SEC Adopts Tougher Position On Qwest Accounting Methods
By DEBORAH SOLOMON and SUSAN PULLIAM
Staff Reporters of THE WALL STREET JOURNAL
The Securities and Exchange Commission is taking a tough stance on how Qwest Communications International Inc. accounted for as much as $1.4 billion in sales of fiber-optic capacity and whether it was proper for the company to recognize the revenue right away, people close to the investigation said.
Qwest officials acknowledge they are trying to convince the SEC that the beleaguered telecommunications company used proper accounting in recording the sales, which included "swaps" of capacity.
Although the sum in question amounts to roughly 4% of the company's combined revenue for the two years, a finding that Qwest improperly booked the sales could be a serious blow to a company struggling to maintain its credibility with investors.
Shares of Qwest have fallen 85% in the past year, and its new management is trying to sell assets to relieve its crushing debt load.
Qwest's outside attorney, Jonathan Schiller, said Qwest's accounting, including for swaps, was "reasonable," and added that "Qwest would hope to bring the SEC to that conclusion as well."
A Qwest spokesman said the "things we are discussing with the SEC are the things we said we were discussing with them on March 11. There are no new issues that we are aware of."
The SEC declined to comment.
Three top company officials, including Joseph P. Nacchio, who resigned under pressure as chief executive last week, have testified before the SEC's Denver office. Qwest's chief financial officer and its president also have testified, according to people close to the matter. The SEC is also questioning executives of other telecom companies, including Global Crossing Ltd., which swapped fiber capacity with Qwest.
FROM THE ARCHIVES
• Qwest's Move to Oust Nacchio, Hire Notebaert Pleases Investors
06/18/02
• Qwest CEO Nacchio Resigns Post at Board Request Amid Troubles
06/17/02
• SEC Broadens Its Investigation Into Revenue-Boosting Tricks
05/16/02
• SEC Launches Formal Inquiry of Qwest Accounting Practices
04/05/02
Mr. Nacchio and his top executives were heavy sellers of Qwest stock during the years that the swapping took place. Mr. Nacchio's sales alone netted him about $130 million in profits during that period, raising questions about his motivation to keep the stock price as high as possible. Qwest insiders sold shares between January 2000 and July 2001 valued at a total of $530 million.
At issue in the SEC investigation is the difference between the way Qwest accounted for the sales and the method used by its competitors, such as Global Crossing, which is also under SEC investigation.
Like Global Crossing, Qwest sold capacity on its fiber-optic network to carriers and also purchased capacity from them. In some cases, the amount of the sale and purchase were almost identical. But unlike Global Crossing and most other players in the industry, Qwest booked the revenue from these sales all at one time instead of deferring part of it over many years.
Global Crossing, by contrast, only booked reported revenue over the life of the contract, which in some cases was as long as 20 years. (It did include the whole amount in something it called "cash revenue," its own term, separate from accepted accounting rules, for the revenue that came in for services that hadn't yet been delivered.)
While its sale was booked upfront, Qwest's purchase of fiber capacity was booked as a capital expense, meaning the company could record the purchase over time instead of all at once.
Among the issues beginning to take shape in the SEC investigation are whether Qwest and its counterparties in the capacity swaps needed the fiber that was being exchanged and whether the company properly followed the accounting guidance given by its auditor on the transactions, Arthur Andersen LLP.
"Was the guidance reasonable and did they follow the guidance or did they do something that went beyond what was allowed?" are among the questions regulators are asking, said one person familiar with the probe. In addition, the SEC is described by some people familiar with the investigation as focusing on whether the guidance itself was proper. Qwest has been defending its accounting to the SEC by referring to guidance it received from Arthur Andersen, specifically a "white paper" that gave clients such as Qwest accounting guidance.
Qwest, arguably more than any other telecom company, engaged in swaps of capacity, equipment sales and other transactions that helped the company achieve phenomenal growth.
The effect was marked and boosted Qwest's revenue by $1 billion in 2001 and $465 million in 2000. In 2001, it recorded total revenue of $19.7 billion, up from $16.6 billion in 2000.
Qwest has said it was able to book revenue upfront because it followed guidelines that allowed it to account for the transactions as "sales type" leases and therefore take the revenue in one lump sum. Qwest's guidelines included steps such as selling a specific asset for a specified period of time and transferring title of the asset to the buyer.
Carr Conway, a former SEC official, said that if the agency concludes the transactions weren't of any substance and were intended to pump up the financial statements unfairly, that could constitute accounting fraud.
"What they're going to do is depose the various parties involved in making the decisions and ask, 'How did these accounting judgments come to be made?' " said Mr. Carr, senior forensic accountant with Dickerson Financial Investigation Group in Denver.
If Qwest is forced to restate revenue, it could open the company up to lawsuits from shareholders who lost money as questions about Qwest's accounting surfaced. The company's stock closed at $4.19, down 23 cents, as of 4 p.m. Tuesday in New York Stock Exchange composite trading.
A restatement could also potentially put Qwest in violation of certain debt covenants, which require the Denver company to keep a certain level of debt to cash flow, as measured by earnings before interest, taxes, depreciation and amortization.
At the same time, congressional interest in Qwest's accounting also is growing. At least one Qwest executive already has been called to testify at the U.S. House Energy and Commerce Committee, according to a person familiar with the federal investigations. And House and SEC inquiries of Global Crossing have taken a strong look at Qwest's roles in telecom transactions during 2000 and 2001.
A person familiar with the situation said that one official who gave extensive testimony to regulators is Robin Wright, the Global Crossing saleswoman in charge of the company's relationship with Qwest. "Qwest is the first issue" that regulators ask Global Crossing officials about, according to a person familiar with the matter.
Compared with Global Crossing, Qwest is said to face more extensive questioning about its aggressive accounting treatment.
The accounting rules that allowed Qwest to book the revenue in one chunk have a number of stringent qualifications. One of the most important is that Qwest -- when selling its telecom capacity -- would have to specify exactly what it sold to another telecom carrier. That means a Qwest customer could not, for example, buy $50 million in capacity and determine later how it would be used.
While battling the government on these points, Qwest attorneys are also expected to argue that the dollar amounts in question weren't material to the company's overall performance. That remains to be seen, particularly given the pressure inside telecom companies during 2001 to meet Wall Street expectations. The difference of just tens of millions of dollars could have significant effects on a company's stock price, people close to the investigation say.
-- Dennis Berman contributed to this article.
Write to Deborah Solomon at deborah.solomon@wsj.com and Susan Pulliam at susan.pulliam@wsj.com
Updated June 26, 2002 |
