Qwest Communications International, Inc.

May Wa Taw (S154623)

Background
Qwest Communications International, Inc. (Qwest) was one of the largest companies in the
telecommunications industry in United States. Since the beginning of its initial public offering in 1997,
Qwest was widely promoted by its then Chief Executive Officer (CEO) Joseph Nacchio, as a leading
innovator in the communications market, with strong long term growth potential, promising double
digit growth in revenues and earnings[1]. However, as growth in the robust sector [2], the senior
executives of Qwest took deceptive measures in order to its strong revenue projections.
I pu sua e to eeti g p o ised sales a d e e ue ta gets, Q ests senior executives used sales of
indefeasible rights of use (IRUs), capital equipment and IRU swaps and recognized their revenues as its
core business, which were regarded as a one off and unsustainable revenue items that did not truly
efle t Q ests fi a ial pe fo a e. Yet, both IRU and capital equipment revenues were
misrepresented in financial statements through aggressive accounting practices that violated generally
accepted accounting principles (GAAP) but were hidden through creative accounting procedures.
Moreover, the a se e of he k a d ala es ithi Q ests i te al a ou ti g a assed e e
oe
accounting errors, all of which led to de epti e e og itio s of o e $ .8 illio i e e ue a d
e luded $
illio i e pe ses from 1999 to 2002[3].

Main Perpetrators
In an official complaint from the Securities Exchange Commission (SEC) that was filed with United States
District Court, SEC had identified 9 offenders to the fraud case, including Nacchio and several key
members of senior management, sales and accounting [4]. As CEO, Nacchio was legally liable for the
edi ilit of all of Q ests fi a ial state e ts that he approved and signed despite knowing that the
state e ts as false. Na hio as also e te si el i ol ed i the a a ge e ts ade to oost Q ests
falsified revenue, which is the reason he is singled out as the main perpetrator of the Qwest fraud for
this report.

Revelation of Qwest Fraud

Although a i
the tele o
u i
lette f o a fo
t a sa tio s et
statements.

esto s e e al ead highl dou tful of Q ests stellar market performance in spite of
atio i dust s downturn, the fraud was only confirmed through a whistle blowing
e e plo ee of Q ests o petito Global Crossing [5]. The letter revealed IRU swap
ee Q est a d Glo al C ossi g that e e used to i p o e oth fi s financial

Follo i g the histle lo i g i ide t, EC lau hed a i ui i to Q ests a ou ti g practices [6].

Qwest was then required to restate its financial reports which affirmed the overstatement of revenues
and understatement of expenses mentioned.

Punishment
A idst ECs i ui , Qwest was ordered to pay $400 million for settlement fees after being sued by
shareholders in 2005 [7]. Also, Nacchio was put on trial in 2005 and 2009, and sentenced to 70 months
in prison and fined $19 million on top of having to return $52 million he had earned through insider
t adi g p io to Q ests de li e.

Sarbanes-Oxley Act
Following this incident, along with other revelations of other corporate fraud, the Sarbanes-Oxley Act
was enacted to protect investors from similar incidents, warranting strict reforms in order to better
prudent financial reporting [8].

Qwest Communications International, Inc.

May Wa Taw (S154623)

Becker Model Joseph Nacchios Perspective

Competitors
After a successful takeover of US West, a part of the Regional Bell Operating Companies telephone
companies (or their successors) that were created as a result of the breakup of American Telephone and
Telegraph Company [9], Qwest merged with US West and took over the position as one quarter of the
remaining RBOC. The RBOCs were allocated to different geographic regions of the US market but now
compete for the same market. The 3 other RBOCs are namely Verizon Communications, AT&T Inc.and
Sprint Corporation [10].
Fraud Count in Telecommunications Sector
Based on SEC complaints, the following telecommunication firms were convicted of fraud in the past 10
years [11]:

Year
Company
Crime
2002-2007
UTStarcom
Bribery and FCPA Violations
2005-2006
Magyar Telekom Plc.
Bribery
2014 AirTouch Communications Inc. Improper Revenue Recognition

Establishing Probability of Arrest

Given the equation from the assignment instructions:

= .

Establishi g Cri i als Legal Wages

As mentioned, Naccio resigned as CEO in 2002 but was hired as a consultant for the next 2 years which
paid $125,000 annually. Thereafter, Naccio was not reported to be employed during his trial from 20052009. He was then sentenced to jail from 2009 to 2013. Na hios last sala as CEO i
as $ .5
million plus an additional bonus of $3.75 milllion, bringing his total compensation in 2002 to $5.25
million [12].
Adjusting to NASDAQ Telecommunications q Index [13], Na ios total o pe satio while he was in jail
is as follows:

Qwest Communications International, Inc.

Year
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

May Wa Taw (S154623)

NASDAQ Teleommunications Index Growth Rate Joseph Naccio's Actual Compensation

$
5,250,000.00
6%
$
125,000.00
8%
$
125,000.00
-7%
$
28%
$
9%
$
-43%
$
48%
$
4%
$
-13%
$
2%
$
24%
$
Total (2009 - 2013)

= .

He e, the Be ke

+ .

odel e e plifies Na hios

<>

=$

oti es fo o

Joseph Naccio's Total Compensation Lost

$
$
5,421,400.42
$
5,729,946.84
$
5,316,639.12
$
6,792,696.75
$
7,415,837.01
$
4,228,165.87
$
6,267,824.86
$
6,513,786.09
$
5,691,795.17
$
5,805,671.60
$
7,200,223.60
$
31,479,301.31

>$

>$

itti g the f aud.

Range of Probability of Arrest (Crime is not committed)

=

=$

>$

Solve for p:
$

> .

Fraud Detection Measures

Anonymous Whistleblowing
Employees who are aware of fraudulent activities by chance can either report to matter to a relevant
authority within the company or a third party through a hotline. This way, the authorities will be able to
investigate the matter without alerting the offender.
Hire Forensic Accountants
With a full-time forensic accountant in the firm, the financial statements will be subjected to regular
checks on its credibility. Increasing the likelihood of an offender to be caught.
Increase Awareness of Fraudulent Behaviour in Managers
All managers could go through a course to identify symptoms and characteristics of people engaging in
fraudulent activity. Once a potential offender has been identified, the manager could monitor that
employee more closely, narrowing the pool of offenders for easier detection.

Qwest Communications International, Inc.

May Wa Taw (S154623)

Net Benefit of Hiring a Forensic Accountant (At time of crime)

Cost of Hiring a Forensic Accountant [14]:
=%

= .

+$

+ .

=$

+%

+$

Assuming that the number of forensic accountants required in a large firm = 25:

=$

+$

=$

+$
,

Net Benefit of Hiring a Forensic Accountant (Inclusive of Probability of Detection)

Let p = probability of detection

= .

+$

=$

+ .
,

$
.

+
.

Qwest Communications International, Inc.

May Wa Taw (S154623)

References
[1]: Qwest has high IPO hopes (2007): http://money.cnn.com/1997/06/24/technology/intv_nacchio/
[2]: Producer prices for telephone communications continue to decline (2000):
http://www.bls.gov/opub/ted/2000/Oct/wk4/art04.htm
[3]: SEC Charges Qwest Communications International Inc. with Multi-Faceted Accounting and Financial
Reporting Fraud (2004): https://www.sec.gov/news/press/2004-148.htm
[4]: SEC Charges Former Qwest CEO Joseph Nacchio and Eight Others with Massive Financial Disclosure
Fraud (2005): https://www.sec.gov/news/press/2005-36.htm
[5]: The Case Against Qwest's Nacchio (2005): http://www.bloomberg.com/bw/stories/2005-12-20/thecase-against-qwests-nacchio
[6]: Qwest, WorldCom Face Scrutiny From SEC on Accounting Practices (2002)
http://www.wsj.com/articles/SB1015855124727078800
[7]: U.S. judge gives final OK for Qwest suit settlement (2009):
http://www.reuters.com/article/2009/05/30/us-qwest-idUSTRE54T05B20090530
[8]: Sarbanes-Oxley Act Of 2002: http://www.investopedia.com/terms/s/sarbanesoxleyact.asp
[9]: regional Bell operating company (RBOC) definition:
http://searchunifiedcommunications.techtarget.com/definition/regional-Bell-operating-company
[10]: Qwest Communications International Competition:
http://www.wikinvest.com/stock/Qwest_Communications_International_(Q)#Competition
[11]: SEC Charges California Telecom Company With Bribery and Other FCPA Violations (2009):
https://www.sec.gov/news/press/2009/2009-277.htm, SEC Charges Magyar Telekom and Former
Executives with Bribing Officials in Macedonia and Montenegro (2011):
https://www.sec.gov/news/press/2011/2011-279.htm, California-Based Telecommunications
Equipment Firm and Two Former Executives Charged in Revenue Recognition Scheme (2014):
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542732440
[12]: Qwest Rewards CEO Nacchio With Bonus Despite Struggles (2002):
http://www.wsj.com/articles/SB10183942065083240
[13]: NASDAQ Telecommunications (^IXTC):
http://finance.yahoo.com/q/hp?s=%5EIXTC&a=11&b=31&c=2002&d=11&e=31&f=2013&g=m 2
[14]: Forensic Accountant Average Salary:
http://www.payscale.com/research/US/Job=Forensic_Accountant/Salary