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Good morning and welcome to the
Subcommittee on Oversight and Investigations’ first day of HEARING on a series
of highly questionable business transactions involving the Global Crossing and
Qwest corporations. in particular, this committee is interested in what
are referred to in the telecommunications industry as reciprocal fiber optic
capacity transactions, more commonly known as “capacity swaps”.
Ideally, In a globally
competitive market place, the ability of one telecommunications firm to purchase
capacity from another improves market efficiency and shareholder value by
eliminating network bottlenecks and reducing redundacies. In such cases, a
firm that is experiencing increased demand on its own network can use such a
purchase to meet increased customer demand.
If, on the other hand, a
telecommunications firm Purchases increased capacity in a market of shrinking
demand, that raises serious questions about the underlying rationale for such a
purchase. and in cases where two firms engage in a capacity swap in which both
firms are confronting shrinking markets, that raises further questions as to the
business motives behind these transactions.
it is this variety of dubious
transaction, in which both Global Crossing and Qwest engaged, that we will
examine in the course of our hearings. were these capacity swap transactions
undertaken to respond to new business opportunities, or were they merely
designed to provide the appearance of expanding business and growing revenues?
evidence uncovered by this
Committee’s investigation SUGGESTS that THE latter IS true. confronted with
shrinking markets and declining business volume, executives at Global Crossing
and Qwest used capacity swaps to Conceal slowing growth by booking fictitious
revenues.
The importance of these swaps
to the financial image these firms were seeking to create becomes clear as we
examine the Details.
Global Crossing reported $720
million in cash revenues from the sale portion of these capacity swaps in the
first and second quarters of 2001 alone. at the same time, We have
acquired Global Crossing documents that suggest that A significant portion of
these transactions was constructed solely to meet the company’s PUBLICLY
ANNOUNCED revenue targets. The documents suggest that it was less
important to the executives authorizing these swaps what capacity was
actually being purchased by Global Crossing as was the perceived need for
consumating the transaction itself and booking the revenues. Documents also
suggest that the amount of capacity to be purchased and sold in these swaps was
remarkably fluid, allowing dollar values that could be set as necessary to
bridge the “gap” in the firm’s ability to meet a particular quarter’s
revenue numbers. it was not the value of the transactions themselves, but
rather the urgency to complete them by the end of certain quarters, that drove
the deals.
As further evidence of this strategy, we have e-mails
showing that the sales team was the driving force behind these deals, while the
network people -- those who would know whether or not such capacity was needed
-- questioned the rationale for many of these purchases.
Moreover, Global Crossing
apparently continued to engage in these questionable transactions even while an
internal review was underway to determine how to dispose of excess capacity
acquired through previous swaps. This review subsequently revealed that
Global Crossing lacked sufficient working capital to incorporate roughly $1
billion OF the purchased capacity into its network. in the end, This
overextension cost the company dearly, as it was forced to try to find buyers of
this excess capacity for pennies on the dollar.
Global Crossing filed for
bankruptcy on January 28, 2002 -- the fourth largest bankruptcy in United States
history. As a result, innocent investors- average american families- lost
$54 billion, and nearly 10,000 employees lost their jobs.
As for Qwest, the company
reported revenues of more than $1 billion from network capacity sales in 2001,
but as it turned out, more than two thirds of those sales were swaps in which
Qwest simultaneously purchased similar amounts of capacity from its purchasers.
Moreover, documents and interviews make plain that the company’s strategy was
to book up front as much revenue from these swaps as possible, even though
Global Crossing and others in the industry generally booked such revenue
gradually over the life of these long-term contracts.
to
recognize revenue from these swaps up-front, the deals had to meet certain
accounting criteria -- such as the inability of the purchaser to freely alter
the capacity route at a later time -- which made it harder to get other
companies to agree to such purchases from Qwest.
What we’ve learned in our
investigation is that, in an apparent attempt to circumvent these and other
accounting criteria, Qwest executives and employees entered into side agreements
with transaction partners to permit the purchaser route flexibility, while
keeping the finance and accounting personnel in the dark. We also have
discovered that Global Crossing personnel agreed to structure these swaps with
Qwest in such a manner as to permit immediate revenue recognition by Qwest, so
long as global crossing received oral promises that the contracts’ terms would
not be enforced.
Just this past Sunday night,
Qwest announced that it was going to restate approximately $950 million in
revenue that it recognized from capacity swaps between June 30, 2000 and the end
of 2001. These are the very swaps that have been the subject of our
investigation, and investigations by other Federal authorities. While we
do not yet know the specific findings that led to this restatement -- all Qwest
has said so far is that “its policies and practices” did not support the
company’s prior accounting treatment for these swaps, we believe their
restatements illuminates the significance of the problems we’ve identified.
Although Global Crossing utilized different formal
accounting methods for its swaps, its pro forma financial reporting -- which
included virtually the full value of the “sale” side of the swaps in its
cash revenue and earnings numbers – can also be said to have MISLED INVESTORS.
And there are questions as well as to whether the Securities and Exchange
Commission and the Financial Accounting Standards Board were sufficiently
proactive in dealing with the important issues arising from the increased use of
such swaps throughout the industry. We will seek to address these vital
issues more in depth during the second day of our hearings into these
transactions.
Like many other
telecommunication firms in the late 1990’s
and the first two years of this
century, Global Crossing and Qwest were confronted with a declining MARKET for
their products AND a glut in telecomunications capacity.
by now, this has become a
familiar, if disturbing story. in the go-go ‘90’s when the irrational
exuberance of the marketplace dictated that stocks only increase in value,
meeting wall street’s expectations came to be seen as the paramount duty of
all too many corporate executives. But that can not justify what these firms
seem to have attempted with these swaps anymore than the bizarre partnerships at
Enron or the ginned up books at worldCom. in every case, these short term
efforts at hiding the true facts only served to dreadfully distort the stock
market’s ability to efficiently allocate resources… THE critical genius of
our economy.
This number-obsessed atmosphere
also placed employees of these companies in untenuous positions. At
today’s hearing, we will hear from some of those current and former employees
from both companies. They have come forward to help us understand these
transactions in more detail and to grasp the importance of these swaps in
meeting wall street’s expectations. Some also will describe their concerns
with these swaps and the efforts they took to raise red flags within the
company. Our second day of hearings will allow us to ask the higher-ranking
current and former executives at these companies about the legitimacy of these
swaps, the impact these swaps had on their financial reporting, and what if any
steps they have taken to avoid similar situations in the future.
I welcome all of our witnesses today, and will now recognize the Ranking Member,
Mr. Deutsch, for an opening statement.
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