Are Qwest Honchos Off The Hook?

Doubts grow about whether a case can be made against Nacchio and others

It seemed like an open-and-shut case. In February, 2003, the U.S. Attorney in Denver charged four former midlevel executives of telecom giant Qwest Communications International Inc. (Q ) with conspiracy, securities fraud, and making false statements to accountants. The government claimed that the cabal accelerated anticipated revenues from a major deal to meet excessively aggressive sales forecasts. Attorney General John Ashcroft announced the indictment himself, while Securities & Exchange Commission Chairman William H. Donaldson hinted at more to come. "Today's action marks the beginning of our public efforts to hold accountable those at Qwest who abuse the public trust," Donaldson declared.

Easier said than done. On Apr. 16, an embarrassed Justice Dept. struck out, failing to win a single conviction against any of the defendants. Two of the execs were found innocent on all charges. Jurors could not reach verdicts on all counts on the other two, forcing U.S. District Judge Robert E. Blackburn to declare mistrials in their cases. At press time, the government hadn't announced if it would retry them.

Despite the government's recent victories against Martha Stewart and investment banker Frank Quattrone, the little-noticed trial underscores the difficulties prosecutors often have proving criminal intent in white-collar cases. What's more, it calls into question whether Qwest's two former co-chairmen, Philip F. Anschutz and Joseph P. Nacchio, and other toop executives who have been accused of fraud and insider trading in civil shareholder suits, will ever be charged by the government. "Here's a company that had financials restated by $2.5 billion," says Lynn E. Turner, a former chief accountant at the SEC who now teaches at Colorado State University. "Somewhere, someone did something wrong. The question is whether the federal prosecutors are going to be able to get the case across to 12 people." Spokespeople for Anschutz and Nacchio say the men maintain that they have done no wrong. Qwest says it is cooperating fully with government investigators.

The case revolved around a deal that seemed to typify accounting shenanigans so popular in the bubble years. In the second quarter of 2001, Qwest booked a high-profile contract to supply high-speed Internet access to public schools in Arizona. According to the indictment, revenues for the $100 million Arizona School Facilities Board contract were supposed to have been booked after Qwest installed the computer equipment -- something that was scheduled to take place over 18 months. Instead, the company separated the hardware portion of the sale from the installation, claimed the equipment was shipped by June, and booked $33 million in revenues and $6.5 million in profits before the installation had been done.

HEAVY BLOWS

During a grueling and often tedious seven-week trial, prosecutors landed some heavy blows. One key witness, for instance, was Mark Iwan, the former Arthur Andersen LLP partner in charge of the Qwest account. He testified that he told defendants Grant P. Graham and Bryan K. Treadway that to book the equipment sales early, the company would have to meet several tests, including having the customer request the change. Iwan said he wanted confirmation of that in a letter from the client.

Philip E. Geiger, the former head of the Arizona School Facilities Board, testified that Qwest representatives, including defendant Thomas W. Hall, a senior vice-president of sales, drafted letters on School Facilities Board stationery that made it look like the state had asked for the change. Geiger testified that he hastily signed the letters at an airport after being assured that the state wouldn't actually have to pay Qwest until the equipment was installed. "There was kind of a veiled threat," he said, "that if we did not execute these orders, the equipment would not be available."

Despite such seemingly clear evidence of fraud, jurors could not convict anyone. George Gerstle, a 46-year-old manager at the Colorado Transportation Dept. who served as foreman, says he and nine other jurors voted to convict Graham and Hall on some of the charges, but in each case two jurors found them not guilty. "Certain members couldn't see beyond a reasonable doubt that there was bad intent," Gerstle said. "Our understanding of the law was that they had to intend to commit a crime. People don't put that in e-mails."

Getting over the hurdle of criminal intent has become a serious problem for prosecutors in cases involving sophisticated business issues. Former Tyco International Ltd. (TYC ) Chairman L. Dennis Kozlowski is still a free man because one juror in his criminal trial had doubts about his intent to steal from his company.

EXTRANEOUS INFORMATION

In the Qwest case, though, proving criminal intent was not the government's only problem. Juror Barbara Carmichael, a 55-year-old housewife, told BusinessWeek that she and other jurors felt the government presented too much extraneous information. Prosecutors called eight witnesses from Cisco Systems Inc. (CSCO ), which supplied equipment to Qwest, for example, even though their contribution was minimal. Two witnesses, says Carmichael, would have done the job. "We felt there was a whole lot of information, [but] nothing we could grab hold of," she says.

The U.S. Attorney's Office in Denver says it's continuing its investigation into other criminal activity at Qwest. Many longtime Qwest watchers believe the government's ultimate goal is to find a link to Nacchio, if one exists. Next to former Enron Corp. Chairman Kenneth L. Lay, Nacchio is one of the most important icons of the recent corporate scandal wave who has yet to be indicted.

The recent trial loss bodes poorly, though, for any criminal case against Nacchio. The prosecutors won't be able to flip any witnesses to testify against the ex-CEO. Worse, no smoking-gun documents or testimony emerged during the trial linking Nacchio to any criminal activities at the company. Anschutz' name never came up at the trial.

Still, there's no shortage of dirty laundry at Qwest, including many other instances of apparent fraud. So Nacchio, Anschutz, and other former executives aren't necessarily in the clear. But so far they seem to have eluded the grasp of government lawyers. Last December, for instance, the SEC notified a dozen former Qwest employees that it was considering bringing charges against them. Neither Nacchio nor Anschutz was among them.

By Christopher Palmeri in Los Angeles

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