Qwestionable time
Inquiry focuses on period in '01 when Nacchio sold stock
By Jeff Smith
Rocky Mountain News

Saturday, June 11, 2005

An insider trading charge against Qwest's former chief financial officer suggests federal prosecutors may be zeroing in on a narrow window of time during which Joe Nacchio sold nearly $50 million of company stock.

Federal prosecutors last week charged former CFO Robin Szeliga with insider trading based on an April 30, 2001, sale that netted her pretax profits of $125,000.  Szeliga has struck a tentative plea agreement and has agreed to cooperate with prosecutors.
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Former Qwest CEO Nacchio's own sales occurred in a three-week flurry in the last week of April 2001 and the first two weeks of May 2001.  He exercised low-priced options and sold the shares for a gross of $49 million and a pretax profit of $42 million, according to data supplied by Lancer Analytics.

Nacchio never sold another share of Qwest stock during his tenure.

Prosecutors allege Szeliga knew by at least April 2001 that the Denver telco couldn't meet its revenue targets without resorting to extraordinary one-time sales and swaps of fiber-optic capacity with other companies.  But until August 2001 such significant information was concealed from investors, regulators charge.

Regulators have claimed the deals not only were improperly accounted for, but, in some cases, served no legitimate business purpose - in other words, they were shams to inflate Qwest's revenue.

Focus on spring 2001

The criminal allegations against Szeliga are similar to the civil charges made against Nacchio by the Securities and Exchange Commission in March.  The SEC alleged Nacchio misrepresented Qwest's true financial condition during the same period.

Nacchio spokeswoman Marcia Horowitz issued a statement Friday reiterating that "... as he has said from the beginning, Mr. Nacchio did absolutely nothing wrong.  These matters are now before the courts and will be addressed there."

Spring 2001 also could be critical because documents show Qwest management was under increasing scrutiny and pressure by its outside auditor and its board of directors' audit committee to provide investors with disclosure about Qwest's heavy reliance on the network capacity sales and swaps, commonly known in the industry as "IRUs."

Qwest's accounting of the swaps already had been characterized as "maximum risk" by auditor Arthur Andersen, bordering on unacceptable.

Qwest management ignored such directives and didn't provide details of the scope of these deals until Nacchio went on the road to meet Wall Street analysts in August 2001.  Even then, Nacchio initially understated the amount of IRU revenue in the first six months of 2001 by more than $300 million, the SEC has alleged.

"The government will have to show deceptive intent, but the government's strongest case is during that window period" in the spring of 2001, said former federal prosecutor Christopher Bebel in Houston, who has been following the Qwest case.

After Nacchio was ousted as CEO in June 2002, Qwest would erase $1.5 billion of IRU revenue from its 2000 and 2001 books, including nearly $1 billion from swaps alone.  During Nacchio's tenure, Qwest swapped fiber or communications capacity with the likes of Global Crossing, Enron and Cable & Wireless.

Overall, Nacchio sold nearly $250 million of Qwest stock.

In congressional testimony in the fall of 2002, Nacchio defended the capacity sales and swaps as having legitimate business purposes, such as to fill gaps in Qwest's own fiber-optic network.  He also noted he killed a giant deal in the second quarter of 2001 that didn't meet those criteria.

Szeliga makes a deal

Szeliga's cooperation with federal investigators raises the possibility she might testify against Nacchio, either in the civil or a possible criminal case.

It's unclear whether the government possesses smoking gun documents or how much information Szeliga may have shared with Nacchio.

Nacchio himself told lawmakers in 2002 that Szeliga's office was next to his, and, "We met daily, and we met, I would say, formally at times when we had a monthly review of results, but we also met frequently on an informal basis.  She had open access."

But Nacchio also told the congressional panel that his stock sales derived from stock options granted in 1997 and that, "I sold my shares based upon the advice of my financial advisers in order to diversify my holdings."

He added:  "Any time I sold Qwest stock, I believed the company's financial statements represented a full and accurate picture of its financial condition."

Bebel, the former federal prosecutor, said "cooking the books and insider-trading charges go hand in hand."

But the tough part for prosecutors, he said, is that auditors signed off on the financial statements, others in the industry were doing similar deals at the same time, and the accounting rules were "somewhat cloudy."

The government will have to prove, he said, that Qwest failed to disclose information a reasonable investor should expect and that Nacchio and Szeliga made fictitious statements about the company's impressive, double-digit revenue growth rates.

Nacchio claims 'puffery'

Nacchio's defense in court filings to the SEC fraud charges is that "puffery" and "corporate optimism" don't constitute securities fraud and that the capacity sales and swaps were done quarter after quarter and thus were an ordinary part of the company's business.

But in February 2001, the board of directors' audit committee told company management to provide additional disclosures of the deals in its quarterly statements, according to congressional testimony provided by Peter Hellman, a member of the audit committee.

That was also the month in which Arthur Andersen classified the swap accounting as "maximum risk," bordering on unacceptable.

By April 2001, the alleged fraud was beginning to unravel, according to the SEC.

In its civil suit, the SEC claims a senior executive sent an e-mail to Szeliga on April 5, 2001, proposing disclosure for Qwest's first-quarter filings "... given the materiality of IRUs to our results and the SEC scrutiny on revenue recognition."  Szeliga rejected such disclosure, according to the SEC.

On April 18, 2001, Arthur Andersen's Mark Iwan, who had just become re-engaged as audit partner on the Qwest account, contacted Tom Stephens, then Qwest's board audit committee chairman, to prep him for an April 20 committee meeting.

Stephens' notes, released by the congressional panel, indicate Iwan raised concerns about a number of capacity deals, the juggling of Dex directory schedules to boost revenue and flat-out said a $109 million swap with Global Crossing "stinks."

Stephens scribbled:  "The sky is falling."

The audit committee was to discuss those issues with Qwest's financial management, including Szeliga, on April 20, but minutes haven't been publicly disclosed.

Told what and when

It's unclear what Nacchio or other Qwest board members were told about those concerns.

On April 24, 2001, Qwest announced its first-quarter earnings, which included double-digit revenue growth despite a weakening telecom economy.

Nacchio and Szeliga highlighted Qwest's continued strong growth and reaffirmed double-digit growth projections. But no detail was provided on the IRUs, which accounted for more than $400 million of Qwest's first-quarter revenue of $5 billion.

Nacchio began exercising stock options two days later, as part of what would be a steady three weeks of sales.

On April 29, 2001, Nacchio went on Fox News Channel and stated:  "Most of our growth comes from development of new products and, quite frankly, the taking of market share from the larger incumbents on the long-distance side."

The SEC has alleged such a statement was fraudulent.

The next day, Szeliga exercised 10,000 options and sold the shares for gross proceeds of $410,000 and pretax profits of $125,000.

On May 10, 2001, an e-mail circulated through Qwest finance, sales and operating ranks to put a lid on such capacity swaps.

According to the original e-mail by then Qwest finance director Matthew Scott, Szeliga had stated at a morning meeting that Qwest couldn't do any swaps of " ...  any significance, ever again.  Her concerns are that the (Arthur Andersen) auditors have stated that we will need to disclose those in our financial releases and that disclosure will be expanded to show the total scope and volume of all IRU transactions.  She will not allow that to happen."

The e-mail worked its way to top sales executive Gregory Casey and then to Qwest Chief Operating Officer Afshin Mohebbi.

"We got to get to the bottom of this thing fast," Mohebbi wrote to Casey.  "Work with the master, Mr. Eveleth."  That was reference to a Qwest finance executive William Eveleth.

Nacchio still was selling his stock.

On May 13, 2001, Casey advised Mohebbi by e-mail that Qwest "... reset expectations and put the best face on to Wall Street that we can."

But, responded Mohebbi:  "Don't count on a reset right now.  I will talk to Robin (Szeliga) on the accounting rules.  Bill is our guy in this area."

On May 15, 2001, Nacchio made his last sale of Qwest stock.

Nacchio told the congressional panel that he had placed a stop order at $38 a share.

"As a result, once Qwest stock dropped below $38 in May 2001, I never exercised my remaining options, roughly two-thirds of those I was granted from Qwest."

Eveleth has since settled with the SEC on civil fraud charges in connection with alleged revenue-inflation deals, while Casey has a tentative settlement with the SEC on civil fraud charges.  Mohebbi is fighting similar fraud allegations by the SEC.

Other Qwest executives and directors also sold stock in late April and May 2001.

In early May 2001, Qwest founder and then-nonexecutive chairman of the board Phil Anschutz, entered into private deals to sell about 2 percent of his holdings in Qwest.

The Anschutz angle

In three separate deals, Anschutz Co. signed forward sale contracts with investment bank Donaldson, Lufkin & Jenrette.  Anschutz Co. put almost 6.1 million shares in escrow until 2011 and got $179.4 million immediately in cash.

Another Anschutz official, Craig Slater, also a Qwest director at the time, netted about $8.3 million of pre-tax profits from exercising 350,000 options and selling the shares in late April 2001.

Several Qwest executives sold smaller amounts of stock during that period, including former chief legal officer Drake Tempest.

A number of authorities especially looked into Anschutz's stock sale, but he hasn't been charged with any wrongdoing.

The Justice Department's criminal probe seems to be tracking the SEC civil fraud complaint, and no former Qwest directors except Nacchio have been charged by the SEC.

"There's been no allegation of insider trading because neither Anschutz nor Slater had any insider information," said Anschutz spokesman Jim Monaghan.

Bebel said the period "would be troublesome" for Anschutz if he knew company management had been directed by the audit committee or its outside auditor to provide more disclosure about the IRUs and if he knew such disclosures to other investors weren't provided.

However, "It's generally more difficult for prosecutors to obtain an insider trading conviction against a director, as directors are further removed from the operations of the company and less knowledgeable about the company's internal state of affairs."

Bebel said he believes prosecutors would have to show Anschutz was aware of the alleged accounting fraud at the company.

The House Energy and Commerce Committee interviewed Anschutz twice and found that Anschutz and Nacchio had different recollections of their conversations.  But at the end of the day, then-committee spokesman Ken Johnson said "... neither Nacchio nor anyone at Qwest has provided us with any documentation to suggest that Anschutz's role was anything more than he has said it was - largely ceremonial."

What analysts were told

On June 20, 2001, two Morgan Stanley telecommunications analysts produced a report questioning some of Qwest's accounting decisions and "lack of visibility."

Nacchio publicly attacked Morgan Stanley, saying the report's assertions were "hogwash."

By then, Qwest shares had sunk to $30, compared with $40 in late April 2001.

On July 20, 2001, Qwest announced double-digit revenue growth for its second quarter.

The earnings release was five pages long and had six attachments, but Qwest mentioned network capacity deals only in passing.

"Commercial wholesale revenues were sparked by strong demand for Internet and optical network capacity worldwide," one passage said.

Another stated that Qwest had acquired new fiber routes "through transactions with other carriers, taking advantage of favorable pricing for existing assets."

It wasn't until August 2001 that Qwest disclosed, for the first time, the level of its fiber-optic capacity deals.

Even then, the numbers were off, the SEC alleges.  Nacchio told analysts at an investor conference that Qwest had generated $540 million of revenue from swaps in the first two quarters of 2001, when Qwest had actually booked $857 million from sales and swaps.

Later, in August 2001, Morgan Stanley issued a second report - which Nacchio called "bogus" - suggesting Qwest's growth was unsustainable.  The investment firm noted that without the IRU revenue, Qwest's growth would have been only 7.5 percent, not 12.2 percent.

On Sept. 10, 2001 - a day before the terrorist attacks - Nacchio lowered Qwest's projections and announced a cut of 5,000 employees in part because of weakening IRU sales.  Qwest's stock that day closed at $19.90 a share. It would eventually hit a low of $1.07 on Aug. 7, 2002, two months after Nacchio left the company.

Joe Nacchio, Former Qwest chief executive officer

  Status:  Sold $49 million in Qwest stock in a three-week period from April 26 to May 15, 2001.  Pretax profit:  $42 million.  Nacchio remains under criminal investigation.  Separately, he is fighting civil fraud charges by the Securities and Exchange Commission.

Robin Szeliga, Former Qwest chief financial officer

  Status:  Charged with insider trading in connection with her sale of Qwest stock on April 30, 2001.  Pretax profit: $125,000.  She has reached a tentative plea agreement and has agreed to cooperate with federal prosecutors.

Under scrutiny

Key events that may be scrutinized by the Justice Department in its investigation of alleged insider trading by former Qwest executives:

  February 2001:  Qwest's board of directors tells company management to provide more disclosure of its fiber-optic capacity sales and swaps, commonly known as IRUs, in its quarterly reports.  Also, auditor Arthur Andersen classifies the accounting of the swaps as "maximum risk."  Qwest has been aggressively booking revenue upfront from capacity trades with other communications carriers such as Global Crossing and Cable & Wireless.

  Sometime between April 18-20, 2001:  Arthur Andersen audit partner Mark Iwan raises concerns to Audit Committee Chairman Tom Stephens about IRUs and Dex directory accounting. Iwan refers to Qwest's booking of $105 million from a swap with Global Crossing and tells Stephens, "This one stinks."  Stephens scribbles, "The sky is falling."

  April 20, 2001:  The audit committee meets with Qwest's financial management team.

  April 24, 2001:  Qwest issues its first-quarter earnings, touting its double-digit revenue growth amid a weakening telecommunications economy.  There are no disclosures of how important IRU revenues were to make those numbers.  IRU revenues totaled more than $400 million in the quarter.

  April 26-30, 2001:  CEO Joe Nacchio exercises 760,000 options at $5.50 a share and sells the stock at prices ranging from $38.86 to $41.12 a share.  His pretax profits:  $25.8 million.

  April 30, 2001:  Chief Financial Officer Robin Szeliga exercises 10,000 options and sells the stock at $41 a share for gross proceeds of $410,000 and a pretax profit of $125,000.  Prosecutors have since charged her with insider trading and say she has reached a plea agreement.

  May 1-8, 2001:  Nacchio exercises 240,000 options at $5.50 a share and sells the stock at prices ranging from $38.31 to $40.84 a share.  Pretax profits: $8.2 million.

  May 10, 2001:  An e-mail by Qwest finance director Matthew Scott states Szeliga said at a morning meeting that Qwest can't do any more swaps "of any significance, ever again.  Her concerns are that the auditors have stated that we will need to disclose those in our financial releases and that disclosure will be expanded to show the total scope and volume of all IRU transactions.  She will not allow that to happen."

  May 9-15, 2001:  Nacchio exercises 255,000 options at $5.50 a share and sells the stock at prices of $37.23 to $38 a share.  Pretax profits:  $8.2 million.  This will be the last time Nacchio sells Qwest stock before being ousted as CEO in June 2002.

Sources:  Court And Congressional Documents, Lancer Analytics