Only Qwest’s shareholders are losing out

A federal grand jury last week indicted former Qwest Communications Inc. chieftain Joseph Nacchio for making a series of 42 stock sales allegedly based on insider information. His take on those transactions; a Christmasy $101 million. He’s at risk for a lot more than that if prosecutors can make those charges stand up to what is expected to be a fierce defense by the combative Nacchio, who was once described as a character out of a Martin Scorsese movie. In other words; a street fighter.

Nacchio sold his shares during the first half of 2001, when prices on Qwest stock turned from a high of about $45 per share to $30. He knew, according to prosecutors, that Qwest earnings were based on fraudulent swaps of fiber-optic cable capacity with partners like Enron Corp. The bogus deals, exposed in January 2002, triggered a huge sell-off of Qwest stock. By July of that year, investors with a high tolerance for risk could scoop up company stock for $1.50 a share.

Qwest managed to avoid bankruptcy, preserving whatever equity was left for its stockholders, but had to whack $2.5 billion off earnings.

Qwest also reached a settlement in 2004 with the U.S. Securities and Exchange Commission that resulted in a $250 million fine that will be passed through to shareholders. But that was hardly the end of Qwest’s misery.

The class action legal hounds pounced in mid-2001. They, like the SEC, claim Nacchio and other Qwest executives misrepresented the true state of the company’s finances by concealing earnings shortfalls with their fiber-optic antics. And, as with the SEC complaint, Qwest has agreed to a deal that, if approved in District Court, will make $400 million available to settle investor claims against the company. Minus, that is, attorneys’ fees.

Here comes what poet William Blake might have called “fearful symmetry.”

Last week, lawyers who represented shareholders in the class action lawsuit against Qwest have notified the court in Denver they may ask for about 24 percent of a proposed $400 million settlement in the case. That, too, is about $100 million. Pity the shareholders mugged on the street and in the courthouse.

The settlement, if approved, will put about 19 cents per share back in the pockets of shareholders who bought stock between May 1999 and July 2002, a period when they may have paid as much as $60 for shares that even today are worth less than one-tenth that amount. The financial wounds inflicted will not be healed by 19 pennies.

If the attorneys do indeed ask for $100 million, the shareholder take could drop to 14 cents per share. Can a bandage get much smaller?

Although lawyers have been known to take more than 25 percent out of a settlement or judgment, the rewards are supposed to reflect risk. But this was not a case in the “Erin Brockovich” vein, in which hardscrabble residents of Hinkley, Calif., took on Pacific Gas & Electric over hard-to-prove claims of chromium-6 contamination, and its ill health effects.(Note: See the December 23rd Wall Street Journal for an interesting article on chromium-6 “science.”) The Qwest case was a slam-dunk, although the company admitted no wrongdoing in either the SEC or shareholder settlements. And the plaintiffs include the New England Health Care Employees Pension Fund of Connecticut, the State of New Jersey, and the omnipresent Eliot Spitzer, New York’s attorney general and aspiring governor.

The lead law firm is steeped in shareholder litigation.

Hard to find $100 million worth of risk here.

As for Nacchio, he has hired a legal team that includes a former U.S. District Court judge. His defense will reportedly be based, in part, on pending secret federal contracts he assumed would prop up the value of Qwest shares. As if the Rocky Mountains could prop up the house of cards he and his fellow executives had framed at Qwest. His case apparently weakened Wednesday, when the company’s former senior vice president agreed to cooperate with Nacchio’s prosecutors. Other executives are ready to testify against him as well. Expect a spirited counterattack from their former boss.

Qwest the company is moving on. Though impeded by the cost of clearing away its past, Qwest has vastly improved the quality of its customer service in Washington. Consumers who once peppered the Utilities and Transportation Commission with complaints about Qwest and predecessor U S West. Now, regulators seldom get a call.

Too bad Qwest executives did not choose to serve their shareholders as well.