Questions about creative accounting in the telecom industry broadened today, following a statement issued by Level 3 Communications Inc.'s (Nasdaq: LVLT) CEO defending his company's participation in Indefeasible Rights of Use (IRUs). The fiber swaps, common in the industry, have become central to questions about Global Crossing Ltd.'s accounting practices (NYSE: GX) (see Jim Crowe Speaks, Qwest Subpoenaed on GlobalX).
But there is much more to the Global Crossing bankruptcy than complicated IRU agreements. The Securities and Exchange Commission, which Global Crossing has confirmed is investigating the company, may find more tasty accounting tidbits ahead. There are also big questions about the timing of insider sales, chairman and founder Gary Winnick's enormous take, and the complicated nature of high-stakes deals at the company.
Here are few of the items the SEC may look at, according to research by the staffs of Light Reading and Optical Oracle, Light Reading’s paid research service:
- Fiber Swaps
The questioning starts with Global Crossing’s accounting treatment of the IRUs, the long-term leases on fiber access that are commonly swapped in the telecom business. The fiber swaps can be accounted for in a number of ways, some of which can be used to boost short-term revenues and cash flow. This issue was raised inside Global Crossing by Roy Olofson, a former vice president of finance at the company who was eventually fired. This was disclosed last week in a Global Crossing press release (see GlobalX Issues Defense). The SEC investigation will focus on whether the accounting was illegal and/or used to prop up quarterly numbers such as cash flow and revenue, while insiders sold their stock.
- Insider sales
Global Crossing Chairman Winnick sold $157 million in Global Crossing stock in May of 2001, as the company’s financial problems were accelerating. He also benefited to the tune of hundreds of millions of dollars when Global Crossing sold Global Center to the now-bankrupt Exodus Communications for $6 billion in stock in 2000. The exact amount of his take in that deal is uncertain, as Exodus Commuications has since had its assets sold to Cable & Wireless PLC (NYSE: CWP), and Light Reading was unable to confirm whether Winnick received or sold Exodus or C&W stock. Although it is difficult to ascertain exactly how much Winnick cashed in, it's certain that, at a minimum, he earned hundreds of millions of dollars leading up to Global's bankruptcy.
- Deferred Revenue
Both Global Crossing’s deferred revenues and accounts receivables increased from 1999 to 2000, at the same time the company was touting financial progress through increased cash revenues. When both of these numbers go up in sync, financial analysts consider it a “red flag,” because it indicates the company is having difficulty with cash collection efforts and revenue recognition.
- Pacific Capital Group
Winnick controlled Global Crossing by holding his shares in the name of his Beverly Hills-based investment company, Pacific Capital Group. According to SEC filings, Pacific Capital also received millions of dollars in fees and additional stock warrants from Global Crossing. The relationship between these two companies is likely to go under the SEC's microscope.
The companies were intertwined in other ways. Lodwrick Cook, co-chairman of Global Crossing, was a managing director at Pacific Capital Group. He also sold stock in May of 2001: 763,688 shares for estimated proceeds of $9 million.
- Debt Structure & Financing
Global Crossing Ltd., itself, was formed as the umbrella company underneath which were a collection of subsidiaries: Global Crossing Holdings Ltd., Pacific Crossing Holdings Ltd., Mid-Atlantic Crossing Holdings Ltd., Pan American Crossing Holdings Ltd. Each of these companies, in turn, were “project financed,” held separate portions of the corporate debt, and raised money through equity offerings. All of this, in turn, was controlled by majority stakeholder Pacific Capital Group, which was in turn controlled by Garry Winnick.
Got that? The complicated nature of the corporation raises questions about how it was financed, and whether all of the debt and equity financing was accounted for on the balance sheet of the parent company, Global Crossing Ltd.
A Global Crossing spokesperson told Light Reading last week that they are cooperating with the SEC investigation and that there were no accounting improprieties at the company. The company is also expected to form an audit panel to look into Olofson's allegations that the company’s accounting practices were unethical. The SEC does not typically comment on ongoing investigations.
Gary’s Winnick’s spokesperson, with a public relations agency outside of the company, said that Winnick is not granting interviews.
— R. Scott Raynovich, US Editor, Light Reading
Editor's Note: Light Reading is not affiliated with Oracle Corporation.