UNITED STATES OF AMERICA
| ORDER INSTITUTING PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER|
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Loren D. Pfau ("Respondent" or "Pfau").1
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except that Respondent has admitted the Commission's jurisdiction over him and over the matters set forth herein, Respondent has consented to the entry of this Order Instituting Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order ("Order") as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds2 that:
1. Qwest Communications International, Inc. ("Qwest"), a telecommunications company based in Denver, Colorado, provides broadband Internet communications, data, and multimedia services on a national and global basis, as well as wireless services, local telecommunications, telephone directory services, and related services in a 14-state local service area.
2. Qwest's common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and the company is obligated to file reports on Forms 10-K and 10-Q. Qwest common stock is traded on the New York Stock Exchange. Qwest filed quarterly and annual reports through and including the quarter ended March 31, 2002. Qwest registered exchange offerings by filing Forms S-4 with the Commission on January 17, 2001, July 12, 2001, and October 30, 2001. On December 5, 2001, April 30, 2002, and June 28, 2002, Qwest filed Forms S-8 registration of securities to be offered to employees in employee benefit plans. On February 5, 2002, Qwest filed a Form S-3 registration statement for face amount certificate companies. On April 9, 2002, Qwest filed a Form S-3A registration statement for face amount certificate companies. On October 31, 2001 and November 5, 2001, Qwest filed Forms SC TO-I and SC TO-I/A, tender offer statements by issuer for securities to be offered to eligible employees. Many of the stock offering materials incorporated by reference Qwest's financial statements filed with the Commission.
3. Pfau, age 43, a resident of Evergreen, Colorado, was employed by Qwest from April 1998 to July 2003. From December 2000 through June 2001 ("the relevant period"), Pfau was a director of business development in the Qwestlink business unit, which was Qwest's construction unit responsible for building fiber-optic cable networks. During the relevant period, Pfau was engaged in sales of Qwest fiber-optic cable or "dark fiber" to other telecommunications providers.
4. During the relevant period, Qwest publicly announced agressive revenue projections. In the final days of each quarter, Qwest used Indefeasible Right of Use ("IRU") agreements to sell dark fiber from its telecommunications network as one means to meet revenue targets. An IRU is an irrevocable right to use a specific amount of fiber capacity for a specified time period.
5. Qwest accounted for IRUs as sales-type leases and recognized revenue upon Qwest's delivery and its customer's acceptance of the dark fiber. By doing so, Qwest recognized nearly the entire amount of IRU revenue "up-front" at the time of contract execution rather than over the life of the IRU agreement. Qwest employees and management commonly referred to IRU sales as "gap fillers," in other words, a means to make up the shortfall between the aggressive revenue projections as publicly announced by Qwest senior management and the actual revenue earned by Qwest.
6. During the relevant period, Pfau was involved in the negotiations of three IRU transactions for the sale of dark fiber. In each of the three IRU transactions, the purchasers of Qwest dark fiber required the ability to exchange or "port" the dark fiber-optic cable purchased for different fiber-optic cable at a later date.
7. With respect to each of the three IRU transactions, Pfau knew or was reckless in not knowing that, under generally accepted accounting principles ("GAAP"), providing a buyer the right to port under an IRU agreement defeated the up-front revenue recognition sought by Qwest. In each instance, Pfau knew also that Qwest's corporate accountants, who reviewed all IRU agreements to determine the propriety of recognizing revenue up-front, would have questioned such up-front revenue treatment had the IRU agreements contained any reference to portability.
8. Pfau circumvented Qwest's internal accounting controls to assist in generating up-front revenue for Qwest. In each of the three IRU transactions, Pfau engaged or assisted in providing secret verbal or e-mail side agreements which allowed the purchasers the right to port at a later date. Pfau intended the side agreements to conceal from Qwest's corporate accountants and outside auditors the purchasers' ability to port so that up-front revenue recognition would not be impeded.
9. Qwest improperly recognized $15.1 million in revenue for the quarter ended March 31, 2001, and $11.5 million for the quarter ended June 30, 2001. By engaging in the above-described conduct, Pfau was a cause of Qwest filing quarterly reports in the first and second quarters of 2001, and its annual report for 2001, which contained materially false information.
10. Section 17(a) of the Securities Act makes it unlawful to employ any device, scheme, or artifice to defraud in the offer or sale of any securities. Section 10(b) of the Exchange Act and Rule 10b-5 prohibit the misrepresentation of or misleading omission of material facts in connection with the purchase or sale of securities. By engaging in the conduct described in paragraphs III.6. through III.9. above, Pfau was a cause of Qwest's violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5.
11. Section 13(a) of the Exchange Act requires all issuers with securities registered under Section 12 of the Exchange Act to file periodic and other reports with the Commission containing such information as the Commission's rules prescribe. Pursuant to Section 13(a), the Commission promulgated Rules 13a-1 and 13a-13 that require issuers to file annual and quarterly reports, respectively. In addition, Rule 12b-20 requires that reports contain such further material information as may be necessary to make the required statements, in light of the circumstances under which they were made, not misleading. As a result of the conduct described in paragraphs III.6. through III.9. above, Pfau was a cause of Qwest's violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13.
12. Section 13(b)(2)(A) of the Exchange Act states that every Section 12 registrant must "make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer." Rule 13b2-1 provides that no person shall, directly or indirectly falsify or cause to be falsified, any book, record, or account subject to Section 13(b)(2)(A). As a result of the conduct described in paragraphs III.6. through III.9. above, Pfau committed violations of Rule 13b2-1 of the Exchange Act, and was a cause of Qwest's violations of Section 13(b)(2)(A) of the Exchange Act.
13. Section 13(b)(5) of the Exchange Act provides that: "No person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record, or account described in [Section 13(b)(2)]." By engaging in the conduct described in paragraphs III.6. through III.9. above, Pfau committed violations of Section 13(b)(5) of the Exchange Act.
14. In determining to accept the Offer, the Commission considered Respondent's cooperation afforded the Commission staff.
15. Respondent undertakes to cooperate with the Commission staff in preparing for and presenting any civil litigation or administrative proceeding concerning any transaction or related transaction that is the subject of the Order. Respondent understands that if he fails to comply with these undertakings, the Commission reserves the right to reopen this proceeding and reconsider the appropriateness of the Order imposed.
16. In determining whether to accept the Offer, the Commission has considered these undertakings.
In view of the foregoing, the Commission deems it appropriate to impose the sanction agreed to in Respondent Pfau's Offer.
Accordingly, it is hereby ORDERED that Respondent cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act, and Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder, and from causing any violations and any future violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
Jonathan G. Katz
1 This matter is related to a civil action, U.S. Securities and Exchange Commission v. Loren D. Pfau, which will be filed simultaneously and in which Pfau has consented to pay a $25,000 penalty.
2 The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding.By the Commission.
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