Litigation Release No. 17996 / February 25, 2003
Accounting and Auditing
Release No. 1726 / February 25, 2003
Securities and Exchange v. Joel M. Arnold, William L. Eveleth, Grant Graham, Thomas W. Hall, Douglas K. Hutchins, Bryan K. Treadway, John M. Walker, and Richard L. Weston, No. (D. Co.) CV 03-Z-0328 (OES)
The Commission today filed civil fraud charges against eight current and former officers and employees of Qwest Communications International Inc. ("Qwest"), alleging that they inflated the company's revenues by approximately $144 million in 2000 and 2001 in order to meet earnings projections and revenue expectations. The Commission's lawsuit, which was brought in federal court in the District of Colorado, seeks anti-fraud injunctions, civil money penalties, disgorgement of ill-gotten gains (including compensation, bonuses and stock trading profits during the relevant period) and, as to certain defendants, permanent bars from service as an officer or director of a public company.
The Commission's complaint alleges that the defendants artificially accelerated Qwest's recognition of revenue in two equipment sale transactions for its Global Business Markets unit ("Global Business"). When Qwest and Global Business determined that Qwest was falling short of its quarterly revenue targets and would not achieve the projected growth for the quarters ending June 30, 2001, and September 30, 2000, the defendants bridged the revenue gap by fraudulently mischaracterizing these transactions.
The Commission's complaint alleges the following:
ASFB Transaction
- Joel Arnold, the former senior vice president of Global Business; Grant Graham, the former chief financial officer ("CFO") of Global Business; Thomas W. Hall, the former senior vice president of a division of Global Business; Bryan K. Treadway, the former assistant controller of Qwest; John M. Walker, the former vice president of sales for a division of Global Business; and Douglas K. Hutchins, a former director of Global Business planned and carried out an elaborate scheme to inflate revenues in connection with the sale of Internet equipment and service to the Arizona School Facilities Board ("ASFB").
- The scheme involved artificially separating the equipment sale from the installation services and wrongfully characterizing the sale as a bill-and-hold transaction under generally accepted accounting principles. It also included accelerated delivery of equipment necessary for the two-year project and delivery of equipment that was not approved for the ASFB project. To support immediate recognition of revenue for sale of the equipment, the defendants prepared false letter agreements for ASFB and a fraudulent internal memorandum.
- As a result of the fraudulent transaction, Qwest recognized approximately $33.6 million in revenue in the quarter ended June 30, 2001. Without the fictitious revenue from the ASFB transaction, Qwest would have fallen short of its projected 12 to 13 percent revenue growth for the quarter.
Genuity Transaction
- Richard L. Weston, the former senior vice president in Product Development for Qwest's Internet Solutions unit, and William L. Eveleth, the current CFO of Qwest's Corporate Planning and Operational Finance unit and senior vice president of Finance, Arnold, and Graham participated in a scheme in which Qwest artificially characterized one transaction with Genuity, Inc., an Internet service provider, as two separate contracts.
- In the first contract Qwest purported to sell equipment to Genuity at an improperly inflated price. In a second contract, Qwest agreed to provide services to Genuity at a loss to Qwest, and reassumed all risk of loss and obsolescence on the equipment purportedly sold pursuant to the first contract.
- As a result of the fraudulent transaction, Qwest improperly recognized $100 million in revenue and claimed $80 million in earnings before interest, taxes, depreciation, and amortization ("EBITDA") in the quarter ended September 30, 2000. Without the fictitious revenue from the Genuity transaction, Qwest would not have achieved the projected double-digit growth for the quarter, and would have recognized growth of 9.8 percent above the same quarter of the prior year rather than the announced 12.4 percent.
- Through the fiscal year ended December 31, 2000, Qwest improperly recognized revenue of approximately $10.6 million under the service agreement despite the fact that Qwest had not begun providing any services.
The Commission's complaint seeks an order against all defendants enjoining them from further violations of Section 17(a) of the Securities Act of 1933 and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 10b-5 and 13b2-1 thereunder and for their aiding and abetting violations of Sections 10(b), 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13; imposing civil money penalties; and ordering disgorgement of all ill-gotten gains, including any compensation, bonuses, or stock trading profits made during their fraudulent activities. The Commission further seeks orders against Arnold, Graham, Hall, Treadway, and Weston permanently barring them from acting as a director or officer of a publicly held company.
The Commission filed its action at the same time that the United States Attorney's Office announced indictments against certain individuals for conduct in the ASFB transaction that is the subject of the Commission's complaint.
The Commission's investigation into the conduct of others is continuing.
