The Association of U S West Retirees



Accounting details would just baffle jury
By David Milstead, Business Columnist
Rocky Mountain News
Wednesday, March 14, 2007

I spent a great deal of time in 2001 and 2002 trying to understand Qwest's accounting theory for network capacity sales.  Just where did that envelope get pushed -- or ripped clear on through?  I now know entirely too much for anyone who also hasn't gone through the brain damage of becoming a certified public accountant.  But all that knowledge looks like it'll be pretty useless next week when U.S. vs. Joe Nacchio begins.

You've read by now that prosecutors want to keep it simple, likely to avoid the botch that was the first Qwest accounting trial, against four midlevel executives in 2004.  (Very few of the charges stuck, and no one served time.)

Indeed, the indictment filed against Nacchio in December 2005 is just eight pages, two of which contain the addresses and signatures of Justice Department lawyers.  In essence, it's pretty simple:  Nacchio knew Qwest really wasn't making its numbers but claimed it was, all the while selling more than $100 million worth of stock.

Contrast that with the Securities and Exchange Commission's complaint against the company, filed in October 2004.  Its 56 pages cover the field:  Qwest's accounting for network capacity sales was fraudulently wrong.  And even if it wasn't, Qwest fraudulently failed to tell investors just how important these capacity sales were.

Here's what we're talking about with these "network capacity sales":  Qwest would lease space on its coast-to-coast fiber optic network, often in multiyear contracts, to other telecommunications companies.  These had the unfortunate name of "indefeasible rights of use," or IRUs.

Often, Qwest and another telco would execute simultaneous sales to each other, which came to be known as "swaps."

Actually, the whole industry was one big swap shop, particularly at quarter's end when the sales and swaps helped companies meet their quarterly goals.

This type of activity typically leads to questions about whether the companies read the fine print of the accounting literature.  In the rapidly evolving telecom industry, there was also much talk about the broad theories of accounting for all these sales and swaps.

In 2002, most telcos were out of the game.  They'd decided they couldn't meet new, tougher standards on booking all the revenue from a long-term lease as soon as the deal was signed.

And the SEC came out and invalidated the main theory that most telcos were using to book swap revenue.  The companies claimed that because one network-capacity contract was a "sales-type" lease, and another was an operating lease, they were exchanging dissimilar assets, and the revenue was kosher.  Phooey, the SEC said:  Different kinds of financing don't make two lengths of capacity a dissimilar asset.

Qwest claimed a hall pass under Nacchio's leadership, though.  For one, the company said its capacity deals still qualified as sales-type leases.  And two, it said it could book revenue on its swaps because the network it was trading away was classified as inventory on the balance sheet -- not as a productive asset.

Qwest's accounting theories, developed in conjunction with then-auditor Arthur Andersen, have never been publicly repudiated.  It's just the details that are the problem.

That multibillion-dollar restatement under Nacchio successor Dick Notebaert?  The company wiped out all that revenue because it re-audited its old financials and said it couldn't find the paperwork that would justify the accounting.

The SEC argues that it never existed, and the company's sales never held up under generally accepted accounting principles.  "Qwest turned a blind eye to these GAAP failures," the agency alleged.

So the SEC goes on for several pages about portability and grooming, as well as property, plant and equipment designations, and "specifically identifiable assets."  (Qwest settled the allegations, paying $250 million.)

Sound like an easy case for a jury?  It sounds like the perfect way to hopelessly confuse a jury.  So if any accountants testify, they'll likely be there to talk about "materiality," the issue of whether Nacchio's omissions were too big to ignore.

The finer points of telecommunications accounting will be left outside the courtroom door and out of the jurors' heads.  And prosecutors hope that'll add up to a guilty verdict.

David Milstead and James Paton take turns writing Up and Down 17th Street. Contact Milstead at 303-954-2648 or,1299,DRMN_82_5415824,00.html