The Securities and Exchange Commission ("the Commission") alleges for its First Amended Complaint as follows: 1. From at least as early as 1999 through the first quarter of 2002, defendant World Com Inc. ("WorldCom") misled investors. Defendant WorldCom has acknowledged that during this period, as a result of undisclosed and improper accounting, it materially overstated the income it reported in its financial statements by approximately $9 billion. 2. In general, World Com manipulated its financial results in two ways. First, World Com reduced its operating expenses by improperly releasing certain reserves held against operating expenses. Second, World Com improperly reduced its operating expenses by recharacterizing certain expenses as capital assets. Neither practice was in conformity with generally accepted accounting principles ("GAAP"). Neither practice was disclosed to WorldCom's investors, despite the fact that both practices constituted changes from WorldCom's previous accounting practices. Both practices falsely reduced WorldCom's expenses and, accordingly, had the effect of artificially inflating the income World Com reported to the public on its financial statements from 1999 through the first quarter of 2002. As a result of, among other things, WorldCom's chronic and pervasive failures to follow GAAP standards, and to mandate and institute appropriate internal controls, the exact amount and extent of World Com's overstatement of its income has not yet been quantified. 3. Certain of the improper accounting entries were made with respect to World Com's so-called "line costs," which were among World Com's major operating expenses. From at least the third quarter of 2000 through the first quarter of 2002, in a scheme directed and approved by members of senior management, World Com concealed the true extent of its "line costs." By improperly reducing reserves held against "line costs" and by transferring certain "line costs" to its capital asset accounts, World Com falsely portrayed itself as a profitable business when it was not, and concealed large losses World Com suffered. WorldCom's fraudulent accounting practices with respect to "line costs" were designed to and did falsely and fraudulently inflate its income to correspond with estimates by Wall Street analysts and to support the price of WorldCom's common stock in the market. 4. While engaging in accounting manipulations with respect to line costs to fraudulently and falsely inflate its income, defendant WorldCom continued to offer and sell additional World Com securities, using fraudulent and materially false financial statements and financial information in the course of those offers and sales. 5. By engaging in such improper conduct, World Com violated the anti-fraud, reporting, record-keeping, and internal controls provisions of the federal securities laws. The Commission requests, among other things, that this Court enjoin World Com from committing further violations of the federal securities laws as alleged herein, and order World Com to pay a monetary penalty based on its violations of the federal securities laws. JURISDICTION 6. The Commission brings this action pursuant to Section 20(b) and 20(d) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. SS 77(b) and 77(d)], and Section 21(d) of the Securities Exchange Act of 1934 ("Exchange Act") (15 U.S.C. SS 78u(d)]. 7. This Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act (15 U.S.C. 77v(a)] and pursuant to Section 27 of the Exchange Act (15 U.S.C. 78aa). 8. The defendant, directly and indirectly, has engaged in, and unless restrained and enjoined by this Court will continue to engage in, transactions, acts, practices, and courses of business that violate Section 17(a) of the Securities Act [15 U.S.C. 779(a)], Sections 10(b), 13(a), 13(b)(2)(A), 13(b) (2)(B) of the Exchange Act (15 U.S.C. $$ 78m(a) and 78m(b) (A)] of the Exchange Act (15 U.S.C. SS 78j(b), 78m(a), 78m(b)(A) and 78m(b)(B)] and Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder [17 C.F.R. S$240.106-5, 240.12b-20, 240.13a-1, and 240.13a-13]. THE FRAUDULENT SCHEME REGARDING WORLDCOM'S LINE COSTS A. The Defendant 9. World Com is a Clinton, Mississippi-based company incorporated in Georgia which provides a broad range of communications services to businesses and consumers in more than 65 countries. World Com provides data transmission and Internet services for businesses, and, through its MCI unit, provides telecommunications services for businesses and consumers. World Com is a public company whose securities are registered with the Commission pursuant to Section 12(b) of the Exchange Act and it is required to file periodic reports with the Commission pursuant to Section 13 of the Act. WorldCom's common stock was, at all times relevant hereto, listed and traded on the NASDAQ National Market System under the symbol "WCOM," and its stock was covered by Wall Street analysts who routinely issued quarterly and annual earnings estimates. B. Relevant Accounting Principles 10. Public companies, such as WorldCom, typically report the financial results of their operations in financial statements that include both an income statement and a balance sheet. A company's income statement reports, among other things, revenue recognized, expenses incurred, and income earned during a stated period of time -- usually for a fiscal quarter or a fiscal year. Within an income statement, expenses are generally subtracted from revenues to calculate income. A company's balance sheet reports, among other things, the assets and liabilities of a company at a point in time, usually as of the end of the company's fiscal quarter or fiscal year. 11. When companies spend money or incur costs, those expenditures can be accounted for in a variety of ways depending on the nature of the transaction. Some types of expenditures, most commonly those incurred by a company in its normal operations, are treated as current period costs or "operating expenses." Examples of operating expenses include recurring costs such as salaries and wages, insurance, equipment rental, electricity, and maintenance contracts. Generally, almost all routine expenditures that a company makes are operating expenses. Other types of expenditures, most commonly those which result in the acquisition of, or improvement to, the company's assets, are treated as "capital expenditures." Examples of capital expenditures include purchases of real estate, manufacturing equipment, and computer equipment. 12. Operating expenses and capital expenditures generally receive different accounting treatment. Operating expenses are generally reported on a company's income statement and subtracted from revenues in the period in which the expense is incurred or paid, resulting in the company's net income for that period. Generally, capital expenditures, by contrast, are not subtracted from revenues and are not reflected on the income statement. Instead, capital expenditures are reported as capital assets on a company's balance sheet. 13. If a company makes entries in its accounts that effectively reclassify or transfer a given expenditure from an "operating expense" to a "capital asset," that action will have the following effects on the company's financial statements: (a) the reclassification or transfer will reduce the company's operating expenses, and the company's pre-tax net income consequently will increase by the amount reclassified or transferred; (b) the value of the company's capital assets and total assets will increase by the amount reclassified or transferred; and (c) the value of the company's net worth will increase. 14. One of World Com's major operating expenses reported on its income statements which were periodically filed with the Commission was its so-called "line costs." "Line costs" represented the various fees World Com paid to third-party telecommunications carriers for WorldCom's right to access the third-party's network facilities in order to serve customers. Under GAAP, these fees must be reported as an expense on a company's income statement. 15. From time to time, World Com established liabilities or "reserves" on its balance sheet for various future payments for goods or services it had previously received or incurred. Among the reserves World Com established were reserves for line costs and income taxes. Line cost reserves and income tax reserves were listed on WorldCom's balance sheet as liabilities. C. WorldCom Changes its Accounting to Fraudulently Inflate Its Income 16. Anticipating unabated growth in telecommunications services, WorldCom entered into a number of long-term lease agreements with various third-party telecommunication carriers to gain the right to access these networks in the late 1990s. Many of these leases required World Com to pay a fixed sum to the third-party carrier over the full term of the lease regardless of whether World Com actually made use of all or part of the capacity of the leased facilities. Before any improper entries to World Com's books and records were made at the corporate level, these fees were recorded by WorldCom employees on its books and records as "line costs," current expenses which would be reported as part of World Com's operating expenses on its income statements. 17. Beginning in or around July 2000, World Com's expenses as a percentage of its total revenue began to increase, resulting in a decline in the rate of growth of WorldCom's income. This decline in income created a substantial risk that World Com's publicly reported income would fail to meet the expectations of Wall Street analysts and that the market price of WorldCom's securities would therefore decline. 18. Starting at least as early as the third quarter of 2000, WorldCom, in a scheme directed and approved by members of senior management, engaged in a continuing series of improper and fraudulent accounting manipulations designed to inflate artificially World Com's publicly reported income by falsely reducing WorldCom's reported line cost expenses. As a result of this scheme, World Com materially understated its expenses, and materially overstated its income, thereby defrauding investors. 19. In or around October 2000, World Com officers and employees fraudulently made and caused the making of certain entries in its general ledger intended to increase WorldCom's publicly reported income and conceal the true extent of its expenses; specifically, fraudulent and false entries were made in WorldCom's general ledger reducing its line cost expense accounts, and reducing -- in amounts corresponding to the fraudulent and false line cost expense amounts -- Various reserve accounts. There was no documentation supporting, nor was there any proper business rationale for, the false and fraudulent entries. These entries had the effect of reducing the third quarter 2000 line costs by approximately $828 million, thereby increasing WorldCom's publically reported income for the third quarter of 2000. 23. WorldCom's fraudulent, false and improper treatment of its line cost expenses, described above, was not disclosed to its investors, nor did World Com disclose to its investors, or elsewhere, that it had implemented such changes in its methods of accounting for line cost expenses. 24. As a result of these fraudulent, false and improper accounting manipulations, World Com materially overstated its earnings as well as its assets and materially understated its expenses in its filings with the Commission, specifically, on its Forms 10-Q for each quarter from the third quarter of 2000 through and including the first quarter of 2002, and on its Forms 10-K for the fiscal years which ended on December 31, 2000 and December 31, 2001. 25. The effects of World Com's fraudulent accounting scheme on WorldCom's filings with the Commission, which scheme resulted in material misstatements therein, are summarized on the following table: Read the following excerpt from a complaint filed by the Securities and Exchange Commission against WorldCom, posted online at: WorldCom officers and employees fraudulently made and caused the making of false and fictitious entries in WorldCom's general ledger which effectively transferred a significant portion of its line cost expenses to a variety of capital asset accounts, thereby effectively re- characterizing, without any supporting documentation, and in a manner inconsistent with GAAP, the operating expenses it had incurred for access to third party networks as "assets." Question Discuss whether it is always easy and straightforward to determine whether costs should be capitalized or expensed, as a consequence whether a manager is acting ethically or unethically for this regard? Give examples to illustrate your views. The Securities and Exchange Commission ("the Commission") alleges for its First Amended Complaint as follows: 1. From at least as early as 1999 through the first quarter of 2002, defendant World Com Inc. ("WorldCom") misled investors. Defendant WorldCom has acknowledged that during this period, as a result of undisclosed and improper accounting, it materially overstated the income it reported in its financial statements by approximately $9 billion. 2. In general, World Com manipulated its financial results in two ways. First, World Com reduced its operating expenses by improperly releasing certain reserves held against operating expenses. Second, World Com improperly reduced its operating expenses by recharacterizing certain expenses as capital assets. Neither practice was in conformity with generally accepted accounting principles ("GAAP"). Neither practice was disclosed to WorldCom's investors, despite the fact that both practices constituted changes from WorldCom's previous accounting practices. Both practices falsely reduced WorldCom's expenses and, accordingly, had the effect of artificially inflating the income World Com reported to the public on its financial statements from 1999 through the first quarter of 2002. As a result of, among other things, WorldCom's chronic and pervasive failures to follow GAAP standards, and to mandate and institute appropriate internal controls, the exact amount and extent of World Com's overstatement of its income has not yet been quantified. 3. Certain of the improper accounting entries were made with respect to World Com's so-called "line costs," which were among World Com's major operating expenses. From at least the third quarter of 2000 through the first quarter of 2002, in a scheme directed and approved by members of senior management, World Com concealed the true extent of its "line costs." By improperly reducing reserves held against "line costs" and by transferring certain "line costs" to its capital asset accounts, World Com falsely portrayed itself as a profitable business when it was not, and concealed large losses World Com suffered. WorldCom's fraudulent accounting practices with respect to "line costs" were designed to and did falsely and fraudulently inflate its income to correspond with estimates by Wall Street analysts and to support the price of WorldCom's common stock in the market. 4. While engaging in accounting manipulations with respect to line costs to fraudulently and falsely inflate its income, defendant WorldCom continued to offer and sell additional World Com securities, using fraudulent and materially false financial statements and financial information in the course of those offers and sales. 5. By engaging in such improper conduct, World Com violated the anti-fraud, reporting, record-keeping, and internal controls provisions of the federal securities laws. The Commission requests, among other things, that this Court enjoin World Com from committing further violations of the federal securities laws as alleged herein, and order World Com to pay a monetary penalty based on its violations of the federal securities laws. JURISDICTION 6. The Commission brings this action pursuant to Section 20(b) and 20(d) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. SS 77(b) and 77(d)], and Section 21(d) of the Securities Exchange Act of 1934 ("Exchange Act") (15 U.S.C. SS 78u(d)]. 7. This Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act (15 U.S.C. 77v(a)] and pursuant to Section 27 of the Exchange Act (15 U.S.C. 78aa). 8. The defendant, directly and indirectly, has engaged in, and unless restrained and enjoined by this Court will continue to engage in, transactions, acts, practices, and courses of business that violate Section 17(a) of the Securities Act [15 U.S.C. 779(a)], Sections 10(b), 13(a), 13(b)(2)(A), 13(b) (2)(B) of the Exchange Act (15 U.S.C. $$ 78m(a) and 78m(b) (A)] of the Exchange Act (15 U.S.C. SS 78j(b), 78m(a), 78m(b)(A) and 78m(b)(B)] and Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder [17 C.F.R. S$240.106-5, 240.12b-20, 240.13a-1, and 240.13a-13]. THE FRAUDULENT SCHEME REGARDING WORLDCOM'S LINE COSTS A. The Defendant 9. World Com is a Clinton, Mississippi-based company incorporated in Georgia which provides a broad range of communications services to businesses and consumers in more than 65 countries. World Com provides data transmission and Internet services for businesses, and, through its MCI unit, provides telecommunications services for businesses and consumers. World Com is a public company whose securities are registered with the Commission pursuant to Section 12(b) of the Exchange Act and it is required to file periodic reports with the Commission pursuant to Section 13 of the Act. WorldCom's common stock was, at all times relevant hereto, listed and traded on the NASDAQ National Market System under the symbol "WCOM," and its stock was covered by Wall Street analysts who routinely issued quarterly and annual earnings estimates. B. Relevant Accounting Principles 10. Public companies, such as WorldCom, typically report the financial results of their operations in financial statements that include both an income statement and a balance sheet. A company's income statement reports, among other things, revenue recognized, expenses incurred, and income earned during a stated period of time -- usually for a fiscal quarter or a fiscal year. Within an income statement, expenses are generally subtracted from revenues to calculate income. A company's balance sheet reports, among other things, the assets and liabilities of a company at a point in time, usually as of the end of the company's fiscal quarter or fiscal year. 11. When companies spend money or incur costs, those expenditures can be accounted for in a variety of ways depending on the nature of the transaction. Some types of expenditures, most commonly those incurred by a company in its normal operations, are treated as current period costs or "operating expenses." Examples of operating expenses include recurring costs such as salaries and wages, insurance, equipment rental, electricity, and maintenance contracts. Generally, almost all routine expenditures that a company makes are operating expenses. Other types of expenditures, most commonly those which result in the acquisition of, or improvement to, the company's assets, are treated as "capital expenditures." Examples of capital expenditures include purchases of real estate, manufacturing equipment, and computer equipment. 12. Operating expenses and capital expenditures generally receive different accounting treatment. Operating expenses are generally reported on a company's income statement and subtracted from revenues in the period in which the expense is incurred or paid, resulting in the company's net income for that period. Generally, capital expenditures, by contrast, are not subtracted from revenues and are not reflected on the income statement. Instead, capital expenditures are reported as capital assets on a company's balance sheet. 13. If a company makes entries in its accounts that effectively reclassify or transfer a given expenditure from an "operating expense" to a "capital asset," that action will have the following effects on the company's financial statements: (a) the reclassification or transfer will reduce the company's operating expenses, and the company's pre-tax net income consequently will increase by the amount reclassified or transferred; (b) the value of the company's capital assets and total assets will increase by the amount reclassified or transferred; and (c) the value of the company's net worth will increase. 14. One of World Com's major operating expenses reported on its income statements which were periodically filed with the Commission was its so-called "line costs." "Line costs" represented the various fees World Com paid to third-party telecommunications carriers for WorldCom's right to access the third-party's network facilities in order to serve customers. Under GAAP, these fees must be reported as an expense on a company's income statement. 15. From time to time, World Com established liabilities or "reserves" on its balance sheet for various future payments for goods or services it had previously received or incurred. Among the reserves World Com established were reserves for line costs and income taxes. Line cost reserves and income tax reserves were listed on WorldCom's balance sheet as liabilities. C. WorldCom Changes its Accounting to Fraudulently Inflate Its Income 16. Anticipating unabated growth in telecommunications services, WorldCom entered into a number of long-term lease agreements with various third-party telecommunication carriers to gain the right to access these networks in the late 1990s. Many of these leases required World Com to pay a fixed sum to the third-party carrier over the full term of the lease regardless of whether World Com actually made use of all or part of the capacity of the leased facilities. Before any improper entries to World Com's books and records were made at the corporate level, these fees were recorded by WorldCom employees on its books and records as "line costs," current expenses which would be reported as part of World Com's operating expenses on its income statements. 17. Beginning in or around July 2000, World Com's expenses as a percentage of its total revenue began to increase, resulting in a decline in the rate of growth of WorldCom's income. This decline in income created a substantial risk that World Com's publicly reported income would fail to meet the expectations of Wall Street analysts and that the market price of WorldCom's securities would therefore decline. 18. Starting at least as early as the third quarter of 2000, WorldCom, in a scheme directed and approved by members of senior management, engaged in a continuing series of improper and fraudulent accounting manipulations designed to inflate artificially World Com's publicly reported income by falsely reducing WorldCom's reported line cost expenses. As a result of this scheme, World Com materially understated its expenses, and materially overstated its income, thereby defrauding investors. 19. In or around October 2000, World Com officers and employees fraudulently made and caused the making of certain entries in its general ledger intended to increase WorldCom's publicly reported income and conceal the true extent of its expenses; specifically, fraudulent and false entries were made in WorldCom's general ledger reducing its line cost expense accounts, and reducing -- in amounts corresponding to the fraudulent and false line cost expense amounts -- Various reserve accounts. There was no documentation supporting, nor was there any proper business rationale for, the false and fraudulent entries. These entries had the effect of reducing the third quarter 2000 line costs by approximately $828 million, thereby increasing WorldCom's publically reported income for the third quarter of 2000. 23. WorldCom's fraudulent, false and improper treatment of its line cost expenses, described above, was not disclosed to its investors, nor did World Com disclose to its investors, or elsewhere, that it had implemented such changes in its methods of accounting for line cost expenses. 24. As a result of these fraudulent, false and improper accounting manipulations, World Com materially overstated its earnings as well as its assets and materially understated its expenses in its filings with the Commission, specifically, on its Forms 10-Q for each quarter from the third quarter of 2000 through and including the first quarter of 2002, and on its Forms 10-K for the fiscal years which ended on December 31, 2000 and December 31, 2001. 25. The effects of World Com's fraudulent accounting scheme on WorldCom's filings with the Commission, which scheme resulted in material misstatements therein, are summarized on the following table: Read the following excerpt from a complaint filed by the Securities and Exchange Commission against WorldCom, posted online at: WorldCom officers and employees fraudulently made and caused the making of false and fictitious entries in WorldCom's general ledger which effectively transferred a significant portion of its line cost expenses to a variety of capital asset accounts, thereby effectively re- characterizing, without any supporting documentation, and in a manner inconsistent with GAAP, the operating expenses it had incurred for access to third party networks as "assets." Question Discuss whether it is always easy and straightforward to determine whether costs should be capitalized or expensed, as a consequence whether a manager is acting ethically or unethically for this regard? Give examples to illustrate your views