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Capacity Swaps by Global Crossing and Qwest: Sham Transactions Designed to Boost Revenues?
Subcommittee on Oversight and Investigations
Mr. Joseph Nacchio
Mr. Chairman, distinguished members of the Committee, my name is Joseph Nacchio, and I am the former Chief Executive Officer and Co-Chairman of the Board of Directors of Qwest Communications. I welcome this opportunity to assist the Committee in its investigation. As this Committee should know, I have made every effort to aid the various investigations concerning Qwest: I testified before the SEC, I met for hours with this Committee's staff, and I appear voluntarily today. I do so out of respect for my government, and my own sense of responsibility. It is with this same sense of respect and responsibility that I served, until recently, as Chairman of the President's National Security Telecommunications Advisory Committee and as Chairman of the Federal Communications Commission's Network Reliability and Interoperability Committee. When
I became the CEO of Qwest in 1997, we set out to create a world class national
and global telecommunications network. We
did this by building a telecommunications infrastructure, initially digging
trenches to lay conduit and fiber optic cable along railroad rights-of-way.
We also spanned gaps in our network by acquiring capacity or facilities
built by other companies. From the
beginning, we were able to finance our activities and defer construction costs
by selling as much as half the fiber in our network to other telecommunications
companies. In the late nineties,
technological advances made it increasingly practical to sell permanent rights
to the wavelengths or signals carried over fiber optic networks, rather than
simply selling the fiber itself. These
rights are commonly referred to as indefeasible rights of use or IRUs. For
Qwest, there were important reasons for selling IRUs and for buying them.
Selling IRUs allowed Qwest to raise capital and to expand the number of
carriers and service providers operating on our network.
Buying IRUs, on the other hand, often allowed us to expand our network
more quickly, more cost effectively, and without the regulatory hurdles that
came with building our own facilities. IRU
transactions therefore had strategic importance to Qwest, although financially
they remained a small portion of our business, with sales of IRUs never
accounting for more than five percent of annual revenue.
Qwest
became a substantial purchaser and seller of IRUs at a time when the demand for
fiber optic capacity to build and expand global networks was at record levels
following the Internet boom of the late nineties.
We found that we could leverage our buying power by persuading potential
sellers of capacity to purchase their needed IRU capacity from Qwest.
As a result, many of the IRU transactions executed by Qwest involved
"contemporaneous transactions"
-- what some have called "swaps"
-- transactions where each party is both selling capacity in certain areas and
buying network capacity in other areas. That
is the context in which these transactions arose, and as members of this
Committee have acknowledged, there is nothing inherently suspicious about the
mere fact of simultaneous IRU transactions. While the individual transactions rarely warranted my
involvement as CEO, I believe each transaction was subject to meaningful
oversight and review by the relevant business units, the finance department, and
the legal department. With respect
to matters of financial accounting for these transactions, the company relied on
the advice of its outside auditors along with Qwest's
financial staff who reported to the company's
Chief Financial Officer. The CFO in turn could bring any matter to the attention of
the Board of Directors independent audit committee, of which I was not a member.
When Qwest was selling IRU capacity, we were informed by our outside
auditors that, under Generally Accepted Accounting Principles, the sale of IRUs,
if they met certain defined criteria, qualified as sales-type leases that should
be booked as current revenue. At
the time, we had no reason to doubt Arthur Andersen's
advice, then one of the country's
leading accounting firms. Today,
I am of course aware of allegations that these contemporaneous transactions were
sham deals designed to inflate revenues to meet earnings forecasts.
I am in no position to comment on the motives of other companies, such as
Global Crossing, who are alleged to have purchased capacity they did not need.
I can tell you that during my tenure as CEO, to my knowledge every
purchase of capacity by Qwest was with the intent of furthering the company's
business plan. That plan was to
build a truly world class national and international fiber optic network.
Our plan was ambitious, but it also sought to be selective.
Had I been aware of any proposal for Qwest to purchase capacity solely to
induce a contemporaneous sale in order to inflate revenues, I would have vetoed
the deal. That is not the way Qwest
did business. That is not the way I
did business. I
also want to tell you that I had no reason to believe that senior management at
Qwest tolerated unethical conduct or forced employees to meet unrealistic
earnings forecasts. The company's
operating budget, including revenue, reflected the collective knowledge of the
entire company, with input from individual operating units, coordination and
oversight by the CFO and the president, and approval by me as the CEO.
The operating budgets, including revenue, were ultimately subject to the
review and approval of the full Board of Directors, to whom I reported.
In addition, the compensation schedule derived from these budgets were
reviewed and approved by the Board's
Compensation Committee. Once budgets were in place, neither I nor to my knowledge did
any senior manager ever suggest, tacitly or expressly, that the company should
attempt to meet its budget by
"cooking the books,"
or fabricating IRU transactions. To
the contrary, in late June 2001, in the one IRU negotiation in which I recall
personal involvement, I killed a $680 million transaction because it did not
meet Qwest's
business or financial goals, and I told three Board members that, as a result,
there was a possibility that Qwest would not meet its budget for the second
quarter. That same year, on
September 10, 2001, I announced to
our investors and the analyst community that Qwest was lowering its guidance for
the third quarter and the balance of 2001 due to softening market conditions
across Qwest's
business, including a foreseen drop in the company's
sales of IRUs. And I subsequently
recommended to the Compensation Committee on two occasions that we lower the
financial targets that were used to determine employee bonuses, because I did
not want to punish our workforce for a sagging economy. Furthermore,
I never suggested that unethical conduct of any kind would be tolerated.
During my tenure as CEO, I believe all company employees, from senior
managers to sales personnel, were required to act in compliance with Qwest's
Code of Conduct. The Qwest Code of
Conduct is a set of guidelines demanding the highest levels of ethics and
responsibility, including specific directives against falsifying financial
records or using unethical or deceptive means to make sales.
It is my understanding that in appropriate cases, employees found to have
engaged in unethical or illegal conduct were disciplined, discharged, and in
some cases referred to law enforcement authorities for prosecution.
Recent suggestions that Qwest's
workers operated in an ethical vacuum cast an undeserved stigma upon the company's
55,000 men and women who built one of the most robust and diverse
telecommunications companies in the country. It
is true that I earned significant compensation from the sale of Qwest stock.
The compensation I received as CEO was honestly come by.
I paid full taxes on it. I
worked my entire 32-year career in the telecom industry as an engineer, a
marketing executive, and then a senior executive.
I was not born into wealth. I
want this Committee to know, as the press has seen fit to ignore, that my stock
sales derived from stock options granted in 1997 that carried a 5-and-a-half
year maturity, leaving me with the choice of exercising the options or losing
them entirely. I sold shares based
upon the advice of my financial advisors in order to diversify my holdings. Yet I have always remained heavily invested in Qwest, and
today I still hold 470,000 Qwest shares. When
I sold shares, I did so in full compliance with all applicable regulations, and
with all necessary and appropriate disclosures to the SEC and the Board of
Directors. I always believed in the
value of the company, and when I eventually implemented a daily stock-selling
plan, I placed a stop order at 38 dollars, a stop order that I never lifted.
As a result, once Qwest stock dropped below 38 dollars in May 2001, I
never exercised my remaining options, roughly two thirds of those I was granted
from Qwest, and I never sold a single share of Qwest stock. At
any time I sold Qwest stock, I believed that the company's
financial statements represented a full and accurate picture of its financial
condition. I regret that I was
unable to complete the job of building Qwest into the global telecommunications
leader we had envisioned, and I am truly sorry for any losses suffered by Qwest's
shareholders and for the thousands of Qwest employees who lost their jobs as the
telecommunications industry and the company fell into hard times.
I now appear voluntarily before this honorable Committee to answer all of
its questions completely and to the best of my ability.
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