Nacchio Opening Arguments: Part I

March 20 2007, 11:46 AM

The jury has been selected. Opening arguments began at noon. The Government is now giving its presentation. I'm in the media courtroom. [This is not a transcript. It is my notes as fast as I can type. I'm beginning at 12:30 pm after a discussion of one timers, recurring and non-recurring revenue. Scroll down for updates or refresh every 15 minutes. Spelling errors will be corrected later, this is live-blogging.] Theme: This case is about cheating. Nacchio sold his stock faster than he ever sold it before.

This is a straightforward case. It isn't a case about accounting; it's a case about fairness. There would have been nothing wrong with Mr. Nacchio selling his stock, so long as he told investors outside of Qwest, including the investors who bought the stock that he sold, about the problems that he knew about inside Qwest, problems that he knew about because of his position as an insider at Qwest Communications.

Gives a basic course on Wall St. and investing, kind of like an investor's 101. He also explained how the structure of a company works, with different divisions. [I came in about 15 minutes into the opening, just as the prosecutor was describing the difference between recurring and non-recurring revenue, the latter also being called one-time transactions or one-timers. The understanding of the difference between the two is one of the most critical issues in the case. I have uploaded the pages of the prosecutor's opening explaining the differences between these revenues here (pdf). Begin at line 14 on the first page.] James Hearty's Opening continued:

Mr. Nacchio valued recurring revenue over non-recurring revenue. Qwest, on its internal financial statements, tracked them separately. Outside Qwest, Nacchio did not break down the difference. We will prove Nacchio knew this information was important to outside investors. He knew if he told them how much Qwest relied on non-recurring revenues, it wouldn't be good. Shows a graphic of "the real basic schematic" of how the company operated. Nacchio was an experienced telecom executive who knew the business. Soon after Nacchio came, Qwest went public, making money by selling stock. Mr. Mohebbi was hired by Nacchio and reported directly to him. Around the time Qwest was going to go public, Nacchio needed someone to be in charge of investor relations. So he hired Mr. Wolfe to deal with investors. Wolfe would tell him the kind of information investors wanted from Qwest and how investors reacted. He will tell you Nacchio was active in investor relations and spoke to them frequently, sometimes on investor calls. Hundreds of investors would listen in. "Earnings release calls" would be held four times a year. They took place about three weeks after quarter ended. During them, he explained how Qwest performed in the last quarter and what Qwest's growth was expected to be in the future. Robin Szeliga rose to the position of Sr. VP. She prepared financials (budgets and plans and forecasts) for internal use. She will tell you about the budget process. She will tell you about how the company was performing in 2001. She plead guilty to insider trading for selling 10,000 shares of Qwest stock on the basis of insider information in April 2001. She knew the risk in Qwest stock was greater than the public had been led to believe. There were three divisions of Qwest. Consumer and small business: largest recurring revenue business. Wholesale divisions: sold to other telecom companies. Sold majority of one timers. Third division sold to large companies. The merger between Qwest and U.S. West announced in June, 1999. Took a year to close until June 30, 2000. 3/4 of the new company was from U.S. West, only 1/4 from Qwest. When merger was announced, Qwest investors weren't happy. Because they were growth investors. U.S. West was not a growth company. Nacchio was upset by the market reaction. He went out to talk to investors to promote the merger. He said company would grow 15 to 17% in the next five years. That was a huge number. He never backed off those numbers. He was repeatedly told by his own team, those growth rates were too high. 12:48 pm Ms Szeliga said in early September they hadn't even built a budget or plan for 2001. Yet Nacchio raised the growth guide for 2001. Wolfe urged Nacchio to lower growth guide, but Nacchio wouldn't do it. You will hear about the budget process. What you will hear from Nacchio's team is that the budget process for 2001 was broken. Unrealistically high targets were placed. Szleliga said the projection was $1 billion to high. Mohebbi was concerned enough about the plan that he sent Nacchio two memos. He put them in writing even though Nacchio didn't like to get bad news in writing. Nacchio didn't react well when he got bad news. Memos said the 2001 targets were a huge stretch. Qwest had to grow their recurring revenue business at twice the rate it had grown in 2000 to meet the target. That's a huge increase for a telecom business. He also told Nacchio Qwest would have big problems in second half of 2001 if recurring revenue didn't take off in the 1st half of 2001. Mr. Mohebbi also reminded him that Qwest's track record of growing non-recurring revenue wasn't very good. The targets were too big. The gap. Explains that the gap is the difference between recurring revenue and total revenue. The only way it could be filled in was with one-timers. As the year went on the gap was too big. He told Nacchio they wouldn't be able to fill it. Evidence will show Mohebbi wasn't telling Nacchio anything he didn't know. He knew recurring revenue was more predictable and reliable than one-timers. Rule of 78's. As time went on, it was harder to make up the revenue. 1:00 Mr. Nacchio said a miss earlier in the year is like a snowball going downhill. It just gets bigger as the year goes on. Shows jury a time line. It's harder to hear this part because he's not by the microphone when he's demonstrating through a chart. There was a September 26, 2001 call in which Nacchio reaffirms to investors that he's very confident Qwest will meet its projected revenues. Even though Mohebbi had told him it was problematic and Szeliga and the budget people told him it was $1 billion too high. In January, Nacchio gave instruction to sell some of his stock. He had to certify the decision was not based on insider information. You will learn a document was backdated. What happened since December 6? Mr. Nacchio had been told the targets were too high. Shows the certification. He says as of the date hereof, he has no other non-publicly available information. The document wasn't even created until December 15. There is no evidence this document was sent to Mr. Nacchio (?) You will hear about the shares he sold based on that instruction on Jan. 2 and 3. The way he obtained those shares is different. They were growth shares, so he was entitled to a certain amount of compensation based on the growth of the company. He knew he was getting these shares and that they were based on the stock price. Once he got them, they were the same as other common shares. It wouldn't have cost him anything to save them because the taxes had already been paid on them. Instead of $25 million in shares, he got 14 million, the net. When he sold them, someone else bought them. At Nachio's price. They didn't know about the warnings from Mohebbi. In beginning of Jan. 2001, company held an earnings release call. In January, investors wanted more information about the projected growth. He told them how Qwest had done in 4th quarter of 2000, and he was confident Qwest would still have industry leading growth rates in a weakening economy. He didn't tell them about the concerns of Mohebbi or Szeliga. When trading window opened two days after earnings call, Nacchio sells $31 million of stock. Trading window is a restriction the company puts on insiders selling stock. When window opens, they can sell, so long as it is not based on material non-public information. 1:15 pm Moves to Feb to May, 2001. Nacchio entered into sales plan which was "an agreement today to sell stock sometime in the future." He had to certify in the sales plan that he was not in possession of insider information. Qwest issued a press release when he entered sales plan. Nacchio gave reasons for sales plan. Reason 1: Qwest had granted him a lot of stock options and they were set to expire in 2/12 years. The second reason was because the board of directors at Qwest had expressed concerns about him bunching the sales. It wouldn't look good. The plan were to sell 11,500 shares a day until all the shares were gone. This plan would have helped Nacchio diversify his wealth. Mr. Nacchio canceled the plan on March 1. The trading window was closed so he couldn't sell stock outside the company. As we go through March, he starts having his internal meetings. At March 20 meeting, company needed $500 million of one-timers that haven't closed yet. The recurring revenue is not taking off as it needed to. On April 9, quarter is over, and Szeliga prepares update for how company had done. In the plan, presented to Nacchio, it said recurring revenue is 19% below plan. The shift Qwest was relying on was not occurring as expected. They were having to rely more on one-timers, the non-recurring revenue. Nacchio got angry at the meeting. After, Nacchio talked to other units and got the same information. They are having to rely more on non-recurring revenue -- one-timers. They didn't see any more significant one-timers happening in second half of the year. 1:30 pm After the meetings he goes out and talks to investors. On April 24, he has earnings call with investors. Again, he tells them he is confident Qwest will make its expectations, and he has seen nothing to dissuade him from his confidence in plan he described 18 months ago after merger. Plays the telephone call with Nacchio stating this. He's reconfirming 15 to 17% projections on revenues. He tells them how well Qwest is doing even though he knew Qwest missed its recurring revenue projections. He didn't tell them the market for one-timers was worse then they had expected. Two days later the trading window opened. On April 26 through May 16, Nacchio sells $49 million of Qwest stock. The first day the window opened, he sold 350,000 shares. The next day he sold 300,000. The rate that he sold during this window was 7 times greater than the March sales plan he had canceled. More charts showing trading pattern. There are always risks when people sell stocks. But Nacchio sold $100 million of stock. When he saw a storm coming, he sold as much stock as he could. He told investors Qwest could achieve the high growth rate it projected, but didn't tell them that internally, he was being told differently. He kept those risks from investors. End of Government opening. 15 minute recess. Time for a new thread.

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