Read Confessions of a Wall Street Analyst Online
Authors: Dan Reingold
But he either couldn’t or wouldn’t acknowledge that he had any responsibility in the debacle. Drake Tempest, Qwest’s general counsel, organized a good-bye dinner for Joe and most of his top staff in a private room at an Italian restaurant in downtown Denver. According to one person who was there, Joe made an emotional speech lamenting the unfairness of life. He insisted that he’d tried to do what was right for the company and the employees. He then quoted some biblical passages about being betrayed and getting revenge, telling everyone that he was not going away. Apparently, he saw Phil Anschutz as his Judas.
A few weeks later, the U.S. Department of Justice opened a formal investigation into Qwest’s conduct. Five midlevel executives have been indicted so far, two of whom have pleaded guilty. Not until March 15, 2005, after nearly three long years had passed, did the law touch Joe. The SEC filed civil charges against him as well as two of his former CFOs, Robin Szeliga and Robert Woodruff, former COO Afshin Mohebbi, and three other executives, alleging that they orchestrated a “massive financial fraud.”
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The SEC complaint cited Qwest’s “culture of fear” and alleged that “Qwest relied so heavily on the immediate revenue recognition from one-time IRU and equipment sales transactions to meet the aggressive revenue and growth targets that Qwest management and employees referred to the practice as a ‘drug,’ an ‘addiction,’ ‘heroin,’ and ‘cocaine on steroids.’ Moreover, Qwest’s reliance on so-called IRU ‘swap’ transactions to meet revenue targets led some in the company to refer sarcastically to those transactions as ‘SLUTs’ (short for Simultaneous Legally Unrelated Transactions).”
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On June 5, 2005, Robin Szeliga agreed to plead guilty to insider trading and cooperate in the ongoing investigations. Nacchio’s trial is expected to begin in early 2006. Maybe I’ll sit in.
The telecom and overall market implosions were in full force. Investors had been wiped out, employees were being laid off weekly at most of the major telecom companies, and we walked around in a state of numbness. What else could go wrong? In mid-June, I became convinced that WorldCom was not even likely to survive the summer, based on its downward-spiraling numbers. Ido and I tried to come up with a valuation for the company based on our best guess of the real numbers.
The target price we came up with was, amazingly, zero, though the shares were trading at almost a dollar. That reflected the fact that the company’s massive amount of debt, roughly $30 billion, exceeded our estimate of the value of its assets. In effect, after paying off bondholders, there would be no value left for shareholders and bankruptcy was imminent.
We wrote a report highlighting the zero target price and reiterating our Sell rating. CNBC’s Maria Bartiromo, known on the Street as the “Money Honey,” ridiculed our target price, as if a zero valuation was preposterous. Right around the same time, in a report dated June 21 but distributed the following Monday, June 24, Jack cut his rating on WorldCom again, to Underperform, or “4,” from Neutral. The stock was trading at $1.22 per share on June 21 and closed at 91 cents on the 24th.
Just after Jack’s downgrade, I flew out to Kansas City to speak at a strategy meeting for Sprint executives. WorldCom was in free fall, but the outlook for other long distance companies wasn’t appreciably better. WorldCom’s efficiencies and synergies had been, up until now, the envy of executives at Sprint and AT&T. Even as WorldCom faltered, executives at AT&T and Sprint remained completely obsessed with understanding how WorldCom managed to get its costs so much lower than their own. So the Sprint folks asked me to come explain how and why WorldCom consistently reported vastly lower cost ratios and thus better profit margins than Sprint. They hoped my words would help to crank up the energy level and get their executives fired up to compete, WorldCom style.
We were all about to find out exactly what that meant. The night before my presentation, I went out to dinner at a steak and brew pub with Steve Fletcher, a former colleague from MCI who was now vice president of strategic planning at Sprint. We hadn’t known each other very well at MCI,
but we did know a lot of folks in common. We ordered beers and reminisced about MCI when it was still a scrappy startup.
We had just started to talk about our kids when my BlackBerry started vibrating insistently. I couldn’t stop myself from stealing a glance at the screen. Rude, I know, but in this business everyone understood. You just never knew what was about to happen.
But this one I could never have anticipated. I glimpsed the headline and choked on my beer.
“Oh, my God,” I gasped. “You’re not going to believe this.”
I held my BlackBerry up to Steve’s eye level. I saw his pupils dilate as he read the headline that I’d just seen: “WorldCom Restates $3.8 Billion; CFO Sullivan Out.” WorldCom was announcing that it had overstated its financial results by almost 70 percent over the past 18 months.
“Holy Shit!” he blurted, probably just one of thousands of “Holy Shit’s” being uttered at that exact moment all over the globe. “What the hell is going on here?”
We had all experienced so many disappointments and reversals over the last few years that I thought I had lost the ability to be shocked by anything. But this one really threw me. I knew that Global and Qwest seemed to have pushed the envelope on a lot of stuff, and that the collapse of Enron had put every chief executive on the defensive, but this was utterly beyond the scope of what I could fathom.
First was the enormity of the numbers: $3.8 billion in missing operating cash flow? In a company whose total operating cash flow was reported at $9.3 billion last year? It was a number so large that it embarrassed everyone who had anything to do with this company. It meant that the company’s profits for at least the previous year, perhaps longer, had been zilch. Why hadn’t Andersen, the auditing firm, noticed almost $4 billion in errors? Why hadn’t the bankers who were always ready to help WorldCom sell another slug of stock or debt seen anything? What about internal executives? The board of directors? The SEC? And, of course, the analysts? As dazed as I was by the news, it wouldn’t be long until WorldCom’s investors were wishing the restatement were only $3.8 billion.
Then there was the Scott Sullivan factor. Scott? The straightlaced, monotonal numbers guy who always had total recall of every component of WorldCom’s balance sheet and income statement? It had been an impressive quality. Too impressive, perhaps.
Steve and I stared at each other. We instantly knew that this was the end
of both a company and an era. All of this navel-gazing and soul-searching on the part of so many companies trying to replicate the WorldCom magic had been for naught. All this strategizing and firing and hiring and relocating and repricing to try to catch up to a company that had been a complete sham was instead a cruel joke. In reality, there was no way to outdo WorldCom with fiber-optic wires, computer software, and clever marketing. All you really needed was a CFO with a pencil and an eraser.
We talked in rapid-fire bursts, the way people do when something terrible happens. I felt numb inside. Sure I had a Sell on the stock, and sure I’d been considerably more cautious than my competitors for the past two years, but I’d had no inkling that there could be something so sinister going on. Why not? And why didn’t anyone else? What about Jack? I wondered. Did he know? Or did Scott dupe him as well? That would be one amazing irony—the insider led astray by his inside connection. As with so many of the questions that had arisen in the past year, I had no answers.
The next morning, I showed up for my presentation to Sprint’s executives with no idea of what to say. I made it through the speech on autopilot, sarcastically commenting that I had been planning to tell everyone how they could become more like WorldCom. My mind was back in that dingy office in Jackson, Mississippi, where Bernie had showed me his handwritten notes on acquisitions.
I thought, too, about my former colleagues at MCI. Those who had stayed on through the WorldCom acquisition had probably lost their life savings by now. And then, of course, there were the investors, large and small, who gambled big on the stock and lost, but had been playing the whole time with a deck stacked against them. One thing was not debatable: Mark Bruneau, the consultant who had called WorldCom the “poster child for buying real things with fake money” in that April 2000
Fortune
article, had been more accurate than he ever could have imagined.
The publicity-shy Sullivan immediately found his name splashed across the front page of every newspaper in the country and many around the world. But he was not the only one to feel the heat of a furious public. The next morning, CNBC reporter Mike Huckman conducted an old-fashioned stakeout in front of Jack Grubman’s post Upper East Side town house near
the Metropolitan Museum of Art. When Jack emerged only to see the cameras rolling, he visibly blanched and tried to keep walking, but Huckman kept up the pace—and unleashed a torrent of aggressive questions.
Jack came off looking shifty. “Look, could you—first of all, this is a huge invasion of privacy,” he said, trying to outpace the reporter. Huckman asked if Jack had known anything about WorldCom’s disaster in advance. “Nobody saw this coming,” he said. “I’m no different from anyone else on Wall Street.” His shoulders were hunched, his body language defensive. But he still couldn’t keep his damn mouth shut!
“I mean, what [
sic
] are you harassing like this?” Jack whined, his voice even squeakier than usual.
“I’m not harassing you,” said Huckman. “I’m just asking you questions about the company that you cover. Do you think WorldCom can survive?”
“Look,” he sputtered. “I have no, I have no comment. I’m as shocked about this as everyone else.”
The video clip zipped around the Street quicker than a Roger Clemens fastball. Jack looked so pathetic that I actually felt bad for him for a moment. Shouldn’t he be allowed to walk freely in his own neighborhood? Then I caught myself and thought about what many now viewed as an endless stream of hype and deception that had spilled from his lips over the past decade.
The next day, the House Financial Services Committee subpoenaed Jack, Bernie, Scott, and Melvin Dick, the Andersen accountant in charge of the WorldCom audit, requiring them to appear at a televised hearing about the downfall of the company.
The thought of having to walk in Jack’s shoes for a city block nearly made my heart stop. What if the committee asked me to testify too? Even if they wanted me as a counterexample to Jack, which didn’t seem likely given the witch-hunt atmosphere, I had no interest in standing next to these questionable characters in front of a bunch of bloodthirsty politicians. Certainly the reputation of analysts was so soiled by now that I’d be a victim of guilt by association. Plus, I realized, there were plenty of embarrassing questions that they could ask me, such as why it had taken me so long to go to a Sell rating on WorldCom or why I had been bullish on Qwest for so long. So mixed in with my anger at Bernie, Scott, and Jack and my gratification that they were finally being called to account was quite a bit of worry that—in the public perception anyhow—I would be viewed as one of them.
The House hearings on WorldCom began on July 8, 2002. I stayed
home that day so that I could watch them. It was, for anyone in my business, the ultimate reality television show. All four of them looked as if they’d aged about 20 years in the last one. Mel Dick looked bewildered. Bernie’s cowboy jauntiness now looked stiff; Scott’s once–crisp, precise demeanor was now tense and clipped; and Jack looked as if he’d spent the previous night on a barstool. He’d never done a lot of television and you could see why.
Scott, who would be arrested three weeks later along with his controller, David Myers, took the Fifth Amendment and just sat there, listening mutely as the committee members railed against WorldCom’s restatement of what was now believed to be over $7 billion. This number was so huge as to be almost incomprehensible. Things didn’t get easier to comprehend when the number jumped up to $11 billion by April 3, 2003, replacing Enron as the largest corporate fraud in history.
Bernie, dressed in a blue suit with a red-striped tie, read a prepared statement. He would speak, he said, “…when all the activities at WorldCom are fully aired and when I get the opportunity…to explain my actions in a setting that will not compromise my ability to defend myself…I believe that no one will conclude that I engaged in any criminal or fraudulent conduct during my tenure at WorldCom. Until that time, however, I must respectfully decline to answer the questions of this committee on the basis of my Fifth Amendment privilege.”
Next came Mel Dick, the former Andersen accountant and now CEO of an apparel company. He passed the buck. “The fundamental premise of financial reporting is that financial statements of a company, in this case WorldCom, are the responsibility of a company’s management, not its outside auditors,” he said.
Finally, it was Jack’s turn. And as always, he talked. Dressed in a navy suit, white shirt, and blue tie, his dark hair thinning, his angular face stretched thin, he looked like a mouse—a mouse caught in a trap.
“Let me say I am saddened by why we are here,” he said. “I am saddened that people lost money, I am saddened that people lost jobs. I am saddened that a major company is enmeshed in a major scandal, but I want to commend you and everybody on this committee for acting quickly to try to find out what went wrong here,” he said. “WorldCom fit my long-held, honestly held investment thesis that newer, more nimbler [
sic
] companies would create value…. I am aware that there is speculation that I had advance knowledge of this fraud. That speculation is categorically false.”
Whatever the politicians thought of that statement, they didn’t go easy
on Jack. They grilled him on WorldCom, repeatedly probing whether his ratings were driven by Salomon Smith Barney’s banking interests. And then they threw him a curve ball, asking him about “special IPO [shares] to executives of WorldCom.”