economic crime assignment

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 pusuae to eetig poised sales ad eeue tagets, Qests 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

eflet Qests fiaial pefoae. 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 asee of hek ad alaes ithi Qests iteal aoutig aassed ee oe accounting errors, all of which led to deeptie eogitios of oe $.8 illio i eeue ad eluded $ illio i epeses 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

ediilit of all of Qests fiaial stateets that he approved and signed despite knowing that the stateets as false. Nahio as also etesiel ioled i the aageets ade to oost Qests 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 iestos ee alead highl doutful of Qests stellar market performance in spite of the teleouiatio idusts downturn, the fraud was only confirmed through a whistle blowing lette fo a foe eploee of Qests opetito Global Crossing [5]. The letter revealed IRU swap tasatios etee Qest ad Gloal Cossig that ee used to ipoe oth fis financial statements.

Folloig the histle loig iidet, EC lauhed a iui ito Qests aoutig practices [6]. Qwest was then required to restate its financial reports which affirmed the overstatement of revenues

and understatement of expenses mentioned.

Punishment

Aidst ECs iui, 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

tadig pio to Qests delie. 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].


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]:

Establishing Probability of Arrest

Given the equation from the assignment instructions: = . = = . Establishig Criials 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 2005-

2009. He was then sentenced to jail from 2009 to 2013. Nahios 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], Naios total opesatio while he was in jail is as follows:

Year Company Crime2002-2007 UTStarcom Bribery and FCPA Violations2005-2006 Magyar Telekom Plc. Bribery

2014 AirTouch Communications Inc. Improper Revenue Recognition


= + = .$,, + .$,, = $,, > $,,.

Hee, the Beke odel eeplifies Nahios oties fo oittig the faud. 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.

Year NASDAQ Teleommunications Index Growth Rate Joseph Naccio's Actual Compensation Joseph Naccio's Total Compensation Lost2002 5,250,000.00$ -$ 2003 6% 125,000.00$ 5,421,400.42$ 2004 8% 125,000.00$ 5,729,946.84$ 2005 -7% -$ 5,316,639.12$ 2006 28% -$ 6,792,696.75$ 2007 9% -$ 7,415,837.01$ 2008 -43% -$ 4,228,165.87$ 2009 48% -$ 6,267,824.86$ 2010 4% -$ 6,513,786.09$ 2011 -13% -$ 5,691,795.17$ 2012 2% -$ 5,805,671.60$ 2013 24% -$ 7,200,223.60$

Total (2009 - 2013) 31,479,301.31$


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 = + + = . $,, + $,, + . $,.. $,. = $,,.


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/the-

case-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

BackgroundMain PerpetratorsRevelation of Qwest FraudPunishmentSarbanes-Oxley ActBecker Model Joseph Nacchios PerspectiveCompetitorsFraud Count in Telecommunications SectorEstablishing Probability of ArrestEstablishing Criminals Legal WagesRange of Probability of Arrest (Crime is not committed)Fraud Detection MeasuresAnonymous WhistleblowingHire Forensic AccountantsIncrease Awareness of Fraudulent Behaviour in Managers

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

References

economic crime assignment

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