Updated from 2:39 p.m. EDT

WorldCom's ( WCOEQ) former controller David Myers, who was arrested early Thursday on fraud charges, acknowledged in June that the company's bookkeeping wasn't in compliance with accounting standards, federal prosecutors allege.

Both Myers and Scott Sullivan, WorldCom's former chief financial officer, turned themselves in to authorities to face a series of charges for their roles in the accounting scandal that led to the company's bankruptcy last month.

The former executives were charged with one count of conspiracy to commit securities fraud, one count of securities fraud and five counts of filing false statements with the Securities and Exchange Commission. If convicted, Sullivan and Myers could face up to 65 years in prison, according to the Justice Department.

Fine Line

In the complaint, which was unsealed on Thursday, prosecutors allege that in April, July and October 2001, and in February and April 2002, Myers -- at Sullivan's direction -- asked WorldCom's accounting department to transfer a total of $3.83 billion in "line costs" to various property plant and equipment accounts in the company's ledger.

By reclassifying ongoing operating expenses as capital expenditures, WorldCom was able to artificially inflate its profits because capital expenditures typically aren't subtracted from revenue immediately but are instead depreciated over time.

The complaint charges that in July 2000, WorldCom's expenses as a percentage of its total revenue began to increase, resulting in a decline in the rate of growth of the firm's earnings. Knowing that the company would likely miss analysts' estimates if things were to continue as they had been, Sullivan "devised a scheme to hide WorldCom's increasing expenses."

When questioned by an internal auditor about the decision to capitalize expenses, Sullivan said he had capitalized line costs in the third quarter of 2001 but that prior to that, the costs had been treated as ongoing expenses. He also tried to delay an internal audit until the third quarter of this year and requested that the auditor only examine the company's second quarter 2002 numbers.

Body in Motion

Myers, on the other hand, acknowledged to the internal auditor in June that he felt uncomfortable with the line cost entries but that once it was done for the first time, it was difficult to stop. He also said he hoped the conduct wouldn't have to be explained to the SEC because he was aware that the approach had no basis in generally accepted accounting principles.

As for WorldCom's external auditor Arthur Andersen, the complaint suggests that the accounting firm asked Sullivan and Myers if they had implemented any changes to the firm's accounting practices, but that the two men didn't disclose that they had.

The SEC has filed civil fraud charges against WorldCom as part of its investigation of the Clinton, Miss., telco, and Congress is also probing the company.

The complaint also alleges that the men filed false financial reports with the SEC in May, August and November of last year and in March and May of this year. The SEC has filed civil fraud charges against WorldCom as part of its investigation of the Clinton, Miss., telco, and Congress is also probing the company.

Grandfather

The two former executives have been released on bail, which was set at $10 million for Sullivan and $2 million for Myers. Both have had their passports confiscated and their travel within the U.S. has been restricted.

Earlier this week, President Bush approved a bill ushering in much stiffer penalties for CEOs and other corporate executives who break securities laws. It is not clear yet whether these new penalties apply to Sullivan and Myers.

The Sarbanes-Oxley bill came amid a series of corporate scandals that have seriously damaged investor confidence this year and sent stocks into a tailspin.

Just last week, several members of Adelphia Communications' founding Rigas family were arrested for systematically looting the company and causing investor losses of more than $60 billion.

Meanwhile, in June, ImClone Systems' ( IMCL)former Chief Executive Sam Waksal was arrested for selling Imclone shares and advising family members to do the same shortly before announcing that the Food and Drug Administration had rejected an application for the firm's cancer treatment Erbitux.

Last year, Enron filed for bankruptcy after announcing that it had shifted billions of dollars of debt off its balance sheet in an effort to make its financials look better than they actually were.

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