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WorldCom Internal Memos Suggest Plan to Bury Misstatement

Jul 8, 2002 | Dow Jones WorldCom Inc. (NasdaqNM: WCOM - News) released internal memos indicating that former Chief Financial Officer Scott Sullivan planned to bury a $3.8 billion accounting misstatement in a second-quarter charge and told Chief Executive John Sidgmore to expect additional write-downs.

The disclosure was made in a revised statement WorldCom provided to the Securities and Exchange Commission which had asked for a more detailed account from the company.

Last week, SEC Chairman Harvey Pitt blasted WorldCom, the nation's second- largest long-distance phone company, and Mr. Sidgmore for failing to give a full rendering of events that led up to its massive accounting restatement several weeks ago.

The company's latest statement makes clearer the role of internal auditor Cynthia Cooper, who discovered the misstatement on her own. In its initial statements regarding the accounting problem, WorldCom took credit for discovering the errors. But the internal memos give more credit to Ms. Cooper and provide the chronology that led up to the company revealing its problem publicly.

An internal memo dated June 12 provides a window into Mr. Sullivan's thinking on why the $3.8 billion could be charged off. Mr. Sullivan believed that line costs, predominantly access fees that WorldCom pays to other phone companies for use of their lines, were legitimate capital expenditures because they weren't generating revenue. After a certain period, however, Mr. Sullivan believed they should be written off.

Neither Mr. Sullivan nor his lawyer could be reached for a comment.

A memo dated June 12 relates points from a June 11 meeting with Mr. Sullivan attended by Ms. Cooper and Glyn Smith, another internal auditor at WorldCom. Mr. Sullivan asked them to delay their review until the third quarter. He noted that there were several capital-expenditure issues that needed to be "cleared up" in the second quarter. The memo says, "When asked by Cynthia to explain pre-paid capacity costs, Scott [Mr. Sullivan] indicated that while revenues had declined, the costs related to certain leases were fixed, creating a matching problem."

The company also said in a revised statement to the SEC of its $3.8 billion discrepancy that Mr. Sullivan told Mr. Sidgmore that the "capital expenditure reduction measures" could lead to a write-down. At a board meeting the next day, Mr. Sullivan noted that the second-quarter report would be "complex" and include $15 billion to $20 billion in charges.

People close to the situation say that the new information in the company's statement provides further support for the idea that Mr. Sullivan planned to bury the problems uncovered by Ms. Cooper in additional charges by the company.

Another delay was apparently caused by Max Bobbitt, the head of WorldCom's audit committee. Ms. Cooper turned to Mr. Bobbitt after being told by Mr. Sullivan that he was planning to deal with the problem in a charge. Mr. Bobbitt, according to an internal memo dated June 13 called "Internal Audit Correspondence," first went to KPMG Ltd., WorldCom's new outside auditing firm that had replaced Arthur Andersen.

Mr. Sullivan indicated that his treatment of line costs as capital expenditures started in the third quarter of 2001 and continued through the first quarter of 2002. Previously, these costs had been expensed. He said the problem would be corrected in the second quarter of 2002, according to the memo.

The audit committee met two days after Ms. Cooper telephoned Mr. Bobbitt to discuss issues surrounding the company's capitalization of line costs. Mr. Bobbitt, however, didn't inform the rest of the committee during its meeting on June 14 . According to the June 13 memo, "Max stated he believed it was premature to discuss the prepaid capacity issue" at that meeting.

The documents filed by the company also provide more insight into the internal wrangling over what to do with Ms. Cooper's discovery. The June 13 memo says that Ms. Cooper felt the audit committee should be apprised of the facts. Ferrell Malone, of KPMG, who was brought into the matter by Mr. Bobbitt, agreed that it was "premature to discuss the issue with the AC [audit committee] because IA [internal audit] was still in the middle of the audit and support hadn't yet been obtained."

Ms. Cooper has been cooperating with federal investigators. Neither Ms. Cooper nor her attorney could be reached for comment. Mr. Bobbitt declined to comment.

A spokeswoman for WorldCom declined to comment.

Former SEC enforcement officials said Mr. Bobbitt doesn't seem to have acted inappropriately by not immediately taking Ms. Cooper's concerns to the audit committee, as long as those concerns were followed up and investigated promptly, as they apparently were.

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