The Qwest Case Starts To Boil

The feds focus on whether former execs pressured suppliers to give them shares

The federal probes into struggling telecommunications giant Qwest Communications International Inc. are shifting into high gear. BusinessWeek has learned that investigators are zeroing in on the conduct of former Qwest executives who took stock from suppliers seeking to do business with the company. To press their case, the Securities & Exchange Commission is seeking information from at least 11 startups that did business with the telecom giant during the technology bubble. And the Justice Dept., which is presenting evidence to a Denver grand jury in a simultaneous probe, is aiming to file criminal charges against ex-Qwest executives by early 2004, according to sources close to the investigations.

That would be the culmination of months of investigation by the SEC and the U.S. Attorney's Office in Denver. The heart of their inquiry, say sources who have been questioned, is whether execs at the Denver company lined their pockets with hot stock that rightfully belonged in company coffers. Moreover, investigators want to know if execs purchased equipment from suppliers based on who gave stock. A successful prosecution is far from certain, as the likely legal strategy in the case is more often applied to civil, not criminal, matters. And while Qwest acknowledges that the stock dealings posed conflicts of interest, it does not believe the former executives' actions were illegal.

Whatever the outcome, this case illustrates a new business environment for technology -- one that will no longer tolerate the cozy, conflicted relationships that have long defined the industry. Almost certainly it will influence how a whole new generation of startups and their customers do business as the tech recovery gets under way. "There is so much populist anger out there," says Robert Weisberg, a law professor at Stanford University. "Anything that angers investors is going to lead to more prosecutions."

GRILLING STARTUPS

For now, the SEC is seeking information from high-tech startups that did business with Qwest during the tech bubble. Mike Deshaies, a spokesman for network equipment maker Tellium Inc., says his company received a letter from the SEC in May, 2003, that detailed 11 companies, including Tellium, whose relationships with Qwest are part of the probe. The others include Opsware (OPSW ), Avici Systems (AVCI ), Sonus Networks (SONS ), CoSine Communications (COSN ), Redback Networks (RBAK ), ONI Systems, Covad Communications (COVD ), Juniper Networks (JNPR ), and Corvis (CORV ). Already several current and former executives from these and other companies say they have been interviewed by government investigators.

The feds are probing whether former Qwest execs pressured Qwest suppliers to give insiders, including ex-CEO Joseph P. Nacchio, shares in their companies as a condition for doing business. A Feb. 10 BusinessWeek story detailed numerous examples of this practice at Qwest and other high-tech companies. Suppliers say they had little choice. "The companies that didn't give out stock were at a clear disadvantage," says former Tellium President Richard Barcus.

Investigators are also making inquiries into transactions between Qwest and its suppliers. They want to know whether gear and services they bought from one another were properly disclosed and accounted for. While the grand jury is focused on Qwest, two vendors, Redback and Tellium, have disclosed in public filings that their dealings with Qwest are also being examined. It's unclear what actions, if any, could be taken against suppliers.

DUSTY GEAR

Qwest's new vice-chairman and CFO, Oren G. Shaffer, says the company is cooperating fully with investi- gators but does not believe executives receiving stock in supplier companies is illegal. "It is a conflict of interest, and we are not allowing it anymore," he says. A Qwest spokesman declines further comment. Nacchio, who has denied wrongdoing, declined to comment. Both the U.S. Attorney's Office and the SEC declined to comment. So did CoSine, Opsware, Covad, Juniper, and Ciena (CIEN ), which now owns ONI. Corvis and Avici didn't return repeated calls. And Redback, Sonus, and Tellium say only that they are cooperating fully with investigators.

According to executives who did business with Qwest, the behavior of the company's brass at the time was downright blatant. A former CEO of a telecom equipment startup who requested anonymity said that while trying to sell the company gear in 1999, the startup offered Qwest shares in its upcoming IPO. But instead of earmarking the stock for the company, a senior Qwest exec gave the vendor a list of 11 Qwest insiders who should receive the shares. "It was a whole bunch of people trying to make millions," say the former CEO, who was interviewed recently by the federal investigators.

Moreover, gear that Qwest ultimately bought from suppliers playing the stock game often wound up collecting dust in warehouses, according to six former Qwest managers and engineers. Indeed, Qwest engineers say they referred in jest to such gear as "flower pots." At the time, they questioned whether management's stock positions had improperly influenced the purchasing decisions.

FLEXING MUSCLES

Does this add up to a criminal offense? That is unclear. Legal experts say the government could argue that the stock Qwest execs pocketed was akin to stolen property that should have gone to Qwest and its shareholders -- a charge known as usurpation of a corporate opportunity. The strength of the cases will depend on a myriad of factors, including how well execs disclosed their conduct, whether the board signed off on it, and whether the amounts of stock involved were large enough to influence purchase decisions. "The danger comes when executives hold enough stock to want to favor that company over another," says Kirk O. Hanson, an ethics professor at Santa Clara University.

But if the government prevails, the case could pave the way for criminal punishment of certain kinds of conduct that typically have yielded little more than a fine. "We're in an era where the government is flexing its muscles," says Stanford's Weisberg. And that's not likely to end anytime soon.

By Ben Elgin and Linda Himelstein in San Mateo, Calif., with Amy Borrus in Washington

Before it's here, it's on the Bloomberg Terminal. LEARN MORE