Qwest: What Did Phil Know?

Anschutz says he didn't notice the shenanigans at Qwest. So far, investigators aren't convinced

As a wildcatter in the 1960s, Philip F. Anschutz was known as a guy who could turn disaster to his advantage. Once, he collected fees from a Hollywood crew that wanted to film a well that had caught fire. Now, it's Anschutz' reputation that's ablaze, and the wily 62-year-old financier is working overtime to douse the flames.

Qwest Communications International Inc. (Q ), the telecom he founded, is under investigation by the Securities & Exchange Commission and the Justice Dept. for questionable accounting. Two class actions accuse Anschutz and other Qwest executives of securities fraud and mismanagement of company savings plans. On Sept. 30, Anschutz was accused in a lawsuit filed by New York State Attorney General Eliot Spitzer of "fraudulent and illegal acts" for steering Qwest's investment banking business to Salomon Smith Barney in exchange for glowing research reports and pieces of lucrative stock offerings. Anschutz' spokesman James Monaghan called Spitzer's suit "unfounded and absolutely without merit."

Anschutz told House Energy & Commerce Committee investigators, who have been probing Qwest's accounting for months, that he was a ceremonial chairman who relied on executives and accountants for advice. That got him a pass when the committee trotted out former Qwest CEO Joseph Nacchio and other executives at an Oct. 1 hearing. But Nacchio testified he talked two or three times a week with his former boss. "Every major decision I made at this firm, I sought his counsel," Nacchio said. That got investigators interested in Anschutz again. "If he didn't know what was going on, why didn't he?" says Ken Johnson, a spokesperson for the House committee. "We all know falling asleep at the wheel can be fatal." The investigators planned to interview Anschutz again on Oct. 25 and decide if further action is needed.

What Anschutz knew and when he knew it have become crucial questions in the unraveling Qwest tangle. The onetime Sunday school teacher has a legion of supporters who attest to his honesty and integrity. "There are a lot of scandalous CEOs," says former U.S. Secretary of Education William J. Bennett, a consultant to one of the film companies Anschutz owns. "Phil Anschutz isn't one of them."

Anschutz told House investigators that his sales of Qwest stock, totaling nearly $2 billion over the past four years, were made without any inside knowledge of the slide in Qwest's business and constituted only 17% of his original holding. Anschutz' one regret, sources close to him say, is that he let Qwest continue investing in telecom infrastructure--some $17 billion in 2000 and 2001--based on overly optimistic growth projections.

But Anschutz is having a far tougher time explaining how a sophisticated investor whose holdings range from railroads to movie theaters didn't spot a looming accounting scandal at his biggest single investment. Documents supplied by congressional investigators, as well as interviews by BusinessWeek with former Qwest execs and others, reveal that Anschutz, who was co-chairman of Qwest until June, may have had reason to suspect that its accounting was too aggressive.

The first warning that something might be amiss was in a Morgan Stanley report of June 20, 2001. It suggested that Qwest was inflating its earnings with maneuvers such as increasing the projected returns of its pension fund. Nacchio reacted swiftly, sharply refuting Morgan Stanley's accusations. Qwest ultimately cut the firm off from future investment banking work, according to testimony that Qwest's former chief financial officer, Robin R. Szeliga, gave Congress.

Yet in a pattern that what would be repeated in the following months, Anschutz and the Qwest board relied on advice from the company's senior management and auditor, Arthur Andersen. Qwest audit-committee member and longtime Anschutz family friend Jordan Haines, a retired banker from Wichita, Kan., defends the handling of the accounting issues. "I believed, and perhaps shouldn't have, that we were getting the best advice available from Arthur Andersen," Haines says. Haines says he never discussed Qwest's accounting issues with Anschutz, who wasn't on the audit committee.

Anschutz' spokesman Monaghan says: "There is a mythology that Phil Anschutz was running Qwest and single-handedly determined policy matters. In this case there was a capable audit committee that was in frequent dialog with management and Arthur Andersen on these issues. We had every reason to believe they were pursuing that diligently. It would have been wholly inappropriate for Phil Anschutz or any other board member to circumvent the audit committee process."

But outsiders are skeptical. "A director has a duty to care, and care means asking the tough questions," says governance activist Nell Minow, co-founder of The Corporate Library LLC. "In that regard, Phil Anschutz didn't measure up."

On July 25, 2001, another Morgan Stanley report raised questions about the company's swaps of long-distance network capacity with other carriers in so-called indefeasible rights of use (IRU) deals. By then, members of Qwest's finance staff had already begun to complain to Szeliga about the swaps accounting. She sent a memo to her staff and Qwest President Afshin Mohebbi on Aug. 2, clarifying company policy.

In October, Szeliga learned that a $109 million capacity swap with British giant Cable & Wireless PLC may have had an unusual side agreement which allowed the company to upgrade to another cable. Accounting rules required Qwest to sell a specific cable if it wanted to book revenue immediately. Szeliga told Congress on Sept. 24 of this year that she called for an audit-committee investigation of the transaction and alerted Nacchio and other executives. Szeliga testified that the audit committee concluded that the transaction was too small to merit a public restatement.

By October, 2001, debate about the company's accounting had become widespread. Press accounts that month highlighted an unusual transaction with a company called Calpoint LLC, in which Qwest sold telecom gear as part of a long-term agreement for Calpoint to send business to Qwest. Qwest later acknowledged that the transaction is part of the SEC's current investigation. In a conference call at the time, Nacchio reiterated that Qwest's accounting was proper. A Qwest audit-committee investigation later supported that conclusion.

Where was Anschutz during all this? Mulling a big raise for Nacchio. Even as Qwest was laying off 4,000 workers because of its poor performance, Anschutz was sitting on Qwest's six-member compensation committee, which gave Nacchio a new five-year contract with a 40% hike in salary and bonus to $5.2 million a year on Oct. 24, 2001. Nacchio also got options on more than 7 million Qwest shares. Nacchio told Congress this year he wanted to leave Qwest when his contract expired in December, 2001. Instead, Anschutz and others persuaded him to stay, with Anschutz calling Nacchio's wife to enlist her help.

The raise is all the more surprising because it came a few weeks after an evaluation of Nacchio had been presented to a board meeting. In it, board members criticized him for not sufficiently "fostering legal and ethical conduct" and not keeping the board fully informed about what was going on at the company. The report also cited "accounting credibility issues" and a "make the numbers or else" attitude at Qwest. Nacchio told Congress on Oct. 1: "Mr. Anschutz manages the board. I stayed because the board asked me to. The overall evaluation was above average."

Longtime associates say Anschutz gives his top lieutenants unusual autonomy, which may be at the root of his current problems. "Phil is not a hands-on manager--he's a big-picture guy," says Jerry Davis, a former chief executive of Southern Pacific Rail Corp., which Anschutz controlled until 1996. Adds Douglas Hanson, Qwest's first CEO: "The day-to-day routine of running a business would drive Phil Anschutz nuts."

However, Anschutz, a business major at the University of Kansas, could easily have found out that Qwest's IRU accounting was among the most aggressive in the industry. According to Lynn E. Turner, the SEC's chief accountant at the time and now a professor of accounting at Colorado State University, other carriers booked such contracts over their life, of up to 25 years. But Qwest counted the entire sales and profit in the quarter the transactions closed. Moreover, Qwest's disclosure was scant. "They set themselves up to take a big fall," says Turner.

Sources close to Andersen say the lead Qwest auditor, Mark Iwan, reported to the audit committee on numerous occasions in the past three years his concerns about the IRUs. "Management and the board conceive, initiate, and structure business transactions and determine accounting policy, not the auditor," says Andersen spokesperson Patrick Dorton.

It wasn't until early February of this year that the Qwest board hired outside counsel to investigate andersen's work, say sources. That was after publication of a letter from former Global Crossing Ltd. finance official Roy Olofson criticizing Global's capacity swaps with Qwest. Later that month, the SEC launched its investigation into Qwest. By May, Qwest's stock had slid to $5 a share, down 90% from its March, 2000, high. Shareholders called for Nacchio's ouster at the company's annual meeting on June 3. Two weeks later, Anschutz flew to New York to tell Nacchio he was being replaced by industry veteran Richard C. Notebaert.

Now, Anschutz, too, has been pushed into the background. He's no longer even the ceremonial chairman, though he remains on the board and the largest shareholder with an 18% stake. The company is moving quickly to correct the damage. After consulting with the SEC over the summer, Qwest decided in late September to write off $950 million in capacity sales on its network. In early October, Notebaert said the company was seeking to renegotiate $2.5 billion in equipment-related deals, such as the one with Calpoint. Qwest declines to comment on the reasons for its restatement until it concludes the investigation of its accounting later this year.

Some former executives suggest Anschutz may be loyal to his managers to a fault. In the past, they say, he has held on to top execs long after they needed to be replaced. Such loyalty and his hands-off management style might have worked in a privately owned business. But in a public company such as Qwest, Phil Anschutz owed shareholders his loyalty as well. This is one blaze even an old wildcatter from Denver will find difficult to put out.

By Christopher Palmeri and Ronald Grover in Los Angeles, and Amy Borrus in Washington

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