Financial Statement Fraud at Qwest Communications
This paper examines in detail the illegal and unethical practices that happened at the Quest Communications between the years 1999-2001. Qwest Communications is based in Denver, Colorado in the United States of America. During the time stated above, the top level managers at the Qwest Communications engaged in a fraud whereby they manipulated the company`s financial statements in order to inflate artificially in that case the company`s revenue and its profits. During that time, the company was headed by a chief executive by the name of Joseph P. Nacchio. Joseph P. Nacchio was later sued by the US securities exchange and convicted (Stanwick, 2009).
Qwest Communications was founded in the year 1996 by Philip Anschutz. At this time Anschutz was the owner of the Southern Pacific Railroad. He began by establishing a subsidiary company that he named the Southern Pacific Telecommunications a company that was the first to install the first fiber optic cables that were meant to serve businesses along his railroad lines with high speed data. Anschutz was later to win a contract from the MCI to lay a nationwide fiber optic along the railway lines something that he took the advantage of and laid his own fiber along the railway lines as well (Stanwick, 2009)
Qwest Communications grew at a high rate and was able to acquire the internet service provider by the name SuperNet in the year 1997. This was followed by yet another major acquisition of the LCI which is a low cost long distance data carrier which was located in Dublin in the following year. Qwest was later to acquire a web hosting provider Icon CMT in the year 1998. Qwest Communications partnered with a Dutch telecom operator by the name of KPN and together they created the pan-European data communications and the hosting company became the KPNQwest. KPNQest was launched on November 1998 and it went ahead and launched an initial Public Offering on the Amsterdam and the Nasdaq stock exchanges. KPNQwest was later to collapse in the year 2002 due to bankruptcy. Qwest Communications was later to merge with the US West in the year 2000 (Stanwick, 2009).
Some of the major problems that affected Qwest Communications started in the year 2003. The company was first accused of manipulating financial documents whereby the company had swapped equipments with some telecommunication companies. Qwest communications had recorded the swap as revenue. It was on 25[th] of February 2003 that the Justice Department had to indict four of the top level executives at the Qwest Communications for fraud. Those who were indicted included John Walker, he was the Vice President in the Educational and Government Solutions GroupBryan Traedway who was the assistant controller at Qwest Communications Grant Graham who by the time of the fraud was the chief financial officer at Qwest Global business unit and Thomas Hall who was also holding a senior position as the Vice President of the Government and Educational Solutions Group at the Qwest Communications. The four senior executives were accused of conspiracy to commit a criminal offense against the United States, wire fraud and securities fraud. This was after they had recorded in the financial statements as revenue for the Qwest Communications a purchase order that the company had, made with the Arizona School Facilities Board (Stanwick, 2009)
The total amount of fraudulent finances that Qwest Communications was responsible for had risen to $ 8 billion by October 2004. Qwest Communications paid a total of $250 million to the federal government though they did not admit or deny guilt in their practices. It was also discovered that Qwest Communications had lots of loopholes in their internal control systems and therefore they were ordered to appoint a compliance officer. Some of the major errors that had resulted from poor bookkeeping within the Qwest Communications company was an overstatement of $56 million as an operator service revenue, Qwest Communications had also improperly capitalized $200 million that was related to designing services and also an understatement amounting to $850 million that resulted to the expenses that had been incurred during the merger between Qwest Communications and the US West.
The following year on March 20065, Joseph Nacchio who was the former chief executive of the Qwest Communications was charged with fraud by the US Securities and Exchange Commission. Nacchio together with six other top executives were charged of having fraud $ 3 billion between the years 1999-2002 and As a result they had benefited from the exaggerated stock price (Stanwick, 2009).
According to the government, Nacchio had continually told Wall Street that the Qwest Communications was going to achieve huge revenues even though he knew that they were not going to be achieved. In his defense however through his lawyer, Nacchio said that he was confident that the Qwest Communications was going to make huge profits and revenue since the company was had won lucrative contracts from the National security. He also claimed that he was not in his best state of mind when he sold his shares at Qwest Communications since he had problems with his son.
December 20, 2005 Nacchio was indicted. In this case therefore, he was forced to surrender his passport on the fear that he would run away. He was discharged with 42 counts related to insider trading. Each count had a potential of ten years in jail. Nacchio had sold shares amounting to $39 million at a time when the Qwest Communications was trading between $ 38.31 and $ 41.12. of the 42 counts that Nacchio was charged with, he was found guilty of 19 counts an convicted on 19[th] April 2007. On July 27[th] the same year, Nacchio was sentenced to six years in the federal prison. He was also ordered to pay $ 19 million as a fine and also to forfeit $52 million that he had earned through his illegal sale of the stock. The US Court of Appeals overturned the conviction of Nacchio and instead ordered a new trial against him. However, the sentence was reinstated after the second trial and Nacchio surrendered to a prison on the 14[th] April, 2009. He was jailed at a federal prison in Schuylkill in Pennsylvania where he was supposed to serve six years. Joseph Nacchio has however finished his conviction which ended in the year 2013 on September 20 (Stanwick, 2009).
Qwest Communications former chief executive Robin Szeliga was charged on June 2005 for fraud that was related to a stock sale that she had made 2001. She admitted to the court that she had traded 10,000 shares and had made a profit of $ 125, 000. She had sold the shares since she knew that this information was not available top the public (Stanwick, 2009).
Qwest Communications generated its revenues from a variety of its services and products. Some of the services that Qwest Communications offered between the years 1999-2001 included the commercial and consumer services which basically were raised from the voice services like the telephone monthly fees, fees from the calling services including voice messaging, other sources included the internet protocol such as the integrated services digital network (ISDN). The total revenues for the Qwest Communications in the year 2001 had grown by 18.6% in comparison to the year 2000 (Bloomberg News, 2007). This was primarily influenced by the merger between Qwest Communications and the US West company. Other sources that made the revenues for the year 2001 grow as compared to the previous year included the increased services such as the internet protocol, an increase in optical capacity and data sales. This is so because when you look at the data and the internet protocol services that Qwest Communications offered in the year 2001, it represented 27% of the total revenues. Compared to the previous years, the data and internet protocol services represented only 21%. In this case therefore the data and revenue services had grown by almost 54% (Stanwick, 2009).
For Qwest Communications, the operational efficiencies were achieved through a consolidation of the main operational units that used to provide common services. This was also done through leveraging the purchasing power for the company throughout. The costs were anticipated to further drop in the following year as a result of a restructure in the company. Some of the strategies that Qwest Communications intended to use in order to reduce its operational costs were to reduce the cost of its facilities through negotiations of a lower rate and also through migration of Qwest Communications services that were carried by other telecommunications service providers to the facilities that belonged to the Qwest Communications. The company had to reduce the number of its employees in order to cope up with the hard economic times especially in the year 2000 and 2001. It is for this reason that Qwest communications had to reduce the number of its employees by 11,000 in the year 2001 (Bloomberg News, 2007). It is obvious that the impacts of the fraud were now being felt within the company though even at this particular time when most of the companies around the world were going through hard economic times, the Qwest Communications chief executive was telling Wall Street that the company was anticipating huge revenues. Asked why he was confident that the company was going to make a growth in its revenues yet there was a global economic slowdown, Nacchio said that the reason for his confidence was that Qwest Communications had won contracts regarding the national security from the federal government and that the contracts were lucrative. This however was not true and it therefore was a major red flag as far as the fraud at the Qwest Communications was concerned (Stanwick, 2009).
It is important to note that there are massive impacts that result from a financial statement fraud. A financial statement fraud undermines in a big way the reliability, the quality, integrity and the transparency of the financial reporting procedures and processes as they should be adhered to and therefore undermining the whole auditing profession. The integrity and the transparency of the auditing professionals especially the auditors and the auditing firms at large is therefore downplayed by those companies that intentionally engages in financial statement fraud. In a larger scale, financial statement fraud belittles the confidence that the financial markets are required to posses, the market participants as far as their reliability with the financial information is concerned and therefore making the capital markets less efficient. It therefore becomes obvious that looking at the bigger picture, financial statement fraud derails in a bigger way the economic growth of the country (Evans, 2008). If the financial statement fraud is disclosed, it results to huge litigation costs, many people are forced to end their careers and it may also lead to the company involved being declared bankruptcy.
It is important to note that there are massive impacts that result from a financial statement fraud. A financial statement fraud undermines in a big way the reliability, the quality, integrity and the transparency of the financial reporting procedures and processes as they should be adhered to and therefore undermining the whole auditing profession. The integrity and the transparency of the auditing professionals especially the auditors and the auditing firms at large is therefore downplayed by those companies that intentionally engages in financial statement fraud.
Some of the major red flags that are used in the detection of financial statement fraud are accounting anomalies, easily noticeable internal and external control weaknesses within the company, the personality of the chief executives and other C-level managers can also help to detect financial statement fraud, unusual profit growth within the company and sometimes aggressive financial actions by the senior management (Stanwick, 2009).
After thorough investigation of the financial statements of the Qwest Communications, it revealed that there were financial frauds that had occurred within the company in the last three years. The financial frauds could be categorized in three main areas for easy identification. Some of the major areas that were affected by the financial statement fraud were asset misappropriation, a gradual increase in gross margin over the last nine months, subcontracts to questionable companies that could not be traced, complexity in the company`s management and therefore creating lots of loopholes, questionable positive cash flows within the fourth quarter that surpassed all the loses that the company had incurred within the last two years happened in the third year (Bloomberg News, 2007)
After identifying the key detecting factors, there was need to carry out an in depth research in order to bring out the fraudulent cover ups that had occurred within the company. More interestingly just like is the case with many companies` that engage in financial statement fraud, Qwest Communications had tried to keep the company look impressive to the investors. First to detect was the accounting anomalies that were noticed within the financial books of the company (Evans, 2008). It was questionable to realize that the company had continually recorded an increase in its revenues and profits in the last nine months besides the fact that the revenues were not in tandem with the sales that the company had made during that period. In this case therefore, investigations of the company`s financial statements revealed that the sales had been deliberately manipulated since they did not match with the cash flow. The company`s senior management had manipulated and altered the sales in order to give a picture to the creditors, investors as well as other market participants that the company was fair well.
According to Qwest Communications financial statements that were available for the last three years, it showed that the company was supposed to conduct an audit on quarterly basis. However, after the interviews with both the internal and external auditors, it was revealed that the chief executive officer had denied the auditors access to important financial information over the last two and a half years. Withheld financial information had therefore made it difficult for the auditors to balance the financial statements of the company (Stanwick, 2009).
The fact that the company`s financial statements showed that there were consistency in the sales over the last nine months despite the fact that strong competitors had experienced weak moments during the same period was a reason enough to raise more questions than the available answers over the company`s financial statements. An in depth investigation showed that the company had continuously increased its sales not because there was efficiency in its business operations but because somebody somewhere had continuously and deliberately altered the figures.
In the period of the three years that the investigation was conducted on the financial statements, it revealed that the company had increased its sales significantly over the last nine months. Established competitors in the same field and region had a declining performance in the same period and this raised the questions on whether Qwest Communications had deliberately altered its figures in an attempt to meet the investigators expectations by the end of the fiscal year. Further investigations revealed that the sales had been entered before they had been actually made (Stanwick, 2009).
The other category of fraud that was revealed by the investigators of the Qwest Communications was the fictitious revenues. It was obvious that after noticing the fact that the company had posted sales that had actually not happened in the reality, there were fictitious revenues that the company consequently claimed to have garnered while they had not. In order to conceal the fictitious revenues, Qwest Communications senior management had attempted to increase the purchase of the assets. The other thing was the fact that there were no physical addresses found in the customer`s records something that raised doubts on whether the said customers really existed or were just ghosts. There were also noticeable unusual ratio patterns. This was more especially the noticed spike in the accounts received that did not commensurate (Evans, 2008).
Bloomberg News, (2007). Ex-Qwest Official Says Chief was Misleading on Growth. The New York Times.
Evans, B. (2008). Qwest Communications Securities Lawsuit. Francisco, CA: Jossey-Bass.
Stanwick, D. (2009). Qwest Communications: A Case Study Of Fraud And Greed. Buckingham: Open University.
Financial Statement Fraud at Qwest Communications