The Commission's complaint alleges that the defendants artificially accelerated Qwest's recognition of revenue in two equipment sale transactions for its Global Business Markets unit. When Qwest and Global Business determined that Qwest was falling short of its quarterly revenue targets and would not achieve the projected growth for the quarters ending June 30, 2001, and Sept. 30, 2000, the defendants bridged the revenue gap by fraudulently mischaracterizing these transactions.
"Accurate financial statements are the bedrock of our capital markets," said SEC Chairman William H. Donaldson. "This agency will pursue aggressively anyone and everyone who has participated in an illegal effort to misrepresent a company's financials and mislead the investing public."
Stephen M. Cutler, the Commission's Enforcement Director, said: "This is another example of the extraordinary efforts of the Commission and the Department of Justice to root out corporate fraud and bring enforcement cases against those who would seek to undermine the integrity of the financial reporting process." Randall J. Fons, Director of the Commission's Central Regional Office, added: "The individuals named in the Commission's action bear responsibility for their roles in the creation and dissemination of deceptive financial statements. These individuals acted illegally to carry out Qwest's `make the numbers' culture. The Commission's investigation, however, does not end here. We will continue investigating until all have been brought to justice."
The Commission's complaint alleges the following:
ASFB Transaction
- Joel Arnold, the former senior vice president of Global Business; Grant Graham, the former chief financial officer of Global Business; Thomas W. Hall, the former senior vice president of a division of Global Business; Bryan K. Treadway, the former assistant controller of Qwest; John M. Walker, the former vice president of sales for a division of Global Business; and Douglas K. Hutchins, a former director of Global Business planned and carried out an elaborate scheme to inflate revenues in connection with the sale of Internet equipment and service to the Arizona School Facilities Board (ASFB).
- The scheme involved artificially separating the equipment sale from the installation services and wrongfully characterizing the sale as a bill-and-hold transaction under generally accepted accounting principles. It also included accelerated delivery of equipment necessary for the two-year project and delivery of equipment that was not approved for the ASFB project. To support immediate recognition of revenue for sale of the equipment, the defendants prepared and furnished to their auditors false letter agreements for ASFB and a fraudulent internal memorandum.
- As a result of the fraudulent transaction, Qwest recognized approximately $33.6 million in revenue in the quarter ended June 30, 2001. Without the fictitious revenue from the ASFB transaction, Qwest would have fallen short of its projected 12 to 13 percent revenue growth for the quarter.
Genuity Transaction
- Richard L. Weston, the former senior vice president in Product Development for Qwest's Internet Solutions unit, and William L. Eveleth, the current CFO of Qwest's Corporate Planning and Operational Finance unit and senior vice president of Finance, along with Arnold and Graham, participated in a scheme in which Qwest artificially characterized one transaction with Genuity Inc., an Internet service provider, as two separate contracts.
- In the first contract, Qwest purported to sell equipment to Genuity at an improperly inflated price. In a second contract, Qwest agreed to provide services to Genuity at a loss to Qwest, and reassumed all risk of loss and obsolescence on the equipment purportedly sold pursuant to the first contract.
- As a result of the fraudulent transaction, Qwest improperly recognized $100 million in revenue and claimed $80 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) in the quarter ended Sept. 30, 2000. Without the fictitious revenue from the Genuity transaction, Qwest would not have achieved the projected double-digit growth for the quarter, and would have recognized growth of 9.8 percent above the same quarter of the prior year rather than the announced 12.4 percent.
- Qwest also improperly recognized revenue of approximately $2.6 million in the quarter ended Sept. 30, 2000, and an additional $8 million in the year ended Dec. 31, 2000, under the service agreement despite the fact that Qwest had not begun providing any services.
The Commission's complaint seeks an order against all defendants enjoining them from violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws; imposing civil money penalties; and ordering disgorgement of all ill-gotten gains, including salaries, bonuses, stock and other compensation made during their fraudulent activities. The Commission further seeks orders against Arnold, Graham, Hall, Treadway and Weston permanently barring them from acting as a director or officer of a publicly held company.
The Commission filed its action at the same time that the U.S. Attorney's Office for the District of Colorado announced indictments against certain individuals for conduct in the ASFB transaction that is the subject of the Commission's complaint.
The Commission's investigation into the conduct of others is continuing.
