required of the independent auditor are those of a
person with the education and experience to practice as such.”
AU 210.03 requires that the auditor be proficient: “In the performance of
the audit which leads to an opinion, the independent auditor holds itself out
as one who is proficient in accounting and auditing.”
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AU 210.04 requires the auditor to be aware of developments in its
profession: “The independent auditor’s formal education and professional
experience compliment one another; each auditor exercising authority upon
an engagement should weigh these attributes in determining the extent of
his or her supervision of the subordinates and review of their work. It
should be recognized that the training of a professional person includes a
continual awareness of developments taking place in business and in his or
her profession.”
AU 210.05 requires the auditor to exercise objective judgment: “In the
course of his or her day-to-day practice, the independent auditor encounters
a wide range of judgment on the part of management, varying from true
objective judgment to the occasional extreme and deliberate misstatement.
He or she is retained to audit and report upon financial statements of a
business because, through training and experience, he or she has become
skilled in accounting and auditing and has acquired the ability to consider
objectively and to exercise independent judgment with respect to the
information recorded in books of account or otherwise disclosed by his or
her audit.”
AU 220.02 requires the auditor to be independent: “the auditor must be
independent.....he must be without bias with respect to the client since
otherwise he would lack that impartiality necessary for the dependability of
his findings, however excellent his technical proficiency may be. However,
independence does not imply the attitude of a prosecutor but rather a
judicial impartiality that recognizes an obligation for fairness not only to
management and owners of a business but also to creditors and those who
may otherwise rely (in part, at least) upon the independent auditor’s report,
as in the case of prospective owners or creditors.”
156. Andersen was aware of these responsibilities and others which govern
independent auditors.
157. Andersen also knew that there were increased responsibilities in
dealing with Audit Committees because of government and business concerns
about misstatements in financial statements. As part of its demonstration of its
expertise in this area, in 1998 and 2000, it published a White Paper entitled
“Arthur Andersen, New Responsibilities and Requirements for Audit Committees,
Global Best Practices for Audit Committee” (attached as Appendix B to
Blackman, Salan editors, Audit Committees: Regulation and Practice (Aspen Law
and Business 2002)). In the introduction of the White Paper, Andersen states:
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New responsibilities for a new century– an introduction
Id, page 4 (App B-6).
As we start this new century, audit committees face new
responsibilities and requirements. They must meet new
standards for membership, independence, and financial
literacy. They must comply with new requirements to
draft or update their chargers and certify their
compliance with the rules. And most importantly, they
have a new obligation each quarter to discuss with the
independent auditor the quality of the company’s
financial reporting. . . . [] These new standards are a
mandate for audit committees (and through them,
auditors) to raise the bar and enhance their effectiveness
as investors’ representatives in financial reporting
oversight. Audit committees can respond to these
changes in many ways to build substantive
improvements into their processes.
The White Paper also recognizes that the independent auditors also have
increased responsibilities to communicate with the audit committee:
Discussion of the quality of financial reporting: the new
requirement ASB requirement In connection with each
SEC audit engagement, independent auditors are
required to discuss with the audit committee the auditors’
judgments about the quality, not just the acceptability, of
the company’s accounting principles as applies in its
financial reporting (the annual quality discussion).
Id. at 9 (App B-11). See also id. at 13 (App B-15) (amended Statement of
Auditing Standards (SAS) 61 requires auditor to meet with audit committee to
discuss quality not just the acceptability of a company’s accounting principles).
Andersen also recognizes that under new SEC requirements, “independent
auditors are required to review interim financial statements before the company
files its Form 10-Q or 10-QSB.” Id. at 11 (App B-13); see also id. at 49 (App. B-
51) re SAS 71, Interim Financial Information).
158. Andersen, in contracting to perform its audit of WorldCom’s financial
statements, assumed all of the responsibilities and obligations.
159. As part of its planning for and implementation of various
engagements for WorldCom, Andersen was required to be thoroughly familiar
with the nature of WorldCom’s business, the manner in which senior management
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ran the company, the internal control environment at the company, and the
existence of any unusually high audit risks at WorldCom. Andersen holds itself
out as an expert in auditing and accounting rules regarding the
telecommunications industry, and thus was familiar with WorldCom’s business
and the proper accounting standards WorldCom had to follow to fairly present its
financial statements in accordance with GAAP.
160. Andersen did investigate WorldCom’s key accounting principles and
practices, transaction processes and judgments, including its treatment of Line
Costs. For example, in a Report to the Audit Committee for year ended December
31, 2001 which was dated February 6, 2002 (Exhibit “C”), Melvin Dick, on behalf
of Andersen, summarized the audit approach and audit results for the year ended
2001, discussed Andersen’s views regarding WorldCom’s key accounting
principles and practices, transaction processes and judgments and estimates used
in preparation of its financial statements, and communicated matters required by
professional standards. On page 8 of the report, Andersen specifically discusses
Line Costs. Andersen gave its assessment that WorldCom’s processes for Line
Costs, including Line Cost accrual, Line Cost Disputes and Line Cost Allocation
Report was effective. Additionally, Andersen represented that WorldCom had
effective processes for: “allowance for doubtful accounts, accrued line costs, line
cost disputes, legal reserves and contingent liabilities, asset depreciable lives and
impairment of long-lived assets.” Id. at 10.
161. Therefore, Andersen specifically analyzed and knew about
WorldCom’s account for the Line Costs. Andersen described WorldCom’s Line
Cost accruals as “Line costs represent charges from LECs for leased lines or traffic
termination.” It stated, “Line costs as a percentage of revenues have remained flat
at 41.9% of use and revenues” and “Line costs are allocated between the
WorldCom group and MCI Group based on minutes of use and revenues.”
Andersen discussed “Accruals are based on metered traffic as determined by
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WorldCom” and “Disputed amounts are reserved separately see discussion
below.” Andersen represented that there were no process changes. Its assessment
was that WorldCom’s process was effective and that there was no residual audit
risk. Id. at 12.
162. In the same report, Andersen described Line Cost Disputes:
“Generally, WorldCom accrues 100% of LEC billed amounts prior to dispute
resolution.” It discussed that “LEC under billing dispute amounts are maintained
for a period of 12 months and are reversed on a monthly basis.”
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Its assessment
was that WorldCom’s process was effective and that there was no residual audit
risk. Ibid.
163. In the report, Andersen stated that WorldCom properly established
reserves. See id. at 14.
164. Andersen further informed the Audit Committee that there were no
disagreements with management, it was not aware of any irregularities or illegal
acts, it encountered no significant difficulties in performing its audit procedures
and no major issues were discussed with management in connection with its
appointment as auditors. Id. at 15.
165. Andersen represented that it would have prepared WorldCom’s
financial statements in the same manner as the company. At a March 6, 2002
Audit Committee meeting, a WorldCom committee member asked “if
Andersen were solely responsible for preparing the company’s financial
statements would they be prepared in the same manner selected by
Management.” Andersen’s representative replied “yes.” Exhibit “D.”
C. Andersen Knew Of and Ignored Material Red Flags Regarding
WorldCom’s Fraud
166. As early as 1993 and continuing through May of 2002, Andersen
knew of extraordinary “red flags” at WorldCom, but nevertheless provided
unqualified audit opinions for the fiscal year end 1994-2001financial statements
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and consented to have its audit opinion attached to public documents. These red
flags included the following:
! Andersen deemed WorldCom to be a maximum risk client with overly
aggressive revenue and earnings targets and a history of
misapplication of GAAP principles. According to the First Interim
Report of Dick Thornburgh, Bankruptcy Court Examiner dated
November 4, 2002, pages 50-51:
In planning the 1999 audit of the Company, Arthur
Andersen personnel noted in workpapers that (1)
historical purchase accounting adjustments represented a
significant portion of the 1999 budgeted income; (2)
WorldCom had misapplied GAAP with respect to
certain investments; and (3) due to WorldCom’s use of
multiple billing systems that require significant human
intervention, there was a high degree of risk in the
Company’s billing and collection areas.
Moreover, a memo in the 1999 Arthur Andersen
workpapers states that, “in the past, we have noted
situations where management has taken aggressive
accounting positions, particularly in the area of
purchasing accounting.” In addition, in its meetings
with WorldCom’s Audit Committee for the 1999 audit,
Arthur Andersen expressed that the items in
WorldCom’s financial statements that represented
particularly sensitive accounting estimates were:
Purchase Accounting, Evaluation of Asset Impairment,
Line Cost Accrual, Tax Accrual; Litigation, and
Depreciation Reserves. (Emphasis added.)
The report also notes that Andersen, in rating the overall risk
assessment of WorldCom and its management team in connection
with the planning of its audits for the years ended December 31,
1999 through 2001 found significant risk for “accounting and
financial reporting risk” and “overly aggressive revenue or
earnings targets.”
! Andersen knew that financial fraud by accounting for costs as capital
investments rather than expenses was not a new scheme. There have
been significant examples of companies which have improperly
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classified costs this way. In the 1980s, United States Surgical
Corporation and Laribee Wire Manufacturing Company engaged in
this practice. More recently, Livent transferred pre-production costs
for shows to fixed asset accounts. An analyst at Lehman Brothers has
stated about capitalizing Line Items: “The thing that has to bother you
was how in the world this was missed. . . . This is the most
fundamental accounting issue– whether to capitalise or expense an
outlay.” [Financial Times (London), June 27, 2002]. Accounting
students learn the basic accounting principle that costs must be
expensed rather than capitalized early on in their first accounting
class.
! Even though it designated WorldCom as a maximum risk client, it
failed to use appropriate audit procedures for such a client.
! Andersen knew that WorldCom was aggressive in reporting revenue,
but allowed WorldCom to improperly recognize revenue from
transactions recognized in the incorrect quarter and from overvalued
barter transactions.
! Andersen knew that WorldCom took aggressive accounting positions
and it failed to question WorldCom’s support for those positions.
! Andersen was aware of the improper capitalization of Line Costs
as early as April of 2000. According to a memo prepared on June
26, 2002 by Steven Brabbs, a WorldCom employee, (Exhibit “E”)
which was disclosed by the internal audit investigation:
In light of the most serious news that broke yesterday in
the U.S., I would like to bring the following matter to
your attention.
In March of 2000, I was Director, International Finance
& Control. My responsibilities at the time included the
provision of information to management on the
consolidated management accounting numbers for
Europe and Asia.
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After we had closed our books and reported our Q1 2000
numbers to the US, a journal entry was made by persons
in the US at the consolidated level which favourably
impacted our reported figures. We had no control over
that entry, the effect of which was to reduce our line
costs by $33,6000,000.
We were not informed about the journal adjustment, we
only discovered it when we retrieved our figures from
one day to the next and could not understand why the
gross margin had moved. After phone calls and emails
to the US, we were told that the entry had been made on
the basis of a directive from Scott Sullivan. Despite
repeated requests, we were given no support of
explanation for the entry.
During April 2000, I reviewed at a high level the
International Q1 results with the UK audit partner and
senior manager. The increase in our margin trend due
to the above entry was obvious and I explained that this
was an entry made in the US, and that the auditors
should request follow through in the US to ensure
appropriate accounting treatment was in place at the
global consolidated level. A relevant paragraph was
included in their report that was sent to both Andersen
and senior WorldCom finance management in the US.
Shortly after, I received an email from David Myers
indicating he was not pleased that this matter had been
raised with Andersens without his knowledge. I
responded indicating that I had not said that the entry
was incorrect, only that we had no support for it in
International, and that it was appropriate therefore to
request justification (or alternatively a corresponding and
reversing entry) from the US. (Emphasis added).
Brabbs further reported that “pressure was exerted and we were
instructed to make the entry. . . .” Brabbs never received any
explanation for the treatment although the continued to raise the
subject.
! By virtue of the fact that Andersen had audited WorldCom’s financial
statements since 1993, Andersen knew that WorldCom had expensed
Line Costs until approximately mid-2000. Andersen knew that
WorldCom then began capitalizing the Line Costs and Andersen
knew that there was no justification for the change. Andersen also
knew that WorldCom failed to disclose the accounting change.
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! There were no records to support decisions to capitalize the Line
Items. The amount which was capitalized was exactly the amount
needed by WorldCom to meet its profit margin goals.
! In testimony to The House Financial Services Committee on July 8,
2002, Melvin Dick, a former Andersen manager, admitted that
Andersen had not asked for documentation to backup WorldCom’s
financial statements.
! In March of 2002, Andersen knew that the SEC was investigating
WorldCom.
167. As the Chairman of the Board of WorldCom, Bert C. Roberts, told
the Committee on Financial Services of the U.S. House of Representatives on July
8, 2002:
The accounting irregularities that are the subject of
today’s hearings are an outrage to me. To my mind, the
failure of our outside auditors to uncover them is
inconceivable.
D. Andersen Allowed the Fraud to Continue and Made False
Representations About WorldCom’s Financial Statements
168. Andersen violated its professional responsibilities, and knowingly or
recklessly participated with WorldCom a scheme to defraud and in order to
artificially boost WorldCom’s reported revenue and profits.
169. Although Andersen was aware that practices of WorldCom artificially
inflated revenue were in violation of GAAP, Andersen provided a “clean” audit
opinion related to the company’s financial statements for year end 1994-2001 in
violation of GAAS (Generally Accepted Auditing Standards). For each of these
years, Andersen consented to its audit opinion to be filed with WorldCom’s 10-K,
Registration Statements and other public documents knowing that those
documents would be disseminated to the investing public. Plaintiff purchased
WorldCom stock in reliance on these representations.
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170. Andersen participated in the fraud in order to continue earning
lucrative fees for the auditing and other services that it provided for WorldCom.
Based on Andersen’s long history of knowing about the red flags, the lack of
support for transactions, and WorldCom’s aggressiveness in reporting its financial
statements, Andersen had knowledge and/or reckless disregard of the fraud.
171. Under professional standards, Andersen had a duty to withdraw from
the engagement upon discovering of the fraud and inform the Audit Committee of
the fraud, but instead, it participated in and encouraged the fraud. In the 8-K
WorldCom filed with the SEC on May 14, 2002, disclosing the change of auditors,
Arthur Andersen confirmed that there had been no disagreements between
Andersen and WorldCom on any matters of accounting principles or practices,
financial statement disclosure, or auditing scope of procedures. WorldCom
changed auditors because of its decision; Andersen did not want to be removed
from the engagement.
E. Andersen Violated Its Professional Obligations
172. As a result of Andersen’s violation of its obligations, and its knowing
participation in the scheme to defraud, WorldCom’s shareholders, the public, and
the SEC were provided materially false information concerning WorldCom’s
revenues and earnings.
173. The auditor’s standard unqualified report states that the financial
statements present fairly, in all material respects, an entity’s financial position,
results of operations, and cash flows in conformity with GAAP. An auditor may
only express this opinion when it has formed such an opinion on the basis on an
audit performed in accordance with GAAS. (AU 508.07). Andersen, knew, or
except for its deliberate disregard of facts, would have known that i) it had not
performed its audit of WorldCom’s financial statements for the years ended 1994 -
2001 in compliance with GAAS; ii) it never should have issued “unqualified”
audit reports on WorldCom’s financial statements for year end 1994-2001; and iii)
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its audit report on WorldCom’s financial statements for year end 1994-2001
contained materially misleading financial information.
174. In light of Andersen’s special knowledge and expertise and its
awareness of WorldCom as a high audit risk, Andersen’s total abdication of
professional skepticism in not challenging the WorldCom’s improper inflating of
revenues resulted in the issuance of an unqualified audit opinion on financial
statements that were known by Andersen to be materially misstated.
175. Andersen made untrue and misleading statements of material facts
and omitted material facts necessary in order to make its statements regarding
WorldCom’s financial statements not misleading. Specifically, Andersen knew
that WorldCom’s annual financial results for fiscal years 1994-2001, and first
quarter 2002 were materially overstated and were not presented in conformity with
GAAP. Andersen’s audits were not performed in accordance with GAAS or
AICPA standards.
176. Throughout the course of its financial reports, WorldCom was
overstating revenues, overvaluing assets including goodwill, double-booking
sales, shifting revenues from one quarter to the other, engaging in sham
transactions, improperly drawing down reserves and capitalizing expenses, and
this resulted in WorldCom overstating its financial results in violation of GAAP.
As a result, the year end 1994-2001financial statements and interim statements for
1994-2001 and first quarter 2002 were materially misleading and false when
made.
177. Andersen violated AU section 316.16, which requires the auditor to
plan and perform its examination of the financial statements with professional
skepticism. Andersen knew, among other red flags, WorldCom was a high risk
client which took aggressive positions on revenue and earning targets, but failed to
use proper procedures for such a client.
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178. Andersen violated GAAS General Standard No. 2, which requires the
auditor to maintain an independence in mental attitude in all matters relating to the
audit.
179. Andersen violated GAAS General Standard No. 3, which requires the
auditor to exercise due professional care in the performance of the audits and the
preparation of the audit reports.
180. Andersen violated AU section 722, which requires the auditor to
ensure that the Audit Committee of the Board of Directors is aware of, and
responds appropriately to, any irregularities that the auditor discovers as part of a
review of the interim financial information to be filed with a regulatory agency,
such as the SEC. Andersen knew, among other red flags, that WorldCom had
changed its accounting procedures for Line Costs, that the company had no
documentation for the change and that capitalizing of Line Costs was contrary to
GAAP, but failed to so advise the Audit Committee.
181. Andersen violated GAAS Reporting Standard No. 1 which requires
the audits reports to state whether the financial statements are presented in
accordance with GAAP. Andersen represented in its unqualified audit opinions
that WorldCom’s financial statements complied with GAAP when in fact it knew
that these representations were false.
182. Although it knew that WorldCom was a maximum audit risk and that
there were numerous red flags, Andersen violated GAAS Field Standard No. 1,
and the standards set forth in AU sections 310, 320, 327, and others, by failing to
adequately plan its audits, including failing to adequately plan for auditing
whether WorldCom had properly accounted for revenues and expenses of the
merged companies, and failing to properly supervise the work of assistants so as to
establish and carry out procedures reasonably designed to search for and detect the
existence of errors and irregularities which would have a material effect upon the
financial statements.
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183. Andersen knew that WorldCom took aggressive accounting positions,
for which there was no documentation and no accounting support, but failed to
properly audit WorldCom’s internal control. Andersen violated GAAS Field
Standard No. 2, which requires the auditor to make a proper study of existing
internal controls, including accounting, financial and managerial controls, to
determine whether reliance thereon is justified, and if such controls are not
reliable, to expand the nature and scope of the auditing procedures to be applied.
184. Andersen violated APB 20 because it allowed WorldCom to change
its method of accounting for Line Costs without disclosing the change of
accounting. Under APB 20, when WorldCom began capitalizing Line Costs, it
was required to add a footnote to its financial statement disclosing the change, the
reason for the change, the class of assets affected by the change and the effect on
the current and prior year’s income as a result of the change.
185. Andersen violated AICPA SAS 65 and corresponding AU sections
because it had little interaction with the Internal Audit Department of WorldCom.
X. SALOMON HAD AN IMPROPER RELATIONSHIP
WITH WORLDCOM
A. Salomon & WorldCom Each Earned Millions of Dollars Because
of their Close Relationship
186. Salomon, recognized as the leader in public offerings for
telecommunications deals, received over $800 million in underwriting telecom
stocks and bonds and $278 million for providing merger advice since 1997. See
The New York Times, November 18, 2001. For example, Salomon received $32.5
million for advising WorldCom in the MCI merger.
187. Salomon was WorldCom’s primary investment banker, helping
WorldCom raise over $17 billion in two public offerings, and also provided
investment advice to the company. Salomon also acted as the exclusive
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administer of WorldCom’s employee stock option plan generating fees and
brokerage clients for Salomon. Both companies depended upon each other’s
success to drive their businesses.
B. Salomon Provided WorldCom Executives With Stock in IPOs and
Favorable Analyst Reports in Exchange for WorldCom’s
Investment Banking Business
188. In order to make sure that it received WorldCom’s investment
banking business, Salomon engaged in a quid pro quo with WorldCom executives
whereby Salomon provided IPO shares to Ebbers and Sullivan, in return for
WorldCom’s investment banking business. As part of the deal, Salomon’s top
telecommunications securities analyst, Jack Grubman, provided favorable ratings
of the company which benefitted both Salomon and WorldCom.
189. On September 30, 2002, the Attorney General of New York, Elliott
Spitzer, filed a complaint against Ebbers, Sullivan and others alleging that Salmon
and its predecessors engaged in a practice called “spinning” which involved
Salomon providing favored executives with nearly risk-free shares of stock in
companies which were about to go public. In a quid pro quo, the executives
reaped enormous profits from the selling of the IPO stock and the executives
selected Salomon as their company’s investment banking for their public
offerings.
190. On August 26 and 30, 2002, Citibank produced documents in
response to a subpoena by the House Committee on Financial Services which
disclosed the executives who received this favorable treatment. Exhibits “F” and
“G. ” The documents, and Citibank’s testimony, demonstrate that these
executives earned over $18 million profits due to these IPO deals. Ebbers and
Sullivan of WorldCom both received IPO stock. Ebbers and Sullivan made
substantial profits from the IPO stock.
191. As a part of the deal, Salmon made sure that its analysts gave
favorable reports about the company. Research analysts are supposed to be
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neutral and provide objective advice about the companies that they rate which can
be relied upon by investors. There is supposed to be a “wall” between the
investment banking side and the research side. In reality, at Salomon, there was
no wall between the two: Salomon’s analysts were cheerleaders of the firm’s
investment banking clients. The pressure was enormous for analysts to give
favorable ratings for Salomon’s investment banking clients. For example, in 2000,
when a technical analyst at Salomon issued negative reports on Windstar, the fund
managers complained to Grubman and at least one person requested that the
technical analyst be punished for suggesting that the stock was going to fall.
National Post’s Financial Post & FP Investing, December 3, 2002. 1 Grubman
agreed that the technical analyst should be punished.
192. Additionally, the financial gains to analyst who gave favorable
ratings was immense because, at Salomon, the structure of the analysts
compensation is tied into the success of the investment banking side.
193. As a result of the institutional pressure, Salomon’s analysts gave
positive ratings about the firm’s investment banking clients, especially near the
time that a company was going public even when they had negative non-public
information. The analysts’ recommendations had a positive effect on the
company. Grubman was the primary analyst at Salomon who provided glowing
reports about investment banking companies, even when he knew of non-disclosed
negative information about the company. Grubman, during his testimony to the
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This information was discovered through a series of e-mail messages. Other such
e-mails have been destroyed by Salomon in violation of federal law, specifically Section 17(a) of
the Securities and Exchange Act of 1934, which requires that broker-dealers keep electronic
communications about their business for two years. On December 3, 2002, Salomon and four
other firms agreed to pay $1.65 million each (for a total of $8.25 million) to the United States
Treasury, the New York Stock Exchange (“NYSE”) and the National Association of Securities
Dealers (“NASD”) for violations of Section 17(a) and NYSE and NASD rules.
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House Committee on Financial Services on July 8, 2002, explained that companies
will not use an investment banker if the analysts provide negative ratings.
C. Grubman Was a Partisan Supporter of Salomon’s Investment
Banking Clients, Including WorldCom
194. Grubman was Salomon’s top telecommunications analyst until he left
in August of 2002 with a severance package of $32 million. In 1999, Institutional
Investor called him the “telecom analyst of the year.” Nicknamed, the “Ax,” he
was the undisputed most influential analyst in the telecommunications industry,
whose ratings could make or break a company. “When Grubman said wonderful
things about a company, it was like a narcotic–everybody wanted it,” recalled
Elliot Dorbian, a former broker at Salomon. “He walked around like he was a god.
And it was perceived by the industry that he was a god.” Grubman was able to
identify trends faster than anyone and was one of the most accurate in picking
stocks that would increase in value. “‘Jack had great power. If he didn’t endorse a
deal or a strategic direction, it wasn’t going to work,’ recalls a former telecom
CEO who raised money during the boom. ‘But he held you hostage. In order to
endorse the deal, he and Salomon had to get a major chunk of the banking
business. He was very blatant. He would tell you what his expectations were in
terms of investment banking for the firm.’” Fortune June 9, 2002.
195. While Salomon held Grubman out to the investment community as an
independent analyst who provided information about the company upon which the
investing public could rely, in fact, Grubman was a partisan supporter of the
companies so that Salomon and he could reap millions of dollars in rewards. He
continued to tout stock even as the companies were experiencing severe financial
difficulties. He gave favorable ratings to such companies as: Qwest, Multimedia,
XO Communications, Metromedia Fiber Network and McLeod USA; companies
which now are bankrupt or are facing substantial financial pressures.
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196. Salomon and Grubman are being investigated by federal authorities
for Grubman’s reversing a rating about ATT to help Salomon win a lead role in
the $10.6 billion IPO of its AT&T wireless unit. According to news reports, in
1999, Citicorp’s Chairman and CEO, Sanford Weil, asked Grubman “to take a
fresh look” at ATT. In the fall of 1999, shortly before ATT’s public offering,
Grubman upgraded the stock from his previous hold rating. As a result, Salomon
became the lead manager earning $45 million in fees and Weil helped Grubman
get his twins into a prestigious New York City nursery school. On November 20,
2002, in an “Op-Ed” for the Financial Times, Roel Campos, Commissioner of the
SEC, stated: “Most recently, reports have emerged that Jack Grubman, Citibank’s
star analyst issued positive research in order to induce his chief executive to help
him gain admission to pre-school for his children.”
197. The New York Attorney General’s Complaint contains comments
made by Salomon’s retail brokers about Grubman, including the following:
Jack Grubman is not an analyst– he is an investment
banker. He sold us a bill of goods on WCOM & T, and
now we’re bleeding red in our client’s accounts. How
about sharing some of the $25MM salary with our clients
who bought his glorified stories? Whose team is
Grubman on?
Has cost millions of dollars for SSB [Salomon] clients. I
am appalled that he is now in a position to profit from
our clients’ losses, through his WCOM invsetment (sic)
banking function. This sends a strong message that retail
clients and retail brokers don’t matter.
State of New York v. Anschutz et al., 65, pages 20-21.
198. Specifically, Grubman’s compensation was tied to his relationship
with WorldCom and Ebbers. According to a September 1, 1998 tele.com article,
Grubman was able to negotiate a $25 million deal with Salomon because he
brought in WorldCom as a client and his “clout” with Ebbers. Grubman,
depended on investment banking fees from WorldCom for his compensation
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which reached $20 million per year his last few years at Salomon. According to
the New York Times News Service:
[a] former analyst at the form [Salomon], Grubman’s pay
was tied specifically to the deals that the firm did in
telecommunications. “I remember meeting with these
guys and they would say, ‘Here’s how much we’re
paying you, deal by deal,’” this person said. “There was
a formula.
199. Grubman also acted like an investment banker, recruiting companies
to Salomon for public offerings. According to Securities Data Company, Grubman
helped Salomon do more telecommunications offerings than any other firm since
1997, 18 public offerings between 1997 and 2000 for a total of $5.7 billion in
deals. In 1997, Grubman reportedly brought at least $60 million in investment
banking revenues to Salomon. See Financial News, November 10, 1997.
D. Grubman and Ebbers Had Close Relationship
200. Grubman began covering WorldCom for Salomon in 1995. Grubman
had a close relationship with WorldCom, and especially its CEO, Ebbers. Ebbers
and Grubman first met in 1988. Their relationship included Grubman socializing
with Ebbers and attending his wedding in 1999 (his expenses were paid for by the
investment banking arm of Salomon rather than the research department).
201. Grubman explained the relationship in an August 31, 1996 USA
Today article: “We both come from the wrong side of the tracks vis-a-vis the
financial community . . . And I can relate to him far better than most people I deal
with. Bernie and I would have a strategic session in Jackson, and it usually was
while shooting pool and drinking beer.”
202. Grubman’s relationship with Ebbers was more than a close personal
one. Grubman became a de facto advisor to WorldCom and its cheerleader, in
total conflict with his role as a “neutral” analyst.
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203. Grubman attended at least three closed-doors Board of Directors’
meetings. In those meetings, he learned insider information which he was legally
prohibited from disclosing until the company disclosed the information.
204. Grubman also advised Ebbers on takeover strategy. He advised
WorldCom on strategy for the MCI merger and then touted the merger to the
market. According to the Tulsa World of October 4, 1997, “The job of persuading
Wall Street that WorldCom is up to the task of buying MCI will fall to Jack
Grubman, Salomon’s senior telecommunications analyst.” If the WorldCom/MCI
merger did not go through, Salomon stood to lose hundreds of millions of dollars.
Grubman was also a key advisor on the Sprint merger.
205. Grubman told WorldCom in advance about the questions he was
going to ask during Analysts Telephone calls and worked with WorldCom so that
they would be able to present the most positive spin on the company as possible.
206. Effective October 23, 2000, the SEC issued Rule FD (for Fair
Disclosure), 17 CFR Parts 240, 243, and 249, which prohibits companies from
providing analysts with insider information. This rule was enacted in response to
the incestuous relationships between analysts and corporations. Ebbers and
Grubman ignored this rule.
E. Grubman Touts WorldCom Stock Notwithstanding
His Knowledge of Adverse Information about
WorldCom’s True Financial Condition
207. During the time that Grubman was advising WorldCom, he was
touting its stock and he was a driving force in helping WorldCom maintain its
value. Between 1995 and April 22, 2002, Grubman and Salomon issued dozens of
analyst reports which made false representations and omitted material facts. In
issuing these reports, Salomon knew that it would serve to increase or inflate the
price at which WorldCom stock traded, compared to the price it would have traded
had the WorldCom analyst report not been issued. Salomon issued these reports
with the intention of increasing and inflating the price at which WorldCom stock
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would trade and as part of its effort to continue to obtain substantial investment
banking and advisory fees. Plaintiff purchased WorldCom stock in reliance on
these representations.
208. In May of 1995, Grubman started covering WorldCom and gave a
“Buy” rating. He continued to tout the stock up until April of 2002 when he gave
it a neutral rating. On May 13, 1997, for example, WorldCom’s shares increased
after Grubman said that shares may double during the next 18 months as the
company took market share from other companies. By October of 1997, news
reports were referring to Grubman as an “outspoken admirer” of WorldCom based
on his positive reports on the company.
209. In November 1997, Grubman represented: “WordCom is at the
intersection of everything we like – no carrier in the world can offer the integrated
set of facilities that it does. The company has nothing to lose and everything to
gain.”
210. On March 16, 1998, Grubman listed a “strong buy” rating for
WorldCom and issued a 12-month stock price target of $60 and a 24-month target
of $90 for WorldCom. He also predicted that during the next five years the
company would post revenues-growth of 17% and earnings per share growth of
32%. Grubman represented: “We believe WorldCom should be able to sustain a
multiple of EPS [earnings per share] similar to other large capitalization growth
stocks which trade at more than 30 times their EPS. . . WorldCom has the most
diverse set of strategic assets in the telecom industry, being the only true fully
integrated provider of voice, data and internet protocal technology. . . The
business logic of the MCI transaction was very compelling, adding MCI’s base of
large customers, world class sales force and industry leading systems, software
and product set capabilities to WorldCom, a diverse set of local and international
assets.” Grubman reported that WorldCom and MCI would increase their
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combined $39 billion in annual revenue at a faster clip than MCI alone.
WorldCom’s shares increased 6.5% as a result of Grubman’s representations.
211. On April 9, 1998, Grubman said that WorldCom was the “telecom
industry’s own legitimate mega-cap growth company that deserves to be
mentioned in the same breath as the Coca Colas, Mercks, GEs and Microsofts of
the world.”
212. On October 9, 1998, Grubman said that WorldCom was a stock that
every portfolio manager must own. Grubman represented that the stock was likely
to sustain a multi-year run and that he viewed the stock as “hands down, the mustown
stock in this industry, since no company has its breadth of assets, internal
growth rate, and ability to become the world leader in the changing telecom and
datacom landscape. We have been very loud and clear that WorldCom is our
favorite stock in the world of telecom notwithstanding our attention to several
other names in the group.”
213. On November 16, 1998, Grubman represented: “In our view, there is
no single enterprise on the planet that is better-positioned than WCOM to capture
growth in that space. Therefore, we strongly reiterate our Buy rate on WCOM.
We believe that the third quarter performance, despite all the distractions, prove
that this company is already well ahead of the curve in the marketplace, offering
fully integrated, on-net services. In addition, the integration of this company from
the back-office to the salesforce is already ahead of where anybody expects it to
be.” He further represented: “Unquestionably, WCOM would be our largest
holding, if we ran a large-cap growth fund and for the managers of growth funds
and capital appreciation funds who do not have WCOM as part of their Top Ten
holdings, we can only say that if that is true a year from now, we would find it
very difficult to believe that those managers could outperform their benchmarks.”
He believed that the stock would be at $80-$90 within a year and at $100 by the
end of 1999.
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214. On January 6, 1999, Grubman said WorldCom was likely to post
earnings growth of 48 percent a year for the next two years, and 28 percent
annually through 2004.
215. On January 13, 1999, Grubman represented: “There are few, if any,
companies anywhere that are as large as WorldCom, that have WorldCom’s
growth potential and the visibility WorldCom has for continuation of top-line
growth.” He added that the company had the best strategic position in the
industry. “We believe WorldCom remains the ‘must own’ growth stock in
anyone’s portfolio.”
216. On February 23, 1999, Grubman reiterated his “Buy” rating on
WorldCom with the representation: “The EDS transaction is a huge, positive, and
4Q98 results provide strong momentum into 1999. The WCOM story is getting
better every day, with 1999 outlook of revenue acceleration, margin expansion,
free cash flow generation and unsurpassed strategic position.” He reported that
the results for 4Q98 were very strong, beating expectations and underscoring
WorldCom’s “unquestioned leadership position in the industry.”
217. On July 1, 1999, Grubman said he expected Worldcom to show
continued strength in the second quarter. He raised his earning per share forecast
for the second quarter to 44 cents from 43 but retained his $2.00 earnings per
share estimate for full-year 1999. “We expect second-quarter core revenue to be
up 16% year-over-year despite an almost 20% decline in wholesale revenues yearover-year
which clearly illustrates our consistent message on MCI WorldCom,
which is that the high quality revenue mix which is skewed toward data,
international and internet is extremely important going forward,” Grubman said in
a research note.
218. Grubman was a big booster for the WorldCom merger with Sprint.
For example, on October 8, 1999, Grubman reiterated his “Buy” rating and
advised, “WorldCom gains valuable wireless assets with its planned merger with
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Sprint. We would take advantage of WCOM’s current stock price pullback to buy
the shares aggressively.”
219. On October 28, 1999, Grubman noted that WorldCom was growing at
about double the pace of the industry as a whole. He predicted that the stock
would double in the next 12-15 months and represented: “We believe that
WorldCom is categorically the biggest ‘Must Own’ stock in the entire world of
telecom.”
220. In December of 1999, Grubman called Worldcom a “must own”
stock. He represented: “Cheap relative to the S&P and outgrowing the industry
2:1. Will benefit from growth in data and proposed merger with Sprint.” He
stated that WorldCom “should sustain a top-line growth rate that is perhaps as
much as 4x the rate of the underlying economy – yet the stock is trading at a
discount to the average company in the S&P 500.”
221. On June 27, 2000, Grubman once again rated Worldcom a “Buy.” A
June 29, 2000 article in the Atlanta Journal and Constitution stated: “WorldCom
(WCOM) rose $4.88 to $44.56. Salomon Smith Barney analyst Jack Grubman
strongly reiterated his ‘buy’ rating and $87 price target on the stock, despite the
Justice Department’s threat to block the company’s proposed merger with Sprint.”
One of his research notes the same month said that WorldCom would have had
even better share performance, if it was not for the uncertainty of the Sprint deal.
See Digital Jam of June 28, 2000.
222. As reported by The Washington Post on July 6, 2000:
The most consistent and strident voice forecasting
approval of the WorldCom-Sprint deal was the analyst
who worked for the company that helped put it together,
Jack Grubman of Salomon Smith Barney Inc. As
WorldCom’s investment banker, Salomon stood to
pocket billions of dollars if the deal closed.
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Much like his colleagues, Grubman made little of the
negative signals about the two companies combining,
assuring investors in a February report that “Justice was
likely to clear the Sprint deal by June.” He urged
investors to buy WorldCom stock and said “the
regulatory process is far less onerous than investors
think, especially with the European Union likely not
even to review the transaction.”
223. In September of 2000, when WorldCom’s stock was near a 52-week
low, Grubman gave a positive recommendation on the stock. According to
Communications Today, September 11, 2000:
Wall Street continued to punish the telecom sector
Friday. Share prices of AT&T [T], Sprint [FON] and
WorldCom [WCOM] danced around new 52 week lows,
as intense competition in the consumer long distance
arena continued to erode investor confidence in the big
three carriers.
However, according to some analysts, WorldCom’s latest
acquisition of Intermedia Communications [IXIC] for $6
billion in equity and debt assumption has added a key
player to its lineup in the form of Digex. . . .
“Given its array of global network assets, we think that
Digex– on top of the WorldCom asset base– can
leverage topline growth at WorldCom to a much greater
degree than is being anticipated at this time,” wrote Jack
Grubman of Salomon, Smith Barney in his latest analysis
of WorldCom. [] Grubman says that WorldCom and
Digex are a natural fit. . .
224. Once again, in January of 2001, with the market declining, Grubman
“strongly reiterated” a buy rating for WorldCom, calling it the firm’s top pick in
the telecom services business. He also said he saw it meeting its 12% to 14%
revenue growth projections and set a target price of $45. That was enough to run
the stock up $1.88 to $15.94 for the session.” TheStreet.com, January 3, 2001; see
also The Toronto Star, January 4, 2001 (“Analysts said that some of the
enthusiasm for telecom stocks was sparked by an upbeat report on WorldCom by
Salomon Smith Barney analysts.”)
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225. In March 2001, Grubman “reiterated his buy rating on WorldCom and
raised his growth forecast for the first quarter to 12.5% from 12% and to 14%
from 13.2% for the full year 2001. Grubman cited gains in Europe.”
TheStreet.com, March 14, 2001. A this time, Ebbers was trying to boost the stock
so that WorldCom could receive a take-over bid at $50 per share.
226. In April of 2001, after WorldCom announced its fourth quarter
earnings, Grubman “raised his first-quarter earnings growth expectations for
WorldCom’s data unit to 12.5% from 12% , and increased the full target to 14%
from 13.2%.” The Mississippi Business Journal, April 2, 2001. At the time, the
telecom industry looked “rather bleak” and the industry had been depressed for
most of the last year. Ibid.
227. In June of 2001, Grubman put WorldCom on the top of his list.
“Grubman expects WorldCom’s revenues will grow 12% to 15% next year,
pushing its stock from 18 to 30 within a year.” Business Week, June 18, 2001.
228. In October of 2001, after WorldCom disclosed its Third Quarter 2001
results, Grubman represented that WorldCom “has the most leverage among any
telecom company” and maintained a “Buy” recommendation.
229. In January of 2002, when the stock was at record lows, Grubman still
maintained his “Buy” recommendation and urged investors to buy the stock
because WorldCom was the “best play” for recovery.
230. On March 12, 2002, after WorldCom disclosed the SEC investigation,
Grubman downplayed the SEC inquiry as unfortunate, calling it just one of many
SEC inquiries this year. New York Times, March 13, 2002.
231. It was not until April 21, 2002, (WorldCom stock closed at $4.01 the
day before) that Grubman issued a neutral rating. He did not rate it as an
underperforming stock until June 24, 2002 (it closed at $.91 the day before).
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232. Grubman’s staff also had access to confidential insider information.
The House Financial Services Committee has released e-mails showing that in the
morning of June 24, 2002, a Salomon bond analyst, Robert Waldman, sent an e-
mail to WorldCom asking about rumors of a major accounting problem.
Publically, Waldman issued a report telling investors that they should not be
concerned about Grubman’s downgrade of the stock three days earlier.
F. Salomon Made Misrepresentations and Omitted
Material Facts to Retain its Lucrative Fees from WorldCom
233. When Salomon issued its WorldCom analyst reports, it had in its
possession material, adverse and non-public information regarding its role in
Salomon’s investment banking business and it knew that this information was
material, adverse, non-public information which reasonable investors deciding to
invest would want to know in making their investment decision.
234. When Salomon issued its WorldCom analyst reports, it knew that
issuing the reports would, as had its prior reports, serve to increase or inflate the
price at which WorldCom stock traded, compared to the price it would have traded
had Salomon not issued the WorldCom analyst report. Salomon issued the
WorldCom analyst reports with the intention of increasing and inflating the price
at which WorldCom stock would trade.
235. Salomon issued its false and misleading analyst reports as part of
Salomon’s effects to obtain substantial investment banking and advisory fees.
236. In each of its WorldCom reports, Salomon stated a “reason for the
report.” The stated reason for the report was false and misleading because it failed
to disclose the true reason Salomon issued each report was to assist Salomon in its
efforts to obtain investment banking fees.
237. Salomon’s WorldCom analyst reports were false and misleading
because Salomon failed to disclose in those analyst reports that it based its
decisions as to which companies to cover in analysts reports and as to what it
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would say in those reports regarding those companies based on the impact its
coverage would have on Salomon’s ability to obtain underwriting and investment
banking engagements from those companies or others.
238. Salomon’s “buy” recommendations in its WorldCom analyst reports
were false and misleading because Salomon failed to disclose that it had a policy
and practice of issuing more positive analyst reports on telecommunications
companies that were clients of Salomon. Salomon adhered to that policy and
practice regardless of whether there was any rational economic basis for its
recommendations. Salomon made the “buy” recommendations because it knew
that assigning an unfavorable rating to the telecommunications company would
jeopardize Salomon’s ability to obtain underwriting and/or investment advisory
engagements from these companies or others. The WorldCom reports were false
and misleading because Salomon did not disclose the existence of, and Salomon’s
reasons for its rating policies and practices.
239. Plaintiff purchased WorldCom’s stock in reliance on Salomon’s
representations.
XI. THE LOANS TO WORLDCOM
240. Throughout WorldCom’s history, WorldCom had financed the
acquisition of companies through obtaining loans and revolving credit facilities
from defendant Citigroup and/or its subsidiaries or divisions, and others.
241. Prior to 1998, Citigroup had extended credit to WorldCom. In
August of 1998, WorldCom, Citigroup and other lenders entered into two
revolving credit agreements, one for $3.75 billion and the other for $1.25 billion
with Citigroup as a co-syndication agent and a lender.
242. In August of 1999, WorldCom, Citigroup and other lenders entered
into an Amended and Restated 364-day Revolving Credit and Term Loan
Agreement for $7 billion with Citigroup as a co-syndication agent and lender.
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243. In August of 2000, WorldCom, Citigroup and other lenders entered
into First Amendment and Renewal of the Amended and Restated 364-day
Revolving Credit and Term Loan Agreement this First Amendment and Renewal
of the Amended and Restated 364-day Revolving Credit and Term Loan
Agreement for $7 billion with Citigroup as a lender.
244. In June of 2001, WorldCom, Citigroup and other lenders entered into
two revolving credit agreements, one for $2.65 billion and the other for $1.6
billion with Citigroup as a lender.
245. As part of its due diligence prior to entering into each of these
agreements, Citigroup reviewed financial records, books and files so that it knew
the financial condition of WorldCom.
246. In the Loan Agreements (generally § 7.4 in each loan agreement),
Citigroup had the right to review the books, files and records, conduct tests and
investigations, and to discuss WorldCom’s finances with WorldCom’s creditors,
directors, officers, employees and independent auditors. As part of its due
diligence, it conducted investigations of WorldCom’s finances on a periodic basis.
XII. THE PUBLIC OFFERINGS
A. Public Offering May 2000
247. On May 19, 2000, according to an 8-K filed by WorldCom on May
22, 2000, WorldCom and Salomon and others entered into an Underwriting
Agreement. Salomon was one of the lead managers and was the book running
manager for the offering. See Prospectus filed May 17, 2000.
248. The Registration statement for the offering included incorporation of
WorldCom’s 10-K for fiscal year end 1999 including Andersen’s unqualified audit
opinion and WorldCom’s first quarter 2000 10-Q. These defendants consented to
their name being used in Proxy Statements. As such, they participated in the
solicitation, offering, and sale of the notes to the investing public pursuant to the
Registration statements.
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249. On May 19, 2000, WorldCom “completed the pricing of a public debt
offering of $5.0 billion principal amount of debt securities. The net proceeds,
which are anticipated to be paid on May 24, 2000, are expected to be
approximately $4.95 billion and will be used to pay down commercial paper.”
WorldCom’s 8-K filed on May 22, 2000.
250. The Registration statements, at the time they were issued and became
effective, were inaccurate and misleading, contained untrue statements of material
fact and/or omitted to state material facts necessary to make the statements made
therein not misleading, as set forth above.
251. In their role as underwriters, Salomon was responsible for the
contents and dissemination of the Registration statement, it made representations
and omitted material facts to investors about the offering, and is liable for any
material misrepresentations or omissions contained therein. Based on its due
diligence in investigating WorldCom’s financial condition before extending
WorldCom credit, and in its roles as advisors and investment bankers, Salomon
knew that the statements contained in the Registration statements were not true,
that it omitted any material fact, and were materially misleading. Salomon knew
that investors would be misled when they purchased WorldCom’s stock, but
nevertheless made the misrepresentations to sell the stock.
B. Public Offering May 2001
252. Although the first public offering was successful, WorldCom’s need
for cash continued to grow. On May 9, 2001, WorldCom entered into an
underwriting agreement with, among others, defendant Salomon. Salomon was
lead manager and one of the joint book-runners.
253. According to an 8-K filed May 16, 2001, on May 9, 2001,
WorldCom, Inc. completed the pricing of a public debt offering of approximately
$11.9 billion principal amount of debt securities, The net proceeds of $11.7
billion were to be used for general corporate purposes, including repaying notes.
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This was the largest public offering to date. The underwriters received about $70
million.
254. The Registration statement included incorporation of WorldCom’s
10-K for fiscal year end 2000 including Andersen’s unqualified audit opinion and
WorldCom’s first quarter 2001 10-Q. These defendants consented to their name
being used in Proxy Statements. As such, they participated in the solicitation,
offering, and sale of the notes to the investing public pursuant to the Registration
statements.
255. The Registration statements, at the time they were issued and became
effective, were inaccurate and misleading, contained untrue statements of material
fact and/or omitted to state material facts necessary to make the statements made
therein not misleading, as set forth above.
256. Due to their role as underwriters, Salomon was responsible for the
contents and dissemination of the Registration statement, it made representations
and omitted material facts to investors about the offering, and is liable for any
material misrepresentations or omissions contained therein. Based upon its due
diligence in investigating WorldCom’s financial condition before extending
WorldCom credit, and in its roles as advisors and investment bankers, Salomon
knew that the statements contained in the Registration statements were not true,
that it omitted any material fact, and were materially misleading. It knew that
investors would be misled when they purchased WorldCom’s stock, but
nevertheless made the misrepresentations to sell the stock.
FIRST CAUSE OF ACTION
(Against All Defendants)
VIOLATION OF CALIFORNIA CORPORATIONS CODE §25400
257. Plaintiff hereby incorporates by reference each of the foregoing
paragraphs.
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258. Defendants, and each of them, acting individually and pursuant to a
scheme and conspiracy, directly and indirectly, induced the purchase of, including
the exchange of stock in the June 2001 recapitalization, by the Plaintiff by
circulating or disseminating, in or from California, information to the effect that
WorldCom was a financially stable corporation and falsely reported the profits of
WorldCom for the purpose of inducing Plaintiff to purchase the stock. Defendants
knew or had reason to believe that their statements were false or misleading in
light of the circumstances under which they were made. As a result of the
misrepresentations, Defendants knew that investors would be misled and purchase,
including the exchange in the June 2001 recapitalization, of WorldCom’s stock
based upon false information. Despite this knowledge, Defendants continued to
make the misrepresentations in order to induce investors to purchase WorldCom
stock.
259. Defendants, and each of them, are liable under Corporations Code
Section 25500 for willfully participating in acts or transactions in violation of
Corporations Code Section 25400, and thus are liable to Plaintiff, who purchased
their stock at a price which was affected by Defendants’ acts, for damages
sustained by Plaintiff as a result of such acts or transactions.
260. As a result of the wrongful conduct of Defendants and each of them,
Plaintiff has sustained economic losses and other general and special damages,
including pursuant to Section 25500, the economic damages as measured by the
difference between the price at which Plaintiff “sold” their stock and its true value
in an amount to be determined according to proof at the time of trial.
261. Plaintiff is entitle to an award of prejudgment interest at the legal rate
on their economic damages, pursuant to Section 25500.
WHEREFORE, Plaintiff prays for relief as set forth below.
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SECOND CAUSE OF ACTION
(Against All Defendants)
VIOLATION OF CALIFORNIA BUSINESS
& PROFESSIONS CODE §17200
262. Plaintiff incorporates and realleges all of the foregoing paragraphs, as
though fully set forth herein.
263. Defendants have engaged in unfair competition within the meaning of
California Business & Professions Code § 17200 because Defendants’ conduct
was fraudulent, unfair and illegal as herein alleged. Defendants’ conduct caused
injury to Plaintiff.
264. The Defendants' business acts and practices, as alleged herein,
constituted and constitute a continuous and continuing course of conduct of unfair
competition by means of unfair, unlawful and/or fraudulent business acts or
practices within the meaning of the UCL including, but in no way limited to, the
following:
a. Defendants’ actions, set forth above, are unlawful;
b. Defendants' business acts and practices, are unfair in that they
induced Plaintiff to purchase the stock based upon false, misleading
statements disseminated by Defendants with full knowledge that the
statements were false and misleading.
265. Defendants’ business acts and practices, as alleged herein, have
caused Plaintiff to purchase the stock at artificially inflated prices.
266. Plaintiff is entitled to relief, including full restitution and/or
disgorgement of all revenues, earnings, profits, compensation and benefits, and
such other relief that the court deems just in light of the ill gotten obtained by
defendants as a result of such business acts or practices and enjoining defendants
to cease and desist from engaging in the practices described herein.
WHEREFORE, plaintiff prays for relief as set forth below.
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THIRD CAUSE OF ACTION
(Against All Defendants)
FRAUD, DECEIT AND CONCEALMENT
267. Plaintiff hereby incorporates all of the foregoing paragraphs.
268. As set forth above, Defendants, and each of them, made material
representations and omissions to Plaintiff which were false and misleading,
including but not limited to those representations and omission as to the financial
condition of WorldCom, the company’s prospects for continued growth, their
relationship with WorldCom and the reasons for their representations. These
material misrepresentation and omissions are contained in and reflected in the
Registration statements, as well as press releases, analysts’ reports, financial
statements, and other disclosures made by Defendants which support and reinforce
the misrepresentations and omissions in the registration statements.
269. These representations were false in that the financial statements were
not prepared in accordance with GAAP. Because of the fraudulent accounting of
WorldCom, as assisted by the Defendants, the financial statements showed
inflated revenues for the years 1994-2001 (including year end and quarterly
statements) and the first quarter of 2002.
270. When Defendants, and each of them, made the misrepresentations and
failed to disclose and suppressed information they had a duty to disclose, as set
forth hereinbefore, Defendants had knowledge of the falsity of their
representations and knew that they were failing to disclose material facts which
they had a duty to disclose.
271. Defendants made the misrepresentations and omitted the material
facts with the intent to defraud Plaintiff and to induce Plaintiff to invest in
WorldCom stock.
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272. At the time that these misrepresentations were made and the material
facts not disclosed, and at the time that Plaintiff took the actions herein alleged,
Plaintiff was ignorant of the true facts. If Plaintiff had known the true facts, it
would not have invested in WorldCom stock.
273. Plaintiff reasonably relied on these representations in investing in
WorldCom stock, and its reliance was justified since Plaintiff was unaware of the
true facts; if the true facts had been known to Plaintiff, it would not have acted as
it did.
274. As set forth above, WorldCom engaged in one of the largest financial
frauds in history. Defendants knew that WorldCom was engaged in the conduct
and that such conduct constituted a fraud. Notwithstanding their knowledge of the
improper and unlawful conduct, Defendants, and each of them, engaged in
conduct, hereinbefore described which rendered substantial assistance to,
encouraged and/or aided and abetted the fraud.
275. With knowledge of the unlawful purpose of the fraudulent conduct of
WorldCom, and the Defendants, and each of them, entered into an agreement to
accomplish the aforesaid scheme, and by their actions took steps to further that
scheme.
276. As a result of Defendants’ wrongful conduct, Plaintiff has sustained
and will sustain economic and other general and specific damages, all in an
amount to be determined according to proof.
277. At all times herein alleged, Defendants acted with actual malice to
defraud Plaintiff. At all times herein alleged, Defendants acted willfully,
wantonly, with oppression, fraud and/or malice, and with a conscious disregard of
the rights of others, such that Plaintiff requests that the trier of fact, in the exercise
of its sound discretion, should award Plaintiff additional damages for the sake of
example and in a sufficient amount to punish the Defendants for their conduct, in
an amount reasonably related to Plaintiff’s actual damages and defendants’ wealth
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and sufficiently large to be an example to others, and to deter plaintiffs and others
from engaging in similar conduct in the future.
WHEREFORE, Plaintiff prays for relief as set forth below.
FOURTH CAUSE OF ACTION
(Against All Defendants)
BREACH OF FIDUCIARY DUTY
278. Plaintiff hereby incorporates each of the foregoing paragraphs.
279. By virtue of Plaintiff’s ownership of the stock that are the subject of
this Complaint, the Defendants, and each of them, owed fiduciary duties of the
highest good faith, integrity and fair dealing to Plaintiff as owners of the stock,
and each of them, further owed fiduciary obligations to Plaintiff as Defendants
sought to induce and did induce Plaintiff to purchase the stock.
280. Defendants and each of them, had insider knowledge of adverse nonpublic
information regarding the stock as alleged above. Defendants knowingly
and intentionally concealed this adverse non-public information from the Plaintiff.
281. Defendants, and each of them, breached and violated their fiduciary
obligations to Plaintiff, to the detriment of Plaintiff, by failing to disclose all
material information known to defendants at the time that Plaintiff purchased the
stock, and by making the above-mentioned misrepresentations to induce Plaintiff
to purchase the stock.
282. As set forth above, WorldCom engaged in one of the largest financial
frauds in history. Defendants knew that WorldCom was engaged in the conduct,
that such conduct constituted a fraud and that WorldCom was breaching its
fiduciary duty to its shareholders. Notwithstanding their knowledge of the
improper and unlawful conduct, Defendants, and each of them, engaged in
conduct, hereinbefore described which rendered substantial assistance to,
encouraged and/or aided and abetted the breach of fiduciary duty.
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283. With knowledge of the unlawful purpose of the conduct of
WorldCom, Defendants, and each of them, entered into an agreement to
accomplish the aforesaid scheme, and by their actions took steps to further that
scheme.
284. As a result of the wrongful conduct of each of the Defendants,
Plaintiff has suffered and will continue to suffer economic losses and other general
and specific damages, all in an amount to be determined according to proof.
285. At all times herein alleged, Defendants acted with actual malice. At
all times herein alleged, Defendants acted willfully, wantonly, with oppression,
fraud and/or malice, and with a conscious disregard of the rights of others, such
that Plaintiff requests that the trier of fact, in the exercise of its sound discretion,
should award Plaintiff additional damages for the sake of example and in a
sufficient amount to punish the Defendants for their conduct, in an amount
reasonably related to Plaintiff’s actual damages and defendants’ wealth and
sufficiently large to be an example to others, and to deter plaintiffs and others
from engaging in similar conduct in the future.
WHEREFORE, Plaintiff prays for relief as set forth below.
PRAYER FOR RELIEF
1. Compensatory and general damages according to proof;
2. Special damages according to proof;
3. For an injunction ordering Defendants, and each of them, to cease and
desist from engaging in the unfair, unlawful, and/or fraudulent
practices alleged in the Complaint;
4. Prejudgment interest at the maximum rate;
5. Punitive and exemplary damages according to proof;
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Costs of the proceedings herein;
Reasonable attorneys fees; and
All such other and further
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PITRE, SIMON & McCARTHY
7 JOSEPH W. COTCHETT
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Attorneys for Plaintiff
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Plaintiff
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JOSEPH W. COTCHETT
Attorneys for Plaintiff
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COMPLAINT

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TABLE OF CONTENTS
Page No.
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I. OVERVIEW OF COMPLAINT ..................................1
II. JURISDICTION AND VENUE ..................................3
III. THE PARTIES ...............................................4
A. Plaintiff ................................................4
B. Defendants .............................................4
1. The Bank Defendants ................................4
2. The Accounting Defendant ...........................5
3. Doe Defendants ....................................6
4. Agents and Co-Conspirators ..........................7
5. Unnamed Participants ................................7
IV. BACKGROUND OF WORLDCOM ..............................8
A. The Early Years .........................................8
B. WorldCom Goes Public and Engages in a Strategy of Growth
Through Acquisition or Merger .............................8
C. 1998: The MCI Merger ....................................9
D. 1999: The Proposed Sprint Merger .........................11
E. 2001: Intermedia/Digex Merger ............................11
V. WORLDCOM’S FINANCIAL STATEMENTS ....................12
A. Financial Statements Must Be Prepared According to GAAP .....12
B. 1997 Year End Statements ................................13
C. 1998 Year End Statements ................................15
D. 1999 Year End Statements ................................17
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E. 2000 Financial Statements ................................19
1. First Quarter 2000 ..................................19
2. Second Quarter 2000 ...............................20
3. Third Quarter 2000 .................................21
4. Fourth Quarter and Year End 2000 ....................23
F. 2001 ..................................................26
1. First Quarter 2001 ..................................26
2. Second Quarter 2001 ...............................28
3. Third Quarter 2001 .................................30
4. Fourth Quarter and Year End 2001 ....................31
G. First Quarter 2002 .......................................34
VI. WORLDCOM’S STOCK ......................................36
VII. THE FRAUDULENT SCHEME ................................37
A. Improper Accounting for Reserves ..........................40
B. Improper Accounting for Line Costs ........................41
C. Other Accounting Irregularities ............................42
VIII. THE FRAUD IS DISCOVERED AND THE COMPANY RESTATES
ITS FINANCIAL STATEMENTS ...............................42
A. Internal Audit and Audit Committee Meetings ................43
B. The Internal Audit Discovers that WorldCom Executives
Intentionally Inflated the Revenues .........................45
C. Andersen States 2001 Financials Not Prepared in Accordance with
GAAP and Cannot Be Relied Upon .........................48
D. June 25, 2002 Announcement of Restatement .................49
E. August 8, 2002 Announcement of Additional Restatement ......50
F. Criminal and SEC Charges Against WorldCom Executives ......52
G. Other Restatements Probable ..............................54
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IX. ROLE OF ARTHUR ANDERSEN ...............................54
A. Andersen Earned Millions of Dollars in Fees By Providing Audit,
Tax and Consulting Advice to WorldCom for 8 Years ..........54
B. Responsibilities of an Independent Auditor ...................55
C. Andersen Knew Of and Ignored Material Red Flags Regarding
WorldCom’s Fraud ......................................59
D. Andersen Allowed the Fraud to Continue and Made False
Representations About WorldCom’s Financial Statements .......63
E. Andersen Violated Its Professional Obligations ...............64
X. SALOMON HAD AN IMPROPER RELATIONSHIP
WITH WORLDCOM .........................................67
A. Salomon & WorldCom Each Earned Millions of Dollars Because of
their Close Relationship ..................................67
B. Salomon Provided WorldCom Executives With Stock in IPOs and
Favorable Analyst Reports in Exchange for WorldCom’s Investment
Banking Business .......................................68
C. Grubman Was a Partisan Supporter of Salomon’s Investment Banking
Clients, Including WorldCom ..............................70
D. Grubman and Ebbers Had Close Relationship ................72
E. Grubman Touts WorldCom Stock Notwithstanding
His Knowledge of Adverse Information about
WorldCom’s True Financial Condition ......................73
F. Salomon Made Misrepresentations and Omitted
Material Facts to Retain its Lucrative Fees from WorldCom .....80
XI. THE LOANS TO WORLDCOM ................................81
XII. THE PUBLIC OFFERINGS ....................................82
A. Public Offering May 2000 ................................82
B. Public Offering May 2001 ................................83
FIRST CAUSE OF ACTION ........................................84
SECOND CAUSE OF ACTION ......................................86
THIRD CAUSE OF ACTION ........................................87
FOURTH CAUSE OF ACTION ......................................89
PRAYER FOR RELIEF ............................................90
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TABLE OF EXHIBITS
A. WorldCom’s July 8, 2002 Revised Statement Pursuant to Section 21(a) of
the Securities and Exchange Act
B. Series of WorldCom e-mails produced to the House Committee on Financial
Services
C. Andersen report to the Audit Committee Year Ended December 31, 2001
dated February 6, 2002
D. WorldCom’s Minutes of Audit Committee for March 6, 2002
E. WorldCom e-mails dated June 26, 2002
F. August 26, 2002 letter from CitiGroup to the House Committee on Financial
Services
G. August 30, 2002 letter from CitiGroup to the House Committee on Financial
Services
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