The Trial of Joe Nacchio

We will have another post or two next week on the approach used by the Delaware courts to essentially eliminate friendship as a means of challenging a director's independence.  Today we give an introduction to the trial of former Qwest CEO Joe Nacchio which begins on Monday, March 19 in the federal district courthouse in downtown Denver.

It is, in effect, the beginning of the end of an era, the last of the criminal trials arising out of the mammoth corporate scandals of the new millennium, including Enron, Worldcom, Tyco, and Adelphia, scandals that led directly to the adoption of Sarbanes-Oxley.  Today the talk is about amending SOX (although the chairman of the SEC thinks otherwise; see his speech here) and repealing investor protections rather than enhancing them. 

In many ways, the trial ends the era with a whimper rather than a bang. In contrast to the SEC complaint against Nacchio and others that refers to “a massive financial fraud” (a copy can be found on the DU Corporate Governance Website here),  the criminal indictment is a mere six pages and says little more than he traded while aware that “there would be insufficient non-recurring revenue sources to close the gap between Qwest’s publicly stated financial targets and its actual performance.” A copy of the indictment is here.  The indictment is fleshed out a bit by a bill of particulars and a supplement to the bill of particulars.

Nacchio is not using the Ostrich defense. From the government pleadings and briefs, it appears that he acknowledges having been told that recurring revenues were not keeping pace with publicly disclosed guidance.  At least some of the guidance, by the way, was included in various filings and periodic reports, no doubt a consequence of Regulation FD. See Qwest Communications International, 8-K FILING, January 24, 2001 (Qwest “ had EPS (earnings per share) of $0.59 and cash EPS of $1.25 for 2000. It expected EPS and cash EPS for 2001 to be flat or slightly higher, due to strong EBITDA growth offset by increase in interest and depreciation expense.”).

Instead, his primary defense seems to be that he expected any shortfall in recurring revenue to be made up by revenue from classified government contracts. Thus, much of the drama surrounding the case so far has involved the right to use classified information at the trial, something that implicates the Classified Information Procedure Act (CIPA), 18 USC App 3, Sec. 1-16. As one brief filed by Nacchio states:
 

• Critically, not only did Mr. Nacchio know that those criticizing the guidance did not share this classified knowledge, but he also knew that none of the prospective government contracts were incorporated in Qwest’s 2001 public guidance. Taken together, Mr. Nacchio reasonably believed that those criticizing the guidance were mistaken, and that Qwest’s public guidance remained accurate, if not actually low. In other words, Mr. Nacchio was able to conclude that the warnings being given to him did not, in actual fact, constitute material, nonpublic, information because they were wrong.

The quote is in this pleading here.  A redacted opinion on the issue is here.   The defense is a tricky one.  Nacchio will not only need to produce evidence that he expected additional contracts, but also will need to show that he expected the contracts to be executed during the relevant time periods and that they would produce sufficient revenue to offset any shortfall in recurring revenues.  At some level, it means admitting that he knew the extent of the projected shortfall.  If the jury does not believe his claim about the government contracts, he may find himself having all but admitted the materiality of the information. 

So, on Monday, this will be the beginning of the end. Jury selection starts at 8:30 am, Mountain Time. We will try to put up at least two blog posts a day on the trial. The posts will sometimes be written by me and other times by six students also covering the case. For more documents on the case, go to the DU Corporate Governance web site.

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