*WorldCom Troubles Likely to Widen As Investigators, Auditors Dig Deeper
By DEBORAH SOLOMON and JARED SANDBERG
Staff Reporters of THE WALL STREET JOURNAL
WorldCom Inc.'s accounting woes are likely to widen as investigators and auditors seek additional evidence of financial misstatements that extend beyond the $3.8 billion the company disclosed earlier this week, according to people familiar with the matter.
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The company's auditors, KPMG LLP, are pushing to do a broad review of WorldCom's financial statements that goes further back than the past five quarters of inflated profits the telecom concern recently reported, these people said. However, KPMG hasn't fully committed to continuing as WorldCom's auditor. Several people close to the matter said they expect the firm will continue as the auditor but on the condition that WorldCom allow it to conduct a broad review of its financials. A spokesman for KPMG said the firm is "still WorldCom's auditor of record."
On Tuesday, WorldCom fired its chief financial officer, Scott Sullivan, saying he inflated profits by transferring more than $3.8 billion in "line cost" expenses to its capital accounts. Line costs are one of the telecom company's biggest expenses and include things such as access fees paid to other telecom concerns. WorldCom said it will restate financials for 2001 and the first quarter of 2002.
People close to the matter said the expenses that Mr. Sullivan capitalized extended beyond access fees to other operating costs, such as maintenance and repair costs.
Each quarter, these people said, Mr. Sullivan would move operating costs to its capital accounts in a systematic method intended to keep WorldCom's profits high. Mr. Sullivan's goal was to keep line costs to 42% of WorldCom's revenue, the normal range of such costs for the company, these people said. Any costs that went beyond that 42% mark were transferred to the capital accounts, where they were written off over a period of time. Such movement allowed the company to keep its costs down and its profits artificially high. Mr. Sullivan couldn't be reached for comment.
One person familiar with the situation said WorldCom "backed into the number needed."
A big reason why Mr. Sullivan failed to convince the board and accountants that his accounting methodology was correct was because there was little evidence to back him up. "There's no documentation for it," said a person close to the situation. "They'd estimate line costs."
Earlier this week, WorldCom said the misstatement of costs -- which has been labeled "fraud" by the Securities and Exchange Commission -- began in the first quarter of 2001. Mr. Sullivan told the company's audit committee that's when he began capitalizing those expenses.
But people close to the company said additional improprieties may exist in years prior to 2001 and that the $3.8 billion restatement will likely be larger. Of particular interest is the period right after WorldCom bought MCI. The merger, which closed in 1998, boosted WorldCom's revenue significantly but also increased its expenses.
Brad Burns, a WorldCom spokesman, said the company is trying to understand exactly what happened. "Having identified the issue, taking it to the SEC and hiring an external investigator, we're certainly looking forward to getting to the bottom of this," Mr. Burns said. WorldCom has hired William McLucas, former chief of enforcement at the SEC, to conduct an internal investigation.
Over the past few years, WorldCom has consistently hit Wall Street's optimistic operating earnings targets. The company was a steady performer and few noticed in 2000 when the company made its target two quarters in a row by tiny fractions of a cent. According to a report issued in 2000 by the Center for Financial Research and Analysis, a watchdog firm based in Maryland, WorldCom would have missed the mark in both the second and third quarters of 2000 if operating earnings had been a mere $1 million less. "When you see that they're making it by one one-hundredth of a penny you know the odds of that happening twice in a row are very slim," says Brad Rexroad, author of the Center's report. "It indicates they're willing to stretch to make the quarter."
Robert Gensler, the media and telecom portfolio manager with T. Rowe Price, said he thinks the alleged fraud began after the MCI merger.
"When you think about it, they promised revenue acceleration and margin expansion. Within 12 months they had problems with revenue acceleration, but their margins were doing fine," said Mr. Gensler. At the time, he said, "everybody thought they were great at cutting costs."
Separately, at a status conference in federal district court in New York, Judge Jed Rakoff signed an order authorizing appointment of a corporate monitor and gave the company and the SEC until July 3 to come up with three mutually agreed upon names.
The order says WorldCom cannot destroy or alter any document relating to their financial reporting obligations, public disclosure requirements or accounting matters. Until the monitor is appointed, WorldCom cannot make any payment greater than $100,000 to any present or former officer, director or employee. When the monitor is appointed, that person will oversee all compensation paid by WorldCom and will make sure the company has "implemented reasonable document retention policies" and is complying with them. WorldCom has to cooperate fully with the monitor, make its books and accounts fully available to the monitor and pay the monitor's fees and expenses.
-- Jerry Markon and Shawn Young contributed to this article.
Write to Deborah Solomon at deborah.solomon@wsj.com and Jared Sandberg at jared.sandberg@wsj.com
Updated June 28, 2002 8:32 p.m. EDT |
