A peek at what SEC says Qwest did wrong
By Rob Reutman
Rocky Mountain News
Saturday, March 19, 2005
It's not a smoking gun or even the straw that broke the camel's back, but
one illuminating scenario in the 50-page civil complaint filed Tuesday
against seven ex-Qwest execs speaks volumes about the inside workings of a
corporation gone wrong.
In fact, it is the reason why the Securities and Exchange Commission filed
the complaint this week - to beat the five-year statute of limitations on
misdeeds associated with the March 17, 2000, filing of Qwest's 1999 annual
In early 2000, Qwest was in the midst of putting together its annual report,
the detailed financial statement required of every company that sells
stock. The comprehensive balance sheet is scrutinized by investors,
creditors, analysts, reporters - and the SEC. The accuracy of all annual
reports is imperative and inaccuracy can be criminal, but for Qwest the 2000
report was especially crucial. The company had announced a merger agreement
with U S West the previous July and the deal had not closed. A lot of
people were suspicious of a deal in which the relatively tiny newcomer could
swallow up a Baby Bell. The currency in the deal was Qwest stock, which the
SEC now says "was significantly inflated by the fraudulent scheme."
Without getting too technical, much of the alleged fraud revolved around
Qwest making a lot of shady one-time transactions but representing them in
its accounting as "recurring revenue." As the complaint reads, "To meet the
aggressive targets, Qwest fraudulently and repeatedly relied on immediate
revenue recognition from one-time sales of assets known as 'IRUs'
(indefeasible rights of use) and certain equipment while falsely claiming to
the investing public that the revenue was recurring." In other words, they
were telling the investment community, these aren't one-time fluke deals,
this is how much we make all the time and our stock price should reflect
James J. Kozlowski was Qwest's senior director of financial reporting at the
time. According to the complaint, in early 2000 Kozlowski determined that
these one-time transactions were a significant-enough part of Qwest's
overall revenue picture that they needed to be disclosed as such in the
company's upcoming annual report, also known as a 10-K. He told Qwest's
chief financial officer, Robert Woodruff, "that the scope and extent of
reliance" on the one-time deals "should be disclosed" in the annual report.
"In response, Woodruff asked Kozlowski to draft proposed language," the
Kozlowski also discussed all this with Qwest's auditing firm, Arthur
Andersen, which "told him Qwest should provide disclosure in the footnotes
to the financial statements, detailing not only Qwest's IRU accounting
policy but also the amount of revenue and gross margins from IRU
transactions." The complaint says Arthur Andersen closed the loop by
telling Woodruff that Qwest should make the disclosures.
Kozlowski and Frank T. Noyes, another Qwest director of financial reporting,
then drafted the disclosures for inclusion in the annual report. "At
Kozlowski's direction, Noyes inserted this draft IRU disclosure" in a draft
version of the annual report, which he circulated to Woodruff and
then-senior vice president of financial planning, Robin Szeliga, for review.
Before filing the report with the SEC, Woodruff told Kozlowski he had to
discuss the IRU disclosure with Chief Executive Officer Joe Nacchio. Then,
before the report was filed with the SEC, Woodruff told Kozlowski "to remove
the IRU disclosure language," the complaint alleges. "As a result Kozlowski
told Noyes to 'take it out' and the IRU disclosure language was removed from
Qwest's 1999 10-K filed with the SEC."
The complaint alleges that Szeliga, who later replaced Woodruff as CFO, knew
the disclosures had been removed and that she, Nacchio and Woodruff "each
signed false management representation letters to Qwest's outside auditors
falsely stating, among other things, that the financial statements in the
1999 10-K were not materially misleading." The complaint also says
that auditor Arthur Andersen approved a version of the annual report that
had included the requested disclosure language and "was never consulted
about the removal of that language from the filed annual report and had no
knowledge that the 10-K was filed without the IRU disclosure language."
For their roles in the above scenario, everyone mentioned is being sued by
the SEC for a fraudulent scheme to report $3 billion in revenue that
"facilitated the company's June 2000 merger with U S West." It was later
determined that these hidden one-time sales accounted for 26 percent of
Qwest's 1999 revenue. What a tangled web the defendants wove and what a
difficult time they will have trying to weasel out of it.
reutemanr@RockyMountainNews.com or 303-892-5177