Sources: Qwest Case Broadening

Justice Department and SEC investigations now include several telecom equipment vendors

November 10, 2003

5 Min Read
Sources: Qwest Case Broadening

The investigations into Qwest Communications International Inc.'s (NYSE: Q) past are beginning to reach far and wide.The government is now broadening the investigation to include several equipment companies associated with Qwest, sources close to the situation say. They're searching for clues to whether Qwest executives misreported facts relating to the relationships between the carrier and its suppliers.Several investigations involving Qwest have been developing over the year. In February, the Securities and Exchange Commission (SEC) filed a civil suit for fraud against eight executives and employees of Qwest. The agency claims the defendants played with the numbers so investors would believe the company was doing better than it actually was. That investigation continues (see Prosecutors' Party at Qwest).In early October the SEC said it was taking a more careful look at the relationship between Redback Networks Inc. (Nasdaq: RBAK) and Qwest (see SEC Digging Deeper at Redback). Now it appears that the Department of Justice, which is proceeding with its own criminal investigation of Qwest, may also take an interest in this relationship, as well as other relationships Qwest had with equipment suppliers. The DOJ investigations have so far resulted in an indictment charging four former Qwest officials of helping the carrier falsely recognize more than $33 million in revenues in 2001 (see Former Qwest Execs Indicted for Fraud).The two cases have some similarities and, in fact, the SEC is holding its case until the DOJ finishes up. An element of both cases is the alleged practice of the defendants helping deliver unnecessary telecom gear and services to customers so Qwest could book enough revenues and make its quarterly financial projections.On top of that, several individuals are suing Qwest for securities violations and other things, generating a slew of investigative inquiries flowing from lawyers' offices to Qwest and its assorted telecom gear providers.Only Redback has publicly acknowledged that the SEC is looking at its relationship with Qwest (see SEC Digging Deeper at Redback). Redback's senior VP of field operations, Joel Arnold, was one of the eight people charged in the SEC's civil suit, and he continues to play a role in the day-to-day business of the company, which last week filed for bankruptcy protection (see Redback Exec Part of Criminal Probe and Redback's Arnold Included in SEC Suit).The task of proving a willful violation of accounting laws is tough, legal experts say. But one way to get there is to examine presumed conflicts of interest -- such as the practice of carrier executives accepting stock from potential customers -- to see whether any sordid details were misreported or left out altogether.

It's hard to say what kinds of details the Justice Department is looking into. It declined to comment for this story. There are several instances where Qwest forged reciprocal relationships that may be of interest. These examples, culled from SEC filings and Light Reading reports, give some idea of the company's practices when working with up-and-coming startups or newly public companies.

  • In early 2000, Qwest bought several different classes of Covad Communications Inc. (OTC: COVD) shares, representing an aggregate investment of $15 million. "Concurrently with these strategic equity investments, we entered into commercial agreements with... Qwest," Covad's SEC filings state. "These agreements provide for the purchase, marketing and resale of our services at volume discounts..."

  • Qwest has told Light Reading that it helped CoSine Communications Inc. (Nasdaq: COSN) design, test, and analyze its equipment during the company's early days. In return, CoSine let some senior Qwest executives -- including former executive VP of corporate development, Marc Weisberg; executive VP and general counsel Drake Tempest; and executive VP and chief strategy officer Lewis Wilks -- buy "friends and family" shares before the startup went public. CoSine went public in 1999 and, in February 2000, it announced that Qwest had placed a multimillion-dollar purchase order for its gear (see Is Qwest Shunning Startups?).

  • Qwest got warrants for agreeing to buy Tellium Inc.'s (Nasdaq: TELM - message board) gear. Qwest executives accepted some $10 million worth of stock options from the startup in exchange for being allowed into its network (see Tellium Lawsuits Allege Rigged IPO). Weisberg was one executive who enjoyed Qwest's cozy relationship with CoSine and other startups, landing a board seat at Tellium for a time (see Love Lost for Tellium).

  • Sometimes, Qwest's relationship with kindred startups didn't fare so well. In 2000, it agreed to purchase some $150 million of equipment from Corvis Corp. (Nasdaq: CORV) within two years. Some months later, it lopped $110 million from the purchase order (see Corvis's Qwest Deal Reduced by $138M).

  • In 2000 and 2001, Qwest bought more than $80 million worth of gear from Redback Networks. During that time, Qwest's Cyber Solutions group announced a five-year, $18 million contract with Redback to help the vendor with enterprise resource planning, customer relationship management, and manufacturing operations.

  • Kleiner Perkins Caufield & Byers partner and Qwest board member Vinod Khosla invested in or served on the boards of several firms that had dealings with Qwest, including Redback, CoSine, Corvis, and Juniper Networks Inc. (Nasdaq: JNPR). Khosla, through a spokesperson, says he hasn't been contacted by the Justice Department regarding any of the Qwest investigations. He declined further comment.

The acceptance of stock options from suppliers was a widespread practice during the peak of the Internet bubble -- and the practice itself isn't necessarily illegal. Where it may be bad news for Qwest, legal experts say, is if prosecutors find some evidence that executives involved were willfully misleading in their representation of the deals.

— Phil Harvey, Senior Editor, Light Reading

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