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Cross hairs on Nacchio
Ex-Qwest CEO likely to be indicted before year's end on insider trading charges
By Jeff Smith, Rocky Mountain News

Saturday, November 5, 2005

Joe Nacchio, former Qwest chief executive officer and the focus of a federal criminal investigation, is likely to be indicted on insider trading charges before year's end, sources have told the Rocky Mountain News.

Prosecutors are said to be in the final phase of completing a three-year-old investigation of former Qwest executives.

Marcia Horowitz, Nacchio's spokeswoman, on Friday referred to a statement this week in which Nacchio reiterated his innocence.

"Mr. Nacchio has repeatedly denied any wrongdoing and will . . . fully assert his rights and defenses as Qwest's former CEO," his attorney Charles Stillman said Tuesday.

It was unclear Friday whether any other former Qwest executive besides Nacchio faces a possible indictment.

A guilty plea last summer on insider trading charges by former Qwest Chief Financial Officer Robin Szeliga indicates federal prosecutors are focusing in large part on April and May 2001, when Nacchio sold about $50 million of stock during a three-week flurry.

Szeliga pleaded guilty to having insider information when she exercised stock options for a $125,000 profit on April 30, 2001.

Nacchio already faces civil fraud charges filed this year by the Securities and Exchange Commission.  The SEC accused Nacchio of orchestrating a massive $3 billion financial fraud at Qwest from 1999 to 2002.  He was accused of misleading investors about the company's true financial condition and of personally profiting from a revenue-inflation scheme that kept the company's stock price propped up.  The stock eventually collapsed, and investors lost billions of dollars.

This week, class-action shareholders settled with Qwest Communications for $400 million, but they carved out Nacchio from the settlement, so they could pursue him and his money separately.

Possible deadline looms

Attorneys close to the case say they believe a decision of whether to charge Nacchio criminally almost has to come before year-end.  The timing is drawn from the federal prosecutors' request last July to freeze the civil cases for 150 days so they wouldn't interfere with the criminal investigation.

That freeze, or stay, was granted by a federal judge through Dec. 31.  While it's possible it could be extended, some believe it would be risky and perhaps embarrassing for the government to ask for another extension.  A judge also may be likely to reject an additional extension, especially if it's vigorously opposed.

Another date that intrigues attorneys relates to lead prosecutor William Leone.  Leone was sworn in as U.S. attorney in Colorado in late July after President Bush failed to nominate a replacement for predecessor John Suthers within the legal deadline.  But Leone's appointment is supposed to last only 120 days or until Bush nominates and the Senate confirms a new U.S. attorney.  That could be putting pressure on Leone to wrap up the investigation.

Szeliga is seen as a key witness, since her ability to avoid prison possibly depends on the level of cooperation she gives to federal prosecutors.  The U.S. attorney's office said in a court filing in late September that Szeliga "has provided significant information."

In her 16-page plea agreement in July, Szeliga said she and other unnamed "senior Qwest executives" knew by at least April 24, 2001, that Qwest was meeting its revenue targets only through "gap fillers" such as questionable one-time sales of network capacity.

But she said Qwest management decided against disclosing that information to investors during its first-quarter earnings call on April 24, 2001.

On that day, Szeliga and Nacchio highlighted Qwest's double-digit revenue growth amid a weakening industry and reaffirmed double-digit growth projections.  No detail was provided on the capacity sales, which accounted for more than $400 million of Qwest's first-quarter revenue of $5 billion.

Two days later, Nacchio started a three-week flurry of exercising stock options that would net him about $42 million in profits that spring.  Those stock sales accounted for more than 20 percent of his total sales during his five years at Qwest.

On April 29, 2001, Nacchio appeared on Fox News and stated that most of Qwest's growth came from new products "and, quite frankly, the taking of market share" from larger long-distance companies.

The SEC, in its civil case against Nacchio, has alleged that such a statement was fraudulent.

On April 30, 2001, Szeliga exercised her stock options.

Auditor leery of sales

Prosecutors have been investigating other key events that spring.  Documents made public from that period show Arthur Andersen, the company's outside auditor, told Qwest to disclose to investors the telco's dependence on network capacity sales.

Qwest at the time was among the most aggressive in the industry in booking revenue upfront from trades or exchanges of network capacity.  Arthur Andersen already had characterized the accounting of those swaps as "maximum risk," bordering on unacceptable.

On April 18, 2001, Arthur Andersen's Mark Iwan, who had recently been re-engaged as Qwest's audit partner, raised concerns to Tom Stephens, then Qwest's audit committee chairman, about a number of deals, including a $109 million swap with Global Crossing.  Stephens' notes from the conversation indicate that Iwan said that particular swap "stinks."

Stephens scribbled:  "The sky is falling."

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

While it's unclear what Szeliga may have shared with Nacchio at the time, Nacchio himself told federal lawmakers in fall 2002 that Szeliga's office was next to his and "we met daily . . . she had open access."

But Nacchio also defended the capacity sales and swaps as having legitimate business purposes, such as to fill geographic holes in Qwest's nationwide fiber-optic network.

And after the SEC civil charges were filed this year, Nacchio's attorney Stillman stated:  "The case against Joe Nacchio comes down to the simple proposition:  Should he have known that a particular kind of revenue needed to be disclosed in Qwest's public statements?  The answer is no.  Qwest made its disclosures only after experienced, expert employees, auditors and lawyers determined what was appropriate."

Szeliga implicated in sales

By May 10, 2001, an e-mail circulating through Qwest finance, sales and operating ranks indicated Szeliga herself had ordered a stop to large capacity swaps.

According to the e-mail by then Qwest finance director Matthew Scott, Arthur Andersen had told Qwest it needed to disclose the total scope and volume of its network capacity sales and swaps.

Gregory Casey, Qwest's top sales executive, got a copy of the e-mail and sent it to Afshin Mohebbi, Qwest's chief operating officer.  Mohebbi immediately realized the importance of the e-mail and wrote back to Casey:  "We've got to get to the bottom of this thing fast."

Casey advised by e-mail that Qwest lower its financial projections and "put the best face on to Wall Street that we can."

Mohebbi responded:  "Don't count on a reset right now.  I will talk to Robin (Szeliga) on the accounting rules."

On May 15, 2001, Nacchio stopped selling Qwest stock.  He said he had exercised his stock options over the years based on the recommendation of his advisers to diversify his holdings.  In testimony before a congressional panel in October 2002, Nacchio said he had placed a stop order once Qwest shares dropped below $38 a share.

"Anytime I sold Qwest stock, I believed the company's financial statements represented a full and accurate picture of its financial condition," he told Congress.

It wasn't until August 2001 that Nacchio disclosed the scope and volume of the company's fiber-optic capacity sales.  He did so during a road trip to talk to Wall Street analysts who had become increasingly skeptical of Qwest's underlying financial condition.

Mohebbi and Qwest's former chief counsel, Drake Tempest, who sold stock during spring 2001, also have been people of interest to criminal investigators.  One or both of them may be cooperating with investigators, according to sources familiar with the case.

There are conflicting accounts of whether former Qwest Chief Financial Officer Robert Woodruff is under criminal investigation.  Woodruff faces a civil fraud suit by the SEC but had left Qwest by spring 2001.

Other possible key witnesses for the prosecution include Casey, the former top sales executive, who agreed to pay $2.1 million to settle civil fraud charges with the SEC.  Casey settled allegations that he backdated contracts and caused the company to buy capacity it didn't need.

Anschutz also sold shares

The period in spring 2001 also could be troublesome for Qwest founder Phil Anschutz and associate Craig Slater, who both sold large amounts of Qwest stock in late April and early May 2001.

Anschutz entered into private deals in early May 2001 to sell about 2 percent of his Qwest stock, receiving $179.4 million in cash.  Slater made about $8 million in pretax profits by exercising options in late April 2001.

But it doesn't appear that either are under active investigation by federal prosecutors.  Prosecutors likely would have to prove that Anschutz and Slater, who were directors on the board at the time, were aware of the alleged accounting fraud at the company.

According to a federal court filing last month, Anschutz testified in front of the SEC last January, while Slater testified for two days in October 2004.  Criminal investigators presumably would have examined the transcripts of that testimony.

Anschutz spokesman Jim Monaghan has long said that neither Anschutz nor Slater had any insider information.  The House and Energy Commerce Committee came to a similar conclusion after interviewing Anschutz twice in 2002, despite Nacchio saying that Anschutz was actively involved in Qwest's business.

The SEC also decided not to press a case against Anschutz or Slater, and the lawyers for the class-action shareholders didn't see Anschutz as being involved in Qwest's day-to-day operations.

"We looked at Anschutz," Patrick Coughlin, a partner in the stockholders' lead law firm, Lerach Coughlin Stoia Geller Rudman & Robbins, said this week.  "And frankly we just didn't think we had anything.  In this case, you have to prove actual involvement."

What's in store

What Joe Nacchio, former Qwest CEO faces:

  Criminal probe:  Focus of a criminal investigation centered on spring 2001.  Nacchio sold $49 million of Qwest stock in a three-week period between April 26 and May 15, 2001, for a pretax profit of about $42 million.

  Civil charges:  Faces civil fraud charges filed by the Securities and Exchange Commission.  The SEC is seeking $216 million that Nacchio made from stock profits, salary, bonuses and perks.

  This week:  Qwest class-action investors said they will proceed to trial with their civil claims against Nacchio.

http://www.rockymountainnews.com/drmn/business/article/0,1299,DRMN_4_4214184,00.html