BOSTON (Reuters) - Bermuda-based Tyco International Ltd. shares surged nearly 12 percent on Tuesday as investors took heart that a massive internal probe failed to find any significant accounting fraud during the regime of indicted former Chairman Dennis Kozlowski.

"The lawyers and forensic (accounting) teams were playing the role of bomb-sniffing dogs, and they confirmed that there are not any bombs to defuse," said Glenn Reynolds, a credit analyst at research firm CreditSights Inc.

Investors, meanwhile, shrugged off Tyco's disclosure that it faces a looming funding shortfall of $3.6 billion at the end of 2003, which is more than double previous company estimates.

Shares of the conglomerate rose $1.73 to $17.08 in afternoon trade on the New York Stock Exchange.

But the stock tumbled 71 percent in 2002, hurt by accounting worries and criminal charges against three former senior executives and a former director who pleaded guilty to hiding a $20 million payment from other board members.

However, not everyone was upbeat about the investigation overseen by lawyer David Boies.

David Tice, of the Prudent Bear Fund, said the report highlighted the existence of a corporate culture within Tyco that openly encourage managers to push the rules of accounting to mislead investors about the company's results.

"The Boies report confirms a lot of what we've been talking about for several years," said Tice, a short seller who has bet that Tyco shares would fall. "We specifically highlight how the Boies team reviewed just fifteen major acquisitions, while more than 700 were made during the period under review," Tice said. "Given that the corporate culture was to suppress results of acquisition targets before combination with Tyco's results, this indicates the degree to which the Boies study was not sufficient to determine the size of the problem."

Tyco's release late on Monday of its internal investigation revealed accounting errors that would trigger a $382.2 million pretax charge against earnings in the fiscal year that ended September 30. But the probe uncovered no significant or systemic fraud, Tyco said.

While some of Tyco's deals did not trigger an accounting correction, they remain controversial nonetheless. Tyco, for example, recorded a $111 million gain in 1999 from the $167 million sale of its Angio Seal product line, even though the business was valued at only $20.4 million.

"(The) sale of the Angio Seal division exemplifies how the Boies report did not find fault with accounting treatment when perhaps it should have," Tice said. "When a division is sold for (8 times) the value allocated to the purchase price one year later, there was obviously a misallocation that later resulted in accounting earnings."

Tyco spent an estimated $50 million as accountants and lawyers logged about 65,000 hours combing through billions of dollars worth of financial transactions.

Tyco admitted that previous management used aggressive bookkeeping to boost results and said that shoddy records and inadequate policies had existed. Tyco Chief Executive Edward Breen backed the company's fiscal 2003 earnings forecast of $1.50 to $1.75 a share. Yet, several significant risks loom as Tyco attempts to distance itself from the decade-long Kozlowski era. The most pressing concern is to pay off or refinance nearly $6 billion in debt due in February. Breen said he is confident he and Tyco finance chief David FitzPatrick can negotiate a new credit agreement with its banks. Tyco also is exploring the sale of convertible debt securities.

Tyco reports $6.2 billion in cash on hand and could use it to pay the obligations if new financing is not in place. Three businesses within Tyco also have been identified for possible divestiture to raise cash. But the real cash crunch comes in the first quarter of fiscal 2004, which begins on October 1. A $3.6 billion funding shortfall could emerge, FitzPatrick told analysts during a conference call on Tuesday. The previous estimate was about $1.5 billion.

If Tyco closes that gap, it could serve as a catalyst for the stock, David Bleustein, an analyst at UBS Warburg, said in a research note. He rates Tyco shares a "strong buy."

Tyco expects to generate up to $3 billion in cash flow during fiscal 2003, but further weakness in its electronics business could put that target in jeopardy.

Nicholas Heymann, an analyst with Prudential Securities, recently wrote in a research note that sharp declines in Tyco's profit margins, $1.7 billion in underfunded pension plans, higher debt costs and general economic uncertainty could diminish the conglomerate's cash flow prospects. As of last week, Heymann had a "hold" rating on Tyco. Tyco's balance sheet could also take a hit from further asset write-downs. The company's failed undersea fibre-optic cable network triggered a $2.5 billion charge in fiscal 2002 amid a glut of capacity and a trickle of revenue. Some analysts see more big-ticket write-downs at the network. Tyco recently gave the US Securities and Exchange Commission more than 1 million pages of documents for the agency's ongoing investigation.