The Trial of Joe Nacchio: The Government Responds

The government filed its response in the appeal of Joe Nacchio on Friday, Nov. 9. A copy of the brief will be posted on the DU Corporate Governance web site later today.  We will post a comment by John Holcomb from the Daniels School of Business later this morning. 

The 70+ page tome is a powerful piece of advocacy. The review of the facts in the introduction is devastating, pulling together for the first time in a written document all of the different pieces of evidence produced by the government to show that Joe Nacchio traded on inside information.  The section detailing the targets set by Nacchio in late 2000 makes the case that he knew they were aggressive or even, as one official put it, unrealistic.  From the description, it is hard to believe that he wasn't highly aware of all of the different developments that had to fall exactly into place to make the numbers, which they didn't.  Instead, Nacchio confronted a raft of bad news, "wave after wave" as the government put it.  

The rendition of the facts not only put paid to any argument on the sufficiency of the evidence, they set a tone for resolving the remaining issues.  Whatever mistakes Judge Nottingham may have made (and the government doesn't concede that he made any), the brief makes the case that they were harmless in effect. 

The government also makes at least one very strong legal point and one very strong strategic point.  With respect to the legal point, the government noted that the "reasonable basis" instruction (and the "bespeaks caution instruction") went to the materiality of the earnings forecast.  But Nacchio is accused of trading while in possession of material non-public information, not on the basis of an inaccurate projection.  During the April-May time period, he had factual information (not projections) that a jury could have found were material under the traditional test for materiality in Northway and Basic. Here is how the government put it in the fact section of the brief.

• Throughout the first quarter of 2001, Nacchio received wave after wave of bad news. In January, the head of the national mass markets unit, Qwest’s biggest source of recurring revenue, began “routine[ly]” telling Nacchio that the unit’s 2001 target was “not attainable” in light of early results. By April, the unit reported that it would miss its year-end number by $323 million. Nacchio was “not pleased.” Similarly, the global business unit reported that it was “way off” of its recurring revenue target and had to rely on IRUs to meet its first-quarter numbers. Nacchio “express[ed] concern,” because this meant the unit would not be able to “ramp” up recurring revenue in the third and fourth quarters of 2001. Szeliga gave Nacchio the bottom line on April 9: Qwest had failed to make the shift to recurring revenue “at the rate expected”—it was behind the recurring revenue growth target by 19%—and the year-end gaps would somehow have to be “filled by IRUs.” Nacchio was “visibly disappointed” with this news. Worse yet, Nacchio then learned during the wholesale unit’s first-quarter review on April 13 that Qwest would not be able to fill the gaps with IRUs because the IRU market was already “drying up” and the unit saw no IRUs in the “funnel” for the third and fourth quarters. Casey explained that the carriers that normally purchased IRUs were going out of business. Therefore, “going into th[e] second quarter” in early April, the wholesale unit “pretty much knew the entire universe” of coming IRU sales, and it would be “draining the pond” of those IRUs in the second quarter, with none left for the third and fourth quarters. Casey told Nacchio that the IRUs were “going away” and that, as a result, the wholesale division alone faced a $675 million gap and could not fill gaps from other units. Nacchio “wasn’t * * * happy” with this news.

In other words, whether the forecasts had a reasonable basis wasn't the issue. The issue was whether Nacchio had material non-public information when he traded. The facts in the quoted paragraph suggest that he did.  The instruction given by Judge Nottingham (what would be considered important by a reasonable investor) ought to cover this type of information.  

The strategic point concerns the exclusion of Daniel Fischel.  The brief points out that Judge Nottingham relied on a variety of grounds for the exclusion, areas where he has considerable discretion.  More importantly, though, the government effectively blames the defendant for providing some of the grounds for exclusion.  As the brief noted (under a caption, "Nacchio misstates the procedural history"):

• Three days before trial (March 16, 2007), the defense disclosed Fischel as an expert. The disclosure listed numerous topics, but where it identified opinions, it failed to provide the “bases and reasons” for them, as required by Rule 16(b)(1)(C). It did not say Fischel would opine that “the magnitude of Qwest’s IRU revenue” was immaterial or mention any “event study." Despite this Rule 16 violation, the court did not exclude Fischel’s testimony. Rather, on the government’s motion, it ordered the defense to provide, by March 26, the “bases and reasons” for the stated opinions, and further directed the defense “to clarify the character and content of Professor Fischel’s testimony” (ibid.). The defense then asked for more time. The court extended the deadline to March 29, but emphasized the need for sufficient disclosure because the government would have no opportunity to depose Fischel. The government added that it anticipated “Daubert issues” with Fischel’s testimony, and the court agreed, citing Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999). The defense responded, “forewarned is forearmed.”  On March 29, the defense proffered another disclosure. It set forth new opinions, including that “the magnitude of Qwest’s IRU revenue” was immaterial. But despite the court’s “forewarn[ing]” about Kumho, the disclosure still said nothing about Fischel’s methodology. And it mentioned no event study.

In other words, to find for Nacchio on this issue, the government is putting the appellate court in a position of having to excuse the actions of the defense. 

Nacchio will likely file a response, providing the last word until the oral argument on December 18.  He will need it.