Updated from 2:34 p.m. EDT

As bad as it is that

WorldCom

(WCOM)

has been committing accounting fraud for the last five quarters, it could get worse.

Following WorldCom's bombshell that its financial statements stretching back to last year's first quarter contained $3.8 billion in fraudulent capital expenses, some on Wall Street were bracing for more bad news.

"This probably is just the tip of the iceberg," said Susan Kalla, who follows the company for Friedman Billings Ramsey. "So far, the disclosures have been limited to the EBITDA numbers for 2001 and part of 2002. Who knows what else they will find?"

According to Kalla, people close to WorldCom say as much as $10 billion of potentially fraudulent accounting may eventually surface once they address items like past receivables and sales lost to failed customers like upstart phone companies.

The Latest and Greatest

The troubled telco, already crumbling under the threat of a debt restructuring, has also been under scrutiny by the

Securities and Exchange Commission

for possibly overstating its revenue through fraudulent billing practices -- items that were not part of the fraud WorldCom copped to on Tuesday.

After the latest revelations, that SEC scrutiny became more serious. The agency filed a civil lawsuit in New York against WorldCom, saying the company committed fraud. SEC Chairman Harvey Pitt said regulators are seeking an order to prevent WorldCom from disposing of assets, destroying documents or making payouts to senior officers.

Pitt, however, didn't stop with WorldCom. He also said he had approved an order directing chief executives and chief financial officers of the largest U.S. companies to personally certify annual and interim financial reports.

His comments came hours after President Bush called the WorldCom disclosures "outrageous" and vowed to launch a full government investigation of the situation. For his part, Senate Majority Leader Tom Daschle (D., S.D.) said the Senate will move up planned votes on an accounting-industry reform bill approved by the Senate Banking Committee last week. But Daschle also took the opportunity to go on the offensive against Pitt, saying the SEC chief wasn't "doing the job."

Meanwhile, in the House of Representatives, Minority Leader Dick Gephardt (D., Mo.) used WorldCom to attack Republicans for what he said was a long-term effort to loosen regulatory oversight of corporations.

"There's certainly the potential that their revenues were also overstated," said Drake Johnstone, of Davenport, who has had a sell rating on WorldCom stock since April.

Late Tuesday Mississippi-based WorldCom confirmed it had inflated its earnings before interest, taxes, depreciation and amortization, or EBITDA, a measure of cash flow, by $3.8 billion over the last five quarters by fraudulently classifying routine operating costs as capital expenditures. The company said it would have lost money in 2001 rather than earning the $1.4 billion it reported. The company said it would issue new figures "as soon as practicable."

Even if the restatements did balloon, as sources warned, it would probably mean little to stockholders. Shares had already dipped below a buck, closing Tuesday -- before the company announced the accounting scandal -- at 83 cents. They've since been halted after trading for 9 cents each on various ECNs before the open.

WorldCom did not return a call seeking comment.

"It's game over for stockholders," said Glenn Reynolds, of Creditsights. He said whether it is "giant fraud, or super giant fraud" matters little, as the damage may already be done. "Can they stay out of bankruptcy? That seems very unlikely."

The Last Battle

The company's bonds, which lately traded at 13.5 cents on the dollar, suggest their owners think the company's going under, Reynolds said. The major battle playing out now, he said, is between the banks -- which will likely negotiate credit lines to keep the company out of bankruptcy, because they would become unsecured creditors in a bankruptcy proceeding -- and the bondholders.

"The best outcome for bondholders, which will become tomorrow's stockholders, is for the company to go bankrupt today," he said.

WorldCom has been trying to

renegotiate a new $5 billion credit line with its bankers, but the clock has been ticking on a separate credit line that expires at the end of the month.

In a bankruptcy proceeding, bondholders would be secured creditors and be paid back before the banks would. Shareholders typically get nothing in bankruptcy, as new equity is doled out to creditors and new, court-approved shareholders.

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EBITDA: Anatomy of an Accounting Gimmick

Some observers were also wondering how far back the company fraudulently booked expenses as capital costs. WorldCom said an internal audit uncovered the fraud dating back to the first quarter of 2001, yet there was no significant boost in the company's operating margins -- as would be expected -- at the beginning of the period that WorldCom says the fraud began, noted Carol Levenson, of GimmeCredit.

In a note published Wednesday, Levenson wrote, "We went back over the past three years and found line costs as a percentage of sales hadn't changed materially. This gives rise to the question: How long has this been going on?"

What Else?

The rest of the sector was reeling Wednesday, as investors worried about similar problems at other successful bubble-era telecommunications companies. In particular, Denver telco

Qwest

(Q)

has been a lightning rod for such concerns; its shares were off lately $1.94, or 46%, at $2.25. The company has faced a well-publicized SEC accounting probe into its use of pro forma accounting to boost its reported results, as well as its part in the industrywide practice of swapping network capacity sales.

As bad as WorldCom's scandal is, observers said it pales next to

Enron

, the standard for fraud and excess.

"This is a lot less nefarious than Enron," said Creditsights' Reynolds. In the case of Enron, he said, the company's fraud was engineered by its accountants and investment banking partners on Wall Street, while WorldCom's was orchestrated by officers of the company, including CFO Scott Sullivan, who lost his job over it.

Also, WorldCom's fraud did not affect the company's free cash flow -- which is cash flow after accounting for capital expenditures and the most reliable financial measure -- noted Levenson.

That's little solace for WorldCom investors who lost their shirts.