Is There A Broader Lesson?
J. Robert Brown | Friday, April 20, 2007 at 06:15AM We had another post ready for today but it was overtaken by events. Joe Nacchio, the former CEO of Qwest, was convicted yesterday of 19 counts of insider trading.
The jury cleanly divided the counts. Counts 1 through 23 involved trades during the first quarter of 2001. On all of these counts, the jury acquitted. The evidence showed that Nacchio knew in December that he was imposing tough targets on his division heads and that they were complaining about them. That, ruled the jury, was not enough to establish insider trading. But it was during this time period that Nacchio was also told that to make the numbers for the year, recurring revenue (internet sales, phone services, etc.) had to "take off" by the end of the first quarter. The evidence showed that in April, after the first quarter had closed, Nacchio was told that the recurring revenues were in fact not taking off. His conviction was based on trades that occurred after he knew this take off was not happening.
What could Nacchio have done to prevent this prosecution from ever occurring? He could have disclosed the concerns raised at the end of the first quarter by his division heads. But it was not his inclination. According to the testimony, he had an aversion to anything that would lower share prices, his so called "golden rule." Moreover, his compensation provided plenty of incentive to keep share prices in the stratosphere. The testimony at the trial indicated that his "entrepreneurial" compensation was 3% of any increase in the company's value that occurred under his watch.
It was a situation that should not have been left entirely to Nacchio to resolve. This is where pressure from the other officers or perhaps the audit committee might have resulted in the necessary disclosure. Sarbanes-Oxley (SOX) in part has tried to supply that pressure. A CFO who simply signs off on the financial statements can go to jail for 20 years. Independent auditors have a more arms length relationship with companies and are in a better position to insist on tough disclosure. Audit committees must contain independent directors and must have the power to hire and fire the independent auditors. They can't hide behind management's representations. Had these safeguards been in place, Nacchio would have had much less ability to control the resulting disclosure. He wouldn't have liked it but he also wouldn't be going to jail.
He also could have avoided the conviction if he had relied on a trading plan adopted under Rule 10b5-1. Such a plan, if done properly, allows corporate officers to trade even when they later acquire inside information. The key is that they must trade pursuant to a predetermined formula that does not allow for interference or discretion by the insider. Nacchio entered into a Rule 10b5-1 plan but chose to terminate it, instead selling large amounts of shares in discretionary trades. These were the trades that resulted in his conviction. Had he stuck with the plan begun in the first quarter, the jury wouldn't have convicted, or so it appears.
Is there a lesson in all of this? Only that id didn't have to happen and with stronger oversight wouldn't have.
Reader Comments (2)
But the prohibitions on insider trading are well known (every large company has an internal policy prohibiting it, including Qwest and every top officers understands there are limitations on their ability to sell shares). This is true now and was true back in the late 1990s. It has never been a defense to say that everyone else is doing it. At most, Joe Nacchio can wonder if it was fair that he was singled out.