Nacchio: Not fraud, just 'puffery'
Former Qwest CEO asks judge to drop charges against him
By Jeff Smith, Rocky Mountain News

Thursday, June 2, 2005

Former Qwest Chief Executive Joe Nacchio on Wednesday asked a federal judge in Denver to dismiss securities fraud charges against him, indicating at most he was guilty of "puffery" and "corporate optimism."

Nacchio, in court filings by his attorneys, disputed allegations by the Securities and Exchange Commission that he misled investors about the Denver telco's true financial condition.

"Virtually all of the statements that the SEC invokes as 'misrepresentations' are easily and properly classified as inactionable puffery, expressions of corporate optimism and predictions," Nacchio's attorneys wrote.

"This is not the stuff of securities fraud. . . . The securities laws should not be misconstrued to require disclosure divined from a crystal ball."

Nacchio's memorandum, which accuses the SEC of overreaching, refers to federal judicial rulings that optimistic statements about a company's future performance don't constitute securities fraud and that reasonable investors don't rely on such vague statements.

SEC officials couldn't be reached for comment.

Nacchio and six other former Qwest executives were accused by federal regulators in March of a "massive" $3 billion financial fraud between 1999 and 2002 and personally benefiting from an inflated stock price.  The SEC alleges Nacchio and former chief financial officers Robert Woodruff and Robin Szeliga orchestrated a scheme to hide from investors that Qwest made much of its revenue from one-time sales or swaps of fiber-optic capacity, referred to internally as "heroin" or the "addiction."

Many of the deals were shams, done only to meet the company's quarterly revenue targets, the SEC claims, and Qwest used aggressive methods to book the revenue.  The Denver telco didn't ask the SEC about the propriety of the accounting because it didn't want to know, the SEC alleges.

Regulators charge Nacchio with having an explosive temper and presiding over a "culture of fear" marked by intense pressure on employees to meet unrealistic double-digit revenue growth targets.

The SEC is seeking "ill-gotten" gains, including salaries and stock sales income, and wants to bar the executives from serving as officers or directors of a public company.

Nacchio alone made $216 million during the period, mostly by exercising stock options, while the group as a whole made about $300 million.

Qwest's stock peaked at $66 a share on March 3, 2000, and plummeted to a low of $1.07 on Aug. 7, 2002.

Nacchio, who lives in Mendham, N.J., has kept a low profile since being ousted from Qwest in June 2002.  But last year he resurfaced as a consultant and as an investor in a small New Jersey telecommunications company.

Qwest began to erase the revenue from its books in late 2002, under new Chief Executive Dick Notebaert, saying it lacked supporting documents.  The company ultimately cleansed more than $2.5 billion of revenue from its 2000 and 2001 books.

Others charged by the SEC included former President Afshin Mohebbi, former top sales executive Gregory Casey and former internal accountants/financial reporting directors James Kozlowski and Frank Noyes.

Casey has worked out a tentative settlement with the SEC, while the others have asked a Denver federal judge to dismiss the charges against them.

The SEC earlier this year settled similar fraud charges with five former Qwest executives.

Separately, Qwest as a company last fall settled accounting fraud allegations with the SEC, agreeing to pay a fine of $250 million.

In his filing, Nacchio argues the SEC's allegations about improper deals and accounting don't even mention him.  That leaves the argument by the SEC that Nacchio misrepresented Qwest's financial performance and growth by not giving investors sufficient information to differentiate between one-time sales or "nonrecurring" revenue and "recurring" revenue.

Nacchio's attorneys argue the SEC has said "nonrecurring" items are "unusual and infrequent events" - and accounting standards define those as "extraordinary items" that have a "high degree of abnormality."

So the SEC undercuts its own allegations, Nacchio's attorneys say, because the "one-time" sales accounted for billions of dollars of revenue for Qwest between 1998-2001.  They "occurred for years as a regular part of Qwest's business in the then-prevailing telecom world."

The SEC, they say, also failed to show why it was misleading to include the sales figures within broader categories such as "communications" or "data and Internet services."

Woodruff's motion to dismiss argued in part that the accounting allegations by the SEC were far too general and, like Nacchio, "vague statements" of corporate optimism aren't actionable under securities laws.  His attorneys further claimed that the capacity swaps alleged by the SEC took place after he resigned from Qwest.

Szeliga's motion to dismiss or for an amended complaint argues the SEC lumped allegations against Nacchio, Woodruff and Szeliga together "in a way that makes it impossible to understand what is being alleged against whom."

"This is improper in a fraud complaint, which requires individualized treatment of each defendant," Szeliga's filing states.

Mohebbi's attorneys argued the SEC attempts to connect him only through his "slight contact" with specific transactions.

"Perhaps most importantly, and in contrast to all but one of his co-defendants, the complaint does not (and cannot) allege that Afshin Mohebbi ever sold a single share of Qwest stock."

Mohebbi's attorneys also argue the SEC tries to "tar" Mohebbi with the allegation that contracts were backdated yet doesn't provide any evidence that Mohebbi himself backdated or knew a contract was backdated.

Noyes argued in part that the SEC allegations are "nothing more than criticism of accounting choices in a new technology."

Kozlowski, in an earlier motion to dismiss, argued that he asked the SEC for accounting advice in 1999 but it wasn't provided.  Others, such as Noyes and Woodruff, also incorporated those arguments into their filings.

The SEC case against former Qwest executives

  Allegations:  Orchestrated a "massive" $3 billion financial fraud between 1999 and 2002, misled investors, personally benefited from inflated stock price.

  Defendants:  Former CEO Joe Nacchio, former CFOs Robert Woodruff and Robin Szeliga, former President Afshin Mohebbi, former top sales executive Gregory Casey, former accountants James Kozlowski and Frank Noyes. Casey has reached a tentative settlement.

  What the SEC is seeking:  "Ill-gotten gains," including salaries and stock sales, and to bar the executives from serving as officers of a public company.  Nacchio alone made $216 million during the period.

  Defenses:  SEC failed to substantiate and individualize the allegations;  Qwest executives weren't required to disclose revenue from network capacity sales;  optimism doesn't constitute securities fraud;  Qwest accountants asked the SEC for advice in 1999.