In Re Worldcom, Inc. Securities Litigation 02-CV-3288-First Amended Class Action Complaint Of

257 Pages·2003·0.71 MB·English

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK

:
IN RE WORLDCOM, INC. : MASTER FILE NO.
SECURITIES LITIGATION : 02 Civ. 3288 (DLC)
:
This Document Relates to: :
02 Civ. 3288 02 Civ. 4973 02 Civ. 8230 :
02 Civ. 3416 02 Civ. 4990 02 Civ. 8234 :
02 Civ. 3419 02 Civ. 5057 02 Civ. 9513 :
02 Civ. 3508 02 Civ. 5071 02 Civ. 9514 :
02 Civ. 3537 02 Civ. 5087 02 Civ. 9515 : JURY TRIAL DEMANDED
02 Civ. 3647 02 Civ. 5108 02 Civ. 9516 :
02 Civ. 3750 02 Civ. 5224 02 Civ. 9519 :
02 Civ. 3771 02 Civ. 5285 02 Civ. 9521 :
02 Civ. 4719 02 Civ. 8226 03 Civ. 2841 :
02 Civ. 4945 02 Civ. 8227 03 Civ. 3592 :
02 Civ. 4946 02 Civ. 8228 :
02 Civ. 4958 02 Civ. 8229 :
:

FIRST AMENDED CLASS ACTION COMPLAINT OF LEAD PLAINTIFF
ALAN G. HEVESI, COMPTROLLER OF THE STATE OF NEW YORK, AS
ADMINISTRATIVE HEAD OF THE NEW YORK STATE AND LOCAL RETIREMENT
SYSTEMS AND AS TRUSTEE OF THE NEW YORK STATE COMMON
RETIREMENT FUND, ON BEHALF OF PURCHASERS AND ACQUIRERS
OF ALL WORLDCOM, INC. PUBLICLY TRADED SECURITIES

BERNSTEIN LITOWITZ BERGER BARRACK, RODOS & BACINE
& GROSSMANN LLP Leonard Barrack (Pro Hac Vice)
Max W. Berger (MB-5010) Gerald J. Rodos (Pro Hac Vice)
John P. Coffey (JC-3832) Jeffrey W. Golan (Pro Hac Vice)
Steven B. Singer (SS-5212) Jeffrey A. Barrack (Pro Hac Vice)
Patricia S. Gillane (PG-1801) Pearlette V. Toussant (Pro Hac Vice)
Beata Gocyk-Farber (BGF-5420) 3300 Two Commerce Square
Jennifer L. Edlind (JE-9138) 2001 Market Street
Joseph A. Fonti (JF-3201) Philadelphia, Pennsylvania 19103
1285 Avenue of the Americas [phone]
New York, New York 10019
[phone]

Attorneys for Lead Plaintiff Alan G. Hevesi, Comptroller of the State of New York, as
Administrative Head of New York State and Local Retirement Systems and as Trustee of the New
York State Common Retirement Fund, and Co-Lead Counsel for the Class
TABLE OF CONTENTS

Pages

NATURE OF ACTION........................................................................................................................i
JURISDICTION AND VENUE.......................................................................................................12
PARTIES ..........................................................................................................................................13
Lead Plaintiff.................................................................................................................................13
Additional Named Plaintiffs.........................................................................................................14
Defendants....................................................................................................................................15
Related Non-Party.........................................................................................................................26
CLASS ALLEGATIONS.................................................................................................................27
THE BASIS OF THE CLAIMS.......................................................................................................30
SUBSTANTIVE ALLEGATIONS..................................................................................................31
The Growth of WorldCom Begins to Slow..................................................................................31
WorldCom Turns to Outright Fraud .............................................................................................33
An Internal Audit Sounds the Whistle..........................................................................................42
Post-June 25, 2002 Events............................................................................................................43
WORLDCOM’S FALSE AND MISLEADING STATEMENTS ...................................................45
False and Misleading Statements Relating to the 1999 First Quarter...........................................45
False and Misleading Statements Relating to the 1999 Second Quarter......................................47
False and Misleading Statements Relating to the 1999 Third Quarter.........................................48
False and Misleading Statements Relating to the 1999 Fourth Quarter and Year........................49
False and Misleading Statements Relating to the 2000 First Quarter...........................................53
False and Misleading Statements Relating to the 2000 Second Quarter......................................54
False and Misleading Statements Relating to the 2000 Third Quarter.........................................56
False and Misleading Statements Relating to the 2000 Fourth Quarter and Year........................57
False and Misleading Statements Relating to the 2001 First Quarter...........................................60
False and Misleading Statements Relating to the 2001 Second Quarter......................................62
False and Misleading Statements Relating to the 2001 Third Quarter.........................................63
False and Misleading Statements Relating to the 2001 Fourth Quarter and Year........................65
False and Misleading Statements Relating to the 2002 First Quarter...........................................69
The False and Misleading Registration Statements (Notes).........................................................71
A. The May 2000 Offering....................................................................................................71
B. The May 2001 Offering....................................................................................................78
The False and Misleading Registration Statements Issued in Connection with WorldCom
Acquisitions ..................................................................................................................................87
A. The SkyTel Acquisition....................................................................................................87
B. The Intermedia Acquisition..............................................................................................88
THE NEFARIOUS RELATIONSHIP BETWEEN SALOMON AND WORLDCOM..................89
The Investment Banking Business According to Salomon...........................................................89
The Initial Public Offering Process...............................................................................................90
Salomon’s Allocation of Hot IPO Shares.....................................................................................91
Salomon’s “Independent” Research Department..........................................................................95
The Grubman Factor.....................................................................................................................97
i
GRUBMAN’S MATERIALLY FALSE AND MISLEADING ANALYST REPORTS...............107
OTHER ELEMENTS OF THE SECRET RELATIONSHIP BETWEEN
SALOMON AND EBBERS...........................................................................................................122
Grubman Alters His Analysis Methodology to Obscure WorldCom’s
Growing Cash Flow Problems...................................................................................122
The Secret Travelers Loans and Travelers’ Business Partnership With Ebbers........129
Grubman’s Finder’s Fees and Commissions .............................................................139
Sullivan Demands Greater Shares of IPO Allocations and Salomon
and Ebbers Willingly Comply..................................................................................139
ADDITIONAL FACTS REGARDING SCIENTER OF CERTAIN DEFENDANTS..................141
Ebbers..........................................................................................................................................141
Sullivan.......................................................................................................................................149
Myers and Yates..........................................................................................................................150
Kellett..........................................................................................................................................150
The Audit Committee..................................................................................................................151
1. The Committee’s Mission.......................................................................................154
2. The Audit Committee’s Failure to Fulfill its Responsibilities
Allowed the Fraud to Go Undetected.....................................................................155
Andersen.....................................................................................................................................168
ADDITIONAL FACTS REGARDING FAILURE OF THE UNDERWRITER
DEFENDANTS TO CONDUCT ADEQUATE DUE DILIGENCE.............................................176
The Underwriter Defendants.......................................................................................................176
WORLDCOM’S VIOLATIONS OF GAAP..................................................................................184
WorldCom’s Improper Reduction of Reserves...........................................................................184
WorldCom’s Improper Capitalization of Expenses....................................................................185
WorldCom’s Excessive Acquisition Write-offs.........................................................................188
WorldCom’s Improper Revenue Recognition............................................................................192
Ebbers’ Reviews of Financials....................................................................................................192
WorldCom’s Other Accounting Violations ................................................................................195
Large Accrual Accounts.............................................................................................195
Reclassification of SG&A expenses to line expenses................................................196
Wireless Bad Debt Accrual Reversals.......................................................................197
EIT Accrual Releases.................................................................................................197
Depreciation Reserve Releases..................................................................................198
WorldCom’s Lack of Controls....................................................................................................199
FRAUD-ON-THE-MARKET DOCTRINE...................................................................................202
CLAIMS FOR RELIEF..................................................................................................................203
COUNT I (Against the Individual Defendants Except Myers
and Yates for Violations of § 11 of the Securities Act)..............................................203
COUNT II (Against the Individual Defendants for Violations of
§ 15 of the Securities Act)...........................................................................................205
COUNT III (Against Andersen for Violations of § 11 of the Securities Act)...........207
COUNT IV (Against the Underwriter Defendants for Violations of
§ 11 of the Securities Act)...........................................................................................208
COUNT V (Against the Underwriter Defendants for Violations
of Section 12(a)(2) of the Securities Act)...................................................................211
ii
COUNT VI (Against Defendants Ebbers, Sullivan, Myers, Yates,
Kellett, Bobbitt, Allen, Areen, and Galesi for Violations of
Section 10(b) of the Exchange Act and Rule 10b-5)..................................................213
COUNT VII (Against the Individual Defendants for Violations
of Sections 20(a) of the Exchange Act).....................................................................215
COUNT VIII (Against Andersen for Violations of Section 10(b)
of the Exchange Act and Rule 10b-5).........................................................................217
Andersen Did Not Maintain Its Independence...........................................................222
COUNT IX (Against Defendants Salomon and Grubman for
Violations of Section 10(b) of the Exchange Act and Rule 10b-5
(Registration Statements))...........................................................................................235
COUNT X (Against Defendant Salomon and Grubman for
Violations of Section 10(b) of the Exchange Act and Rule
10b-5 (Analyst Reports and Adoption of Ebbers’ Statements)).................................238
COUNT XI (Against Defendants Citigroup and Salomon
for Violations of Sections 20(a) of the Exchange Act)...............................................242
PRAYER FOR RELIEF .................................................................................................................243

iii
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK

:
IN RE WORLDCOM, INC. : MASTER FILE NO.
SECURITIES LITIGATION : 02 Civ. 3288 (DLC)
:
This Document Relates to: :
02 Civ. 3288 02 Civ. 4973 02 Civ. 8230 :
02 Civ. 3416 02 Civ. 4990 02 Civ. 8234 :
02 Civ. 3419 02 Civ. 5057 02 Civ. 9513 :
02 Civ. 3508 02 Civ. 5071 02 Civ. 9514 :
02 Civ. 3537 02 Civ. 5087 02 Civ. 9515 : JURY TRIAL DEMANDED
02 Civ. 3647 02 Civ. 5108 02 Civ. 9516 :
02 Civ. 3750 02 Civ. 5224 02 Civ. 9519 :
02 Civ. 3771 02 Civ. 5285 02 Civ. 9521 :
02 Civ. 4719 02 Civ. 8226 03 Civ. 2841 :
02 Civ. 4945 02 Civ. 8227 03 Civ. 3592 :
02 Civ. 4946 02 Civ. 8228 :
02 Civ. 4958 02 Civ. 8229 :
:

FIRST AMENDED CLASS ACTION COMPLAINT OF LEAD PLAINTIFF
ALAN G. HEVESI, COMPTROLLER OF THE STATE OF NEW YORK, AS
ADMINISTRATIVE HEAD OF THE NEW YORK STATE AND LOCAL RETIREMENT
SYSTEMS AND AS TRUSTEE OF THE NEW YORK STATE COMMON
RETIREMENT FUND, ON BEHALF OF PURCHASERS AND ACQUIRERS
OF ALL WORLDCOM, INC. PUBLICLY TRADED SECURITIES

Alan G. Hevesi, Comptroller of the State of New York, as Administrative Head of the New
York State and Local Retirement Systems and as Trustee of the New York State Common
Retirement Fund (the “NYSCRF”), as the Court-appointed Lead Plaintiff, together with Additional
Named Plaintiffs, Fresno County Employees Retirement Association (“FCERA”), the County of
Fresno, California (“Fresno”) and HGK Asset Management, Inc. (“HGK”), bring this federal
securities law class action individually and on behalf of all other persons and entities who
purchased or acquired publicly traded shares, bonds or notes of WorldCom, Inc. (“WorldCom” or
the “Company”) between April 29, 1999 and June 25, 2002 (the “Class Period”), based on the
misrepresentations and material omissions asserted herein, and were injured thereby.
NATURE OF ACTION
1. This case arises from the largest corporate fraud and accounting scandal in United
States history, a fraud that inflicted billions of dollars of damage across a broad swath of the
investing public and triggered the largest bankruptcy in United States history. The fraud asserted in
this Amended Complaint was perpetrated by, among others, senior officers of WorldCom, its
directors, its outside auditor Arthur Andersen LLP (“Andersen”), the investment banking firm of
Salomon Smith Barney, Inc. (“Salomon”), and a syndicate of underwriters, in violation of the
Securities Act of 1933 (the “Securities Act”) and the Securities and Exchange Act of 1934 (the
“Exchange Act”).
2. The scheme entailed the dissemination of materially false and misleading
information concerning quarterly and annual financial statements of WorldCom in press releases;
in each of the Company’s filings with the United States Securities and Exchange Commission
(“SEC”); in the registration statements issued for acquisitions initiated by WorldCom; and in the
registration statements for Offerings of Senior Notes (“Notes”) issued by WorldCom. The
cornerstone of the scheme involved gross overstatements of earnings – well over $9 billion – in
WorldCom’s financial statements for the years 1999, 2000, 2001 and the first quarter of 2002.
3. As was ultimately revealed, this scheme was simple to perpetrate and even easier to
discover, had the gatekeepers for the investing public – the auditors, underwriters and ostensibly
independent research analysts – not averted their eyes. After each quarter, senior WorldCom
officers reviewed the Company’s results in order to determine how far those results fell below the
consensus estimates of Wall Street analysts. They would then conspire to hide what in some cases
were nine-figure shortfalls by making bogus entries in WorldCom’s general ledger, reclassifying
2
line cost expenses to a variety of capital asset accounts without any supporting documentation or
legitimate business rationale. According to the former WorldCom Controller who played a major
role in the execution of the fraud: “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 reported actual
costs and therefore to increase WorldCom’s reported earnings.” See “Former WorldCom Exec
Pleads Guilty,” Associated Press, Sept. 27, 2002. The magnitude of this part of the fraud was first
disclosed on June 25, 2002, when WorldCom announced that it would have to restate the certified
financial results for all four quarters of 2001 and the first quarter of 2002 because it had, among
other things, improperly treated more than $3.8 billion in ordinary costs as capital expenditures, in
violation of generally accepted accounting principles (“GAAP”).
4. These practices were patently criminal – the former Controller and three other
WorldCom executives subsequently pleaded guilty to securities fraud and related charges – and
they enabled WorldCom to report earnings that were inflated by billions of dollars. This in turn
enabled the Company to meet Wall Street’s estimates, thereby artificially inflating the price of
WorldCom’s stock and bonds in the secondary market. In addition, the scheme enabled WorldCom
and one of its principal underwriters, Salomon, to defraud investors into purchasing approximately
$17 billion in ostensibly “investment grade” Notes in May 2000 and May 2001 when, in fact, the
Company was in dire financial straits.
5. The Company has further admitted that senior WorldCom executives also
fraudulently manipulated reserves – amounts set aside primarily in connection with WorldCom’s
mergers to cover bad debt, merger costs and other problems – by deliberately setting aside too high
a dollar figure in reserve accounts and then dipping back into the reserve accounts to make up for
gaps in projected and actual profits. WorldCom has to date estimated the impact of these
3
maneuvers as adding an additional $3.3 billion in improperly reported earnings before interest,
taxes, depreciation and amortization (“EBITDA”) for the years 1999, 2000, 2001 and the first
quarter 2002. WorldCom has also admitted that it improperly booked close to $1 billion in revenue
during the Class Period. In sum, as of the filing of this Amended Complaint, WorldCom has
admitted that its financial statements for the years 1999 through 2002 were overstated by well over
$9 billion. WorldCom has also written off approximately $80 billion of the stated book value of
the assets on its balance sheet as of June 25, 2002.
6. WorldCom’s disclosures wreaked havoc on the financial markets. WorldCom
common stock dropped from a Class Period high of approximately $96.75 per share to pennies,
leading to its delisting from the NASDAQ exchange. The impact on WorldCom bonds was also
catastrophic. For example, on June 27, 2002, WorldCom 8% Notes, which had a value of $62.25 a
few days prior to the announcement, traded at $11, a loss of over 80%. These Notes once traded as
high as $106. Published estimates place the losses of WorldCom bondholders alone at more than
$9 billion. On July 21, 2002, WorldCom filed for protection under Chapter 11 of the Bankruptcy
Code in this District – the largest bankruptcy ever.
7. The reaction of the Nation’s senior leadership to the unfolding WorldCom debacle
was immediate and fierce. The President called the revelations “outrageous.” The Chairman of the
SEC labeled the accounting manipulations “fraud, not mistake.” On June 26, 2002, the day after
WorldCom’s announcement of the initial $3.8 billion restatement, the SEC filed a complaint in this
District accusing the Company of securities fraud. One day later, Congress launched an
investigation of WorldCom. On July 8, 2002, the House Committee on Financial Services held a
hearing regarding WorldCom. Rather than answer the Committee’s questions concerning what had
occurred at WorldCom, Bernard Ebbers (“Ebbers”), WorldCom’s former CEO, and Scott Sullivan
4
(“Sullivan”), WorldCom’s former CFO, invoked their Fifth Amendment right against self-
incrimination and refused to testify.
8. The scope and audacity of the fraud also triggered a swift response by the United
States Attorney for this District. Sullivan and WorldCom’s former Controller, David Myers
(“Myers”), were arrested on August 1, 2002 and charged with seven felonies, including securities
fraud, conspiracy to commit securities fraud, and filing false statements with the SEC. Myers
pleaded guilty to those charges several weeks later; Sullivan did not, and was indicted on those
charges on August 28, 2002. Named as a co-defendant with Sullivan in that indictment was Buford
Yates, Jr. (“Yates”), the former WorldCom Director of General Accounting. Yates pleaded guilty
to those charges on October 7, 2002. On October 10, 2002, two other senior WorldCom
employees, Betty Vinson (“Vinson”) and Troy Normand (“Normand”), pleaded guilty to charges of
securities fraud and conspiracy to commit securities fraud. Myers, Yates, Vinson and Normand,
who are cooperating with the U.S. Attorney in the continuing investigation of the WorldCom fraud,
each told the Court that they were instructed to cook the books at WorldCom by their superiors in
management.
9. The fraud could not have succeeded to the extent it did without the active
participation and collaboration of Salomon. Salomon was a co-lead underwriter for two huge
public offerings of WorldCom Notes that generated a staggering $17 billion for WorldCom in one
twelve-month span. Like the other underwriters on those debt offerings, Salomon is liable under
§ 11 of the Securities Act for the materially false and misleading statements and omissions
regarding WorldCom’s financial condition and business affairs that were set forth in the
registration statements issued in connection with those offerings. As described more fully below,
Salomon is also liable for fraud in connection with those offerings because, under § 10(b) of the
5
Exchange Act, at the time the offerings were made, Salomon knew, or recklessly disregarded, that
WorldCom’s financial condition and other material facts were not as the offering documents
represented them to be.
10. Salomon’s knowledge, or reckless disregard, of the falsity of statements regarding
WorldCom’s financial condition and matters pertaining to its business was not limited to the two
bond offerings. Throughout the Class Period, Salomon’s “star” telecommunications analyst, Jack
Grubman (“Grubman”), issued dozens of analyst reports touting WorldCom and urging investors
to, in Grubman’s words, “load up the truck” with WorldCom stock. However, as was ultimately
revealed, Grubman’s analyst reports and the public offerings underwritten by Salomon – which
generated tens of millions of dollars in underwriting fees and brokerage commissions for Salomon
– were part of a shell game that WorldCom and Salomon played on investors. Purchasers of
WorldCom’s stocks and bonds were never told that the purportedly “independent” raves from
Grubman had in fact been purchased as an integral part of the investment banking services that
Salomon provided to WorldCom.
11. Nor were investors apprised that WorldCom officers and directors received millions
in profits through “hot” offerings in initial public offerings (“IPOs”) underwritten by Salomon.
From the late 1990s through 2001, Salomon and Grubman routinely allocated to WorldCom
executives, including Ebbers and Sullivan, extremely valuable, coveted shares in companies that
Salomon was about to take public. Ebbers sold many of these shares soon after the IPOs, making
millions of dollars. The NYSCRF’s investigation has determined that when then-CFO Sullivan
complained to Salomon and Ebbers that his share of the allocations was in his view too low,
Salomon responded by increasing Sullivan’s allocation – and Ebbers pacified his confederate by
sharing his profits from these sales. In turn, Ebbers and Sullivan ensured that the lion’s share of
6