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Qwest Quenches Fraud Probe

Qwest Communications International Inc. (NYSE: Q) inches closer to freeing itself from civil charges of accounting fraud as it negotiates one of the largest settlements ever with the Securities and Exchange Commission (SEC).

Analysts watching the situation say wrapping up the SEC investigation allows Qwest to focus on launching such services as VOIP to offset losses from its traditional local telephone service.

The Midwest incumbent phone company has agreed to pay $250 million to settle an SEC investigation into its accounting practices, according to Candice Johnson, a spokeswoman for the Communications Workers of America. Johnson says Qwest told the union on Friday it had reached an agreement with the SEC. The union, which represents about 27,000 Qwest workers, says the settlement allows the company to move forward.

Qwest spokesman Steve Hammack would not comment on the SEC agreement beyond saying, “We continue in our efforts to cooperate with the SEC and the DOJ [Department of Justice] in their investigations.”

SEC spokesman John Heine declined to comment.

“This allows Notebaert to put the Nacchio years behind the company,” says Scott Cleland, CEO of Precursor Group, an investment research firm based in Washington.

About two and a half years ago, the SEC began to investigate charges that Qwest inflated revenues by $2.5 billion in 2000 and 2001, while under the leadership of former CEO Joseph Nacchio (see Sources: Qwest Case Broadening).

When Qwest’s new CEO, Richard Notebaert, arrived in June 2002, the company was on the brink of bankruptcy.

“Notebaert has done an amazing job at taking the company literally hours away from bankruptcy to stabilizing it. Qwest is by no means out of the woods, but the near-term crisis has been adverted,” Cleland says.

The accounting-fraud settlement with the SEC doesn’t end or in anyway affect the ongoing criminal investigation by the DOJ, says Jeff Dorschner, spokesman for the U.S. attorney’s office in Denver. “I am not aware of any agreement with the SEC, but if there was one, it would have no affect on the ongoing Department of Justice investigation,” Dorschner says.

On top of the criminal investigation, the company must battle a slew of shareholder lawsuits and dig its way out of $17.2 billion in debt.

According to its 10-K, dated Aug. 3, Qwest says it increased its reserves from $300 million to $500 million to pay possible penalties from pending investigations. Analysts expect these reserves to be sufficient to cover the cost of settling shareholder lawsuits.

Some analysts say shareholders would get more from the $250 million settlement with the SEC than from the shareholder lawsuits. They expect the government would set up a fund for shareholder restitution, similar to the fund created as part of the $750 million SEC settlement with WorldCom Inc., which included paying $500 million to investors.

Analysts say a settlement with the SEC means the company has cleared its biggest hurdle on the road to recovery, leaving it to concentrate on improving its services (see Qwest Heads for Convergence).

Qwest's coming improvements include rolling out VOIP services to its residential customers to help offset losses from its regional telephone service. Last December, the company began to provide VOIP service to customers in St. Paul, Minn. Spokeswoman Claire Mylott says Qwest plans to offer VOIP service in all its residential markets by the end of the year.

“The settlement will be a huge relief to management, since they will no longer be distracted with the SEC’s investigation,” says Donna Jaegers, a research analyst at Janco Partners Inc. “They can now focus on improving their business.”

— Joanna Sabatini, Reporter, Light Reading

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