February 12, 2002
U.S. Widens Global Crossing Inquiry
By SIMON ROMERO
he federal investigation of the accounting practices of Global Crossing, the troubled communications company, expanded yesterday into an inquiry on a type of financial transaction also used by Enron (news/quote) and many other companies.
The signal of the broader investigation was a subpoena that Qwest Communications (news/quote), the main local phone company in 14 Western states, said yesterday that it had received from the Securities and Exchange Commission.
The subpoena, received on Friday, ordered Qwest to hand over documents from transactions with Global Crossing involving the right to use each other's fiber optic networks to fill gaps in their own coverage. The S.E.C. wants to know whether those contracts in some cases were sham deals to inflate reported revenue.
Such long-term contracts were widely bought and sold during the Internet boom, as network operators like Qwest, Global Crossing and other communications upstarts tried to build, buy or borrow network capacity in anticipation of demand for data traffic — demand that seldom materialized to the extent forecast. A glut of unused network capacity, in fact, was behind the bankruptcy filings of Global Crossing and several other communications companies.
Enron, the energy company that evolved into a financial trading enterprise, was a large buyer and seller of such contracts before it filed for bankruptcy in December. Indeed, Enron's unraveling last year helped speed the collapse of the market for the contracts.
The S.E.C. investigation "gives us much-needed scrutiny into the legitimacy of contracts that could have allowed companies to look healthier on paper than they were in reality," said Susan Kalla, senior telecommunications analyst at Friedman, Billings & Ramsey.
Global Crossing's bankruptcy filing last month, involving $22 billion in reported assets, was the fourth- largest ever by an American company. (Enron's ranks as the largest.) Global Crossing came under investigation last week by the S.E.C. and the Federal Bureau of Investigation.
The S.E.C. began its inquiry after Roy Olofson, a former Global Crossing executive, questioned the way the company had booked its revenue in deals with Qwest and other companies. Mr. Olofson, a former vice president for finance, wrote in a letter last August to Global Crossing executives that the company had improperly inflated sales in deals of the type that the S.E.C. has asked Qwest to document.
The contents of Mr. Olofson's letter were made public by his lawyers last week.
According Mr. Olofson, Qwest and Global Crossing swapped about $100 million of capacity in each of the first two quarters of last year. But each company accounted for the deals differently even though they used the same outside auditor, Arthur Andersen — the accounting firm whose work for Enron is under scrutiny.
Mr. Olofson's lawyer, Brian C. Lysaght, said in a statement: "Global Crossing was giving the impression that it was generating cash revenues when, in actuality, these transactions did not increase the cash position of the company in any material sense."
Qwest sought yesterday to distance itself from the Global Crossing inquiry.
"We're cooperating with an investigation of Global Crossing, not of us," said Michael Tarpey, a Qwest spokesman. "We think we were squeaky clean on the issue of these swaps."
Yet Qwest had already come under scrutiny by financial analysts in recent months over its use of such transactions. Shares of Qwest fell 2.5 percent yesterday to $9.36 after it disclosed the S.E.C. request; the decrease extended a decline of 34 percent so far this year.
Global Crossing, which embarked in 1997 on an ambitious plan to extend its sole asset — a trans-Atlantic cable — into a 100,000-mile worldwide fiber optic network, often sought to acquire capacity on competitors' networks in North America that it said it needed to fill gaps in its system. Likewise, Qwest said it needed to buy capacity on Global Crossing's trans-Pacific and trans-Atlantic routes to meet its customers' needs.
Analysts said the S.E.C., which does not comment on active investigations, would presumably examine how Global Crossing and Qwest accounted for the transactions and how they disclosed the deals to investors. Also in question is whether the companies eventually even needed such long-term contracts at a time when network capacity was in ample supply. Another question is whether it was proper to record revenue for what were essentially barter deals in which no cash exchanged hands.
A Global Crossing spokeswoman, Tisha Kresler, said there was nothing unusual about the deals.
"It's common in the telecommunication industry for carriers to buy capacity from each other in order to provide service in an area where one company has routes or capacity that another needs in order to service customers," Ms. Kresler said. "That's our relationship with Qwest."
Qwest was primarily a long-haul network operator like Global Crossing before it used its soaring stock in 1999 to became a major local phone company by buying the regional Bell company U S West. It outbid Global Crossing to cinch that deal. But any hard feelings did not stop Qwest and Global Crossing from dealing with each other, and others, in the market for the communications contracts. That included other companies that have filed for bankruptcy protection, like 360networks (news/quote) of Canada.
Until around six months ago, these transactions, known in the telecommunications world as swaps of I.R.U.'s, or indefeasible rights of use, were especially widespread among operators of transoceanic and transcontinental networks, like Global Crossing and Qwest.
The deals, often covering terms of 15 to 25 years, allowed companies to book a purchase of capacity as a capital expense, thus avoiding an erosion of cash flow on their financial statements. They could record the sale of such contracts as an increase in revenue, even though no cash exchanged hands.
The market for these swaps began to decline last year as it became apparent that the industry had built more network capacity during the Internet boom than users needed. The decline hastened with the mounting troubles at Enron, whose active trading of shorter-term communications contracts had stimulated the market.
That meant trouble for Global Crossing, which was unable to show strong revenue growth without the contracts.
In part of his August 2001 letter, Mr. Olofson said Global Crossing's chief financial officer, Dan J. Cohrs, had sent an e-mail message to Thomas Casey, who was chief executive, and to other high-ranking executives, expressing concern about a news release that Qwest had issued, giving details of its I.R.U. agreements.
Mr. Cohrs was worried that the Qwest statement would draw unwanted attention to Global Crossing's I.R.U.'s, Mr. Olofson said, according to his lawyer.